UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 Rule 12b-2 of the Exchange Act.) Yes X No
----- -----
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act.) Yes No X
----- -----
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 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 was 44,511,194
as of September 30, 2005.
TABLE OF CONTENTS
Page
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Statements of Earnings:
Three Months and Nine Months
Ended September 30, 2005 and 2004 3
Consolidated Balance Sheets:
As of September 30, 2005 and December 31, 2004 4
Consolidated Statements of Cash Flows:
Nine Months Ended September 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 43
Item 4. Controls and Procedures 58
Report of Independent Registered Public Accounting Firm 59
PART II OTHER INFORMATION
Item 1. Legal Proceedings 61
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 61
Item 6. Exhibits 62
Signatures 63
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PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
USG CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS
(DOLLARS IN MILLIONS EXCEPT PER-SHARE DATA)
(UNAUDITED)
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------- -------------------------
2005 2004 2005 2004
----------- ----------- ----------- -----------
Net sales $ 1,344 $ 1,175 $ 3,804 $ 3,340
Cost of products sold 1,043 941 3,022 2,719
----------- ----------- ----------- -----------
Gross profit 301 234 782 621
Selling and administrative expenses 88 82 264 238
Chapter 11 reorganization expenses 2 4 2 10
----------- ----------- ----------- -----------
Operating profit 211 148 516 373
Interest expense 1 2 4 4
Interest income (3) (2) (7) (4)
Other expense, net -- -- 1 3
----------- ----------- ----------- -----------
Earnings before income taxes 213 148 518 370
Income taxes 55 58 173 143
----------- ----------- ----------- -----------
Net earnings 158 90 345 227
=========== =========== =========== ===========
Basic earnings per common share 3.58 2.10 7.94 5.28
Diluted earnings per common share 3.57 2.10 7.90 5.28
Average common shares 43,978,786 43,016,919 43,471,228 43,019,286
Average diluted common shares 44,117,708 43,018,186 43,692,726 43,020,448
See accompanying Notes to Consolidated Financial Statements.
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USG CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
(UNAUDITED)
AS OF AS OF
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 900 $ 756
Short-term marketable securities 189 138
Restricted cash 77 43
Receivables (net of reserves - $15 and $14) 496 413
Inventories 333 338
Income taxes receivable 6 24
Deferred income taxes 1 25
Other current assets 214 53
------ ------
Total current assets 2,216 1,790
Long-term marketable securities 318 312
Property, plant and equipment (net of accumulated
depreciation and depletion - $961 and $878) 1,902 1,853
Deferred income taxes 215 152
Goodwill 64 43
Other assets 209 128
------ ------
Total Assets 4,924 4,278
====== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable 299 270
Accrued expenses 248 224
Current portion of long-term debt 1 1
Deferred income taxes 25 --
Income taxes payable 92 75
------ ------
Total current liabilities 665 570
Deferred income taxes 28 25
Other liabilities 454 417
Liabilities subject to compromise 2,243 2,242
Commitments and contingencies
Stockholders' Equity:
Preferred stock -- --
Common stock 5 5
Treasury stock (223) (256)
Capital received in excess of par value 433 417
Accumulated other comprehensive income 133 17
Retained earnings 1,186 841
------ ------
Total stockholders' equity 1,534 1,024
------ ------
Total Liabilities and Stockholders' Equity 4,924 4,278
====== ======
See accompanying Notes to Consolidated Financial Statements.
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USG CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
NINE MONTHS
ENDED SEPTEMBER 30,
-------------------
2005 2004
----- -----
OPERATING ACTIVITIES:
Net earnings $ 345 $ 227
Adjustments to reconcile net earnings to net cash:
Depreciation, depletion and amortization 92 83
Deferred income taxes (81) 44
Gain on asset dispositions (1) (1)
(Increase) decrease in working capital:
Receivables (74) (132)
Income taxes receivable 18 6
Inventories 9 (84)
Payables 41 64
Accrued expenses 23 5
Increase in other assets (30) (28)
Increase in other liabilities 16 16
Change in asbestos receivable -- 11
Increase (decrease) in liabilities subject to compromise 1 (4)
Other, net (12) 2
----- -----
Net cash provided by operating activities 347 209
----- -----
INVESTING ACTIVITIES:
Capital expenditures (125) (80)
Purchases of marketable securities (489) (361)
Sales or maturities of marketable securities 430 210
Net proceeds from asset dispositions 1 6
Acquisitions of businesses (29) (4)
Deposit of restricted cash (34) (13)
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Net cash used for investing activities (246) (242)
----- -----
FINANCING ACTIVITIES:
Issuances of common stock 40 --
----- -----
Net cash provided by financing activities 40 --
----- -----
Effect of exchange rate changes on cash 3 2
Net increase (decrease) in cash and cash equivalents 144 (31)
Cash and cash equivalents at beginning of period 756 700
----- -----
Cash and cash equivalents at end of period 900 669
===== =====
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Interest paid 1 1
Income taxes paid, net 209 73
See accompanying Notes to Consolidated Financial Statements.
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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.
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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. The Debtors have obtained
several extensions of the exclusive period, which is currently extended to
December 31, 2005. 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 for payment in whole or in part.
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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 the
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 Note 13, Litigation, for
additional information regarding Debtors' asbestos liabilities and their
estimated cost.
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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 $6.5 million and $16.9 million in
the third quarter and first nine months of 2005, respectively. For the
comparable 2004 periods, expenses totaled $6.2 million and $11.5 million.
Expenses were lower in 2004 primarily due to accruals in 2003 and 2002 of
amounts that were paid in 2004.
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").
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The FAIR Bill is co-sponsored by sixteen 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
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
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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 839 claims by a total of $21.3
million; and allowed the correction of the Debtors on 1,529 claims and the
reclassification of 291 claims to general unsecured claims. The Debtors 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 more
than 400 asbestos property damage claims alleging more than $300 million in
damages. Approximately 100 additional asbestos
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property damage claims have been withdrawn. 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.
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
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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 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 then-pending 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
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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
September 30, December 31,
2005 2004
------------- ------------
Asbestos reserve $1,061 $1,061
Debt 1,005 1,005
Accounts payable 173 169
Accrued expenses 36 37
Other long-term liabilities 11 13
------ ------
Subtotal 2,286 2,285
Elimination of intercompany accounts payable (43) (43)
------ ------
Total liabilities subject to compromise 2,243 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 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,
-14-
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 September 30, 2005, U.S. Gypsum and USG Interiors had net pre-petition
payable balances to the Parent Company for Intercompany Corporate Transactions
of $302 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 September 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 $614 million, $256 million, and $32 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 Nine Months
ended September 30, ended September 30,
------------------- -------------------
2005 2004 2005 2004
---- ---- ---- ----
Legal and financial advisory fees $11 $ 7 $ 23 $17
Bankruptcy-related interest income (9) (3) (21) (7)
--- --- ---- ---
Total chapter 11 reorganization expenses 2 4 2 10
=== === ==== ===
-15-
INTEREST EXPENSE
Contractual interest expense not accrued or recorded on pre-petition debt
totaled $20 million and $59 million in the third quarter and first nine months
of 2005, respectively. From the Petition Date through September 30, 2005,
contractual interest expense not accrued or recorded on pre-petition debt
totaled $316 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 $7 million and $19 million in the third quarter and
first nine months of 2005, respectively, and $53 million from the Petition Date
through September 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.
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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- -------------------
2005 2004 2005 2004
-------- -------- -------- --------
Net sales $1,212 $1,066 $3,430 $3,019
Cost of products sold 953 870 2,763 2,518
Selling and administrative expenses 75 69 225 201
Chapter 11 reorganization expenses 2 4 2 10
Interest expense 1 1 3 3
Interest income -- -- (2) (1)
Other (income) expense, net -- -- (1) --
------ ------ ------ ------
Earnings before income taxes 181 122 440 288
Income taxes 47 51 154 124
------ ------ ------ ------
Net earnings 134 71 286 164
====== ====== ====== ======
-17-
DEBTOR-IN-POSSESSION BALANCE SHEETS
(DOLLARS IN MILLIONS)
(UNAUDITED)
AS OF AS OF
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------- ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 660 $ 516
Short-term marketable securities 158 135
Restricted cash 73 38
Receivables (net of reserves - $10 and $10) 434 373
Inventories 276 275
Income taxes receivable 6 24
Deferred income taxes -- 25
Other current assets 203 45
------ ------
Total current assets 1,810 1,431
Long-term marketable securities 276 276
Property, plant and equipment (net of accumulated
depreciation and depletion - $800 and $728) 1,642 1,604
Deferred income taxes 215 152
Goodwill 64 43
Other assets 435 361
------ ------
Total Assets 4,442 3,867
====== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable 259 237
Accrued expenses 223 203
Deferred income taxes 26 --
Income taxes payable 85 58
------ ------
Total current liabilities 593 498
Other liabilities 424 391
Liabilities subject to compromise 2,243 2,242
Stockholders' Equity:
Preferred stock -- --
Common stock 5 5
Treasury stock (223) (256)
Capital received in excess of par value 117 101
Accumulated other comprehensive income 114 3
Retained earnings 1,169 883
------ ------
Total stockholders' equity 1,182 736
------ ------
Total Liabilities and Stockholders' Equity 4,442 3,867
====== ======
-18-
DEBTOR-IN-POSSESSION STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
NINE MONTHS
ENDED SEPTEMBER 30,
-------------------
2005 2004
-------- --------
OPERATING ACTIVITIES:
Net earnings $ 286 $ 164
Adjustments to reconcile net earnings to net cash:
Depreciation, depletion and amortization 79 70
Deferred income taxes (82) 43
(Gain) loss on asset dispositions -- --
(Increase) decrease in working capital:
Receivables (52) (131)
Income taxes receivable 18 1
Inventories 3 (76)
Payables 44 59
Accrued expenses 21 6
Decrease in intercompany receivable 6 33
Increase in other assets (26) (29)
Increase in other liabilities 13 16
Change in asbestos receivable -- 11
Increase (decrease) in liabilities subject to compromise 1 (4)
Other, net (11) (2)
----- -----
Net cash provided by operating activities 300 161
----- -----
INVESTING ACTIVITIES:
Capital expenditures (107) (70)
Purchases of marketable securities (433) (361)
Sale or maturities of marketable securities 408 210
Net proceeds from asset dispositions -- 1
Acquisitions of businesses (29) (4)
Deposit of restricted cash (35) (5)
----- -----
Net cash used for investing activities (196) (229)
----- -----
FINANCING ACTIVITIES:
Issuances of common stock 40 --
----- -----
Net cash provided by financing activities 40 --
----- -----
Net increase (decrease) in cash and cash equivalents 144 (68)
Cash and cash equivalents at beginning of period 516 489
----- -----
Cash and cash equivalents at end of period 660 421
===== =====
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Interest paid 1 1
Income taxes paid, net 178 64
-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
Earnings (000) Amount
-------- ------ ---------
Three Months Ended September 30,
2005:
Basic earnings $158 43,979 $3.58
Dilutive effect of stock options 139
---- ------ -----
Diluted earnings 158 44,118 3.57
==== ====== =====
2004:
Basic earnings 90 43,017 2.10
Dilutive effect of stock options 1
---- ------ -----
Diluted earnings 90 43,018 2.10
==== ====== =====
Nine Months Ended September 30,
2005:
Basic earnings 345 43,471 7.94
Dilutive effect of stock options 222
---- ------ -----
Diluted earnings 345 43,693 7.90
==== ====== =====
2004:
Basic earnings 227 43,019 5.28
Dilutive effect of stock options 1
---- ------ -----
Diluted earnings 227 43,020 5.28
==== ====== =====
-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 third quarter and first nine months of 2005
amounted to a pretax gain of $13 million and $16 million, respectively. For
derivatives designated as net investment hedges, changes in the value of
these derivatives are recorded in OCI.
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 September 30,
2005, the Corporation had swap contracts to exchange monthly payments on
notional amounts of natural gas amounting to $345 million. These contracts
mature by December 31, 2007. As of September 30, 2005, the fair value of
these swap contracts, most of which remained in OCI, was a $203 million
($124 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 September 30, 2005, $0.8 million ($0.5 million after-tax) of such
gains are included in OCI.
FOREIGN EXCHANGE DERIVATIVE INSTRUMENTS
During the third quarter of 2005, the Corporation entered into foreign
currency contracts to hedge a portion of the net investment in one of its
foreign subsidiaries from exchange rate fluctuations. As of September 30,
2005, the fair value of these contracts was ($2) million, or ($1) million
after-tax.
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 fully satisfy their obligations
under the contracts. The Corporation receives collateral from its
counterparties based on the provisions in certain credit support
agreements.
-21-
Similarly, the Corporation may be required to post collateral if aggregate
payables exceed certain limits. Currently, the Corporation has no
collateral requirement. The Corporation enters into master agreements which
contain netting arrangements that minimize counterparty credit exposure.
(5) COMPREHENSIVE INCOME
The components of comprehensive income are summarized in the following
table (dollars in millions):
Three Months Nine Months
ended September 30, ended September 30,
------------------- -------------------
2005 2004 2005 2004
---- ---- ---- ----
Net earnings $158 $ 90 $345 $227
---- ---- ---- ----
Pretax gain on derivatives 144 15 191 27
Income tax expense (56) (5) (74) (10)
---- ---- ---- ----
After-tax gain on derivatives 88 10 117 17
---- ---- ---- ----
Pretax minimum pension liability -- -- (10) --
Income tax expense -- -- 4 --
---- ---- ---- ----
After-tax minimum pension liability -- -- (6) --
---- ---- ---- ----
Foreign currency translation 13 14 5 5
Unrealized gain on marketable
securities -- 1 -- --
---- ---- ---- ----
Total comprehensive income 259 115 461 249
==== ==== ==== ====
There was no tax impact on the foreign currency translation adjustments.
OCI consisted of the following (dollars in millions):
As of As of
September 30, December 31,
2005 2004
------------- ------------
Gain on derivatives, net of tax $123 $ 6
Foreign currency translation 20 15
Minimum pension liability, net of tax (9) (3)
Unrealized loss on marketable securities, net of tax (1) (1)
---- ---
Total 133 17
==== ===
During the third quarter of 2005, accumulated net after-tax gains of $21
million ($33 million pretax) on derivatives were reclassified from OCI to
earnings. As of September 30, 2005, the estimated net after-tax gain
expected to be reclassified within the next 12 months from OCI to earnings
is $93 million.
-22-
(6) MARKETABLE SECURITIES
The Corporation's investments in marketable securities were as follows
(dollars in millions):
As of As of
September 30, December 31,
2005 2004
------------------ -------------------
Fair Fair
Amortized Market Amortized Market
Cost Value Cost Value
--------- ------ --------- -------
Asset-backed securities $193 $192 $174 $173
U.S. government and agency securities 182 181 121 121
Municipal securities 15 15 36 36
Corporate securities 109 109 112 112
Time deposits 10 10 8 8
---- --- ---- ----
Total marketable securities 509 507 451 450
==== === ==== ====
Contractual maturities of marketable securities as of September 30, 2005,
were as follows (dollars in millions):
Fair
Amortized Market
Cost Value
--------- ------
Due in 1 year or less $190 $189
Due in 1-5 years 87 87
Due in 5-10 years 1 1
Due after 10 years 38 38
---- ----
316 315
Asset-backed securities 193 192
---- ----
Total marketable securities 509 507
==== ====
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 were as follows (dollars in millions):
As of September 30, 2005 As of December 31, 2004
------------------------ -----------------------
Less than 12 Months Less than 12 Months
12 Months or Longer 12 Months or Longer
--------- --------- --------- ---------
Asset-backed securities $ 36 $130 $149 $ 2
U.S. government and agency securities 37 109 83 --
Corporate securities 37 31 34 --
---- ---- ---- ---
Total fair market value 110 270 266 2
---- ---- ---- ---
Aggregate amount of unrealized losses 1 1 1 --
==== ==== ==== ===
-23-
(7) ASSET RETIREMENT OBLIGATIONS
Changes in the liability for asset retirement obligations consisted of the
following (dollars in millions):
Nine Months ended September 30
------------------------------
2005 2004
---- ----
Balance as of January 1 $43 $35
Accretion expense 2 2
Liabilities incurred 9 7
Liabilities settled (1) (2)
Foreign currency translation 1 --
--- ---
Balance as of September 30 54 42
=== ===
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
September 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 nine 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 September 30, 2005, common shares totaling 732,650 were reserved for
future issuance in conjunction with existing stock option grants. In
addition, 4,174,070 common shares were reserved for future grants. Shares
issued in option exercises may be originally issued or from treasury
shares.
(10) EMPLOYEE RETIREMENT PLANS
The components of net pension and postretirement benefits costs for the
three months and nine months ended September 30, 2005 and 2004 are
summarized in the following table (dollars in millions):
Three Months Nine Months
ended September 30, ended September 30,
------------------- -------------------
2005 2004 2005 2004
---- ---- ---- ----
PENSION:
Service cost of benefits earned $ 9 $ 7 $ 26 $ 23
Interest cost on projected
benefit obligation 14 14 42 41
Expected return on plan assets (14) (13) (42) (40)
Net amortization 4 5 14 14
---- ---- ---- ----
Net cost 13 13 40 38
==== ==== ==== ====
POSTRETIREMENT:
Service cost of benefits earned 3 4 10 11
Interest cost on projected
benefit obligation 5 6 14 17
Recognized (gain) loss (1) (1) (3) 1
---- ---- ---- ----
Net cost 7 9 21 29
==== ==== ==== ====
In accordance with the Corporation's funding policy, the Corporation and
its subsidiaries contributed cash of $15 million and $51 million during the
third quarter and first nine 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 Nine Months
ended September 30, ended September 30,
------------------- -------------------
2005 2004 2005 2004
------ ------ ------ ------
NET SALES
North American Gypsum $ 842 $ 708 $2,371 $2,025
Worldwide Ceilings 181 168 529 524
Building Products Distribution 544 470 1,506 1,286
Eliminations (223) (171) (602) (495)
------ ------ ------ ------
Total USG Corporation 1,344 1,175 3,804 3,340
====== ====== ====== ======
OPERATING PROFIT:
North American Gypsum 179 125 434 308
Worldwide Ceilings 18 14 47 55
Building Products Distribution 41 31 106 76
Corporate (23) (20) (68) (56)
Chapter 11 reorganization expenses (2) (4) (2) (10)
Eliminations (2) 2 (1) --
------ ------ ------ ------
Total USG Corporation 211 148 516 373
====== ====== ====== ======
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.
-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 $90 million
of unremitted foreign earnings as a result of the repatriation provision
with a related income tax liability of between 3% and 15% of the amount
remitted. The Corporation expects to complete its evaluation of this matter
during the fourth quarter of 2005.
During the third quarter of 2005, the Internal Revenue Service ("IRS")
finalized its audit of the Corporation's federal income tax returns for the
years 2000 through 2002. As a result of the audit, the Corporation's
federal income tax liability for the years 2000 through 2002 was increased
by $60 million in the aggregate, which was covered by liabilities
previously recorded on the Corporation's financial statements. In addition,
due to the results of the audit, a portion of the Corporation's recorded
income tax contingency reserves became unnecessary. Consequently, the
Corporation's income tax provision was reduced (and consolidated net
earnings increased) in the third quarter of 2005 by $25 million.
In the aggregate (including the impact on related state income tax
liabilities), the audit is expected to result in net cash outflows by the
end of 2005 of $105 million ($55 million of which has already been paid),
including $47 million directly related to the 2000 through 2002 audit, and
an additional $58 million relating to the Corporation's 2003 and 2004
years. A substantial portion of the outflows relating to the audited years
and all of the outflows relating to the 2003 and 2004 years are the result
of the disallowance by the IRS of the Corporation's current deduction of
contractual interest on debt incurred prior to its bankruptcy filing in
2001. In addition, the audit is expected to result in net cash outflows of
$12 million related to the 2000 year. Because this amount is considered a
pre-petition liability under the Bankruptcy Code, the timing of payment is
subject to Bankruptcy Court approval and has not yet been determined.
Assuming that the contractual interest is ultimately paid, a substantial
portion of these outflows will be recovered by the Corporation on its tax
returns in future years following its emergence from bankruptcy.
-27-
(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.
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 the Debtors are liable for the asbestos liabilities of
A.P. Green Refractories Co. ("A.P. Green"), a former subsidiary of U.S.
Gypsum.
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. As discussed below, there
are significant proceedings before Judge Conti relating to estimation of
the Debtors' liability for asbestos personal injury claims, and there are
significant proceedings pending before Judge Fitzgerald relating to whether
the Debtors other than U.S. Gypsum have responsibility for U.S. Gypsum's
asbestos liabilities, including any liabilities that might be associated
with A.P. Green.
-28-
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
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
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.
The parties have had several hearings before Judge Conti relating to
estimation of the Debtors' asbestos personal injury liabilities. Although
Judge Conti has not issued a ruling regarding which specific issues she
will consider in the estimation of the Debtors' asbestos personal injury
liabilities, Judge Conti has indicated in court hearings that she generally
will allow the parties to take discovery of, and present evidence
regarding, issues that they consider relevant to estimation of those
liabilities, including the medical and scientific issues as appropriate. In
an order entered on October 17, 2005, Judge Conti ruled that the Debtors
may submit a questionnaire to a sample of about 2,000 asbestos personal
injury claimants who had a claim pending against U.S. Gypsum as of the
Petition Date. The questionnaire asks for information, including certain
medical records, relating to the claimants' alleged injury and exposure to
U.S. Gypsum asbestos-containing products. Judge Conti also set June 30,
2006, as the date for the end of all fact discovery relating to estimation.
Judge Conti has scheduled a status conference for July 18, 2006, to set a
date for the end of
-29-
all discovery regarding expert witnesses to be presented at the estimation
hearing. Judge Conti has not yet set a date for the estimation hearing, but
the hearing likely will not take place until at least a few months after
the close of expert discovery.
In addition to the motion the Debtors filed seeking estimation of their
asbestos personal injury liabilities, the Debtors also filed a motion in
2002 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.
As indicated 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 the
Debtors have responsibility for the asbestos liabilities of A.P. Green, a
former subsidiary of U.S. Gypsum. In the fourth quarter of 2004, the
Debtors other than U.S. Gypsum filed a complaint for declaratory relief
before Judge Fitzgerald requesting a ruling that the assets of the Debtors
other than U.S. Gypsum are not available to satisfy the asbestos
liabilities of U.S. Gypsum. The Official Committee of Unsecured Creditors
and the Official Committee of Equity Holders joined the Debtors in this
action.
The Official Committee of Asbestos Personal Injury Claimants and the legal
representative for future asbestos claimants oppose the Debtors in this
proceeding. The committee and the legal representative have alleged that
the asbestos personal injury liabilities of U.S. Gypsum exceed its value,
and, in opposition to the Debtors' complaint, the committee and the legal
representative filed counterclaims in late 2004 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. The Official Committee of Asbestos Property Damage Claimants
has asserted similar counterclaims.
In that same proceeding, the asbestos committees and the legal
representative 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
asbestos committees and the legal representative also allege 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 responsible for
A.P. Green's asbestos 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 further 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. However, as discussed below, in the third quarter of 2005, the
Official Committee of Asbestos Personal
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Injury Claimants and legal representative for future asbestos claimants
filed motions to dismiss these proceedings relating to the liability of
other Debtors for U.S. Gypsum liabilities and the Debtors' liability for
the liabilities of A.P. Green.
If the assets of all Debtors were 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.
In addition, if U.S. Gypsum were 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. More information regarding the asbestos liabilities of
A.P. Green and the status of the proceedings before Judge Fitzgerald is set
forth below.
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) 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).
In September 2005, the debtors in the A.P. Green reorganization proceeding
filed a proposed plan of reorganization which, if approved, would resolve
the asbestos liabilities of the debtors in that proceeding by channeling
those asbestos liabilities to a trust created under Section 524(g) of the
Bankruptcy Code. The plan documents specifically exclude U.S. Gypsum from
the protection of the proposed channeling injunction. The plan documents
state that the trust that will address asbestos claims against A.P. Green
will be funded with approximately $343 million dollars in insurance
proceeds and 21% of the stock of a corporate affiliate of A.P. Green. The
proposed plan of
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reorganization has not been confirmed. The plan documents state that, as of
A.P. Green's petition date, about 235,757 asbestos-related claims were
pending against it and about 58,899 such claims were pending against an
affiliate. Prior to its petition date, A.P. Green had resolved about
203,000 asbestos-related claims for about $448 million in indemnity costs.
In addition, A.P. Green had resolved approximately 49,500 asbestos related
claims in the aggregate amount of $491 million, which were unpaid as of the
petition date. (These 49,500 claims are included in the 235,757 pending
claims referenced above.)
At this stage in the proceedings, the Corporation does not have sufficient
information to estimate the amount, or range of amounts, of A.P. Green's
asbestos liabilities. The A.P. Green plan documents do not provide an
estimate of the amount of A.P. Green's present or future asbestos
liabilities and do not indicate the percentage of recovery that A.P. Green
asbestos claimants will receive from the trust established pursuant to the
plan. However, based upon the plan documents filed in the A.P. Green
reorganization proceeding, it appears that the assets in the trust
established to pay A.P. Green asbestos claims will not be sufficient to pay
in full the presumed liability for present and future asbestos claims
against A.P. Green. The Debtors also do not have sufficient information to
predict whether or how any plan of reorganization in the Debtors' Chapter
11 Cases will address liability based on sales of asbestos-containing
products by A.P. Green or its affiliates.
As stated above, in September 2005, the Official Committee of Asbestos
Personal Injury Claimants and the legal representative for future asbestos
claimants filed a motion to dismiss the proceeding before Judge Fitzgerald
regarding whether Debtors other than U. S. Gypsum are responsible for its
asbestos liabilities and whether Debtors have responsibility for the
asbestos liabilities of A.P. Green. The committee and the legal
representative contend that they are not proper parties to the proceeding
and cannot bind individual claimants, present or future, who are not before
the court. The committee and the legal representative also contend that
there should not be any resolution of whether Debtors other than U.S.
Gypsum are responsible for its asbestos liabilities until it has been
determined that U.S. Gypsum's asbestos liabilities are greater than its
enterprise value. The Debtors, the Official Committee of Unsecured
Creditors, and the Official Committee of Equity Security Holders oppose
dismissal of the action. The motions to dismiss were argued before Judge
Fitzgerald on October 24, 2005, but she continued the matter to December
19, 2005, for further argument.
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
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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
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' asbestos-containing 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
more than 400 asbestos property damage claims alleging more than $300
million in damages for failure to provide sufficient product identification
evidence. In addition, approximately 100 asbestos property damage claims
have been withdrawn. 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
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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
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
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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
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 Supply 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
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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.
INSURANCE COVERAGE: As of September 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.
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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.
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
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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 Supply, 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 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'
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. The reserve as of September 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 sixteen Republican
Senators and three Democratic Senators. The FAIR Bill was approved by the
Senate Committee on
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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 personal injury
and property damage claims can be determined. If the FAIR Bill or similar
legislation is not enacted, the Debtors' asbestos personal injury
liability, as determined through the bankruptcy proceedings, could be
materially greater than that reflected in 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. In addition, the amount of
Debtors' liability for asbestos property damage claims could be determined
to be greater than that included in the accrued reserve. 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
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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 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
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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. In the third quarter of 2005, 14 of these complaints,
involving 392 plaintiffs, were voluntarily dismissed without prejudice to
refile. The Corporation does not have sufficient information to estimate
the likely cost of resolving the pending silica claims. However, the
Corporation believes that it has 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.
-41-
(14) LETTER OF CREDIT FACILITY
The Corporation has a $175 million credit agreement, which expires on April
30, 2008, with LaSalle Bank N.A. to support the issuance of letters of
credit needed to support business operations. As of September 30, 2005, $69
million of letters of credit under the LaSalle Facility, which are cash
collateralized at 103%, were outstanding.
-42-
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 $1,484 million of cash, cash equivalents, restricted cash
and marketable securities as of September 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 third quarter of 2005 were a record level
for any quarter in its history and represented a 14% 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 third quarter of 2005 due to continued strength in the new housing and
repair and remodel markets. Shipments of gypsum wallboard in the third 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 15% from the third quarter of 2004. The Corporation's
Worldwide Ceilings operating segment also reported increased net sales and
operating profit in the third quarter of 2005 largely due to higher selling
prices for ceiling tile and higher shipments of ceiling grid.
The Corporation's gross margin percentage (gross profit as a percent of net
sales) was 22.4% in the third quarter of 2005, up from 19.9% in the third
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.
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During the third quarter of 2005, the Internal Revenue Service ("IRS") finalized
its audit of the Corporation's federal income tax returns for the years 2000
through 2002. As a result of the audit, the Corporation's federal income tax
liability for the years 2000 through 2002 was increased by $60 million in the
aggregate, which was covered by liabilities previously recorded on the
Corporation's financial statements. In addition, due to the results of the
audit, a portion of the Corporation's recorded income tax contingency reserves
became unnecessary. Consequently, the Corporation's income tax provision was
reduced (and consolidated net earnings increased) in the third quarter of 2005
by $25 million.
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. The Debtors have obtained
several extensions of the exclusive period, which is currently extended to
December 31, 2005. 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 dispute and 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 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
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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 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 sixteen 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
-45-
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
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 September 30, 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
-46-
will gain more information from which a reasonable estimate of the Debtors'
probable liability for present and future asbestos personal injury and property
damage claims can be determined. If such estimate differs from the existing
reserve, 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.
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 Item 1, Note 2,
Voluntary Reorganization Under Chapter 11), 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
-47-
and detail of liabilities subject to compromise and chapter 11 reorganization
expenses.
CONSOLIDATED RESULTS OF OPERATIONS
NET SALES
Net sales in the third quarter of 2005 totaled $1,344 million, a record for any
quarter in the Corporation's history and a 14% increase from $1,175 million in
the third quarter of 2004. For the first nine months of 2005, record net sales
totaled $3,804 million, also up 14% from $3,340 million in the comparable 2004
period. Net sales increased primarily 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 third quarter of 2005 was $1,043 million, up 11%
from $941 million a year ago. For the first nine months of 2005, cost of
products sold totaled $3,022 million, also up 11% from $2,719 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.
GROSS PROFIT
Gross profit in the third quarter of 2005 was $301 million, a 29% increase from
$234 million in the third quarter of 2004. For the first nine months of 2005,
gross profit totaled $782 million, up 26% from $621 million in the comparable
2004 period. The gross margin percentage was 22.4% in the third quarter of 2005,
up from 19.9% in the third quarter of 2004. For the first nine months of 2005,
gross margin was 20.6%, up from 18.6% in the comparable 2004 period.
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses in the third quarter of 2005 were $88
million, up 7% from $82 million in the third quarter of 2004. For the first nine
months, these expenses were $264 million versus $238 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
6.5% and 6.9% for the third quarter and first nine months of 2005, respectively,
versus 7.0% and 7.1% for the comparable 2004 periods.
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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 Nine Months
ended September 30, ended September 30,
------------------- -------------------
2005 2004 2005 2004
---- ---- ---- ----
Legal and financial advisory fees $11 $ 7 $ 23 $17
Bankruptcy-related interest income (9) (3) (21) (7)
--- --- ---- ---
Total chapter 11 reorganization expenses 2 4 2 10
=== === ==== ===
INTEREST EXPENSE
Interest expense was $1 million and $4 million in the third quarter and first
nine months of 2005, respectively, versus $2 million and $4 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 $59 million in the third quarter and first nine months
of 2005, respectively. From the Petition Date through September 30, 2005,
contractual interest expense not accrued or recorded on pre-petition debt
totaled $316 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 $7 million and $19 million in the third quarter and
first nine months of 2005, respectively, and $53 million from the Petition Date
through September 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.
INTEREST INCOME
Non-bankruptcy related interest income was $3 million in the third quarter and
$7 million in the first nine months of 2005. Non-bankruptcy related interest
income for the respective 2004 periods was $2 million and $4 million.
INCOME TAXES
Income tax expense amounted to $55 million and $173 million in the third quarter
and first nine months of 2005, respectively, compared with $58 and $143 million
in the corresponding 2004 periods. The effective tax rates were 33.4% and 38.7%
for the first nine months of 2005 and 2004, respectively. The change in the
effective tax rates was primarily attributable to the $25 million reduction in
the
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Corporation's third quarter 2005 income tax provision in connection with the
IRS's audit described above in the Overview.
NET EARNINGS
Net earnings for the third quarter of 2005 were $158 million, or $3.57 per
diluted share, compared with $90 million, or $2.10 per diluted share, for the
third quarter of 2004. For the first nine months of 2005, net earnings totaled
$345 million, or $7.90 per diluted share, compared with $227 million, or $5.28
per diluted share, for the first nine months of 2004.
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CORE BUSINESS RESULTS OF OPERATIONS
(dollars in millions)
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- -------------------
2005 2004 2005 2004
------ ------ ------ ------
NET SALES:
NORTH AMERICAN GYPSUM:
U.S. Gypsum Company $ 755 $ 638 $2,129 $1,829
CGC Inc. (gypsum) 81 73 238 214
Other subsidiaries* 62 49 157 129
Eliminations (56) (52) (153) (147)
------ ------ ------ ------
Total 842 708 2,371 2,025
------ ------ ------ ------
WORLDWIDE CEILINGS:
USG Interiors, Inc. 124 118 365 373
USG International 56 50 159 150
CGC Inc. (ceilings) 13 12 40 40
Eliminations (12) (12) (35) (39)
------ ------ ------ ------
Total 181 168 529 524
------ ------ ------ ------
BUILDING PRODUCTS DISTRIBUTION:
L&W Supply Corporation 544 470 1,506 1,286
------ ------ ------ ------
Eliminations (223) (171) (602) (495)
------ ------ ------ ------
Total USG Corporation 1,344 1,175 3,804 3,340
====== ====== ====== ======
OPERATING PROFIT:
NORTH AMERICAN GYPSUM:
U.S. Gypsum Company 153 103 371 251
CGC Inc. (gypsum) 12 12 38 34
Other subsidiaries* 14 10 25 23
------ ------ ------ ------
Total 179 125 434 308
------ ------ ------ ------
WORLDWIDE CEILINGS:
USG Interiors, Inc. 13 9 32 40
USG International 3 4 8 9
CGC Inc. (ceilings) 2 1 7 6
------ ------ ------ ------
Total 18 14 47 55
------ ------ ------ ------
BUILDING PRODUCTS DISTRIBUTION:
L&W Supply Corporation 41 31 106 76
------ ------ ------ ------
Corporate (23) (20) (68) (56)
Chapter 11 reorganization expenses (2) (4) (2) (10)
Eliminations (2) 2 (1) --
------ ------ ------ ------
Total USG Corporation 211 148 516 373
====== ====== ====== ======
* 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.
-51-
NORTH AMERICAN GYPSUM
Net sales of $842 million increased 19% from the third quarter of 2004, while
operating profit increased 43% to $179 million. First nine months net sales of
$2,371 million reflected an increase of 17% from a year ago, while operating
profit of $434 million increased 41%.
United States Gypsum Company: Third quarter 2005 net sales for U.S. Gypsum
increased $117 million, or 18%, from the third quarter of 2004, while operating
profit rose $50 million, or 49%. 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 and FIBEROCK(R) brand gypsum fiber panels.
U.S. Gypsum's nationwide average realized selling price for SHEETROCK(R) brand
gypsum wallboard was $147.85 per thousand square feet in the third quarter of
2005. This price represented a 15% increase from $128.65 in the third quarter of
2004 and a 7% increase from $138.28 in the second quarter of 2005. The benefit
of improved pricing was partially offset by higher manufacturing costs related
to energy and raw material prices.
Record shipments of SHEETROCK(R) brand gypsum wallboard totaled 2.9 billion
square feet during the third quarter of 2005, up 7% from 2.7 billion square feet
sold in the third quarter of 2004. Wallboard plants operated at 97% and 93% of
capacity in the third quarters of 2005 and 2004, respectively. Industry
shipments of gypsum wallboard were up approximately 8% from the third quarter of
2004.
CGC Inc.: Net sales for the gypsum business of Canada-based CGC Inc. increased
11%, while operating profit was unchanged versus the third quarter of 2004.
Improvements in gypsum wallboard pricing, as well as the favorable effects of
currency translation, were offset by higher manufacturing costs related to
energy and raw material prices.
WORLDWIDE CEILINGS
Net sales of $181 million increased 8%, and operating profit of $18 million rose
29% from the third quarter of 2004. First nine months net sales of $529 million
reflected a 1% increase from a year ago, while operating profit of $47 million
declined 15%.
USG Interiors, Inc.: The Corporation's domestic ceilings business, USG
Interiors, Inc. reported third quarter 2005 net sales and operating profit of
$124 million and $13 million, respectively. This compared with net sales of $118
million and operating profit of $9 million in the third quarter of 2004. Factors
contributing to the improvement in USG Interiors' results included higher
selling prices for ceiling tile and higher shipments of ceiling grid. These
improvements were partially offset by higher energy and raw material costs.
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USG International: Net sales for USG International were up 12% from the third
quarter of 2004 primarily due to increased demand in the Pacific region, Europe
and Latin America. However, operating profit declined to $3 million from $4
million primarily due to higher prices for steel used in manufacturing ceiling
grid in Europe.
CGC Inc.: The ceilings business of CGC Inc. reported increases of $1 million for
both net sales and operating profit as compared with the third quarter of 2004.
These results primarily reflected improved pricing and increased shipments of
ceiling grid, as well as the favorable effects of currency translation.
BUILDING PRODUCTS DISTRIBUTION
Third 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
$544 million represented a 16% increase versus the third quarter of 2004, while
operating profit rose 32% to $41 million. These results were primarily
attributable to record shipments of gypsum wallboard, which were up 12% versus
the third quarter of 2004. Third quarter results also benefited from improved
selling prices for gypsum wallboard, which increased 16%.
For the first nine months of 2005, net sales of $1,506 million and operating
profit of $106 million increased 17% and 39%, respectively, versus the first
nine 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
193 locations in the United States as of September 30, 2005, compared with 186
locations as of December 31, 2004, and 184 locations as of September 30, 2004.
MARKET CONDITIONS AND OUTLOOK
Industry shipments of gypsum wallboard in the United States were an estimated
9.6 billion square feet in the third quarter of 2005, an 8% increase from 8.9
billion square feet in the third quarter of 2004. The robust level of activity
in the new housing and residential repair and remodel markets, which together
account for over 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.
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. Housing starts through the first
nine months of 2005 are running 6% ahead of 2004's level. The impact of rising
short term interest rates and declining housing affordability have not yet been
felt in the new housing
-53-
market and may impact demand levels in the future. After an increase in 2004,
the commercial construction market (the principal market for the Corporation's
ceilings products) has eased in 2005, particularly in the office segment, as a
result of uncertainty created by rising building material prices. The
fundamentals for commercial building remain solid and modest growth is expected
to resume in this segment next year. Overall, these market factors, combined
with the Corporation's continued focus on margin improvement and select growth
opportunities, should continue to produce strong results during the remainder of
2005. However, the Corporation faces ongoing cost pressures such as higher
prices for natural gas and raw materials.
In this environment, the Corporation continues to focus its 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 September 30, 2005, the Corporation had $1,484 million of cash, cash
equivalents, restricted cash and marketable securities, up $235 million, or 19%,
from $1,249 million as of December 31, 2004. Of the total September 30, 2005
amount, $317 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 $59 million in the first nine months of 2005
and $316 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
increased $144 million during the first nine 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 $59 million, (ii) capital
spending of $125 million, (iii) pension funding of $51 million, (iv)
acquisitions of businesses of $29 million and (v) deposit of restricted cash of
$34 million.
Comparing the first nine months of 2005 with the first nine months of 2004, net
cash from operating activities was $347 million in the 2005 period compared with
$209 million a year ago. This variation was largely attributable to increased
net earnings. Net cash used for investing activities increased to $246 million
from $242 million primarily reflecting increases in capital spending,
acquisitions of businesses and deposit of restricted cash offset to a larger
extent by a lower level of net purchases of marketable securities. Net cash of
$40 million provided
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by financing activities during the first nine months of 2005 reflected the
exercise of stock options.
CAPITAL EXPENDITURES
Capital spending amounted to $125 million in the first nine months of 2005,
compared with $80 million in the corresponding 2004 period. As of September 30,
2005, remaining capital expenditure commitments for the replacement,
modernization and expansion of operations amounted to $456 million, compared
with $283 million as of December 31, 2004. The Corporation's capital
expenditures program includes:
- approximately $180 million for the 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 early 2007.
- approximately $13 million for a project to rebuild the Ready-Mix joint
compound facility at U.S. Gypsum's Jacksonville, Fla., plant. This
project is expected to be completed in mid-2007.
Construction has begun on the Norfolk project. Construction will begin in early
2006 for the Plaster City and Jacksonville projects and late 2006 for the
Washingtonville plant. The costs for these projects 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 September 30,
2005, amounted to $1,551 million, and the ratio of current assets to current
liabilities was 3.33-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.
Receivables increased to $496 million as of September 30, 2005, from $413
million as of December 31, 2004, primarily reflecting first quarter payments of
customer rebates and a 19% increase in net sales for the month of September 2005
as compared with December 2004. Inventories declined slightly to $333 million
from $338
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million. Accounts payable increased to $299 million from $270 million. Accrued
expenses increased to $248 million from $224 million as of December 31, 2004.
MARKETABLE SECURITIES
As of September 30, 2005, $507 million was invested in marketable securities, up
$57 million from $450 million as of December 31, 2004. Of the September 30, 2005
amount, $318 million was invested in long-term marketable securities and $189
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 September 30, 2005, a total of $77 million was reported as restricted cash
on the consolidated balance sheet. Restricted cash primarily represented
collateral to support outstanding letters of credit.
The Corporation has a $175 million credit agreement, which expires on April 30,
2008, with LaSalle Bank N.A. to support the issuance of letters of credit needed
to support business operations. As of September 30, 2005, $69 million of letters
of credit under the LaSalle Facility, which are cash collateralized at 103%,
were outstanding.
DEBT
As of September 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
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.
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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 nine months 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.
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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.
On October 1, 2005, the Corporation began to roll out a new enterprise resource
planning system in the United States and Canada. The rollout is being undertaken
in phases and is currently planned to be substantially completed in 2007.
Management expects that the new system will enhance operational efficiencies and
help the Corporation better serve its customers. Other than the changes related
to the new system, 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.
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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 September 30, 2005 and the related consolidated
statements of earnings for the three month and nine month periods ended
September 30, 2005 and 2004 and the consolidated statements of cash flows for
the nine month periods ended September 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,
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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
October 26, 2005
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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 -- --
=== ===== === ===
July -- -- --
August -- -- -- --
September -- -- -- --
--- ----- --- ---
Total 3rd Quarter -- -- -- --
=== ===== === ===
(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.
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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
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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
October 31, 2005
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