UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended
September 30, 2002
-------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from to
-------- -------
Commission File Number 1-8864
USG CORPORATION
- -------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 36-3329400
- -------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
125 South Franklin Street, Chicago, Illinois 60606-4678
- -------------------------------------------------------------------------------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (312) 606-4000
----------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes X No
----- -----
As of September 30, 2002, 43,249,351 shares of USG common stock were
outstanding.
TABLE OF CONTENTS
Page
------
PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Statements of Earnings:
Three Months and Nine Months
Ended September 30, 2002 and 2001 3
Consolidated Balance Sheets:
As of September 30, 2002 and December 31, 2001 4
Consolidated Statements of Cash Flows:
Nine Months Ended September 30, 2002 and 2001 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Results
of Operations and Financial Condition 36
Item 4. Controls and Procedures 50
Reports of Independent Public Accountants 51
PART II OTHER INFORMATION
Item 1. Legal Proceedings 54
Item 6. Exhibits and Reports on Form 8-K 54
SIGNATURES 55
-2
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
USG CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS
(DOLLARS IN MILLIONS EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------- -------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Net sales $ 903 $ 842 $ 2,617 $ 2,474
Cost of products sold 749 734 2,164 2,196
Selling and administrative expenses 76 69 238 202
Chapter 11 reorganization expenses 3 (1) 12 9
Provision for restructuring expenses - (9) - (9)
---------- ---------- ---------- ----------
Operating profit 75 49 203 76
Interest expense 1 1 4 31
Interest income (1) (1) (3) (4)
Other expense (income), net - 2 (1) 2
---------- ---------- ---------- ----------
Earnings before income taxes and
cumulative effect of accounting
change 75 47 203 47
Income taxes 31 20 85 22
---------- ---------- ---------- ----------
Earnings before cumulative effect
of accounting change 44 27 118 25
---------- ---------- ---------- ----------
Cumulative effect of accounting
change for SFAS No. 142 - - (96) -
---------- ---------- ---------- ----------
Net earnings 44 27 22 25
========== ========== ========== ==========
EARNINGS (LOSS) PER COMMON SHARE:
Basic and diluted before
cumulative effect of accounting
change 1.03 0.61 2.73 0.57
Cumulative effect of accounting
change for SFAS No. 142 - - (2.22) -
---------- ---------- ---------- ----------
Basic and diluted 1.03 0.61 0.51 0.57
========== ========== ========== ==========
Dividends paid per common share - - - 0.025
Average common shares 43,251,295 43,460,145 43,292,083 43,423,602
Average diluted common shares 43,251,295 43,460,145 43,292,083 43,432,405
See accompanying Notes to Consolidated Financial Statements.
-3-
USG CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
(UNAUDITED)
AS OF AS OF
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 596 $ 493
Short-term marketable securities 31 -
Receivables (net of reserves - $18 and $17) 326 274
Inventories 291 254
Income taxes receivable - 76
Deferred income taxes 57 66
Other current assets 39 34
------------- ------------
Total current assets 1,340 1,197
Long-term marketable securities 121 -
Property, plant and equipment (net of
accumulated depreciation and depletion -
$652 and $592) 1,781 1,800
Deferred income taxes 206 243
Other assets 117 224
------------- ------------
Total Assets 3,565 3,464
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable 194 140
Accrued expenses 231 181
Taxes on income 5 -
------------- ------------
Total current liabilities 430 321
Long-term debt 2 2
Other liabilities 334 339
Liabilities subject to compromise 2,276 2,311
Stockholders' Equity:
Preferred stock - -
Common stock 5 5
Treasury stock (256) (255)
Capital received in excess of par value 411 408
Accumulated other comprehensive loss (23) (31)
Retained earnings 386 364
------------- ------------
Total stockholders' equity 523 491
------------- ------------
Total Liabilities and Stockholders' Equity 3,565 3,464
============= ============
See accompanying Notes to Consolidated Financial Statements.
-4-
USG CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
NINE MONTHS
ENDED SEPTEMBER 30,
-------------------------------
2002 2001
------------- ------------
OPERATING ACTIVITIES:
Net earnings $ 22 $ 25
Adjustments to reconcile net earnings to
net cash:
Cumulative effect of accounting change 96 -
Depreciation, depletion and amortization 77 80
Deferred income taxes 45 106
(Increase) decrease in working capital:
Receivables 24 (93)
Inventories (37) 4
Payables 59 102
Accrued expenses 53 7
Increase in other assets (2) (20)
Increase (decrease) in other liabilities (5) 9
Increase (decrease) in asbestos reserve,
net of receivables 22 (102)
Decrease in liabilities subject to compromise (35) (46)
Other, net (2) 32
------------- ------------
Net cash from operating activities 317 104
------------- ------------
INVESTING ACTIVITIES:
Capital expenditures (64) (75)
Purchases of marketable securities (177) -
Sale or maturities of marketable securities 25 -
Net proceeds from asset dispositions 2 1
------------- ------------
Net cash to investing activities (214) (74)
------------- ------------
FINANCING ACTIVITIES:
Issuance of debt - 262
Repayment of debt - (131)
Short-term borrowings, net - 165
Cash dividends paid - (1)
------------- ------------
Net cash from financing activities - 295
------------- ------------
Net increase in cash and cash equivalents 103 325
Cash and cash equivalents at beginning
of period 493 70
------------- ------------
Cash and cash equivalents at end of period 596 395
============= ============
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Interest paid 1 31
Income taxes refunded, net (41) (4)
See accompanying Notes to Consolidated Financial Statements.
-5-
USG CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) PREPARATION OF FINANCIAL STATEMENTS
The accompanying unaudited consolidated financial statements of USG
Corporation and its subsidiaries ("the Corporation") have been prepared in
accordance with applicable United States Securities and Exchange Commission
guidelines pertaining to interim financial information. The preparation of
financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses. Actual results could differ from those
estimates. In the opinion of management, the financial statements reflect
all adjustments, which are of a normal recurring nature, necessary for a
fair presentation of the Corporation's financial results for the interim
periods. These financial statements and notes are to be read in conjunction
with the financial statements and notes included in the Corporation's 2001
Annual Report on Form 10-K dated March 1, 2002.
(2) VOLUNTARY REORGANIZATION UNDER CHAPTER 11
On June 25, 2001 (the "Petition Date"), the parent company (the "Parent
Company") of the Corporation and the ten United States subsidiaries listed
below (collectively, the "Debtors") filed voluntary petitions for
reorganization (the "Filing") under chapter 11 of the United States
Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy
Court for the District of Delaware (the "Bankruptcy Court"). The chapter 11
cases of the Debtors (collectively, the "Chapter 11 Cases") have been
consolidated for purposes of joint administration as In re: USG Corporation
et al. (case no. 01-2094). The Chapter 11 Cases do not include any of the
Corporation's non-U.S. subsidiaries. The following subsidiaries filed
chapter 11 petitions:
United States Gypsum Company
USG Interiors, Inc.
USG Interiors International, Inc.
L&W Supply Corporation
Beadex Manufacturing, LLC
B-R Pipeline Company
La Mirada Products Co., Inc.
Stocking Specialists, Inc.
USG Industries, Inc.
USG Pipeline Company
This action was taken to resolve asbestos-related claims in a fair and
equitable manner, to protect the long-term value of the Debtors' businesses
and to maintain the Debtors' leadership positions in their markets.
-6-
CONSEQUENCES OF THE FILING
The Debtors are operating their businesses without interruption as
debtors-in-possession subject to the provisions of the Bankruptcy Code. All
vendors are being paid for all goods furnished and services provided after
the Filing. However, as a consequence of the Filing, pending litigation
against the Debtors as of the Petition Date is stayed, and no party may
take any action to pursue or collect pre-petition claims except pursuant to
an order of the Bankruptcy Court. It is the Debtors' intention to address
all pending and future asbestos-related claims and all other pre-petition
claims in a plan of reorganization. However, it is impossible to predict
currently how the plan will treat asbestos and other pre-petition claims
and what impact any reorganization plan may have on the shares of the
Corporation's common stock and other outstanding securities. The
formulation and implementation of the plan of reorganization could take a
significant period of time.
Three creditors' committees, one representing asbestos personal injury
claimants, another representing asbestos property damage claimants, and a
third representing general unsecured creditors, were organized in 2001.
These committees have been appointed as official committees in the Chapter
11 Cases and, in accordance with the provisions of the Bankruptcy Code,
will have the right to be heard on all matters that come before the
Bankruptcy Court. The Bankruptcy Court appointed the Hon. Dean M. Trafelet
as the legal representative for future asbestos claimants in the Debtors'
bankruptcy proceeding. Mr. Trafelet was formerly a judge of the Circuit
Court of Cook County, Illinois. The Corporation expects that the appointed
committees, together with Mr. Trafelet, will play important roles in the
Chapter 11 Cases and the negotiation of the terms of any plan of
reorganization.
Pursuant to the Bankruptcy Code, the Debtors initially had the exclusive
right to propose a plan of reorganization for 120 days following the
Petition Date, until October 23, 2001, unless extended. The Bankruptcy
Court has granted requests by the Debtors to extend the period of
exclusivity, initially until May 1, 2002, then until November 1, 2002. The
Debtors have sought an additional extension of the exclusivity period to
May 1, 2003, and may seek one or more additional extensions depending on
developments in the Chapter 11 Cases. If the Debtors fail to file a plan of
reorganization during such extension period, or if such plan is not
accepted by the requisite numbers of creditors and equity holders entitled
to vote on the plan, other parties in interest in the Chapter 11 Cases may
be permitted to propose their own plan(s) of reorganization for the
Debtors.
The Corporation is unable to predict at this time what the treatment of
creditors and equity security holders of the respective Debtors will be
under any proposed plan or plans of reorganization. Such plan or plans may
provide, among other things, that all present and future asbestos-related
liabilities of the Debtors will be discharged and assumed and resolved by
one or more independently administered trusts established in compliance
with Section 524(g) of the Bankruptcy Code. Section 524(g) of the
Bankruptcy Code provides that,
-7-
if certain specified conditions are satisfied, a court may issue, in
connection with the confirmation of a plan of reorganization, a permanent
injunction barring the assertion of present and future asbestos-related
claims against the reorganized company and channeling those claims to an
independent trust for payment in whole or in part. Among other things, the
trust must own, or have the right to own upon the occurrence of
contingencies specified in the plan of reorganization, a majority of the
voting shares of the debtor or its parent, and the plan must be approved by
75% of the voting asbestos claimants whose claims are addressed by the
trust. Similar plans of reorganization have been confirmed in chapter 11
cases of other companies involved in asbestos-related litigation. However,
there is no assurance that such creation of a trust for the Debtors under
Section 524(g), or the issuance of such a permanent injunction, will be
approved by the Bankruptcy Court.
The Corporation is unable to predict at this time what treatment will be
accorded under any such reorganization plan or plans to intercompany
indebtedness, licenses, transfers of goods and services, and other
intercompany arrangements, transactions, and relationships that were
entered into prior to the Petition Date. These arrangements, transactions,
and relationships may be challenged by various parties in the Chapter 11
Cases, and the outcome of those challenges, if any, may have an impact on
the treatment of various claims under such plan or plans.
The Bankruptcy Court may confirm a plan of reorganization only upon making
certain findings required by the Bankruptcy Code, and a plan may be
confirmed over the dissent of non-accepting creditors and equity security
holders if certain requirements of the Bankruptcy Code are met. The payment
rights and other entitlements of pre-petition creditors and USG
shareholders may be substantially altered by any plan or plans of
reorganization confirmed in the Chapter 11 Cases. There is no assurance
that there will be sufficient assets to satisfy the Debtors' pre-petition
liabilities in whole or in part, and the pre-petition creditors of some
Debtors may be treated differently than those of other Debtors. While it is
the Corporation's intent to seek a full recovery for its creditors,
pre-petition creditors may receive under a plan or plans less than 100% of
the face value of their claims, and the interests of the Corporation's
equity security holders are likely to be substantially diluted or cancelled
in whole or in part. As noted above, it is not possible at this time to
predict the outcome of the Chapter 11 Cases, the terms and provisions of
any plan or plans of reorganization, or the effect of the chapter 11
reorganization process on the claims of the pre-petition creditors of the
Debtors or the interests of the Corporation's equity security holders. The
Corporation urges that appropriate caution be exercised with respect to
existing and future investments in these claims and/or securities. Recent
developments in the Corporation's bankruptcy proceeding are discussed in
Part I, Item 1. Note 12. "Litigation".
In connection with the Filing, the Corporation implemented a Bankruptcy
Court-approved key employee retention plan that commenced on July 1, 2001,
and
-8-
continues until the date the Corporation emerges from bankruptcy, or June
30, 2004, whichever occurs first. Under the plan, participants receive
semiannual payments that began in January 2002. Expenses associated with
this plan are being accrued pro rata over the term of the plan and amounted
to $12 million in 2001, $5 million in the third quarter of 2002, and $16
million in the first nine months of 2002.
CHAPTER 11 FINANCING
A $350 million debtor-in-possession financing facility from JP Morgan Chase
(the "DIP Facility") was approved by the Bankruptcy Court on July 31, 2001.
The DIP Facility, which matures on June 25, 2004, is available to
supplement liquidity and fund operations during the reorganization process.
Borrowing availability under the DIP Facility is based primarily on
accounts receivable and inventory levels and, to a lesser extent, property,
plant and equipment. Given these levels, as of September 30, 2002, the
Corporation had the capacity to borrow up to $338 million. There were no
outstanding borrowings under the DIP Facility as of September 30, 2002.
However, $15 million of standby letters of credit were outstanding, leaving
$323 million of unused borrowing capacity available as of September 30,
2002.
FINANCIAL STATEMENT PRESENTATION
The accompanying consolidated financial statements have been prepared in
accordance with AICPA Statement of Position 90-7 ("SOP 90-7"), "Financial
Reporting by Entities in Reorganization Under the Bankruptcy Code," and on
a going-concern basis, which contemplates continuity of operations,
realization of assets and liquidation of liabilities in the ordinary course
of business. However, as a result of the Filing, such realization of assets
and liquidation of liabilities, without substantial adjustments and/or
changes of ownership, are subject to uncertainty. Given this uncertainty,
there is doubt about continuing the going-concern basis of presentation.
While operating as debtors-in-possession under the protection of chapter 11
of the Bankruptcy Code and subject to Bankruptcy Court approval or
otherwise as permitted in the ordinary course of business, the Debtors, or
some of them, may sell or otherwise dispose of assets and liquidate or
settle liabilities for amounts other than those reflected in the
consolidated financial statements. Further, a plan of reorganization could
materially change the amounts and classifications in the historical
consolidated financial statements.
As of the date of this report, virtually all of the Corporation's
pre-petition debt is in default due to the Filing. As described below, the
accompanying consolidated financial statements present the Debtors'
pre-petition debt under the caption "Liabilities Subject to Compromise."
This includes debt outstanding of $469 million under the pre-petition bank
credit facilities and $536 million of other outstanding debt. The
Corporation accelerated the amortization of its debt-related costs
attributable to the Debtors and recorded a pretax expense of $2 million
during the second quarter of 2001, which was included under the caption
"Chapter 11 Reorganization Expenses."
-9-
As reflected in the consolidated financial statements, "liabilities subject
to compromise" refers to Debtors' liabilities incurred prior to the
commencement of the Chapter 11 Cases. The amounts of the various
liabilities that are subject to compromise are set forth below. These
amounts represent the Corporation's estimate of known or potential
pre-petition claims to be resolved in connection with the Chapter 11 Cases.
Such claims remain subject to future adjustments. Adjustments may result
from (i) negotiations (ii) actions of the Bankruptcy Court (iii) further
developments with respect to disputed claims (iv) rejection of executory
contracts and unexpired leases (v) the determination as to the value of any
collateral securing claims (vi) proofs of claim or (vii) other events. In
particular, the amount shown for the Asbestos Reserve reflects the
Corporation's pre-petition estimate of liability associated with asbestos
claims to be filed in the tort system through 2003, and this liability,
including liability for post-2003 claims, is the subject of significant
legal proceedings and negotiation in the Chapter 11 Cases. See Part I, Item
1. Note 12. "Litigation" for additional information on asbestos and related
bankruptcy litigation. Payment terms for these amounts will be established
in connection with the Chapter 11 Cases.
Pursuant to the Bankruptcy Code, schedules were filed by the Debtors with
the Bankruptcy Court on October 23, 2001, and certain of the schedules were
amended and filed with the Bankruptcy Court on May 31, 2002, setting forth
the assets and liabilities of the Debtors as of the date of the Filing.
Differences between amounts recorded by the Debtors and claims filed by
creditors will be investigated and resolved as part of the proof-of-claim
process in the Chapter 11 Cases. The Bankruptcy Court has approved a bar
date of January 15, 2003, by which proofs of claim must be filed against
the Debtors for all claims other than asbestos personal injury claims.
Subsequent to the Filing, the Debtors received approval from the Bankruptcy
Court to pay or otherwise honor certain of their pre-petition obligations,
including employee wages, salaries, benefits and other employee
obligations, and from limited available funds, pre-petition claims of
certain critical vendors, real estate taxes, environmental obligations,
certain customer programs and warranty claims, and certain other
pre-petition claims.
For the third quarter and first nine months of 2002, contractual interest
expense not accrued or recorded on pre-petition debt totaled $18 and $55
million, respectively. From the Petition Date through September 30, 2002,
contractual interest expense not accrued or recorded on pre-petition debt
totaled $96 million.
The Corporation believes that cash available from operations and the DIP
Facility will provide sufficient liquidity to allow its businesses to
operate in the normal course without interruption. This includes its
ability to meet post-petition obligations of the Debtors and to meet
obligations of the non-debtor subsidiaries. The appropriateness of using
the going-concern basis for the Corporation's financial statements is
dependent upon, among other things,
-10-
(i) the Corporation's ability to comply with the terms of the DIP Facility
and the cash management order entered by the Bankruptcy Court in connection
with the Chapter 11 Cases (ii) the ability of the Corporation to maintain
adequate cash on hand (iii) the ability of the Corporation to generate cash
from operations (iv) confirmation of a plan or plans of reorganization
under the Bankruptcy Code and (v) the Corporation's ability to achieve
profitability following such confirmation.
Liabilities subject to compromise in the consolidated and DIP balance
sheets consist of the following items (dollars in millions):
AS OF AS OF
SEPTEMBER 30, DECEMBER 31,
2002 2001
-------------------------------
Accounts payable $ 158 $ 162
Accrued expenses 59 86
Debt 1,005 1,005
Asbestos reserve 1,061 1,061
Other long-term liabilities 36 38
-------------------------------------------------------------------------
Subtotal 2,319 2,352
Elimination of intercompany
accounts payable (43) (41)
-------------------------------------------------------------------------
Total liabilities subject to compromise 2,276 2,311
=========================================================================
Chapter 11 reorganization expenses in the consolidated and DIP statements
of earnings consist of the following (dollars in millions):
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------------------
2002 2001 2002 2001
------------------------------------------
Legal and financial
advisory fees $ 5 $ 1 $ 18 $ 9
Bankruptcy-related interest
income (2) (2) (6) (2)
Accelerated amortization
of debt issuance costs - - - 2
-------------------------------------------------------------------------
Total chapter 11
reorganization expenses 3 (1) 12 9
=========================================================================
DIP FINANCIAL STATEMENTS
Under the Bankruptcy Code, the Corporation is required to file periodically
with the Bankruptcy Court various documents including financial statements
of the Debtors (the "Debtor-In-Possession" or "DIP" financial statements).
The Corporation cautions that these financial statements are prepared
according to requirements under the Bankruptcy Code. While these financial
statements accurately provide information required under the Bankruptcy
Code, they are nonetheless unconsolidated, unaudited and prepared in a
format different from that used in the Corporation's consolidated financial
statements filed under
-11-
the securities laws. Accordingly, the Corporation believes the substance
and format do not allow meaningful comparison with the Corporation's
regular publicly disclosed consolidated financial statements. The Debtors
consist of the Parent Company and the following wholly owned subsidiaries:
United States Gypsum Company; USG Interiors, Inc.; USG Interiors
International, Inc.; L&W Supply Corporation; Beadex Manufacturing, LLC; B-R
Pipeline Company; La Mirada Products Co., Inc.; Stocking Specialists, Inc.;
USG Industries, Inc.; and USG Pipeline Company. On March 1, 2002, USG
Funding, a non-debtor subsidiary of USG Corporation, declared a dividend in
the amount of $50 million (subsequently reduced to $30 million in the
second quarter) payable to the Parent Company, which was paid in effect by
eliminating the intercompany payable from USG Corporation. This payment is
included in other (income) expense, net in the DIP statement of earnings
for the nine months ended September 30, 2002. The condensed financial
statements of the Debtors are presented as follows:
USG CORPORATION
DEBTOR-IN-POSSESSION STATEMENTS OF EARNINGS
(DOLLARS IN MILLIONS)
(UNAUDITED)
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
---------------------------------------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Net sales $ 813 $ 750 $ 2,361 $ 2,210
Cost of products sold 684 668 1,982 2,003
Selling and administrative expenses 63 57 203 168
Chapter 11 reorganization expenses 3 (1) 12 9
Provision for restructuring expenses - (9) - (9)
Interest expense 1 1 4 27
Other (income) expense, net - - (31) 5
--------- --------- --------- ---------
Earnings before income taxes and
cumulative effect of accounting
change 62 34 191 7
Income taxes 26 16 73 10
--------- --------- --------- ---------
Earnings (loss) before cumulative
effect of accounting change 36 18 118 (3)
Cumulative effect of accounting
change for SFAS No. 142 - - (41) -
--------- --------- --------- ---------
Net earnings (loss) 36 18 77 (3)
========= ========= ========= =========
-12-
USG CORPORATION
DEBTOR-IN-POSSESSION BALANCE SHEETS
(DOLLARS IN MILLIONS)
(UNAUDITED)
AS OF AS OF
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- -----------
ASSETS
Cash and cash equivalents $ 433 $ 346
Short-term marketable securities 31 -
Receivables (net of reserves - $13 and $13) 273 234
Inventories 247 215
Income taxes receivable - 77
Deferred income taxes 57 66
Other current assets 38 33
------------- -----------
Total current assets 1,079 971
Long-term marketable securities 121 -
Property, plant and equipment (net of accumulated
depreciation and depletion - $540 and $481) 1,568 1,581
Deferred income taxes 219 258
Other assets 457 494
------------- -----------
Total Assets 3,444 3,304
============= ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable 166 112
Accrued expenses 198 153
Taxes on income 1 -
------------- -----------
Total current liabilities 365 265
Other liabilities 326 333
Liabilities subject to compromise 2,276 2,311
Stockholders' Equity:
Preferred stock - -
Common stock 5 5
Treasury stock (256) (255)
Capital received in excess of par value 98 95
Accumulated other comprehensive income 15 12
Retained earnings 615 538
------------- -----------
Total stockholders' equity 477 395
------------- -----------
Total Liabilities and Stockholders' Equity 3,444 3,304
============= -----------
-13-
USG CORPORATION
DEBTOR-IN-POSSESSION STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
NINE MONTHS
ENDED SEPTEMBER 30,
---------------------------
2002 2001
------------- -----------
OPERATING ACTIVITIES:
Net earnings (loss) $ 77 $ (3)
Adjustments to reconcile net earnings (loss)
to net cash:
Cumulative effect of accounting change 41 -
Depreciation, depletion and amortization 63 68
Deferred income taxes 46 108
(Increase) decrease in working capital:
Receivables 38 (180)
Inventories (32) (4)
Payables 55 107
Accrued expenses 47 6
Decrease in pre-petition intercompany receivable - 7
Increase in post-petition intercompany receivable (44) (108)
Decrease (increase) in other assets 24 (41)
(Decrease) increase in other liabilities (7) 9
Increase (decrease) in asbestos reserve, net
of receivables 22 (102)
Decrease in liabilities subject to compromise (35) (46)
Other, net (7) 42
------------- -----------
Net cash from (to) operating activities 288 (137)
------------- -----------
INVESTING ACTIVITIES:
Capital expenditures (50) (44)
Purchases of marketable securities (177) -
Sale or maturities of marketable securities 25 -
Net proceeds from asset dispositions 1 1
------------- -----------
Net cash to investing activities (201) (43)
------------- -----------
FINANCING ACTIVITIES:
Issuance of debt - 262
Repayment of debt - (56)
Short-term borrowings, net - 200
Cash dividends paid - (1)
------------- -----------
Net cash from financing activities - 405
------------- -----------
Net increase in cash and cash equivalents 87 225
Cash and cash equivalents at beginning of period 346 37
------------- -----------
Cash and cash equivalents at end of period 433 262
============= ===========
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Interest paid 1 26
Income taxes refunded, net (50) (16)
-14-
INTERCOMPANY TRANSACTIONS
In the normal course of business, the operating subsidiaries and the Parent
Company engage in intercompany transactions. To document the relationships
created by these transactions, the Parent Company and the operating
subsidiaries, from the formation of USG Corporation in 1985, have been
parties to intercompany loan agreements that evidence their obligations as
borrowers or rights as lenders arising out of intercompany cash transfers
and various allocated intercompany charges (the "Intercompany Corporate
Transactions"). During the first six months of 2001, the Parent Company
took steps to secure the obligations from each of the principal operating
subsidiaries under the intercompany loan agreements when it became clear
that U.S. Gypsum's asbestos liability claims were becoming an increasingly
greater burden on the Corporation's cash resources.
The Corporation operates a consolidated cash management system under which
the cash receipts of the domestic operating subsidiaries are ultimately
concentrated in Parent Company accounts. Cash disbursements for those
operating subsidiaries originate from those Parent Company concentration
accounts. Allocated intercompany charges from the Parent Company to the
operating subsidiaries primarily include expenses related to rent, property
taxes, information technology, and research and development, while
allocated intercompany charges between certain operating subsidiaries
primarily include expenses for shared marketing, sales, customer service,
engineering and accounting services. Detailed accounting records are
maintained of all cash flows and intercompany charges through the system in
either direction. Net balances, receivables or payables of such cash
transactions are tracked on a regular basis, with interest earned or paid
on the balances. As of September 30, 2002, U.S. Gypsum's and USG Interiors'
net pre-petition payable balances to the Parent Company for Intercompany
Corporate Transactions were $301 million and $110 million, respectively.
L&W Supply Corporation had a net pre-petition receivable balance from the
Parent Company of $43 million.
In addition to the above transactions, the operating subsidiaries engage in
ordinary course purchase and sale of products with other operating
subsidiaries (the "Intercompany Trade Transactions"). Detailed accounting
records also are maintained of all such transactions, and settlements are
made on a monthly basis.
Certain Intercompany Trade Transactions between U.S. and non-U.S. operating
subsidiaries are settled via wire transfer payments utilizing several
payment systems.
-15-
(3) EARNINGS PER SHARE
Basic earnings per share are based on the weighted average number of common
shares outstanding for the period. Diluted earnings per share are based on
the weighted average number of common shares outstanding and, if
applicable, the dilutive effect of the potential exercise of outstanding
stock options. The dilutive effect of the potential exercise of outstanding
options to purchase shares of common stock is calculated using the treasury
stock method. The reconciliation of basic earnings per share to diluted
earnings per share is shown in the following table (dollars in millions
except share data):
NET SHARES PER SHARE
THREE MONTHS ENDED SEPTEMBER 30, EARNINGS (000) AMOUNT
-------------------------------------------------------------------------
2002:
Basic earnings $ 44 43,251 $ 1.03
Dilutive effect of stock options -
-------------------------------------------------------------------------
Diluted earnings 44 43,251 1.03
=========================================================================
2001:
Basic earnings 27 43,460 0.61
Dilutive effect of stock options -
-------------------------------------------------------------------------
Diluted earnings 27 43,460 0.61
=========================================================================
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------------
2002:
Basic earnings 22 43,292 0.51
Dilutive effect of stock options -
-------------------------------------------------------------------------
Diluted earnings 22 43,292 0.51
=========================================================================
2001:
Basic earnings 25 43,424 0.57
Dilutive effect of stock options 8
-------------------------------------------------------------------------
Diluted earnings 25 43,432 0.57
=========================================================================
-16-
(4) STOCK OPTION GRANTS
As of September 30, 2002, common shares totaling 2,701,825 were reserved
for future issuance in conjunction with existing stock option grants. In
addition, 1,981,587 common shares were reserved for future grants. Shares
issued in option exercises may be from original issue or available treasury
shares.
(5) OPERATING SEGMENTS
The Corporation's operations are organized into three operating segments:
North American Gypsum, which manufactures and markets gypsum wallboard and
related products in the United States, Canada and Mexico; Worldwide
Ceilings, which manufactures and markets ceiling tile, ceiling grid and
other interior systems products worldwide; and Building Products
Distribution, which distributes gypsum wallboard, drywall metal, ceiling
products, joint compound and other building products throughout the United
States. Operating segment results were as follows (dollars in millions):
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------------------------------
2002 2001 2002 2001
NET SALES: -------------------------------------------
North American Gypsum $ 552 $ 504 $ 1,628 $ 1,445
Worldwide Ceilings 162 168 468 511
Building Products Distribution 317 294 898 867
Eliminations (128) (124) (377) (349)
--------------------------------------------------------------------------------
Total USG Corporation 903 842 2,617 2,474
================================================================================
OPERATING PROFIT (LOSS):
North American Gypsum 63 27 202 22
Worldwide Ceilings 15 10 31 28
Building Products Distribution 18 16 38 53
Corporate (17) (12) (54) (27)
Chapter 11 reorganization expenses (3) 1 (12) (9)
Provision for restructuring expenses - 9 - 9
Eliminations (1) (2) (2) -
--------------------------------------------------------------------------------
Total USG Corporation 75 49 203 76
================================================================================
-17-
(6) MARKETABLE SECURITIES
During the third quarter of 2002, the Corporation began investing in
marketable securities with maturities greater than three months. These
securities are listed as either short- or long-term marketable securities
on the consolidated balance sheet. The securities are classified as
available-for-sale securities and reported at fair market value with
unrealized gains and losses excluded from earnings and reported in
accumulated other comprehensive loss on the consolidated balance sheet. As
of September 30, 2002, the Corporation's investments in marketable
securities were as follows (dollars in millions):
FAIR
AMORTIZED MARKET
COST VALUE
---------------------------
Asset-backed securities $ 47 $ 47
U.S. government and agency securities 43 43
Municipal securities 33 33
Time deposits 18 18
Corporate securities 11 11
-------------------------------------------------------------------------
Total marketable securities 152 152
=========================================================================
Contractual maturities of marketable securities as of September 30,
2002, were as follows (dollars in millions):
FAIR
AMORTIZED MARKET
COST VALUE
---------------------------
Due in one year or less $ 31 $ 31
Due in 1-5 years 45 45
Due in 5-10 years 5 5
Due after 10 years 24 24
-------------------------------------------------------------------------
105 105
Asset-backed securities 47 47
-------------------------------------------------------------------------
Total marketable securities 152 152
=========================================================================
Realized gains and losses were not material for the third quarter of 2002.
-18-
(7) COMPREHENSIVE INCOME
The components of comprehensive income are summarized in the following
table (dollars in millions):
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------------------
2002 2001 2002 2001
------------------------------------------
Net earnings $ 44 $ 27 $ 22 $ 25
-------------------------------------------------------------------------------
Pretax gain (loss) on derivatives - (5) 5 25
Income tax benefit (expense) - 2 (2) (10)
-------------------------------------------------------------------------------
After-tax gain (loss) on derivative - (3) 3 15
-------------------------------------------------------------------------------
Deferred currency translation (7) (5) 5 (8)
-------------------------------------------------------------------------------
Unrealized gain (loss) on marketable
securities - - - -
-------------------------------------------------------------------------------
Total comprehensive income 37 19 30 32
===============================================================================
There was no tax impact on the foreign currency translation adjustments.
The components of accumulated other comprehensive loss included on the
consolidated balance sheet are summarized in the following table (dollars
in millions):
AS OF AS OF
SEPTEMBER 30, DECEMBER 31,
2002 2001
-------------------------------
After-tax gain (loss) on derivatives $ 19 $ 16
Deferred currency translation (42) (47)
Unrealized gain (loss) on
marketable securities - -
-------------------------------------------------------------------------
Total accumulated other comprehensive loss (23) (31)
=========================================================================
During the third quarter of 2002, $2 million of accumulated net
after-tax gains ($3 million pretax) on derivatives were reclassified
from accumulated other comprehensive loss to earnings. As of September
30, 2002, the estimated net after-tax gain expected to be reclassified
within the next 12 months from accumulated other comprehensive loss
into earnings is $12 million.
-19
(8) FINANCIAL INSTRUMENTS
The Corporation uses derivative instruments to manage well-defined
commodity price and foreign currency exposures. The Corporation does not
use derivative instruments for trading purposes. Under Statement of
Financial Accounting Standards ("SFAS") No. 133, as amended, all derivative
instruments must be recorded on the balance sheet at fair value. For
derivatives designated as fair value hedges, the changes in the fair values
of both the derivative instrument and the hedged item are recognized in
earnings in the current period. For derivatives designated as cash flow
hedges, the effective portion of changes in the fair value of the
derivative is recorded to accumulated other comprehensive loss on the
consolidated balance sheet and is reclassified to earnings when the
underlying transaction has an impact on earnings.
Commodity Derivative Instruments: The Corporation uses swap contracts to
hedge anticipated purchases of natural gas to be used in its manufacturing
operations. These contracts are designated as cash flow hedges, and changes
in fair value are recorded in accumulated other comprehensive income (loss)
until the hedged transaction occurs, at which time it is reclassified to
earnings. The fair value of all outstanding natural gas swap contracts was
$10 million as of September 30, 2002, and all of these contracts mature by
December 31, 2003.
The Corporation had swap agreements, maturing through 2003, with Enron to
hedge the cost of wastepaper. During the second quarter of 2002, the
Corporation paid $2.1 million to terminate all outstanding wastepaper
swaps. Effective with Enron's bankruptcy filing in December 2001, the
Corporation discontinued hedge accounting with respect to these swap
contracts and changes in the fair value of these hedges were recognized in
earnings during the period in which the change occurred. The fair value of
the outstanding contracts in accumulated other comprehensive loss as of
Enron's bankruptcy filing on December 2, 2001, was $2.4 million. During the
first nine months of 2002, $2.4 million was reclassified into earnings in
accordance with SFAS No. 133.
During the second quarter of 2001, the Corporation received proceeds of $35
million ($21 million after-tax) from the termination of natural gas swap
contracts scheduled to mature through 2005. In accordance with SFAS No.
133, the net after-tax gain resulting from the termination of these
contracts remains in accumulated other comprehensive loss and is
reclassified into earnings in the period which the hedged forecasted
transactions are scheduled to occur. As of September 30, 2002, $20 million
($12 million after-tax) remained in accumulated other comprehensive loss.
Foreign Exchange Derivative Instruments: The Corporation has operations in
a number of countries and uses forward contracts from time to time to hedge
the risk of changes in cash flows resulting from forecasted intercompany
and third-party sales or purchases in foreign currencies. These contracts
are
-20-
designated as cash flow hedges, and changes in fair value are recorded in
accumulated other comprehensive income (loss) until the underlying
transaction has an impact on earnings. As of September 30, 2002, the
Corporation had no outstanding forward contracts.
(9) RESTRUCTURING
2001 Restructuring Plan: In the fourth quarter of 2001, the Corporation
recorded a pretax charge of $12 million related to a restructuring plan
that included the shutdown of a gypsum wallboard plant in Fremont, Calif.,
a drywall steel plant in Prestice, Czech Republic, a ceiling tile plant in
San Juan Ixhuatepec, Mexico, a ceiling tile manufacturing line in
Greenville, Miss., and other restructuring activities. Included in the $12
million charge was $8 million for severance related to a workforce
reduction of more than 350 positions (primarily hourly positions), $2
million for the write-off of property, plant and equipment, and $2 million
for line shutdown and removal and contract cancellations. The 2001
restructuring is intended to allow the Corporation to optimize its
manufacturing operations. Final payments associated with this plan are
expected to be completed in the first half of 2003.
The reserve for this plan is included in accrued expenses on the
consolidated balance sheets. Fourth quarter 2001 charges against the
reserve included the $2 million write-off of property, plant and equipment
and payments totaling $2 million. An additional $3 million of payments were
charged against the reserve in the first nine months of 2002. All payments
for the 2001 restructuring plan are being funded with cash from operations.
As of September 30, 2002, 260 employees have been terminated, and 26 open
positions have been eliminated and the ceiling tile manufacturing line at
Greenville, Miss., and the plants in San Juan Ixhuatepec, Mexico, and
Prestice, Czech Republic, have been shutdown. The Fremont, Calif., plant
ceased production in April 2002.
2000 Restructuring Plan: In the fourth quarter of 2000, the Corporation
recorded a pretax charge of $50 million related to a restructuring plan
that included a salaried workforce reduction and the shutdown of three
gypsum wallboard manufacturing lines and other operations. Included in the
$50 million charge was $16 million for severance related to the salaried
workforce reduction of more than 500 positions, $15 million for the
write-off of property, plant and equipment, $12 million for razing
buildings and equipment, $5 million for line shutdown and removal, and $2
million for contract cancellations and severance for more than 100 hourly
positions. An additional restructuring-related charge of $4 million was
included in cost of products sold for the writedown of certain inventory.
This restructuring was designed to streamline operations and improve
business efficiency.
-21-
During the third quarter of 2001, the Corporation reversed $9 million
pretax of the restructuring reserve recorded in the fourth quarter of 2000
due to changes from previous estimates and to reflect a change in the scope
of restructuring activities undertaken. The primary change involved a
decision made in September 2001 to eliminate a portion of the closure
activities originally planned at the Alabaster, Mich., facility.
The reserve for the 2000 restructuring was included in liabilities subject
to compromise on the consolidated balance sheets and payments totaling $22
million were charged against this reserve through December 31, 2001. The
remaining $4 million was charged against this reserve in the first six
months of 2002. All payments for this plan were funded with cash from
operations.
The salaried workforce reduction program was completed as of June 30, 2001,
with the termination of 394 salaried employees and the elimination of 179
open salaried positions. In addition, 73 hourly employees were terminated,
and 44 open hourly positions were eliminated. Closure of the three gypsum
wallboard manufacturing lines and other operations was completed by
December 31, 2001.
The following table details the reserves and activity for the 2001 and 2000
restructuring plans (dollars in millions):
Writedown of
Provisions Assets to Net Reversal Reserve
for Realizable Cash of Balance
Restructuring Value Payments Reserve 9/30/02
----------------------------------------------------------------------------------------------
2001 RESTRUCTURING:
Severance (primarily hourly) $ 8 $ - $ (3) $ - $ 5
Property, plant and
equipment write-off 2 (2) - - -
Line shutdown/removal and
contract cancellations 2 - (2) - -
----------------------------------------------------------------------------------------------
Subtotal 12 (2) (5) - 5
----------------------------------------------------------------------------------------------
2000 RESTRUCTURING:
Severance (salaried) 16 - (16) - -
Property, plant and
equipment write-off 15 (15) - - -
Razing buildings and equipment 12 - (6) (6) -
Line shutdown and removal 5 - (3) (2) -
Contract cancellations
and severance (hourly) 2 - (1) (1) -
----------------------------------------------------------------------------------------------
Subtotal 50 (15) (26) (9) -
----------------------------------------------------------------------------------------------
Total 62 (17) (31) (9) 5
==============================================================================================
-22-
(10) NEW ACCOUNTING PRONOUNCEMENTS
The Corporation adopted three new accounting standards in the first
quarter of 2002.
SFAS No. 141, "Business Combinations," requires all business combinations
initiated after June 30, 2001, to be accounted for using the purchase
method. This standard, which became effective for the Corporation on
January 1, 2002, had no impact on its financial statements upon adoption.
SFAS No. 142, "Goodwill and Other Intangible Assets," eliminates the
amortization of goodwill over its estimated useful life. See Note 11,
"Adoption of SFAS No. 142" for information regarding the adoption of this
standard and the resulting impairment charge.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," supersedes SFAS No. 121 and a portion of APB Opinion No. 30. This
statement establishes a single accounting model for the disposal of
long-lived assets and resolves significant implementation issues related to
SFAS No. 121. This standard, which became effective for the Corporation on
January 1, 2002, had no impact on its financial statements upon adoption.
The Corporation will adopt SFAS No. 143, "Accounting for Asset Retirement
Obligations," in January 2003. This standard requires entities to record
the fair value of a liability for an asset retirement obligation in the
period in which it is incurred. This standard becomes effective January 1,
2003, and is likely to have an impact on the Corporation's financial
statements. However, as of the date of this report, the Corporation has not
determined what impact the adoption of this standard may have on its
financial statements.
(11) ADOPTION OF SFAS NO. 142
On January 1, 2002, the Corporation adopted SFAS No. 142, "Goodwill and
Other Intangible Assets." Although SFAS No. 142 eliminates the amortization
of goodwill and certain other intangible assets, it initiates an annual
assessment of goodwill for impairment.
During the second quarter of 2002, the Corporation completed its transition
date assessment of goodwill. The assessment was performed for each
reporting unit (as defined by SFAS No. 142) that has goodwill. For the
Corporation, the reporting units with goodwill were the North American
Gypsum and the Building Products Distribution operating segments.
The Corporation determined that goodwill for its Building Products
Distribution segment was not impaired, but will be reviewed at least
annually for impairment. However, goodwill for its North American Gypsum
-23-
segment was impaired. This impairment was attributable to U.S. Gypsum's
asbestos liability and related filing for bankruptcy protection on June 25,
2001. As a result, the Corporation recorded a noncash, nontaxable
impairment charge of $96 million. This charge, which includes a $6 million
deferred currency translation write-off, is reflected on the Corporation's
consolidated statement of earnings as a cumulative effect of a change in
accounting principle as of January 1, 2002. In accordance with SFAS No.
142, the Corporation is reflecting this charge in its financial statements
for the three months ended March 31, 2002.
The reconciliation of pro forma net earnings, basic earnings per share and
diluted earnings per share for the three months and nine months ended
September 30, 2001, is shown in the following table (dollars in millions
except per-share data):
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------------------------------
2002 2001 2002 2001
-------------------------------------------
NET EARNINGS:
Reported net earnings $ 44 $ 27 $ 22 $ 25
Add back:
Goodwill amortization, net of tax - 1 - 3
Cumulative effect of accounting
change for SFAS No. 142 - - 96 -
--------------------------------------------------------------------------------
Pro forma net earnings 44 28 118 28
================================================================================
BASIC AND DILUTED EARNINGS
PER SHARE:
Reported basic and diluted 1.03 0.61 0.51 0.57
Add back:
Goodwill amortization - 0.02 - 0.06
Cumulative effect of accounting
change for SFAS No. 142 - - 2.22 -
--------------------------------------------------------------------------------
Pro forma basic and diluted 1.03 0.63 2.73 0.63
================================================================================
(12) LITIGATION
ASBESTOS AND RELATED BANKRUPTCY LITIGATION
One of the Corporation's subsidiaries, U.S. Gypsum, is among many
defendants in lawsuits arising out of the manufacture and sale of
asbestos-containing materials. On June 25, 2001 (the "Petition Date"), U.S.
Gypsum, the Parent Company, and other domestic subsidiaries (the "Debtors")
filed voluntary petitions for relief under chapter 11 of the U.S.
Bankruptcy Code (the "Filing") to manage the growing costs of resolving
asbestos claims and to achieve a fair and final resolution of liability for
both pending and future asbestos claims. The Chapter 11 Cases are being
jointly administered under
-24-
Case No. 01-2094 in the United States Bankruptcy Court for the District of
Delaware (the "Bankruptcy Court").
U.S. Gypsum's asbestos liability derives from its sale of certain
asbestos-containing products beginning in the late 1920s; in most cases,
the products were discontinued or asbestos was removed from the formula by
1972, and no asbestos-containing products were produced after 1978. Certain
of the asbestos lawsuits against U.S. Gypsum seek to recover compensatory
and, in many cases, punitive damages for costs associated with the
maintenance or removal and replacement of asbestos-containing products in
buildings (the "Property Damage Cases"). Other asbestos lawsuits seek
compensatory and, in many cases, punitive damages for personal injury
allegedly resulting from exposure to asbestos-containing products (the
"Personal Injury Cases"). A more detailed description of the Property
Damage and Personal Injury Cases is set forth below.
As a result of the Filing, all pending Personal Injury and Property Damage
Cases against U.S. Gypsum are stayed, and no party may take any action to
pursue or collect on such asbestos lawsuits absent specific authorization
of the Bankruptcy Court. Since the Filing, U.S. Gypsum has ceased making
both cash payments and accruals with respect to asbestos lawsuits,
including cash payments and accruals pursuant to settlements of asbestos
lawsuits. The Bankruptcy Court has approved creditors' committees that
represent claimants in Personal Injury and Property Damage Cases and, as
noted below, a legal representative for future asbestos claimants.
U.S. Gypsum anticipates that its liability for pending and future asbestos
claims will be addressed in a plan of reorganization developed and approved
in the bankruptcy proceeding. The Debtors' exclusive right to propose such
a plan of reorganization was previously extended by the Bankruptcy Court to
November 1, 2002. The Debtors are seeking an additional extension of the
exclusivity period to May 1, 2003, and may seek one or more additional
extensions depending upon developments in the Chapter 11 Cases. It is the
Debtors' intention that the plan of reorganization will include the
creation of a trust under Section 524(g) of the Bankruptcy Code which will
be funded to allow payment of present and future asbestos claims, and, as a
result of creation of the trust, the Bankruptcy Court will issue a
permanent injunction channeling all asbestos-related claims to the trust
and barring the assertion of pending or future asbestos-related claims
against the reorganized companies. However, there is no assurance that
creation of a trust under Section 524(g) or the issuance of such a
permanent injunction will be approved by the Bankruptcy Court. It is
anticipated that the plan or plans of reorganization ultimately approved
will include all Debtors in the final resolution of asbestos-related claims
that are or might be asserted against U.S. Gypsum, the Corporation, and all
other Debtor affiliates.
Developments in the Reorganization Proceeding: During the fourth quarter of
-25-
2001, the Corporation's bankruptcy proceeding, along with four other
asbestos-related bankruptcy proceedings pending in the federal courts in
the District of Delaware, were assigned to the Honorable Alfred M. Wolin of
the United States District Court for the District of New Jersey.
Judge Wolin has indicated that he will handle all issues relating to
asbestos personal injury claims and that other bankruptcy claims and issues
in the Chapter 11 Cases, including issues relating to asbestos property
damage claims, will remain assigned to Bankruptcy Judge Randall J. Newsome
in the United States Bankruptcy Court for the District of Delaware.
In July 2002, the Bankruptcy Court appointed the Hon. Dean M. Trafelet as
the legal representative for future asbestos claimants in the Debtors'
bankruptcy proceeding. Mr. Trafelet was formerly a judge of the Circuit
Court of Cook County, Illinois.
The Debtors have filed a motion requesting Judge Wolin to conduct hearings
to substantively estimate the Debtors' liability for asbestos personal
injury claims. The Debtors propose that, in these substantive estimation
hearings, the court will hear evidence and make rulings regarding the
characteristics of valid asbestos personal injury claims against the
Debtors, and the Court will then estimate the Debtors' liability for
present and future asbestos personal injury claims based upon these
rulings. One of the key liability issues is whether claimants who do not
have objective evidence of asbestos-related disease have valid claims and
are entitled to be compensated by Debtors, or whether such claimants are
entitled to compensation only if and when they develop asbestos-related
disease.
The Official Committee of Asbestos Personal Injury Claimants opposes the
substantive estimation hearings proposed by Debtors. The committee contends
that U.S. Gypsum's liability for present and future asbestos personal
injury claims should be based on extrapolation from U.S. Gypsum's
settlement history of such claims and not on litigating liability issues in
the bankruptcy proceeding. The committee contends that the Court does not
have the power to exclude claimants who do not meet objective evidence of
asbestos-related disease if such claimants are compensated in the tort
system outside of bankruptcy.
Other constituencies have filed briefs with the Court indicating their
views on the estimation protocol that should be adopted by the Court.
Briefs supporting the Debtors' substantive estimation proposal were filed
by the Official Committee of Unsecured Creditors as well as the United
States Chamber of Commerce, the Coalition for Asbestos Justice
(representing certain insurers), and a group of fourteen companies that are
defendants in asbestos personal injury litigation but are not in
bankruptcy. An unofficial committee representing select asbestos claimants
(claimants who have cancer claims) has indicated that they endorse Debtors'
substantive estimation proposal insofar as Debtors are asking the Court to
address Debtors'
-26-
liability for certain types of claims, but are opposed to Debtors' proposal
in certain other respects. The legal representative for future asbestos
claimants (described below) has endorsed the estimation protocol requested
by the Official Committee of Asbestos Personal Injury Claimants.
In August 2002, Debtors also filed a motion with Judge Wolin requesting the
Court to issue a ruling declaring that putative claimants who cannot
satisfy objective standards of asbestos-related disease are not entitled to
vote on a Section 524(g) plan. The Debtors' motion is supported by the
Official Committee of Unsecured Creditors as well as the unofficial
committee representing select asbestos claimants and the group of fourteen
companies that are defendants in asbestos personal injury litigation but
are not in bankruptcy. The Debtors' motion on this voting issue has been
stayed by order of Judge Wolin. It is anticipated that the Official
Committee of Asbestos Personal Injury Claimants will oppose the Debtors'
motion.
At present, it is not known whether Judge Wolin will conduct the type of
substantive estimation hearings requested by the Debtors, when these
hearings might be held, or whether the Court will exclude from voting
putative claimants who do not satisfy objective standards of
asbestos-related disease. The estimated amount of the Debtors' liability
for present and future asbestos personal injury claims could be
significantly different depending upon whether the estimated liability is
based on substantive estimation, as proposed by Debtors, or based on the
estimation protocol proposed by the committee representing the asbestos
personal injury claimants.
If the hearings on liability issues relating to asbestos personal injury
claims do not go forward, or a consensual resolution is not reached as a
result of the hearings or otherwise, the Corporation will employ other
means to resolve the Debtors' asbestos personal injury liability. These
other means may include, but are not limited to, setting a bar date for
filing asbestos personal injury claims and determining which of the claims
are entitled to vote on and participate in an asbestos trust under 11
U.S.C. ss. 524(g) of the Bankruptcy Code. A bar date proceeding likely
would lengthen the bankruptcy case significantly.
The Corporation expects that U.S. Gypsum's liability for asbestos property
damage claims will also be resolved in the reorganization proceeding,
whether by including those liabilities in a ss. 524(g) trust or by other
means. Toward that end, the Bankruptcy Court has set a bar date of January
15, 2003, by which all entities with asbestos property damage claims or any
other types of claims (except asbestos personal injury claims or claims
derivative thereof) must file their claims against the Debtors in the
bankruptcy proceeding. The Debtors have mailed and published notice of the
claims bar date to potential asbestos property damage claimants as well as
other claimants affected by the bar date. The Official Committee of
Asbestos Property Damage Claimants requested leave to appeal the Bankruptcy
Court's
-27-
order establishing a bar date for property damage claims. By order dated
September 20, 2002, Judge Wolin denied the committee's request to appeal.
Given the current status of the Chapter 11 Cases, the Corporation is unable
to forecast with any reasonable degree of certainty the timing or substance
of the resolution of the Debtors' asbestos-related liability or the
reorganization proceeding.
The following is a summary of the Property Damage and Personal Injury Cases
pending against U.S. Gypsum as of the Petition Date.
Property Damage Cases: As of the Petition Date, U.S. Gypsum was a defendant
in eleven Property Damage Cases, most of which involved multiple buildings.
One of the cases is a conditionally certified class action comprising all
colleges and universities in the United States, which certification is
presently limited to the resolution of certain allegedly "common" liability
issues. (Central Wesleyan College v. W.R. Grace & Co., et al., U.S.D.C.
S.C.). On June 15, 2001, a Property Damage Case was filed by The County of
Orange, Texas, in the district court of Orange County, Texas, naming as
defendants U.S. Gypsum and other manufacturers of asbestos-containing
materials. This was the first Property Damage case filed against U.S.
Gypsum since June 1998. The Orange County case is a putative class action
brought by The County of Orange on behalf of an alleged class comprising
the State of Texas, its public colleges and universities, and all political
subdivisions of the State of Texas. As to U.S. Gypsum, the putative class
also includes all private and/or non-public colleges, universities, junior
colleges, community colleges, and elementary and secondary schools in the
State of Texas. The Orange County action seeks recovery of the costs of
removing and replacing asbestos-containing materials in buildings at issue
as well as punitive damages. The complaint does not specify how many
buildings are at issue. As a result of the Filing, all Property Damage
Cases, including the Central Wesleyan and Orange County cases, are stayed
against U.S. Gypsum. U.S. Gypsum's estimated cost of resolving the Property
Damage Cases is discussed below (see "Estimated Cost").
Personal Injury Cases: As reported by the Center for Claims Resolution (the
"Center"), as described below, U.S. Gypsum was a defendant in approximately
106,000 pending Personal Injury Cases as of the Petition Date, as well as
an additional approximately 52,000 Personal Injury Cases that are the
subject of settlement agreements. In the first half of 2001, up to the
Petition Date, approximately 26,200 new Personal Injury Cases were filed
against U.S. Gypsum, as reported by the Center, as compared to 27,800 new
filings in the first half of 2000. Filings of new Personal Injury Cases
totaled approximately 53,000 claims in 2000, 48,000 claims in 1999, and
80,000 claims in 1998.
Prior to the Filing, U.S. Gypsum managed the handling and settlement of
Personal Injury Cases through its membership in the Center. From 1988 up to
-28-
February 1, 2001, the Center administered, and arranged for the defense and
settlement of, Personal Injury cases against U.S. Gypsum and other Center
members. During that period, costs of defense and settlement of Personal
Injury Cases were shared among the members of the Center pursuant to
predetermined sharing formulae. Effective February 1, 2001, the Center
members, including U.S. Gypsum, ended their prior settlement sharing
arrangement. The Center continued to administer and arrange for the defense
and settlement of the Personal Injury Cases, but liability payments were
not shared among the Center members. As of the Petition Date and as a
result of the stay of asbestos lawsuits against U.S. Gypsum, U.S. Gypsum no
longer requires the services of the Center in negotiating or defending
Personal Injury Cases.
In 2000 and years prior, U.S. Gypsum and other Center members negotiated a
number of settlements with plaintiffs' law firms that included agreements
to resolve over time the firms' pending Personal Injury Cases as well as
certain future claims ("Long-Term Settlements"). With regard to future
claims, these Long-Term Settlements typically provide that the plaintiffs'
firms will recommend to their future clients that they defer filing, or
accept nominal payments on, personal injury claims that do not meet
established disease criteria, and, with regard to those claims meeting
established disease criteria, that the future clients accept specified
amounts to settle those claims. These Long-Term Settlements typically
resolve claims for amounts consistent with historical per claim settlement
costs paid to the plaintiffs' firms involved. As a result of the Filing,
cash payments by U.S. Gypsum under these Long-Term Settlements have ceased,
and U.S. Gypsum expects that its obligations under these settlements will
be determined in the bankruptcy proceeding and plan of reorganization.
In 2000, U.S. Gypsum closed approximately 57,000 Personal Injury Cases.
U.S. Gypsum's cash payments in 2000 to defend and resolve Personal Injury
Cases totaled $162 million, of which $90 million was paid or reimbursed by
insurance. In 2000, the average settlement per case was approximately
$2,600, exclusive of defense costs. U.S. Gypsum made cash payments of $100
million in 1999 and $61 million in 1998 to resolve Personal Injury Cases,
of which $85 million and $45.5 million, respectively, were paid or
reimbursed by insurance.
In the first and second quarters of 2001, prior to the Filing, cash
payments to resolve Personal Injury Cases increased dramatically, primarily
as a result of the bankruptcy filings of other defendants in asbestos
personal injury lawsuits. As a result of these bankruptcy filings,
plaintiffs substantially increased their settlement demands to the
remaining defendants, including U.S. Gypsum, to replace the expected
payments of the bankrupt defendants. In response to these increased
settlement demands, U.S. Gypsum attempted to manage its asbestos liability
by contesting, rather than settling, a greater number of cases that it
believed to be non-meritorious. As a result, in the first and second
quarters of 2001, U.S. Gypsum agreed
-29-
to settle fewer Personal Injury Cases, but at a significantly higher cost
per case.
In the first half of 2001 (up to the Petition Date), U.S. Gypsum closed
approximately 18,900 Personal Injury Cases. In the first half of 2001 (up
to the Petition Date), U.S. Gypsum's total asbestos-related cash payments,
including defense costs, were approximately $124 million, of which
approximately $10 million was paid or reimbursed by insurance. A portion of
these payments were for settlements agreed to in prior periods. As of March
31, 2001, U.S. Gypsum had estimated that cash expenditures for Personal
Injury Cases in 2001 would total approximately $275 million before
insurance recoveries of approximately $37 million.
As a result of these increasing settlement demands and the concern that
federal legislation, if any, addressing the asbestos litigation problem
likely would not be enacted within the necessary timeframe, U.S. Gypsum
concluded that it would not be able to manage and resolve its asbestos
liability in the tort system, and, on June 25, 2001, the Debtors filed a
voluntary petition under Chapter 11 of the Bankruptcy Code. As a result of
the Filing, all Personal Injury Cases are stayed against U.S. Gypsum, new
cases may not be filed due to the automatic stay, and payments relating to
settlements of Personal Injury Cases before the Filing may not be made.
In addition to the Personal Injury Cases pending against U.S. Gypsum, one
of the Corporation's subsidiaries and a Debtor in the bankruptcy
proceeding, L&W Supply Corporation, was named as a defendant in
approximately 21 pending Personal Injury Cases as of the Petition Date.
L&W, a distributor of building products manufactured by U.S. Gypsum and
other building products manufacturers, has not made any payments in the
past to resolve Personal Injury Cases. It is believed that L&W has been
named as a defendant in Personal Injury Cases based on its role as a
distributor of U.S. Gypsum products. Therefore, the Corporation expects
that any asbestos-related liability of L&W would be derivative of the
liability of U.S. Gypsum, and that any plan or plans of reorganization
should reflect that L&W's liability, if any, rests with U.S. Gypsum as the
manufacturer. However, because of the small number of Personal Injury Cases
against L&W to date and the lack of development of the cases against L&W,
the Corporation does not have sufficient information at this time to
predict as to how any plan or plans of reorganization will address any
asbestos-related liability of L&W and whether any such liability will be
limited to L&W's role as a distributor of U.S. Gypsum products.
One of U.S. Gypsum's subsidiaries and a Debtor in the bankruptcy
proceeding, Beadex Manufacturing, LLC ("Beadex"), manufactured and sold
joint compound containing asbestos from 1963 through 1978 in the northwest
United States. As of the Petition Date, Beadex was a named defendant in
approximately 40 Personal Injury Cases pending primarily in the states of
Washington and Oregon. Beadex has approximately $11 million in primary or
umbrella
-30-
insurance coverage available to pay asbestos-related costs, as well as $15
million in available excess coverage. The Corporation expects that any
asbestos-related liability of Beadex will be addressed in the plan of
reorganization. However, because of the small number of Personal Injury
Cases pending against Beadex to date, the Corporation does not have
sufficient information at this time to predict as to how any plan or plans
of reorganization will address any asbestos-related liability of Beadex.
Insurance Coverage: As of the Petition Date, after deducting insurance used
to date, U.S. Gypsum had $66 million of insurance remaining to cover
asbestos-related costs. This figure is adjusted from the previously
reported $76 million to reflect additional amounts received in an earlier
period. After receipt of insurance payments, $30 million remained as of
September 30, 2002. The increase of $22 million in asbestos reserve, net of
receivables, for the first nine months of 2002 as shown on the consolidated
statement of cash flows was attributable to changes in the asbestos
insurance receivable. This insurance is scheduled to be collected at
various times through 2004.
Estimated Cost: In evaluating U.S. Gypsum's estimated asbestos liability
prior to the Filing, the Corporation considered numerous uncertainties that
made it difficult to estimate reliably U.S. Gypsum's asbestos liability in
the tort system for both pending and future asbestos claims.
In the Property Damage Cases, such uncertainties included, but were not
limited to, the identification and volume of asbestos-containing products
in the buildings at issue in each case, which is often disputed; the
claimed damages associated therewith; the viability of statute of
limitations, product identification and other defenses, which varies
depending upon the facts and jurisdiction of each case; the amount for
which such cases can be resolved, which normally (but not uniformly) has
been substantially lower than the claimed damages; and the viability of
claims for punitive and other forms of multiple damages.
Uncertainties in the Personal Injury Cases included, but were not limited
to, the number, disease and occupational characteristics, and venue of
Personal Injury Cases that are filed against U.S. Gypsum; the age and level
of asbestos-related disease of claimants; the viability of claims for
conspiracy or punitive damages; the elimination of indemnity sharing among
Center members for future settlements and its negative impact on U.S.
Gypsum's ability to continue to resolve claims at historical or acceptable
levels; the adverse impact on U.S. Gypsum's settlement costs of recent
bankruptcies of co-defendants; the continued solvency of other defendants
and the possibility of additional bankruptcies; the possibility of
significant adverse verdicts due to recent changes in settlement strategies
and related effects on liquidity; the inability or refusal of former Center
members to fund their share of existing settlements and its effect on such
settlement agreements; the continued ability to negotiate settlements or
-31-
develop other mechanisms that defer or reduce claims from unimpaired
claimants; and the possibility that federal legislation addressing asbestos
litigation will be enacted. The Corporation reported that adverse
developments with respect to any of these uncertainties could have a
material impact on U.S. Gypsum's settlement costs and could materially
increase the cost above the estimated range discussed below.
Prior to the fourth quarter of 2000, the Corporation, in the opinion of
management, was unable to reasonably estimate the probable cost of
resolving future asbestos claims in the tort system, although the
Corporation had estimated and reserved for costs associated with
then-pending claims. However, in 1999 and increasingly in 2000, as U.S.
Gypsum entered into Long-Term Settlements of Personal Injury Cases, the
Corporation undertook a detailed, independent study of U.S. Gypsum's
current and potential future asbestos liability. This analysis was based on
the assumption that U.S. Gypsum's asbestos liability would continue to be
resolved in the tort system. The analysis was completed in the fourth
quarter of 2000.
As part of this analysis, the Corporation reviewed, among other things,
historical case filings and increasing settlement costs; the type of
products sold by U.S. Gypsum and the occupations of claimants expected to
bring future asbestos-related claims; epidemiological data concerning the
incidence of past and projected future asbestos-related diseases; trends in
the propensity of persons alleging asbestos-related disease to sue U.S.
Gypsum; the adverse effect on settlement costs of historical reductions in
the number of solvent defendants available to pay claims, including
reductions in membership of the Center; the pre-agreed settlement
recommendations in, and the continued viability of, the Long-Term
Settlements described above; and anticipated trends in recruitment by
plaintiffs' law firms of non-malignant or unimpaired claimants. The study
attempted to weigh relevant variables and assess the impact of likely
outcomes on future case filings and settlement costs. In addition, the
Corporation considered future defense costs, as well as allegations that
U.S. Gypsum and the other Center members bear joint liability for the share
of certain settlement agreements that was to be paid by former members that
now have refused or are unable to pay.
In the fourth quarter of 2000, the Corporation concluded that it was
possible to provide a reasonable estimate of U.S. Gypsum's liability in the
tort system for asbestos cases to be filed through 2003 as well as those
currently pending. Based on an independent study, the Corporation
determined that, although substantial uncertainty remained, it was probable
that asbestos claims currently pending against U.S. Gypsum and future
asbestos claims to be filed against it through 2003 (both property damage
and personal injury) could be resolved in the tort system for an amount
between $889 million and $1,281 million, including defense costs, and that
within this range the most likely estimate was $1,185 million. Consistent
with this analysis, in the fourth quarter of 2000, the Corporation recorded
a pretax
-32-
non-cash charge of $850 million to results of operations, which, combined
with the previously existing reserve, increased U.S. Gypsum's reserve for
asbestos claims to $1,185 million. Substantially all of this reserve
relates to the estimated costs of resolving then-pending asbestos personal
injury claims and those expected to be filed through 2003, and the reserve
reflected management's expectation that U.S. Gypsum's average payment per
asbestos personal injury claim would increase at least in the short term
due to distortions caused by the bankruptcy filings of other asbestos
personal injury defendants discussed above. Less than 10 percent of the
reserve is attributable to defense and administrative costs.
At the time of recording this reserve, it was expected that the reserve
amounts would be expended over a period extending several years beyond
2003, because asbestos cases have historically been resolved an average of
three years after filing. The Corporation concluded that it did not have
adequate information to allow it to reasonably estimate the number of
claims to be filed after 2003, or the liability associated with such
claims.
During 2001 up to the Filing, U.S. Gypsum's cash payments for asbestos
claims and related legal fees totaled approximately $124 million, reducing
its reserve for asbestos claims to $1,061 million as of June 30, 2001. The
reserve remained at $1,061 million as of September 30, 2002. U.S. Gypsum
has a receivable from insurance carriers (the estimated portion of the
reserved amount that is expected to be paid or reimbursed by insurance) of
$30 million as of September 30, 2002. The above amounts are stated before
tax benefit and are not discounted to present value.
It is the Corporation's view that, as a result of the Filing, there is even
greater uncertainty in estimating the reasonably possible range of asbestos
liability for pending and future claims as well as the most likely estimate
of liability within this range. There are significant differences in the
treatment of asbestos claims in a bankruptcy proceeding as compared to the
tort litigation system. Among other things, these uncertainties include how
the Long-Term Settlements will be treated in the bankruptcy proceeding and
plan of reorganization, and whether those settlements will be set aside;
the number of asbestos-related claims that will be filed in the proceeding;
the number of future claims that will be estimated in connection with
preparing a plan of reorganization; how claims for punitive damages and
claims by persons with no asbestos-related disease will be treated and
whether such claims will be allowed; the impact historical settlement
values for asbestos claims may have on the estimation of asbestos liability
in the bankruptcy proceeding; and the impact any relevant potential federal
legislation may have on the proceeding. These factors, as well as the
uncertainties discussed above in connection with the resolution of asbestos
cases in the tort system, increase the uncertainty of any estimate of
asbestos liability.
As a result of the increased uncertainty of estimating asbestos liability
due to the Filing, it is the Corporation's view that no change should be
-33-
made at this time to the previously recorded reserve for asbestos claims.
However, it is possible that the cost of resolving asbestos claims will be
greater than that set forth in the high end of the estimated reserve range.
As the bankruptcy proceeding continues, it is expected that the Corporation
will obtain additional information that may provide greater certainty to
the expected range of liability.
When a reasonable estimate can be made of the Debtors' probable liability
for asbestos claims, if such estimate differs from the existing reserve,
the reserve will be adjusted to reflect the estimate, and it is possible
that a charge to results of operations will be necessary at that time.
Bond to Secure Certain CCR Obligations: In January 2001, U.S. Gypsum
obtained a performance bond from Safeco Insurance Company of America
("Safeco") in the amount of $60.3 million to secure certain obligations of
U.S. Gypsum for extended payout settlements of Personal Injury Cases and
other obligations owed by U.S. Gypsum to the Center. The bond is secured by
an irrevocable letter of credit obtained by the Corporation in the amount
of $60.3 million and issued by Chase Manhattan Bank to Safeco. After the
Filing, by letter dated July 6, 2001, the Center stated that certain
amounts allegedly covered by the bond, totaling approximately $15.7
million, were overdue from U.S. Gypsum to the Center. In subsequent letters
dated November 19, 2001, and December 11, 2001, the Center stated that
additional amounts allegedly covered by the bond totaling approximately $14
million and $113 million, respectively, were also overdue from U.S. Gypsum.
The amounts for which the Center made demand were for the payment of, among
other things, settlements of Personal Injury Cases that were entered into
pre-petition. By letter dated November 16, 2001, the Center made a demand
to Safeco for payment of $15.7 million under the bond, and by letter dated
December 28, 2001, the Center made a demand to Safeco for payment of
approximately $127 million under the bond. The total amount demanded by the
Center under the bond, approximately $143 million, exceeds the original
penal sum of the bond, which is $60.3 million. Safeco has not made any
payment under the bond, but, to the extent that Safeco were to pay any
portion of the bond, it is likely that Safeco would draw down the Chase
letter of credit to cover the bond payment and Chase would assert a
pre-petition claim in a corresponding amount against the Corporation in the
bankruptcy proceeding.
On November 30, 2001, the Corporation and U.S. Gypsum filed an Adversary
Complaint in the Chapter 11 Cases to, among other things, enjoin the Center
from drawing on the bond and enjoin Safeco from paying on the bond during
the pendency of these bankruptcy proceedings. This Adversary Proceeding is
pending in the United States Bankruptcy Court for the District of Delaware
and is captioned USG Corporation and United States Gypsum Company v. Center
for Claims Resolution, Inc. and Safeco Insurance Company of America, No.
01-08932. Judge Wolin has consolidated the Adversary Proceeding with
similar adversary proceedings brought by Federal-Mogul Corp., et al., and
Armstrong World Industries, Inc., et al., in their bankruptcy proceedings.
Due to the
-34-
status of the Adversary Proceeding, the Corporation cannot predict whether
or when any portion of the bond proceeds will be paid, what amount, if any,
will be paid, and whether the letter of credit will be drawn.
Conclusion: There are many uncertainties associated with the resolution of
asbestos liability in the bankruptcy proceeding. These uncertainties
include, among others, the number of asbestos-related claims that will be
filed against the Debtors in the proceeding; the number of future claims
that will be estimated in connection with preparing a plan of
reorganization; how the Long-Term Settlements will be treated in the
bankruptcy proceeding and plan of reorganization, and whether those
settlements will be set aside; how claims for punitive damages and claims
by persons with no asbestos-related physical impairment will be treated and
whether such claims will be allowed; the impact historical settlement
values for asbestos claims may have on the estimation of asbestos liability
in the bankruptcy proceeding; and the impact any relevant potential federal
legislation may have on the proceeding. The Corporation has not revised its
previously recorded reserve for asbestos liability. The Corporation will
continue to review its asbestos liability as the Chapter 11 Cases progress.
When a reasonable estimate can be made of the Debtors' probable liability
for asbestos claims, if such estimate differs from the existing reserve,
the reserve will be adjusted to reflect the estimate, and it is possible
that a charge to results of operations will be necessary at that time. It
is possible that the Corporation's asbestos liability may vary
significantly from the recorded estimate of liability and that this
difference could be material to the results of operations in the period
recorded.
ENVIRONMENTAL LITIGATION
The Corporation and certain of its subsidiaries have been notified by state
and federal environmental protection agencies of possible involvement as
one of numerous "potentially responsible parties" in a number of so-called
"Superfund" sites in the United States. In most of these sites, the
involvement of the Corporation or its subsidiaries is expected to be
minimal. The Corporation believes that appropriate reserves have been
established for its potential liability in connection with all Superfund
sites but is continuing to review its accruals as additional information
becomes available. Such reserves take into account all known or estimated
costs associated with these sites, including site investigations and
feasibility costs, site cleanup and remediation, legal costs, and fines and
penalties, if any. In addition, environmental costs connected with site
cleanups on Corporation-owned property also are covered by reserves
established in accordance with the foregoing. The Debtors have been given
permission by the Bankruptcy Court to satisfy environmental obligations up
to $12 million. The Corporation believes that neither these matters nor any
other known governmental proceeding regarding environmental matters will
have a material adverse effect upon its results of operations or financial
position.
-35-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
VOLUNTARY REORGANIZATION UNDER CHAPTER 11
On June 25, 2001 (the "Petition Date"), the parent company (the "Parent
Company") of the Corporation and the ten United States subsidiaries listed below
(collectively, the "Debtors") filed voluntary petitions for reorganization (the
"Filing") under chapter 11 of the United States Bankruptcy Code (the "Bankruptcy
Code") in the United States Bankruptcy Court for the District of Delaware (the
"Bankruptcy Court"). The chapter 11 cases of the Debtors (collectively, the
"Chapter 11 Cases") have been consolidated for purposes of joint administration
as In re: USG Corporation et al. (case no. 01-2094). The Chapter 11 Cases do not
include any of the Corporation's non-U.S. subsidiaries. The following
subsidiaries filed chapter 11 petitions:
United States Gypsum Company
USG Interiors, Inc.
USG Interiors International, Inc.
L&W Supply Corporation
Beadex Manufacturing, LLC
B-R Pipeline Company
La Mirada Products Co., Inc.
Stocking Specialists, Inc.
USG Industries, Inc.
USG Pipeline Company
This action was taken to resolve asbestos-related claims in a fair and equitable
manner, to protect the long-term value of the Debtors' businesses and to
maintain the Debtors' leadership positions in their markets.
BACKGROUND OF THE FILING
U.S. Gypsum is a defendant in asbestos lawsuits alleging both property damage
and personal injury. Chapter 11 filings during 2000 and early 2001 by other
companies subject to asbestos litigation dramatically increased U.S. Gypsum's
asbestos costs beyond its legitimate liability. The Corporation has been and
continues to be committed to finding a legislative solution to the increase in
asbestos costs. However, in 2001 it became apparent that a timely resolution to
the problem through legislation was not feasible. The Corporation determined
that voluntary protection under chapter 11 would be the best alternative for
obtaining a fair and final resolution of U.S. Gypsum's asbestos liability and
the best way to preserve value for stakeholders. See Part I, Item 1. Note 12.
"Litigation" for additional information on asbestos litigation.
USG was the eighth major company with a large number of asbestos claims that
filed a chapter 11 petition in the 18 months prior to the Petition Date. Since
1994, U.S. Gypsum has been named in more than 250,000 asbestos-related personal
injury
-36-
claims and made cash payments of approximately $575 million (before insurance
recoveries) to manage and resolve asbestos-related litigation. Based on an
independent study conducted in 2000 and on U.S. Gypsum's historical experience
of litigating asbestos claims in the tort system, the Corporation estimated that
U.S. Gypsum's probable liability for costs associated with asbestos cases
pending as of December 31, 2000, and expected to be filed through 2003 to be
between $889 million and $1,281 million. In the fourth quarter of 2000, U.S.
Gypsum recorded a noncash, pretax provision of $850 million, increasing its
total accrued reserve for asbestos claims to $1,185 million as of December 31,
2000. Substantially all of this reserve related to personal injury claims and
reflected management's expectation that U.S. Gypsum's average cost per case
would increase, at least in the short term, due to distortions in the tort
system resulting from the bankruptcies of other defendants that led to increased
settlement demands from asbestos plaintiffs. Less than 10% of the reserve
related to defense and administrative costs. Between January 1, 2001, and the
Petition Date, according to the Center for Claims Resolution, U.S. Gypsum was
served with more than 26,000 new claims. On a cash basis, U.S. Gypsum's
asbestos-related personal injury costs (before insurance) rose from $30 million
in 1997 to $162 million in 2000 and, absent the Filing, were expected to exceed
$275 million in 2001. Because of the Filing, there is greater uncertainty
concerning the liability associated with asbestos cases, as discussed below.
When a reasonable estimate can be made of the Debtors' probable liability for
asbestos claims, if such estimate differs from the existing reserve, the reserve
will be adjusted to reflect the estimate, and it is possible that a charge to
results of operations will be necessary at that time. It is possible that the
Corporation's asbestos liability may vary significantly from the recorded
estimate of liability and that this difference could be material to the results
of operations in the period recorded.
CONSEQUENCES OF THE FILING
The Debtors are operating their businesses as debtors-in-possession subject to
the provisions of the Bankruptcy Code. All vendors are being paid for all goods
furnished and services provided after the Filing. However, as a consequence of
the Filing, pending litigation against the Debtors as of the Petition Date is
stayed, and no party may take any action to pursue or collect pre-petition
claims except pursuant to an order of the Bankruptcy Court. It is the Debtors'
intention to address all pending and future asbestos-related claims and all
other pre-petition claims in a plan of reorganization. However, it is impossible
to predict currently how the plan will treat asbestos and other pre-petition
claims and what impact any reorganization plan may have on the shares of the
Corporation's common stock and other outstanding securities. The formulation and
implementation of the plan of reorganization could take a significant period of
time.
Three creditors' committees, one representing asbestos personal injury
claimants, another representing asbestos property damage claimants, and a third
representing general unsecured creditors, were organized in 2001. These
committees have been appointed as official committees in the Chapter 11 Cases
and, in accordance with the provisions of the Bankruptcy Code, will have the
right to be heard on all matters that come before the Bankruptcy Court. The
Bankruptcy Court appointed the
-37-
Hon. Dean M. Trafelet as the legal representative for future asbestos claimants
in the Debtors' bankruptcy proceeding. Mr. Trafelet was formerly a judge of the
Circuit Court of Cook County, Illinois. The Corporation expects that the
appointed committees, together with Mr. Trafelet, will play important roles in
the Chapter 11 Cases and the negotiation of the terms of any plan of
reorganization. Recent developments in the Corporation's bankruptcy proceeding
are discussed in Part I, Item 1. Note 12. "Litigation."
CHAPTER 11 FINANCING
A $350 million debtor-in-possession financing facility from JP Morgan Chase (the
"DIP Facility") was approved by the Bankruptcy Court on July 31, 2001. The DIP
Facility is available to supplement liquidity and fund operations during the
reorganization process. The Corporation believes that cash available from
operations and the DIP Facility will provide sufficient liquidity to allow its
businesses to operate in the normal course without interruption. The DIP
Facility matures on June 25, 2004. See "Available Liquidity" below for more
information on the DIP Facility.
ACCOUNTING IMPACT
The Corporation is required to follow AICPA Statement of Position 90-7 ("SOP
90-7"), "Financial Reporting by Entities in Reorganization under the Bankruptcy
Code." Pursuant to SOP 90-7, the Corporation's pre-petition liabilities that are
subject to compromise are reported separately on the consolidated balance sheet.
Virtually all of the Corporation's pre-petition debt is currently in default and
was recorded at face value and classified within liabilities subject to
compromise. U.S. Gypsum's asbestos liability also is classified within
liabilities subject to compromise. See Part I, Item 1. Note 2. "Voluntary
Reorganization Under Chapter 11," which includes information related to
financial statement presentation, the debtor-in-possession statements and detail
of the liabilities subject to compromise and chapter 11 reorganization expenses.
OUTCOME OF THE FILING
The Corporation is unable to predict at this time what the treatment of
creditors and equity holders of the respective Debtors will be under any
proposed plan or plans of reorganization. While it is the Corporation's intent
to seek a full recovery for its creditors, pre-petition creditors may receive
under a plan or plans less than 100% of the face value of their claims, and the
interests of the Corporation's equity security holders are likely to be
substantially diluted or cancelled in whole or in part. It is not possible at
this time to predict the outcome of the Chapter 11 Cases, the terms and
provisions of any plan or plans of reorganization, or the effect of the chapter
11 reorganization process on the claims of the pre-petition creditors of the
Debtors or the interests of the Corporation's equity security holders.
-38-
CONSOLIDATED RESULTS
NET SALES
Net sales in the third quarter and first nine months of 2002 were $903 million
and $2,617 million, respectively, up 7% and 6% from the corresponding 2001
periods. These increases reflect higher levels of sales for the Corporation's
North American Gypsum and Building Products Distribution segments, partially
offset by lower sales for its Worldwide Ceilings business.
Net sales for North American Gypsum are up in 2002 primarily due to increased
selling prices for SHEETROCK brand gypsum wallboard sold by United States Gypsum
Company. These prices increased 23% for the third quarter and 21% for the first
nine months of 2002 compared with last year's prices. Shipments of U.S. Gypsum's
gypsum wallboard were up 4% for the first nine months, but were down 4% for the
third quarter versus the same periods in 2001. Net sales for Building Products
Distribution are up in 2002 primarily due to increased shipments and selling
prices for gypsum wallboard sold by L&W Supply Corporation. For Worldwide
Ceilings, demand for ceiling tile and grid has weakened in Europe and other
foreign markets. Consequently, net sales for this business declined primarily
due to lower export shipments of ceiling tile and lower shipments of
internationally produced ceiling tile and grid.
COST OF PRODUCTS SOLD
Cost of products sold in the third quarter of 2002 increased 2% versus the third
quarter of 2001 primarily due to higher manufacturing costs for SHEETROCK brand
gypsum wallboard. These costs rose primarily due to higher prices for
wastepaper, the primary raw material of wallboard paper. However, the higher
gypsum wallboard costs were partially offset by cost reductions for ceiling tile
resulting from lower energy and raw material costs and from the closure of a
high-cost ceiling tile production line in the fourth quarter of 2001. For the
first nine months of 2002, cost of products sold were down 1% from the
comparable 2001 period.
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses for the third quarter and first nine months
of 2002 were $76 million and $238 million, up 10% and 18% from the respective
2001 periods. As a percent of net sales, selling and administrative expenses for
the quarter increased to 8.4% from 8.2% a year ago. For the first nine months,
expenses were 9.1% of net sales compared with 8.2% last year. Selling and
administrative expenses reflect the impact of a Bankruptcy-Court-approved key
employee retention plan, which became effective in the third quarter of 2001.
Expenses associated with this plan are being accrued pro rata over the term of
the plan and amounted to $5 million in the third quarter of 2002 and $16 million
in the first nine months of 2002 compared with $5 million in the third quarter
and first nine months of 2001. Expenses for the 2002 periods also reflect a
higher level of accruals for incentive compensation associated with attainment
of profit and other performance goals.
-39-
CHAPTER 11 REORGANIZATION EXPENSES
Chapter 11 reorganization expenses consist of the following (dollars in
millions):
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------------------------------
2002 2001 2002 2001
-------------------------------------------
Legal and financial advisory fees $ 5 $ 1 $ 18 $ 9
Bankruptcy-related interest income (2) (2) (6) (2)
Accelerated amortization of debt issuance costs - - - 2
- ---------------------------------------------------------------------------------------------
Total chapter 11 reorganization expenses 3 (1) 12 9
=============================================================================================
PROVISION FOR RESTRUCTURING EXPENSES
During the third quarter of 2001, the Corporation reversed $9 million pretax ($5
million after-tax) of the restructuring reserve recorded in the fourth quarter
of 2000 due to changes from previous estimates and to reflect a change in the
scope of restructuring activities undertaken. Also during the third quarter of
2001, the Corporation reversed restructuring-related inventory reserves totaling
$3 million pretax ($2 million after-tax) to cost of products sold because the
sale or use of certain affected inventory exceeded expectations. See
Restructuring Activities below for additional information.
OPERATING PROFIT
Operating profit in the third quarter and first nine months of 2002 was $75
million and $203 million, up 53% and 167% from the respective 2001 periods.
These increases primarily reflect increased selling prices for SHEETROCK brand
gypsum wallboard.
INTEREST EXPENSE
Interest expense of $1 million and $4 million was incurred in the third quarter
and first nine months of 2002, respectively. Interest expense amounted to $1
million and $31 million in the respective 2001 periods. Under SOP 90-7,
virtually all of the Corporation's outstanding debt is classified as liabilities
subject to compromise, and interest expense on this debt has not been accrued or
recorded since the Petition Date. Consequently, a comparison of interest expense
for the first nine months of 2002 and 2001 is not meaningful. For the third
quarter and first nine months of 2002, contractual interest expense not accrued
or recorded on pre-petition debt totaled $18 million and $55 million,
respectively.
INTEREST INCOME
Interest income was $1 million in the third quarter and $3 million in the first
nine months of 2002. These amounts represent interest earned on cash held by
non-debtor subsidiaries.
-40-
INCOME TAXES
Income taxes amounted to $31 million and $85 million in the third quarter and
first nine months of 2002, respectively, compared with $20 million and $22
million in the corresponding 2001 periods. The effective tax rates were 41.7%
and 46.3% for the first nine months of 2002 and 2001, respectively.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE FOR SFAS NO. 142
On January 1, 2002, USG Corporation adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." In
accordance with the provisions of SFAS No. 142, the Corporation determined that
goodwill for its North American Gypsum segment was impaired and recorded a
noncash, nontaxable impairment charge of $96 million. This charge, which
includes a $6 million deferred currency translation write-off, is reflected on
the Corporation's consolidated statement of earnings as a cumulative effect of a
change in accounting principle as of January 1, 2002. See Recent Accounting
Pronouncements below for more information related to the adoption of SFAS No.
142.
NET EARNINGS
Net earnings of $44 million, or $1.03 per share, were reported for the third
quarter of 2002 compared with $27 million, or $0.61 per share, for the third
quarter of 2001.
For the first nine months of 2002, net earnings of $22 million, or $0.51 per
share, were reported versus net earnings of $25 million, or $0.57 per share, for
the first nine months of 2001.
PRO FORMA NET EARNINGS
Net earnings for the first nine months of 2002 included the nontaxable goodwill
impairment charge of $96 million, or $2.22 per share, described above. Excluding
this charge, pro forma net earnings were $118 million, or $2.73 per share, for
the first nine months of 2002.
Net earnings for the third quarter and first nine months of 2001 included the
after-tax reversals of restructuring reserves of $5 million, or $0.12 per share,
and restructuring-related inventory reserves of $2 million, or $0.04 per share,
described above. Excluding these reversals, pro forma net earnings were $20
million, or $0.45 per share, for the third quarter of 2001 and $18 million, or
$0.41 per share, for the first nine months of 2001.
-41-
CORE BUSINESS RESULTS
(dollars in millions) THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------------------
NET SALES: 2002 2001 2002 2001
------------------------------------------
NORTH AMERICAN GYPSUM:
U.S. Gypsum Company $ 502 $ 459 $ 1,488 $ 1,321
CGC Inc. (gypsum) 56 53 162 152
Other subsidiaries* 36 33 100 86
Eliminations (42) (41) (122) (114)
- ------------------------------------------------------------------------------
Total 552 504 1,628 1,445
- ------------------------------------------------------------------------------
WORLDWIDE CEILINGS:
USG Interiors, Inc. 120 120 348 370
USG International 46 54 132 162
CGC Inc. (ceilings) 9 10 30 31
Eliminations (13) (16) (42) (52)
- ------------------------------------------------------------------------------
Total 162 168 468 511
- ------------------------------------------------------------------------------
BUILDING PRODUCTS DISTRIBUTION:
L&W Supply Corporation 317 294 898 867
- ------------------------------------------------------------------------------
Eliminations (128) (124) (377) (349)
- ------------------------------------------------------------------------------
Total USG Corporation 903 842 2,617 2,474
==============================================================================
OPERATING PROFIT (LOSS):
NORTH AMERICAN GYPSUM:
U.S. Gypsum Company 50 13 164 (14)
CGC Inc. (gypsum) 7 6 20 17
Other subsidiaries* 6 8 18 19
- ------------------------------------------------------------------------------
Total 63 27 202 22
- ------------------------------------------------------------------------------
WORLDWIDE CEILINGS:
USG Interiors, Inc. 13 9 31 27
USG International 1 (1) (4) (3)
CGC Inc. (ceilings) 1 2 4 4
- ------------------------------------------------------------------------------
Total 15 10 31 28
- ------------------------------------------------------------------------------
BUILDING PRODUCTS DISTRIBUTION:
L&W Supply Corporation 18 16 38 53
- ------------------------------------------------------------------------------
Corporate (17) (12) (54) (27)
Chapter 11 reorganization expenses (3) 1 (12) (9)
Provision for restructuring expenses - 9 - 9
Eliminations (1) (2) (2) -
- ------------------------------------------------------------------------------
Total USG Corporation 75 49 203 76
==============================================================================
*Includes USG Mexico, S.A. de C.V., a building products business in Mexico,
Gypsum Transportation Limited, a shipping company in Bermuda, and USG Canadian
Mining Ltd., a mining operation in Nova Scotia.
-42-
NORTH AMERICAN GYPSUM
Net sales in the third quarter and first nine months of 2002 were $552 million
and $1,628 million, respectively, up 10% and 13% from the corresponding 2001
periods. Operating profit in the third quarter and first nine months of 2002 was
$63 million and $202 million, respectively, compared with $27 million and $22
million for the corresponding 2001 periods.
Third quarter net sales for U.S. Gypsum increased 9% primarily due to higher
selling prices for SHEETROCK brand gypsum wallboard. The average realized price
per thousand square feet (selling price less freight to the customer) was
$101.03 in the third quarter of 2002. This price was up 23% from the average
realized price of $82.25 in the third quarter of 2001, but down 1% from $102.13
in the second quarter of 2002. U.S. Gypsum sold 2.6 billion square feet of
SHEETROCK brand gypsum wallboard during the third quarter of 2002, a 4% decrease
from 2.7 billion square feet sold in the third quarter of 2001. However, U.S.
Gypsum experienced record third quarter shipments of SHEETROCK brand joint
compounds and DUROCK brand cement board.
Third quarter 2002 operating profit for U.S. Gypsum increased to $50 million
from $13 million in the third quarter of 2001. This improvement was primarily
attributable to higher selling prices, partially offset by lower shipments and
higher manufacturing costs for gypsum wallboard. Manufacturing costs increased
primarily due to higher prices for wastepaper, the primary raw material of
wallboard paper.
U.S. Gypsum's wallboard plants operated at 94% of capacity in the third quarter
of 2002 versus an estimated average rate of 85% for the U.S. wallboard industry.
This compares with operating rates for the third quarter of 2001 of 97% for U.S.
Gypsum and an estimated 88% for the industry. Industry shipments of gypsum
wallboard in the third quarter of 2002 were down approximately 3% versus the
same period in 2001.
Improved results also were recorded for the gypsum business of Canada-based CGC
Inc. Third quarter net sales of $56 million and operating profit of $7 million
represented increases of 6% and 17%, respectively, compared to 2001. Most of the
improvement in CGC's net sales and operating profit was due to higher shipments
and selling prices for its SHEETROCK brand joint compounds and lower raw
material costs.
WORLDWIDE CEILINGS
Net sales in the third quarter and first nine months of 2002 were $162 million
and $468 million, respectively, down 4% and 8% from the corresponding 2001
periods. However, operating profit in the third quarter and first nine months of
2002 increased to $15 million and $31 million, respectively, up 50% and 11% from
the comparable 2001 periods.
For USG Interiors, Inc., the Corporation's ceilings business in the United
States, third quarter 2002 net sales were $120 million, unchanged from the third
quarter
-43-
of 2001. USG Interiors' domestic sales increased due to improved volume and
pricing for ceiling tile and grid. However, these improvements were offset by a
21% decrease in export shipments of ceiling tile. The lower exports of ceiling
tile primarily reflected lower demand in Europe where the market for commercial
ceiling products has weakened. Third quarter operating profit for USG Interiors
increased to $13 million from $9 million a year ago primarily due to lower
costs. Cost reductions resulted from lower energy and raw material costs and
from the closure of a high-cost ceiling tile production line in the fourth
quarter of 2001.
Net sales for USG International were down primarily due to lower demand for
ceiling tile and grid in Europe. Operating profit for USG International of $1
million was experienced in the third quarter of 2002, compared to an operating
loss of $1 million a year ago. This improvement was primarily attributable to
lower costs at the Aubange, Belgium, plant.
Net sales and operating profit for the ceilings division of CGC Inc. each
declined from the third quarter of 2001. These declines reflected lower grid and
tile shipments due to softness in Canada's non-residential construction market.
BUILDING PRODUCTS DISTRIBUTION
L&W Supply, the largest specialty building products distribution business in the
United States, reported third quarter 2002 net sales and operating profit of
$317 million and $18 million, increases of 8% and 13% over the respective 2001
periods. Net sales rose primarily due to increased selling prices (up 9%) and a
record level of shipments (up 1%) for gypsum wallboard sold by L&W Supply. In
addition, sales of complementary building products increased 6%. The increase in
operating profit was primarily attributable to higher operating profit for
complementary building products (up 6%), which more than offset a lower gypsum
wallboard margin. L&W Supply's gypsum wallboard margin declined as gypsum
manufacturers' increased selling prices to L&W Supply were not fully passed on
to its customers.
For the first nine months of 2002, net sales of $898 million rose 4% versus the
first nine months of 2001 primarily due to higher gypsum wallboard selling
prices (up 6%) and increased shipments (up 2%). However, operating profit of $38
million fell 28% primarily due higher gypsum wallboard unit costs (up 14%),
which more than offset the increases in shipments and prices.
L&W Supply currently operates 180 locations in the United States distributing a
variety of gypsum, ceilings and related building materials.
MARKET CONDITIONS AND OUTLOOK
The new housing market has remained strong through the first nine months of
2002. Growth in new housing and a strong level of residential remodeling
resulted in first and second quarter records for gypsum wallboard shipments.
Despite a 3% drop in industry shipments versus the third quarter of 2001,
shipments in the third quarter of 2002 were still at a historically high level.
The favorable levels of
-44-
activity in the new housing and repair and remodel markets, which together
account for nearly two-thirds of all demand for gypsum wallboard, and increased
operating rates in the gypsum industry allowed selling prices to rise in the
first and second quarters. Prices have remained relatively stable in the third
quarter of 2002. Commercial construction has been affected by reduced corporate
earnings, resulting in lower investments in office and other commercial space.
The outlook for the Corporation's markets during the balance of the year is
mixed. The Corporation expects demand for gypsum wallboard to remain strong,
primarily due to the continued high demand for new homes. At the same time,
nonresidential construction, the principal market for the Corporation's ceiling
products, is likely to remain weak. In addition, recent increases in wastepaper
prices are causing wallboard manufacturing costs to rise. The Corporation
continues to face a very uncertain economic environment. The effect of this
uncertainty, including the recent declines in consumer confidence, could
negatively affect the Corporation's businesses.
During the fourth quarter of 2002, the Corporation will closely monitor
developments in this soft economy while remaining focused on managing the
fundamentals of its businesses such as customer satisfaction, costs and
profitability and will diligently continue its attempt to resolve the Chapter
11 proceedings, consistent with the goal of achieving a fair, comprehensive and
final resolution to its asbestos liability.
LIQUIDITY AND CAPITAL RESOURCES
WORKING CAPITAL
Working capital (current assets less current liabilities) as of September 30,
2002, amounted to $910 million, and the ratio of current assets to current
liabilities was 3.12-to-1. As of December 31, 2001, working capital amounted to
$876 million, and the ratio of current assets to current liabilities was
3.73-to-1.
Cash and cash equivalents as of September 30, 2002, amounted to $596 million,
compared with $493 million as of December 31, 2001. During the first nine months
of 2002, net cash flows from operating activities totaled $317 million. Net cash
flows to investing activities totaled $214 million and consisted of capital
spending of $64 million, purchases of marketable securities, net of sales and
maturities, of $152 million, offset slightly by proceeds of $2 million from
asset sales. Because of the Filing, there were no financing activities during
the first nine months of 2002.
As of September 30, 2002, $121 million was invested in long-term marketable
securities and $31 million in short-term marketable securities. The
Corporation's marketable securities are classified as available-for-sale
securities and reported at fair market value with unrealized gains and losses
excluded from earnings and reported in accumulated other comprehensive loss on
the consolidated balance sheet.
-45-
Receivables increased to $326 million as of September 30, 2002, from $274
million as of December 31, 2001, primarily reflecting a 22% increase in net
sales for the month of September 2002 as compared with December 2001.
Inventories and payables also were up from December 31, 2001, primarily due to
the increased level of business. Inventories increased to $291 million from $254
million, and accounts payable increased to $194 million from $140 million.
DEBT
As of September 30, 2002, total debt amounted to $1,007 million, of which $1,005
million was included in liabilities subject to compromise. These amounts were
unchanged from the December 31, 2001, levels.
AVAILABLE LIQUIDITY
A $350 million DIP Facility is available to supplement liquidity and fund
operations during the reorganization process. Borrowing availability under the
DIP Facility is based primarily on accounts receivable and inventory levels and,
to a lesser extent, property, plant and equipment. As of September 30, 2002, the
Corporation had the capacity to borrow up to $338 million. There were no
outstanding borrowings under the DIP Facility as of September 30, 2002. However,
$15 million of standby letters of credit were outstanding, leaving $323 million
of unused borrowing capacity available as of September 30, 2002. The Corporation
believes that cash available from operations and the DIP Facility will provide
sufficient liquidity to allow its businesses to operate in the normal course
without interruption. As of September 30, 2002, the Corporation, on a
consolidated basis, had $596 million of cash and cash equivalents and $152
million of marketable securities. Of the total amount of cash, $163 million was
in the possession of non-Debtor subsidiaries.
CAPITAL EXPENDITURES
Capital spending amounted to $64 million in the first nine months of 2002
compared with $75 million in the corresponding 2001 period. In response to
demand, construction of a new production line to manufacture DUROCK brand cement
board was completed in the third quarter of 2002 at U.S. Gypsum's Baltimore,
Maryland, plant and a new plant to produce SHEETROCK brand joint compounds is
under construction in Glendale, Arizona. The Glendale plant is expected to be
completed by year-end 2002. As of September 30, 2002, remaining capital
expenditure commitments for the replacement, modernization and expansion of
operations amounted to $69 million, compared with $63 million as of December 31,
2001.
During the bankruptcy proceeding, the Corporation expects to have limited
ability to access capital other than its own cash flows to fund potential future
growth opportunities such as new products, acquisitions and joint ventures. In
addition, one of the terms of the DIP Facility limits capital spending to a
total of $175 million per year. Within such constraints, the Corporation expects
to be able to maintain a program of capital spending aimed at focused areas of
growth within its businesses.
-46-
RESTRUCTURING ACTIVITIES
2001 Restructuring Plan: In the fourth quarter of 2001, the Corporation recorded
a pretax charge of $12 million related to a restructuring plan that included the
shutdown of a gypsum wallboard plant in Fremont, Calif., a drywall steel plant
in Prestice, Czech Republic, a ceiling tile plant in San Juan Ixhuatepec,
Mexico, a ceiling tile manufacturing line in Greenville, Miss., and other
restructuring activities. Included in the $12 million charge was $8 million for
severance related to a workforce reduction of more than 350 positions (primarily
hourly positions), $2 million for the write-off of property, plant and
equipment, and $2 million for line shutdown and removal and contract
cancellations. The 2001 restructuring is intended to allow the Corporation to
optimize its manufacturing operations. Final payments associated with this plan
are expected to be completed in the first half of 2003.
The reserve for this plan is included in accrued expenses on the consolidated
balance sheets. Fourth quarter 2001 charges against the reserve included the $2
million write-off of property, plant and equipment and payments totaling $2
million. An additional $3 million of payments were charged against the reserve
in the first nine months of 2002. All payments for the 2001 restructuring plan
are being funded with cash from operations.
As of September 30, 2002, 260 employees have been terminated, and 26 open
positions have been eliminated and the ceiling tile manufacturing line at
Greenville, Miss., and the plants in San Juan Ixhuatepec, Mexico, and Prestice,
Czech Republic, have been shutdown. The Fremont, Calif., plant ceased production
in April 2002. Annual savings from the full implementation of the 2001
restructuring initiatives are estimated at $11 million.
2000 Restructuring Plan: In the fourth quarter of 2000, the Corporation recorded
a pretax charge of $50 million related to a restructuring plan that included a
salaried workforce reduction and the shutdown of three gypsum wallboard
manufacturing lines and other operations. Included in the $50 million charge was
$16 million for severance related to the salaried workforce reduction of more
than 500 positions, $15 million for the write-off of property, plant and
equipment, $12 million for razing buildings and equipment, $5 million for line
shutdown and removal, and $2 million for contract cancellations and severance
for more than 100 hourly positions. An additional restructuring-related charge
of $4 million was included in cost of products sold for the writedown of certain
inventory. This restructuring was designed to streamline operations and improve
business efficiency.
During the third quarter of 2001, the Corporation reversed $9 million pretax of
the restructuring reserve recorded in the fourth quarter of 2000 due to changes
from previous estimates and to reflect a change in the scope of restructuring
activities undertaken. The primary change involved a decision made in September
2001 to eliminate a portion of the closure activities originally planned at the
Alabaster, Mich., facility.
-47-
The reserve for the 2000 restructuring was included in liabilities subject to
compromise on the consolidated balance sheets and payments totaling $22 million
were charged against this reserve through December 31, 2001. The remaining $4
million was charged against this reserve in the first six months of 2002. All
payments for this plan were funded with cash from operations.
The salaried workforce reduction program was completed as of June 30, 2001, with
the termination of 394 salaried employees and the elimination of 179 open
salaried positions. In addition, 73 hourly employees were terminated, and 44
open hourly positions were eliminated. Closure of the three gypsum wallboard
manufacturing lines and other operations was completed by December 31, 2001.
Annual savings from the 2000 restructuring initiatives are estimated at $40
million. See Part I, Item 1. Note 9. "Restructuring" for additional information
related to restructuring payments and reserve balances.
OTHER MATTERS
LEGAL CONTINGENCIES
As a result of the Filing, all pending asbestos lawsuits against U.S. Gypsum are
stayed, and no party may take any action to pursue or collect on such asbestos
claims absent specific authorization of the Bankruptcy Court. Since the Filing,
U.S. Gypsum has ceased making both cash payments and accruals with respect to
asbestos lawsuits, including cash payments and accruals pursuant to settlements
of asbestos lawsuits. U.S. Gypsum continues to receive payments from its
insurance carriers pursuant to previous settlements. Creditors' committees have
been appointed representing asbestos personal injury and property damage
claimants with pending claims against U.S. Gypsum, and the Bankruptcy Court has
appointed the Hon. Dean M. Trafelet as the legal representative for the
interests of potential future asbestos claimants. As part of the bankruptcy
proceeding, it will be determined which present and future asbestos claims
should be allowed, or compensated, and the aggregate value of such claims. The
Corporation is unable to predict the value that the court will assign to such
claims.
The Corporation and certain of its subsidiaries have been notified by state and
federal environmental protection agencies of possible involvement as one of
numerous "potentially responsible parties" in a number of so-called "Superfund"
sites in the United States. The Corporation believes that neither these matters
nor any other known governmental proceeding regarding environmental matters will
have a material adverse effect upon its results of operations or financial
position. See Part I, Item 1. Note 12. "Litigation" for additional information
on asbestos and environmental litigation.
RECENT ACCOUNTING PRONOUNCEMENTS
The Corporation adopted three new accounting standards in the first quarter of
2002.
On January 1, 2002, the Corporation adopted SFAS No. 142, "Goodwill and Other
-48-
Intangible Assets." Although SFAS No. 142 eliminates the amortization of
goodwill and certain other intangible assets, it initiates an annual assessment
of goodwill for impairment. During the second quarter of 2002, the Corporation
completed its transition date assessment of goodwill. The assessment was
performed for each reporting unit (as defined by SFAS No. 142) that has
goodwill. For the Corporation, the reporting units with goodwill were the North
American Gypsum and the Building Products Distribution operating segments. The
Corporation determined that goodwill for its Building Products Distribution
segment was not impaired, but will be reviewed at least annually for impairment.
However, goodwill for its North American Gypsum segment was impaired. This
impairment was attributable to U.S. Gypsum's asbestos liability and related
filing for bankruptcy protection on June 25, 2001. As a result, the Corporation
recorded a noncash, nontaxable impairment charge of $96 million. This charge,
which includes a $6 million deferred currency translation write-off, is
reflected on the Corporation's consolidated statement of earnings as a
cumulative effect of a change in accounting principle as of January 1, 2002. In
accordance with SFAS No. 142, the Corporation is reflecting this charge in its
financial statements for the three months ended March 31, 2002.
SFAS No. 141, "Business Combinations," requires all business combinations
initiated after June 30, 2001, to be accounted for using the purchase method.
This standard, which became effective for the Corporation on January 1, 2002,
had no impact on its financial statements upon adoption.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets,"
supersedes SFAS No. 121 and a portion of APB Opinion No. 30. This statement
establishes a single accounting model for the disposal of long-lived assets and
resolves significant implementation issues related to SFAS No. 121. This
standard, which became effective for the Corporation on January 1, 2002, had no
impact on the Corporation's financial statements upon adoption.
The Corporation will adopt SFAS No. 143, "Accounting for Asset Retirement
Obligations," in January 2003. This standard requires entities to record the
fair value of a liability for an asset retirement obligation in the period in
which it is incurred. This standard becomes effective January 1, 2003, and is
likely to have an impact on the Corporation's financial statements. However, as
of the date of this report, the Corporation has not determined what impact the
adoption of this standard may have on its financial statements.
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements related to management's
expectations about future conditions. The effects of the Filing and the conduct,
outcome and costs of the Chapter 11 Cases, as well as the ultimate costs
associated with the Corporation's asbestos litigation, may differ from
management's expectations. Actual business or other conditions may also differ
significantly from management's expectations and accordingly affect the
Corporation's sales and profitability or other results. Actual results may
differ
-49-
due to various other factors, including economic conditions such as the levels
of construction activity, interest rates, currency exchange rates and consumer
confidence; competitive conditions such as price and product competition;
increases in raw material and energy costs; and the unpredictable effects of the
global war on terrorism upon domestic and international economies and financial
markets. The Corporation assumes no obligation to update any forward-looking
information contained in this report.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
The Corporation's chief executive officer and chief financial officer, after
evaluating the effectiveness of the Corporation's "disclosure controls and
procedures" (as defined in the Rules 13a-14(c) and 15-d-14(c) of the Securities
Exchange Act of 1934) as of a date (the "Evaluation Date") within 90 days before
the filing date of this quarterly report, have concluded that as of the
Evaluation Date, the Corporation's disclosure controls and procedures were
adequate and designed to ensure that material information relating to the
Corporation and its consolidated subsidiaries would be made known to them by
others within those entities.
(b) Changes in internal controls.
There were no significant changes in the Corporation's internal controls or in
other factors that could significantly affect the Corporation's internal
controls subsequent to the Evaluation Date.
-50-
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors of USG Corporation:
We have reviewed the accompanying consolidated balance sheet of USG Corporation
and subsidiaries as of September 30, 2002, and the related consolidated
statements of earnings for the three and nine month periods ended September 30,
2002 and the consolidated statement of cash flows for the nine month period
ended September 30, 2002. These financial statements are the responsibility of
the Corporation's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such consolidated financial statements for them to be in conformity
with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Corporation will continue as a going concern. As discussed in Notes 2
and 12 to the consolidated financial statements, certain conditions raise
substantial doubt about its ability to continue as a going concern. Management's
plans in regard to these matters are also described in Notes 2 and 12 to the
financial statements.
/s/ DELOITTE & TOUCHE LLP
DELOITTE & TOUCHE LLP
Chicago, Illinois
October 23, 2002
-51-
INFORMATION REGARDING PREDECESSOR INDEPENDENT PUBLIC ACCOUNTANTS' REVIEW
REPORTS
This is a copy of a review report previously issued by Arthur Andersen LLP
("Andersen"). The report has not been reissued by Andersen nor has Andersen
provided an awareness letter for the inclusion of its report in this Current
Report on Form 10-Q.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors of USG Corporation:
We have reviewed the accompanying condensed consolidated balance sheet of
USG CORPORATION (a Delaware corporation) AND SUBSIDIARIES as of March 31, 2002,
and the related condensed consolidated statements of earnings for the
three-month periods ended March 31, 2002 and 2001 and the condensed consolidated
statements of cash flows for the three-month periods ended March 31, 2002 and
2001. These financial statements are the responsibility of the Corporation's
management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the financial statements referred to above for them to be in
conformity with accounting principles generally accepted in the United States.
The accompanying condensed consolidated financial statements have been
prepared assuming that the Corporation will continue as a going concern. As
discussed in Note 2 to the consolidated financial statements, the Corporation
voluntarily filed for Chapter 11 bankruptcy protection on June 25, 2001.
Management's plans in regard to these matters are also described in Note 2. This
action, which was taken primarily as a result of asbestos litigation as
discussed in Note 11 to the condensed consolidated financial statements, raises
substantial doubt about the Corporation's ability to continue as a going
concern. Such doubt includes, but is not limited to, a possible change in
control of the Corporation as well as a potential change in the composition of
the Corporation's business portfolio. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
/s/ ARTHUR ANDERSEN LLP
ARTHUR ANDERSEN LLP
Chicago, Illinois
April 24, 2002
-52-
INFORMATION REGARDING PREDECESSOR INDEPENDENT PUBLIC ACCOUNTANTS' REVIEW
REPORTS
This is a copy of a review report previously issued by Andersen. The report has
not been reissued by Andersen nor has Andersen provided an awareness letter for
the inclusion of its report in this Current Report on Form 10-Q.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors of USG Corporation:
We have reviewed the accompanying condensed consolidated balance sheet of
USG CORPORATION (a Delaware corporation) AND SUBSIDIARIES as of September 30,
2001, and the related condensed consolidated statements of earnings for the
three-month and nine-month periods ended September 30, 2001 and 2000 and the
condensed consolidated statements of cash flows for the nine-month periods ended
September 30, 2001 and 2000. These financial statements are the responsibility
of the Corporation's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the financial statements referred to above for them to be in
conformity with accounting principles generally accepted in the United States.
The accompanying condensed consolidated financial statements have been
prepared assuming that the Corporation will continue as a going concern. As
discussed in Note 2 to the consolidated financial statements, the Corporation
voluntarily filed for Chapter 11 bankruptcy protection on June 25, 2001.
Management's plans in regard to these matters are also described in Note 2. This
action, which was taken primarily as a result of asbestos litigation as
discussed in Note 9 to the condensed consolidated financial statements, raises
substantial doubt about the Corporation's ability to continue as a going
concern. Such doubt includes, but is not limited to, a possible change in
control of the Corporation as well as a potential change in the composition of
the Corporation's business portfolio. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
/s/ ARTHUR ANDERSEN LLP
ARTHUR ANDERSEN LLP
Chicago, Illinois
October 24, 2001
-53-
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Part I, Item 1. Note 12. "Litigation" for information concerning the
asbestos and related bankruptcy litigation and environmental litigation.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
3(c) Amended and Restated By-Laws of USG Corporation.
15. Letter from Deloitte & Touche LLP regarding unaudited financial
information.
99. Certifications of USG Corporation's Chief Executive Officer and
Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
(b) Reports on Form 8-K:
A Form 8-K was filed on August 13, 2002, to report under Item 9
"Regulation FD Disclosure" that the Corporation submitted to the
Securities and Exchange Commission the Statements Under Oath of the
Principal Executive Officer and the Principal Financial Officer in
accordance with the Securities and Exchange Commission's June 27,
2002, Order requiring the filing of sworn statements pursuant to
Section 21(a)(1) of the Securities Exchange Act of 1934.
-54-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
USG CORPORATION
By /s/ William C. Foote
---------------------------------
William C. Foote,
Chairman, Chief Executive Officer
and President
By /s/ Richard H. Fleming
---------------------------------
Richard H. Fleming
Executive Vice President and
Chief Financial Officer,
By /s/ D. Rick Lowes
---------------------------------
D. Rick Lowes,
Vice President and Controller,
November 5, 2002
-55-
ANNUAL AND QUARTERLY CERTIFICATIONS
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, William C. Foote, certify that:
1. I have reviewed this quarterly report on Form 10-Q of USG Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of USG Corporation as of, and for, the periods presented in this
quarterly report;
4. USG Corporation's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for USG Corporation and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to USG Corporation, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
(b) evaluated the effectiveness of USG Corporation's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. USG Corporation's other certifying officers and I have disclosed, based on
our most recent evaluation, to USG Corporation's auditors and the audit
committee of USG Corporation's board of directors:
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect USG Corporation's
ability to record, process, summarize and report financial data
and have identified for USG Corporation's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in USG Corporation's
internal controls; and
6. USG Corporation's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of their evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
November 5, 2002 /s/ William C. Foote
-----------------------------------------------
William C. Foote
Chairman, Chief Executive Officer and President
-56-
ANNUAL AND QUARTERLY CERTIFICATIONS
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Richard H. Fleming, certify that:
1. I have reviewed this quarterly report on Form 10-Q of USG Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of USG Corporation as of, and for, the periods presented in this
quarterly report;
4. USG Corporation's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for USG Corporation and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to USG Corporation, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
(b) evaluated the effectiveness of USG Corporation's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. USG Corporation's other certifying officers and I have disclosed, based on
our most recent evaluation, to USG Corporation's auditors and the audit
committee of USG Corporation's board of directors:
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect USG
Corporation's ability to record, process, summarize and
report financial data and have identified for USG
Corporation's auditors any material weaknesses in internal
controls; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in USG
Corporation's internal controls; and
6. USG Corporation's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of their evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
November 5, 2002 /s/ Richard H. Fleming
------------------------------------------
Richard H. Fleming
Executive Vice President and
Chief Financial Officer
-57-