-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, DOhZJnuuSpKOh+uvqgouVNqOGTlBZDEgdY56JZjcM0ZFwdhpRBy6CkhE3+jYDu5V olRxNVx0RHvWZR6ygLQdjg== 0000950146-98-001184.txt : 19980709 0000950146-98-001184.hdr.sgml : 19980709 ACCESSION NUMBER: 0000950146-98-001184 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980708 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: CORNING INC /NY CENTRAL INDEX KEY: 0000024741 STANDARD INDUSTRIAL CLASSIFICATION: GLASS, GLASSWARE, PRESSED OR BLOWN [3220] IRS NUMBER: 160393470 STATE OF INCORPORATION: NY FISCAL YEAR END: 1228 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 001-03247 FILM NUMBER: 98661832 BUSINESS ADDRESS: STREET 1: ONE RIVERFRONT PLAZA CITY: CORNING STATE: NY ZIP: 14831 BUSINESS PHONE: 6079749000 FORMER COMPANY: FORMER CONFORMED NAME: CORNING INC /NY / CORNING LAB SERVICES INC DATE OF NAME CHANGE: 19930713 FORMER COMPANY: FORMER CONFORMED NAME: CORNING GLASS WORKS DATE OF NAME CHANGE: 19890512 10-K/A 1 AMMENDMENT TO ANNUAL REPORT SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A AMENDMENT TO APPLICATION OR REPORT FILED PURSUANT TO SECTION 12, 13, OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 CORNING INCORPORATED AMENDMENT NO. 1 The undersigned registrant hereby amends the following items, financial statements, exhibits or other portions of its Annual Report on Form 10-K for the fiscal year ended December 31, 1997 as set forth below and in the pages attached hereto: PART IV ITEM 14 AND EXHIBIT #27 The information contained in Item 14 and Exhibit #27 attached hereto is hereby substituted for the information contained in Item 14 and Exhibit #27 previously filed as part of the Annual Report on Form 10-K for the fiscal year ended December 31, 1997. The information contained in Item 14 and Exhibit #27 reflects the divestiture of the consumer housewares business, which is reported as a discontinued operation. Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this amendment to be signed on its behalf by the undersigned thereunto duly authorized. CORNING INCORPORATED By: /s/ KATHERINE A. ASBECK ----------------------- Katherine A. Asbeck Vice President and Controller DATE: July 6, 1998 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K - ------------------------------------------------------------------------- (a) Documents filed as part of this report: 1. Index to financial statements and financial statement schedules, filed as part of this report:
Page Report of Independent Accountants 3 Consolidated Statements of Income 4 Consolidated Balance Sheets 5 Consolidated Statements of Cash Flows 6 Notes to Consolidated Financial Statements 7-29 Financial Statement Schedule: II Valuation Accounts and Reserves 30
2. Supplementary Data: Quarterly Operating Results and Related Market Data 31 Five Years in Review - Historical Comparison 32-33 3. Exhibits filed as part of this report: see (c) below. (b) Reports on Form 8-K filed during the last quarter of fiscal 1997: A report on Form 8-K dated October 15, 1997, filed in connection with the registrant's medium-term note facility, includes Corning's third quarter earnings press release of October 15, 1997. (c) Exhibits filed as part of this report: #3(i) Articles of Incorporation of the Registrant: Restated Certificate of Incorporation, dated July 12, 1989, and the Certificate of Amendment, dated September 28, 1989, of the Restated Certificate of Incorporation of the Registrant which appear as Exhibit 3(a) to the 1989 Annual Report on Form 10-K are incorporated herein by reference in this Annual Report on Form 10-K pursuant to an exemption in accordance with Section 232.102(a) of Regulation S-T. Certificate of Amendment, dated April 30, 1992, of the Restated Certificate of Incorporation of the Registrant which appears as Exhibit 3(a) to the 1992 Annual Report on Form 10-K is incorporated herein by reference in this Annual Report on Form 10-K pursuant to an exemption in accordance with Section 232.102(a) of Regulation S-T. Certificate of Amendment, dated July 15, 1994, as amended by the Certificate of Correction filed on July 26, 1994, of the Restated Certificate of Incorporation of the Registrant which appears as Exhibit 3 to the 1994 Annual Report on Form 10-K is incorporated herein by reference in this Annual Report pursuant to an exemption in accordance with Section 232.102(a) of Regulation S-T. 1 Certificate of Amendment, dated October 24, 1994, of the Restated Certificate of Incorporation of the Registrant which appears as Exhibit 3 to the 1994 Annual Report on Form 10-K is incorporated herein by reference in this Annual Report pursuant to an exemption in accordance with Section 232.102(a) of Regulation S-T. Certificate of Amendment, dated June 24, 1996, of the Restated Certificate of Incorporation of the Registrant which amends the number of shares of Series A Preferred Stock designated. #3(ii)By-laws of Corning Incorporated as amended to and effective as of April 25, 1996. #4 Rights Agreement dated June 5, 1996, that defines the preferred share purchase rights which trade with the Registrant's common stock, which appears as Exhibit 1 to Form 8-K, dated July 10, 1996, is incorporated herein by reference in this Annual Report on Form 10-K. #12 Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Dividends #21 Subsidiaries of the Registrant at December 31, 1997 #23 Consent of Independent Accountants #24 Powers of Attorney #27 Financial Data Schedule (d) Dow Corning Corporation:
Page Report of Independent Accountants 34 Consolidated Balance Sheets 35-36 Consolidated Statements of Operations and Retained Earnings 37 Consolidated Statements of Cash Flow 38 Notes to Consolidated Financial Statements 39-66
Financial statements of unconsolidated subsidiary companies and associated companies accounted for under the equity method, other than Dow Corning Corporation, have been omitted. Summary financial information on Corning's equity-basis companies is presented in Note 5 (Investments) of the Notes to Consolidated Financial Statements appearing on pages 12 and 13. 2 REPORT OF INDEPENDENT ACCOUNTANTS PricewaterhouseCoopers LLP To the Board of Directors and Stockholders of Corning Incorporated In our opinion, the consolidated financial statements appearing on pages 4 through 29 of this Form 10-K/A present fairly, in all material respects, the financial position of Corning Incorporated and its subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ PricewaterhouseCoopers LLP 1177 Avenue of the Americas New York, New York 10036 January 28, 1998, except for the first paragraph of Note 1, as to which the date is June 30, 1998 3
CONSOLIDATED STATEMENTS OF INCOME Corning Incorporated and Subsidiary Companies - ----------------------------------------------------------------------------------------- Year Ended December 31, - ----------------------------------------------------------------------------------------- (In millions, except per share amounts) 1997 1996 1995 - ----------------------------------------------------------------------------------------- Revenues Net sales $3,516.8 $3,024.0 $2,644.7 Royalty, interest and dividend income 37.5 29.7 26.7 - ----------------------------------------------------------------------------------------- 3,554.3 3,053.7 2,671.4 - ----------------------------------------------------------------------------------------- Deductions Cost of sales 2,042.3 1,830.1 1,608.7 Selling, general and administrative expenses 541.6 499.4 404.1 Research and development expenses 250.3 189.2 172.2 Provision for restructuring 26.5 Interest expense, net 72.0 57.2 56.6 Other, net 18.9 22.0 13.9 - ----------------------------------------------------------------------------------------- Income from continuing operations before taxes on income 629.2 455.8 389.4 Taxes on income from continuing operations 209.5 151.4 107.3 - ----------------------------------------------------------------------------------------- Income from continuing operations before minority interest and equity earnings 419.7 304.4 282.1 Minority interest in earnings of subsidiaries (76.3) (52.5) (64.3) Dividends on convertible preferred securities of subsidiary (13.7) (13.7) (13.7) Equity in earnings (losses) of associated companies: Other than Dow Corning Corporation 79.2 85.1 66.6 Dow Corning Corporation (348.0) - ----------------------------------------------------------------------------------------- Income (loss) from continuing operations 408.9 323.3 77.3) Income (loss) from discontinued operations, net of income taxes Life science businesses (167.3) 20.7 Consumer housewares business 30.9 19.6 5.8 - ----------------------------------------------------------------------------------------- Net Income (Loss) $ 439.8 $ 175.6 $ (50.8) - ----------------------------------------------------------------------------------------- Basic Earnings Per Share Continuing operations $ 1.79 $ 1.42 $ (0.35) Discontinued operations 0.13 (0.66) 0.12 - ----------------------------------------------------------------------------------------- Net Income (Loss) $ 1.92 $ 0.76 $ (0.23) - ----------------------------------------------------------------------------------------- Diluted Earnings Per Share Continuing operations $ 1.72 $ 1.40 $ (0.35) Discontinued operations 0.13 (0.62) 0.12 - ----------------------------------------------------------------------------------------- Net Income (Loss) $ 1.85 $ 0.78 $ (0.23) - ----------------------------------------------------------------------------------------- Shares Used In Computing Earnings Per Share Basic earnings per share 228.1 227.1 226.6 Diluted earnings per share 245.4 239.5 226.6
See Notes to Consolidated Financial Statements beginning on page 7. 4
CONSOLIDATED BALANCE SHEETS Corning Incorporated and Subsidiary Companies - -------------------------------------------------------------------------------------------------- December 31, - -------------------------------------------------------------------------------------------------- (In millions, except share amounts) 1997 1996 - -------------------------------------------------------------------------------------------------- Assets Current Assets Cash $ 61.0 $ 43.8 Short-term investments, at cost, which approximates market value 36.0 171.3 Accounts receivable, net of doubtful accounts and allowances - $10.7/1997; $14.2/1996 559.7 485.9 Inventories 428.3 364.5 Deferred taxes on income and other current assets 114.1 111.9 - -------------------------------------------------------------------------------------------------- Total current assets 1,199.1 1,177.4 - -------------------------------------------------------------------------------------------------- Investments Associated companies, at equity 292.9 313.8 Others, at cost 17.1 23.4 Plant and Equipment, at Cost, Net of Accumulated Depreciation 2,267.9 1,808.6 Goodwill and Other Intangible Assets, Net of Accumulated Amortization - $51.5/1997; $35.0/1996 294.2 259.9 Other Assets 263.1 236.3 Net Assets of Discontinued Operations 357.6 364.0 - -------------------------------------------------------------------------------------------------- Total Assets $4,691.9 $4,183.4 - -------------------------------------------------------------------------------------------------- Liabilities and Stockholders' Equity Current Liabilities Loans payable $ 213.0 $ 53.5 Accounts payable 300.0 247.3 Other accrued liabilities 444.7 431.4 - -------------------------------------------------------------------------------------------------- Total current liabilities 957.7 732.2 - -------------------------------------------------------------------------------------------------- Other Liabilities 627.5 597.8 Loans Payable Beyond One Year 1,125.8 1,195.1 Minority Interest in Subsidiary Companies 349.3 309.9 Convertible Preferred Securities of Subsidiary 365.3 365.1 Convertible Preferred Stock 19.8 22.2 Common Stockholders' Equity Common stock, including excess over par value and other capital - par value $0.50 per share; Shares authorized: 500 million; Shares issued: 264.3 million/1997; 261.0 million/1996 707.2 566.0 Retained earnings 1,296.0 1,024.0 Less cost of 32.7 million/1997 and 32.3 million/1996 shares of common stock in treasury (724.5 (672.5) Cumulative translation adjustment (32.2 43.6 - -------------------------------------------------------------------------------------------------- Total common stockholders' equity 1,246.5 961.1 - -------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $4,691.9 $4,183.4 - --------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements beginning on page 7. 5
CONSOLIDATED STATEMENTS OF CASH FLOWS Corning Incorporated and Subsidiary Companies - --------------------------------------------------------------------------------------------------------------------------- Year Ended December 31, - -------------------------------------------------------------------------------------------------------------------------- (In millions) 1997 1996 1995 - --------------------------------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities: Net income (loss) $439.8 $175.6 $(50.8) Adjustments to reconcile net income (loss) to net cash provided by operating activities of continuing operations: (Income) loss from discontinued operations (30.9) 147.7 (26.5) Depreciation and amortization 285.9 252.3 221.1 Equity in earnings of associated companies, other than Dow Corning Corporation, less than (in excess of) dividends received (13.9) 2.9 7.8 Equity in losses of Dow Corning Corporation 348.0 Minority interest in earnings of subsidiaries in excess of dividends paid 40.8 18.8 25.1 (Gains) losses on disposition of properties and investments (6.2) 5.1 11.0 Provision for restructuring, net of cash spent 25.4 Deferred tax provision (benefit) (10.3) 17.7 (14.1) Other 39.0 4.4 15.6 Changes in operating assets and liabilities: Accounts receivable (69.9) (92.1) 5.8 Inventories (69.5) (64.5) (46.0) Deferred taxes and other current assets (8.4) (21.1) 4.1 Accounts payable and other current liabilities 57.7 74.3 7.9 - --------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities of Continuing Operations 654.1 521.1 534.4 - --------------------------------------------------------------------------------------------------------------------------- Cash Flows from Investing Activities: Additions to plant and equipment (745.6) (560.2) (337.1) Acquisitions of businesses, net (32.0) (15.1) (3.1) Net proceeds from disposition of properties and investments 56.2 35.9 18.3 Proceeds from Distributions of subsidiaries 650.0 Net increase in long-term investments (8.8) (12.7) (28.1) Other, net 16.8 19.7 (5.0) - --------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by (Used in) Investing Activities of Continuing Operations (713.4) 117.6 (355.0) - --------------------------------------------------------------------------------------------------------------------------- Cash Flows from Financing Activities: Proceeds from issuance of loans 129.8 415.4 167.9 Repayment of loans (33.0) (205.0) (85.7) Repayment of loans with proceeds from Distributions of subsidiaries (450.0) Increase in minority interest due to capital contributions 8.6 Proceeds from issuance of common stock 37.2 43.4 24.3 Repurchases of common stock (50.1) (83.9) (33.1) Payment of dividends (167.8) (167.2) (167.2) - --------------------------------------------------------------------------------------------------------------------------- Net Cash Used in Financing Activities of Continuing Operations (83.9) (438.7) (93.8) - --------------------------------------------------------------------------------------------------------------------------- Effect of exchange rates on cash 3.1 (2.2) 1.2 - --------------------------------------------------------------------------------------------------------------------------- Effect of accounting calendar change on cash (17.5) - --------------------------------------------------------------------------------------------------------------------------- Cash provided by (used in) discontinued operations 22.0 (141.9) (41.3) - --------------------------------------------------------------------------------------------------------------------------- Net change in cash and cash equivalents (118.1) 38.4 45.5 Cash and cash equivalents at beginning of year 215.1 176.7 131.2 - --------------------------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents at End of Year $ 97.0 $215.1 $176.7 - ---------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements beginning on page 7. 6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Corning Incorporated and Subsidiary Companies (Dollars in millions, except share and per-share amounts) - ------------------------------------------------------------------------------- 1. Summary of Significant Accounting Policies Principles of Consolidation On April 1, 1998, Corning completed the recapitalization and sale of a controlling interest in its consumer housewares business. As a result of the sale, Corning's consolidated financial statements and notes to consolidated financial statements report the consumer housewares business as a discontinued operation. On December 31, 1996, Corning distributed all of the shares of its health care services segment (Quest Diagnostics Incorporated and Covance Inc.), to its shareholders on a pro rata basis. Corning's consolidated financial statements and notes to consolidated financial statements report Quest Diagnostics and Covance as discontinued operations. The consolidated financial statements include the accounts of all entities controlled by Corning. All significant intercompany accounts and transactions are eliminated. The equity method of accounting is used for investments in associated companies which are not controlled by Corning and in which Corning's interest is generally between 20% and 50%. Effective January 1, 1996, Corning made several changes to its accounting calendar to make Corning's results more comparable with other companies and to enable Corning to report results of certain subsidiaries on a more current basis. As part of the changes, Corning adopted an annual reporting calendar. Previously, Corning operated on a fiscal year ending on the Sunday nearest December 31. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Foreign Currencies Balance sheet accounts of foreign subsidiaries are translated at current exchange rates and income statement accounts are translated at average exchange rates for the year. Translation gains and losses are accumulated in a separate component of common stockholders' equity. Foreign currency transaction gains and losses affecting cash flows are included in current earnings. Corning enters into foreign exchange contracts primarily as hedges against identifiable foreign currency commitments. Gains and losses on contracts identified as hedges are deferred and included in the measurement of the related foreign currency transactions. Gains and losses on foreign currency contracts which are not designated as hedges of foreign currency commitments are included in current earnings. Corning management does not believe that its foreign exchange exposure or its hedging program are material to Corning's financial position or results of operations. Cash and Cash Equivalents Short-term investments, comprised of repurchase agreements and debt instruments with original maturities of three months or less, are considered cash equivalents. Inventories Inventories are stated at the lower of cost or market. Approximately 57% and 62% of Corning's inventories at December 31, 1997, and 1996, respectively, are valued using the first-in, first-out (FIFO) method. The last-in, first-out (LIFO) method is used to value the remaining inventories, which are principally at consolidated subsidiaries. 7 1. Summary of Significant Accounting Policies (continued) Property and Depreciation Land, buildings and equipment are recorded at cost. Depreciation is based on estimated useful lives of properties using straight-line and accelerated methods. Goodwill and Other Intangible Assets Investment costs in excess of the fair value of net assets acquired are amortized over appropriate periods not exceeding 40 years. Other intangible assets are recorded at cost and amortized over periods not exceeding 15 years. Taxes on Income Corning uses the asset and liability approach to account for income taxes. Under this method, deferred tax assets and liabilities are recognized for the expected future tax consequences of differences between the carrying amounts of assets and liabilities and their respective tax bases using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period when the change is enacted. 2. Earnings Per Common Share Corning adopted Financial Accounting Standard No. 128, "Earnings per Share," (FAS 128) in 1997. FAS 128 revised standards for the computation and presentation of earnings per share (EPS), requiring the presentation of both basic and diluted earnings per share. Basic earnings per share is computed by dividing net income, less dividends on Series B convertible preferred stock, by the weighted-average number of common shares outstanding during each period. Diluted earnings per share is computed by dividing net income, plus dividends on convertible preferred securities of subsidiary, by the weighted-average number of common shares outstanding during the period after giving effect to dilutive stock options and adjusted for dilutive common shares assumed to be issued on conversion of Corning's convertible securities. A reconciliation of the basic and diluted earnings per share from continuing operations computations for 1997 and 1996 are as follows:
For the years ended December 31, ----------------------------------------------------------------------------- 1997 1996 ------------------------------------ ---------------------------------- Weighted- Weighted- Average Average Shares Per Share Shares Per Share Income (in millions) Amount Income (in millions) Amount ------ ------------- ------ ------ ------------- ------ Net income from continuing operations $408.9 - - $323.3 - - Less: Preferred stock dividends (1.6) - - (1.9) - - ------------------------------------ ---------------------------------- Basic Earnings per Share 407.3 228.1 $1.79 321.4 227.1 $1.42 ===== ===== Effect of Dilutive Securities Options - 4.8 - - 2.8 - Convertible monthly income preferred securities 13.7 11.5 - 13.7 9.6 - Convertible preferred stock 1.6 1.0 - - - - ------------------------------------ ---------------------------------- Diluted Earnings per Share $422.6 245.4 $1.72 $335.1 239.5 $1.40 =================================== ==================================
8 2. Earnings Per Common Share (continued) In January 1997, the conversion rate of the convertible monthly income preferred shares was increased to recognize the effect of the Distributions of Quest Diagnostics and Covance. At December 31, 1996, 222,000 shares of Series B Convertible Preferred Stock were outstanding. Each Series B share is convertible into four shares of Corning common stock. These shares were not included in the calculation of diluted EPS due to the anti-dilutive effect they would have had on EPS if converted. Due to Corning's loss from continuing operations in 1995, a calculation of diluted EPS is not required. In 1995, dilutive securities consisted of options convertible into 1.6 million shares of common stock, Series B convertible preferred stock which paid dividends of $2.0 million and were convertible into 1.0 million shares of common stock, and convertible monthly income preferred securities which paid dividends of $13.7 million and were convertible into 9.6 million shares of common stock. Weighted-average shares outstanding were 226.6 million. 3. Business Combination and Divestitures Purchases In April 1997, Corning acquired 100% of the stock of Optical Corporation of America (OCA) for a total purchase price of approximately $70 million. The consideration was comprised of approximately 950,000 shares of Corning restricted stock, options and $32 million of cash. The acquisition was recorded using the purchase method of accounting. The results of operations of OCA are included in the consolidated financial statements from the date of acquisition. The excess cost over the fair value of the net tangible assets acquired is approximately $52 million and is being amortized over periods of up to 20 years. Divestitures In February 1997, Corning sold its Serengeti eyewear business to Solar-Mates, Inc. for approximately $28 million. In March 1996, Corning sold its equity investment in CALP S.p.A. for approximately $30 million. The gains recognized on these transactions were not material. Other In January 1996, Corning and International Technology completed a transaction whereby Corning increased its ownership in Quanterra Incorporated, a jointly owned company between Corning and International Technology, from 50% to 81% in exchange for an investment of approximately $20 million. In addition, Corning granted International Technology the right to put the remaining 19% interest in Quanterra to Corning at fair market value in January 2003. As a result of this transaction, Corning began consolidating Quanterra's results beginning in 1996. 4. Information by Industry Segment Corning is a diversified, global, technology-based corporation which operates in two broadly-based business industry segments: Communications and Specialty Materials. The Communications segment includes the opto-electronics and information display businesses. The opto-electronics business produces optical fiber, optical cable, hardware and equipment and photonic technology components for the worldwide telecommunications industry. The information display business manufactures glass panels and funnels for the conventional television industry, projection video lens assemblies and liquid crystal display glass for flat panel displays. The Specialty Materials segment includes the environmental products business, which produces emission control substrates and related technologies for all major vehicle producing market applications worldwide, the advanced materials business, which produces high purity fused silica for high-performance optical applications, and the science products business, which produces various plastic and glass laboratory products. The other businesses which operate in this segment specialize in the production of optical and lighting products. Sales and income from the Steuben Crystal and Serengeti Eyewear business (prior to its divestiture in February, 1997), are included in Other. These businesses were included in the Consumer Products segment in previous presentations. 9 4. Information by Industry Segment (continued) Many of Corning's administrative and staff functions are performed on a centralized basis. Corning charges these expenses to operating segments based on the extent to which each business uses a centralized function. Certain staff functions and certain research and development expenses which benefit all businesses or relate to future technologies are included in Other, along with net assets from discontinued operations. As a result of Corning's decision to fully reserve its investment in Dow Corning Corporation and discontinue recognition of equity earnings from Dow Corning during 1995, summary financial information for Dow Corning is not included in the segment data. Information for Dow Corning is presented separately in Note 5 of the Notes to Consolidated Financial Statements. Certain equity companies that are not associated with Corning's operating segments are classified in Other. Information about the Company's segment operations is summarized on the following page. 10 4. Information by Industry Segment (continued)
Commun- Specialty Operations ications Materials Other Total - -------------------------------------------------------------------------------- Revenues: 1997 $2,465.9 $1,022.7 $ 65.7 $3,554.3 1996 1,969.4 996.4 87.9 3,053.7 1995 1,711.7 871.9 87.8 2,671.4 Income (loss) from continuing operations before taxes: 1997 $ 684.3 $ 237.1 $ (292.2) $ 629.2 1996 528.5 195.8 (268.5) 455.8 1995 (1) 434.9 174.7 (220.2) 389.4 Assets - -------------------------------------------------------------------------------- Operating assets: 1997 $2,436.7 $ 787.0 $1,175.3 $4,399.0 1996 1,967.2 740.9 1,161.5 3,869.6 1995 1,484.1 706.3 2,803.1 4,993.5 Capital expenditures: 1997 $ 434.9 $ 102.6 $ 208.1 $ 745.6 1996 364.7 67.8 127.7 560.2 1995 180.7 96.3 60.1 337.1 Depreciation and amortization: 1997 $ 167.5 $ 68.3 $ 50.1 $ 285.9 1996 141.0 65.0 46.3 252.3 1995 121.4 60.5 39.2 221.1 Equity Investments Other Than Dow Corning - -------------------------------------------------------------------------------- Investment in associated companies, at equity: 1997 $ 195.1 $ 35.6 $ 62.2 $ 292.9 1996 216.1 27.6 70.1 313.8 1995 195.8 60.2 85.0 341.0 Equity company sales: 1997 $1,350.3 $ 210.5 $ 247.3 $1,808.1 1996 1,120.4 182.5 290.4 1,593.3 1995 982.2 290.8 318.3 1,591.3 Equity company net income: 1997 $ 114.4 $ 44.8 $ 18.5 $ 177.7 1996 158.5 23.8 26.0 208.3 1995 101.6 5.6 26.9 134.1 Corning's share of net income: 1997 $ 57.9 $ 13.1 $ 8.2 $ 79.2 1996 67.5 8.8 8.8 85.1 1995 47.4 6.4 12.8 66.6
(1)The 1995 restructuring charge totaling $26.5 million was included in income from continuing operations before taxes of Communications ($9.3 million), Specialty Materials ($6.6 million) and Other, including R&D ($10.6 million). 11 5. Investments Investments Other Than Dow Corning Corporation Samsung-Corning Company Ltd., a 50% owned South Korea-based manufacturer of glass panels and funnels for cathode-ray tubes, represented $134.1 million and $150.3 million of Corning's investments accounted for by the equity method at year end 1997 and 1996, respectively. The financial position and results of operations of Samsung-Corning and Corning's other equity companies are summarized as follows:
1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------------ Samsung- Total Samsung- Total Samsung- Total Corning Equity Corning Equity Corning Equity Co. Ltd. Companies Co. Ltd. Companies Co. Ltd. Companies - -------------------------------------------------------------------------------------------------------------------------------- Net sales $ 997.4 $ 1,808.1 $ 794.9 $ 1,593.3 $ 713.4 $ 1,591.3 Gross profit 265.8 637.9 192.8 554.7 152.8 491.6 Net income 63.6 177.7 54.6 208.3 43.1 134.1 - -------------------------------------------------------------------------------------------------------------------------------- Corning's equity in net income (1) $ 31.1 $ 79.2 $ 26.4 $ 85.1 $ 19.6 $ 66.7 - -------------------------------------------------------------------------------------------------------------------------------- Current assets $ 371.9 $ 775.4 $ 328.1 $ 661.3 $ 290.5 $ 673.5 Non-current assets 934.4 1,311.9 1,415.0 1,826.3 978.1 1,336.5 - -------------------------------------------------------------------------------------------------------------------------------- Current liabilities $ 291.0 $ 537.0 $ 446.3 $ 647.6 $ 351.5 $ 543.9 Non-current liabilities 717.1 884.5 979.1 1,132.8 618.2 805.7 - --------------------------------------------------------------------------------------------------------------------------------
(1) Equity in earnings shown above and in the Consolidated Statements of Income are net of amounts recorded for income tax. Dividends received from Samsung-Corning and Corning's other equity companies totaled $65.3 million, $88.2 million and $74.3 million in 1997, 1996 and 1995, respectively. At December 31, 1997, approximately $232.3 million of equity in undistributed earnings of equity companies were included in Corning's retained earnings. Dow Corning Corporation Corning is a 50% owner of Dow Corning Corporation, a manufacturer of silicones. The other 50% of Dow Corning is owned by The Dow Chemical Company. On May 15, 1995, Dow Corning voluntarily filed for protection under Chapter 11 of the United States Bankruptcy Code as a result of several negative developments related to the breast implant litigation. At that time, Corning management believed it was impossible to predict if and when Dow Corning would successfully emerge from Chapter 11 proceedings. As a result, Corning recorded an after-tax charge of $365.5 million in the second quarter of 1995 to fully reserve its investment in Dow Corning. Corning also discontinued recognition of equity earnings from Dow Corning beginning in the second quarter of 1995. 12 5. Investments (continued) The financial position and results of operations of Dow Corning are summarized as follows:
- ---------------------------------------------------------------------------------------------------------------------------------- 1997 1996 1995 - ---------------------------------------------------------------------------------------------------------------------------------- Net sales $ 2,643.5 $ 2,532.3 $ 2,492.9 Gross profit 847.6 858.3 828.5 Net income (loss) 237.6 221.7 (30.6) - ---------------------------------------------------------------------------------------------------------------------------------- Corning's equity in net loss (1) - - $ (348.0)(2) - ---------------------------------------------------------------------------------------------------------------------------------- Current assets $ 1,378.8 $ 1,524.7 $ 1,835.7 Non-current assets 3,939.9 3,589.4 3,122.7 - ---------------------------------------------------------------------------------------------------------------------------------- Current liabilities $ 489.8 $ 480.5 $ 459.5 Non-current liabilities 383.5 343.2 347.9 Liabilities subject to compromise (3) 3,419.1 3,452.1 3,504.1 - ----------------------------------------------------------------------------------------------------------------------------------
(1) Equity in earnings shown above and in the Consolidated Statements of Income are net of amounts recorded for income tax. (2) Includes $17.5 million of equity earnings recognized in the first quarter of 1995 and a charge taken by Corning of $365.5 million in the second quarter of 1995 to fully reserve its investment in Dow Corning. Corning discontinued recognition of equity earnings from Dow Corning beginning in the second quarter of 1995. (3) Dow Corning's financial statements for 1997, 1996 and 1995 have been prepared in conformity with the American Institute of Certified Public Accountants' Statement of Position 90-7, "Financial Reporting by Entities in Reorganization under the Bankruptcy Code," (SOP 90-7). SOP 90-7 requires a segregation of liabilities subject to compromise by the Bankruptcy Court as of the filing date (May 15, 1995) and identification of all transactions and events that are directly associated with the reorganization. As disclosed in Dow Corning's financial statements, its 1995 results were impacted by charges related to breast implant litigation matters. Subsequent to Corning's decision to fully reserve its investment in Dow Corning in 1995, Dow Corning recorded an accounting charge of $221.2 million after tax. Dow Corning's 1997, 1996 and 1995 results have also been impacted by the suspension of interest payments and reorganization costs resulting from the Chapter 11 filing. Dow Corning filed its first plan of reorganization with the Federal Bankruptcy Court in December 1996. Dow Corning filed a first amended plan of reorganization in August 1997. On February 17, 1998, Dow Corning filed its Second Amended Plan of reorganization with the Bankruptcy Court. Corning continues to believe that it is impossible to predict if and when Dow Corning will successfully emerge from Chapter 11 proceedings. 13 6. Employee Retirement Plans Pension Benefits Corning has defined benefit pension plans covering certain domestic employees and certain employees in foreign countries. Corning's funding policy has been to contribute as necessary an amount determined jointly by the Company and its consulting actuaries, which provides for the current cost and amortization of prior service cost. The funded status of Corning's pension plans as of year end is as follows:
- ---------------------------------------------------------------------------------------------------------------------------------- 1997 1996 - ---------------------------------------------------------------------------------------------------------------------------------- Vested benefits $ 1,076.8 $ 1,043.2 Non-vested benefits 96.2 95.3 - ---------------------------------------------------------------------------------------------------------------------------------- Accumulated benefit obligation $ 1,173.0 $ 1,138.5 - ---------------------------------------------------------------------------------------------------------------------------------- Current fair market value of plan assets $ 1,443.4 $ 1,332.2 Present value of projected benefit obligation 1,246.0 1,213.8 - ---------------------------------------------------------------------------------------------------------------------------------- Plan assets in excess of projected benefit obligation 197.4 118.4 Unrecognized prior service cost 121.4 133.5 Unrecognized transition gain (10.0) (10.7) Unrecognized net losses from changes in actuarial assumptions 85.6 70.9 Other unrecognized net experience gains (288.9) (210.4) - ---------------------------------------------------------------------------------------------------------------------------------- Recorded pension asset $ 105.5 $ 101.7 - ----------------------------------------------------------------------------------------------------------------------------------
Plan assets are comprised principally of publicly traded debt and equity securities. Corning common stock represented 3.1% and 7.7% of plan assets at year end 1997 and 1996, respectively. The unrecognized prior service cost, unrecognized transition gain, net gains and losses from changes in actuarial assumptions and net experience gains are deferred and amortized to pension expense over the remaining service life of plan participants, if they exceed certain limits. For Corning's principal defined benefit plan, the assumed discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 7.5% and 4.5%, respectively, in both 1997 and 1996. The expected long-term rate of return on plan assets was 9% for 1997 and 1996. Assumptions of the Company's other plans are not significantly different. The components of pension expense for Corning's defined benefit pension plans are as follows:
- ------------------------------------------------------------------------------------------------------ 1997 1996 1995 - ------------------------------------------------------------------------------------------------------ Present value of benefits earned during the year $ 19.2 $ 17.4 $ 14.0 Interest cost on projected benefit obligation 88.1 84.2 83.8 Actual return on plan assets (183.3) (179.6) (223.1) Net amortization and deferral 90.4 91.2 132.6 - ------------------------------------------------------------------------------------------------------ Net pension expense for the year $ 14.4 $ 13.2 $ 7.3 - ------------------------------------------------------------------------------------------------------
Measurement of pension expense is based on assumptions used to value the pension liability at the beginning of the year. Total consolidated pension expense, including defined contribution pension plans, was $44.9 million in 1997, $41.7 million in 1996 and $36.6 million in 1995. 14 6. Employee Retirement Plans (continued) Postretirement Health Care and Life Insurance Benefits Corning and certain of its domestic subsidiaries have defined benefit postretirement plans that provide health care and life insurance benefits for retirees and eligible dependents. Certain employees may become eligible for such benefits upon reaching retirement age. Corning's principal retiree medical plans require increased retiree contributions each year equal to the excess of medical cost increases over general inflation rates. Corning's consolidated postretirement benefit obligation is determined by application of the terms of health care and life insurance plans, together with relevant actuarial assumptions and health care cost trend rates. The discount rate used in determining the accumulated postretirement benefit obligation was 7.5% in 1997 and 1996. The health care cost trend rate for Corning's principal plan is assumed to be 9% in 1997 for covered individuals under age 65 decreasing gradually to 5% in 2010 and thereafter. For covered individuals over 65, the rate is assumed to be 8% in 1997 decreasing gradually to 5% in 2010 and thereafter. Assumptions for Corning's other plans are not significantly different. The effect of a 1% annual increase in the assumed healthcare cost trend rates would increase the accumulated postretirement benefit obligation and the net periodic postretirement benefit expense by $45.9 million and $4.6 million, respectively. Gains and losses from plan amendments or changes in actuarial assumptions are deferred and amortized to post-retirement benefit expense, if they exceed certain limits, over the expected remaining service life of plan participants. Corning's accrued postretirement liability as of year end was comprised of the following:
- ------------------------------------------------------------------------------------------------------ 1997 1996 - ------------------------------------------------------------------------------------------------------ Accumulated postretirement benefit obligation: Retirees $356.6 $353.4 Fully eligible active plan participants 56.0 58.1 Other active plan participants 108.1 109.6 - ------------------------------------------------------------------------------------------------------ 520.7 521.1 - ------------------------------------------------------------------------------------------------------ Unrecognized gain from plan amendments 10.9 11.7 Other unrecognized net experience gains 33.2 34.3 - ------------------------------------------------------------------------------------------------------ Total postretirement liability 564.8 567.1 Less current portion 31.0 30.9 - ------------------------------------------------------------------------------------------------------ Accrued postretirement liability $533.9 $536.2 - ------------------------------------------------------------------------------------------------------ Corning has not funded these obligations. The components of net periodic postretirement benefit expense are as follows: - -------------------------------------------------------------------------------------------------------- 1997 1996 1995 - -------------------------------------------------------------------------------------------------------- Present value of benefits earned during the year $ 8.4 $ 8.5 $ 7.8 Interest cost on the accumulated postretirement benefit obligation 37.0 37.0 39.2 Net amortization (1.8) (1.2) (1.5) - -------------------------------------------------------------------------------------------------------- Postretirement benefit expense $ 43.6 $ 44.3 $ 45.5 - --------------------------------------------------------------------------------------------------------
Measurement of postretirement benefit expense is based on assumptions used to value the postretirement liability at the beginning of the year. 15 7. Taxes on Income
- ------------------------------------------------------------------------------------------------------------------------------- 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------------- Income from continuing operations before taxes on income: U.S. companies $ 545.1 $ 381.7 $ 321.6 Non-U.S. companies 84.1 74.1 67.8 - ----------------------------------------------------------------------------------------------------------------------------- Income before taxes on income $ 629.2 $ 455.8 $ 389.4 - ----------------------------------------------------------------------------------------------------------------------------- Taxes on income from continuing operations $ 209.5 $ 151.4 $ 107.3 - ------------------------------------------------------------------------------------------------------------------------------ Effective tax rate reconciliation: Statutory U.S. tax rate 35.0% 35.0% 35.0% State taxes, net of federal benefit 1.6 1.3 1.0 Foreign and other tax credits (0.6) (0.5) (2.1) Lower taxes on subsidiary earnings (2.7) (2.6) (6.5) Other 0.2 - ------------------------------------------------------------------------------------------------------------------------------ Effective tax rate 33.3% 33.2% 27.6% - ------------------------------------------------------------------------------------------------------------------------------ Components of net tax expense: Taxes on income from continuing operations $ 209.5 $ 151.4 $ 107.3 Taxes on equity in earnings 13.8 15.1 11.9 Tax benefits included in common stockholders' equity (18.8) (17.0) (11.5) - ------------------------------------------------------------------------------------------------------------------------------ Net tax expense before discontinued operations 204.5 149.5 107.7 Income tax expense from discontinued operations 17.7 19.6 43.2 - ----------------------------------------------------------------------------------------------------------------------------- Net tax expense $ 222.2 $ 169.1 $ 150.9 - ------------------------------------------------------------------------------------------------------------------------------ Current and deferred tax expense (benefit) before discontinued operations: Current: U.S. $ 139.1 $ 64.1 $ 54.1 State and municipal 20.1 11.0 15.6 Foreign 55.6 49.3 41.3 Deferred: U.S. (11.2) 14.3 1.9 State and municipal (4.2) 6.9 (3.4) Foreign 5.1 3.9 (1.8) - ------------------------------------------------------------------------------------------------------------------------------ Net tax expense before discontinued operations $ 204.5 $ 149.5 $ 107.7 - ------------------------------------------------------------------------------------------------------------------------------
16 7. Taxes on Income (continued) The tax effects of temporary differences and carryforwards that gave rise to significant portions of the deferred tax assets and liabilities as of year end are comprised of the following:
- ----------------------------------------------------------------------------------------------------------------- 1997 1996 - ----------------------------------------------------------------------------------------------------------------- Postretirement medical and life benefits $ 230.1 $ 226.3 Other employee benefits 49.0 35.3 Other accrued liabilities 11.5 10.4 Loss and tax credit carryforwards 44.5 25.7 Other 36.3 31.4 - ----------------------------------------------------------------------------------------------------------------- Gross deferred tax assets 371.4 329.1 Deferred tax assets valuation allowance (22.0) (12.5) - ------------------------------------------------------------------------------------------------------------------ Deferred tax assets 349.4 316.6 - ----------------------------------------------------------------------------------------------------------------- Fixed assets (107.3) (95.3) Pensions (40.5) (41.4) Other (20.9) (8.3) - ------------------------------------------------------------------------------------------------------------------ Deferred tax liabilities (168.7) (145.0) - ------------------------------------------------------------------------------------------------------------------ Net deferred tax assets $ 180.7 $ 171.6 - ------------------------------------------------------------------------------------------------------------------
The net change in the total valuation allowance for the years ended December 31, 1997, and 1996, was an increase of $9.5 million and a decrease of $4.7 million, respectively. Corning currently provides income taxes on the earnings of foreign subsidiaries and associated companies to the extent they are currently taxable or expected to be remitted. Taxes have not been provided on $395.6 million of accumulated foreign unremitted earnings which are expected to remain invested indefinitely. It is not practicable to estimate the amount of additional tax that might be payable on the foreign earnings; however, if these earnings were remitted, income taxes payable would be provided at a rate which is significantly lower than the effective tax rate. The Company has, as required, provided for tax on undistributed earnings of its domestic subsidiaries and affiliated companies beginning in 1993 even though these earnings have been and will continue to be reinvested indefinitely. The Company estimates that $32.1 million of tax would be payable on pre-1993 undistributed earnings of its domestic subsidiaries and affiliated companies should the unremitted earnings reverse and become taxable to the Company. The Company expects these earnings to be reinvested indefinitely. Total payments for taxes on income were $209.4 million, $120.1 million and $103.8 million during 1997, 1996 and 1995, respectively. Deferred income tax benefits totaling $67.4 million and $61.0 million were included in other current assets at year end 1997 and 1996, respectively. At December 31, 1997, Corning had tax benefits attributable to loss carryforwards and credits aggregating $44.5 million that expire at various dates through 2012. 17 8. Supplemental Income Statement Data
- ----------------------------------------------------------------------------------------------------- 1997 1996 1995 - ----------------------------------------------------------------------------------------------------- Depreciation expense $ 265.4 $ 235.4 $ 194.3 Amortization of goodwill and other intangible assets 20.5 16.9 26.8 - ---------------------------------------------------------------------------------------------------- Depreciation and amortization expense $ 285.9 $ 252.3 $ 221.1 - ---------------------------------------------------------------------------------------------------- Rental expense $ 47.6 $ 36.5 $ 40.0 - ---------------------------------------------------------------------------------------------------- Interest expense incurred $ 96.7 $ 73.6 $ 65.4 Interest capitalized (24.7) (16.4) (8.8) - ----------------------------------------------------------------------------------------------------- Interest expense, net $ 72.0 $ 57.2 $ 56.6 - ---------------------------------------------------------------------------------------------------- Interest paid $ 111.1 $ 113.6 $ 111.6 - ----------------------------------------------------------------------------------------------------
Consolidated interest expense allocated to discontinued operations totaled $13.0 million, $63.5 million and $61.2 million in 1997, 1996 and 1995, respectively. The allocations were based on the ratio of net assets of discontinued operations to consolidated net assets. 9. Provision for Restructuring In the second quarter 1995, Corning recorded a restructuring charge of $26.5 million ($16.1 million after tax). The charge included $18.5 million of severance for workforce reductions, primarily in corporate staff groups, a curtailment loss in Corning's primary pension plan attributable to workforce reductions and $8.0 million for the write-off of production equipment caused by the decision to exit the manufacturing facility for glass ceramic memory disks. Spending under this restructuring program was completed in 1997. 10. Supplemental Balance Sheet Data
- ---------------------------------------------------------------------------------------------------------------------------------- 1997 1996 - ---------------------------------------------------------------------------------------------------------------------------------- Inventories Finished goods $ 193.5 $ 153.0 Work in process 107.3 97.1 Raw materials and accessories 84.3 91.8 Supplies and packing materials 64.0 50.0 - ---------------------------------------------------------------------------------------------------------------------------------- Total inventories valued at current cost 449.1 391.9 Reduction to LIFO valuation (20.8) (27.4) - ---------------------------------------------------------------------------------------------------------------------------------- Inventories $ 428.3 $ 364.5 - ---------------------------------------------------------------------------------------------------------------------------------- Plant and Equipment Land $ 51.4 $ 51.7 Buildings 842.6 738.7 Equipment 3,107.2 2,559.3 - ---------------------------------------------------------------------------------------------------------------------------------- 4,001.2 3,349.7 Accumulated depreciation (1,733.3) (1,541.1) - ---------------------------------------------------------------------------------------------------------------------------------- Plant and equipment, net $ 2,267.9 $ 1,808.6 - ---------------------------------------------------------------------------------------------------------------------------------- Other Accrued Liabilities Taxes on income $ 112.9 $ 95.0 Wages and employee benefits 180.0 174.4 Other liabilities 151.8 162.0 - ---------------------------------------------------------------------------------------------------------------------------------- Other accrued liabilities $ 444.7 $ 431.4 - ----------------------------------------------------------------------------------------------------------------------------------
18 11. Loans Payable
- ---------------------------------------------------------------------------------------------------------------------------------- 1997 1996 - ---------------------------------------------------------------------------------------------------------------------------------- Loans Payable Current maturities of loans payable beyond one year $ 45.8 $ 51.5 Other short-term borrowings 167.2 2.0 - ---------------------------------------------------------------------------------------------------------------------------------- $ 213.0 $ 53.5 - ---------------------------------------------------------------------------------------------------------------------------------- Loans Payable Beyond One Year Notes, 7.78%, due 1998 $ 6.9 $ 13.3 Notes, 8.75%, due 1999 99.9 99.9 Series A senior notes, 7.99%, due 1999 24.0 36.0 Series B senior notes, 8.4%, due 2002 35.7 42.9 Debentures, 8.25%, due 2002 75.0 75.0 Debentures, 6%, due 2003 99.5 99.5 Debentures, 7% due 2007, net of unamortized discount of $39.3 million 60.7 58.8 Notes, 6.73%, due 2008 40.0 40.0 Notes, 6.83%, due 2009 30.0 30.0 Debentures, 6.75%, due 2013 99.5 99.5 Debentures, 8.875%, due 2016 74.5 74.5 Debentures, 8.875%, due 2021 74.9 74.9 Debentures, 7.625%, putable in 2004, due 2024 99.7 99.7 Medium-term notes, average rate 7.8%, due through 2025 265.0 265.0 Other, average rate 5.020%, due through 2031 86.3 137.6 - ----------------------------------------------------------------------------------------------------------------------------------- 1,171.6 1,246.6 Less current maturities 45.8 51.5 - ----------------------------------------------------------------------------------------------------------------------------------- $ 1,125.8 $ 1,195.1 - -----------------------------------------------------------------------------------------------------------------------------------
At December 31, 1997 and 1996, the weighted-average interest rate on short-term borrowings was 6.6%. At December 31, 1997, loans payable beyond one year become payable:
- ---------------------------------------------------------------------------------------- 1999 2000 2001 2002 2003-2031 - ---------------------------------------------------------------------------------------- $134.1 $31.0 $43.0 $93.5 $824.2 - ----------------------------------------------------------------------------------------
Based on borrowing rates currently available to Corning for loans with similar terms and maturities, the fair value of loans payable beyond one year was $1.4 billion at year end 1997. Unused bank revolving credit agreements in effect at December 31, 1997 provide for Corning to borrow up to $799 million. The revolving credit agreements provide for borrowing of U.S. dollars and Eurocurrency at various rates. Corning also has the ability to issue up to $375 million of medium and long-term debt through public offerings under existing shelf-registration statements filed with the Securities and Exchange Commission. 19 12. Convertible Monthly Income Preferred Securities In July 1994, Corning and Corning Delaware L.P., a special purpose limited partnership in which Corning is the sole general partner, completed a public offering of 7.5 million shares of Convertible Monthly Income Preferred Securities (MIPS). The MIPS are guaranteed by Corning and convertible into Corning common stock at the rate of 1.534 shares of Corning common stock for each preferred security (equivalent to a conversion price of $32.59 per share). Dividends on the preferred securities are payable by Corning Delaware at the annual rate of 6% of the liquidation preference of $50 per preferred security. After August 5, 1998, the preferred securities will be redeemable, at the option of Corning Delaware, for $51.80 per preferred security reduced annually by $0.30 to a minimum of $50 per preferred security. The preferred securities are subject to mandatory redemption on July 21, 2024, at a redemption price of $50 per preferred security. Corning may cause Corning Delaware to delay the payment of dividends for up to 60 months. During such period, dividends on the MIPS will compound monthly and Corning may not declare or pay dividends on its common stock. If Corning Delaware fails to pay dividends on the MIPS for 15 consecutive months or upon the occurrence of certain other events, the preferred securities may convert, at the option of the holders, to Corning Series C convertible preferred stock, par value $100 per share. The Series C convertible preferred stock will have dividend, conversion, optional redemption and other terms substantially similar to the terms of the MIPS, except that the holders of Series C preferred stock will have the right to elect two additional directors of Corning whenever dividends are in arrears for 18 months and the Series C preferred stock will not be subject to mandatory redemption. Based on quoted market prices at December 31, 1997, the fair value of the preferred securities approximated $461 million. 13. Convertible Preferred Stock Corning has 10 million authorized shares of Series Preferred Stock, par value $100 per share. Of the authorized shares, 2.4 million shares have been designated Series A Junior Participating Preferred Stock of which no shares have been issued. At year end 1997, 1996 and 1995, 198,100, 222,000 and 239,400 shares of Series B Convertible Preferred Stock were outstanding, respectively. Each Series B share is convertible into 4.79 shares of Corning common stock and has voting rights equivalent to four common shares. The Series B shares were sold exclusively to the trustee of Corning's existing employee investment plans, based upon directions from plan participants. Participants may cause Corning to redeem the shares at 100% of par upon reaching age 55 or later, retirement, termination of employment or in certain cases of financial hardship. The Series B shares are redeemable by Corning at $108 per share reduced annually on October 1, commencing in 1990, by $1 per share to a minimum of $100 per share. 20 14. Common Stockholders' Equity
- ---------------------------------------------------------------------------------------------------------------------------------- 1997 1996 1995 - ---------------------------------------------------------------------------------------------------------------------------------- Common stock at par value: Balance at beginning of year $ 130.5 $ 129.3 $ 127.9 Shares issued 1.7 1.2 1.4 - ---------------------------------------------------------------------------------------------------------------------------------- Balance at end of year $ 132.2 $ 130.5 $ 129.3 - ---------------------------------------------------------------------------------------------------------------------------------- Capital in excess of par value: Balance at beginning of year $ 562.3 $ 1,116.7 $ 1,042.9 Shares issued 130.6 99.1 73.8 Distributions of subsidiaries - (653.5) - - ---------------------------------------------------------------------------------------------------------------------------------- Balance at end of year $ 692.9 $ 562.3 $ 1,116.7 - ---------------------------------------------------------------------------------------------------------------------------------- Unearned compensation: Balance at beginning of year $ (126.8) $ (133.0) $ (139.4) Corning Stock Ownership Trust 14.5 (19.7) 4.6 Distributions of subsidiaries - 4.5 - Other, net (5.6) 21.4 1.8 - ---------------------------------------------------------------------------------------------------------------------------------- Balance at end of year $ (117.9) $ (126.8) $ (133.0) - ---------------------------------------------------------------------------------------------------------------------------------- Retained earnings: Balance at beginning of year $ 1,024.0 $ 1,496.5 $ 1,714.5 Net income (loss) 439.8 175.6 (50.8) Dividends declared ($0.72 per share in all years) (167.8) (167.2) (167.2) Distributions of subsidiaries - (473.2) - Change in accounting calendar - (7.7) - - ---------------------------------------------------------------------------------------------------------------------------------- Balance at end of year $ 1,296.0 $ 1,024.0 $ 1,496.5 - ---------------------------------------------------------------------------------------------------------------------------------- Treasury stock: Balance at beginning of year $ (672.5) $ (563.0) $ (523.7) Repurchases of shares (50.1) (86.3) (34.8) Termination of Equity Purchase Plan - (14.5) - Other, net (1.9) (8.7) (4.5) - ---------------------------------------------------------------------------------------------------------------------------------- Balance at end of year $ (724.5) $ (672.5) $ (563.0) - ---------------------------------------------------------------------------------------------------------------------------------- Cumulative translation adjustment: Balance at beginning of year $ 43.6 $ 56.5 $ 40.8 Translation adjustment (75.8) (11.5) 15.7 Distributions of subsidiaries - (1.4) - - ---------------------------------------------------------------------------------------------------------------------------------- Balance at end of year $ (32.2) $ 43.6 $ 56.5 - ---------------------------------------------------------------------------------------------------------------------------------- Common stockholders' equity $ 1,246.5 $ 961.1 $ 2,103.0 - ----------------------------------------------------------------------------------------------------------------------------------
21 14. Common Stockholders' Equity (continued) As part of Corning's change to its accounting calendar, effective January 1, 1996, certain consolidated subsidiaries that previously reported on a fiscal year ending November 30 adopted a calendar year end. The December 1995 net loss of these subsidiaries totaled $7.7 million and was recorded in retained earnings in the first quarter of 1996. Corning has established the Corning Stock Ownership Trust (CSOT) to fund future employee purchases of common stock through its contributions to Corning's Investment and Employee Stock Purchase Plans (the Plans). Corning sold 4 million treasury shares to the CSOT. At December 31, 1997, 2.2 million shares remained in the CSOT. Shares held by the CSOT are not considered outstanding for earnings per common share calculations until released to the Plans. Corning and the trustee of the CSOT reached an agreement whereby the trustee waived its right to receive the Distribution of Quest Diagnostics and Covance and, in lieu thereof, received 400,000 additional shares of Corning common stock. Corning repurchased approximately 1.1 million, 2.2 million and 1.2 million shares of its common stock in 1997, 1996 and 1995, respectively. All of the 1997 and 1995 amounts and approximately 1.3 million shares of the 1996 amount were repurchased pursuant to a systematic plan authorized by the Board of Directors. Corning's systematic plan is designed to provide shares for Corning's various employee benefit programs. The remainder of the 1996 stock repurchases were from employees to satisfy tax withholding requirements on shares issued under employee benefit plans. In June 1996, the Board of Directors approved the renewal of the Preferred Share Purchase Right Plan which entitles shareholders to purchase one-hundredth of a share of Series A Junior Participating Preferred Stock upon the occurrence of certain events. In addition, the rights entitle shareholders to purchase shares of common stock at a 50 percent discount in the event a person or group acquires 20 percent or more of Corning's outstanding common stock. The preferred share purchase rights became effective July 15, 1996 and expire July 15, 2006. 15. Stock Compensation Plans At December 31, 1997, Corning's stock compensation plan includes the 1994 Employee Equity Participation Program, which covers 9 million shares. This plan and predecessor plans provide the authorization for Corning's common stock plans discussed below. No future awards or grants may be made under the predecessor plans except for currently outstanding rights. At December 31, 1997, 1.2 million shares were available for sale or grant under this plan. Proceeds from the sale of stock under this plan are added to capital stock accounts. This plan does not include stock options granted in substitution for stock options assumed in connection with Corning's acquisition of certain companies. Accordingly, these grants do not reduce shares available under the stock compensation plan. In October 1995, the Financial Accounting Standards Board issued Statement No. 123 "Accounting for Stock-Based Compensation" (FAS 123). This statement defines a fair value-based method of accounting for employee stock options and similar equity investments and encourages adoption of that method of accounting for employee stock compensation plans. However, it also allows entities to continue to measure compensation cost for employee stock compensation plans using the intrinsic value-based method of accounting prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25). Corning applies APB 25 accounting for its stock-based compensation plans. Compensation expense is recorded for awards of shares or share rights over the period earned. This plan resulted in compensation expense of $29.2 million in 1997, $27.6 million in 1996 and $12.0 million in 1995. Corning has adopted the disclosure-only provisions of FAS 123. If Corning had elected to recognize compensation expense under FAS 123, Corning's net income in 1997, 1996 and 1995 would have decreased by $5.3 million, $2.0 million and $2.6 million, respectively. Corning's basic and diluted earnings per share amounts would have decreased by $0.02 in 1997 and $0.01 in 1995. Earnings per share amounts in 1996 would not have been affected. The pro forma effect on net income for 1997, 1996 and 1995 may not be representative of the pro forma effect on net income of future years because the FAS 123 method of accounting for pro forma compensation expense has not been applied to options granted prior to January 1, 1995. 22 15. Stock Compensation Plans (continued) Stock Option Plan Non-qualified and incentive stock options to purchase unissued shares at the market price on the grant date generally become exercisable in installments from one to two years from the grant date, except for the December 1995 and February 1997 grants, which become exercisable in installments from two to five years from the grant date; the maximum term of non-qualified and incentive stock options is generally 10 years from the grant date. Transactions for the three years ended December 31, 1997 were:
Number Weighted- of Shares Average in Thousands Exercise Price - ---------------------------------------------------------------------------------------------------------------- Options outstanding January 1, 1995 9,833 $25.07 Options granted under Plan 3,389 31.34 Options exercised (1,052) 13.83 Options terminated (393) 24.40 - ---------------------------------------------------------------------------------------------------------------- Options outstanding January 1, 1996 11,777 $27.90 Options granted under Plan 763 34.54 Options exercised (1,147) 13.52 Options terminated (1,022) 31.40 Adjustment due to Distributions 908 - - ---------------------------------------------------------------------------------------------------------------- Options outstanding January 1, 1997 11,279 $24.26 Options granted under Plan 929 41.10 Options exercised (2,114) 15.82 Options terminated (152) 25.93 - ---------------------------------------------------------------------------------------------------------------- Options outstanding December 31, 1997 9,942 $26.83 - ----------------------------------------------------------------------------------------------------------------
At the end of 1996, the number and exercise price of all options outstanding were adjusted for the Distributions of Quest Diagnostics and Covance. This adjustment increased the number of options outstanding by approximately 908,000 and decreased the exercise price of the options by approximately 18%. For purposes of FAS 123, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1997, 1996 and 1995, respectively: risk-free interest rate of 6.4%, 6.6% and 5.7%; dividend yield of 1.6%, 2.3% and 2.3%; expected volatility of 25.0%, 24.5% and 24.5% and expected life of 6, 7 and 7 years. The number of options exercisable and the corresponding weighted-average exercise price was 5.3 million and $24.73 in 1997, 6.5 million and $23.11 in 1996 and 5.2 million and $23.93 in 1995. The weighted-average fair value of options granted was $14.45 in 1997, $10.77 in 1996 and $9.12 in 1995. 23 15. Stock Compensation Plans (continued) The following table summarizes information about stock options outstanding at December 31, 1997:
- ---------------------------------------------------------------------------------------------------------------------------------- Number Number Outstanding at Remaining Weighted- Exercisable at Weighted- Range of December 31, 1997 Contractual Life Average December 31, 1997 Average Exercise Prices in Thousands in Years Exercise Price in Thousands Exercise Price - ---------------------------------------------------------------------------------------------------------------------------------- $ 3.06 to 26.03 2,825 4.2 $18.96 2,134 $16.99 $26.04 to 26.87 3,619 7.6 $26.16 946 $26.33 $26.88 to 36.26 2,952 5.8 $31.15 2,252 $31.40 $36.27 to 64.38 546 9.4 $46.74 - - - ---------------------------------------------------------------------------------------------------------------------------------- 9,942 6.2 $26.83 5,332 $24.73 - ----------------------------------------------------------------------------------------------------------------------------------
Incentive Stock Plans The Incentive Stock Plan permits stock grants, either determined by specific performance goals or issued directly, in most instances, subject to the possibility of forfeiture and without cash consideration. In 1997, 1996 and 1995, grants of 999,000, 340,000 and 549,000 shares, respectively, were made under this plan. In connection with the 1996 Distributions, approximately 280,000 additional shares were issued to employees in lieu of receiving the Distributions and approximately 180,000 shares were forfeited by employees of the Distributed companies. At December 31, 1997, there were no outstanding incentive rights. The weighted-average exercise price of the grants was $40.07 in 1997, $32.61 in 1996, and $30.52 in 1995, respectively. A total of 2.7 million shares issued in prior years remain subject to forfeiture at December 31, 1997. Worldwide Employee Share Purchase Plan In addition to the Stock Option Plan and Incentive Stock Plans, Corning has a Worldwide Employee Share Purchase Plan (WESPP). Under the WESPP, substantially all employees can elect to have up to 10% of their annual wages withheld to purchase Corning common stock. The purchase price of the stock is 85% of the lower of the beginning-of-quarter or end-of-quarter market price. The Corning Stock Ownership Trust is utilized to fund employee purchases of common stock under the WESPP. Equity Purchase Plan Under the Equity Purchase Plan (EPP), shares were sold to certain employees at book value and must be repurchased by the Company at book value or converted to equivalent unrestricted shares. Effective September 30, 1996, the Board of Directors voted to terminate the EPP. As a result of the EPP termination, approximately 1.4 million restricted shares outstanding under the EPP were repurchased by Corning for approximately $3.4 million and 312,000 unrestricted common shares during the fourth quarter of 1996. 16. Employee Stock Ownership Plan Corning has established the Employee Stock Ownership Plan (ESOP) within its existing employee investment plans. At inception of the plan, Corning borrowed $50 million and loaned the proceeds to the ESOP. The ESOP used the proceeds to purchase 4 million treasury shares. Corning's receivable from the ESOP was $2.9 million and $9.6 million at the end of 1997 and 1996, respectively, and is classified as unearned compensation in common stockholders' equity. Corning is obligated to make monthly contributions to the plan sufficient to enable the ESOP to pay its loan, including interest. These contributions are classified as expense at the time they are made. 24 16. Employee Stock Ownership Plan (continued) Contributions to the ESOP were $7.0 million in 1997, $6.7 million in 1996 and $6.4 million in 1995. Dividends on unallocated shares reduced contribution requirements by $0.2 million in 1997, $0.5 million in 1996 and $0.8 million in 1995. Interest costs amounted to $0.8 million in 1997, $1.2 million in 1996 and $1.6 million in 1995. Shares held by the ESOP are included in weighted-average shares outstanding for earnings per share calculations. The trustee of the ESOP sold the shares of Quest Diagnostics and Covance that it received from the Distributions. The proceeds from the sale of these shares were used to purchase shares of Corning common stock. 17. Commitments, Contingencies, Guarantees and Hedging Activities Minimum rental commitments under leases outstanding at December 31, 1997 are:
- ---------------------------------------------------------------------------------------------------------------------------------- 1998 1999 2000 2001 2002 2003-2013 - ---------------------------------------------------------------------------------------------------------------------------------- $42.3 $37.0 $28.9 $22.1 $17.4 $102.9 - ----------------------------------------------------------------------------------------------------------------------------------
At December 31, 1997, future minimum lease payments to be received under a noncancelable sublease to Quest Diagnostics totaled $74.0 million. Quest Diagnostics, in turn, has a noncancelable sublease covering approximately $48.6 million of the minimum lease payments due to Corning. Corning has agreed to indemnify Quest Diagnostics should Quest Diagnostics' subleasee default on the minimum lease payments. Additionally, Corning continues to guarantee certain obligations of Quest Diagnostics totaling $20.9 million. Corning operates and conducts business in many foreign countries. As a result, there is exposure to potentially adverse movement in foreign currency rate changes. Corning enters into foreign exchange forward contracts with durations generally less than 12 months to reduce its exposure to exchange rate risk on foreign source income and purchases. The objective of these contracts is to neutralize the impact of foreign currency exchange rate movements on Corning's operating results. These contracts require Corning to exchange currencies at rates agreed upon at the inception of the contracts. The hedge contracts reduce the exposure to fluctuations in exchange rate movements because the gains and losses associated with foreign currency balances and transactions are generally offset with the gains and losses of the hedge contracts. Because the impact of movements in foreign exchange rates on forward contracts offsets the related impact on the underlying items being hedged, these financial instruments help alleviate the risk that might otherwise result from changes in currency exchange rate fluctuations. At December 31, 1997, Corning had foreign currency contracts to purchase $115.1 million U.S. dollars with a fair value of $14.7 million. These contracts are held by Corning and its subsidiaries and will mature at varying dates in 1998. The ability of certain subsidiaries and associated companies to transfer funds is limited by provisions of certain loan agreements and foreign government regulations. At December 31, 1997, the amount of equity subject to such restrictions for consolidated subsidiaries totaled $68.7 million. While this amount is legally restricted, it does not result in operational difficulties since Corning has generally permitted subsidiaries to retain a majority of equity to support their growth programs. At December 31, 1997, loans of equity affiliates guaranteed by Corning totaled $44.9 million. Corning has agreed to indemnify Quest Diagnostics, on an after-tax basis, for the settlement of certain governmental claims pending at December 31, 1996. In addition, Corning, Quest Diagnostics and Covance have entered into tax indemnification and tax sharing agreements. Additional information on these indemnification agreements is presented in Note 19 of the Notes to Consolidated Financial Statements. 25 18. International Activities Information by geographic area is presented below on a source basis, with exports shown in their area of origin, and research and development expenses shown in the area where the activity was performed. Other revenues, interest expense and miscellaneous income and expense are included with other unallocated amounts to allow a reconciliation to amounts reported in the Consolidated Statements of Income. Transfers between areas are accounted for at prices approximating prices to unaffiliated customers.
Eliminations Latin America, and United Asia- Canada Unallocated 1997 States Pacific Europe and Other Amounts Consolidated - ---------------------------------------------------------------------------------------------------------------------------------- Revenues $2,896.1 (1) $414.1 $191.4 $15.8 $ 36.9 $3,554.3 Transfers between areas 531.6 0.6 38.2 3.7 (574.1) - - ---------------------------------------------------------------------------------------------------------------------------------- Total revenues 3,427.7 414.7 229.6 19.5 (537.2) 3,554.3 Income (loss) before tax 550.5 (1.8) 82.5 7.7 (9.7) 629.2 Identifiable assets at year end 3,611.4 409.5 310.8 26.9 (24.3) 4,334.3 Research and development expense 230.3 3.8 16.2 - - 250.3 - ---------------------------------------------------------------------------------------------------------------------------------- 1996 - ---------------------------------------------------------------------------------------------------------------------------------- Revenues $2,422.7 (1) $350.6 $229.2 $18.3 $ 32.9 $3,053.7 Transfers between areas 180.2 0.1 18.4 3.6 (202.3) - - ---------------------------------------------------------------------------------------------------------------------------------- Total revenues 2,602.9 350.7 247.6 21.9 (169.4) 3,053.7 Income before tax 385.7 6.0 68.9 7.9 (12.7) 455.8 Identifiable assets at year end 3,202.4 273.5 315.1 28.4 - 3,819.4 Research and development expense 171.6 4.2 13.4 - - 189.2 - ---------------------------------------------------------------------------------------------------------------------------------- 1995 - ---------------------------------------------------------------------------------------------------------------------------------- Revenues $2,356.4 (1) $ 94.8 $176.8 $12.8 $ 30.6 $2,671.4 Transfers between areas 104.4 - 11.5 2.4 (118.3) - - ---------------------------------------------------------------------------------------------------------------------------------- Total revenues 2,460.8 94.8 188.3 15.2 (87.7) 2,671.4 Income before tax 358.0 (2) 36.7 53.6 1.1 (60.0) 389.4 Identifiable assets at year end 2,661.0 261.8 322.0 28.1 5.6 3,278.5 Research and development expense 157.9 3.1 11.2 - - 172.2 - ----------------------------------------------------------------------------------------------------------------------------------
(1) U.S. sales to unaffiliated customers in 1997, 1996 and 1995 include $749 million, $610 million and $376 million of export sales; $226 million, $206 million and $119 million to Europe; $305 million, $220 million and $127 million to Asia-Pacific, and $218 million, $184 million and $130 million to Latin America, Canada and Other. (2) The 1995 restructuring charge of $26.5 million was included in income before tax of the United States. 26 19. Discontinued Operations On April 1, 1998, Corning completed the recapitalization and sale of a controlling interest in its consumer housewares business to an affiliate of Borden, Inc. (the Consumer transaction). Corning received proceeds of $583 million in cash and will continue to retain an 8 percent interest in the Corning Consumer Products Company. In addition, Corning could receive an additional payment of up to $15 million if certain financial targets are met by Corning Consumer Products Company for the three year period 1998 - 2000. On December 31, 1996, Corning distributed all of the shares of Quest Diagnostics Incorporated (formerly Corning Clinical Laboratories Inc.) and Covance Inc. (formerly Corning Pharmaceutical Services Inc.) (the Distributions) (collectively, the Health Care Services segment) to its shareholders on a pro rata basis. Prior to the Distributions, Corning received a ruling from the Internal Revenue Service that the Distributions were tax-free to Corning and its shareholders. As a result of the Distributions, Quest Diagnostics and Covance became independent, publicly traded companies. Corning's stockholders' equity was reduced by $1.1 billion, which represented Corning's investment in equity and intercompany debt of Quest Diagnostics and Covance on the date of the Distributions. Prior to the Distributions, Quest Diagnostics and Covance borrowed $650 million from third-party lenders and repaid intercompany debt to Corning. Corning used the proceeds from the repayment of intercompany debt to repay approximately $375 million of short-term borrowings and $75 million of long-term debt. Summarized results of Corning's discontinued operations are as follows:
1997 - ---------------------------------------------------------------------------------------------------------------------------------- Consumer Housewares business Total - ---------------------------------------------------------------------------------------------------------------------------------- Sales $ 574.8 $ 574.8 Income before income taxes $ 49.0 $ 49.0 Income tax provision 17.7 17.7 - ---------------------------------------------------------------------------------------------------------------------------------- Income from operations, net of income taxes 31.3 31.3 Provision for loss on Distributions, including income tax benefit of $3.5 million Minority interest in earnings of subsidiaries (0.4) (0.4) - ---------------------------------------------------------------------------------------------------------------------------------- Discontinued operations, net of income taxes $ 30.9 $ 30.9 - ----------------------------------------------------------------------------------------------------------------------------------
1996 - ---------------------------------------------------------------------------------------------------------------------------------- Health Care Consumer Services Housewares segment business Total - ---------------------------------------------------------------------------------------------------------------------------------- Sales $ 515.0 $ 630.8 $ 1,145.8 Income before income taxes $ 20.5 $ 31.5 $ 52.0 Income tax provision 11.3 11.8 23.1 - ---------------------------------------------------------------------------------------------------------------------------------- Income from operations, net of income taxes 9.2 19.7 28.9 Provision for loss on Distributions, including income tax benefit of $3.5 million (176.5) (176.5) Minority interest in earnings of subsidiaries (0.1) (0.1) - ---------------------------------------------------------------------------------------------------------------------------------- Discontinued operations, net of income taxes $ (167.3) $ 19.6 $ (147.7) - ----------------------------------------------------------------------------------------------------------------------------------
27 19. Discontinued Operations (continued)
1995 - ---------------------------------------------------------------------------------------------------------------------------------- Health Care Consumer Services Housewares segment business Total - ---------------------------------------------------------------------------------------------------------------------------------- Sales $ 2,055.0 $ 616.3 $ 2,671.3 Income before income taxes $ 57.2 $ 16.7 $ 73.9 Income tax provision 36.5 10.9 47.4 - ---------------------------------------------------------------------------------------------------------------------------------- Income from operations, net of income taxes 20.7 5.8 26.5 Provision for loss on Distributions, including income tax benefit of $3.5 million Minority interest in earnings of subsidiaries - ---------------------------------------------------------------------------------------------------------------------------------- Discontinued operations, net of income taxes $ 20.7 $ 5.8 $ 26.5 - ----------------------------------------------------------------------------------------------------------------------------------
The 1996 sales of $515.0 million and income from operations of $9.2 million for the Health Care Services segment only includes results through March 31, 1996. Results of the discontinued businesses include allocations of consolidated interest expense totaling $13.0 million, $63.5 million and $61.2 million in 1997, 1996 and 1995, respectively. The allocations were based on the ratio of net assets of discontinued operations to consolidated net assets. The $176.5 million provision for loss on Distributions includes a second quarter after-tax charge of $56.8 million, a third quarter after-tax charge of $115 million and a fourth quarter after-tax charge of $4.7 million. The second quarter charge includes a $37 million after-tax charge to increase reserves for government claims and an after-tax charge for the estimated costs related to the Distributions, offset by the estimated results of operations of the businesses to be Distributed from April 1, 1996 through December 31, 1996, the Distribution date. The third quarter charge related primarily to a $105 million after-tax charge taken by Quest Diagnostics to increase reserves related to certain government investigations of billing practices of certain clinical laboratories acquired by Quest Diagnostics in 1993 and 1994. The fourth quarter charge of $4.7 million represents the final accounting for estimates recorded in the second quarter of 1996. Quest Diagnostics has entered into several settlement agreements with various governmental and private payors during recent years. At present, government investigations of certain practices by clinical laboratories acquired in recent years are ongoing. In the second quarter 1996, the U.S. Department of Justice (DOJ) notified Quest Diagnostics that it had taken issue with certain payments received by Damon Corporation (Damon) from federally funded healthcare programs prior to its acquisition by Quest Diagnostics. As a result, in the second quarter 1996, Quest Diagnostics increased its reserves by $46 million ($37 million after tax) to equal management's estimate, at that time, of the low end of the range of potential amounts which could be required to satisfy claims related to the Damon and other related and similar investigations. During the third quarter of 1996, Quest Diagnostics' management met with the government several times to evaluate the substance of the government's allegations. As a result of these discussions in October 1996, Quest Diagnostics' management, on behalf of its Damon subsidiary, reached a settlement agreement with the DOJ which caused Quest Diagnostics to pay $119 million to the government. This settlement concludes all federal and Medicaid claims relating to the billing by Damon of certain blood tests to Medicare and Medicaid patients and other matters relating to Damon being investigated by the DOJ. As a result of this settlement agreement, Quest Diagnostics' management reassessed the level of reserves recorded for other asserted and unasserted claims related to the Damon and other similar government investigations, including the investigation of billing practices by Nichols Institute (Nichols) prior to its acquisition by Quest Diagnostics in 1994. Quest Diagnostics recorded a charge totaling $142 million ($105 million after tax) in the third quarter 1996 to establish additional reserves equal to the Damon settlement agreement and Quest Diagnostics management's best estimate of potential amounts which could be required to satisfy the remaining claims. Corning has agreed to indemnify Quest Diagnostics on an after-tax basis for the settlement of the Nichols' and certain other claims that were pending at December 31, 1996. Coincident with the Distributions, Corning recorded a reserve accrual of approximately $25 million which is equal to management's best estimate of amounts, which are probable of being paid by Corning to Quest Diagnostics to satisfy the remaining indemnified claims on an after-tax basis. 28 19. Discontinued Operations (continued) Although management believes that established reserves for indemnified claims are sufficient, it is possible that additional information may become available to Quest Diagnostics' management, which may cause the final resolution of these matters to exceed established reserves by an amount which could be material to Corning's results of operations and cash flow in the period in which such claims are settled. Corning does not believe that these issues will have a material adverse impact on Corning's overall financial condition. Corning, Quest Diagnostics and Covance have entered into tax indemnification agreements that prohibit Quest Diagnostics and Covance for a period of two years after the Distributions from taking certain actions that might jeopardize the favorable tax treatment of the Distributions and provide Corning with certain rights of indemnification against Quest Diagnostics and Covance. The tax indemnification agreements also require Quest Diagnostics and Covance to take such actions as Corning may request to preserve the favorable tax treatment provided for in any rulings obtained from the Internal Revenue Service in respect of the Distributions. Corning, Quest Diagnostics and Covance have also entered into a tax sharing agreement which allocates among Corning, Quest Diagnostics and Covance responsibility for federal, state and local taxes relating to taxable periods before and after the Distributions and provide for computing and apportioning tax liabilities and tax benefits for such periods among the parties. Quest Diagnostics and Covance have paid or will pay Corning for all income taxes due at December 31, 1996. Corning will indemnify Quest Diagnostics and Covance for any adjustments to these liabilities resulting from future audits of Corning's consolidated federal and certain other tax returns for periods prior to the Distribution date. 29 Corning Incorporated and Subsidiary Companies Schedule II - Valuation Accounts and Reserves
- ---------------------------------------------------------------------------------------------------------------------------------- Balance at Net Deductions Balance at Year Ended December 31, 1997 12-31-96 Additions and Other 12-31-97 - ------------------------------------------------------------------------------------------------------------------------------- Doubtful accounts and allowances $ 14.2 $ 17.5 $ 21.0 $ 10.7 LIFO valuation $ 27.4 $ 1.0 $ 7.6 $ 20.8 Deferred tax assets valuation allowance $ 12.5 $ 9.5 $ 22.0 Accumulated amortization of goodwill and other intangible assets $ 35.0 $ 20.4 3.9 $ 51.5 - ---------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- Balance at Net Deductions Balance at Year Ended December 31, 1996 12-31-95 Additions and Other 12-31-96 - ------------------------------------------------------------------------------------------------------------------------------- Doubtful accounts and allowances $ 11.5 $ 18.0 $ 15.3 $ 14.2 LIFO valuation $ 31.2 $ 2.0 $ 5.8 $ 27.4 Deferred tax assets valuation allowance $ 17.2 $ 4.7 $ 12.5 Accumulated amortization of goodwill and other intangible assets $ 24.5 $ 16.5 6.0 $ 35.0 - ---------------------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------------------- Balance at Net Deductions Balance at Year Ended December 31, 1995 1-1-95 Additions and Other 12-31-95 - ------------------------------------------------------------------------------------------------------------------------------- Doubtful accounts and allowances $ 11.5 $ 13.1 $ 13.1 $ 11.5 LIFO valuation $ 36.7 $ 5.5 $ 31.2 Deferred tax assets valuation allowance $ 19.5 $ 5.7 $ 8.0 $ 17.2 Accumulated amortization of goodwill and other intangible assets $ 12.4 $ 12.1 $ 24.5 - ----------------------------------------------------------------------------------------------------------------------------------
30 QUARTERLY OPERATING RESULTS AND RELATED MARKET DATA (unaudited)
(In millions, except per share amounts) Corning Incorporated and Subsidiary Companies - ------------------------------------------------------------------------------------------------------------------------------------ First Second Third Fourth Total 1997 Quarter Quarter Quarter Quarter Year - ---------------------------------------------------------------------------------------------------------------------------------- Revenues $ 827.0 $ 914.6 $ 901.3 $ 911.4 $ 3,554.3 Gross profit 341.4 390.2 367.0 375.9 1,474.5 Income from continuing operations before income taxes 143.5 189.3 150.1 146.3 629.2 Equity in earnings of associated companies 6.8 24.2 31.0 17.2 79.2 Income from continuing operations 85.4 125.0 106.8 91.7 408.9 Income from discontinued operations, net of income taxes (1) 6.6 2.0 5.5 16.8 30.9 Net income $ 92.0 $ 127.0 $ 112.3 $ 108.5 $ 439.8 - ---------------------------------------------------------------------------------------------------------------------------------- Basic Earnings Per Share Continuing operations $ 0.37 $ 0.55 $ 0.47 $ 0.40 $ 1.79 Discontinued operations 0.03 0.01 0.02 0.07 0.13 Net income $ 0.40 $ 0.56 $ 0.49 $ 0.47 $ 1.92 Diluted Earnings Per Share Continuing operations $ 0.36 $ 0.52 $ 0.45 $ 0.39 $ 1.72 Discontinued operations 0.03 0.01 0.02 0.07 0.13 Net income $ 0.39 $ 0.53 $ 0.47 $ 0.46 $ 1.85 Dividend declared $ 0.18 $ 0.18 $ 0.18 $ 0.18 $ 0.72 Price range High $ 46 $ 56 $ 65 $ 49 1/4 - Low 34 43 1/2 41 35 3/4 - - ---------------------------------------------------------------------------------------------------------------------------------- 1996 - ---------------------------------------------------------------------------------------------------------------------------------- Revenues $ 712.2 $ 787.7 $ 755.2 $ 798.6 $ 3,053.7 Gross profit 280.9 304.5 307.7 300.8 1,193.9 Income from continuing operations before income taxes 103.3 138.5 122.0 92.0 455.8 Equity in earnings of associated companies 11.6 22.5 24.4 26.6 85.1 Income from continuing operations $ 65.4 $ 96.3 $ 89.6 $ 72.0 $ 323.3 Income (loss) from discontinued operations, net of income taxes (1) 6.4 (59.3) (109.4) 14.6 (147.7) Net income (loss) $ 71.8 $ 37.0 $ (19.8) $ 86.6 $ 175.6 - ---------------------------------------------------------------------------------------------------------------------------------- Basic Earnings Per Share Continuing operations $ 0.29 $ 0.42 $ 0.39 $ 0.32 $ 1.42 Discontinued operations (1) 0.02 (0.26) (0.48) 0.06 (0.66) Net income (loss) $ 0.31 $ 0.16 $ (0.09) $ 0.38 $ 0.76 Diluted Earnings Per Share Continuing operations $ 0.29 $ 0.41 $ 0.39 $ 0.31 $ 1.40 Discontinued operations (1) 0.02 (0.24) (0.46) 0.06 (0.62) Net income (loss) $ 0.31 $ 0.17 $ (0.07) $ 0.37 $ 0.78 Dividend declared $ 0.18 $ 0.18 $ 0.18 $ 0.18 $ 0.72 Price range (2) High $ 36 $ 39 5/8 $ 39 1/4 $ 46 1/4 - Low 29 33 3/4 35 1/2 37 3/8 - - ----------------------------------------------------------------------------------------------------------------------------------
(1) Discontinued operations are described in Note 19 of the Notes to Consolidated Financial Statements. (2) Includes the value of Quest Diagnostics and Covance up to the Distribution date. At the Distribution date, the fair value of Quest Diagnostics and Covance included in Corning's share price was $7 1/4. 31
FIVE YEARS IN REVIEW - HISTORICAL COMPARISON (In millions, except per-share amounts) Corning Incorporated and Subsidiary Companies - ------------------------------------------------------------------------------------------------------------------------------------ 1997 1996 1995 1994 1993 - --------------------------------------------------------------------------------------------------------------------------------- Basic Earnings Per Share Income (loss) from continuing operations $ 1.79 $ 1.42 $ (0.35) $ 0.89 $ (0.15) Income (loss) from discontinued operations, net of income taxes 0.13 (0.66) 0.12 0.43 0.06 Net income (loss) $ 1.92 $ 0.76 $ (0.23) $ 1.32 $ (0.09) Diluted Earnings Per Share Continuing operations $ 1.72 $ 1.40 $ (0.35) $ 0.88 $ (0.15) Discontinued operations 0.13 (0.62) 0.12 0.42 0.06 Net income (loss) $ 1.85 $ 0.78 $ (0.23) $ 1.30 $ (0.09) Dividends declared $ 0.72 $ 0.72 $ 0.72 $ 0.69 $ 0.68 Shares used in computing earnings per share Basic earnings per share 228.1 227.1 226.6 211.8 192.0 Diluted earnings per share 245.4 239.5 226.6 214.2 192.0 - --------------------------------------------------------------------------------------------------------------------------------- Operations Net sales $ 3,516.8 $ 3,024.0 $ 2,644.7 $ 2,367.5 $ 2,018.4 Research and development expenses 250.3 189.2 172.2 169.7 165.3 Provision for restructuring and other special charges 26.5 65.5 Equity in earnings (losses) of associated companies: Other than Dow Corning Corporation 79.2 85.1 66.6 48.5 44.0 Dow Corning Corporation (348.0) (2.8) (144.5) Income (loss) from continuing operations $ 408.9 $ 323.3 $ (77.3) $ 190.6 $ (26.3) Income (loss) from discontinued operations, net of income taxes 30.9 (147.7) 26.5 90.7 11.1 Net Income (Loss) $ 439.8 $ 175.6 $ (50.8) $ 281.3 $ (15.2) - ---------------------------------------------------------------------------------------------------------------------------------- Financial Position Assets Working capital $ 241.4 $ 445.2 $ 276.5 $ 281.3 $ 151.0 Investments: Other than Dow Corning Corporation 310.0 337.2 364.9 339.5 281.4 Dow Corning Corporation 341.8 326.0 Plant and equipment, net 2,267.9 1,808.6 1,438.7 1,334.9 1,283.1 Goodwill and other intangible assets, net 294.2 259.9 258.1 255.7 95.6 Net assets of discontinued operations 357.6 364.0 2,056.0 1,972.4 1,675.0 Total assets 4,691.9 4,183.4 5,334.5 5,365.5 4,661.6 - --------------------------------------------------------------------------------------------------------------------------------- Capitalization Loans payable beyond one year $ 1,125.8 $ 1,195.1 $ 1,326.0 $ 1,330.5 $ 1,534.7 Other liabilities 627.5 597.8 587.4 564.5 576.3 Minority interest in subsidiary companies 349.3 309.9 269.2 244.5 239.9 Convertible preferred securities of subsidiary 365.3 365.1 364.7 364.4 Convertible preferred stock 19.8 22.2 23.9 24.9 25.7 Common stockholders' equity 1,246.5 961.1 2,103.0 2,263.0 1,685.8 Total capitalization $ 3,734.2 $ 3,451.2 $ 4,674.2 $ 4,791.8 $ 4,062.4 - ---------------------------------------------------------------------------------------------------------------------------------
32 FIVE YEARS IN REVIEW - HISTORICAL COMPARISON (Continued)
1997 1996 1995 1994 1993 - ------------------------------------------------------------------------------------------------------------------------------- Selected Data Common dividends declared $ 166.2 $ 165.3 $ 165.2 $ 150.1 $ 134.1 Preferred dividends declared $ 1.6 $ 1.9 $ 2.0 $ 2.1 $ 2.1 Additions to plant and equipment $ 745.6 $ 560.2 $ 337.1 $ 248.8 $ 332.9 Depreciation and amortization $ 285.9 $ 252.3 $ 221.1 $ 210.1 $ 176.4 Number of employees (1) 16,100 15,300 12,800 17,000 15,800 Number of common stockholders 17,900 18,000 18,800 21,600 19,000 - ----------------------------------------------------------------------------------------------------------------------------------
(1) Amounts do not include employees of discontinued operations. 33 Suite 3900 Telephone 313 259 0500 200 Renaissance Center Detroit, MI 48243 Price Waterhouse LLP Report of Independent Accountants January 21, 1998 To the Stockholders and Board of Directors of Dow Corning Corporation In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations and retained earnings and of cash flows present fairly, in all material respects, the financial position of Dow Corning Corporation and its subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based upon our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 4 to the consolidated financial statements, on May 15, 1995, Dow Corning Corporation voluntarily filed for protection under Chapter 11 of the United States Bankruptcy Code. This action, which was taken primarily as a result of breast implant litigation as discussed in Note 3 to the financial statements, raises substantial doubt about the Company's ability to continue as a going concern in its present form. Management's plans in regard to these matters are also described in Notes 3 and 4. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ Price Waterhouse LLP 34 DOW CORNING CORPORATION AND SUBSIDIARY COMPANIES CONSOLIDATED BALANCE SHEETS (in millions of dollars) ASSETS
December 31, 1997 1996 ---------- ---------- CURRENT ASSETS: Cash and cash equivalents $ 253.1 $ 344.4 ---------- ---------- Marketable securities 97.4 184.1 ---------- ---------- Accounts and notes receivable - Trade (less allowance for doubtful accounts of $11.7 in 1997, and of $11.7 in 1996) 424.4 421.7 Anticipated implant insurance receivable 85.5 23.8 Other receivables 49.9 68.1 ---------- ---------- 559.8 513.6 ---------- ---------- Inventories 325.9 298.3 ---------- ---------- Other current assets - Deferred income taxes 122.3 153.7 Other 20.3 30.6 ---------- ---------- 142.6 184.3 ---------- ---------- Total current assets 1,378.8 1,524.7 ---------- ---------- PROPERTY, PLANT AND EQUIPMENT: Land and land improvements 144.0 148.1 Buildings 522.9 514.3 Machinery and equipment 2,372.4 2,289.1 Construction-in-progress 461.9 346.2 ---------- ---------- 3,501.2 3,297.7 Less - Accumulated depreciation (2,021.1) (1,992.4) ---------- ---------- 1,480.1 1,305.3 ---------- ---------- OTHER ASSETS: Marketable securities 242.9 50.7 Anticipated implant insurance receivable 911.6 999.0 Restricted insurance proceeds 517.2 480.9 Implant deposit 275.0 275.0 Environmental trusts 23.2 21.0 Deferred income taxes 393.8 383.0 Other 96.1 74.5 ---------- ---------- 2,459.8 2,284.1 ---------- ---------- $ 5,318.7 $ 5,114.1 ========== ==========
The Notes to consolidated financial statements are an integral part of these financial statements. 35 DOW CORNING CORPORATION AND SUBSIDIARY COMPANIES CONSOLIDATED BALANCE SHEETS (in millions of dollars except share data) LIABILITIES AND STOCKHOLDERS' EQUITY
December 31, ---------------------- 1997 1996 ---------- ---------- CURRENT LIABILITIES: Notes payable $ 14.8 $ 5.0 Current portion of long-term debt 24.2 1.3 Trade accounts payable 167.0 174.3 Accrued payrolls and employee benefits 59.6 68.9 Accrued taxes 117.8 94.4 Other current liabilities 106.4 136.6 ---------- ---------- Total current liabilities 489.8 480.5 ---------- ---------- LONG-TERM DEBT 140.9 103.3 ---------- ---------- OTHER LONG-TERM LIABILITIES 112.0 111.5 ---------- ---------- LIABILITIES SUBJECT TO COMPROMISE: Trade accounts payable 66.2 66.0 Accrued employee benefits 170.5 176.3 Accrued taxes 3.6 3.6 Implant reserve 2,406.3 2,424.4 Notes payable 375.0 375.0 Long-term debt 267.2 270.4 Other 130.3 136.4 ---------- ---------- 3,419.1 3,452.1 ---------- ---------- CONTINGENT LIABILITIES (NOTE 3) MINORITY INTEREST IN CONSOLIDATED SUBSIDIARIES 130.6 128.4 ---------- ---------- STOCKHOLDERS' EQUITY: Common stock, $5 par value - 2,500,000 shares authorized and outstanding 12.5 12.5 Retained earnings 1,026.2 788.6 Cumulative translation adjustment (12.4) 37.2 ---------- ---------- Stockholders' equity 1,026.3 838.3 ---------- ---------- $ 5,318.7 $ 5,114.1 ========== ==========
The Notes to consolidated financial statements are an integral part of these financial statements. 36 DOW CORNING CORPORATION AND SUBSIDIARY COMPANIES CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS (in millions of dollars except share data)
Year ended December 31, ---------------------------------- 1997 1996 1995 ---------- ---------- ---------- NET SALES $ 2,643.5 $ 2,532.3 $ 2,492.9 ---------- ---------- ---------- OPERATING COSTS AND EXPENSES: Manufacturing cost of sales 1,795.9 1,674.0 1,664.4 Marketing and administrative expenses 466.9 462.3 450.3 Implant costs - - 351.1 ---------- ---------- ---------- 2,262.8 2,136.3 2,465.8 ---------- ---------- ---------- OPERATING INCOME 380.7 396.0 27.1 OTHER INCOME (EXPENSE): Interest income 70.4 54.1 36.6 Interest expense (11.0) (7.8) (43.0) Other, net 32.2 16.1 (22.6) ---------- ---------- ---------- INCOME (LOSS) BEFORE REORGANIZATION COSTS AND INCOME TAXES 472.3 458.4 (1.9) Reorganization costs 45.0 49.4 21.0 ---------- ---------- ---------- INCOME (LOSS) BEFORE INCOME TAXES 427.3 409.0 (22.9) Income tax provision (benefit) 168.8 168.9 (9.6) Minority interests' share in income 20.9 18.4 17.3 ---------- ---------- ---------- NET INCOME (LOSS) (1997 - $95.04 per share; 1996 - $88.68 per share; 1995 - $(12.24) per share) 237.6 221.7 (30.6) Retained earnings at beginning of year 788.6 566.9 597.5 ---------- ---------- ---------- Retained earnings at end of year $ 1,026.2 $ 788.6 $ 566.9 ========== ========== ==========
The Notes to consolidated financial statements are an integral part of these financial statements. 37 DOW CORNING CORPORATION AND SUBSIDIARY COMPANIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in millions of dollars)
Year ended December 31, ------------------------- 1997 1996 1995 ------ ------ ------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 237.6 $221.7 $(30.6) Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities - Depreciation and amortization 185.5 188.9 214.0 Deferred income taxes 17.0 32.8 (131.0) Implant charges including imputed interest - - 364.5 Reorganization costs 45.0 49.4 21.0 Other 52.5 30.7 42.5 Implant payments (17.3) (25.3) (107.3) Implant insurance reimbursement 25.5 368.4 163.5 Restricted insurance proceeds (36.8) (374.8) (108.3) Changes in assets and liabilities - Accounts and notes receivable (22.2) (32.0) (56.0) Inventories (41.4) 16.6 (19.2) Accounts payable 3.7 29.2 33.1 Accrued taxes 32.4 8.0 17.1 Other (48.8) 31.0 30.5 ------ ------ ------ Cash provided by operating activities 432.7 544.6 433.8 ------ ------ ------ CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (425.2) (312.6) (204.2) Proceeds from sales of marketable securities 331.3 26.8 2.8 Purchases of marketable securities (462.5) (224.9) (12.4) Other 14.9 (2.4) 2.7 ------ ------ ------s Cash (used for) investing activities (541.5) (513.1) (211.1) ------ ------ ------ CASH FLOWS FROM FINANCING ACTIVITIES: Long-term borrowings 115.9 47.3 58.2 Payments on long-term debt (53.4) (57.0) (57.8) Net change in other short-term borrowings 10.9 (8.9) (16.9) ------ ------ ------ Cash provided by (used for) financing activities 73.4 (18.6) (16.5) ------ ------ ------ CASH FLOWS USED FOR REORGANIZATION COSTS (45.0) (49.4) (21.0) ------ ------ ------ EFFECT OF EXCHANGE RATE CHANGES ON CASH (10.9) (6.4) 1.0 ------ ------ ------ CHANGES IN CASH AND CASH EQUIVALENTS: Net increase (decrease) in cash and cash equivalents (91.3) (42.9) 186.2 Cash and cash equivalents at beginning of year 344.4 387.3 201.1 ------ ------ ------ Cash and cash equivalents at end of year $253.1 $344.4 $387.3 ====== ====== ======
38 CORNING CORPORATION AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in millions of dollars except where noted) NOTE 1 - BUSINESS AND BASIS OF PRESENTATION Dow Corning Corporation was incorporated in 1943 by Corning Glass Works (now "Corning Incorporated") and Dow Chemical for the purpose of developing and producing polymers and other materials based on silicon chemistry. Dow Corning Corporation operates in various countries around the world through numerous wholly-owned or majority-owned subsidiary corporations. Most of the Company's products are based on polymers known as silicones which have a silicon-oxygen-silicon backbone. Through various chemical processes, the Company manufactures silicones that have an extremely wide variety of characteristics in forms ranging from fluids, gels, greases and elastomeric materials to resins and other rigid materials. Silicones combine the temperature and chemical resistance of glass and the versatility of plastics and, regardless of form or application, generally possess such qualities as electrical resistance, resistance to extreme temperatures, resistance to deterioration from aging, water repellency, lubricating characteristics, relative chemical and physiological inertness and resistance to ultraviolet radiation. The Company currently manufactures over 10,000 products and serves approximately 50,000 customers worldwide, with no single customer accounting for more than three percent of the Company's sales in 1997. Principal United States manufacturing plants are located in Kentucky, Michigan and North Carolina. Principal non-U.S. manufacturing plants are located in Belgium, Germany, Japan and the United Kingdom. The Company also owns research and development facilities in the United States, Belgium, Japan, Germany and the United Kingdom. Dow Corning's average employment for 1997 was approximately 9,100 persons. On May 15, 1995, Dow Corning Corporation, excluding its subsidiaries (the "Debtor Company"), voluntarily filed for protection under Chapter 11 of the U.S. Bankruptcy Code (the "Bankruptcy Code") with the U.S. Bankruptcy Court for the Eastern District of Michigan, Northern Division, in Bay City, Michigan (the "Bankruptcy Court"). The Debtor Company consists of a majority of the Company's United States operations and certain non-U.S. branches. The Debtor Company's Chapter 11 proceeding (the "Chapter 11 Proceeding") does not include any subsidiaries of the Debtor Company (see Note 4 below for further discussion of this matter). The consolidated financial statements of the Company have been prepared on a "going-concern" basis, which contemplates the realization of assets and the liquidation of liabilities in the ordinary course of business. However, as a result of the Chapter 11 Proceeding of the Debtor Company, such realization of assets and liquidation of liabilities is subject to significant uncertainties including the approval of a plan of reorganization by the Bankruptcy Court. Also, the ability of the Company to continue as a going concern (including its ability to meet post-petition obligations of the Debtor Company and to meet obligations of the subsidiaries of the Debtor Company) is dependent primarily on (a) the ability of the Company to maintain adequate cash on hand, the ability of the Company to generate cash from operations and the ability of the subsidiaries of the Debtor Company to obtain necessary financing and (b) if required, the availability of a debtor-in-possession credit facility. Management believes that conditions (a) and (b) will be satisfied. The Company's financial statements have been presented in conformity with the American Institute of Certified Public Accountants' Statement of Position 90-7 ("SOP 90-7"), "Financial Reporting By Entities In Reorganization Under the Bankruptcy Code," issued November 19, 1990. SOP 90-7 requires a segregation of liabilities subject to compromise by the Bankruptcy Court as of the bankruptcy filing date (May 15, 1995) and identification of all transactions and events that are directly associated with the reorganization of the Debtor Company. The consolidated financial statements do not include any adjustments relating to the recoverability of recorded asset amounts or the amounts of liabilities that may result from the Chapter 11 Proceeding. Upon confirmation of a plan of reorganization by the Bankruptcy Court, if there are no material unsatisfied conditions precedent to the effectiveness of a confirmed plan of reorganization, adjustments to the carrying values of the Company's assets and liabilities may be required to reflect the terms of such plan. 39 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The accompanying consolidated financial statements include the accounts of Dow Corning Corporation and all of its wholly-owned and majority-owned domestic and international subsidiaries. The Company's interests in 20% to 50% owned affiliates are carried on the equity basis and are included under the caption "OTHER ASSETS - Other" in the accompanying consolidated balance sheets. Intercompany transactions and balances have been eliminated in consolidation. Cash and Cash Equivalents Cash equivalents include all highly liquid investments purchased with an original maturity of ninety days or less. The carrying amounts for cash equivalents approximate their fair values. Inventories Inventories are stated at the lower of cost or market. The cost of the majority of inventories is determined using the last-in, first-out (LIFO) method and the remainder is valued using the first-in, first-out (FIFO) method. Property and Depreciation Property, plant and equipment is carried at cost less any impairment and is depreciated principally using accelerated methods over estimated useful lives ranging from 10 to 20 years for land improvements, 10 to 45 years for buildings and 3 to 20 years for machinery and equipment. Upon retirement or other disposal, the asset cost and related accumulated depreciation are removed from the accounts and the net amount, less any proceeds, is charged or credited to income. Expenditures for maintenance and repairs are charged against income as incurred. Expenditures which significantly increase asset value or extend useful asset lives are capitalized. The Company follows the policy of capitalizing interest as a component of the cost of capital assets constructed for its own use. Interest capitalized was $3.3 in 1995. However, in conformity with the provisions of SOP 90-7, the Company has discontinued accruing interest expense related to unsecured pre-petition debts of the Debtor Company. As a result, the Company has also discontinued the capitalization of interest as a component of the cost of capital assets for its own use, since any amounts that would be capitalized after the application of SOP 90-7 would be considered immaterial. The Company adopted Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", effective January 1, 1996. This statement establishes accounting standards for the impairment of long-lived assets, certain identifiable assets and certain identifiable intangibles to be disposed of. The adoption of the new standard did not have a material impact on the Company's financial statements for the year ended December 31, 1996. Restricted and Unrestricted Investments The Company accounts for investments in debt and equity securities in conformity with Statement of Financial Accounting Standards No. 115 ("SFAS 115"), "Accounting for Certain Investments in Debt and Equity Securities." SFAS 115 requires the use of fair value accounting for trading or available-for-sale securities, while retaining the use of the amortized cost method for investments in debt securities that the Company has the positive intent and ability to hold to maturity. Investments in debt and equity securities are included in the captions "Marketable securities," "Restricted insurance proceeds," "Implant deposit," and "Environmental trusts" in the accompanying consolidated balance sheets. 40 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Intangibles Other assets include $27.1 and $36.2 of intangible assets, net of accumulated amortization, at December 31, 1997 and 1996, respectively. Goodwill, representing the excess of cost over net assets of businesses acquired is included in the above amounts, and is being amortized on a straight-line basis over 10 years. Other identifiable intangible assets are amortized on a straight-line basis over their estimated useful lives. Deferred Investment Grants Included in other long-term liabilities are deferred investment incentives (grants) which the Company has received related to certain capital expansion projects in Belgium and the United Kingdom. Such grants are deferred and recognized in income over the service lives of the related assets. At December 31, 1997 and 1996, gross deferred investment incentives were $79.7 and $90.3 with related accumulated amortization of $73.4 and $80.3, respectively. Income Taxes The Company accounts for income taxes in conformity with the provisions of Statement of Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income Taxes." SFAS 109 requires a company to recognize deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in a company's financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement carrying amounts and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Research and Development Costs Research and development costs are charged to operations when incurred and are included in manufacturing cost of sales. These costs totaled $210.4 in 1997, $203.5 in 1996 and $194.5 in 1995. Currency Translation Assets and liabilities of non-U.S. subsidiaries, for which the U.S. dollar is not the functional currency, are translated into U.S. dollars at end-of-period exchange rates; translation gains and losses, hedging activity and related tax effects for these subsidiaries are reported as a separate component of stockholders' equity. Revenues and expenses for these non-U.S. subsidiaries are translated at average exchange rates during the period. For all consolidated entities for which the U.S. dollar is the functional currency, monetary assets and liabilities are remeasured into U.S. dollars using end-of-period exchange rates; remeasurement gains and losses, hedging activity and related tax effects for these entities are recognized in the consolidated statement of operations. Historical exchange rates are used for non-monetary assets and related elements of expense. All other revenues and expenses are remeasured at average exchange rates during the period. Foreign currency transaction gains and losses are included in the consolidated statement of operations. Currency Derivatives The Company enters into currency derivative instruments to manage certain currency exposures, which principally include monetary assets and liabilities not denominated in functional currencies, and net investments in non-U.S. entities for which the U. S dollar is not the functional currency. The Company does not hold or enter into currency derivative instruments for trading or speculative purposes. All currency derivative instruments are designated as hedges of currency exposures. The derivative instruments are reviewed regularly against the exposure to which they have been designated to ensure that they continue to serve as an effective hedge. To the extent that the position created by the instruments is in excess of the exposure to which it has been designated, the gain or loss attributable to that excess position is recognized currently under the caption "Other, net" in the accompanying Consolidated Statements of Operations and Retained Earnings, and the excess position is eliminated by the Company entering into offsetting instruments. The types of instruments used to manage these risks are primarily forward exchange contracts. 41 NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Realized and unrealized gains and losses on currency derivative instruments are recognized currently under the caption "Other, net" in the accompanying consolidated statements of operations and retained earnings if designated as a hedge of monetary assets and liabilities, or, in the cumulative translation adjustment account, net of tax, in stockholders' equity if designated as a hedge of a net investment. Any gains or losses on currency derivative instruments which are intended to hedge the tax effects of the currency exposure are included as an offset to the related tax effects in the period in which such tax effects are recognized. Discounts and premiums on all forward exchange contracts are amortized over the life of the contracts and are included under the caption "Other, net" in the accompanying consolidated statements of operations and retained earnings. Discounts and premiums on forward exchange contracts which are intended to hedge the tax effects of the currency exposure are amortized over the life of the contracts and are included in the tax provision. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the reported amounts of revenues and expenses during the reporting period and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates. Reclassifications Certain reclassifications of prior year amounts have been made to conform to the presentation adopted in 1997. NOTE 3 - CONTINGENCIES Breast Implant Litigation and Claims - Background Prior to 1992, the Company was engaged in the manufacture and sale of silicone gel breast implants and the raw material components of these products. In January, 1992, the United States Food and Drug Administration ("FDA") asked breast implant producers to voluntarily halt the sale of silicone gel breast implants pending the FDA's further review of the safety and effectiveness of such devices, and the Company complied with the FDA's request. Subsequently, the Company announced that it would not resume the production or sale of breast implants. Between 1991 and 1995, the Company experienced a substantial increase in the number of lawsuits against the Company relating to breast implants. As of December 31, 1997, the Company has been named, often together with other defendants, in approximately 19,000 pending breast implant products liability lawsuits filed by or on behalf of individuals who claim to have or have had breast implants. Many of these cases involve multiple plaintiffs. In addition, there are 46 breast implant products liability class action lawsuits which have been filed against the Company as of December 31, 1997; however, only three of these class actions have been certified. The Company has sometimes been named as the manufacturer of breast implants, and other times the Company is named as the supplier of silicone raw materials to other breast implant manufacturers. Since the commencement of the Company's Chapter 11 Proceeding, the Company has been dismissed from a number of breast implant lawsuits in which the Company was named as a supplier of silicone raw material to other breast implant manufacturers. However, other breast implant manufacturers which purchased silicone raw materials from the Company, and other defendants in breast implant litigation, have filed claims for indemnity and contribution against the Company in the Company's Chapter 11 Proceeding (see Note 4 for further discussion). The typical alleged factual bases for these lawsuits primarily include allegations that the plaintiffs' breast implants (a) caused specific, recognized autoimmune diseases including scleroderma, systemic lupus erythematosus, and multiple sclerosis, (b) caused a vague combination of symptoms, including chronic fatigue and joint pain, alleged to be a new disease not generally recognized in the medical community and variously described by terms such as "human adjuvant disease," "siliconosis," "atypical connective tissue disease," and "atypical neurological disease," (c) have or may have ruptured (d) caused other local complications, and/or (e) caused disfigurement. The Company vigorously asserts, among other defenses, that there is no causal connection between silicone breast implants and the ailments alleged by the plaintiffs in these cases. A substantial number of breast implant lawsuits were consolidated for pretrial purposes in the U.S. District Court for the Northern District of Alabama (the "Court"), and in various state courts. Further information related to the jurisdictional status of these cases is described in Note 4 below. 42 NOTE 3 - CONTINGENCIES (Continued) The Debtor Company's filing for protection under Chapter 11 of the Bankruptcy Code has resulted in a stay of this litigation in the United States. However, claims prosecuted against the Debtor Company in non-U.S. jurisdictions and against subsidiaries of the Debtor Company are not stayed by the Chapter 11 Proceeding. In addition to the 19,000 individual breast implant lawsuits referred to above, approximately 6,000 individual claims had been filed in non-U.S. jurisdictions, primarily in Australia. Of these approximately 6,000 individual claims, approximately 170 have been served and are in a position to proceed under the legal systems of their relevant jurisdictions, approximately 3,330 of these claims have been effectively terminated as to the Company under the Australian court system and approximately 2,500 of these claims are inactive. The Company believes that many of the non-U.S. claims are duplicative of proofs of claim filed by such non-U.S. claimants in the Debtor Company's Chapter 11 Proceeding. Approximately 5,700 non-U.S. plaintiffs have filed claims in the United States (included in the 19,000 lawsuits referenced above); however, these approximately 5,700 claims are stayed by the Debtor Company's Chapter 11 Proceeding. In addition to the 46 class action lawsuits referred to above, five class actions are pending in non-U.S. jurisdictions. Two of these non-U.S. class actions have not been served and none of the non-U.S. class actions are stayed by the Chapter 11 Proceeding. Breast Implant Litigation and Claims - Settlement Agreement In 1994, the Company, along with other defendants and representatives of breast implant litigation plaintiffs, entered into a settlement agreement under the supervision of the Court (the "Settlement Agreement"). Under the Settlement Agreement, certain industry participants originally agreed to contribute up to approximately $4.2 billion, of which the Company agreed to contribute up to approximately $2.02 billion, over a period of more than thirty years. Although the Settlement Agreement was designed to cover claims of most breast implant recipients brought in the courts of U.S. federal and state jurisdictions, approximately 7,000 U.S. and non-U.S. potential claimants elected not to settle their claims by way of the Settlement Agreement and elected to pursue their individual breast implant litigation against the Company. In 1995, the Court concluded the total amount of claims likely to be approved for payment would result in substantially lower payments to claimants than anticipated under the Settlement Agreement, and the Court requested the parties negotiate possible modifications to the Settlement Agreement. The Company did not actively participate in the subsequent negotiations and is not a party to the resulting modification of the Settlement Agreement. The Company has not exercised its option to withdraw from, and the Company has not been released from, the Settlement Agreement. In addition, the Company has not been officially excluded from participating in modification of the Settlement Agreement. The Company anticipates breast implant litigation and claims pending against it will be resolved pursuant to the Debtor Company's plan of reorganization arising out of the Debtor Company's Chapter 11 Proceeding (see Note 4 below for further discussion). Breast Implant Litigation and Claims - Insurance Matters The Company has a substantial amount of unexhausted claims-made, occurrence and occurrence-noticed products liability insurance coverage with respect to breast implant lawsuits and claims commencing in 1986 and thereafter. For breast implant lawsuits and claims involving implant dates prior to 1986, substantial coverage exists under a number of primary and excess occurrence and occurrence-noticed policies having various limits. For breast implant lawsuits and claims filed after 1985 in cases with implant dates prior to 1986, potential coverage exists under all of the above referenced policies. Because defense costs and disposition of particular breast implant lawsuits and claims may be covered, in whole or in part, both by the coverage issued from and after 1986, and one or more of the policies issued prior to 1986, the ultimate determination of aggregate insurance coverage depends on, among other things, how defense and indemnity costs are allocated among the various policy periods. Depending on policy language, applicable law and agreements with insurers, compensatory and punitive damages which may be awarded pursuant to breast implant lawsuits may or may not be covered, in whole or in part, by insurance. A substantial number of the Company's insurers reserved the right to deny coverage, in whole or in part, due to differing theories regarding, among other things, when coverage may attach and their respective obligations relative to other insurers. Since 1993, the Company has been involved in litigation against certain insurance companies which issued occurrence based products liability insurance policies to the Company from 1962 through 1985 ("Occurrence Insurers"). This litigation resulted from an inability of the Occurrence Insurers to reach an agreement with the Company on a formula for the allocation among the Occurrence Insurers of payments of defense and indemnity expenses submitted by the Company related to breast implant products liability lawsuits and claims. The Company sought a judicial enforcement of the obligations of the Occurrence Insurers under the relevant insurance policies. Following certain initial procedural steps, this litigation has been conducted in the Wayne County, Michigan Circuit Court (the "Michigan Court"). A number of the Occurrence Insurers have been dismissed from this litigation pursuant to settlements reached with the Company. 43 NOTE 3 - CONTINGENCIES (Continued) During 1994, the Michigan Court (a) ruled that certain of the Company's primary Occurrence Insurers have a duty to defend the Company with respect to breast implant products liability lawsuits, (b) directed these insurers to reimburse the Company for certain defense costs previously incurred and (c) ruled in favor of the Company on allocation of defense costs. During 1995, the Michigan Court ruled in favor of the Company on allocation of indemnity costs, ordering that each primary Occurrence Insurer is obligated to pay the defense costs for all cases alleging a date of implant either before or during the insurers' policy periods and for all cases involving unknown implant dates; once implant dates become known, the appropriate insurer becomes responsible for relevant claims. The Michigan Court also ruled that relevant insurance contracts afford coverage for punitive damages except where specific policy provisions expressly exclude coverage for such damages. In addition, a trial on the merits of the claims in this litigation commenced. During 1996, a Michigan Court jury found the remaining Occurrence Insurers liable for coverage including costs of defense and settlement of the Company's breast implant lawsuits and claims in the United States and in other countries. The Michigan Court also ruled that the Company is entitled to recover substantially all defense, settlement and judgment costs previously incurred. Certain of the Occurrence Insurers have appealed the results of this litigation to the Michigan Court of Appeals. The Company is uncertain as to when these appeals will be resolved. In the interim, the Company is continuing settlement negotiations with the Occurrence Insurers as well as other insurers that are not involved in the litigation. Furthermore, the Company is pursuing resolution of a significant portion of currently unresolved insurance coverage provided by solvent non-Occurrence Insurers through arbitration proceedings. The Company is also pursuing recovery from insolvent insurance carriers via settlement discussions. Based on the results of this litigation, management continues to believe it is probable the Company will recover from its insurers a substantial amount of breast implant-related payments which have been or may be made by the Company. In addition to the results of this litigation, this belief is further supported by the fact that the Company received insurance recoveries of $628.6 from September 1, 1994, through December 31, 1997 (see Note 6 for further discussion), and entered into settlements with certain insurers for future reimbursement. Breast Implant Litigation and Claims - Financial Provisions The Company has taken steps in the past to reflect the anticipated financial consequences to the Company of the breast implant situation. Prior to 1995 the Company recorded aggregate pre-tax charges of $1.981 billion and related insurance receivables of $1.006 billion to cover (a) the Company's best estimate, at the time, of its potential liability under the Settlement Agreement, (b) the Company's best estimate, at the time, of additional costs to resolve breast implant litigation outside of the Settlement Agreement and (c) legal, administrative, and research costs related to the breast implant controversy. The portion of the pre-1995 charges related to the Settlement Agreement and related to the anticipated implant insurance receivable were recorded on a present value basis. In 1995, the Company recorded a pre-tax charge of $351.1 to abandon this present value treatment. This charge was taken because of the uncertainty associated with the Debtor Company's filing for protection under Chapter 11 of the Bankruptcy Code. As a result of filing for Chapter 11 protection, management could no longer make the assessment that the amount and timing of the settlement payments were reliably determinable as required by accounting rules relevant to present value discounting of future liabilities. Based on information currently available and due to the uncertainty associated with the Debtor Company's filing for protection under Chapter 11 of the Bankruptcy Code, management cannot currently estimate the ultimate cost of resolving breast implant litigation and claims. Notwithstanding the inherent uncertainties associated with estimating the ultimate cost of resolving breast implant litigation and claims, management believes it has accrued amounts required under generally accepted accounting principles. The Company has not revised its implant reserves since the Debtor Company's filing for protection under Chapter 11 of the Bankruptcy Code, except (a) to reflect the 1995 charge referred to above, and (b) to reflect payment of certain legal, administrative, and research costs related to the breast implant controversy. The Company anticipates that the ultimate cost to resolve breast implant litigation and claims will be estimated for purposes of determining the feasibility of any plan of reorganization during the Debtor Company's Chapter 11 Proceeding (see Note 4 below). As additional facts and circumstances develop, it is at least reasonably possible that the amount of the Company's implant reserves may be revised in the near term to reflect any material developments relating to the resolution of the breast implant litigation and claims. Future revisions, if required, could have a material effect on the Company's financial position or results of operations in the period or periods in which such revisions are recorded. 44 NOTE 3 - CONTINGENCIES (Continued) The "Anticipated implant insurance receivable" recorded in the accompanying consolidated balance sheets is the result of the provisions described above; a substantial portion of this "Anticipated implant insurance receivable" relates to amounts expected to be recovered from the Occurrence Insurers. The principal uncertainties which exist with respect to the realization of this asset include the ultimate cost of resolving breast implant litigation and claims, the results of litigation against and settlement negotiations with insurers and the extent to which insurers may become insolvent in the future. The Company took these factors into account when estimating the amount of insurance recovery to record in the financial statements. As additional facts and circumstances develop, it is at least reasonably possible that the estimate may be revised in the near term to reflect any material developments relating to insurance matters. Future revisions, if required, could have a material effect on the Company's financial position or results of operations in the period or periods in which such revisions are recorded. Notwithstanding the above, the Company believes it is probable that the "Anticipated implant insurance receivable" recorded in the accompanying consolidated balance sheet at December 31, 1997 will ultimately be realized. Securities Laws Class Action Lawsuits As previously reported, in 1992 the Company and certain of its former and present directors and officers were named, as defendants with others, in two securities laws class action lawsuits filed by purchasers of stock of Corning Incorporated and Dow Chemical. These cases were originally filed as several separate cases in the Federal District Court for the Southern District of New York; they were subsequently consolidated so that there is one case involving claims on behalf of purchasers of stock of Corning Incorporated and one case involving claims on behalf of purchasers of stock of Dow Chemical. The plaintiffs in these cases allege, among other things, misrepresentations and omissions of material facts and breach of duty with respect to purchasers of stock of Corning Incorporated and Dow Chemical relative to the breast implant issue. The relief sought in these cases is monetary damages in unspecified amounts. The Debtor Company's filing for protection under Chapter 11 of the Bankruptcy Code has resulted in a stay of this litigation with respect to the Debtor Company. These cases have been dismissed without prejudice with respect to directors, officers and other individuals originally named as defendants. Corning Incorporated and Dow Chemical continue as defendants in this litigation. Tax Matters On January 20, 1997, the Company received a Statutory Notice of Deficiency (the "Notice") from the United States Internal Revenue Service (the "IRS"). The Notice asserts tax deficiencies totaling approximately $105.3. The alleged deficiencies in the Notice relate to the Company's consolidated federal income tax returns for the 1992, 1993 and 1994 calendar years. The Company believes that the deficiencies asserted by the IRS are excessive. The Company is vigorously contesting the IRS' claims, has filed refund claims aggregating approximately $4.5 relating to research and development credits, and intends to file additional refund claims in connection with its protest, which was filed May 1, 1997. The Company anticipates that this matter will be resolved either in the Company's Chapter 11 Proceeding or through procedures provided by the Internal Revenue Code, and that such resolution will not have a material adverse impact on the Company's consolidated financial position or results of operations. The Company is currently engaged in discussions with the IRS in an effort to resolve this matter. Environmental Matters The Company has been advised by the United States Environmental Protection Agency ("EPA") or by similar state regulatory agencies that the Company, together with others, is a Potentially Responsible Party ("PRP") with respect to a portion of the cleanup costs and other related matters involving a number of abandoned hazardous waste disposal sites. Management currently believes that there are 13 sites at which the Company may have some liability, although management currently expects to settle the Company's liability for a majority of these sites for de minimis amounts. Based upon preliminary estimates by the EPA or the PRP groups formed with respect to these sites, the aggregate liabilities for all PRPs at those sites at which management currently believes the Company may have more than a de minimis liability is $15.5. Management cannot currently estimate the aggregate liability for all PRPs at those sites at which management expects the Company has a de minimis liability. The Company records accruals for environmental matters when it is probable that a liability has been incurred and the Company's costs can be reasonably estimated. The amount accrued for environmental matters at December 31, 1997, was $7.8. In addition, receivables of $4.0 for probable third-party recoveries have been recorded related to these environmental matters. 45 NOTE 3 - CONTINGENCIES (Continued) Reductions in aggregate environmental liability estimates, reserves, and receivables from amounts previously reported are the result of a negotiated fourth quarter 1997 indemnification commitment to the Company from another PRP at a significant hazardous waste disposal site relating to the Company's potential environmental liability at the site. As additional facts and circumstances develop, it is at least reasonably possible that either the accrued liability or the recorded receivable relative to environmental matters may be revised in the near term. While there are a number of uncertainties with respect to the Company's estimate of its ultimate liability for cleanup costs at these hazardous waste disposal sites, the Company believes that any costs incurred in excess of those accrued will not have a material adverse impact on the Company's consolidated financial position or results of operations. This opinion is based upon the number of identified PRPs at each site, the number of such PRPs that are believed by management to be financially capable of paying their share of the ultimate liability, and the portion of waste sent to the sites for which management believes the Company might be held responsible based on available records. As a result of financial provisions recorded with respect to breast implant liability, the Debtor Company has been unable to meet certain federal and state environmental statutory financial ratio tests. Consequently, in order for the Debtor Company to continue to operate hazardous waste storage facilities at certain plant sites, the states involved have required the Debtor Company to establish trusts to provide for aggregate estimated closure, post-closure, corrective action and potential liability costs of $23.2 associated with these hazardous waste storage facilities; and the Debtor Company has fully funded these trusts as of December 31, 1997. Interest on the funds held in trust will be available to the Debtor Company under certain circumstances, and the amount required to be held in trust may vary annually. At such time as the Debtor Company satisfies the above referenced financial ratio tests or the Debtor Company no longer needs or closes the permitted facilities, the funds then remaining in these trusts will revert to the Debtor Company. The establishment and funding of these trusts is subject to the continuing jurisdiction of the Bankruptcy Court. Other Litigation Due to the nature of its business as a supplier of specialty materials to a variety of industries, the Company, at any particular time, is a defendant in a number of products liability lawsuits for injury allegedly related to the Company's products and, in certain instances, products manufactured by others. Many of these lawsuits seek damages in substantial amounts. The Company has been named in products liability lawsuits pertaining to materials previously used in connection with temporomandibular joint implant applications and raw materials supplied by the Company to manufacturers of the NORPLANT(R) Implant contraceptive device (NORPLANT(R) is a registered trademark of the Population Council for Subdermal Levonorgestrel Implants). The Company believes that these claims are covered in whole or in part by substantial insurance or certain indemnity arrangements. This belief is supported in part by the fact that the indemnitors under these arrangements have been honoring their indemnity commitments. The Company has followed a practice of aggressively defending all products liability claims asserted against it, and although the Company intends to continue this practice, currently pending proceedings and any future claims are subject to the uncertainties attendant to litigation and the ultimate outcome of any such proceedings or claims cannot be predicted with certainty. The prosecution of lawsuits and claims against the Debtor Company has been stayed in the U.S. as a result of the Debtor Company's filing for protection under Chapter 11 of the Bankruptcy Code. However, claims prosecuted against the Debtor Company in non-U.S. jurisdictions and against subsidiaries of the Debtor Company are not stayed by the Chapter 11 Proceeding. The Company is currently unable to estimate its potential liability for these claims; however, the Company believes that these products liability claims will not have a material adverse effect on the Company's consolidated results of operations or financial condition. The Company anticipates that the cost to resolve a substantial portion of these claims will ultimately be determined during the Debtor Company's Chapter 11 Proceeding (see Note 4). NOTE 4 - PROCEEDING UNDER CHAPTER 11 Filing for Chapter 11 Protection On May 15, 1995, the Debtor Company voluntarily filed for protection under Chapter 11 of the Bankruptcy Code. The Debtor Company consists of a majority of the Company's U.S. operations and certain non-U.S. branches. The Debtor Company's Chapter 11 Proceeding does not include any subsidiaries of the Debtor Company. This action was taken because (a) the Debtor Company was not satisfied with the rate of progress toward resolving breast implant litigation outside of the Settlement Agreement, (b) the Debtor Company was not satisfied with the rate of progress toward achieving commitments from certain of the Company's insurers relative to insurance recovery and (c) the Debtor Company was concerned by the uncertainty associated with the conclusions of the U.S. District Court for the Northern District of Alabama relative to the Settlement Agreement (see Note 3 above for further discussion). 46 NOTE 4 - PROCEEDING UNDER CHAPTER 11 (Continued) The Debtor Company is operating as a debtor-in-possession under the supervision of the Bankruptcy Court. As a debtor-in-possession, the Debtor Company is authorized to operate its business but may not engage in transactions outside the ordinary course of its business without the approval of the Bankruptcy Court. Under the Bankruptcy Code, any creditor actions to obtain possession of property from the Debtor Company are stayed by the Chapter 11 Proceeding. As a result, the creditors of the Debtor Company are precluded from collecting pre-petition debts without the approval of the Bankruptcy Court. Certain pre-petition liabilities, including wages and benefits of employees and obligations to certain non-U.S. vendors, have been paid after obtaining the approval of the Bankruptcy Court. In November, 1996, the Bankruptcy Court granted the Debtor Company's motion to allow for the offset of certain receivables and payables between the Debtor Company and its subsidiaries existing as of May 15, 1995. Subject to certain exceptions under the Bankruptcy Code, the Debtor Company's Chapter 11 filing automatically stayed the continuation of any judicial or administrative proceedings against the Debtor Company. The Debtor Company filed notices to remove certain lawsuits filed by plaintiffs from state courts to federal courts. The Debtor Company also filed transfer motions seeking to transfer certain lawsuits filed by plaintiffs from various federal courts to the federal district court having jurisdiction over the Debtor Company's Chapter 11 Proceeding (the U.S. District Court for the Eastern District of Michigan, the "U.S. District Court in Michigan"). The purpose of these transfer motions was to lay a foundation for the eventual consolidation of these lawsuits in connection with a threshold "common issues" trial on the core issue, among others, of whether silicone gel implants cause the diseases claimed by those who filed such lawsuits. In September, 1995, the U.S. District Court in Michigan granted the Debtor Company's transfer motion to transfer certain lawsuits filed by plaintiffs to the U.S. District Court in Michigan. This court also indicated that if trials ultimately proceed, they should be conducted in either the U.S. District Court in Michigan or the U.S. district court for the district in which the claim underlying the lawsuit arose. In the interim, the U.S. District Court for the Northern District of Alabama has been assigned jurisdiction over these cases for pretrial purposes. The U.S. District Court in Michigan also suggested that a "common issues" trial could proceed, if needed, in connection with the Bankruptcy Court's estimation of products liability claims against the Debtor Company during the Debtor Company's Chapter 11 Proceeding. The U.S. Trustee appointed a "Committee of Unsecured Creditors," a "Committee of Tort Claimants" and an "Official Physicians' Committee" (collectively, the "Creditor Committees") in the Chapter 11 Proceeding. In accordance with the provisions of the Bankruptcy Code, the Creditor Committees have been appointed to represent the diversity of interests of the entire constituency that each committee is designated to serve, and the Creditor Committees have the right to be heard with respect to transactions outside the ordinary course of business and other matters arising in the Chapter 11 Proceeding. Bar Date and Creditors Claims In June, 1996, the Bankruptcy Court established bar dates, deadlines for creditors to file claims against the Debtor Company, of January 15, 1997, for all claims against the Debtor Company arising out of the United States and its territories, and of February 14, 1997, for all claims against the Debtor Company arising out of non-U.S. jurisdictions. Creditors who are required to file claims but fail to meet the bar dates generally will be prohibited from voting upon or receiving distributions under any plan of reorganization. As of January 21, 1998, approximately 722,000 proofs of claim have been filed by creditors of the Debtor Company with the Bankruptcy Court. Of these proofs of claim, approximately 463,000 are Implant Primary Claims (claims by implant recipients), approximately 205,000 are Implant Supplemental Claims (claims by persons related to implant recipients) and approximately 54,000 are General Claims (claims by lenders, holders of public debt securities, vendors and other miscellaneous parties, including claims for contribution and indemnity). Because the cataloging of filed proofs of claim is ongoing, the ultimate number of claims is not precisely determinable at this time. The Bankruptcy Court and the Debtor Company continue to assess the validity and accuracy of the information contained in or submitted with the filed proofs of claim. In addition, the Debtor Company believes that a significant number of the filed proofs of claim are duplicative. On December 4, 1997, the Bankruptcy Court disallowed approximately 33,000 of these duplicate claims. On December 30, 1997, a motion for summary judgment was filed with the Bankruptcy Court requesting the disallowance of approximately 18,000 additional duplicate claims. The process of identifying possible duplicate claims is ongoing. The Debtor Company anticipates that all duplicate claims will ultimately be disallowed. In addition, a number of these proofs of claim were received subsequent to the bar date and may be disallowed on that basis. Other than as described above, there has been no determination of allowability of the filed proofs of claim by either the Bankruptcy Court or the Debtor Company. 47 NOTE 4 - PROCEEDING UNDER CHAPTER 11 (Continued) On April 7, 1997, the Debtor Company filed (a) an omnibus objection with the Bankruptcy Court challenging all claims alleging that silicone breast implants caused disease and (b) a motion for summary judgment requesting that the Bankruptcy Court dismiss all such claims on the basis that there is no scientifically valid evidence sufficient to support such claims. Also on April 7, 1997, the Debtor Company filed a motion with the Chief Judge of the U.S. Court of Appeals for the Sixth Circuit requesting that, to the extent that a U.S. District Judge is required to decide the Debtor Company's motion for summary judgment or to decide issues related to disease claims which might survive the motion for summary judgment, such issues be referred to U.S. District Judge Sam C. Pointer, Jr. (of the U.S. District Court for the Northern District of Alabama) due to his experience as the federal multi-district litigation judge for breast implant litigation. Under this request, Judge Pointer would be temporarily assigned to the U.S. District Court in Michigan to preside over any proceedings regarding all claims arising from implanted medical devices, including breast implant claims, against the Debtor Company and its shareholders. The Chief Justice of the United States granted his approval of this request on June 29, 1997. Implementation of this action may be subject to the operation of local procedural rules of the U.S. District Court in Michigan. On December 19, 1997, the Bankruptcy Court recommended that, although it has the authority to decide the issues presented in the Debtor Company's omnibus objection and motion for summary judgment described above, the U.S. District Court in Michigan should take responsibility for ruling on such matters. The U.S. District Court in Michigan has indicated that it will take such responsibility with the participation of Judge Pointer. In addition, the U.S. District Court in Michigan indicated that the results of Judge Pointer's National Science Panel, established in the U.S. District Court for the Northern District of Alabama under the U.S. Federal Rules of Civil Procedure, will be used in connection with resolving the issue of whether silicone gel implants cause the diseases claimed by those who assert such claims. On August 19, 1997, the Tort Creditors Committee filed a motion with the Bankruptcy Court requesting that issues regarding estimation or liquidation of products liability claims in the Debtor Company's Chapter 11 Proceedings, including issues relating to confirmation of a plan of reorganization, be removed from the Bankruptcy Court to the U.S. District Court in Michigan. This motion will be adjudicated by the U.S. District Court in Michigan. On September 26, 1997, the U.S. District Court in Michigan conducted a hearing on this motion, but no decision has yet been rendered. Initial Plan of Reorganization and Exclusivity Period Under applicable provisions of the Bankruptcy Code, a debtor in Chapter 11 has certain periods of exclusivity during which it has the exclusive right to file and seek acceptances of its reorganization plan. After the expiration of such periods, as may be extended from time to time, any creditor has the right to file a plan of reorganization with the Bankruptcy Court. The Debtor Company had the exclusive right to file a plan of reorganization for 120 days after its Chapter 11 filing (the "Plan Exclusivity Period"). After several extensions of the Plan Exclusivity Period, in May, 1996, the Bankruptcy Court extended the Plan Exclusivity Period until the expiration of 21 days after the Bankruptcy Court enters orders related to (a) the procedure for the estimation of products liability and other claims against the Debtor Company, (b) the Debtor Company's request for the appointment of a panel of scientific experts to assist the Bankruptcy Court in the products liability claims estimation process, (c) the Debtor Company's request to establish a bar date for creditors to file claims against the Debtor Company and (d) the establishment by the Bankruptcy Court of a claims notice procedure. Also in May, 1996, the Bankruptcy Court extended the Debtor Company's exclusive statutory 60-day period for soliciting acceptances of its plan of reorganization (the "Solicitation Exclusivity Period") for an indefinite period, subject to further order of the Bankruptcy Court. In June, 1996, the Bankruptcy Court issued an order establishing bar dates for creditors to file claims against the Debtor Company, and approved a claims notice procedure. In December, 1996, the Debtor Company filed its initial plan of reorganization (the "Initial Plan") and related initial disclosure statement with the Bankruptcy Court. Under the Initial Plan, the Debtor Company would have committed up to $3.0 billion to satisfy claims of the Debtor Company's creditors. Critical to the treatment of claims related to breast implants under the Initial Plan was a common issue causation trial to determine if any causal connection exists between the Debtor Company's silicone implants and the various diseases claimed by the products liability claimants (see Note 3 for further discussion). The Initial Plan was superseded by the Debtor Company's amended plan of reorganization (the "Amended Plan") and a related amended disclosure statement (the "Amended Disclosure Statement") discussed below. 48 NOTE 4 - PROCEEDING UNDER CHAPTER 11 (Continued) On July 29, 1997, the Bankruptcy Court issued an order (a) denying previously filed separate motions of the Debtor Company and the Tort Creditor Committee regarding the procedure for the estimation of products liability and other claims against the Debtor Company and (b) denying without prejudice the Debtor Company's request for the appointment of a panel of scientific experts to assist the Bankruptcy Court in the products liability claims estimation process. Issuance of this order fixed the expiration date of the Plan Exclusivity Period at August 19, 1997. Subsequently, the expiration date of the Plan Exclusivity Period was extended by the Bankruptcy Court until August 26, 1997. Also on July 29, 1997, the Bankruptcy Court issued an opinion regarding (a) a process for estimation of products liability claims and (b) the use of a panel of scientific experts and a common issues trial in connection with such estimation process. The opinion indicated that a common issues trial, to resolve the core issue of whether silicone implants cause certain diseases as alleged by products liability claimants (see Note 3 for further discussion), should be used as a means for resolving products liability claims if (a) a plan of reorganization is not agreed between the Debtor Company and its creditors or (b) the disease causation issue is not resolved through rulings on other motions pending before the Bankruptcy Court. The opinion also indicated that court-appointed experts should be involved with the causation trial. Amended Plan of Reorganization and Amended Disclosure Statement On August 25, 1997, the Debtor Company filed its Amended Plan and Amended Disclosure Statement with the Bankruptcy Court. On November 20, 1997, the Bankruptcy Court indicated that the Debtor Company's Amended Disclosure Statement would not be approved in its current form. The Bankruptcy Court also expressed concerns about certain provisions of the Amended Plan (see below for further discussion). The Amended Plan would have provided up to $3.7 billion to satisfy claims of the Debtor Company's creditors. Specifically, under the Amended Plan, the Debtor Company would have committed up to $2.4 billion to resolve products liability claims through several settlement options or through litigation. Amounts allocated to resolution of products liability claims by settlement would have been placed in a settlement trust (the "Settlement Trust"), and amounts allocated to resolution of products liability claims by litigation would have been placed in a litigation trust (the "Litigation Trust"). In addition, the Amended Plan would have provided $1.3 billion to satisfy commercial claims which would have been paid in full, including accrued interest. The Amended Plan would have provided that seven year senior notes of the Debtor Company would have been issued to satisfy 70% of the amount of allowed unsecured commercial creditor claims. Under the Amended Plan, breast implant claimants voting to approve the Amended Plan would have been required to settle their claims through the Settlement Trust. The amount of funds allocated by the Amended Plan to settle breast implant claims through the Settlement Trust would have been directly linked to the number of breast implant claimants voting to approve the Amended Plan. The Amended Plan would have provided that, as more individuals in each class of breast implant claimants would have voted to approve the Amended Plan, the amount available to each class of breast implant claimants for resolution of breast implant claims through the Settlement Trust would have increased, and the amount of funds available for resolution of breast implant claims by litigation through the Litigation Trust would have decreased. The Settlement Trust would have provided four settlement options for breast implant claimants, with individual settlement amounts ranging up to approximately $200,000.00. Under the Amended Plan, breast implant claimants could have chosen one of the following four settlement options: (a) an expedited settlement option which would have paid between $650.00 and $1,000.00 to breast implant claimants (the "Expedited Settlement Option"); (b) a rupture settlement option which would have paid between $5,000.00 and $8,000.00 to breast implant claimants who, prior to final approval of the Amended Plan, had undergone surgery to remove a ruptured breast implant manufactured by the Debtor Company (the "Rupture Settlement Option"); (c) a medical procedure settlement option which would have paid expenses for approved procedures to remove breast implants manufactured by the Debtor Company from breast implant claimants after final approval of the Amended Plan and also would have paid up to $1,000.00 to such claimants for reasonable related expenses (the "Medical Procedure Settlement Option"); and (d) a qualified medical condition settlement option which would have paid between $2,500.00 and $200,000.00 to breast implant claimants if they had certain specified symptoms or medical conditions which were adequately documented and evaluated (the "Qualified Medical Condition Settlement Option"). 49 NOTE 4 - PROCEEDING UNDER CHAPTER 11 (Continued) Under the Amended Plan, amounts otherwise payable under the Qualified Medical Condition Settlement Option would have been reduced by one-half for breast implant claimants who have had breast implants manufactured by the Debtor Company and have also had breast implants produced by another manufacturer. The Amended Plan also would have provided that breast implant claimants who (a) would not have previously had their breast implants removed, (b) would not have currently qualified for the Qualified Medical Condition Settlement Option and (c) did not elect to settle their claims under either the Expedited Settlement Option or the Medical Procedure Settlement Option would have been limited to recovery of 20% of the amounts that were provided by the Qualified Medical Condition Settlement Option, in the event that such claimants would have qualified for that option in the future. Finally, settlement amounts payable to breast implant claimants who have had breast implants produced by another manufacturer using raw materials supplied by the Debtor Company would have been limited to $500.00 per claimant. Under the Amended Plan, non-breast implant products liability claimants who would have chosen to settle their claims through the Settlement Trust mechanism would have been able to elect (a) the Expedited Settlement Option under which such claimants would have been paid $500.00 or (b) the Qualified Medical Condition Settlement Option. Under the latter option, non-breast implant products liability claimants would have received a single level of payment depending on the type of Debtor Company implant product involved, with a second level of payment for claimants with a more severe condition related to a tempormandibular joint implant. For non-breast implant products liability claims settled under either of these options, there would have been no enhancement of the payment levels based on the percentage of claimants voting for the Amended Plan in each class of claimants. The Amended Plan would also have provided for settlement payments to family members of settling products liability claimants under certain circumstances specified in the Amended Plan. In addition, settlement payments to non-U.S. products liability claimants, other than those payments provided under the Expedited Settlement Option, would have been subject to downward adjustment based on local economic and legal system factors. Furthermore, the Amended Plan provided that punitive damage claims would have been waived with respect to products liability claimants who would have settled their claims through the Settlement Trust. The Debtor Company would have funded the Settlement Trust pursuant to a funding agreement with the Settlement Trust. The Debtor Company anticipated that it would have been able to meet its payment obligations to the Settlement Trust utilizing cash flow from operations, insurance proceeds, cash on hand and/or prospective borrowings. In addition, under certain circumstances, the Settlement Trust and the Debtor Company would have had access to a substantial revolving credit facility which would have been made available by Dow Chemical and Corning Incorporated. Upon termination of the Settlement Trust, any funds remaining in the Settlement Trust would have been distributed to an organization involved in research on the cause of and cure for autoimmune-connective tissue diseases. The Settlement Trust would have been managed by five independent trustees who would have reviewed claims under set guidelines and procedures and would have paid claims once they were qualified under one of the four settlement options specified above. Under the Amended Plan, products liability claimants voting against the Amended Plan would have been required to pursue their claims through a process potentially including mediation, arbitration, and/or litigation against the Litigation Trust if their claims would have survived a common issue causation trial. Such claimants would initially have been subject to a common issue causation trial to resolve the core issue of whether silicone implants cause certain diseases as alleged by those claimants (see Note 3 for further discussion). The result of this common issue causation trial would not have affected those claimants who would have elected to resolve their claims through the Settlement Trust. If the common issue causation trial would have concluded that silicone implants do not cause disease, all disease claims against the Litigation Trust would have been disallowed and the products liability claimants choosing to resolve their disease claims by litigation would not have received any distribution from the Litigation Trust. If the common issue causation trial would have concluded that silicone implants do cause disease, individual claims that would have remained against the Litigation Trust would have been resolved either through (a) an individual claim review process leading to settlement, (b) nonbinding mediation, (c) binding arbitration or (d) trial. The Amended Plan also contemplated that other common issue trials may have been undertaken by the Litigation Trust, including trials to determine (a) the application of bulk-supplier defenses to raw material claims, (b) the amount, if any, of punitive damages which might have been available, and (c) other issues. 50 NOTE 4 - PROCEEDING UNDER CHAPTER 11 (Continued) The actual level of funding of the Litigation Trust would have depended on the level of vote on the Amended Plan; if the vote had called for an enhanced level of funding of the Settlement Trust, it would have reduced the level of funding for the Litigation Trust. If the Amended Plan would have been accepted by all classes of products liability claimants and confirmed by the Bankruptcy Court (a "Consensual Plan"), the Debtor Company would have funded the Litigation Trust with an amount intended to cover initial administration of the Litigation Trust and preparation for the common issue causation trial. If the common issue causation trial would have concluded that silicone implants do cause disease, the Litigation Trust would have been funded with an amount, payable in annual installments, which would have reflected the results of products liability claimants voting in favor of the Amended Plan (see discussion above). If the amount of claims allowed in a given year would have exceeded the amount available in the Litigation Trust for distribution to claimants in that year, the balance of the claims payable would have been paid when additional funding became available. Upon termination of the Litigation Trust, any funds that would have remained in the Litigation Trust would have been distributed to the Debtor Company. If the Amended Plan would not have been accepted by all classes of products liability claimants, but would nonetheless have been confirmed by the Bankruptcy Court under the "cramdown" provisions of the Bankruptcy Code (a "Non-Consensual Plan"), funding of the Litigation Trust would have varied for classes which would have voted to accept the Amended Plan (the "Assenting Classes") and for classes which would have voted to reject the Amended Plan (the "Dissenting Classes"). In this situation, the funding for Assenting Classes would have operated in a manner consistent with the funding of the Litigation Trust under a Consensual Plan as described above. With respect to Dissenting Classes, if the amount of funding of the Litigation Trust would have been insufficient to satisfy claims of the Dissenting Classes in full, the trustees of the Litigation Trust would have been able to call on the Debtor Company to provide the additional funding needed to satisfy such claims. If the Debtor Company would not or could not pay the additional amounts needed, the trustees of the Litigation Trust would have been able to direct that all or a portion of the Debtor Company's stock (which, in the case of a Non-Consensual Plan, would have been conditionally pledged to the Litigation Trust by Dow Chemical and Corning Incorporated) be transferred to the Trust or sold to provide the additional funding needed. Furthermore, the Amended Plan would have provided that, in the case of either a Consensual Plan or a Non-Consensual Plan, punitive damage claims would have been waived with respect to products liability claimants in Assenting Classes, and with respect to those products liability claimants in Dissenting Classes who would have voted to accept the Amended Plan. Punitive damage claims by products liability claimants in Dissenting Classes who would have voted to reject the Amended Plan would have been separated from the compensatory damage claims of such claimants. Subsequently, after the litigation and payment of all compensatory damage claims from the Litigation Trust, the amount, if any, of punitive damages which might have been available would have been determined by a common issue trial. Only claimants who would have rejected the Amended Plan and who would have liquidated their claims through litigation would have been eligible to participate in this trial. Under the Amended Plan, products liability claims relating to long-term contraceptive implants would have been assigned to the Litigation Trust for administrative purposes and would have been resolved as to the Debtor Company by indemnification from and/or litigation against the ultimate manufacturers of these implants. The Litigation Trust would have been managed by three trustees appointed by the Debtor Company. If the Amended Plan would have been confirmed, all claims against the Debtor Company subject to the jurisdiction of the Bankruptcy Court would have been discharged and released. Personal injury claims, and certain related claims, would have been transferred to the Settlement Trust and the Litigation Trust for handling and payment. The treatment of claims would have been binding on all claimants regardless of whether they would have voted to accept or reject the Amended Plan, or whether they would have voted at all. All claims subject to the jurisdiction of Bankruptcy Court relating to products of the Debtor Company against (a) the Debtor Company, Dow Chemical, Corning Incorporated, and their subsidiaries and affiliates, (b) certain of the Debtor Company's insurers who have settled coverage issues with the Debtor Company relating to products liability claims, and (c) all of the officers, directors, employees and representatives of these parties, would have been discharged and released, and any prosecution or enforcement of those claims would have been permanently barred. In an effort to encourage resolution of key issues between the Debtor Company and the Creditor Committees regarding the Amended Plan and the Amended Disclosure Statement, the Bankruptcy Court appointed a mediator on November 5, 1997. The term of the mediator's appointment is scheduled to expire on February 2, 1998, unless extended by the Bankruptcy Court. 51 NOTE 4 - PROCEEDING UNDER CHAPTER 11 (Continued) After extensive hearings on the adequacy of the Amended Disclosure Statement, the Bankruptcy Court, on November 20, 1997, indicated that the Debtor Company's Amended Disclosure Statement would not be approved in its current form. The Bankruptcy Court also expressed the following five concerns about certain provisions of the Amended Plan: (a) the treatment of foreign claimants; (b) the use of insurance proceeds; (c) the degree of discretion reserved by the Debtor Company over the post-confirmation litigation process; (d) the proposal that the Bankruptcy Court would order releases of products liability claims against parties other than the Debtor Company; and (e) the linkage of claimants voting on the Amended Plan with the treatment of such claimants under the Amended Plan. In addition, the Bankruptcy Court expressed various concerns regarding several aspects of the Amended Disclosure Statement. In early January, 1998, the Debtor Company was given until February 17, 1998, to file a second amended plan of reorganization and related second amended disclosure statement. The Debtor Company intends to file a second amended plan of reorganization and a related second amended disclosure statement designed to address the Bankruptcy Court's concerns by February 17, 1998. Implant Reserves and Confirmation Procedure The "Implant reserve" as of December 31, 1997, was approximately $2.4 billion as recorded in the accompanying consolidated balance sheet. Since May 15, 1995, the "Implant reserve" recorded in the accompanying consolidated balance sheets has been reduced only as a result of payments made by the Debtor Company for certain legal, administrative, and research costs related to the breast implant controversy that were taken into consideration when the reserve was recorded in prior years (see Note 3 for further information). The Company anticipates that the ultimate cost to resolve breast implant litigation and claims will be determined as part of the Debtor Company's Chapter 11 Proceeding. As additional facts and circumstances develop, it is at least reasonably possible that the amount of the Company's implant reserves may be revised in the near term to reflect any material developments relating to the resolution of the breast implant litigation and claims. Future revisions, if required, could have a material effect on the Company's financial position or results of operations in the period or periods in which such revisions are recorded. Confirmation of a plan of reorganization requires, among other things, acceptance of the plan by the affirmative vote (in excess of 50% of the number and in excess of 66 2/3% of the dollar amount of the claims) of the creditors who vote in each class of creditors having claims that are impaired by the plan of reorganization. The Company is prohibited from soliciting acceptances of a plan of reorganization from creditors until after the Bankruptcy Court approves the adequacy of the related disclosure statement. Thereafter, the Debtor Company will have a period of time to obtain necessary acceptances from its creditors for its plan of reorganization. In the interim, the Debtor Company will continue to conduct discussions with the Creditor Committees regarding its plan of reorganization and related disclosure statement. Absent the requisite approvals referenced above, the Bankruptcy Court may confirm the Debtor Company's plan of reorganization, or a competing plan of reorganization, under the "cramdown" provisions of the Bankruptcy Code, assuming certain tests are met. Debtor Company Financial Statements The condensed financial statements of the Debtor Company are presented as follows: 52 NOTE 4 - PROCEEDINGS UNDER CHAPTER 11 (Continued) - ------------------------------------- DOW CORNING CORPORATION DEBTOR COMPANY CONDENSED BALANCE SHEET (in millions of dollars) ASSETS
December 31, 1997 ---------- CURRENT ASSETS: Cash and cash equivalents $ 55.1 Marketable securities 96.2 Accounts and notes receivable, including $348.6 receivable from subsidiaries 491.8 Anticipated implant insurance receivable 85.5 Inventories 144.1 Other current assets - Deferred income taxes 63.8 Other 19.9 ---------- Total current assets 956.4 ---------- INVESTMENTS: Equity in unconsolidated subsidiaries 622.6 PROPERTY, PLANT AND EQUIPMENT: 1,701.3 Less - Accumulated depreciation (1,129.9) ---------- 571.4 ---------- OTHER ASSETS: Marketable securities 145.3 Anticipated implant insurance receivable 911.6 Restricted insurance proceeds 517.2 Implant deposit 275.0 Environmental trusts 23.2 Deferred income taxes 389.9 Receivable from subsidiaries 330.2 Other assets 85.2 ---------- 2,677.6 ---------- $ 4,828.0 ==========
53 NOTE 4 - PROCEEDING UNDER CHAPTER 11 (Continued) DOW CORNING CORPORATION DEBTOR COMPANY CONDENSED BALANCE SHEET (in millions of dollars except share data) LIABILITIES AND STOCKHOLDERS' EQUITY
December 31, 1997 ---------- CURRENT LIABILITIES: Accounts payable $ 46.3 Payable to subsidiaries 78.1 Other current liabilities 138.3 ---------- Total current liabilities 262.7 ---------- OTHER LIABILITIES 75.7 LIABILITIES SUBJECT TO COMPROMISE: Trade accounts payable 66.2 Payable to subsidiaries 44.2 Accrued employee benefits 170.5 Accrued taxes 3.6 Implant reserve 2,406.3 Notes payable 375.0 Long-term debt 267.2 Other 130.3 ---------- 3,463.3 ---------- STOCKHOLDERS' EQUITY: Common stock, $5 par value - 2,500,000 shares 12.5 authorized and outstanding Retained earnings 1,026.2 Cumulative translation adjustment (12.4) ---------- 1,026.3 ---------- Stockholders' equity $4,828.0 ==========
54 NOTE 4 - PROCEEDING UNDER CHAPTER 11 (Continued) DOW CORNING CORPORATION DEBTOR COMPANY CONDENSED STATEMENT OF OPERATIONS AND RETAINED EARNINGS (in millions of dollars)
Year ended December 31, 1997 ----------------- NET SALES (includes $686.0 of sales to subsidiaries) $1,744.3 OPERATING COSTS AND EXPENSES: Manufacturing cost of sales 1,247.6 Marketing and administrative expenses 249.2 -------- 1,496.8 -------- OPERATING INCOME 247.5 OTHER INCOME: Interest income 57.6 Other, net 56.3 -------- INCOME BEFORE REORGANIZATION COSTS AND INCOME TAXES 361.4 Reorganization costs 45.0 -------- INCOME BEFORE INCOME TAXES 316.4 Income tax provision 133.6 -------- NET INCOME $ 182.8 ======== Earnings of unconsolidated subsidiaries and related eliminations 54.8 Retained earnings at beginning of year 788.6 -------- Retained earnings at end of year $1,026.2 ========
55 NOTE 4 - PROCEEDING UNDER CHAPTER 11 (Continued) DOW CORNING CORPORATION DEBTOR COMPANY CONDENSED STATEMENT OF CASH FLOWS (in millions of dollars)
Year ended December 31, 1997 ----------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 182.8 Adjustments to reconcile net income to net cash provided by operating activities - Depreciation and amortization 96.0 Deferred income taxes 23.0 Reorganization costs 45.0 Other (30.0) Implant payments (17.3) Implant insurance reimbursement 25.5 Restricted insurance proceeds (20.7) Changes in assets and liabilities - Accounts and notes receivable (56.1) Inventories (16.8) Accounts payable (32.3) Accrued taxes 21.8 Receivables from subsidiaries (132.6) Other (24.6) ------- Cash provided by operating activities 63.7 ------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (120.6) Proceeds from sales of marketable securities 319.3 Purchases of marketable securities (425.7) Dividends from subsidiaries 42.5 Other 99.2 ------- Cash (used for) investing activities (85.3) ------- CASH FLOWS FROM FINANCING ACTIVITIES: Net change in other short-term borrowings (4.4) ------- Cash (used for) financing activities (4.4) CASH FLOWS USED FOR REORGANIZATION COSTS (45.0) ------- CHANGES IN CASH AND CASH EQUIVALENTS: Net decrease in cash and cash equivalents (71.0) Cash and cash equivalents at beginning of year 126.1 ------- Cash and cash equivalents at end of year $ 55.1 =======
56 NOTE 4 - PROCEEDING UNDER CHAPTER 11 (Continued) The financial statements of the Debtor Company reflect transactions of the Debtor Company and transactions between the Debtor Company and all subsidiaries of the Debtor Company. The Debtor Company condensed statement of operations and retained earnings includes $686.0 of sales to subsidiaries in the caption "NET SALES." These sales are conducted at prices substantially comparable to those which would prevail in open-market transactions between unrelated parties. While operating in the Chapter 11 Proceeding, the Debtor Company is generally prohibited from paying interest on unsecured pre-petition debts of the Debtor Company. During such time as the Debtor Company is operating in the Chapter 11 Proceeding, it will only report interest expense to the extent that such interest will be paid during the Chapter 11 Proceeding at the direction or with the approval of the Bankruptcy Court. The amount of interest that has not been accrued as a result of the Chapter 11 Proceeding amounted to $49.0 ($30.9 after tax) for the year ended December 31, 1997, and $49.2 ($31.0 after tax) for the year ended December 31, 1996. Since May 15, 1995, the cumulative amount of interest that has not been accrued as a result of the Chapter 11 Proceeding amounted to $129.1 ($81.5 after tax). In accordance with the provisions of Statement of Financial Accounting Standards No. 34, "Capitalization of Interest Cost," $25.4 ($16.0 after tax) would have been capitalized as part of the historical cost of acquiring certain assets for the year ended December 31, 1997, and $14.1 ($8.9 after tax) for the year ended December 31, 1996. Since May 15, 1995, $46.1 ($29.1 after tax) would have been capitalized as part of the historical cost of acquiring certain assets. The Debtor Company has incurred and will continue to incur significant costs associated with the Chapter 11 Proceeding. The aggregate amount of these costs, which are being expensed as incurred, may have a material adverse impact on the Company's results of operations in future periods. These costs are recorded under the caption "Reorganization costs" in the accompanying statements of operations and retained earnings. The accompanying Debtor Company condensed statement of operations and retained earnings reflects interest income of $57.6 for the year ended December 31, 1997. The amount of interest income that the Debtor Company has earned as a result of the Chapter 11 Proceeding is immaterial. Due to the Debtor Company's status as a debtor-in-possession under Chapter 11 of the Bankruptcy Code, the Debtor Company is in default of its debt agreements. All outstanding debt of the Debtor Company as of May 15, 1995, has been presented under the caption "LIABILITIES SUBJECT TO COMPROMISE" in the accompanying balance sheets. NOTE 5 - FOREIGN CURRENCY Following is an analysis of the changes in the cumulative translation adjustment:
1997 1996 1995 ---- ---- ---- Balance, beginning of year $ 37.2 $ 67.5 $ 66.2 Translation adjustments, including gains (losses) from certain hedges and intercompany balances (48.6) (29.2) (4.2) Income tax effect of current year activity (1.0) (1.1) 5.5 ------ ------ ------ Balance, end of year $(12.4) $ 37.2 $ 67.5 ====== ====== ======
Net foreign currency losses currently recognized in income amounted to $(0.1) in 1997, $(3.9) in 1996, and $(4.5) in 1995. The net foreign currency loss currently recognized in income for 1997 includes $1.3 in net foreign currency gains which are included as part of the income tax provision in the accompanying consolidated statement of operations and retained earnings. 57 NOTE 6 - RESTRICTED ASSETS Implant Deposit In connection with the Settlement Agreement (as further described in Note 3 above), the Company has entered into an agreement whereby $275.0 is restricted to use for future breast implant settlement payments. Accordingly, this amount is included in the caption "Implant deposit" in the accompanying consolidated balance sheets. This amount is also subject to the provisions of a related escrow agreement which, among other things, appointed an independent escrow agent. The escrowed funds are invested in investment categories approved by the Bankruptcy Court. At December 31, 1997, the marketable securities included in the caption "Implant deposit" in the accompanying consolidated balance sheet primarily consisted of certificates of deposit, fixed rate and floating rate federal agency and corporate notes, and commercial paper. Anticipated Implant Insurance Receivable and Restricted Insurance Proceeds In addition, $492.3 of cash proceeds from settlements with insurers (received since the commencement of the Chapter 11 Proceeding) and $24.9 (net of tax) of related investment income is restricted as to its use pursuant to orders of the Bankruptcy Court. Accordingly, $517.2 is included in the caption "Restricted insurance proceeds" in the accompanying consolidated balance sheet. A majority of these proceeds relate to settlements of policies which name the Company and Dow Chemical as co-insureds. The Company and/or Dow Chemical will have rights to petition the Bankruptcy Court for distribution of these proceeds primarily for the purpose of making specified indemnity payments or reimbursing specified expense payments under conditions prescribed by the Bankruptcy Court. The "Restricted insurance proceeds" are invested in investment categories approved by the Bankruptcy Court. As of December 31, 1997, the marketable securities included in the caption "Restricted insurance proceeds" consisted primarily of state and municipal securities, and fixed and floating rate corporate notes. A majority of the "Anticipated implant insurance receivable" recorded in the accompanying consolidated balance sheets relates to policies which name the Company and Dow Chemical as co-insureds. The Company anticipates that future settlements of policies which name the Company as a co-insured will be subject to the approval of the Bankruptcy Court and restricted in a manner similar to that described above. Notwithstanding the above, the Company believes that it is probable that it will have access to such restricted funds sufficient to ultimately realize the "Restricted insurance proceeds" and "Anticipated implant insurance receivable" recorded in the accompanying consolidated balance sheets. At December 31, 1997 and 1996, the aggregate fair value of the marketable securities included in the caption "Restricted insurance proceeds" approximates carrying value. These amounts are summarized in the accompanying balance sheet as follows (at cost):
December 31, December 31, 1997 1996 ---- ---- Money Market Funds $ 13.9 $ 22.6 Demand Notes, Commercial Paper and Certificates of Deposit Maturity in a year or less 17.4 28.3 Maturity greater than one year 2.0 -- State and Municipal Securities Maturity in a year or less 289.7 365.7 Maturity between 1 and 5 years 141.0 55.1 Corporate Obligations Maturity in a year or less 53.2 9.2 ------ ------ $517.2 $480.9 ====== ======
58 NOTE 6 - RESTRICTED ASSETS (Continued) Other Assets - Environmental Trusts In order to comply with certain environmental regulations, the Company has contributed $23.2 to fund certain trusts in order to provide a financial assurance for the potential payment of aggregate estimated closure, post-closure, corrective action and potential liability costs associated with the operation of hazardous waste storage facilities at certain plant sites (see Note 3 for further discussion). Accordingly, this amount is included in the caption "Environmental trusts" in the accompanying consolidated balance sheet. As of December 31, 1997, these funds were primarily invested in money market funds. NOTE 7 - INVENTORIES Following is a summary of inventories by costing method at December 31:
1997 1996 ---- ---- Raw material, work-in-process and finished goods: Valued at LIFO $221.9 $205.6 Valued at FIFO 104.0 92.7 ------ ------ $325.9 $298.3 ====== ======
Under the dollar value LIFO method used by the Company, it is impracticable to separate inventory values by classifications. Inventories valued using LIFO at December 31, 1997 and 1996 are stated at approximately $76.0 and $55.8, respectively, less than they would have been if valued at replacement cost. NOTE 8 - UNRESTRICTED INVESTMENTS Excluding investments accounted for on the equity basis, the carrying amount for unrestricted investments at December 31, 1997 and 1996 was $340.3 and $234.8, respectively. These unrestricted investments consist principally of obligations backed by the U. S. Government or one of its agencies and corporate issue preferred equities; and have been classified as "available for sale" in conformity with SFAS 115. The aggregate fair value of these unrestricted investments approximates carrying value, and there were no material realized gain or losses for the years ended December 31, 1997 and 1996, nor unrealized gains or losses at December 31, 1997 or 1996. Fair values are determined based on quoted market prices or, if quoted market prices are not available, on market prices of comparable instruments. Unrestricted investments are included in the captions "Marketable securities" in the current and noncurrent section of the accompanying consolidated balance sheets. NOTE 9 - NOTES PAYABLE AND CREDIT FACILITIES Notes payable at December 31, consisted of the following:
1997 1996 ---- ---- CURRENT LIABILITIES: Notes payable $ 14.8 $ 5.0 ====== ====== LIABILITIES SUBJECT TO COMPROMISE: Revolving credit agreement $375.0 $375.0 ====== ======
59 NOTE 9 - NOTES PAYABLE AND CREDIT FACILITIES (Continued) During 1993, the Debtor Company entered into a revolving credit agreement with 16 domestic and foreign banks which provided for borrowings on a revolving credit basis until November, 1997, of up to $400.0. Under the provisions of the revolving credit agreement, the Debtor Company is subject to certain debt restrictions and provisions. Due to the Debtor Company's status as a debtor-in-possession under Chapter 11 of the Bankruptcy Code, the Debtor Company is in default on its debt agreements, including the revolving credit agreement. At May 15, 1995, the interest rate on amounts outstanding under the revolving credit agreement was 7.13%. While operating in the Chapter 11 Proceeding, the Debtor Company is prohibited from paying interest on unsecured pre-petition debts including the debt incurred under the revolving credit agreement. The Company is unable to estimate the fair value of the debt incurred under the revolving credit agreement due to the uncertainty associated with the Debtor Company's filing for protection under Chapter 11 of the Bankruptcy Code. Amounts outstanding under short-term lines of credit are liabilities of the subsidiaries of the Debtor Company and are described as "Other bank borrowings" in the table above. The carrying amounts of these short-term borrowings approximate their fair value. NOTE 10 - LONG-TERM DEBT Long-term debt at December 31, consisted of the following:
1997 1996 ---- ---- LONG-TERM DEBT: Variable-rate Notes, maturing serially 1997-1999, 6.14375% at December 31, 1997 $ 19.0 $ 20.0 Variable-rate Notes due 1998, 4.84531%-5.9000% at December 31, 1997 19.7 22.6 Variable rate long-term line of credit expiring 2002, 6.5175% at December 31, 1997 101.3 36.0 Other obligations and capital leases 25.1 26.0 ------ ------ 165.1 104.6 Less - Payments due within one year 24.2 1.3 ------ ------ $140.9 $103.3 ====== ====== LIABILITIES SUBJECT TO COMPROMISE: 9.375% Debentures due 2008 $ 75.0 $ 75.0 8.15% Debentures due 2029 50.0 50.0 8.125%-9.5% Medium-term Notes due 1995-2001, 8.71% average rate at December 31, 1997 34.5 34.5 Variable-rate Notes due 1995-1998, 6.688%-7.234% at December 31, 1997 84.8 84.8 5.55% Japanese Yen Notes due 1998 22.9 26.1 ------ ------ $267.2 $270.4 ====== ======
Due to the Debtor Company's filing for protection under Chapter 11 of the Bankruptcy Code (see Note 4 above), long-term debt of the Debtor Company was reclassified in 1995 to the caption "LIABILITIES SUBJECT TO COMPROMISE" in the table above and in the accompanying consolidated balance sheets. At December 31, 1997, the amount shown under the caption "Long-term debt" in the table above represents long-term debt of the subsidiaries of the Debtor Company. At December 31, 1997, the fair value of the long-term debt of the subsidiaries of the Debtor Company approximated the book value of $165.1. The Company is unable to estimate the fair value of the long-term debt of the Debtor Company at December 31, 1997, due to the uncertainty associated with the Debtor Company's filing for protection under Chapter 11 of the Bankruptcy Code. 60 NOTE 10 - LONG-TERM DEBT (Continued) Due to the Debtor Company's status as a debtor-in-possession under Chapter 11 of the Bankruptcy Code, the Debtor Company is in default on its debt agreements. Annual aggregate maturities of the long-term debt of the subsidiaries of the Debtor Company are: $24.2 in 1998, $19.7 in 1999, $1.7 in 2000, $0.5 in 2001, and $119.0 thereafter.40 While operating in the Chapter 11 Proceeding, the Debtor Company is prohibited from paying interest on unsecured pre-petition debts of the Debtor Company. Cash paid during the year for interest was $10.7 in 1997, $7.8 in 1996 and $34.5 in 1995. NOTE 11 - CURRENCY RATE DERIVATIVES The Company enters into forward exchange contracts primarily to hedge monetary assets and liabilities not denominated in functional currencies. In 1997, the Company entered into additional forward exchange contract positions to hedge the tax effects attributable to this exposure. Gains and losses on these contracts are recognized concurrent with the gains and losses from the associated exposures. Forward exchange contracts are shown in the following table:
December 31, 1997 December 31, 1996 ----------------- ----------------- Book Notional Book Notional Value Amount Value Amount ----- ------ ----- ------ Forward exchange contracts: -to buy Belgian Francs / US Dollars (0.1) 15.7 -- 6.3 -to sell Belgian Francs / US Dollars 0.1 3.9 0.1 6.1 -to sell Belgian Francs / ECU 0.1 68.8 -- -- -to buy British Pounds / US Dollars -- -- 0.4 13.1 -to sell British Pounds / US Dollars 1.5 61.7 (1.3) 53.0 -to buy British Pounds / ECU 3.9 190.8 -- -- -to sell ECU / US Dollars 7.1 267.8 2.9 159.6 -to buy German Marks / US Dollars -- -- (0.1) 8.3 -to sell German Marks / US Dollars 0.1 7.3 -- 2.6 -to buy German Marks / ECU 0.1 38.4 -- -- -to sell German Marks / ECU -- 4.5 -- -- -to buy Japanese Yen / US Dollars (0.1) 2.0 (0.3) 11.9 -to sell Japanese Yen / US Dollars 0.4 8.2 0.5 13.1 -to buy Korean Won / US Dollars (4.9) 17.3 -- -- -to sell Korean Won / US Dollars 6.2 24.0 -- 18.7 -to buy other currencies / US Dollars (0.2) 7.9 -- 14.8 -to sell other currencies / US Dollars 1.4 90.4 (0.1) 88.2
The fair values of forward exchange contracts are estimated by obtaining quotes from brokers. The book values of these instruments approximate fair values. The weighted average maturity for all outstanding forward exchange contracts at December 31, 1997 and 1996 was less than one year. The Company maintains defined benefit employee retirement plans covering most domestic and certain non-U.S. employees. The Company also has various defined contribution and savings plans covering certain employees. Plan benefits for defined benefit employee retirement plans are based primarily on years of service and compensation. The Company's funding policy is consistent with national laws and regulations. Plan assets include marketable equity securities, insurance contracts, corporate and government debt securities, real estate and cash. 61 NOTE 12 - POST EMPLOYMENT BENEFITS The components of pension expense for the Company's domestic and international plans are set forth below:
1997 1996 1995 ---- ---- ---- Defined benefit plans: Service cost (benefits earned during the period) $ 22.9 $24.3 $19.5 Interest cost on projected benefit obligations 54.2 51.3 48.1 Actual return on plan assets (152.8) (56.4) (110.7) Net amortization 92.0 4.0 3.6 Difference between actual and expected return on plan assets 13.8 11.3 68.3 ------ ----- ------ 30.1 34.5 28.8 ------ ----- ------ Defined contribution and savings plans 14.2 13.7 13.4 ------ ----- ------ Total Pension Expense $ 44.3 $48.2 $42.2 ====== ===== =====
The following table presents reconciliations of defined benefit plans' funded status with amounts recognized in the Company's consolidated balance sheets as part of other assets and other long-term liabilities. Plans with assets exceeding the accumulated benefit obligation ("ABO") are segregated by column from plans with ABO exceeding assets.
December 31, ------------ 1997 1996 ------------------ -------------------- Assets ABO Assets ABO exceed exceeds exceed exceeds ABO assets ABO assets --- ------ --- ------ Actuarial present value of benefit obligations: Vested $567.7 $ 41.8 $482.7 $ 42.6 Nonvested 54.0 4.2 48.1 5.3 ------ ----- ------ ----- Accumulated benefit obligation 621.7 46.0 530.8 47.9 Provision for future salary increases 133.9 9.9 115.9 13.2 ----- ----- ------ ----- Projected benefit obligation 755.6 55.9 646.7 61.1 Plan assets at fair value 774.4 6.3 640.4 6.7 ------ ----- ------ ----- Plan assets less projected benefit obligation 18.8 (49.6) (6.3) (54.4) Unrecognized net loss (gain) (52.2) 4.2 (26.7) 7.4 Unrecognized (negative) prior service costs 32.2 (3.3) 35.6 (4.0) Unrecognized net transition obligation 4.7 0.8 5.7 1.3 Contribution between measurement date and fiscal year end 0.4 -- -- -- Additional minimum liability (6.6) 0.2 (6.5) (0.3) ------ ----- ------ ----- Prepaid (accrued) pension cost$ $ (2.7) $(47.7) $ 1.8 $(50.0) ====== ===== ====== =====
62 NOTE 12 - POST EMPLOYMENT BENEFITS (Continued) The weighted average discount rate used in determining the actuarial present value of the projected benefit obligation for defined benefit plans was 7.6% in 1997 and 7.9% in 1996. The weighted average rate of increase in future compensation levels was determined using an age specific salary scale and was 5.6% in 1997 and 5.5% in 1996. The weighted average expected long-term rate of return on plan assets was 8.5% in 1997 and 8.5% in 1996. In addition to providing pension benefits, the Company, primarily in the United States, provides certain health care and life insurance benefits for most retired employees. The cost of providing these benefits to retirees outside the United States is not significant. Net periodic postretirement benefit cost includes the following components:
1997 1996 1995 ---- ---- ---- Service cost $ 3.7 $ 3.6 $ 3.5 Interest cost 10.9 10.1 10.4 Amortization of negative prior service cost (14.1) (14.1) (14.1) ----- ----- ------ $ 0.5 $(0.4) $(0.2) ===== ====== ======
The following table presents the accrued postretirement benefit cost recognized in the Company's consolidated balance sheets as part of liabilities subject to compromise:
December 31, December 31, 1997 1996 ---- ---- Accumulated postretirement benefit obligation: Retirees $ 76.2 $ 73.2 Fully eligible, active plan participants 41.3 36.4 Other active plan participants 40.3 28.2 ------ ------ 157.8 137.8 Unrecognized negative prior service cost 24.4 39.7 Unrecognized net loss (11.7) (1.2) ------ ------ Accrued postretirement benefit cost $170.5 $176.3 ====== ======
In December 1992, the Company amended its retiree health care benefit plan to require that, beginning in 1994, employees have a certain number of years of service to be eligible for any retiree health care benefit. This amendment resulted in the Company recording an unrecognized negative prior service cost, which is being amortized in the accompanying consolidated statement of operations. The retiree health care plan provides for certain cost-sharing changes which limit the Company's share of retiree health care costs. The Company continues to fund benefit costs on a pay-as-you-go basis with the retiree paying a portion of the costs. The health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 8.17% in 1997 and was assumed to decrease gradually to 5.0% in 2004 and remain at that level thereafter. For retirees under age 65, plan features limit the health care cost trend rate assumption to a maximum of 8.0% for years 1994 and later. The health care cost trend rate assumption has a significant effect on the amounts reported. Increasing the assumed health care cost trend rate by one percentage point in each year would increase the accumulated postretirement benefit obligation by 7.8% and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1997 by 7.7%. The discount rate used in determining the accumulated postretirement benefit obligation was 7.5% at December 31, 1997 and 8.0% at December 31, 1996. 63 NOTE 13 - RELATED PARTY TRANSACTIONS The Company purchased raw materials and services totaling $59.5 in 1997, $51.1 in 1996 and $49.7 in 1995 from Dow Chemical and its affiliates. The Company believes the costs of such purchases were competitive with alternative sources of supply. Other transactions between the Company and related parties were not material. NOTE 14 - INCOME TAXES The components of income (loss) before income taxes are as follows:
1997 1996 1995 ---- ---- ---- U.S. companies $385.4 $387.9 $(126.4) Non-U.S. companies 41.9 21.1 103.5 ------ ------ ------- $427.3 $409.0 $(22.9) ====== ====== =======
The components of the income tax provision (benefit) are as follows:
1997 1996 1995 ---- ---- ---- Current U.S. $ 93.7 $ 96.7 $ 38.5 Non-U.S. 35.2 35.0 52.6 ------ ------ ------ 128.9 131.7 91.1 ----- ------ ------ Deferred U.S. 28.7 35.5 (101.8) Non-U.S. 11.2 1.7 1.1 ------ ------ ------ 39.9 37.2 (100.7) ------ ------ ------ $168.8 $168.9 $ (9.6) ====== ====== ======
The tax effects of the principal temporary differences giving rise to deferred tax assets and liabilities were as follows:
December 31, December 31, 1997 1996 ---- ---- Implant costs $387.2 $392.7 Accruals deductible for tax purposes when paid 98.2 62.1 Postemployment benefits 72.1 62.4 Basis in inventories 30.4 25.7 Tax credit and net operating loss carryforwards 11.1 9.0 Other 40.2 52.5 ------ ------ 639.2 604.4 Valuation allowance (0.4) (3.3) ------ ------ 638.8 601.1 ------ ------ Long-term debt (45.3) (28.1) Property, plant and equipment (81.3) (40.6) ------ ------ (126.6) (68.7) Net deferred tax asset $512.2 $532.4 ====== ======
Management believes that it is more likely than not that the net deferred tax asset will be realized. This belief is based on criteria established in Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." 64 NOTE 14 - INCOME TAXES (Continued) At December 31, 1997 income and remittance taxes have not been recorded on $225.1 of undistributed earnings of non-U.S. subsidiaries, either because any taxes on dividends would be offset substantially by foreign tax credits or because the Company intends to indefinitely reinvest those earnings. Cash paid during the year for income taxes, net of refunds received, was $108.8 in 1997, $142.0 in 1996 and $107.4 in 1995. The income tax provision (benefit) at the effective rate differs from the income tax provision (benefit) at the U.S. federal statutory tax rate in effect during those years for the following reasons:
Year ended December 31, ----------------------- 1997 1996 1995 ---- ---- ---- Income tax provision (benefit) at statutory rate $149.5 $143.1 $(8.0) Foreign taxes, net 14.1 14.0 8.6 Foreign sales corporation (9.9) (8.6) (5.8) State income taxes 6.7 5.6 (6.2) Accrued expenses 13.6 14.6 7.7 Tax exempt interest (6.0) (1.5) (0.4) Other, net 0.8 1.7 (5.5) ------ ------ ------ Income tax provision (benefit) at effective rate $168.8 $168.9 $(9.6) ====== ====== =====
NOTE 15 - COMMON STOCK The outstanding shares of the Company's common stock are held in equal portions by Corning Incorporated and Dow Holdings Inc., a wholly-owned subsidiary of Dow Chemical. There were no changes in outstanding shares during 1997, 1996 or 1995. Per share data is based upon 2,500,000 shares outstanding for all periods. NOTE 16 - COMMITMENTS AND GUARANTEES The Company leases certain real and personal property under agreements which generally require the Company to pay for maintenance, insurance and taxes. Rental expense was $49.4 in 1997, $46.3 in 1996 and $47.9 in 1995. The minimum future rental payments required under noncancelable operating leases at December 31, 1997, in the aggregate are $89.7 including the following amounts due in each of the next five years: 1998 - $36.9, 1999 - $25.2, 2000 - $14.9, 2001 - $5.7, and 2002 - $2.3. At December 31, 1997, the Company had entered into various take or pay agreements for steam, electrical power, and materials used in the normal course of business for terms extending from one to fifteen years at prices not in excess of current market prices. The Company has not issued any guarantees of a material nature as of December 31, 1997. 65 NOTE 17 - INDUSTRY SEGMENT AND INTERNATIONAL OPERATIONS The Company's operations are classified as a single industry segment. Financial data by geographic area are presented below:
1997 1996 1995 ---- ---- ---- Net sales to customers: United States $1,166.9 $1,094.3 $1,005.4 Europe 608.7 610.1 642.4 Asia 718.9 697.0 725.9 Other 149.0 130.9 119.2 -------- -------- -------- Net sales to customers $2,643.5 $2,532.3 $2,492.9 ======== ======== ======== Interarea sales: United States $ 437.6 $ 379.0 $ 381.4 Europe 55.5 53.7 48.7 Asia 11.6 9.4 10.6 Other 0.6 3.1 0.5 -------- -------- -------- Interarea sales $ 505.3 $ 445.2 $ 441.2 ======== ======== ======== Operating profit: United States $ 434.4 $ 455.5 $ 410.3 Europe 30.4 54.5 51.2 Asia 25.5 12.3 35.7 Other and eliminations 24.1 16.8 13.2 -------- -------- -------- 514.4 539.1 510.4 General corporate expenses (177.0) (203.6) (534.9) Unallocated income (expense), net 89.9 73.5 1.6 -------- -------- -------- Income (loss) before income taxes $ 427.3 $ 409.0 $ (22.9) ======== ======== ======== Identifiable assets: United States $1,380.4 $1,202.8 $1,040.1 Europe 732.8 627.3 568.6 Asia 535.2 539.0 609.9 Other and eliminations 66.1 73.0 43.0 -------- -------- -------- 2,714.5 2,442.1 2,261.6 Corporate assets 2,604.2 2,672.0 2,696.8 -------- -------- -------- Total assets $5,318.7 $5,114.1 $4,958.4 ======== ======== ========
Interarea sales are made on the basis of arm's length pricing. Operating profit is total sales less certain operating expenses. General corporate expenses, equity in earnings of associated companies, interest income and expense, certain currency gains (losses), minority interests' share in income, and income taxes have not been reflected in computing operating profit. General corporate expenses include implant costs, certain research and development costs and corporate administrative personnel and facilities costs not specifically identified with a geographic area. Identifiable assets are those operating assets identified with the operations in each geographic area. Corporate assets are principally cash and cash equivalents, marketable securities, restricted insurance proceeds, anticipated implant insurance receivables, certain deferred income tax assets, intangible assets, investments accounted for on the equity basis and corporate facilities. 66 Item 14(c) Exhibit #12 CORNING INCORPORATED AND SUBSIDIARY COMPANIES COMPUTATION OF RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED DIVIDENDS (Dollars in millions, except ratios)
Fiscal Year Ended ------------------------------------------------------ Dec. 31, Dec. 31, Dec. 31, Jan. 1, Jan. 2, 1997 1996 1995 1995 1994 ------ ------ ------ ------ ----- Income before taxes on income $629.2 $455.9 $389.4 $286.3 $ 93.7 Adjustments: Share of earnings (losses) before taxes of 50% owned companies 111.5 130.3 95.2 89.0 (137.0) Gain (loss) before taxes of greater than 50% owned unconsolidated subsidiary 0.7 (3.1) (4.0) (3.1) Distributed income of less than 50% owned companies and share of loss if debt is guaranteed 2.1 4.5 Amortization of capitalized interest 16.6 11.8 9.6 13.3 13.0 Fixed charges net of capitalized interest 141.9 105.9 82.6 128.8 91.4 ------ ------ ------ ------ ------ Earnings before taxes and fixed charges as adjusted $899.2 $704.6 $573.7 $515.5 $ 62.5 ====== ====== ====== ====== ====== Fixed charges: Interest incurred $ 96.7 $ 73.6 $ 65.4 $ 64.9 $ 51.1 Share of interest incurred of 50% owned companies and interest on guaranteed debt of less than 50% owned companies 51.0 38.7 10.2 60.8 40.9 Interest incurred by greater than 50% owned unconsolidated subsidiary 0.7 0.8 0.8 Portion of rent expense which represents interest factor 15.9 12.1 13.3 10.8 7.3 Share of portion of rent expense which represents interest factor for 50% owned companies 3.8 1.4 2.7 9.4 9.1 Portion of rent expense which represents interest factor for greater than 50% owned unconsolidated subsidiary 0.1 0.1 Amortization of debt costs 1.6 2.2 (0.1) 0.6 0.4 ------ ------ ------ ------ ------ Total fixed charges 169.0 128.0 92.2 147.4 109.7 Capitalized interest (27.1) (22.1) (9.6) (18.6) (18.3) ------ ------ ------ ------ ------ Total fixed charges net of capitalized interest $141.9 $105.9 $ 82.6 $128.8 $ 91.4 ====== ====== ====== ====== ====== Preferred dividends: Preferred dividend requirements $ 15.3 $ 15.7 $ 15.7 $ 8.2 $ 2.1 Ratio of pre-tax income to income before minority interest and equity earnings 1.5 1.5 1.4 1.4 1.0 ------ ------ ------ ------ ----- Pre-tax preferred dividend requirement 23.0 23.6 22.0 11.5 2.1 Total fixed charges 169.0 128.0 92.2 147.4 109.7 ------ ------ ------ ------ ------ Fixed charges and pre-tax preferred dividend requirement $192.0 $151.6 $114.2 158.9 $111.8 ====== ====== ====== ====== ====== Ratio of earnings to combined fixed charges and preferred dividends 4.7x 4.7x 5.0x 3.2x -- ====== ====== ====== ====== ======
Earnings did not cover combined fixed charges and preferred dividends by $49.4 in the fiscal year ended January 2, 1994. 67 Item 14(c) Exhibit #23 CONSENT OF INDEPENDENT ACCOUNTANTS PricewaterhouseCoopers LLP We hereby consent to the incorporation by reference in the Prospectus constituting part of the Registration Statements on Form S-8 (Nos. 2-77248, 33-12605, 33-25162, 33-30575, 33-30815, 33-47133, 33-62682, 33-50201, 33-55345, 33-34602, 33-58193, 33-63887, 33-18329, 33-3036, 333-24337, 333-26049 and 333-26151) and Form S-3 (Nos. 33-40956, 33-44295, 33-49903, 33-53821 and 33-56887) of Corning Incorporated of our report dated January 28, 1998, except for the first paragraph of Note 1, as to which the date is June 30, 1998, appearing on Page 3 of this Form 10-K/A and our report relating to the Dow Corning Corporation financial statements dated January 21, 1998, appearing on page 34 of this Form 10-K/A. /s/ PricewaterhouseCoopers LLP 1177 Avenue of the Americas New York, New York 10036 July 6, 1998 The following exhibits are included only in copies of the 1997 Annual Report on Form 10-K filed with Securities and Exchange Commission. Exhibit #3(i) Certificate of Amendment, dated June 24, 1996 of the Restated Certificate of Incorporation Exhibit #3(ii) By-Laws of Corning Incorporated, as amended and effective as of April 25, 1996 Exhibit #24 Powers of Attorney Exhibit #27 Financial Data Schedule Copies of these exhibits may be obtained by writing to Mr. A. John Peck Jr., secretary, Corning Incorporated, MP-HQ-E2-10, Corning, New York 14831. EX-27.1 2 RESTATED CORNING INC. Q4 '97 EX-27
5 1,000 U.S. DOLLARS Dec-31-1997 Jan-1-1997 Dec-31-1997 12-mos 1 61,000 36,000 559,700 10,700 428,300 1,199,100 2,267,900 1,733,400 4,691,900 957,700 1,125,800 365,300 19,800 707,200 539,300 4,691,900 3,516,800 3,554,300 2,042,300 2,042,300 0 23,800 72,000 629,200 209,500 408,900 30,900 0 0 439,800 1.92 1.85
EX-27.2 3 RESTATED CORNING INC. Q4 '96 EX-27
5 1,000 U.S. DOLLARS Dec-31-1996 Jan-1-1996 Dec-31-1996 12-mos 1 43,800 171,300 485,900 14,200 364,500 1,177,400 1,808,600 1,541,100 4,183,400 732,200 1,195,100 365,100 22,200 566,000 395,100 4,183,400 3,024,000 3,053,700 1,830,100 1,830,100 0 18,400 57,200 455,800 151,400 323,300 (147,700) 0 0 175,600 0.76 0.78
EX-27.3 4 RESTATED CORNING INC. Q4 '95 EX-27
5 1,000 U.S. DOLLARS Dec-31-1995 Jan-1-1995 Dec-31-1995 12-mos 1 62,600 114,100 382,500 11,500 299,200 936,800 1,438,700 1,316,600 5,334,500 660,300 1,326,000 364,700 23,900 1,113,000 990,000 5,334,500 2,644,700 2,671,400 1,608,700 1,608,700 0 400 56,600 389,400 107,300 (77,300) 26,500 0 0 (50,800) (0.23) (0.23)
EX-27.4 5 RESTATED CORNING INC. Q1 '97 EX-27
5 1,000 U.S. DOLLARS Dec-31-1997 Jan-1-1997 Mar-31-1997 3-mos 1 28,200 71,100 575,300 15,600 389,700 1,165,800 1,804,400 1,583,300 4,169,700 680,900 1,181,600 365,100 21,700 590,600 403,900 4,169,700 817,100 827,000 475,700 475,700 0 10,000 21,200 143,500 49,000 85,400 6,600 0 0 92,000 0.40 0.39
EX-27.5 6 RESTATED CORNING INC. Q2 '97 EX-27
5 1,000 U.S. DOLLARS Dec-31-1997 Jan-1-1997 Jun-30-1997 6-mos 1 58,200 80,100 578,600 14,400 417,800 1,243,600 1,897,000 1,645,100 4,396,800 768,400 1,148,500 365,100 21,100 660,100 475,800 4,396,800 1,722,600 1,741,600 991,000 991,000 0 13,300 40,700 332,800 113,200 210,400 8,600 0 0 219,000 0.96 0.92
EX-27.6 7 RESTATED CORNING INC. Q3 '97 EX-27
5 1,000 U.S. DOLLARS Dec-31-1997 Jan-1-1997 Sep-30-1997 9-mos 1 12,900 64,700 576,600 12,800 432,000 1,209,800 1,982,900 1,697,300 4,499,900 775,600 1,134,400 365,200 20,100 693,300 534,000 4,499,900 2,614,500 2,642,900 1,515,900 1,515,900 0 18,900 56,900 482,900 161,200 317,200 14,100 0 0 331,300 1.45 1.39
EX-27.7 8 RESTATED CORNING INC. Q1 '96 EX-27
5 1,000 U.S. DOLLARS Dec-31-1996 Jan-1-1996 Mar-31-1996 3-mos 1 101,800 57,500 899,900 13,700 371,700 1,621,500 1,959,400 1,471,300 5,928,700 1,096,400 1,378,700 364,800 23,600 1,135,400 999,800 5,928,700 704,800 712,200 423,900 423,900 0 600 14,700 103,300 33,900 65,400 6,400 0 0 71,800 0.31 0.31
EX-27.8 9 RESTATED CORNING INC. Q2 '96 EX-27
5 1,000 U.S. DOLLARS Dec-31-1996 Jan-1-1996 Jun-30-1996 6-mos 1 59,000 55,700 495,000 12,800 332,400 1,048,700 1,611,500 1,445,800 5,649,100 924,600 1,296,700 364,900 23,300 1,155,800 980,300 5,649,100 1,486,200 1,499,900 900,800 900,800 0 0 29,800 241,800 79,300 162,500 (52,900) 0 0 108,800 0.47 0.48
EX-27.9 10 RESTATED CORNING INC. Q3 '96 EX-27
5 1,000 U.S. DOLLARS Dec-31-1996 Jan-1-1996 Sep-30-1996 9-mos 1 37,300 84,300 466,100 12,400 343,400 1,028,500 1,687,800 1,430,200 5,609,800 967,700 1,264,300 365,000 22,700 1,174,400 900,900 5,609,800 2,233,100 2,255,100 1,340,000 1,340,000 0 100 44,500 363,800 119,700 251,300 (162,300) 0 0 89,000 0.38 0.41
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