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 June 30, 2005
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 is an accelerated filer (as
defined in Exchange Act Rule 12b-2). 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 [ ]
The number of shares outstanding of the registrant's common stock as of June 30,
2005, was 43,535,144.
TABLE OF CONTENTS
Page
-----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Statements of Earnings:
Three Months and Six Months
Ended June 30, 2005 and 2004 3
Consolidated Balance Sheets:
As of June 30, 2005 and December 31, 2004 4
Consolidated Statements of Cash Flows:
Six Months Ended June 30, 2005 and 2004 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Results
of Operations and Financial Condition 41
Item 4. Controls and Procedures 56
Report of Independent Registered Public Accounting Firm 57
PART II OTHER INFORMATION
Item 1. Legal Proceedings 59
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 59
Item 4. Submission of Matters to a Vote of Security Holders 60
Item 5. Other Information 61
Item 6. Exhibits 61
Signatures 62
-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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------------------- ----------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Net sales $ 1,287 $ 1,145 $ 2,460 $ 2,165
Cost of products sold 1,020 929 1,979 1,778
------------ ------------ ------------ ------------
Gross profit 267 216 481 387
Selling and administrative expenses 87 79 176 156
Chapter 11 reorganization expenses (1) 4 - 6
------------ ------------ ------------ ------------
Operating profit 181 133 305 225
Interest expense 2 1 3 2
Interest income (2) (1) (4) (2)
Other expense, net 1 1 1 3
------------ ------------ ------------ ------------
Earnings before income taxes 180 132 305 222
Income taxes 70 52 118 85
------------ ------------ ------------ ------------
Net earnings 110 80 187 137
============ ============ ============ ============
Basic earnings per common share 2.55 1.86 4.32 3.18
Diluted earnings per common share 2.53 1.86 4.30 3.18
Average common shares 43,484,405 43,017,068 43,374,104 43,020,344
Average diluted common shares 43,774,634 43,017,971 43,615,954 43,021,448
See accompanying Notes to Consolidated Financial Statements.
-3-
USG CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
(UNAUDITED)
AS OF AS OF
JUNE 30, DECEMBER 31,
2005 2004
--------- ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 682 $ 756
Short-term marketable securities 200 138
Restricted cash 71 43
receivables (net of reserves - $14 and $ 14) 513 413
Inventories 338 338
Income taxes receivable 34 24
Deferred income taxes 14 25
Other current assets 85 53
--------- ---------
Total current assets 1,937 1,790
Long-term marketable securities 333 312
Property, plant and equipment (net of accumulated
depreciation and depletion - $927 and $ 878) 1,869 1,853
Deferred income taxes 239 152
Goodwill 64 43
Other assets 169 128
--------- ---------
Total assets 4,611 4,278
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable 278 270
Accrued expenses 218 224
Current portion of long-term debt 1 1
Income taxes payable 176 75
--------- ---------
Total current liabilities 673 570
Deferred income taxes 26 25
Other liabilities 438 417
Liabilities subject to compromise 2,242 2,242
Commitments and contingencies
Stockholders' Equity:
Preferred stock - -
Common stock 5 5
Treasury stock (253) (256)
Capital received in excess of par value 420 417
Accumulated other comprehensive income 32 17
Retained earnings 1,028 841
--------- ---------
Total stockholders' equity 1,232 1,024
--------- ---------
Total liabilities and stockholders' equity 4,611 4,278
========= =========
See accompanying Notes to Consolidated Financial Statements.
-4-
USG CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
SIX MONTHS
ENDED JUNE 30,
----------------------
2005 2004
-------- --------
OPERATING ACTIVITIES:
Net earnings $ 187 $ 137
Adjustments to reconcile net earnings to net cash:
Depreciation, depletion and amortization 60 55
Deferred income taxes (89) 25
(Gain) loss on asset dispositions - (1)
(Increase) decrease in working capital:
Receivables (90) (167)
Income taxes receivable (10) 2
Inventories 4 (77)
Payables 104 94
Accrued expenses (3) (3)
Increase in other assets (23) (6)
Increase in other liabilities 9 12
Change in asbestos receivable - 11
Decrease in liabilities subject to compromise - (3)
Other, net (8) (5)
-------- --------
Net cash provided by operating activities 141 74
-------- --------
INVESTING ACTIVITIES:
Capital expenditures (76) (47)
Purchases of marketable securities (388) (171)
Sales or maturities of marketable securities 303 135
Net proceeds from asset dispositions - 6
Acquisitions of businesses (29) (4)
Deposit of restricted cash (28) (26)
-------- --------
Net cash used for investing activities (218) (107)
-------- --------
FINANCING ACTIVITIES:
Issuances of common stock 6 -
-------- --------
Net cash provided by financing activities 6 -
-------- --------
Effect of exchange rate changes on cash (3) (3)
Net decrease in cash and cash equivalents (74) (36)
Cash and cash equivalents at beginning of period 756 700
-------- --------
Cash and cash equivalents at end of period 682 664
======== ========
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Interest paid 1 1
Income taxes paid, net 115 32
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 ("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 2004 Annual Report on Form 10-K which was filed on February
18, 2005.
(2) VOLUNTARY REORGANIZATION UNDER CHAPTER 11
On June 25, 2001 (the "Petition Date"), the Corporation and the 10 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"). This action was taken to resolve asbestos 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.
The chapter 11 cases of the Debtors (collectively, the "Chapter 11 Cases")
are jointly administered 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 ("U.S. Gypsum"); USG Interiors,
Inc. ("USG Interiors"); USG Interiors International, Inc.; L&W Supply
Corporation ("L&W Supply"); Beadex Manufacturing, LLC; B-R Pipeline
Company; La Mirada Products Co., Inc.; Stocking Specialists, Inc.; USG
Industries, Inc.; and USG Pipeline Company.
The background of asbestos litigation, developments in the Corporation's
reorganization proceedings and estimated cost are discussed in Note 13,
Litigation.
-6-
CONSEQUENCES OF THE FILING
As a consequence of the Filing, all asbestos lawsuits and other lawsuits
pending against the Debtors as of the Petition Date are stayed, and no
party may take any action to pursue or collect pre-petition claims except
pursuant to an order of the Bankruptcy Court. Since the Filing, the
Debtors have ceased making both cash payments and accruals with respect to
asbestos lawsuits. The Debtors are operating their businesses without
interruption as debtors-in-possession subject to the provisions of the
Bankruptcy Code, and vendors are being paid for goods furnished and
services provided after the Filing.
The Debtors' Chapter 11 Cases are assigned to Judge Judith K. Fitzgerald,
a bankruptcy court judge, and Judge Joy Flowers Conti, a district court
judge. Judge Conti will hear matters relating to estimation of the
Debtors' liability for asbestos personal injury claims. Other matters will
be heard by Judge Fitzgerald. Four official committees have been appointed
in the Chapter 11 Cases. One appointed committee represents asbestos
personal injury claimants (the "Official Committee of Asbestos Personal
Injury Claimants"), another represents asbestos property damage claimants
(the "Official Committee of Asbestos Property Damage Claimants"), a third
represents unsecured creditors (the "Official Committee of Unsecured
Creditors"), and the fourth represents the Corporation's shareholders (the
"Official Committee of Equity Security Holders"). In addition, the
Bankruptcy Court appointed Dean M. Trafelet as the legal representative
for future asbestos claimants. Mr. Trafelet was formerly a judge of the
Circuit Court of Cook County, Illinois. The appointed committees, together
with Mr. Trafelet, will play significant roles in the Chapter 11 Cases and
resolution of the terms of any plan of reorganization.
The Debtors intend to address their liability for all present and future
asbestos claims, as well as all other pre-petition claims, in a plan or
plans of reorganization approved by the Bankruptcy Court. The Debtors
currently have the exclusive right to file a plan of reorganization. This
exclusive period extended to June 30, 2005, and the Debtors have filed a
motion to further extend the exclusive period to December 31, 2005. This
motion is scheduled to be addressed by the Bankruptcy Court on August 29,
2005, and, by operation of the bankruptcy rules, the exclusive period is
extended at least until the Bankruptcy Court rules on the extension
request. The Debtors may seek additional extensions of the exclusive
period depending upon developments in the Chapter 11 Cases.
Any plan of reorganization ultimately approved by the Bankruptcy Court may
include one or more independently administered trusts under Section 524(g)
of the Bankruptcy Code, which may be funded by the Debtors to allow
payment of present and future asbestos personal injury claims. If the
confirmed plan of reorganization includes the creation and funding of a
Section 524(g) trust relating to one or more of the Debtors, the
Bankruptcy Court will issue a permanent injunction barring the assertion
of present and future asbestos claims against the relevant Debtors, their
successors, and their affiliates, and channeling those claims to the trust
-7-
for payment in whole or in part.
There are several requirements for confirmation of a plan of
reorganization containing an asbestos trust with all of the features set
forth in Section 524(g). One of the requirements is that the court
determine that the asbestos trust will be structured and funded so as to
be in a financial position to pay present claims and future demands that
involve similar claims in substantially the same manner. Another
requirement is that a class or classes of asbestos claimants affected by
the trust vote to approve the plan by at least 75% of those voting.
Section 524(g) also requires that such trust own (or have the right to
acquire if specified contingencies occur) a majority of the voting stock
of each relevant Debtor, its parent corporation, or a subsidiary that is
also a Debtor. A plan of reorganization, including a plan creating a
Section 524(g) trust, may be confirmed without the consent of non-asbestos
creditors and stockholders if certain requirements of the Bankruptcy Code
are met.
The Debtors also expect that the plan of reorganization will address the
Debtors' liability for asbestos property damage claims, whether by
including those liabilities in a Section 524(g) trust or by other means.
Similar plans of reorganization containing Section 524(g) trusts have been
confirmed in the chapter 11 cases of other companies with asbestos
liabilities, but there is no guarantee that the Bankruptcy Court in the
Debtors' Chapter 11 Cases will approve creation of a Section 524(g) trust
or issue a permanent injunction channeling to the trust all asbestos
claims against the Debtors and/or their successors and affiliates. In
addition, if federal legislation addressing asbestos personal injury
claims is passed, which is extremely speculative, such legislation may
affect whether the Debtors establish a trust under Section 524(g). See
Potential Federal Legislation Regarding Asbestos Personal Injury Claims,
below.
A key factor in determining whether or to what extent there will be any
recovery for pre-petition creditors or stockholders under any plan of
reorganization is the amount that must be provided in the plan of
reorganization to address the Debtors' liability for present and future
asbestos claims. The amount of Debtors' asbestos liabilities has not yet
been determined and is subject to substantial dispute and uncertainty. The
Official Committee of Asbestos Personal Injury Claimants and the legal
representative for future asbestos claimants have indicated in a court
filing that they estimate that the net present value of the Debtors'
liability for present and future asbestos personal injury claims is
approximately $5.5 billion and that the Debtors are insolvent. The Debtors
have stated that they believe they are solvent if their asbestos
liabilities are fairly and appropriately valued. If the amount of Debtors'
asbestos liabilities is not resolved through negotiation in the Chapter 11
Cases or addressed by federal legislation, the amount of these liabilities
may be determined through litigation proceedings before Judge Conti. See
-8-
Note 13, Litigation, for additional information regarding Debtors'
asbestos liabilities and their estimated cost.
While it is the Debtors' intention to seek a full recovery for their
creditors, it is not possible to predict the amount that will have to be
provided in the plan of reorganization to address present and future
asbestos claims, how the plan of reorganization will treat other
pre-petition claims, whether there will be sufficient assets to satisfy
the Debtors' pre-petition liabilities, and what impact any plan may have
on the value of the shares of the Corporation's common stock. The payment
rights and other entitlements of pre-petition creditors and the
Corporation's stockholders may be substantially altered by any plan of
reorganization confirmed in the Chapter 11 Cases. Pre-petition creditors
may receive under the plan of reorganization less than 100% of the face
value of their claims, the pre-petition creditors of some Debtors may be
treated differently from the pre-petition creditors of other Debtors, and
the interests of the Corporation's stockholders are likely to be
substantially diluted or cancelled in whole or in part. There can be no
assurance as to the value of any distributions that might be made under
any plan of reorganization with respect to such pre-petition claims or
equity interests.
It is also not possible to predict how the plan of reorganization will
treat intercompany indebtedness, licenses, transfers of goods and
services, and other intercompany arrangements, transactions and
relationships that were entered into before the Petition Date. Certain of
these intercompany transactions have been challenged by various parties in
these Chapter 11 Cases, and other arrangements, transactions and
relationships may be challenged by parties to these Chapter 11 Cases. The
outcome of such challenges may have an impact on the treatment of various
claims under any plan of reorganization.
In connection with the Filing, the Corporation implemented a Bankruptcy
Court-approved key employee retention plan that commenced on July 1, 2001,
and continued until June 30, 2004. Effective July 1, 2004, the key
employee retention plan, in an amended form, was extended until December
31, 2005. Under the amended plan, participants continue to earn awards
semiannually. The amendments introduced a performance feature for the last
two (of four) payments to be made under the extended plan which could
increase the final two payments up to a maximum of 25% above par or
eliminate them altogether.
Expenses associated with this plan amounted to $5.0 million and $10.4
million in the second quarter and first six months of 2005, respectively.
For the comparable 2004 periods, expenses totaled $2.6 million and $5.3
million. Expenses were lower in 2004 primarily due to accruals in 2003 and
2002 of amounts that were paid in 2004.
-9-
POTENTIAL FEDERAL LEGISLATION REGARDING ASBESTOS PERSONAL INJURY CLAIMS
On April 19, 2005, Senator Arlen Specter (R. Pa.) introduced in the United
States Senate legislation addressing compensation and administration of
asbestos personal injury claims. The legislation is titled the Fairness in
Asbestos Injury Resolution Act of 2005 (Senate Bill 852, the "FAIR Bill").
The FAIR Bill is co-sponsored by fourteen Republican Senators and three
Democratic Senators. The FAIR Bill was referred to the Senate Committee on
the Judiciary and was approved by the Committee on May 27, 2005, with
thirteen senators voting in favor of the bill and five voting against it.
However, several senators on the Committee who voted in favor of the bill
have stated that additional changes must be made to the FAIR Bill in order
for them to vote in favor of passage of the bill by the full Senate. The
FAIR bill has not been approved by the full Senate, has not been
considered by the House of Representatives, and is not law.
The FAIR Bill approved by the Senate Judiciary Committee is intended to
establish a nationally administered trust fund to compensate asbestos
personal injury claimants. In the FAIR Bill's current form, companies that
have made past payments for asbestos personal injury claims would be
required to contribute amounts to a national trust fund on a periodic
basis that would pay the claims of qualifying asbestos personal injury
claimants. The nationally administered trust fund would be the exclusive
remedy for asbestos personal injury claims, and such claims could not be
brought in state or federal court as long as such claims are being
compensated under the national trust fund. A copy of the FAIR Bill as
introduced is available at http://thomas.loc.gov (type in "S. 852" in the
search field).
In the FAIR Bill's current form, the amounts to be paid to the national
trust fund are based on an allocation methodology set forth in the FAIR
Bill. In addition to the annual payments required under the allocation
methodology, defendant participants may be subject to surcharges under
certain circumstances, including but not limited to a failure of the
scheduled contributions to meet the defendant participants' guaranteed
annual funding requirements under the FAIR Bill. The amounts that
participants, including the Debtors, would be required to pay are not
dischargeable in a bankruptcy proceeding. In addition, the FAIR Bill, in
its current form, requires affected companies currently in chapter 11,
including the Debtors, to make their first payment to the national trust
fund not later than 60 days after enactment of the FAIR Bill,
notwithstanding the fact that the companies are still in chapter 11
proceedings. The FAIR Bill also provides, among other things, that if it
is determined that the money in the trust fund is not sufficient to
compensate eligible claimants, the claimants and defendants (including
current chapter 11 debtors) would return to the court system to resolve
claims not paid by the national trust fund.
The outcome of the legislative process is inherently speculative, and it
cannot be known whether the FAIR Bill or similar legislation will ever be
enacted or, if enacted, what the terms of the final legislation might be.
-10-
Previously, in April 2004, a similar, but not identical, bill (the
"Fairness in Asbestos Injury Resolution Act of 2004") was introduced in
the Senate and was approved by the Senate Committee on the Judiciary, but
the full Senate defeated a motion to proceed with floor consideration of
the bill. Even if the FAIR Bill is enacted, the terms of the enacted
legislation may differ from those of the FAIR Bill as approved by the
Judiciary Committee, and those differences may be material to the FAIR
Bill's impact on the Corporation.
Enactment of the FAIR Bill or similar legislation addressing the financial
contributions of the Debtors for asbestos personal injury claims would
have a material impact on the amount of the Debtors' asbestos personal
injury liability and the Debtors' Chapter 11 Cases.
During the legislative process, proceedings in the Chapter 11 Cases will
continue. See Consequences of the Filing, above, and Note 13, Litigation.
PRE-PETITION LIABILITIES 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.
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 on May 31, 2002, December 13, 2002, and September 30, 2004,
setting forth the assets and liabilities of the Debtors as of the date of
the Filing. The Bankruptcy Court established a bar date of January 15,
2003, by which date proofs of claim were required to be filed against the
Debtors for all claims other than asbestos-related personal injury claims
as defined in the Bankruptcy Court's order.
Approximately 5,000 proofs of claim for general unsecured creditors
(including pre-petition debtholders and contingent claims, but excluding
asbestos-related claims) totaling approximately $8.7 billion were filed by
the bar date. Of this amount, $5.7 billion worth of claims have been
withdrawn from the case by creditors. The Debtors have been analyzing the
remaining proofs of claim and determined that many of them are duplicates
of other proofs of claim or of liabilities previously scheduled by the
Debtors. In addition, many claims were filed against multiple Debtors or
against an incorrect Debtor, or were incorrectly claiming a priority level
higher than general unsecured or an incorrect dollar amount. To date, the
court has expunged 264 claims totaling $29.5 million as duplicates;
expunged 471 claims totaling $232.4 million as amended or superceded;
allowed the reduction of 830 claims by a total of $20.9 million; and
allowed the correction of the Debtors on 1,525 claims and the
reclassification of 290 claims to general unsecured claims. The Debtors
-11-
continue to analyze and reconcile filed claims. In addition to the general
unsecured claims described in this paragraph, approximately 1,400 asbestos
property damage claims were filed as of the bar date. To date, the court
has disallowed approximately 400 asbestos property damage claims alleging
more than $300 million in damages. The asbestos property damage claims are
described in Note 13, Litigation, Developments in the Reorganization
Proceeding.
The deadline to bring avoidance actions in the Chapter 11 Cases was June
25, 2003. Avoidance actions could include claims to avoid alleged
preferences made during the 90-day period prior to the filing (or one-year
period for insiders) and other transfers made or obligations incurred
which could be alleged to be constructive or actual fraudulent conveyances
under applicable law. Effective prior to the avoidance action deadline,
the Bankruptcy Court granted the motion of the committee representing the
unsecured creditors to file a complaint seeking to avoid and recover as
preferences certain pre-petition payments made by the Debtors to 206
creditors, where such payments, in most cases, exceeded $500,000. The
Bankruptcy Court also granted the committee's request to extend the time
by which the summons and complaint are served upon each named defendant
until 90 days after confirmation of a plan of reorganization filed in
connection with the Chapter 11 Cases.
In addition, prior to the deadline for filing avoidance actions, certain
of the Debtors entered into a Tolling Agreement pursuant to which the
Debtors voluntarily agreed to extend the time during which actions could
be brought to avoid certain intercompany transactions that occurred during
the one-year period prior to the filing of the Chapter 11 Cases. The
transactions as to which the Tolling Agreement applies are the creation of
liens on certain assets of Debtor subsidiaries in favor of the Corporation
in connection with intercompany loan agreements; a transfer by U.S. Gypsum
to the Corporation of a 9% interest in the equity of CGC Inc., the
principal Canadian subsidiary of the Corporation; and transfers made by
the Corporation to USG Foreign Investments, Ltd., a non-Debtor subsidiary.
The Bankruptcy Court approved the Tolling Agreement in June 2003.
The Debtors expect to address claims for general unsecured creditors
through liquidation, estimation or disallowance of the claims. In
connection with this process, the Debtors will make adjustments to their
schedules and financial statements as appropriate. Any such adjustments
could be material to the Corporation's consolidated financial position,
cash flows and results of operations in any given period. At this time, it
is not possible to estimate the Debtors' liability for these claims.
However, it is likely that the Debtors' liability for these claims will be
different from the amounts now recorded by the Debtors. Proofs of claim
alleging asbestos property damage claims are discussed in Note 13,
Litigation, under Developments in the Reorganization Proceeding.
-12-
FINANCIAL STATEMENT PRESENTATION
The accompanying consolidated financial statements have been prepared in
accordance with American Institute of Certified Public Accountants
("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 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. 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 any 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.
The Corporation's ability to continue as a going concern is dependent
upon, among other things, (i) the ability of the Corporation to maintain
adequate cash on hand, (ii) the ability of the Corporation to generate
cash from operations, (iii) confirmation of a plan of reorganization under
the Bankruptcy Code and (iv) the Corporation's ability to achieve
profitability following such confirmation. The Corporation believes that
cash and marketable securities on hand and future cash available from
operations will provide sufficient liquidity to allow its businesses to
operate in the normal course without interruption for the duration of the
chapter 11 proceedings. This includes its ability to meet post-petition
obligations of the Debtors and to meet obligations of the non-Debtor
subsidiaries.
LIABILITIES SUBJECT TO COMPROMISE
As reflected in the consolidated financial statements, liabilities subject
to compromise refers to the 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 in the table
below. These amounts represent the Debtors' 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, including
unaccrued and unrecorded post-petition interest expense, (vii) effect of
-13-
any legislation which may be enacted or (viii) other events.
The amount shown below for the asbestos reserve reflects the Corporation's
pre-petition estimate of liability associated with asbestos claims and
those expected to be filed in the tort system through 2003. This
liability, as well as liability for post-2003 claims, is the subject of
significant legal proceedings and negotiation in the Chapter 11 Cases. See
Note 13. Litigation for additional information on the background of
asbestos litigation, developments in the Corporation's reorganization
proceeding and estimated cost.
As of the date of this report, virtually all of the Corporation's
pre-petition debt is in default due to the Filing and included in
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.
Payment terms for liabilities subject to compromise will be established as
part of a plan of reorganization under the Chapter 11 Cases. Liabilities
subject to compromise in the consolidated and debtor-in-possession balance
sheets consisted of the following items (dollars in millions):
As of As of
June 30, December 31,
2005 2004
--------- ------------
Asbestos reserve $ 1,061 $ 1,061
Debt 1,005 1,005
Accounts payable 169 169
Accrued expenses 37 37
Other long-term liabilities 13 13
--------- ---------
Subtotal 2,285 2,285
Elimination of intercompany accounts payable (43) (43)
--------- ---------
Total liabilities subject to compromise 2,242 2,242
========= =========
INTERCOMPANY TRANSACTIONS
In the normal course of business, the Corporation (also referred to as the
"Parent Company" in the following discussion of intercompany transactions)
and the operating subsidiaries engage in intercompany transactions. To
document the relations created by these transactions, the Parent Company
and the operating subsidiaries, from the formation of the 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").
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
-14-
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 reviewed on a regular basis with interest
earned or accrued on the balances. During the first six months of 2001,
the Corporation took steps to secure the obligations from each of the
principal domestic operating subsidiaries under the intercompany loan
agreements when it became clear that the asbestos liability claims of U.S.
Gypsum were becoming an increasingly greater burden on the Corporation's
cash resources.
As of June 30, 2005, U.S. Gypsum and USG Interiors had net pre-petition
payable balances to the Parent Company for Intercompany Corporate
Transactions of $295 million and $109 million, respectively. L&W Supply
had a net pre-petition receivable balance from the Parent Company of $33
million. These pre-petition balances are subject to the provisions of the
Tolling Agreement discussed above. See Pre-Petition Liabilities Other Than
Asbestos Personal Injury Claims, above.
As of June 30, 2005, U.S. Gypsum, L&W Supply, and USG Interiors had net
post-petition receivable balances from the Parent Company for Intercompany
Corporate Transactions of $481 million, $221 million, and $8 million
respectively.
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.
CHAPTER 11 REORGANIZATION EXPENSES
Chapter 11 reorganization expenses in the consolidated and
debtor-in-possession statements of earnings consisted of the following
(dollars in millions):
Three Months Six Months
ended June 30, ended June 30,
---------------------- ----------------------
2005 2004 2005 2004
-------- -------- -------- --------
Legal and financial advisory fees $ 6 $ 6 $ 12 $ 10
Bankruptcy-related interest income (7) (2) (12) (4)
-------- -------- -------- --------
Total chapter 11 reorganization expenses (1) 4 - 6
======== ======== ======== ========
-15-
INTEREST EXPENSE
Contractual interest expense not accrued or recorded on pre-petition debt
totaled $20 million and $39 million in the second quarter and first six
months of 2005, respectively. From the Petition Date through June 30,
2005, contractual interest expense not accrued or recorded on pre-petition
debt totaled $296 million. This calculation assumes that all such interest
was paid when required at the applicable contractual interest rate (after
giving effect to any applicable default rate). However, the calculation
excludes the impact of any compounding of interest on unpaid interest that
may be payable under the relevant contractual obligations, as well as any
interest that may be payable under a plan of reorganization to trade or
other creditors that are not otherwise entitled to interest under the
express terms of their claims. The impact of compounding alone would have
increased the contractual interest expense reported above by $6 million
and $12 million in the second quarter and first six months of 2005,
respectively, and $46 million from the Petition Date through June 30,
2005. For financial reporting purposes, no post-petition accruals have
been made for contractual interest expense not accrued or recorded on
pre-petition debt.
On April 11, 2005, the Unsecured Creditors Committee filed a motion with
the bankruptcy court requesting that the Debtors make interest payments to
all non-asbestos unsecured creditors for interest accrued from January 1,
2005, on liquidated, undisputed pre-petition claims (including accrued
unpaid interest through December 31, 2004). Upon approval, this motion
would have required the Debtors to make interest payments of approximately
$84 million on an annual basis. However, on May 20, 2005, the bankruptcy
court denied this motion.
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 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 Corporation and the following wholly owned
subsidiaries: U.S. Gypsum; USG Interiors; USG Interiors International,
Inc.; L&W Supply; Beadex Manufacturing, LLC; B-R Pipeline Company; La
Mirada Products Co., Inc.; Stocking Specialists, Inc.; USG Industries,
Inc.; and USG Pipeline Company. The condensed financial statements of the
Debtors are presented as follows:
-16-
DEBTOR-IN-POSSESSION STATEMENTS OF EARNINGS
(DOLLARS IN MILLIONS)
(UNAUDITED)
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------ ------------------------
2005 2004 2005 2004
--------- --------- --------- ---------
Net sales $ 1,160 $ 1,035 $ 2,218 $ 1,953
Cost of products sold 933 853 1,810 1,648
Selling and administrative expenses 74 67 150 132
Chapter 11 reorganization expenses (1) 4 - 6
Interest expense 1 1 2 2
Interest income (1) (1) (2) (1)
Other (income) expense, net - - (1) -
--------- --------- --------- ---------
Earnings before income taxes 154 111 259 166
Income taxes 64 47 107 73
--------- --------- --------- ---------
Net earnings 90 64 152 93
========= ========= ========= =========
-17-
DEBTOR-IN-POSSESSION BALANCE SHEETS
(DOLLARS IN MILLIONS)
(UNAUDITED)
AS OF AS OF
JUNE 30, DECEMBER 31,
2005 2004
---------- ----------
ASSETS
Current Assets:
Cash and cash equivalents $ 470 $ 516
Short-term marketable securities 170 135
Restricted cash 68 38
Receivables (net of reserves - $10 and $10) 443 373
Inventories 284 275
Income taxes receivable 34 24
Deferred income taxes 14 25
Other current assets 74 45
---------- ----------
Total current assets 1,557 1,431
Long-term marketable securities 300 276
Property, plant and equipment (net of accumulated
depreciation and depletion - $774 and $728) 1,619 1,604
Deferred income taxes 239 152
Goodwill 64 43
Other assets 396 361
---------- ----------
Total Assets 4,175 3,867
========== ==========
LIABILITIES AND STOCKHOLDERS' Equity
Current Liabilities:
Accounts payable 241 237
Accrued expenses 196 203
Income taxes payable 170 58
---------- ----------
Total current liabilities 607 498
Other liabilities 411 391
Liabilities subject to compromise 2,242 2,242
Stockholders' Equity:
Preferred stock - -
Common stock 5 5
Treasury stock (253) (256)
Capital received in excess of par value 103 101
Accumulated other comprehensive income 25 3
Retained earnings 1,035 883
---------- ----------
Total stockholders' equity 915 736
---------- ----------
Total Liabilities and Stockholders' Equity 4,175 3,867
========== ==========
-18-
DEBTOR-IN-POSSESSION STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
SIX MONTHS
ENDED JUNE 30,
------------------------
2005 2004
--------- ---------
OPERATING ACTIVITIES:
Net earnings $ 152 $ 93
Adjustments to reconcile net earnings to net cash:
Depreciation, depletion and amortization 52 46
Deferred income taxes (89) 24
(Gain) loss on asset dispositions - (1)
(Increase) decrease in working capital:
Receivables (61) (146)
Income taxes receivable (10) 1
Inventories (5) (77)
Payables 110 95
Accrued expenses (4) (2)
Decrease in intercompany receivable 5 18
Increase in other assets (20) (9)
Increase in other liabilities 8 12
Change in asbestos receivables - 11
Decrease in liabilities subject to compromise - (3)
Other, net (6) (8)
--------- ---------
Net cash provided by operating activities 132 54
--------- ---------
INVESTING ACTIVITIES:
Capital expenditures (65) (41)
Purchases of marketable securities (356) (171)
Sale or maturities of marketable securities 296 135
Net proceeds from asset dispositions - 1
Acquisitions of businesses (29) (4)
Deposit of restricted cash (30) (19)
--------- ---------
Net cash used for investing activities (184) (99)
--------- ---------
FINANCING ACTIVITIES:
Issuances of common stock 6 -
--------- ---------
Net cash provided by financing activities 6 -
--------- ---------
Net decrease in cash and cash equivalents (46) (45)
Cash and cash equivalents at beginning of period 516 489
--------- ---------
Cash and cash equivalents at end of period 470 444
========= =========
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Interest paid 1 1
Income taxes paid, net 92 25
-19-
(3) EARNINGS PER SHARE
Basic earnings per share are based on the weighted average number of
common shares outstanding. Diluted earnings per share are based on the
weighted average number of common shares outstanding and the dilutive
effect of the potential exercise of outstanding stock options. Diluted
earnings per share exclude the potential exercise of outstanding stock
options for any period in which such exercise would have an anti-dilutive
effect. The reconciliation of basic earnings per share to diluted earnings
per share is shown in the following table (dollars in millions, except
share data):
Weighted
Average
Net Shares Per-Share
Three Months Ended June 30, Earnings (000) Amount
- -------------------------------- --------- ------ ---------
2005:
Basic earnings $ 110 43,484 $ 2.55
Dilutive effect of stock options 291
--------- ------ ---------
Diluted earnings 110 43,775 2.53
========= ====== =========
2004:
Basic earnings 80 43,017 1.86
Dilutive effect of stock options 1
--------- ------ ---------
Diluted earnings 80 43,018 1.86
========= ====== =========
Six Months Ended June 30,
2005:
Basic earnings 187 43,374 4.32
Dilutive effect of stock options 242
--------- ------ ---------
Diluted earnings 187 43,616 4.30
========= ====== =========
2004:
Basic earnings 137 43,020 3.18
Dilutive effect of stock options 1
--------- ------ ---------
Diluted earnings 137 43,021 3.18
========= ====== =========
-20-
(4) DERIVATIVE INSTRUMENTS
The Corporation uses derivative instruments to manage selected commodity
price and foreign currency exposures. The Corporation does not use
derivative instruments for trading purposes. All derivative instruments
are 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 income ("OCI") on the balance
sheet and is reclassified to earnings when the underlying transaction has
an impact on earnings. The ineffective portion of changes in the fair
value of the derivative is reported in cost of products sold. The amount
of ineffectiveness recorded in the second quarter and first six months of
2005 amounted to pretax gain of $1.4 million and $3 million, respectively.
As of June 30, 2005, the Corporation had no foreign currency contracts.
COMMODITY DERIVATIVE INSTRUMENTS
The Corporation uses swap contracts to hedge most anticipated purchases of
natural gas to be used in its manufacturing operations. As of June 30,
2005, the Corporation had swap contracts to exchange monthly payments on
notional amounts of natural gas amounting to $306 million. These contracts
mature by December 31, 2007. As of June 30, 2005, the fair value of these
swap contracts, which remained in OCI, was a $56 million ($34 million
after-tax) unrealized gain.
Net after-tax gains or losses resulting from the termination of natural
gas swap contracts are recorded to OCI and reclassified into earnings in
the period in which the hedged forecasted transactions are scheduled to
occur. As of June 30, 2005, $2 million ($1 million after-tax) of such
gains are included in OCI.
COUNTERPARTY RISK
The Corporation is exposed to credit losses in the event of nonperformance
by the counterparties on its financial instruments. All counterparties
have investment grade credit standing; accordingly, the Corporation
anticipates that these counterparties will be able to satisfy fully their
obligations under the contracts. The Corporation has not generally
obtained collateral or other security to support financial instruments
subject to credit risk, but it is possible that the Corporation could
receive collateral from its counterparties based on the provisions in
certain credit support agreements. Similarly, the Corporation may be
required to post collateral if aggregate payables exceed certain limits.
Currently, there is no collateral requirement. The Corporation enters into
master agreements which contain netting arrangements that minimize
counterparty credit exposure.
-21-
(5) COMPREHENSIVE INCOME
The components of comprehensive income are summarized in the following
table (dollars in millions):
Three Months Six Months
ended June 30, ended June 30,
------------------------ ------------------------
2005 2004 2005 2004
--------- --------- --------- ---------
Net earnings $ 110 $ 80 $ 187 $ 137
--------- --------- --------- ---------
Pretax gain (loss) on derivatives (12) (1) 47 12
Income tax expense 5 - (18) (5)
--------- --------- --------- ---------
After-tax gain (loss) on derivative (7) (1) 29 7
--------- --------- --------- ---------
Pretax minimum pension liability (10) - (10) -
Income tax expense 4 - 4 -
--------- --------- --------- ---------
After-tax minimum pension liability (6) - (6) -
--------- --------- --------- ---------
Foreign currency translation (4) (7) (8) (9)
Unrealized gain (loss) on marketable
securities - (1) - (1)
--------- --------- --------- ---------
Total comprehensive income 93 71 202 134
========= ========= ========= =========
There was no tax impact on the foreign currency translation adjustments.
OCI consisted of the following (dollars in millions):
As of As of
June 30, December 31,
2005 2004
--------- ------------
Gain on derivatives, net of tax $ 35 $ 6
Foreign currency translation 7 15
Minimum pension liability, net of tax (9) (3)
Unrealized loss on marketable securities, net of tax (1) (1)
--------- -----------
Total 32 17
========= ===========
During the second quarter of 2005, accumulated net after-tax gains of $6
million ($9 million pretax) on derivatives were reclassified from OCI to
earnings. As of June 30, 2005, the estimated net after-tax gain expected
to be reclassified within the next 12 months from OCI to earnings is $22
million.
-22-
(6) MARKETABLE SECURITIES
The Corporation's investments in marketable securities consisted of the
following (dollars in millions):
As of As of
June 30, December 31,
2005 2004
----------------------- -----------------------
Amortized Amortized
Cost FMV Cost FMV
--------- --------- --------- ---------
Asset-backed securities $ 189 $ 188 $ 174 $ 173
U.S. Government and agency securities 186 186 121 121
Municipal securities 54 54 36 36
Corporate securities 100 100 112 112
Time deposits 5 5 8 8
--------- --------- --------- ---------
Total marketable securities 534 533 451 450
========= ========= ========= =========
Contractual maturities of marketable securities as of June 30, 2005, were
as follows (dollars in millions):
Fair
Amortized Market
Cost Value
--------- ---------
Due in 1 year or less $ 201 $ 201
Due in 1-5 years 96 96
Due in 5-10 years 1 1
Due after 10 years 47 47
--------- ---------
345 345
Asset-backed securities 189 188
--------- ---------
Total marketable securities 534 533
========= =========
The average duration of the portfolio is less than one year because a
majority of the longer-term securities have paydown or put features and
liquidity facilities.
Investments in marketable securities that were in an unrealized loss
position for less than 12 months consisted of the following (dollars in
millions):
As of As of
June 30, December 31,
2005 2004
--------- ------------
Asset-backed securities $ 112 $ 149
U.S. Government and agency securities 84 83
Corporate securities 47 34
--------- ---------
Total FMV 243 266
--------- ---------
Aggregate amount of unrealized losses 1 1
========= =========
-23-
The fair market value of investments that had been in a continuous
unrealized loss position for a period greater than 12 months amounted to
$69 million and $2 million as of June 30, 2005 and December 31, 2004,
respectively. The unrealized losses for those investments were $0.5
million as of June 30, 2005.
(7) ASSET RETIREMENT OBLIGATIONS
Changes in the liability for asset retirement obligations consisted of the
following (dollars in millions):
Six Months ended June 30
------------------------
2005 2004
--------- ---------
Balance as of January 1 $ 43 $ 35
Accretion expense 1 -
Liabilities incurred - -
Liabilities settled - -
Foreign currency translation - -
--------- ---------
Balance as of June 30 44 35
========= =========
The Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 47 ("FIN 47"), "Accounting for Conditional Asset
Retirement Obligations" (an interpretation of Statement of Financial
Accounting Standard No. 143, "Accounting for Asset Retirement
Obligations"). In accordance with FIN 47, companies must recognize a
liability for the fair value of a legal obligation to perform
asset-retirement activities that are conditional on a future event if the
amount can be reasonably estimated. This interpretation provides guidance
on whether the fair value is reasonably estimable. FIN 47 becomes
effective no later than the end of fiscal years ending after December 15,
2005. As of the date of this report, the Corporation has not determined
what impact the adoption of FIN 47 may have on its financial statements.
(8) GOODWILL AND OTHER INTANGIBLE ASSETS
Total goodwill and other intangible assets (excluding intangible pension
assets) amounted to $64 million and $3 million, respectively, as of June
30, 2005. All of the Corporation's goodwill and such other intangible
assets relates to the Building Products Distribution operating segment.
Goodwill and other intangible assets increased by $21 million and $1
million during the first six months of 2005 as a result of acquisitions.
Other intangible assets are included in other assets on the consolidated
balance sheets.
-24-
(9) STOCK-BASED COMPENSATION
The Corporation accounts for stock-based compensation using the intrinsic
value method, which measures compensation cost as the quoted market price
of the stock at the date of grant less the grant price, if any, that the
employee is required to pay. If the Corporation had elected to recognize
compensation cost for stock-based compensation grants using the fair value
method, net earnings and net earnings per common share would not have
changed because stock options issued prior to the Filing are fully vested
and no stock options have been issued subsequent to the Filing.
As of June 30, 2005, common shares totaling 1,705,700 were reserved for
future issuance in conjunction with existing stock option grants. In
addition, 3,202,020 common shares were reserved for future grants. Shares
issued in option exercises may be from original issue or available
treasury shares.
(10) EMPLOYEE RETIREMENT PLANS
The components of net pension and postretirement benefits costs for the
three months and six months ended June 30, 2005 and 2004 are summarized in
the following table (dollars in millions):
Three Months Six Months
ended June 30, ended June 30,
------------------------------------------------------
2005 2004 2005 2004
--------- --------- --------- ---------
PENSION:
Service cost of benefits earned $ 8 $ 9 $ 17 $ 16
Interest cost on projected
benefit obligation 14 14 28 27
Expected return on plan assets (14) (14) (28) (27)
Net amortization 5 4 10 9
--------- --------- --------- ---------
Net cost 13 13 27 25
========= ========= ========= =========
POSTRETIREMENT:
Service cost of benefits earned 4 3 7 7
Interest cost on projected
benefit obligation 4 6 9 11
Recognized loss (1) 2 (2) 2
--------- --------- --------- ---------
Net cost 7 11 14 20
========= ========= ========= =========
In accordance with the Corporation's funding policy, the Corporation and
its subsidiaries contributed cash of $15 million and $36 million during
the second quarter and first six months of 2005, respectively, and expect
to contribute cash of approximately $71 million during the full year 2005
to their pension plans.
-25-
(11) OPERATING SEGMENTS
The Corporation's operations are organized into three operating segments:
(i) North American Gypsum, which manufactures SHEETROCK(R) brand gypsum
wallboard and joint compound, DUROCK(R) brand cement board, FIBEROCK(R)
brand gypsum fiber panels and other related building products in the
United States, Canada and Mexico; (ii) Worldwide Ceilings, which
manufactures ceiling tile in the United States and ceiling grid in the
United States, Canada, Europe and the Asia-Pacific region; and (iii)
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 Six Months
ended June 30, ended June 30,
------------------------ ------------------------
2005 2004 2005 2004
--------- --------- --------- ---------
NET SALES:
North American Gypsum $ 804 $ 678 $ 1,529 $ 1,317
Worldwide Ceilings 178 190 348 356
Building Products Distribution 506 454 962 816
Eliminations (201) (177) (379) (324)
--------- --------- --------- ---------
Total USG Corporation 1,287 1,145 2,460 2,165
========= ========= ========= =========
OPERATING PROFIT:
North American Gypsum 148 102 255 183
Worldwide Ceilings 17 26 29 41
Building Products Distribution 39 31 65 45
Corporate (22) (20) (45) (36)
Chapter 11 reorganization expenses 1 (4) - (6)
Eliminations (2) (2) 1 (2)
--------- --------- --------- ---------
Total USG Corporation 181 133 305 225
========= ========= ========= =========
L&W Supply, which makes up the Building Products Distribution segment,
completed two acquisitions during the second quarter of 2005. These
acquisitions, which were part of L&W Supply's strategy to profitably grow
its specialty dealer business, consisted of eight distribution locations
operating in Arkansas, Delaware, Maryland, Mississippi and Tennessee.
Total cash payments for these acquisitions amounted to $29 million. L&W
Supply now has a total of 194 locations in the United States as of June
30, 2005, compared with 184 locations as of June 30, 2004.
-26-
(12) INCOME TAXES
On October 22, 2004, the President signed the American Jobs Creation Act
of 2004 (the "Act"). The Act creates a temporary incentive for U.S.
corporations to repatriate accumulated income earned abroad by providing
an 85% dividends received deduction for certain dividends from controlled
foreign corporations. The deduction is subject to several limitations, and
the Corporation is continuing to evaluate those limitations and the future
cash requirements of its foreign subsidiaries. As a result, the
Corporation has not yet determined whether, and to what extent, it will
repatriate foreign earnings that have not yet been remitted to the United
States. Based on the Corporation's analysis to date, however, it is
reasonably possible that the Corporation may repatriate between zero and
$70 million of unremitted foreign earnings as a result of the repatriation
provision with a related income tax liability of between 1% and 15% of the
amount remitted. The Corporation expects to complete its evaluation of
this matter by the fourth quarter of 2005.
As disclosed in the Corporation's Annual Report on Form 10-K for the year
ended December 31, 2004, the Internal Revenue Service ("IRS") is auditing
the Corporation's U.S. federal income tax returns for the years 2000, 2001
and 2002. On June 27, 2005, the IRS informed the Corporation that the
Congressional Joint Committee on Taxation (the "Joint Committee") had
commenced a review of the preliminary findings of the IRS' audit. The IRS'
audit of the Corporation's 2000, 2001 and 2002 U.S. federal income tax
returns will not be completed until the Joint Committee completes its
review. That review is currently anticipated to be completed in the third
quarter of 2005.
(13) LITIGATION
ASBESTOS AND RELATED BANKRUPTCY LITIGATION
One of the Corporation's subsidiaries and a Debtor, U.S. Gypsum, is among
many defendants in more than 100,000 asbestos lawsuits alleging personal
injury or property damage liability. Most of the asbestos lawsuits against
U.S. Gypsum seek compensatory and, in many cases, punitive damages for
personal injury allegedly resulting from exposure to asbestos-containing
products (the "Personal Injury Cases"). Certain of the asbestos lawsuits
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").
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.
-27-
In addition to the Personal Injury Cases pending against U.S. Gypsum, two
other Debtors, L&W Supply and Beadex Manufacturing, LLC ("Beadex"), have
been named as defendants in a small number of asbestos personal injury
cases. The Official Committee of Asbestos Personal Injury Claimants, the
legal representative for future asbestos claimants, and the Official
Committee of Asbestos Property Damage Claimants have also asserted in a
court filing that all of the Debtors are liable for the asbestos
liabilities of A.P. Green Refractories Co. ("A.P. Green").
More information regarding the Property Damage and Personal Injury Cases
against U.S. Gypsum and the asbestos personal injury cases against L&W
Supply, Beadex, and A.P. Green is set forth below.
The amount of the Debtors' present and future asbestos liabilities is the
subject of significant dispute in Debtors' Chapter 11 Cases. If the amount
of the Debtors' asbestos liabilities is not resolved through negotiation
in the Chapter 11 Cases or addressed by federal legislation, the amount of
those liabilities may be determined through litigation proceedings in the
Chapter 11 Cases.
DEVELOPMENTS IN THE REORGANIZATION PROCEEDING: The Debtors' Chapter 11
Cases are assigned to Judge Judith K. Fitzgerald, a bankruptcy court
judge, and Judge Joy Flowers Conti, a district court judge, who was
assigned to the Debtors' Chapter 11 Cases in September 2004. Judge Conti
will hear matters relating to estimation of the Debtors' liability for
asbestos personal injury claims. Other matters will be heard by Judge
Fitzgerald.
The Debtors have requested Judge Conti to conduct hearings to estimate
Debtors' asbestos personal injury liability, taking into account the legal
and scientific issues that govern the validity of claims. The Debtors have
requested that the Court hear evidence and make rulings regarding the
characteristics of valid asbestos personal injury claims against the
Debtors and then estimate the Debtors' liability for present and future
asbestos personal injury claims based upon these rulings. Key liability
issues include: whether claimants who do not have objective evidence of
asbestos-related disease have valid claims and are entitled to be
compensated by the Debtors or whether such claimants are entitled to
compensation only if and when they develop asbestos-related disease; what
are the characteristics and number of present and future claimants who are
likely to have had exposure to the Debtors' asbestos-containing products
sufficient to cause disease; whether the particular type of asbestos
present in certain of the Debtors' products during the relevant time has
been shown to cause cancer; and what are the appropriate claim values to
apply in the estimation process. There may also be other important
liability issues raised in the estimation process.
The Official Committee of Asbestos Personal Injury Claimants and the legal
representative for future asbestos claimants oppose the type of estimation
-28-
hearings proposed by the Debtors. The committee and the legal
representative contend that the Debtors' liability for present and future
asbestos personal injury claims should be based on extrapolation from the
settlement history of such claims and not on litigating liability issues
in the bankruptcy proceedings. The committee and the legal representative
also contend that the Bankruptcy Court does not have the power to deny
recovery to claimants on the grounds that they do not have objective
evidence of disease or do not have adequate exposure to the Debtors'
products where such claimants, or claimants with similar characteristics,
are compensated in the tort system outside of bankruptcy.
In response to the parties' submissions regarding estimation proceedings,
Judge Conti indicated in a status hearing on June 13, 2005, that she will
conduct a hearing to estimate Debtors' liability for present and future
asbestos personal injury claims. Toward that end, Judge Conti directed the
Debtors, the official committees, and the legal representative for future
asbestos claimants to develop a timetable for the parties to conduct
pre-hearing discovery of issues relating to estimation. Although Judge
Conti did not issue a ruling regarding which specific issues she will
consider in the estimation hearing, Judge Conti did indicate that the
discovery timetable should include discovery of a broad range of issues
considered relevant by the parties, including the medical and scientific
issues raised by the Debtors. This discovery timetable is to be submitted
to the Court on August 12, 2005, and, pursuant to the direction of Judge
Conti, the timetable should allow approximately six months for discovery.
Judge Conti also indicated that she will hold the estimation hearing
shortly after the conclusion of discovery; however, she did not set a date
for the estimation hearing.
The Debtors also filed a motion in 2004 requesting a ruling that putative
claimants who cannot satisfy objective standards of asbestos-related
disease are not entitled to vote on a Section 524(g) plan. To date, there
has been no ruling or hearing on the motion.
In the third quarter of 2004, the parties, including the committees,
engaged in non-binding mediation relating to the Debtors' asbestos
personal injury liability and the potential terms of a plan of
reorganization. The mediation did not result in an agreement regarding the
Debtors' asbestos liability or the terms of a plan of reorganization.
In addition to the proceedings before Judge Conti relating to estimation
of the amount of Debtors' asbestos personal injury liabilities (discussed
above), there are also significant proceedings before Judge Fitzgerald
relating to whether Debtors other than U.S. Gypsum have responsibility for
U.S. Gypsum's asbestos liabilities and whether Debtors have responsibility
for the asbestos liabilities of A.P. Green Refractories Co. ("A.P.
Green"). In the fourth quarter of 2004, the Debtors other than U.S. Gypsum
filed a complaint for declaratory relief in the Bankruptcy Court
requesting a ruling that the assets of the Debtors other than U.S. Gypsum
are not available to
-29-
satisfy the asbestos liabilities of U.S. Gypsum. The Official Committee of
Unsecured Creditors and the Official Committee of Equity Holders have
joined the Debtors in this action. In opposition, the Official Committee
of Asbestos Personal Injury Claimants, the legal representative for future
asbestos claimants, and the Official Committee of Asbestos Property Damage
Claimants filed counterclaims seeking a ruling that the assets of all
Debtors should be available to satisfy the asbestos liabilities of U.S.
Gypsum under various asserted legal grounds, including successor
liability, piercing the corporate veil, and substantive consolidation. If
the assets of all Debtors are pooled for the payment of all liabilities,
including the asbestos liabilities of U.S. Gypsum, this could materially
and adversely affect the recovery rights of creditors of Debtors other
than U.S. Gypsum as well as the holders of the Corporation's equity.
The Official Committee of Asbestos Personal Injury Claimants, the legal
representative for future asbestos claimants, and the Official Committee
of Asbestos Property Damage Claimants also seek a ruling that L&W Supply
has direct liability for asbestos personal injury claims on the asserted
grounds that L&W Supply distributed asbestos-containing products and
assumed the liabilities of former U.S. Gypsum subsidiaries that
distributed such products.
The Official Committee of Asbestos Personal Injury Claimants, the legal
representative for future asbestos claimants, and the Official Committee
of Asbestos Property Damage Claimants also have asserted in the same
proceeding that the Debtors are liable for claims arising from the sale of
asbestos-containing products by A.P. Green. They allege that U.S. Gypsum
is liable for A.P. Green's liabilities due to U.S. Gypsum's acquisition by
merger of A.P. Green in 1967 and that, pursuant to the merger documents,
U.S. Gypsum assumed A.P. Green's liabilities. They also allege that
because the Debtors other than U.S. Gypsum are liable for U.S. Gypsum's
liabilities, the other Debtors are therefore liable for A.P. Green's
liabilities.
A.P. Green, which manufactured and sold products used in refractories, was
acquired through a merger of A.P. Green into U.S. Gypsum on December 29,
1967. On the next business day after the merger, January 2, 1968, U.S.
Gypsum conveyed A.P. Green's assets and liabilities to a newly formed
Delaware corporation and wholly owned subsidiary of U.S. Gypsum, also
called A.P. Green Refractories Co. (this newly formed corporation is also
referred to herein as "A.P. Green"). A.P. Green was operated as a wholly
owned subsidiary of U.S. Gypsum until 1985, at which time A.P. Green
became a wholly owned subsidiary of USG Corporation. In 1988, A.P. Green
became a publicly traded company when its shares were distributed to the
stockholders of USG Corporation. In February 2002, A.P. Green (now known
as A.P. Green Industries, Inc.) as well as its parent company, Global
Industrial Technologies, Inc., and other affiliates filed voluntary
petitions for reorganization through which A.P. Green and its affiliates
seek to resolve their asbestos liabilities through creation and funding of
a Section 524(g)
-30-
trust. The A.P. Green reorganization proceeding is pending in the United
States Bankruptcy Court for the Western District of Pennsylvania and is
captioned In re: Global Industrial Technologies, Inc. (Case No. 02-21626).
The draft disclosure statement filed in July 2003 by the debtors in the
A.P. Green reorganization proceedings indicates that, in early 2002, there
were 235,757 asbestos personal injury claims pending against A.P. Green as
well as about 59,000 such claims pending against an A.P. Green affiliate,
and that A.P. Green estimates that several hundred thousand additional
claims will be asserted against it and/or its affiliate. The disclosure
statement also states that, as of early 2002, A.P. Green had resolved
approximately 203,000 asbestos personal injury claims by payment of
approximately $446 million in indemnity and defense costs and that A.P.
Green had approximately $492 million in unpaid pre-petition settlements
and judgments relating to asbestos personal injury claims. The disclosure
statement does not provide an estimate of the cost of resolving A.P.
Green's liability for pending or future asbestos claims. No plan of
reorganization has been approved in the A.P. Green bankruptcy proceeding.
The Corporation does not have sufficient information to predict whether or
how any plan of reorganization in the Debtors' Chapter 11 Cases might
address any liability based on sales of asbestos-containing products by
A.P. Green. The Corporation also does not have sufficient information to
estimate the amount, or range of amounts, of A.P. Green's asbestos
liabilities. If U.S. Gypsum is determined to be liable for the sale of
asbestos-containing products by A.P. Green or its affiliates, this result
likely would materially increase the amount of U.S. Gypsum's present and
future asbestos liabilities. Such a result could materially and adversely
affect the recovery of other Debtors' pre-petition creditors and the
Corporation's stockholders, depending upon, among other things, the amount
of A.P. Green's alleged asbestos liabilities and whether the other Debtors
are determined to be liable for U.S. Gypsum's liabilities, including A.P.
Green liabilities.
The parties are beginning discovery in the proceedings before Judge
Fitzgerald relating to whether Debtors other than U.S. Gypsum are
responsible for the asbestos liabilities of U.S. Gypsum and A.P. Green,
and no trial date has been scheduled.
With regard to asbestos property damage claims, the Bankruptcy Court
established a bar date requiring all such claims against the Debtors to be
filed by January 15, 2003. Approximately 1,400 asbestos property damage
claims were filed, representing more than 2,000 buildings. In contrast, as
of the Petition Date, 11 Property Damage Cases were pending against U.S.
Gypsum. Approximately 500 of the asbestos property damage claims filed by
the bar date assert a specific dollar amount of damages, and the total
damages alleged in those claims is approximately $1.6 billion. However,
this amount reflects numerous duplicate claims filed against multiple
Debtors. Approximately 900 claims do not specify a damage amount. Counsel
for the Official Committee of Asbestos Property Damage Claimants has
stated in a
-31-
court hearing that the committee believes that the amount of the asbestos
property damage claims will reach $1 billion.
Most of the asbestos property damage claims filed do not provide evidence
that the Debtors' products were ever installed in any of the buildings at
issue. Certain of the proof of claim forms purport to file claims on
behalf of two classes of claimants that were the subject of pre-petition
class actions. One of these claim forms was filed on behalf of a class of
colleges and universities that was certified for certain purposes in a
pre-petition lawsuit filed in federal court in South Carolina. However,
many of the putative members of this class also filed individual claim
forms. Four of the claim forms were filed by a claimant allegedly on
behalf of putative members of certified and uncertified classes in
connection with a pre-petition lawsuit pending in South Carolina state
court.
The Debtors believe that they have substantial defenses to the property
damage claims, including the lack of evidence that the Debtors' products
were ever installed in the buildings at issue, the failure to file the
claims within the applicable statutes of limitation, and the lack of
evidence that the claimants have any injury or damages. The Debtors intend
to address many of these claims through an objection and disallowance
process in the Bankruptcy Court. Beginning in late 2004, the Debtors began
filing objections to asbestos property damage claims that did not provide
any evidence that the Debtors' products were installed in the buildings at
issue. To date, in response to these objections, the Court has disallowed
approximately 400 asbestos property damage claims alleging more than $300
million in damages for failure to provide sufficient product
identification evidence. Debtors expect to file additional objections to
claims that have not provided product identification evidence and also
expect to file objections to asbestos property damage claims on additional
grounds. Because of the preliminary nature of the objection process, the
Corporation cannot predict the outcome of these proceedings or the impact
the proceedings may have on the estimated cost of resolving asbestos
property damage claims. See Estimated Cost, below.
The following is a summary of the Personal Injury and Property Damage
Cases pending against U.S. Gypsum and certain other Debtors as of the
Petition Date.
PERSONAL INJURY CASES: As reported by the Center for Claims Resolution
(the "Center"), U.S. Gypsum was a defendant in more than 100,000 pending
Personal Injury Cases as of the Petition Date, as well as an additional
approximately 52,000 Personal Injury Cases that may be the subject of
settlement agreements. These numbers do not include asbestos personal
injury claims that would have been filed after June 25, 2001, the Petition
Date, but for the automatic stay.
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
-32-
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 formulas. Effective February 1, 2001, the Center
members, including U.S. Gypsum, ended their prior settlement-sharing
arrangement. Up until the Petition Date, 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.
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 (the "Long-Term Settlements"). With regard to future
claims, these Long-Term Settlements typically provided that the
plaintiffs' firms would 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 agree to settle
those claims for specified amounts. These Long-Term Settlements typically
resolved 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 proceedings 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.
During late 2000 and in 2001, following the bankruptcy filings of other
defendants in asbestos personal injury litigation, plaintiffs
substantially increased their settlement demands to U.S. Gypsum. 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 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
-33-
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.
In addition to the Personal Injury Cases pending against U.S. Gypsum, one
of the Corporation's subsidiaries and a Debtor in the bankruptcy
proceedings, L&W Supply, was named as a defendant in approximately 21
pending Personal Injury Cases as of the Petition Date. L&W Supply, 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.
Beadex, a subsidiary of U.S. Gypsum and a Debtor in the bankruptcy
proceedings, was named as a defendant in approximately 40 Personal Injury
Cases pending primarily in the states of Washington and Oregon as of the
Petition Date. Beadex manufactured and sold joint compound containing
asbestos from 1963 through 1978 in the northwestern United States. Beadex
has approximately $11 million in primary or umbrella insurance coverage
available to pay asbestos-related costs, as well as $15 million in
available excess coverage.
The Official Committee of Asbestos Personal Injury Claimants, the legal
representative for future asbestos claimants, and the Official Committee
of Asbestos Property Damage Claimants also allege that both L&W and
Beadex, as well as all other Debtors, are responsible for the asbestos
liabilities of U.S. Gypsum and A.P. Green under various asserted legal
theories including successor liability, piercing the corporate veil, and
substantive consolidation. See Developments in the Reorganization
Proceeding, above.
The Corporation expects that any asbestos-related liability of L&W Supply
and Beadex will be addressed in the plan of reorganization. However,
because of, among other things, the small number of Personal Injury Cases
pending against L&W Supply and Beadex to date, the Corporation does not
have sufficient information at this time to predict how any plan of
reorganization will address any asbestos-related liability of L&W Supply
and Beadex.
PROPERTY DAMAGE CASES: As of the Petition Date, U.S. Gypsum was a
defendant in 11 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.). As a result of the Filing, all Property Damage
Cases are stayed against U.S. Gypsum. U.S. Gypsum's estimated cost of
resolving the Property Damage Cases is discussed in Estimated Cost, below.
-34-
INSURANCE COVERAGE: As of June 30, 2005, all prior receivables relating to
insurance remaining to cover asbestos-related costs had been collected by
U.S. Gypsum, and its insurance coverage for asbestos claims has been
completely exhausted. As noted above, Beadex has approximately $26 million
in primary and excess insurance.
ESTIMATED COST: In 2000, prior to the Filing, an independent consultant
completed an actuarial study of U.S. Gypsum's current and potential future
asbestos liabilities. This study was based on the assumption that U.S.
Gypsum's asbestos liability would continue to be resolved in the tort
system.
As part of this study, the Corporation and its independent consultant
considered various factors that would impact the amount of U.S. Gypsum's
asbestos personal injury liability. These factors included the number,
disease, age, and occupational characteristics of claimants in the
Personal Injury Cases; the jurisdiction and venue in which such cases were
filed; the viability of claims for conspiracy or punitive damages; the
elimination of indemnity-sharing among Center members, including U.S.
Gypsum, 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 possibility of additional bankruptcies
of other defendants; 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; allegations that U.S. Gypsum and the other Center members are
responsible for the share of certain settlement agreements that was to be
paid by former members that have refused or are unable to pay; the
continued ability to negotiate settlements or develop other mechanisms
that defer or reduce claims from unimpaired claimants; the possibility
that federal legislation addressing asbestos litigation would be enacted;
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 pre-agreed settlement
recommendations in, and the viability of, the Long-Term Settlements;
anticipated trends in recruitment of non-malignant or unimpaired claimants
by plaintiffs' law firms; and future defense costs. The study attempted to
weigh relevant variables and assess the impact of likely outcomes on
future case filings and settlement costs.
In connection with the Property Damage Cases, the Corporation considered,
among other things, the extent to which claimants could identify the
manufacturer of any alleged asbestos-containing products in the buildings
at issue in each case; the amount of asbestos-containing products at
issue; the claimed damages; the viability of statute of limitations and
other defenses; 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.
-35-
Based upon the results of the actuarial study, the Corporation determined
that, although substantial uncertainty remained, it was probable that
asbestos claims then 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 noncash, pretax 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.
These amounts are stated before tax benefit and are not discounted to
present value. Less than 10% of the reserve was 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 in the tort
system historically had 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 U.S. Gypsum's liability for
asbestos claims to be filed after 2003.
Because of the Filing and activities relating to potential federal
legislation addressing asbestos personal injury claims, the Corporation
believes that there is greater uncertainty in estimating the reasonably
possible range of the Debtors' liability for pending and future asbestos
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. The
factors that impact the estimation of liability for pending and future
asbestos claims in a bankruptcy proceeding and the amount that must be
provided in the plan of reorganization for such liabilities include: (i)
the number of present and future asbestos claims that will be addressed in
the plan of reorganization; (ii) the value that will be paid to present
and future claims, including the impact historical settlement values for
asbestos claims may have on the estimation of asbestos liability in the
bankruptcy proceedings; (iii) how claims by individuals who have no
objective evidence of impairment will be treated in the bankruptcy
proceedings and plan of reorganization; (iv) how the Long-Term Settlements
will be treated in the plan of reorganization and whether those
settlements will be set aside; (v) how claims for punitive damages will be
treated; (vi) the results of any litigation proceedings in the Chapter 11
Cases regarding the estimated number or value of present and future
asbestos personal injury claims; (vii) the treatment of asbestos property
damage claims in the bankruptcy proceedings; (viii) the potential asbestos
liability of L&W, Beadex, A.P. Green or any other past or present
affiliates of the Debtors and how any such liability will be addressed in
the bankruptcy proceedings and plan of reorganization; (ix) whether the
assets of all of the Debtors are determined to be available to satisfy the
asbestos liabilities of U.S. Gypsum; (x) how the requirement of Section
524(g) that 75% of the voting asbestos claimants approve the plan
-36-
of reorganization will impact the amount that must be provided in the plan
of reorganization for pending and future asbestos claims and (xi) the
impact any relevant potential federal legislation may have on the
proceedings. See Note 2. Voluntary Reorganization Under Chapter 11 -
Potential Federal Legislation Regarding Asbestos Personal Injury Claims.
In addition, the estimates of the Debtors' asbestos liability that would
be recorded as a result of the bankruptcy proceedings or potential federal
legislation are likely to include all expected future asbestos cases to be
brought against the Debtors (as opposed to the cases filed over a
three-year period) and are likely to be computed using the present value
of the estimated liability. 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.
Because of the uncertainties associated with estimating the Debtors'
asbestos liability at this stage of the proceedings, no change has been
made at this time to the previously recorded reserve for asbestos claims,
except to reflect certain minor asbestos-related costs incurred since the
Filing. The reserve as of June 30, 2005, was $1,061 million.
Because the Filing and possible federal legislation have changed the basis
upon which the Debtors' asbestos liability would be estimated, there can
be no assurance that the current reserve accurately reflects the Debtors'
ultimate liability for pending and future asbestos claims. At the time the
reserve was increased to its current level in December 2000, the reserve
was an estimate of the cost of resolving in the tort system U.S. Gypsum's
asbestos liability for then-pending claims and those expected to be filed
through 2003. Because of the Filing and the stay of pre-petition asbestos
lawsuits, the Debtors have not participated in the tort system since June
2001 and thus cannot measure the recorded reserve against actual
experience. However, the reserve is generally consistent with the amount
the Corporation estimates that the Debtors would be required to pay to
resolve all of their asbestos liability if the FAIR Bill, in its current
form, is enacted. On April 19, 2005, Senator Arlen Specter (R. Pa.)
introduced in the United States Senate legislation addressing compensation
and administration of asbestos personal injury claims. The legislation is
titled the Fairness in Asbestos Injury Resolution Act of 2005 (Senate Bill
852, the "FAIR Bill"). The FAIR Bill is co-sponsored by fourteen
Republican Senators and three Democratic Senators. The FAIR Bill was
approved by the Senate Committee on the Judiciary on May 27, 2005, but has
not been approved or considered by the full Senate or the House of
Representatives, and is not law. It is speculative as to whether the Fair
Bill will be enacted. See Note 2. Voluntary Reorganization Under Chapter
11 - Potential Federal Legislation Regarding Asbestos Personal Injury
Claims.
As the Chapter 11 Cases and the legislation process proceed, the Debtors
likely will gain more information from which a reasonable estimate of the
Debtors' probable liability for present and future asbestos claims can be
-37-
determined. If the FAIR Bill or similar legislation is not enacted, the
Debtors' asbestos liability, as determined through the bankruptcy
proceedings, could be materially greater than the accrued reserve. The
Official Committee of Asbestos Personal Injury Claimants and the legal
representative for future asbestos claimants have indicated in a court
filing that they estimate that the net present value of the Debtors'
liability for present and future asbestos personal injury claims is
approximately $5.5 billion and that the Debtors are insolvent. The Debtors
have stated that they believe they are solvent if their asbestos
liabilities are fairly and appropriately valued. When the Debtors
determine that there is a reasonable basis for revision of the estimate of
their asbestos liability, the reserve will be adjusted, and it is possible
that a charge to results of operations will be necessary at that time. In
such a case, the Debtors' asbestos liability could vary significantly from
the recorded estimate of liability and could be greater than the high end
of the range estimated in 2000. This difference could be material to the
Corporation's financial position, cash flows and results of operations in
the period recorded.
BOND TO SECURE CERTAIN CENTER 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 JPMorgan Chase Bank (formerly Chase
Manhattan Bank) ("JPMorgan Chase") to Safeco. After the Filing, by a
letter dated November 16, 2001, the Center made a demand to Safeco for
payment of $15.7 million under the bond, and, by a letter dated December
28, 2001, the Center made a demand to Safeco for payment of approximately
$127 million under the bond. 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. 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.
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 Bankruptcy Court 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.
The court 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.
The parties filed cross-motions for summary judgment in the consolidated
proceedings. On March 28, 2003, in response to the cross-motions for
summary
-38-
judgment, the court issued an order and memorandum opinion which granted
in part and denied in part the Center's motion for summary judgment.
Although the court ruled that Safeco is not required to remit any surety
bond proceeds to the Center at this time, the court stated that certain
settlements that were completed before U.S. Gypsum's Petition Date likely
are covered by the surety bond but that the bond does not cover settlement
payments that were not yet completed as of the Petition Date. The court
did not rule on whether the bond covers other disputed obligations and
reserved these issues to a subsequent phase of the litigation. As a result
of the court's decision, it is likely that, absent a settlement of this
matter, some portion of the bond may be drawn but that the amount drawn
may be substantially less than the full amount of the bond. To the extent
that Safeco were to pay all or any portion of the bond, it is likely that
Safeco would draw down the JPMorgan Chase letter of credit to cover the
bond payment and JPMorgan Chase would assert a pre-petition claim in a
corresponding amount against the Corporation in the bankruptcy
proceedings.
The Center bond litigation is pending before Judge Fitzgerald and has not
been resolved.
CONCLUSION: There are many uncertainties associated with the resolution of
the asbestos liability in the bankruptcy proceeding. The Corporation will
continue to review its asbestos liability as the Chapter 11 Cases progress
and as issues relating to the estimation of the Debtors' asbestos
liabilities are addressed. If, after any such review, the Debtors'
estimate of the probable liability for present and future asbestos claims
is different from the existing reserve, the reserve will be adjusted, and
such adjustment could be material to the Corporation's financial position,
cash flows and results of operations in the period recorded.
SILICA LITIGATION
During the 10 years prior to the Filing, Debtor U.S. Gypsum was named as a
defendant in approximately 10 lawsuits claiming personal injury from
exposure to silica allegedly from U.S. Gypsum products. The claims against
U.S. Gypsum in silica personal injury lawsuits pending at the time of the
Filing were stayed as a result of the Filing. Only one proof of claim
alleging silica personal injury liability was filed against any of the
Debtors as of the bar date in the Bankruptcy Case. However, it has been
estimated that tens of thousands of silica personal injury lawsuits have
been filed against other defendants nationwide in recent years.
In the fourth quarter of 2004, U.S. Gypsum was served with 17 complaints
involving more that 400 plaintiffs alleging personal injury resulting from
exposure to silica. These complaints were filed in various Mississippi
state courts, and each names from 178 to 195 defendants. U.S. Gypsum
believes that the claims against it in these lawsuits are stayed as a
result of the Filing. The Corporation does not have sufficient information
to estimate the likely cost of resolving these claims. However, the
Corporation believes that it has
-39-
significant defenses to these claims if they are allowed to proceed. The
Corporation has provided notice of these recent complaints to its
insurance carriers.
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 undiscounted 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 proceedings
regarding environmental matters will have a material adverse effect upon
its financial position, cash flows or results of operations.
(14) LETTER OF CREDIT FACILITY
Effective April 29, 2005, the Corporation's credit agreement with LaSalle
Bank N.A. (the "LaSalle Facility") was increased to $175 million from $100
million and the term of the facility was extended until April 30, 2008.
The LaSalle Facility is used exclusively to support the issuance of
letters of credit needed to support business operations. As of June 30,
2005, $64 million of letters of credit under the LaSalle Facility, which
are cash collateralized at 103%, were outstanding.
-40-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
OVERVIEW
USG Corporation (the "Corporation") and 10 of its United States subsidiaries
(collectively, the "Debtors") are currently operating under chapter 11 of the
United States Bankruptcy Code (the "Bankruptcy Code"). The Debtors took this
action to resolve asbestos 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. To properly understand the Corporation
and its businesses, it is important to understand the nature of this voluntary
reorganization process under chapter 11 and the potential impacts the
reorganization may have on the rights and interests of the Debtors' investors
and creditors, as described in more detail below. At this point, there is great
uncertainty as to the amount of the Debtors' asbestos liability and thus the
value of any recovery for pre-petition creditors or stockholders under any final
plan of reorganization. No plan of reorganization has thus far been proposed by
the Debtors.
The Corporation had $1,286 million of cash, cash equivalents, restricted cash
and marketable securities as of June 30, 2005, and management believes that this
liquidity plus expected operating cash flows will meet the Corporation's cash
needs, including making regular capital investments to maintain and enhance its
businesses, throughout the chapter 11 proceedings.
The Corporation's net sales for the second quarter of 2005 were a record level
for any quarter in its history and represented a 12% increase from the same
period in 2004. Demand for products sold by the Corporation's North American
Gypsum and Building Products Distribution operating segments was favorable in
the second quarter of 2005 due to continued strength in the new housing and
repair and remodel markets. Shipments of gypsum wallboard in the second quarter
2005 were a record for any quarter in the history of both the Corporation and
the industry, and are expected to be strong for the remainder of the year. The
favorable level of activity in the aforementioned markets and high industry
capacity utilization rates have resulted in the continuing rise in market
selling prices for gypsum wallboard. The nationwide average realized selling
price for United States Gypsum Company's ("U.S. Gypsum's") SHEETROCK(R) brand
gypsum wallboard was up 17% from the second quarter of 2004. However, the
Corporation's Worldwide Ceilings operating segment reported lower net sales and
operating profit in the second quarter of 2005 largely due to decreased demand
for ceiling grid and tile.
The Corporation's gross margin percentage (gross profit as a percent of net
sales) was 20.7% in the second quarter of 2005, up from 18.9% in the second
quarter of 2004. This improvement was primarily the result of higher selling
prices and increased shipments for SHEETROCK(R) brand gypsum wallboard. Profit
margins have been pressured by high levels of manufacturing costs related to the
prices of natural gas (a major source of energy for the Corporation) and raw
materials, as well as by costs associated with the implementation of a new
enterprise-wide software system.
-41-
However, manufacturing costs for gypsum wallboard improved in the second quarter
of 2005 as compared to the first quarter primarily due to improved operating
factors.
VOLUNTARY REORGANIZATION UNDER CHAPTER 11
On June 25, 2001 (the "Petition Date"), the Debtors filed voluntary petitions
for reorganization (the "Filing") under the Bankruptcy Code. The Debtors'
bankruptcy cases (the "Chapter 11 Cases") are pending in the United States
Bankruptcy Court for the District of Delaware (the "Bankruptcy Court").
The Debtors intend to address their liability for all present and future
asbestos claims, as well as all other pre-petition claims, in a plan or plans of
reorganization approved by the Bankruptcy Court. The Debtors currently have the
exclusive right to file a plan of reorganization. This exclusive period extended
to June 30, 2005, and the Debtors have filed a motion to further extend the
exclusive period to December 31, 2005. This motion is scheduled to be addressed
by the Bankruptcy Court on August 29, 2005, and, by operation of the bankruptcy
rules, the exclusive period is extended at least until the Bankruptcy Court
rules on the extension request. The Debtors may seek additional extensions of
the exclusive period depending upon developments in the Chapter 11 Cases.
A key factor in determining whether or to what extent there will be any recovery
for pre-petition creditors or stockholders under any plan of reorganization is
the amount that must be provided in the plan of reorganization to address the
Debtors' liability for present and future asbestos claims. The amount of the
Debtors' asbestos liabilities has not yet been determined and is subject to
substantial uncertainty.
The Corporation's Annual Report on Form 10-K, filed on February 18, 2005,
discusses the background and impact of the Filing, developments in the
reorganization proceeding, proceedings relating to estimation of Debtors'
liability for asbestos personal injury claims, and potential federal legislation
regarding asbestos personal injury claims. Since the filing of the Form 10-K,
there have been additional developments in the Debtors' Chapter 11 proceedings.
On April 21, 2005, the United States Trustee appointed an Official Committee of
the Equity Security Holders of the Corporation. This committee, along with the
three official committees representing various creditors of the Debtors, are
expected to play significant roles in the Chapter 11 Cases.
During the second quarter of 2005, there have also been developments regarding
potential federal legislation. See Potential Federal Legislation Regarding
Asbestos Personal Injury Claims, below. See also, Item 1, Note 2, Voluntary
Reorganization Under Chapter 11, and Note 13, Litigation, for additional
information on the background of asbestos litigation, estimated cost, and
developments in the Corporation's reorganization proceedings, including
litigation proceedings relating to estimation of the Debtors' asbestos personal
injury liabilities, whether the Debtors other than U.S. Gypsum are responsible
for U.S. Gypsum's asbestos liabilities, and whether the Debtors are liable for
the asbestos liabilities of
-42-
A.P. Green Refractories Co.
POTENTIAL FEDERAL LEGISLATION REGARDING ASBESTOS PERSONAL INJURY CLAIMS
On April 19, 2005, Senator Arlen Specter (R. Pa.) introduced in the United
States Senate legislation addressing compensation and administration of asbestos
personal injury claims. The legislation is titled the Fairness in Asbestos
Injury Resolution Act of 2005 (Senate Bill 852, the "FAIR Bill"). The FAIR Bill
is co-sponsored by fourteen Republican Senators and three Democratic Senators.
The FAIR Bill was referred to the Senate Committee on the Judiciary and was
approved by the Committee on May 27, 2005, with thirteen senators voting in
favor of the bill and five voting against it. However, several senators on the
Committee who voted in favor of the bill have stated that additional changes
must be made to the FAIR Bill in order for them to vote in favor of passage of
the bill by the full Senate. The FAIR bill has not been approved by the full
Senate, has not been considered by the House of Representatives, and is not law.
The FAIR Bill approved by the Senate Judiciary Committee is intended to
establish a nationally administered trust fund to compensate asbestos personal
injury claimants. In the FAIR Bill's current form, companies that have made past
payments for asbestos personal injury claims would be required to contribute
amounts to a national trust fund on a periodic basis that would pay the claims
of qualifying asbestos personal injury claimants. The nationally administered
trust fund would be the exclusive remedy for asbestos personal injury claims,
and such claims could not be brought in state or federal court as long as such
claims are being compensated under the national trust fund. A copy of the FAIR
Bill as introduced is available at http://thomas.loc.gov (type in "S. 852" in
the search field).
In the FAIR Bill's current form, the amounts to be paid to the national trust
fund are based on an allocation methodology set forth in the FAIR Bill. In
addition to the annual payments required under the allocation methodology,
defendant participants may be subject to surcharges under certain circumstances,
including but not limited to a failure of the scheduled contributions to meet
the defendant participants' guaranteed annual funding requirements under the
FAIR Bill. The amounts that participants, including the Debtors, would be
required to pay are not dischargeable in a bankruptcy proceeding. In addition,
the FAIR Bill, in its current form, requires affected companies currently in
chapter 11, including the Debtors, to make their first payment to the national
trust fund not later than 60 days after enactment of the FAIR Bill,
notwithstanding the fact that the companies are still in chapter 11 proceedings.
The FAIR Bill also provides, among other things, that if it is determined that
the money in the trust fund is not sufficient to compensate eligible claimants,
the claimants and defendants (including current chapter 11 debtors) would return
to the court system to resolve claims not paid by the national trust fund.
The outcome of the legislative process is inherently speculative, and it cannot
be known whether the FAIR Bill or similar legislation will ever be enacted or,
if enacted, what the terms of the final legislation might be. Previously, in
April 2004, a similar, but not identical, bill (the "Fairness in Asbestos Injury
-43-
Resolution Act of 2004") was introduced in the Senate and was approved by the
Senate Committee on the Judiciary, but the full Senate defeated a motion to
proceed with floor consideration of the bill. Even if the FAIR Bill is enacted,
the terms of the enacted legislation may differ from those of the FAIR Bill as
approved by the Judiciary Committee, and those differences may be material to
the FAIR Bill's impact on the Corporation.
Enactment of the FAIR Bill or similar legislation addressing the financial
contributions of the Debtors for asbestos personal injury claims would have a
material impact on the amount of the Debtors' asbestos personal injury liability
and the Debtors' Chapter 11 Cases.
During the legislative process, proceedings in the Chapter 11 Cases will
continue. See Item 1, Note 2, Voluntary Reorganization Under Chapter 11 and Note
13, Litigation.
ESTIMATED COST OF ASBESTOS LIABILITY
Prior to the Filing, in the fourth quarter of 2000, U.S. Gypsum recorded a
noncash, pretax provision of $850 million, increasing to $1,185 million its
total accrued reserve for resolving in the tort system the asbestos claims
pending as of December 31, 2000, and expected to be filed through 2003. At that
time, the estimated range of U.S. Gypsum's probable liability for such claims
was between $889 million and $1,281 million, including defense costs. These
amounts are stated before tax benefit and are not discounted to present value.
As of March 31, 2005, the Corporation's accrued reserve for asbestos claims
totaled $1,061 million.
Because of the uncertainties associated with estimating the Debtors' liability
for present and future asbestos claims at this stage of the bankruptcy
proceedings, no change has been made to the previously recorded reserve except
to reflect certain minor asbestos-related costs incurred since the Filing.
Because the Filing and possible federal legislation have changed the basis upon
which the Debtors' asbestos liability would be estimated, there can be no
assurance that the current reserve accurately reflects the Debtors' ultimate
liability for pending and future asbestos claims. At the time the reserve was
increased to its current level in December 2000, the reserve was an estimate of
the cost of resolving in the tort system U.S. Gypsum's asbestos liability for
then-pending claims and those expected to be filed through 2003. Because of the
Filing and the stay of pre-petition asbestos lawsuits, the Debtors have not
participated in the tort system since June 2001 and thus cannot measure the
recorded reserve against actual experience. However, the reserve is generally
consistent with the amount the Corporation estimates that the Debtors would be
required to pay to resolve all of their asbestos liability if the FAIR Bill, in
its current form, is enacted.
As the Chapter 11 Cases and the legislation process proceed, the Debtors likely
will gain more information from which a reasonable estimate of the Debtors'
probable liability for present and future asbestos claims can be determined. If
such estimate differs from the existing reserve, the reserve will be adjusted,
and
-44-
it is possible that a charge to results of operations will be necessary at that
time. In such a case, the Debtors' asbestos liability could vary significantly
from the recorded estimate of liability and could be greater than the high end
of the range estimated in 2000. This difference could be material to the
Corporation's financial position, cash flows and results of operations in the
period recorded.
POTENTIAL OUTCOMES OF THE FILING
While it is the Debtors' intention to seek a full recovery for their creditors,
it is not possible to predict the amount that will have to be provided in the
plan of reorganization to address present and future asbestos claims, how the
plan of reorganization will treat other pre-petition claims, whether there will
be sufficient assets to satisfy the Debtors' pre-petition liabilities, and what
impact any plan may have on the value of the shares of the Corporation's common
stock. The payment rights and other entitlements of pre-petition creditors and
the Corporation's stockholders may be substantially altered by any plan of
reorganization confirmed in the Chapter 11 Cases. Pre-petition creditors may
receive under the plan of reorganization less than 100% of the face value of
their claims, the pre-petition creditors of some Debtors may be treated
differently from the pre-petition creditors of other Debtors, and the interests
of the Corporation's stockholders are likely to be substantially diluted or
cancelled in whole or in part. There can be no assurance as to the value of any
distributions that might be made under any plan of reorganization with respect
to such pre-petition claims or equity interests.
It is also not possible to predict how the plan of reorganization will treat
intercompany indebtedness, licenses, transfers of goods and services, and other
intercompany arrangements, transactions and relationships that were entered into
before the Petition Date. Certain of these intercompany transactions have been
challenged by various parties in these Chapter 11 Cases (see Developments in the
Reorganization Proceeding, above), and other arrangements, transactions and
relationships may be challenged by parties to these Chapter 11 Cases. The
outcome of such challenges may have an impact on the treatment of various claims
under any plan of reorganization.
ACCOUNTING IMPACT
The Corporation is required to follow American Institute of Certified Public
Accountants ("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 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 liabilities subject to compromise
and chapter 11 reorganization expenses.
-45-
CONSOLIDATED RESULTS OF OPERATIONS
NET SALES
Net sales in the second quarter of 2005 totaled $1,287 million, a record for any
quarter in the Corporation's history and a 12% increase from $1,145 million in
the second quarter of 2004. For the first six months of 2005, net sales totaled
$2,460 million, up 14% from $2,165 million in the comparable 2004 period. Net
sales increased due to higher selling prices and record shipments for
SHEETROCK(R) brand gypsum wallboard and other gypsum-related products. See Core
Business Results of Operations below for an explanation of product line results
by operating segment.
COST OF PRODUCTS SOLD
Cost of products sold in the second quarter of 2005 was $1,020 million, up 10%
from $929 million a year ago. For the first six months of 2005, cost of products
sold totaled $1,979 million, up 11% from $1,778 million in the comparable 2004
period. These increases were primarily attributable to higher volume for gypsum
wallboard and other gypsum-related products and higher manufacturing costs
related to the prices of natural gas and raw materials, as well costs associated
with the implementation of a new enterprise-wide software system.
GROSS PROFIT
Gross profit in the second quarter of 2005 was $267 million, a 24% increase from
$216 million in the second quarter of 2004. For the first six months of 2005,
gross profit totaled $481 million, up 24% from $387 million in the comparable
2004 period. The gross margin percentage was 20.7% in the second quarter of
2005, up from 18.9% in the second quarter of 2004. For the first six months of
2005, gross margin was 19.6%, up from 17.9% in the comparable 2004 period.
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses in the second quarter of 2005 were $87
million, up 10% from $79 million in the second quarter of 2004. For the first
six months, these expenses were $176 million versus $156 million a year ago.
These increases primarily related to compensation and benefits, including
retention and incentive compensation, and higher funding for marketing and
growth initiatives. Selling and administrative expenses as a percent of net
sales were 6.8% and 7.2% for the second quarter and first six months of 2005,
respectively, versus 6.9% and 7.2% for the comparable 2004 periods.
CHAPTER 11 REORGANIZATION EXPENSES
Chapter 11 reorganization expenses in the consolidated and debtor-in-possession
statements of earnings consisted of the following (dollars in millions):
-46-
Three Months Six Months
ended June 30, ended June 30,
---------------------------------
2005 2004 2005 2004
---------------------------------
Legal and financial advisory fees $ 6 $ 6 $ 12 $ 10
Bankruptcy-related interest income (7) (2) (12) (4)
- ---------------------------------------------------------------------------
Total chapter 11 reorganization expenses (1) 4 - 6
===========================================================================
INTEREST EXPENSE
Interest expense was $2 million and $3 million in the second quarter and first
six months of 2005, respectively, versus $1 million and $2 million for the
corresponding 2004 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.
Contractual interest expense not accrued or recorded on pre-petition debt
totaled $20 million and $39 million in the second quarter and first six months
of 2005, respectively. From the Petition Date through June 30, 2005, contractual
interest expense not accrued or recorded on pre-petition debt totaled $296
million. This calculation assumes that all such interest was paid when required
at the applicable contractual interest rate (after giving effect to any
applicable default rate). However, the calculation excludes the impact of any
compounding of interest on unpaid interest that may be payable under the
relevant contractual obligations, as well as any interest that may be payable
under a plan of reorganization to trade or other creditors that are not
otherwise entitled to interest under the express terms of their claims. The
impact of compounding alone would have increased the contractual interest
expense reported above by $6 million and $12 million in the second quarter and
first six months of 2005, respectively, and $46 million from the Petition Date
through June 30, 2005. For financial reporting purposes, no post-petition
accruals have been made for contractual interest expense not accrued or recorded
on pre-petition debt.
On April 11, 2005, the Unsecured Creditors Committee filed a motion with the
bankruptcy court requesting that the Debtors make interest payments to all
non-asbestos unsecured creditors for interest accrued from January 1, 2005, on
liquidated, undisputed pre-petition claims (including accrued unpaid interest
through December 31, 2004). Upon approval, this motion would have required the
Debtors to make interest payments of approximately $84 million on an annual
basis. However, on May 20, 2005, the bankruptcy court denied this motion.
INTEREST INCOME
Non-bankruptcy related interest income was $2 million in the second quarter and
$4 million in the first six months of 2005. Non-bankruptcy related interest
income for the respective 2004 periods was $1 million and $2 million.
-47-
INCOME TAXES
Income tax expense amounted to $70 million and $118 million in the second
quarter and first six months of 2005, respectively, compared with $52 and $85
million in the corresponding 2004 periods. The effective tax rates were 38.6%
and 38.4% for the first six months of 2005 and 2004, respectively.
NET EARNINGS
Net earnings of $110 million, or $2.53 per diluted share, were reported for the
second quarter of 2005 compared with $80 million, or $1.86 per diluted share,
for the second quarter of 2004. For the first six months of 2005, net earnings
totaled $187 million, or $4.30 per diluted share, compared with $137 million, or
$3.18 per diluted share, for the first six months of 2004.
-48-
CORE BUSINESS RESULTS OF OPERATIONS
THREE MONTHS SIX MONTHS
(dollars in millions) ENDED JUNE 30, ENDED JUNE 30,
------------------------- -------------------------
NET SALES: 2005 2004 2005 2004
---------- ---------- ---------- ----------
NORTH AMERICAN GYPSUM:
U.S. Gypsum Company $ 720 $ 617 $ 1,374 $ 1,191
CGC Inc. (gypsum) 82 68 157 141
Other subsidiaries* 55 44 95 80
Eliminations (53) (51) (97) (95)
---------- ---------- ---------- ----------
Total 804 678 1,529 1,317
---------- ---------- ---------- ----------
WORLDWIDE CEILINGS:
USG Interiors, Inc. 124 135 241 255
USG International 52 54 103 100
CGC Inc. (ceilings) 14 15 27 28
Eliminations (12) (14) (23) (27)
---------- ---------- ---------- ----------
Total 178 190 348 356
---------- ---------- ---------- ----------
BUILDING PRODUCTS DISTRIBUTION:
L&W Supply Corporation 506 454 962 816
---------- ---------- ---------- ----------
Eliminations (201) (177) (379) (324)
---------- ---------- ---------- ----------
Total USG Corporation 1,287 1,145 2,460 2,165
========== ========== ========== ==========
OPERATING PROFIT:
NORTH AMERICAN GYPSUM:
U.S. Gypsum Company 125 87 218 148
CGC Inc. (gypsum) 14 9 26 22
Other subsidiaries* 9 6 11 13
---------- ---------- ---------- ----------
Total 148 102 255 183
---------- ---------- ---------- ----------
WORLDWIDE CEILINGS:
USG Interiors, Inc. 13 19 19 31
USG International 2 4 5 5
CGC Inc. (ceilings) 2 3 5 5
---------- ---------- ---------- ----------
Total 17 26 29 41
---------- ---------- ---------- ----------
BUILDING PRODUCTS DISTRIBUTION:
L&W Supply Corporation 39 31 65 45
---------- ---------- ---------- ----------
Corporate (22) (20) (45) (36)
Chapter 11 reorganization expenses 1 (4) - (6)
Eliminations (2) (2) 1 (2)
---------- ---------- ---------- ----------
Total USG Corporation 181 133 305 225
========== ========== ========== ==========
*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.
-49-
NORTH AMERICAN GYPSUM
Net sales of $804 million increased 19% from the second quarter of 2004, while
operating profit increased 45% to $148 million. First six months net sales of
$1,529 million reflected an increase of 16% from a year ago, while operating
profit of $255 million increased 39%.
United States Gypsum Company: Second quarter 2005 net sales for U.S. Gypsum
increased $103 million, or 17%, from the second quarter of 2004, while operating
profit rose $38 million, or 44%. These increases largely reflected higher
selling prices and record shipments for SHEETROCK(R) brand gypsum wallboard. In
addition, record shipments and higher selling prices were also realized for
SHEETROCK(R) brand joint compound, DUROCK(R) brand cement board and FIBEROCK(R)
brand gypsum fiber panels.
U.S. Gypsum's nationwide average realized selling price for SHEETROCK(R) brand
gypsum wallboard was $138.28 per thousand square feet in the second quarter of
2005. This price represented a 17% increase from $118.47 in the second quarter
of 2004 and a 3% increase from $133.73 in the first quarter of 2005. The benefit
of improved pricing was partially offset by higher manufacturing costs related
to energy and raw material prices. However, manufacturing costs for gypsum
wallboard improved in the second quarter of 2005 as compared to the first
quarter primarily due to improved operating factors.
Shipments of SHEETROCK(R) brand gypsum wallboard totaled 2.9 billion square feet
during the second quarter of 2005, compared with 2.8 billion square feet sold in
the second quarter of 2004. Wallboard plants operated at 96% and 95% of capacity
in the second quarters of 2005 and 2004, respectively. Industry shipments of
gypsum wallboard were up approximately 7% from the second quarter of 2004.
CGC Inc.: Net sales for the gypsum business of Canada-based CGC Inc. increased
21% and operating profit increased 56% versus the second quarter of 2004
primarily due to higher selling prices for SHEETROCK(R) brand gypsum wallboard.
WORLDWIDE CEILINGS
Net sales of $178 million decreased 6%, while operating profit of $17 million
declined 35% from the second quarter of 2004. First six months net sales of $348
million reflected a 2% decrease from a year ago, while operating profit of $29
million declined 29%.
USG Interiors, Inc.: The Corporation's domestic ceilings business, USG
Interiors, Inc. reported second quarter 2005 net sales and operating profit of
$124 million and $13 million, respectively. This compared with net sales of $135
million and operating profit of $19 million in the second quarter of 2004. The
decline in net sales was largely due to lower shipments of ceiling grid and
tile, partially offset by higher selling prices for both product lines.
During the first half of 2004, market concerns over a shortage of steel used to
make grid and related increases in steel costs contributed to unusually strong
-50-
demand for grid products. Demand in 2005 for ceiling grid, as well as ceiling
tile, has been in line with overall industry demand, which remained relatively
weak.
The decline in USG Interiors' operating profit reflected the lower level of
shipments as well as higher manufacturing costs, primarily related to energy and
raw materials for ceiling tile and steel for ceiling grid.
USG International: Net sales for USG International were down 4% from the second
quarter of 2004, while operating profit decreased to $2 million from $4 million.
These declines primarily reflected lower demand and higher operating costs for
ceiling grid and tile in Europe.
CGC Inc.: The ceilings business of CGC Inc. reported declines of $1 million for
both net sales and operating profit as compared with the second quarter of 2004.
These results primarily reflected lower volume and higher manufacturing costs
for ceiling grid, partially offset by higher selling prices.
BUILDING PRODUCTS DISTRIBUTION
Second quarter 2005 net sales and operating profit for L&W Supply Corporation
("L&W Supply"), the leading specialty building products distribution business in
the United States, were the highest for any quarter in its history. Net sales of
$506 million represented an 11% increase versus the second quarter of 2004,
while operating profit rose 26% to $39 million. These results were primarily
attributable to record shipments of gypsum wallboard, which were up 10% versus
the second quarter of 2004. Second quarter results also benefited from improved
selling prices for gypsum wallboard, which increased 16%.
For the first six months of 2005, net sales of $962 million and operating profit
of $65 million increased 18% and 44%, respectively, versus the first six months
of 2004.
L&W Supply remains focused on opportunities to profitably grow its specialty
dealer business, as well as optimize asset utilization. As part of its plan, L&W
Supply acquired eight locations in the second quarter of 2005 and now operates
194 locations in the United States as of June 30, 2005, compared with 186
locations as of December 31, 2004, and 184 locations as of June 30, 2004.
MARKET CONDITIONS AND OUTLOOK
Industry shipments of gypsum wallboard in the United States were an estimated
9.5 billion square feet in the second quarter of 2005, a 7% increase from 8.9
billion square feet in the second quarter of 2004. The robust level of activity
in the new housing and residential repair and remodel markets, which together
account for nearly two-thirds of all demand for gypsum wallboard, and high
industry capacity utilization rates, have resulted in a rise of market selling
prices for gypsum wallboard.
-51-
The outlook for the remainder of 2005 is positive and the industry is on track
to achieve another record year of shipments. The strong new housing and
residential repair and remodel markets are expected to keep demand for the
Corporation's gypsum wallboard products high. The impact of rising short term
interest rates and tightening lending standards have not yet been felt in the
new housing market. Housing starts through the first six months of 2005 are
running 5% ahead of 2004's level. However, these factors may still impact demand
levels in the future. The commercial construction market (the principal market
for the Corporation's ceilings products), while still soft, is showing some
signs of improvement. These factors, combined with the Corporation's continued
focus on margin improvement and select growth opportunities, should produce
strong results in 2005. U.S. Gypsum continues to make investments to meet its
customers' needs, satisfy the growing demand for SHEETROCK(R) brand gypsum
wallboard and improve its cost position. The recently announced construction of
a new gypsum wallboard plant in Washingtonville, Pa., and the state-of-the-art
modernization of its Norfolk, Virginia, gypsum wallboard plant will increase
capacity, reduce production costs and improve service to customers in the
Northeast and Mid-Atlantic markets. However, the Corporation, like many other
companies, faces many ongoing cost pressures such as higher prices for natural
gas and raw materials.
In this environment, the Corporation continues to focus its management attention
and investments on improving customer service, manufacturing costs and operating
efficiencies, as well as investing to grow its businesses. In addition, the
Corporation 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
LIQUIDITY
As of June 30, 2005, the Corporation had $1,286 million of cash, cash
equivalents, restricted cash and marketable securities, up $37 million, or 3%,
from $1,249 million as of December 31, 2004. Of the total June 30, 2005 amount,
$278 million was held by non-Debtor subsidiaries. Since the Petition Date, the
Corporation's level of liquidity has increased due to strong operating cash
flows and the absence of cash payments related to asbestos settlements and
interest on pre-petition debt. Contractual interest expense not accrued or
recorded on pre-petition debt was $39 million in the first six months of 2005
and $296 million since the Petition Date. See Interest Expense, above, for a
full discussion of contractual interest not accrued or recorded.
CASH FLOWS
As shown on the consolidated statement of cash flows, cash and cash equivalents
decreased $74 million during the first six months of 2005. The primary source of
cash during this period was earnings from operations. Primary uses of cash were:
(i) net purchases of marketable securities of $85 million, (ii) capital spending
of $76 million, (iii) pension funding of $36 million, (iv) acquisitions of
businesses
-52-
of $29 million and (v) deposit of restricted cash of $28 million.
Comparing the first six months of 2005 with the first six months of 2004, net
cash from operating activities was $141 million in the 2005 period compared with
$74 million a year ago. This variation was largely attributable to increased net
earnings. Net cash used for investing activities increased to $218 million from
$107 million primarily reflecting increases in capital spending, net purchases
of marketable securities and acquisitions of businesses. Net cash of $6 million
provided by financing activities during the first six months of 2005 reflected
the exercise of stock options.
CAPITAL EXPENDITURES
Capital spending amounted to $76 million in the first six months of 2005,
compared with $47 million in the corresponding 2004 period. As of June 30, 2005,
remaining capital expenditure commitments for the replacement, modernization and
expansion of operations amounted to $438 million, compared with $283 million as
of December 31, 2004. The Corporation's capital expenditures program includes:
- approximately $180 million for the recently announced construction
of a new gypsum wallboard plant in Washingtonville, Pa. This
facility, which will serve the Northeast markets, is expected to
begin operation in mid-2008.
- approximately $130 million for a project to replace existing
capacity at U.S. Gypsum's Norfolk, Va., gypsum wallboard plant with
a new low-cost wallboard line that will position the company for
profitable growth in the mid-Atlantic market. This project is
expected to be completed in early 2007.
- approximately $30 million for a mill modernization project at U.S.
Gypsum's Plaster City, Calif., gypsum wallboard plant. This project
is expected to be completed in late 2006.
Construction on the Norfolk and Plaster City projects will begin in 2005, and
their costs are being funded by cash from operations. Construction of the
Washingtonville plant will begin in 2006 and its cost also will be funded by
cash from operations.
During the bankruptcy proceeding, the Corporation may have limited ability to
access capital other than its own cash, marketable securities and future cash
flows to fund potential future growth opportunities such as new products,
acquisitions and joint ventures. Nonetheless, the Corporation expects to be able
to maintain a program of capital spending aimed at maintaining and enhancing its
businesses.
WORKING CAPITAL
Working capital (current assets less current liabilities) as of June 30, 2005,
amounted to $1,264 million, and the ratio of current assets to current
liabilities was 2.88-to-1. As of December 31, 2004, working capital amounted to
$1,220 million, and the ratio of current assets to current liabilities was
3.14-to-1.
-53-
Receivables increased to $513 million as of June 30, 2005, from $413 million as
of December 31, 2004, primarily reflecting first quarter payments of customer
rebates and a 18% increase in net sales for the month of June 2005 as compared
with December 2004. Inventories were unchanged at $338 million. Accounts payable
increased to $278 million from $270 million. Accrued expenses declined to $218
million from $224 million as of December 31, 2004.
MARKETABLE SECURITIES
As of June 30, 2005, $533 million was invested in marketable securities, up $83
million from $450 million as of December 31, 2004. Of the June 30, 2005 amount,
$333 million was invested in long-term marketable securities and $200 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 income (loss) on the consolidated balance
sheets.
RESTRICTED CASH AND LETTERS OF CREDIT
As of June 30, 2005, a total of $71 million was reported as restricted cash on
the consolidated balance sheet. Restricted cash primarily represented collateral
to support outstanding letters of credit.
Effective April 29, 2005, the Corporation's credit agreement with LaSalle Bank
N.A. (the "LaSalle Facility") was increased to $175 million from $100 million
and the term of the facility was extended until April 30, 2008. The LaSalle
Facility is used exclusively to support the issuance of letters of credit needed
to support business operations. As of June 30, 2005, $64 million of letters of
credit under the LaSalle Facility, which are cash collateralized at 103%, were
outstanding.
DEBT
As of June 30, 2005, total debt amounted to $1,006 million, of which $1,005
million was included in liabilities subject to compromise. These amounts were
unchanged from the December 31, 2004, levels and do not include any accruals for
post-petition contractual interest expense.
LEGAL CONTINGENCIES
As a result of the Filing, all pending asbestos lawsuits against the Debtors are
stayed, and no party may take any action to pursue or collect on such asbestos
claims absent specific authorization of the Bankruptcy Court.
U.S. Gypsum has also been named as a defendant in lawsuits claiming personal
injury from exposure to silica allegedly from U.S. Gypsum products. Pre-petition
claims against U.S. Gypsum in silica personal injury lawsuits are also stayed as
a result of the Filing.
The Corporation and certain of its subsidiaries have been notified by state and
federal environmental protection agencies of possible involvement as one of
-54-
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 financial position, cash flows or
results of operations.
See Item 1, Note 13, Litigation, for additional information on (i) the
background of asbestos litigation, developments in the Corporation's
reorganization proceeding and estimated cost, (ii) silica litigation and (iii)
environmental litigation.
CRITICAL ACCOUNTING POLICIES
The preparation of the Corporation's financial statements requires management to
make estimates, judgments and assumptions that affect the reported amounts of
assets, liabilities, revenues and expenses during the periods presented. The
Corporation's 2004 Annual Report on Form 10-K, which was filed on February 18,
2005, includes a summary of the critical accounting policies the Corporation
believes are the most important to aid in understanding its financial results.
There have been no material changes to these critical accounting policies that
impacted the Corporation's reported amounts of assets, liabilities, revenues or
expenses during the first half of 2005.
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, including the possible
impact of any asbestos-related legislation, may differ from management's
expectations. Actual business, market or other conditions may also differ from
management's expectations and accordingly affect the Corporation's sales and
profitability or other results. Actual results may differ due to various other
factors, including economic conditions such as the levels of construction
activity, employment levels, interest rates, currency exchange rates and
consumer confidence; competitive conditions such as price and product
competition and competition for procurement of synthetic gypsum; shortages in
raw materials and energy; increases in raw material, energy and employee benefit
costs; loss of one or more significant customers; and the unpredictable effects
of acts of terrorism or war upon domestic and international economies and
financial markets. The Corporation assumes no obligation to update any
forward-looking information contained in this report.
-55-
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 Rule 13a-15(e) of the Securities Exchange Act of
1934), have concluded that, as of the end of the fiscal quarter covered by this
report on Form 10-Q, 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 control over financial reporting.
There was no change in the Corporation's "internal control over financial
reporting" (as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934)
identified in connection with the evaluation required by Rule 13a-15(d) of the
Securities Exchange Act of 1934 that occurred during the fiscal quarter covered
by this report on Form 10-Q that has materially affected, or is reasonably
likely to materially affect, the Corporation's internal control over financial
reporting.
-56-
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of USG Corporation:
We have reviewed the accompanying consolidated balance sheets of USG Corporation
and subsidiaries as of June 30, 2005 and the related consolidated statements of
earnings for the three month and six month periods ended June 30, 2005 and 2004
and the consolidated statements of cash flows for the six month periods ended
June 30, 2005 and 2004. These interim financial statements are the
responsibility of the Corporation's management.
We conducted our reviews in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board (United States), 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 reviews, we are not aware of any material modifications that should
be made to the accompanying consolidated interim financial statements for them
to be in conformity with accounting principles generally accepted in the United
States of America.
We have previously audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheets of USG Corporation and subsidiaries as of December 31, 2004 and 2003, and
the related consolidated statements of earnings, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 2004 (not
presented herein); and in our report dated February 8, 2005 we expressed an
unqualified opinion on those consolidated financial statements and included
explanatory paragraphs concerning (i) matters which raise substantial doubt
about the Corporation's ability to continue as a going concern; (ii) changes in
methods of accounting for asset retirement obligations and goodwill and other
intangible assets due to the Corporation's adoption of Statement of Financial
Accounting Standards (SFAS) No. 143, "Accounting for Asset Retirement
Obligations" in 2003, and SFAS No. 142, "Goodwill and Other Intangible Assets"
in 2002; In our opinion, the information set forth in the accompanying
consolidated balance sheet as of December 31, 2004 is fairly stated, in all
material respects, in relation to the consolidated balance sheet from which it
has been derived.
As discussed in Note 2 to the consolidated financial statements, USG Corporation
and certain subsidiaries voluntarily filed for Chapter 11 bankruptcy protection
on June 25, 2001. The accompanying consolidated financial statements do not
purport to reflect or provide for the consequences of the bankruptcy
proceedings. In particular, such financial statements do not purport to show (a)
as to assets,
-57-
their realizable value on a liquidation basis or their availability to satisfy
liabilities; (b) as to pre-petition liabilities, the amounts that may be allowed
for claims or contingencies, or the status and priority thereof; (c) as to
stockholder accounts, the effect of any changes that may be made in the
capitalization of the Corporation; or (d) as to operations, the effect of any
changes that may be made in its business.
The accompanying consolidated financial statements have been prepared assuming
that the Corporation will continue as a going concern. As discussed in Notes 2
and 13 to the consolidated financial statements, there is significant
uncertainty as to the resolution of the Corporation's asbestos litigation,
which, among other things, may lead to possible changes in the composition of
the Corporation's business portfolio, as well as changes in the ownership of the
Corporation. This uncertainty raises substantial doubt about the Corporation's
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Notes 2 and 13 to the financial statements. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ DELOITTE & TOUCHE LLP
DELOITTE & TOUCHE LLP
Chicago, Illinois
July 28, 2005
-58-
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Part I, Item 1, Note 13, Litigation, for information concerning the asbestos
and related bankruptcy litigation, silica litigation and environmental
litigation.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(c) Total Number of (c) Maximum Number (or
Shares (or Units) Approximate Dollar Value)
(a) Total Number (b) Average Price Purchased as Part of of Shares (or Units)
of Shares (or Units) Paid per Share (or Publicly Announced that May Yet Be Purchased
Period Purchased Unit) Plans or Programs Under the Plans or Programs
- ----------------- -------------------- ------------------ --------------------- ---------------------------
2005
January - - - -
February - - - -
March - - - -
--- ----- --- ---
Total 1st Quarter - - - -
--- ----- --- ---
April - - -
May 789 45.85 - -
June - - - -
--- ----- --- ---
Total 2nd Quarter 789 45.85 - -
--- ----- --- ---
(a) Reflects shares reacquired to provide for tax withholdings on shares
issued to employees under the terms of the USG Corporation 1995 Long-Term
Equity Plan, 1997 Management Incentive Plan or 2000 Omnibus Management
Incentive Plan.
(b) The price per share is based upon the mean of the high and the low prices
for a USG Corporation common share on the NYSE on the date of the tax
withholding transaction.
(c) The Corporation currently does not have in place a share repurchase plan
or program.
-59-
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) In accordance with the Corporation's notice and proxy statement
dated April 1, 2005, the matters set forth in paragraphs (b) and (c)
below were submitted to a vote of stockholders at its May 11, 2005
annual meeting of stockholders.
(b) The four director-nominees (Robert L. Barnett, David W. Fox, Valerie
B. Jarrett and Marvin E. Lesser) were each re-elected to a
three-year term of office which will expire in 2008. The directors
whose terms of office continued after the annual meeting of
stockholders were: Keith A. Brown, James C. Cotting, Lawrence M.
Crutcher, William C. Foote, W. Douglas Ford, John B. Schwemm and
Judith A. Sprieser.
Votes Abstentions
Votes Withheld and Broker
For or Against Non-Votes
---------- ---------- -----------
Election of Directors:
Robert L. Barnett 40,544,215 386,458 -
David W. Fox 40,513,115 417,558 -
Valerie B. Jarrett 40,453,690 476,983 -
Marvin E. Lesser 40,553,906 376,767
(c) The following proposal was recommended by the Corporation's Board of
Directors and was approved by a majority of the shares voted.
Votes Abstentions
Votes Withheld and Broker
For or Against Non-Votes
---------- ---------- -----------
Ratification of Appointment of
Deloitte & Touche LLP as Independent
Registered Public Accountants 40,689,526 205,123 -
-60-
ITEM 5. OTHER INFORMATION
DISPOSITION OF USG STOCK BY CORPORATE OFFICERS
Following the Corporation's filing of the Chapter 11 cases in June 2001, the
officers of the Corporation informally agreed not to dispose of their USG stock
other than for charitable donations and for those officers who announced an
intent to retire within the next twelve months. No public disclosure of this
arrangement was made at the time internally or externally. USG employees below
the officer level have been free to exercise options and dispose of their USG
stock without similar restriction since the filing of the Chapter 11 cases.
Certain factors have prompted a re-evaluation of this informal prohibition on
disposition of stock by officers. First, a number of stock option grants made to
officers prior to filing the Chapter 11 cases will expire over the next several
years, with the earliest such outstanding grant set to expire in February 2006.
Second, the stock is now trading in price ranges experienced prior to the filing
of the Chapter 11 cases. Third, a number of these pre-petition grants have value
based on current market prices for USG stock. In light of these developments,
the Corporation has concluded that officers should be free to exercise stock
options and immediately resell stock received upon exercise of such options,
subject to USG's long-standing policies on trading by officers, shortly after
the filing of this quarterly report.
The informal arrangement had also extended to ownership of USG stock through the
USG Investment Plan. The Corporation has also concluded that officers who held
USG stock in their Investment Plan accounts should be free to reinvest these
accounts in other investment options as part of their retirement planning
strategies and is releasing those with Investment Plan accounts invested in USG
stock from any further adherence to the informal arrangement. It is presently
contemplated that, with the exception of shares underlying stock options and
shares held in the Investment Plan, officers who are not retiring will still be
expected to hold all shares of USG stock that they currently beneficially own.
However, this understanding is subject to change at any time.
ITEM 6. EXHIBITS
15. Letter from Deloitte & Touche LLP regarding unaudited financial information.
31.1 Rule 13a - 14(a) Certifications of USG Corporation's Chief Executive
Officer
31.2 Rule 13a - 14(a) Certifications of USG Corporation's Chief Financial
Officer
32.1 Section 1350 Certifications of USG Corporation's Chief Executive Officer
32.2 Section 1350 Certifications of USG Corporation's Chief Financial Officer
-61-
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
August 2, 2005
-62-