USG CORP - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q

(Mark One)

(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2003

OR

( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from __________ to
___________

Commission File Number 1-8864

USG CORPORATION
------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)

Delaware 36-3329400
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

125 South Franklin Street, Chicago, Illinois 60606-4678
- ------------------------------------------------------------------------------
(Address of principal executive offices) (Zip code)

Registrant's telephone number, including area code (312) 606-4000

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes (X) No ( )

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes (X) No ( )

Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes (X) No ( )

As of June 30, 2003, 43,050,592 shares of USG common stock were outstanding.

TABLE OF CONTENTS

Page
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PART I FINANCIAL INFORMATION

Item 1. Financial Statements:

Consolidated Statements of Earnings:
Three Months and Six Months
Ended June 30, 2003 and 2002 3

Consolidated Balance Sheets:
As of June 30, 2003 and December 31, 2002 4

Consolidated Statements of Cash Flows:
Six Months Ended June 30, 2003 and 2002 5

Notes to Consolidated Financial Statements 6

Item 2. Management's Discussion and Analysis of Results
of Operations and Financial Condition 42

Item 4. Controls and Procedures 57

Report of Independent Public Accountants 58

PART II OTHER INFORMATION

Item 1. Legal Proceedings 60

Item 4. Submission of Matters to a Vote of Security Holders 60

Item 6. Exhibits and Reports on Form 8-K 61

SIGNATURES 62

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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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------

Net sales $ 914 $ 885 $ 1,776 $ 1,714
Cost of products sold 780 718 1,525 1,415
Selling and administrative expenses 81 80 161 162
Chapter 11 reorganization expenses 3 7 5 9
------------ ------------ ------------ ------------
Operating profit 50 80 85 128
Interest expense 2 2 3 3
Interest income (1) (1) (2) (2)
Other income, net (5) (2) (5) (1)
------------ ------------ ------------ ------------
Earnings before income taxes and
cumulative effect of accounting
change 54 81 89 128
Income taxes 23 33 36 54
------------ ------------ ------------ ------------
Earnings before cumulative effect
of accounting change 31 48 53 74
------------ ------------ ------------ ------------
Cumulative effect of accounting
change, net of tax - - (16) (96)
------------ ------------ ------------ ------------
Net earnings (loss) 31 48 37 (22)
============ ============ ============ ============

EARNINGS (LOSS) PER COMMON SHARE:
Basic and diluted before
cumulative effect of accounting
change 0.73 1.11 1.24 1.71

Cumulative effect of accounting
change - - (0.37) (2.22)
------------ ------------ ------------ ------------
Basic and diluted 0.73 1.11 0.86 (0.52)
============ ============ ============ ============
Dividends paid per common share - - - -
Average common shares 43,045,854 43,250,655 43,097,190 43,309,735
Average diluted common shares 43,045,854 43,250,655 43,097,190 43,309,735

See accompanying Notes to Consolidated Financial Statements.

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USG CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
(UNAUDITED)

AS OF AS OF
JUNE 30, DECEMBER 31,
2003 2002
------------ ------------

ASSETS
Current Assets:
Cash and cash equivalents $ 529 $ 649
Short-term marketable securities 66 50
Restricted cash 21 -
Receivables (net of reserves - $17 and $17) 369 284
Inventories 287 270
Income taxes receivable 11 14
Deferred income taxes 51 49
Other current assets 76 77
------------ ------------
Total current assets 1,410 1,393

Long-term marketable securities 172 131
Property, plant and equipment (net of accumulated
depreciation and depletion - $761 and $701) 1,794 1,788
Deferred income taxes 190 199
Other assets 109 106
------------ ------------
Total Assets 3,675 3,617
============ ============

LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable 200 170
Accrued expenses 189 243
Income taxes payable 27 25
------------ ------------
Total current liabilities 416 438

Long-term debt 2 2
Other liabilities 406 370
Liabilities subject to compromise 2,255 2,272

Stockholders' Equity:
Preferred stock - -
Common stock 5 5
Treasury stock (258) (257)
Capital received in excess of par value 414 412
Accumulated other comprehensive loss (9) (32)
Retained earnings 444 407
------------ ------------
Total stockholders' equity 596 535
------------ ------------
Total Liabilities and Stockholders' Equity 3,675 3,617
============ ============

See accompanying Notes to Consolidated Financial Statements.

-4-

USG CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)

SIX MONTHS
ENDED JUNE 30,
--------------------
2003 2002
-------- --------

OPERATING ACTIVITIES:
Net earnings (loss) $ 37 $ (22)
Adjustments to reconcile net earnings (loss) to net cash:
Cumulative effect of accounting change 16 96
Depreciation, depletion and amortization 52 51
Deferred income taxes 18 33
(Increase) decrease in working capital:
Receivables (85) (56)
Income taxes receivable 3 15
Inventories (17) (27)
Payables 32 43
Accrued expenses (55) 37
Increase in other assets (12) (8)
Increase in other liabilities 5 9
Decrease in asbestos receivables 19 11
Decrease in liabilities subject to compromise (17) (24)
Other, net - 1
-------- --------
Net cash (used for) provided by operating activities (4) 159
-------- --------
INVESTING ACTIVITIES:
Capital expenditures (36) (38)
Purchases of marketable securities (148) -
Sales or maturities of marketable securities 91 -
Net proceeds from asset dispositions - 1
Acquisition of business (2) -
-------- --------
Net cash used for investing activities (95) (37)
-------- --------
FINANCING ACTIVITIES:
Deposit of restricted cash (21) -
-------- --------
Net cash used for financing activities (21) -
-------- --------

Net (decrease) increase in cash and cash equivalents (120) 122

Cash and cash equivalents at beginning of period 649 493
-------- --------
Cash and cash equivalents at end of period 529 615
======== ========
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Interest paid 1 1
Income taxes paid, net 9 6

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 and its subsidiaries ("the Corporation") have been prepared
in accordance with applicable United States Securities and Exchange
Commission guidelines pertaining to interim financial information. The
preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues and expenses. Actual results
could differ from those estimates. In the opinion of management, the
financial statements reflect all adjustments, which are of a normal
recurring nature, necessary for a fair presentation of the
Corporation's financial results for the interim periods. These
financial statements and notes are to be read in conjunction with the
financial statements and notes included in the Corporation's 2002
Annual Report on Form 10-K which was filed on February 27, 2003.

(2) VOLUNTARY REORGANIZATION UNDER CHAPTER 11

On June 25, 2001 (the "Petition Date"), the parent company (the "Parent
Company") of 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"). The
chapter 11 cases of the Debtors (collectively, the "Chapter 11 Cases")
are being 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; USG Interiors,
Inc.; USG Interiors International, Inc.; L&W Supply Corporation; Beadex
Manufacturing, LLC; B-R Pipeline Company; La Mirada Products Co., Inc.;
Stocking Specialists, Inc.; USG Industries, Inc.; and USG Pipeline
Company.

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.

CONSEQUENCES OF THE FILING

The Debtors are operating their businesses without interruption as
debtors-in-possession subject to the provisions of the Bankruptcy Code.
All vendors are being paid for all goods furnished and services
provided after the Filing. However, as a consequence of the Filing,
pending litigation against the Debtors as of the Petition Date is
stayed, and no

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party may take any action to pursue or collect pre-petition claims
except pursuant to an order of the Bankruptcy Court.

Three creditors' committees, one representing asbestos personal injury
claimants, another representing asbestos property damage claimants, and
a third representing general unsecured creditors, were appointed as
official committees in the Chapter 11 Cases and, in accordance with the
provisions of the Bankruptcy Code, will have the right to be heard on
all matters that come before the Bankruptcy Court. The Bankruptcy Court
also appointed the Honorable Dean M. Trafelet as the legal
representative for future asbestos claimants in the Debtors' bankruptcy
proceeding. Mr. Trafelet was formerly a judge of the Circuit Court of
Cook County, Illinois. The Debtors expect that the appointed
committees, together with Mr. Trafelet, will play important roles in
the Chapter 11 Cases and the negotiation of the terms of any plan of
reorganization.

Debtors intend to address all pending and future asbestos personal
injury claims as well as all other pre-petition claims in a plan or
plans of reorganization confirmed by the Bankruptcy Court. Debtors
expect that the plan will include the creation of one or more
independently administered trusts under Section 524(g) of the
Bankruptcy Code, which will be funded by Debtors to allow payment of
present and future asbestos personal injury claims and demands. Debtors
also expect that the plan of reorganization will address Debtors'
liability for asbestos property damage claims, whether by including
those liabilities in a Section 524(g) trust or by other means.

It is anticipated that, as a result of creation and funding of the
Section 524(g) trust(s), the Bankruptcy Court will issue a permanent
injunction barring the assertion of present and future asbestos claims
against Debtors, their successors, and their affiliates, and channeling
those claims to the trust(s) for payment in whole or in part. Section
524(g) contains specific requirements for issuance of such a permanent
injunction, including the requirement that the trust must own, or have
the right to own upon the occurrence of contingencies specified in the
plan of reorganization, a majority of the voting shares of the debtor
or its parent. Section 524(g) also requires that the plan be approved
by 75% of the voting asbestos claimants whose claims are addressed by
the trust. 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 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 Debtors, and/or their successors
and affiliates. In addition, if federal legislation addressing asbestos
personal injury claims is passed, which is extremely speculative at
this time, such legislation may affect the manner in which asbestos
personal injury claims are to be addressed in Debtors' Chapter 11 Cases
and may affect whether the Debtors establish a trust under Section
524(g). (see Potential Federal Legislation Regarding Asbestos Personal
Injury Claims, below)

-7-

Pursuant to the Bankruptcy Code, the Debtors had the exclusive right to
propose a plan of reorganization for 120 days following the Petition
Date, unless extended. The Bankruptcy Court has granted requests by the
Debtors to extend the period of exclusivity, which currently runs
through September 1, 2003. The Debtors intend to seek one or more
additional extensions depending upon developments in the Chapter 11
Cases. If the Debtors fail to file a plan of reorganization during such
extension period, or if such plan is not accepted by the requisite
numbers of creditors and equity holders entitled to vote on the plan,
other parties in interest in the Chapter 11 Cases may be permitted to
propose their own plan(s) of reorganization for the Debtors.

While it is the Debtors' intention to seek a full recovery for their
creditors, it is not possible to predict how the plan of reorganization
will treat asbestos and other pre-petition claims and what impact any
plan may have on the value of the shares of the Corporation's common
stock and other outstanding securities. Under the Bankruptcy Code, a
plan of reorganization, including a plan creating a Section 524(g)
trust, may be confirmed without the consent of non-asbestos creditors
and equity security holders if certain requirements of the Code are
met. There is no assurance that there will be sufficient assets to
satisfy the Debtors' pre-petition liabilities in whole or in part, and
the pre-petition creditors of some Debtors may be treated differently
from the pre-petition creditors of other Debtors. The payment rights
and other entitlements of pre-petition creditors and USG shareholders
may be substantially altered by any plan or plans of reorganization
confirmed in the Chapter 11 Cases. Pre-petition creditors may receive
under the plan of reorganization less than 100% of the face value of
their claims, and the interests of the Corporation's equity security
holders are likely to be substantially diluted or cancelled in whole or
in part.

It is also not possible to predict at this time 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. These arrangements, transactions, and relationships may
be challenged by various parties in the Chapter 11 Cases, and the
outcome of those challenges, if any, may have an impact on the
treatment of various claims under any plan of reorganization.

Whether the Corporation's equity has significant value and Debtors'
non-asbestos creditors recover the full value of their claims depend
upon the outcome of the analysis of the amount of Debtors' assets and
liabilities, especially asbestos liabilities, that must be funded under
the plan. Counsel for the Official Committee of Asbestos Personal
Injury Claimants and counsel for the legal representative for future
asbestos personal injury claimants have advised the court that is
presiding over the Chapter 11 Cases that they believe Debtors' asbestos
liabilities exceed the value of Debtors' assets and that Debtors are
insolvent. The Debtors have advised the court that they believe they
are solvent if their asbestos

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liabilities are fairly and appropriately valued. Toward that end, the
Debtors filed a motion with the court requesting the court to begin
proceedings to estimate the value of Debtors' asbestos personal injury
liabilities.

In response to the Debtors' motion requesting an estimation of asbestos
personal injury liabilities, the court issued an order and memorandum
opinion on February 19, 2003, setting forth a procedure for estimating
Debtors' liability for asbestos personal injury claims alleging cancer.
(See Note 12. Litigation, for additional information on this
procedure.) The court has not set a timetable for this process. Thus,
Debtors do not know when estimation of Debtors' liability for these
cancer claims will occur, what the outcome of that proceeding will be,
what impact that proceeding will have on estimating Debtors' liability
for asbestos personal injury claims alleging other diseases, and
whether the estimation proceeding will lead to a negotiated resolution
of Debtors' asbestos personal injury liabilities. Debtors also cannot
predict at this time the estimated cost of resolving asbestos property
damage claims (see Note 12, Litigation, for additional information.) If
the amount of the Debtors' asbestos liabilities cannot be resolved
through negotiation or is not addressed by legislation (see Potential
Federal Legislation Regarding Asbestos Personal Injury Claims, below),
the outcome of the estimation proceedings regarding Debtors' liability
for cancer claims, as provided in the Court's order, likely will be a
significant component of determining Debtors' asbestos personal injury
liability, Debtors' solvency, and the recovery of Debtors' pre-petition
creditors and equity security holders under any plan or plans of
reorganization.

As a result of this uncertainty, it is not possible at this time to
predict the timing or outcome of the Chapter 11 Cases, the terms and
provisions of any plan or plans of reorganization, or the effect of the
chapter 11 reorganization process on the claims of pre-petition
creditors of the Debtors or the interests of the Corporation's equity
security holders. There can be no assurance as to the value of any
distributions that might be made under any plan or plans of
reorganization with respect to such pre-petition claims, equity
interests, or other outstanding securities. Recent developments in the
Corporation's bankruptcy proceeding are discussed in Note 12.
Litigation.

In connection with the Filing, the Corporation implemented a Bankruptcy
Court approved key employee retention plan that commenced on July 1,
2001, and continues until the date the Corporation emerges from
bankruptcy, or June 30, 2004, whichever occurs first. Under the plan,
participants receive semiannual payments that began in January 2002.
Expenses associated with this plan amounted to $5.5 million in the
second quarter of 2003 and 2002 and $11.1 million in the first six
months of each year.

POTENTIAL FEDERAL LEGISLATION REGARDING ASBESTOS PERSONAL INJURY CLAIMS

The Corporation has for many years actively supported proposals for
federal legislation addressing asbestos personal injury claims. On July

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10, 2003, the Judiciary Committee of the United States Senate narrowly
approved the Fairness in Asbestos Injury Resolution Act of 2003 (Senate
Bill 1125, the "FAIR Bill"), which is intended to establish a
nationally administered trust to compensate asbestos personal injury
claimants. This bill has not been approved by the Senate, has not been
introduced in the House of Representatives, and is not law.

Under the terms of the FAIR Bill as approved by the Judiciary
Committee, companies that have been defendants in asbestos personal
injury litigation, as well as insurance companies, are to contribute
amounts to a national trust on a periodic basis to fund payment of
claims filed by asbestos personal injury claimants who qualify for
payment under the FAIR Bill based on an allocation methodology
specified in the FAIR Bill. The FAIR Bill also provides, among other
things, that the national fund would terminate if the administrator
could not certify that 95% of the previous year's eligible claimants
had been paid, in which case the claimants and defendants would return
to the tort system on a retroactive basis. There are many other
provisions in the FAIR Bill that would affect its impact on the
Corporation and its Chapter 11 Cases.

It is not possible to determine whether the FAIR Bill will ever be
presented for a vote or passed by the full Senate or the House of
Representatives, or whether the FAIR Bill will be signed into law. Nor
is it possible at this time to predict the final terms or cost of any
bill that might become law or its impact on the Corporation or the
Chapter 11 Cases. The Corporation anticipates that, during the
legislative process, the terms of the FAIR Bill as approved by the
Judiciary Committee will change and that any such changes may be
material to the FAIR Bill's impact on the Corporation. It is possible
that the level of funding required from insurers and defendants,
including the Corporation, would increase. Many organized labor
organizations, including the AFL-CIO, have indicated their opposition
to the FAIR Bill, and the American Insurance Association, a national
organization of insurance companies, has also expressed opposition to
the FAIR Bill in the form passed by the Judiciary Committee. In light
of such opposition, as well as other factors, there is no assurance
that any legislation will be enacted.

Enactment of the FAIR Bill or other legislation addressing the
financial contributions of USG Corporation for asbestos personal injury
claims would have a material impact on the Corporation's Chapter 11
Cases. Legislation such as the FAIR Bill would have a material impact
on the amount of the Corporation's asbestos personal injury liability
that must be addressed in Debtors' Chapter 11 Cases. Such legislation
may also affect the manner in which such liability may be addressed in
Debtors' Chapter 11 Cases. As noted above (See Consequences of the
Filing, above), the amount of Debtors' asbestos personal injury
liability is a principal factor in determining the payment rights and
other entitlements of the Corporation's pre-petition creditors and its
shareholders. At this time, however, the outcome of the legislative
process is extremely speculative, and there can be no assurance that
national legislation will be enacted or what the

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terms of any such legislation might be. During this process, the
Corporation anticipates that the Chapter 11 Cases, including the
proceedings regarding estimation of the Corporation's asbestos personal
injury liabilities, will continue. (see Consequences of the Filing,
above, and Note 12. Litigation)

CHAPTER 11 FINANCING

On July 31, 2001, a $350 million debtor-in-possession financing
facility (the "DIP Facility") was approved by the Bankruptcy Court to
supplement liquidity and fund operations during the reorganization
process. The DIP Facility was provided by a syndicate of lenders led by
JPMorgan Chase Bank (formerly The Chase Manhattan Bank) as agent. In
January 2003, the Corporation reduced the size of the DIP Facility to
$100 million and subsequently terminated the DIP Facility in June 2003.
These actions were taken at the election of the Corporation due to the
levels of cash and marketable securities on hand and to eliminate costs
associated with the DIP Facility.

The DIP Facility was used largely for the issuance of standby letters
of credit needed to support business operations. As of June 30, 2003,
$15.2 million of standby letters of credit remained outstanding under
the DIP Facility. Following the termination of the DIP Facility, the
Corporation has been required to cash collateralize 105% of these
outstanding letters of credit until the letters of credit either expire
or are returned by the beneficiary. The Corporation expects the
collateral related to the DIP Facility to be released during the third
quarter of 2003.

In June 2003, the Corporation entered a three-year, $100 million credit
agreement with LaSalle Bank to be used exclusively to support the
issuance of standby letters of credit. As of June 30, 2003, $4.5
million of standby letters of credit, which are cash collateralized at
103%, had been issued under this facility to replace those to be
surrendered by the beneficiaries in connection with the termination of
the DIP Facility.

As of June 30, 2003, a total of $21 million in cash collateral was
posted to back up letters of credit as indicated above and was reported
as restricted cash on the consolidated balance sheet.

PRE-PETITION LIABILITIES OTHER THAN ASBESTOS PERSONAL INJURY

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 and December 13, 2002, setting
forth the

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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
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 Court's order.

Approximately 5,000 proofs of claim for general unsecured creditors
(including pre-petition debtholders), totaling approximately $8.7
billion were filed by the bar date. There was an additional
approximately $500 million of contingent claims. The Debtors are
analyzing the proofs of claim filed by the bar date. 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. Of these to date, the
court has expunged 233 claims totaling $24 million as duplicates, 115
claims totaling $15 million as amended or superceded and allowed a
correction of the Debtors on another 446 claims. Of the duplicate
claims, approximately $5.7 billion have been withdrawn to date. The
Debtors continue to analyze and reconcile filed claims on an on-going
basis.

On June 25, 2003, the second anniversary of the filing of the Chapter
11 Cases, the period during which the Debtors could bring avoidance
actions in the Chapter 11 Cases expired. Such 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 bankruptcy and
state law. In advance of such expiration date, the Debtors had provided
to the several Creditor Committees information regarding payments or
other relevant transactions that had occurred between the Debtors and
third persons, together with the Debtors' recommendation that no
avoidance actions be filed against any third persons. On June 24, 2003,
the Committee representing the unsecured creditors filed a motion with
the Bankruptcy Court requesting authorization to file a complaint
seeking to avoid and recover as preferences certain pre-petition
payments made by Debtors to 206 creditors in amounts greater than
$500,000. The Committee also requested the Court 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. Recently, the Bankruptcy Court
granted the Committee's motion.

In addition, prior to the June 24, 2003 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 the Debtor subsidiaries in favor of the Parent Company in connection
with intercompany loan agreements, a transfer by U.S. Gypsum Company to
the Parent Company of a 9% interest in

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the equity of CGC Inc., the principal Canadian subsidiary of the Parent
Company, and transfers made by the Parent Company 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, Debtors will make adjustments to their
schedules and financials statements as appropriate. Any such
adjustments could be material to the Company's consolidated financial
position 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 presently recorded by the Debtors. Proofs
of claim alleging asbestos property damage claims are discussed in Note
12. Litigation, under Developments in the Reorganization Process.

FINANCIAL STATEMENT PRESENTATION

The accompanying consolidated financial statements have been prepared
in accordance with AICPA Statement of Position 90-7 ("SOP 90-7"),
"Financial Reporting by Entities in Reorganization Under the Bankruptcy
Code," and on a going-concern basis, which contemplates continuity of
operations, realization of assets and liquidation of liabilities in the
ordinary course of business. However, as a result of the Filing, such
realization of assets and liquidation of liabilities, without
substantial adjustments and/or changes of ownership, are subject to
uncertainty. Given this uncertainty, there is 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 appropriateness of using the going-concern basis for the
Corporation's financial statements 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 or plans 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

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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
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,
(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
asbestos claims to be filed in the tort system through 2003, and this
liability, including liability for post-2003 claims, is the subject of
significant legal proceedings and negotiation in the Chapter 11 Cases.
See Note 12. Litigation for additional information on asbestos and
related bankruptcy litigation.

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 DIP balance
sheets consist of the following items (dollars in millions):

As of As of
June 30, December 31,
2003 2002
---------------------------

Accounts payable $ 160 $ 157
Accrued expenses 52 56
Debt 1,005 1,005
Asbestos reserve 1,061 1,061
Other long-term liabilities 20 36
- -------------------------------------------------------------------------
Subtotal 2,298 2,315
Elimination of intercompany accounts payable (43) (43)
- -------------------------------------------------------------------------
Total liabilities subject to compromise 2,255 2,272
=========================================================================

-14-

INTERCOMPANY TRANSACTIONS: In the normal course of business, the
operating subsidiaries and the Parent Company engage in intercompany
transactions. To document the relations created by these transactions,
the Parent Company and the operating subsidiaries, from the formation
of USG Corporation in 1985, have been parties to intercompany loan
agreements that evidence their obligations as borrowers or rights as
lenders arising out of intercompany cash transfers and various
allocated intercompany charges (the "Intercompany Corporate
Transactions").

The Corporation operates a consolidated cash management system under
which the cash receipts of the domestic operating subsidiaries are
ultimately concentrated in Parent Company accounts. Cash disbursements
for those operating subsidiaries originate from those Parent Company
concentration accounts. Allocated intercompany charges from the Parent
Company to the operating subsidiaries primarily include expenses
related to rent, property taxes, information technology, and research
and development, while allocated intercompany charges between certain
operating subsidiaries primarily include expenses for shared marketing,
sales, customer service, engineering and accounting services. Detailed
accounting records are maintained of all cash flows and intercompany
charges through the system in either direction. Net balances,
receivables or payables of such cash transactions, are reviewed on a
regular basis with interest earned or accrued on the balances. During
the first six months of 2001, the Corporation took steps to secure the
obligations from each of the principal domestic operating subsidiaries
under the intercompany loan agreements when it became clear that the
asbestos liability claims of U.S. Gypsum were becoming an increasingly
greater burden on the Corporation's cash resources.

As of June 30, 2003, U.S. Gypsum and USG Interiors had net pre-petition
payable balances to the Parent Company for Intercompany Corporate
Transactions of $297 million and $109 million, respectively. L&W Supply
had a net pre-petition receivable balance from the Parent Company of
$32 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, above)

As of June 30, 2003, U.S. Gypsum, USG Interiors and L&W Supply had net
post-petition receivable balances from the Parent Company for
Intercompany Corporate Transactions of $166 million, $1 million and
$160 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.

-15-

CHAPTER 11 REORGANIZATION EXPENSES: Chapter 11 reorganization expenses
in the consolidated and DIP statements of earnings consist of the
following (dollars in millions):

THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------------------------
2003 2002 2003 2002
----------------------------------

Legal and financial advisory fees $ 5 $ 9 $ 9 $ 13
Bankruptcy-related interest income (2) (2) (4) (4)
- -----------------------------------------------------------------------------
Total chapter 11 reorganization expenses 3 7 5 9
=============================================================================

INTEREST EXPENSE: For the second quarter and first six months of 2003,
contractual interest expense not accrued or recorded on pre-petition
debt totaled $18 and $36 million, respectively. From the Petition Date
through June 30, 2003, contractual interest expense not accrued or
recorded on pre-petition debt totaled $151 million. Although no
post-petition accruals are required to be made for such contractual
interest expense, debtholders may seek to recover such amounts in the
Chapter 11 Cases.

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 Parent
Company and the following wholly owned subsidiaries: United States
Gypsum Company; USG Interiors, Inc.; USG Interiors International, Inc.;
L&W Supply Corporation; Beadex Manufacturing, LLC; B-R Pipeline
Company; La Mirada Products Co., Inc.; Stocking Specialists, Inc.; USG
Industries, Inc.; and USG Pipeline Company.

On March 1, 2002, USG Funding, a non-Debtor subsidiary of USG
Corporation, declared a dividend in the amount of $50 million
(subsequently reduced to $30 million in the second quarter) payable to
the Parent Company, which was paid in effect by eliminating the
intercompany payable from USG Corporation. This payment is included in
other (income) expense, net in the DIP statement of earnings for the
six months ended June 30, 2002. The condensed financial statements of
the Debtors are presented as follows:

-16-

USG CORPORATION
DEBTOR-IN-POSSESSION STATEMENT OF EARNINGS
(DOLLARS IN MILLIONS)
(UNAUDITED)

THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- --------------------
2003 2002 2003 2002
------- ------- ------- -------

Net sales $ 827 $ 798 $ 1,608 $ 1,548
Cost of products sold 719 658 1,403 1,298
Selling and administrative expenses 70 69 139 140
Chapter 11 reorganization expenses 3 7 5 9
Interest expense 2 1 3 3
Interest income (1) - (1) -
Other (income) expense, net (2) 19 (4) (31)
------- ------- ------- -------
Earnings before income taxes and
cumulative effect of accounting
change 36 44 63 129

Income taxes 17 29 29 47
------- ------- ------- -------
Earnings before cumulative effect
of accounting change 19 15 34 82

Cumulative effect of accounting
change - - (13) (41)
------- ------- ------- -------
Net earnings 19 15 21 41
======= ======= ======= =======

-17-

USG CORPORATION
DEBTOR-IN-POSSESSION BALANCE SHEETS
(DOLLARS IN MILLIONS)
(UNAUDITED)

AS OF AS OF
JUNE 30, DECEMBER 31,
2003 2002
----------- ------------

ASSETS
Current Assets:
Cash and cash equivalents $ 364 $ 478
Short-term marketable securities 66 50
Restricted cash 21 -
Receivables (net of reserves - $13 and $13) 305 235
Inventories 237 227
Income taxes receivable 11 14
Deferred income taxes 51 49
Other current assets 58 67
----------- ------------
Total current assets 1,113 1,120

Long-term marketable securities 172 131
Property, plant and equipment (net of accumulated
depreciation and depletion - $601 and $557) 1,556 1,572
Deferred income taxes 209 218
Other assets 390 378
----------- ------------
Total Assets 3,440 3,419
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable 167 142
Accrued expenses 165 207
Income taxes payable 27 20
----------- ------------
Total current liabilities 359 369

Other liabilities 389 362
Liabilities subject to compromise 2,255 2,272
Stockholders' Equity:
Preferred stock - -
Common stock 5 5
Treasury stock (258) (257)
Capital received in excess of par value 101 99
Accumulated other comprehensive income 3 4
Retained earnings 586 565
----------- ------------
Total stockholders' equity 439 416
----------- ------------
Total Liabilities and Stockholders' Equity 3,440 3,419
=========== ============

-18-

USG CORPORATION
DEBTOR-IN-POSSESSION STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)

SIX MONTHS
ENDED JUNE 30,
----------------------
2003 2002
-------- --------

OPERATING ACTIVITIES:
Net earnings $ 21 $ 41
Adjustments to reconcile net earnings to net cash:
Cumulative effect of accounting change 13 41
Depreciation, depletion and amortization 44 42
Deferred income taxes 16 34
(Increase) decrease in working capital:
Receivables (70) (42)
Income taxes receivable 3 15
Inventories (10) (25)
Payables 31 44
Accrued expenses (43) 34
Decrease in pre-petition intercompany receivable - -
Increase in post-petition intercompany receivable (10) (52)
(Increase) decrease in other assets (3) 23
Increase in other liabilities 2 8
Decrease in asbestos receivables 19 11
Decrease in liabilities subject to compromise (17) (24)
Other, net (6) (7)
-------- --------
Net cash (used for) provided by operating activities (10) 143
-------- --------
INVESTING ACTIVITIES:
Capital expenditures (24) (31)
Purchases of marketable securities (148) -
Sale or maturities of marketable securities 91 -
Net proceeds from asset dispositions - 1
Acquisition of business (2) -
-------- --------
Net cash used for investing activities (83) (30)
-------- --------
FINANCING ACTIVITIES:
Deposit of restricted cash (21) -
-------- --------
Net cash used for financing activities (21) -
-------- --------
Net (decrease) increase in cash and cash equivalents (114) 113
Cash and cash equivalents at beginning of period 478 346
-------- --------
Cash and cash equivalents at end of period 364 459
======== ========
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Interest paid 1 1
Income taxes paid (refunded), net 1 (1)

-19-

(3) EXIT ACTIVITIES

2002 DOWNSIZING PLAN: In the fourth quarter of 2002, the Corporation
recorded a nontaxable charge of $11 million related to the shutdown of
the Aubange, Belgium, ceiling tile plant and other downsizing
activities in Europe to address the continuing weakness of the
commercial ceilings market in Europe. The charge was included in cost
of products sold for USG International and reflected severance of $6
million related to a workforce reduction of over 50 positions (salaried
and hourly), equipment writedowns of $3 million and other reserves of
$2 million. The other reserves primarily related to lease
cancellations, inventories and receivables.

As of June 30, 2003, 53 employees were terminated. The Aubange,
Belgium, plant ceased operations in December 2002. The reserve for the
2002 downsizing plan was included in accrued expenses on the
consolidated balance sheets. Charges against the reserve included the
$3 million write-off of equipment in 2002 and payments totaling $6
million in the first six months of 2003. All payments associated with
the 2002 downsizing plan are being funded with cash from operations.

2001 RESTRUCTURING PLAN: In the fourth quarter of 2001, the Corporation
recorded a charge of $12 million pretax ($10 million after-tax) related
to a restructuring plan that included the shutdown of a gypsum
wallboard plant in Fremont, Calif., a drywall steel plant in Prestice,
Czech Republic, a ceiling tile plant in San Juan Ixhuatepec, Mexico, a
ceiling tile manufacturing line in Greenville, Miss., and other
restructuring activities. Included in the $12 million pretax charge was
$8 million for severance related to a workforce reduction of more than
350 positions (primarily hourly positions), $2 million for the
write-off of property, plant and equipment, and $2 million for line
shutdown and removal and contract cancellations. The 2001 restructuring
was intended to allow the Corporation to optimize its manufacturing
operations.

A total of 348 employees were terminated, and 26 open positions were
eliminated, and a ceiling tile manufacturing line at Greenville, Miss.,
and the plants in San Juan Ixhuatepec, Mexico, and Prestice, Czech
Republic, were shut down. The Fremont, Calif., plant ceased production
in the second quarter of 2002. The reserve for the 2001 restructuring
plan was included in accrued expenses on the consolidated balance
sheets. Charges against the reserve in 2001 included the $2 million
write-off of property, plant and equipment and payments totaling $2
million. An additional $3 million of payments were made and charged
against the reserve in 2002. The remaining $5 million of payments were
made and charged against the reserve in the first quarter of 2003. All
payments associated with the 2001 restructuring plan were funded with
cash from operations.

The following table details the reserves and activity for the 2002
downsizing and 2001 restructuring plan (dollars in millions):

-20-

Provisions for Writedown of Reserve
Downsizing/ Assets to Net Cash Balance
Restructuring Realizable Value Payments 6/30/03
- -----------------------------------------------------------------------------------------------------------

2002 Downsizing:

Severance (salaried and hourly) $ 6 $ - $ (6) $ -

Equipment write-off 3 (3) - -

Other reserves 2 - - 2
- -----------------------------------------------------------------------------------------------------------
Subtotal 11 (3) (6) 2
- -----------------------------------------------------------------------------------------------------------
2001 Restructuring:

Severance (primarily hourly) 8 - (8) -

Property, plant and equipment write-off 2 (2) - -

Line shutdown/removal and contract cancellations 2 - (2) -
- -----------------------------------------------------------------------------------------------------------
Subtotal 12 (2) (10) -
- -----------------------------------------------------------------------------------------------------------
Total 23 (5) (16) 2
===========================================================================================================

(4) 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):

-21-

NET SHARES PER SHARE
SIX MONTHS ENDED JUNE 30, EARNINGS (000) AMOUNT
- -------------------------------------------------------------------

2003:
Basic earnings $ 37 43,097 $ 0.86
Dilutive effect of stock options -
- -------------------------------------------------------------------
Diluted earnings 37 43,097 0.86
===================================================================
2002:
Basic loss (22) 43,310 (0.52)
Dilutive effect of stock options -
- -------------------------------------------------------------------
Diluted loss (22) 43,310 (0.52)
===================================================================

(5) MARKETABLE SECURITIES

As of June 30, 2003, the Corporation's investments in marketable
securities consisted of the following:

Fair
Amortized Market
Cost Value
--------------------

Asset-backed securities $ 108 $ 108
U.S. government and agency securities 64 65
Municipal securities 28 28
Time deposits 10 10
Corporate securities 27 27
- ----------------------------------------------------------------
Total marketable securities 237 238
================================================================

Contractual maturities of marketable securities as of June 30, 2003,
were as follows (dollars in millions):

Fair
Amortized Market
Cost Value
--------------------

Due in 1 year or less $ 59 $ 60
Due in 1-5 years 44 44
Due in 5-10 years 3 3
Due after 10 years 23 23
- ----------------------------------------------------------------
129 130
- ----------------------------------------------------------------
Asset-backed securities 108 108
- ----------------------------------------------------------------
Total marketable securities 237 238
================================================================

The average duration of the portfolio is less than one year because a
majority of the longer-term securities have paydown or put features.

-22-

(6) ADOPTION OF SFAS NO. 143

On January 1, 2003, the Corporation adopted Statement of Financial
Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement
Obligations." This standard requires the recording of the fair value of
a liability for an asset retirement obligation in the period in which
it is incurred. The Corporation's asset retirement obligations include
reclamation requirements as regulated by government authorities related
principally to assets such as the Corporation's mines, quarries,
landfills, ponds and wells. The impact of adopting SFAS No. 143 was an
increase in the Corporation's assets and liabilities of $14 million and
$30 million, respectively. A noncash, after-tax charge of $16 million
($27 million pretax) was reflected on the consolidated statement of
earnings as a cumulative effect of a change in accounting principle as
of January 1, 2003.

(7) ADOPTION OF SFAS NO. 142

On January 1, 2002, the Corporation adopted SFAS No. 142, "Goodwill and
Other Intangible Assets." Although SFAS No. 142 eliminated the
amortization of goodwill and certain other intangible assets, it
initiated an annual assessment of goodwill for impairment.

The initial assessment was completed as of the adoption date. The
assessment was performed for each reporting unit (as defined by SFAS
No. 142) that had goodwill. For the Corporation, the reporting units
with goodwill were the North American Gypsum and the Building Products
Distribution operating segments.

The Corporation determined that goodwill for its Building Products
Distribution segment was not impaired, but will be reviewed at least
annually for impairment. However, goodwill for its North American
Gypsum segment was impaired. This impairment was attributable to U.S.
Gypsum's asbestos liability and related filing for bankruptcy
protection on June 25, 2001. As a result, the Corporation recorded a
noncash, nontaxable impairment charge of $96 million. This charge
included a $90 million write-off of goodwill (net of accumulated
amortization of $8 million) and a $6 million write-off of deferred
currency translation. In accordance with SFAS No. 142, the Corporation
reflected this charge in its financial statements as a cumulative
effect of a change in accounting principle as of January 1, 2002.

-23-

(8) 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. Under SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," as
amended, all derivative instruments must be recorded on the balance
sheet at fair value. For derivatives designated as fair value hedges,
the changes in the fair values of both the derivative instrument and
the hedged item are recognized in earnings in the current period. For
derivatives designated as cash flow hedges, the effective portion of
changes in the fair value of the derivative is recorded to accumulated
other comprehensive income (loss) and is reclassified to earnings when
the underlying transaction has an impact on earnings.

COMMODITY DERIVATIVE INSTRUMENTS: The Corporation uses swap contracts
from time to time to hedge anticipated purchases of natural gas,
wastepaper and fuel to be used in its manufacturing and shipping
operations. The current contracts, all of which mature by December 31,
2004, are generally designated as cash flow hedges, with changes in
fair value recorded to accumulated other comprehensive income (loss)
until the hedged transaction occurs, at which time it is reclassified
to earnings. As of June 30, 2003, the fair value of these swap
contracts, which remained in accumulated other comprehensive income
(loss), was $16 million ($10 million after-tax).

FOREIGN EXCHANGE DERIVATIVE INSTRUMENTS: The Corporation has operations
in a number of countries and uses forward contracts from time to time
to hedge selected risk of changes in cash flows resulting from
forecasted intercompany and third-party sales or purchases in foreign
currencies. These contracts are generally designated as cash flow
hedges, for which changes in fair value are recorded to accumulated
other comprehensive income (loss) until the underlying transaction has
an impact on earnings. As of June 30, 2003, the Corporation had foreign
currency contracts in place which mature on the anticipated date of the
underlying transaction, and all contracts mature by December 31, 2003.
The notional amounts of foreign currency contracts as of June 30, 2003,
was $1 million. The fair value of these contracts as of June 30, 2003,
was zero.

COUNTERPARTY RISK: The Corporation is exposed to credit losses in the
event of nonperformance by the counterparties on its financial
instruments. All counterparties have investment grade credit standing;
accordingly, the Corporation anticipates that these counterparties will
be able to satisfy fully their obligations under the contracts. The
Corporation does not generally obtain collateral or other security to
support financial instruments subject to credit risk but regularly
monitors the credit standing of all counterparties.

-24-

(9) COMPREHENSIVE INCOME (LOSS)

The components of comprehensive income (loss) are summarized in the
following table (dollars in millions):

THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------------------
2003 2002 2003 2002
------------------------------------

Net earnings (loss) $ 31 $ 48 $ 37 $ (22)
- -------------------------------------------------------------------------------------

Pretax gain (loss) on derivatives (2) (8) (2) 5
Income tax benefit (expense) 1 3 1 (2)
- -------------------------------------------------------------------------------------
Gain (loss) on derivatives, net of tax (1) (5) (1) 3
- -------------------------------------------------------------------------------------
Deferred currency translation 13 7 24 12
- -------------------------------------------------------------------------------------
Unrealized gain (loss) on marketable
securities, net of tax - - - -
- -------------------------------------------------------------------------------------
Total comprehensive income (loss) 43 50 60 (7)
=====================================================================================

There was no tax impact on the foreign currency translation
adjustments. The components of accumulated other comprehensive income
(loss) included on the consolidated balance sheet are summarized in the
following table (dollars in millions):

As of As of
June 30, December 31,
2003 2002
------------------------

Gain on derivatives, net of tax $ 17 $ 18
Deferred currency translation (15) (39)
Minimum pension liability, net of tax (11) (11)
Unrealized gain (loss) on marketable securities, net of tax - -
- -----------------------------------------------------------------------------------------
Total accumulated other comprehensive income (loss) (9) (32)
=========================================================================================

During the second quarter of 2003, $6 million of accumulated net
after-tax gains ($10 million pretax) on derivatives were reclassified
from accumulated other comprehensive income (loss) to earnings. As of
June 30, 2003, the estimated net after-tax gain expected to be
reclassified within the next 12 months from accumulated other
comprehensive income (loss) into earnings is $15 million.

-25-

(10) STOCK-BASED COMPENSATION

The Corporation accounts for stock-based compensation under the
provisions of Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees." APB No. 25 prescribes the
use of the intrinsic value method, which measures compensation cost as
the quoted market price of the stock at the date of grant less the
amount, if any, that the employee is required to pay. If the
Corporation had elected to recognize compensation cost for stock-based
compensation grants consistent with the fair value method prescribed by
SFAS No. 123, "Accounting for Stock-Based Compensation," as amended by
SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and
Disclosure," net earnings (loss) and net earnings (loss) per common
share would have changed to the following pro forma amounts:

THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------------------
2003 2002 2003 2002
------------------------------------

NET EARNINGS (LOSS):
Net Earnings(Loss): As reported $ 31 $ 48 $ 37 $ (22)
Deduct: Fair value method of stock
-based employee compensation
expense, net of tax - - - (1)
- ------------------------------------------------------------------------------------
Pro forma net earnings(loss) 31 48 37 (23)
====================================================================================
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE:
As reported 0.73 1.11 0.86 (0.52)
Pro forma 0.73 1.11 0.86 (0.54)
====================================================================================

Subsequent to the Filing, no stock option grants have been issued. The
deduction of $1 million shown above to the first six months of 2002 net
earnings reflects the vesting of options granted prior to the Filing.

As of June 30, 2003, common shares totaling 2,600,375 were reserved for
future issuance in conjunction with existing stock option grants. In
addition, 2,263,620 common shares were reserved for future grants.
Shares issued in option exercises may be from original issue or
available treasury shares.

-26-

(11) OPERATING SEGMENTS

The Corporation's operations are organized into three operating
segments: North American Gypsum, which manufactures SHEETROCK brand
gypsum wallboard and joint compounds, DUROCK brand cement board and
other related building products in the United States, Canada and
Mexico; 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 Building Products Distribution, which
distributes gypsum wallboard, drywall metal, ceiling products, joint
compound and other building products throughout the United States.
Operating segment results were as follows (dollars in millions):

THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------------------
2003 2002 2003 2002
------------------------------------

NET SALES:
North American Gypsum $ 566 $ 551 $1,108 $1,076
Worldwide Ceilings 154 158 301 306
Building Products Distribution 325 306 620 581
Eliminations (131) (130) (253) (249)
- ------------------------------------------------------------------------------------
Total USG Corporation 914 885 1,776 1,714
====================================================================================
OPERATING PROFIT (LOSS):
North American Gypsum 47 81 85 139
Worldwide Ceilings 9 11 17 16
Building Products Distribution 16 13 24 20
Corporate (18) (17) (36) (37)
Chapter 11 reorganization expenses (3) (7) (5) (9)
Eliminations (1) (1) - (1)
- ------------------------------------------------------------------------------------
Total USG Corporation 50 80 85 128
====================================================================================

(12) LITIGATION

ASBESTOS AND RELATED BANKRUPTCY LITIGATION

One of the Corporation's subsidiaries, U.S. Gypsum, is among many
defendants in lawsuits arising out of the manufacture and sale of
asbestos-containing materials. On June 25, 2001 (the "Petition Date"),
U.S. Gypsum, the Parent Company, and other domestic subsidiaries (the
"Debtors") filed voluntary petitions for reorganization ("Filing")
under chapter 11 of the U.S. Bankruptcy Code to manage the growing
costs of resolving asbestos claims and to achieve a fair and final
resolution of liability for both pending and future asbestos claims.
The Debtors' chapter 11 cases ("Chapter 11 Cases") are being jointly
administered as In re: USG Corporation et al. (Case No. 01-2094) in the
United States Bankruptcy Court for the District of Delaware (the
"Bankruptcy Court").

-27-

U.S. Gypsum's asbestos liability derives from its sale of certain
asbestos-containing products beginning in the late 1920s; in most
cases, the products were discontinued or asbestos was removed from the
formula by 1972, and no asbestos-containing products were produced
after 1978. Certain of the asbestos lawsuits against U.S. Gypsum seek
to recover compensatory and, in many cases, punitive damages for costs
associated with the maintenance or removal and replacement of
asbestos-containing products in buildings (the "Property Damage
Cases"). Other asbestos lawsuits seek compensatory and, in many cases,
punitive damages for personal injury allegedly resulting from exposure
to asbestos-containing products (the "Personal Injury Cases"). A more
detailed description of the Property Damage and Personal Injury Cases
against U.S. Gypsum and certain other Debtors is set forth below.

As a result of the Filing, all pending Personal Injury and Property
Damage Cases against U.S. Gypsum are stayed, and no party may take any
action to pursue or collect on these claims absent specific
authorization of the Bankruptcy Court. Since the Filing, U.S. Gypsum
has ceased making both cash payments and accruals with respect to
asbestos lawsuits, including cash payments and accruals pursuant to
settlements of asbestos lawsuits. The Bankruptcy Court has approved
creditors' committees that represent claimants in Personal Injury and
Property Damage Cases and, as noted below, a legal representative for
future asbestos claimants.

Debtors anticipate that U.S. Gypsum's liability for asbestos personal
injury and property damage claims will be addressed in a plan of
reorganization developed and approved in the bankruptcy proceeding. The
Debtors' exclusive right to propose such a plan of reorganization has
been extended by the Bankruptcy Court to September 1, 2003. The Debtors
intend to seek one or more additional extensions depending upon
developments in the Chapter 11 Cases.

Debtors expect that the plan of reorganization will include creation of
one or more independently administered trusts under Section 524(g) of
the Bankruptcy Code, which will be funded by Debtors to allow payment
of present and future asbestos personal injury claims and demands.
Debtors also expect that the plan of reorganization will address
Debtors' liability for asbestos property damage claims, whether by
including those liabilities in a Section 524(g) trust or by other
means. It is anticipated that, as a result of creation and funding of
the Section 524(g) trust(s), the Bankruptcy Court will issue a
permanent injunction barring the assertion of present and future
asbestos claims against Debtors, their successors, and their
affiliates, and channeling those claims to the trust(s) for payment in
whole or in part. 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 Debtors' Chapter 11 Cases will approve creation of
a Section 524(g) trust or issue a permanent injunction channeling to
the

-28-

trust all asbestos claims against Debtors and/or their successors and
affiliates. In addition, if federal legislation addressing asbestos
personal injury claims is passed, which is extremely speculative at
this time, such legislation may affect the manner in which asbestos
personal injury claims are to be addressed in Debtors' Chapter 11 Cases
and may affect whether the Debtors establish a trust under Section
524(g). (see Note 2. Voluntary Reorganization Under Chapter 11 -
Potential Federal Legislation Regarding Asbestos Personal Injury
Claims)

While it is the Debtors' intention to seek a full recovery for their
creditors, it is not possible to predict how the plan of reorganization
will treat asbestos and other pre-petition claims and what impact any
plan may have on the value of the shares of the Corporation's common
stock and other outstanding securities. Under the Bankruptcy Code, a
plan of reorganization, including a plan creating a Section 524(g)
trust, may be confirmed without the consent of non-asbestos creditors
and equity security holders if certain requirements of the Code are
met. There is no assurance that there will be sufficient assets to
satisfy the Debtors' pre-petition liabilities in whole or in part, and
the pre-petition creditors of some Debtors may be treated differently
from the pre-petition creditors of other Debtors. The payment rights
and other entitlements of pre-petition creditors and USG shareholders
may be substantially altered by any plan or plans of reorganization
confirmed in the Chapter 11 Cases. Pre-petition creditors may receive
under the plan of reorganization less than 100% of the face value of
their claims, and the interests of the Corporation's equity security
holders are likely to be substantially diluted or cancelled in whole or
in part.

Whether the Corporation's equity has significant value and Debtors'
non-asbestos creditors recover the full value of their claims depend
upon the outcome of the analysis of the amount of Debtors' assets and
liabilities, especially asbestos liabilities, that must be funded under
the plan. Counsel for the Official Committee of Asbestos Personal
Injury Claimants and counsel for the legal representative for future
asbestos personal injury claimants have advised the court that is
presiding over the Chapter 11 Cases that they believe Debtors' asbestos
liabilities exceed the value of Debtors' assets and that Debtors are
insolvent. The Debtors have advised the court that they believe they
are solvent if their asbestos liabilities are fairly and appropriately
valued. Toward that end, the Debtors filed a motion with the court
requesting the court to begin proceedings to estimate the value of
Debtors' asbestos personal injury liabilities.

In response to the Debtors' motion requesting an estimation of asbestos
personal injury liabilities, the court issued an order and memorandum
opinion on February 19, 2003, setting forth a procedure for estimating
Debtors' liability for asbestos personal injury claims alleging cancer.
(See Developments in the Reorganization Proceeding, below.) The court
has not set a timetable for this process. Thus, Debtors do not know
when

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estimation of Debtors' liability for these cancer claims will occur,
what the outcome of that proceeding will be, what impact that
proceeding will have on estimating Debtors' liability for asbestos
personal injury claims alleging other diseases, and whether the
estimation proceeding will lead to a negotiated resolution of Debtors'
asbestos personal injury liabilities. Debtors also cannot predict at
this time the estimated cost of resolving asbestos property damage
claims. If the amount of the Debtors' asbestos liabilities cannot be
resolved through negotiation or is not addressed by legislation (see
Note 2. Voluntary Reorganization Under Chapter 11 - Potential Federal
Legislation Regarding Asbestos Personal Injury Claims), the outcome of
the estimation proceeding regarding Debtors' liability for cancer
claims likely will be a significant component of determining Debtors'
asbestos personal injury liability, Debtors' solvency, and the recovery
of Debtors' pre-petition creditors and equity security holders under
any plan or plans of reorganization.

As a result of this uncertainty, it is not possible at this time to
predict the timing or outcome of the Chapter 11 Cases, the terms and
provisions of any plan or plans of reorganization, or the effect of the
chapter 11 reorganization process on the claims of pre-petition
creditors of the Debtors or the interests of the Corporation's equity
security holders. There can be no assurance as to the value of any
distributions that might be made under any plan or plans of
reorganization with respect to such pre-petition claims, equity
interests, or other outstanding securities.

Recent developments in the Corporation's bankruptcy proceeding and a
more detailed discussion of the Debtors' asbestos liabilities are
addressed below.

DEVELOPMENTS IN THE REORGANIZATION PROCEEDING: During the fourth
quarter of 2001, the Corporation's bankruptcy proceeding, along with
four other asbestos-related bankruptcy proceedings pending in the
federal courts in the District of Delaware, were assigned to the
Honorable Alfred M. Wolin of the United States District Court for the
District of New Jersey. Judge Wolin has indicated that he will handle
all issues relating to asbestos personal injury claims and that other
bankruptcy claims and issues in the Chapter 11 Cases, including issues
relating to asbestos property damage claims, will remain assigned to
Bankruptcy Judge Randall J. Newsome in the United States Bankruptcy
Court for the District of Delaware.

In July 2002, the Bankruptcy Court appointed the Honorable Dean M.
Trafelet as the legal representative for future asbestos claimants in
the Debtors' bankruptcy proceeding. Mr. Trafelet was formerly a judge
of the Circuit Court of Cook County, Illinois.

The Debtors filed a motion requesting Judge Wolin to conduct hearings
to substantively estimate the Debtors' liability for asbestos personal
injury claims. The Debtors requested that the court hear evidence and
make rulings

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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. One of the key liability issues is whether claimants who do
not have objective evidence of asbestos-related disease have valid
claims and are entitled to be compensated by Debtors, or whether such
claimants are entitled to compensation only if and when they develop
asbestos-related disease.

The Official Committee of Asbestos Personal Injury Claimants opposed
the substantive estimation hearings proposed by Debtors. The committee
contends that U.S. Gypsum's liability for present and future asbestos
personal injury claims should be based on extrapolation from U.S.
Gypsum's settlement history of such claims and not on litigating
liability issues in the bankruptcy proceeding. The committee contends
that the Court does not have the power to exclude claimants who do not
meet objective evidence of asbestos-related disease if such claimants
are compensated in the tort system outside of bankruptcy.

In August 2002, Debtors also filed a motion with Judge Wolin 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. The Debtors' motion on this voting issue has been stayed
by order of Judge Wolin. It is expected that the Official Committee of
Asbestos Personal Injury Claimants will oppose the Debtors' motion.

In response to the Debtors' motion seeking substantive estimation of
Debtors' asbestos personal injury liability, Judge Wolin issued a
Memorandum Opinion and Order ("Order") on February 19, 2003, setting
forth a procedure for estimating Debtors' liability for asbestos
personal injury claims alleging cancer. The Order states that a bar
date will be established for filing claims by all persons who wish to
assert an asbestos personal injury claim alleging cancer against
Debtors. The bar date will not apply to non-malignant claims, which the
Order states will not be addressed at this time.

The Order provides that after the claims bar date for these cancer
claims has passed, the Court will hold an estimation hearing under 11
U.S.C. Section 502(c) at which the "debtors will be permitted to
present their defenses." Although the Order explicitly contemplates a
bar date for filing these cancer claims, the Order does not establish a
bar date or a date for the subsequent estimation hearing. The Order
contemplates that after the estimation of Debtors' liability for
present and future cancer claims, the Court will determine whether
Debtors' liability for these claims exceeds Debtors' assets. The Court
notes that the Official Committee of Asbestos Personal Injury Claimants
has asserted that the Debtors are insolvent and do not have sufficient
assets to pay cancer claimants, without regard to Debtors' liability
for non-malignant asbestos personal injury claims. The Court further
notes that Debtors dispute this contention. According to the

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Order, the determination of whether the Debtors have sufficient assets
to pay legitimate cancer claimants will guide the Court in determining
whether the Debtors' resources should be spent resolving the issue of
the validity of non-malignant claims where there is no objective
evidence of asbestos-related disease.

Pursuant to the Order, on March 21, 2003, the Debtors submitted to the
court a proposed timetable for the bar date for cancer claims, a
proposed proof of claim form, and a plan for providing notice of the
bar date. The Committee for Asbestos Personal Injury Claimants has
requested the Court to limit the bar date and estimation proceeding to
asbestos personal injury cancer claimants who filed a lawsuit against
Debtors before the Petition Date. The court has indicated that it
likely will limit the bar date to cancer claimants who filed a lawsuit
against Debtors before the Petition Date, but the Court has not yet
issued any order to that effect and has not yet set a bar date for
cancer claims or a date for any hearing on estimation of Debtors'
liability for these claims.

At this stage in the proceedings, Debtors do not know when estimation
of Debtors' liability for these cancer claims will occur, what the
outcome of the estimation proceeding will be, what impact that
proceeding will have on estimating Debtors' liability for asbestos
personal injury claims alleging other diseases, and whether the
estimation proceeding will lead to a negotiated resolution of Debtors'
asbestos liabilities. Debtors also do not know whether the Court will
ultimately address the validity and voting rights of non-malignant
claims. If the amount of the Debtors' asbestos liabilities cannot be
resolved through negotiation or is not addressed by legislation (see
Note 2. Voluntary Reorganization Under Chapter 11 - Potential Federal
Legislation Regarding Asbestos Personal Injury Claims), as has been the
case to date, the outcome of the estimation proceeding regarding
Debtors' liability for cancer claims likely will be a significant
component of determining Debtors' asbestos personal injury liability,
Debtors' solvency, and the recovery of Debtors' pre-petition creditors
and equity security holders under any plan or plans of reorganization.

There have also been developments in the reorganization proceedings
regarding asbestos property damage claims. The Bankruptcy Court
established a bar date of January 15, 2003, by which all entities with
asbestos-related property damage claims or any other types of claims
(except asbestos personal injury claims or claims derivative thereof)
must file their claims against the Debtors in the bankruptcy
proceeding. The Debtors mailed and published notice of the claims bar
date to potential asbestos property damage claimants as well as other
claimants affected by the bar date.

The Debtors have made a preliminary analysis of the asbestos-related
property damage claims received as of the claims bar date.
Approximately 1,400 asbestos property damage claims were filed,
representing more than

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2,000 buildings. In contrast, as of the Petition Date, 11 Property
Damage Cases were pending against U.S. Gypsum. Approximately 500 of the
asbestos property damage claims filed by the bar date assert a specific
dollar amount of damages, and the total damages alleged in those claims
is approximately $1.6 billion. However, this amount reflects numerous
duplicate claims filed against multiple Debtors, and therefore, likely
overstates the claimed damages. Approximately 900 claims do not specify
a damage amount. Many of the filed claims do not provide any evidence
that Debtors' products were ever installed in any of the buildings at
issue, and some of the claims are duplicates of other claims. Debtors
believe that they have substantial defenses to many of these property
damage claims, including the lack of evidence that Debtors' products
were ever installed in the buildings at issue, the claims are barred by
the applicable statutes of limitation, and the claims lack evidence
that the claimants have any damages. Debtors intend to address many of
these claims through an objection and disallowance process in the
bankruptcy court. Because of the preliminary nature of this process,
Debtors' 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 Property Damage and Personal Injury
Cases pending against U.S. Gypsum and certain other Debtors as of the
Petition Date.

PROPERTY DAMAGE CASES: As of the Petition Date, U.S. Gypsum was a
defendant in 11 Property Damage Cases, most of which involved multiple
buildings. One of the cases is a conditionally certified class action
comprising all colleges and universities in the United States, which
certification is presently limited to the resolution of certain
allegedly "common" liability issues. (Central Wesleyan College v. W.R.
Grace & Co., et al., U.S.D.C. S.C.). On June 15, 2001, a Property
Damage Case was filed by The County of Orange, Texas, in the district
court of Orange County, Texas, naming as defendants U.S. Gypsum and
other manufacturers of asbestos-containing materials. This was the
first Property Damage case filed against U.S. Gypsum since June 1998.
The Orange County case is a putative class action brought by The County
of Orange on behalf of an alleged class comprising the State of Texas,
its public colleges and universities, and all political subdivisions of
the State of Texas. As to U.S. Gypsum, the putative class also includes
all private and/or non-public colleges, universities, junior colleges,
community colleges, and elementary and secondary schools in the State
of Texas. The Orange County action seeks recovery of the costs of
removing and replacing asbestos-containing materials in buildings at
issue as well as punitive damages. The complaint does not specify how
many buildings are at issue. As a result of the Filing, all Property
Damage Cases, including the Central Wesleyan and Orange County cases,
are stayed against U.S. Gypsum. U.S. Gypsum's estimated cost of
resolving the Property Damage Cases is discussed below. (see Estimated
Cost, below)

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PERSONAL INJURY CASES: As reported by the Center for Claims Resolution
(the "Center"), U.S. Gypsum was a defendant in approximately 106,000
pending Personal Injury Cases as of the Petition Date, as well as an
additional approximately 52,000 Personal Injury Cases that are the
subject of settlement agreements. In the first half of 2001, up to the
Petition Date, approximately 26,200 new Personal Injury Cases were
filed against U.S. Gypsum, as reported by the Center, as compared to
27,800 new filings in the first half of 2000. Filings of new Personal
Injury Cases totaled approximately 53,000 claims in 2000, 48,000 claims
in 1999, and 80,000 claims in 1998.

Prior to the Filing, U.S. Gypsum managed the handling and settlement of
Personal Injury Cases through its membership in the Center. From 1988
up to February 1, 2001, the Center administered and arranged for the
defense and settlement of Personal Injury Cases against U.S. Gypsum and
other Center members. During that period, costs of defense and
settlement of Personal Injury Cases were shared among the members of
the Center pursuant to predetermined sharing formulae. Effective
February 1, 2001, the Center members, including U.S. Gypsum, ended
their prior settlement-sharing arrangement. The Center continued to
administer and arrange for the defense and settlement of the Personal
Injury Cases, but liability payments were not shared among the Center
members. As of the Petition Date and as a result of the stay of
asbestos lawsuits against U.S. Gypsum, U.S. Gypsum no longer requires
the services of the Center in negotiating or defending Personal Injury
Cases.

In 2000 and years prior, U.S. Gypsum and other Center members
negotiated a number of settlements with plaintiffs' law firms that
included agreements to resolve over time the firms' pending Personal
Injury Cases as well as certain future claims (the "Long-Term
Settlements"). With regard to future claims, these Long-Term
Settlements typically provide that the plaintiffs' firms will recommend
to their future clients that they defer filing, or accept nominal
payments on, personal injury claims that do not meet established
disease criteria, and, with regard to those claims meeting established
disease criteria, that the future clients accept specified amounts to
settle those claims. These Long-Term Settlements typically resolve
claims for amounts consistent with historical per-claim settlement
costs paid to the plaintiffs' firms involved. As a result of the
Filing, cash payments by U.S. Gypsum under these Long-Term Settlements
have ceased, and U.S. Gypsum expects that its obligations under these
settlements will be determined in the bankruptcy proceeding and plan of
reorganization.

In 2000, U.S. Gypsum closed approximately 57,000 Personal Injury Cases.
U.S. Gypsum's cash payments in 2000 to defend and resolve Personal
Injury Cases totaled $162 million, of which $90 million was paid or
reimbursed by insurance. In 2000, the average settlement per case was
approximately $2,600, exclusive of defense costs. U.S. Gypsum made cash
payments of $100 million in 1999 and $61 million in 1998 to resolve
Personal Injury Cases,

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of which $85 million and $45.5 million, respectively, were paid or
reimbursed by insurance.

In the first and second quarters of 2001, prior to the Filing, payments
to resolve Personal Injury Cases increased dramatically, primarily as a
result of the bankruptcy filings of other defendants in asbestos
personal injury lawsuits. Following these bankruptcy filings,
plaintiffs substantially increased their settlement demands to the
remaining defendants, including U.S. Gypsum. In response to these
increased settlement demands, U.S. Gypsum attempted to manage its
asbestos liability by contesting, rather than settling, a greater
number of cases that it believed to be non-meritorious. As a result, in
the first and second quarters of 2001, U.S. Gypsum agreed to settle
fewer Personal Injury Cases, but at a significantly higher cost per
case.

In the first half of 2001 (up to the Petition Date), U.S. Gypsum closed
approximately 18,900 Personal Injury Cases. In the first half of 2001
(up to the Petition Date), U.S. Gypsum's total asbestos-related cash
payments, including defense costs, were approximately $124 million, of
which 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
proceeding, 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. Because of the small number of
Personal Injury Cases against L&W Supply to date and the lack of
development of the cases against L&W Supply, the Corporation does not
have sufficient information at this time to predict as to how any plan
or plans of reorganization will address any asbestos-related liability
of L&W Supply and whether any such liability will be limited to L&W
Supply's role as a distributor of U.S. Gypsum products.

One of U.S. Gypsum's subsidiaries and a Debtor in the bankruptcy
proceeding, Beadex Manufacturing, LLC ("Beadex"), manufactured and sold
joint compound containing asbestos from 1963 through 1978 in the
northwest United States. As of the Petition Date, Beadex was a named
defendant in approximately 40 Personal Injury Cases pending primarily
in the states of Washington and Oregon. Beadex has approximately $11
million in primary or umbrella insurance coverage available to pay
asbestos-related costs, as well as $15 million in available excess
coverage. The Corporation expects that any asbestos-related liability
of Beadex will be addressed in the plan

-35-

of reorganization. However, because of the small number of Personal
Injury Cases pending against Beadex to date, the Corporation does not
have sufficient information at this time to predict as to how any plan
or plans of reorganization will address any asbestos-related liability
of Beadex.

INSURANCE COVERAGE: During the second quarter of 2003, U.S. Gypsum
received $7 million of insurance payments of which $3 million was
applied to the insurance receivable, while unanticipated payments of $4
million were recorded to earnings. As of June 30, 2003, U.S. Gypsum has
recorded a $12 million insurance receivable relating to insurance
remaining to cover asbestos-related costs. The insurance receivable is
scheduled to be collected at various times through the next 12 months
and is included in other current assets on the consolidated balance
sheet.

ESTIMATED COST: In evaluating U.S. Gypsum's estimated asbestos
liability prior to the Filing, the Corporation considered numerous
uncertainties that made it difficult to estimate reliably U.S. Gypsum's
asbestos liability in the tort system for both pending and future
asbestos claims.

In the Property Damage Cases, such uncertainties included, but were not
limited to, the identification and volume of asbestos-containing
products in the buildings at issue in each case, which is often
disputed; the claimed damages associated therewith; the viability of
statute of limitations, product identification and other defenses,
which varies depending upon the facts and jurisdiction of each case;
the amount for which such cases can be resolved, which normally (but
not uniformly) has been substantially lower than the claimed damages;
and the viability of claims for punitive and other forms of multiple
damages.

Uncertainties in the Personal Injury Cases included, but were not
limited to, the number, disease and occupational characteristics, and
venue of Personal Injury Cases that are filed against U.S. Gypsum; the
age and level of asbestos-related disease of claimants; the viability
of claims for conspiracy or punitive damages; the elimination of
indemnity sharing among Center members for future settlements and its
negative impact on U.S. Gypsum's ability to continue to resolve claims
at historical or acceptable levels; the adverse impact on U.S. Gypsum's
settlement costs of recent bankruptcies of co-defendants; the continued
solvency of other defendants and the possibility of additional
bankruptcies; the possibility of significant adverse verdicts due to
recent changes in settlement strategies and related effects on
liquidity; the inability or refusal of former Center members to fund
their share of existing settlements and its effect on such settlement
agreements; the continued ability to negotiate settlements or develop
other mechanisms that defer or reduce claims from unimpaired claimants;
and the possibility that federal legislation addressing asbestos
litigation would be enacted. The Corporation reported that adverse
developments with respect to any of these uncertainties could have a
material impact on U.S. Gypsum's settlement costs and could materially

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increase the cost above the estimated range discussed below.

Prior to the fourth quarter of 2000, the Corporation, in the opinion of
management, was unable to reasonably estimate the probable cost of
resolving future asbestos claims in the tort system, although the
Corporation had estimated and reserved for costs associated with
then-pending claims. However, in 1999 and increasingly in 2000, as U.S.
Gypsum entered into Long-Term Settlements of Personal Injury Cases, the
Corporation undertook a detailed, independent study of U.S. Gypsum's
current and potential future asbestos liability. This analysis was
based on the assumption that U.S. Gypsum's asbestos liability would
continue to be resolved in the tort system. The analysis was completed
in the fourth quarter of 2000.

As part of this analysis, the Corporation reviewed, among other things,
historical case filings and increasing settlement costs; the type of
products U.S. Gypsum sold and the occupations of claimants expected to
bring future asbestos-related claims; epidemiological data concerning
the incidence of past and projected future asbestos-related diseases;
trends in the propensity of persons alleging asbestos-related disease
to sue U.S. Gypsum; the adverse effect on settlement costs of
historical reductions in the number of solvent defendants available to
pay claims, including reductions in membership of the Center; the
pre-agreed settlement recommendations in, and the continued viability
of, the Long-Term Settlements described above; and anticipated trends
in recruitment by plaintiffs' law firms of non-malignant or unimpaired
claimants. The study attempted to weigh relevant variables and assess
the impact of likely outcomes on future case filings and settlement
costs. In addition, the Corporation considered future defense costs, as
well as allegations that U.S. Gypsum and the other Center members bear
joint liability for the share of certain settlement agreements that was
to be paid by former members that now have refused or are unable to
pay.

In the fourth quarter of 2000, the Corporation concluded that it was
possible to provide a reasonable estimate of U.S. Gypsum's liability in
the tort system for asbestos cases to be filed through 2003 as well as
those currently pending. Based on an independent study, the Corporation
determined that, although substantial uncertainty remained, it was
probable that asbestos claims currently pending against U.S. Gypsum and
future asbestos claims to be filed against it through 2003 (both
property damage and personal injury) could be resolved in the tort
system for an amount between $889 million and $1,281 million, including
defense costs, and that within this range the most likely estimate was
$1,185 million. Consistent with this analysis, in the fourth quarter of
2000, the Corporation recorded a pretax noncash charge of $850 million
to results of operations, which, combined with the previously existing
reserve, increased U.S. Gypsum's reserve for asbestos claims to $1,185
million. Substantially all of this reserve relates to the estimated
costs of resolving then-pending asbestos

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personal injury claims and those expected to be filed through 2003, and
the reserve reflected management's expectation that U.S. Gypsum's
average payment per asbestos personal injury claim would increase at
least in the short term due to distortions caused by the bankruptcy
filings of other asbestos personal injury defendants discussed above.
Less than 10 percent of the reserve is attributable to defense and
administrative costs.

At the time of recording this reserve, it was expected that the reserve
amounts would be expended over a period extending several years beyond
2003, because asbestos cases have historically been resolved an average
of three years after filing. The Corporation concluded that it did not
have adequate information to allow it to reasonably estimate the number
of claims to be filed after 2003, or the liability associated with such
claims.

During 2001 up to the Filing, U.S. Gypsum's cash payments for asbestos
claims and related legal fees totaled approximately $124 million,
reducing its reserve for asbestos claims to $1,061 million as of June
30, 2001. The reserve remained at $1,061 million as of June 30, 2003.
The above amounts are stated before tax benefit and are not discounted
to present value.

It is the Corporation's view that, as a result of the Filing, there is
even greater uncertainty in estimating the reasonably possible range of
asbestos liability for pending and future claims as well as the most
likely estimate of liability within this range. There are significant
differences in the treatment of asbestos claims in a bankruptcy
proceeding as compared to the tort litigation system. Among other
things, these uncertainties include how the Long-Term Settlements will
be treated in the bankruptcy proceeding and plan of reorganization and
whether those settlements will be set aside; the number of
asbestos-related claims that will be filed in the proceeding; the
number of future claims that will be estimated in connection with
preparing a plan of reorganization; how claims for punitive damages and
claims by persons with no asbestos-related disease will be treated and
whether such claims will be allowed; the impact historical settlement
values for asbestos claims may have on the estimation of asbestos
liability in the bankruptcy proceeding; the results of the estimation
proceeding regarding asbestos personal injury claims alleging cancer;
the treatment of asbestos property damage claims in the bankruptcy
proceeding; and the impact any relevant potential federal legislation
may have on the proceeding (see Note 2. Voluntary Reorganization Under
Chapter 11 - Potential Federal Legislation Regarding Asbestos Personal
Injury Claims). These factors, as well as the uncertainties discussed
above in connection with the resolution of asbestos cases in the tort
system, increase the uncertainty of any estimate of asbestos liability.

As a result, it is the Corporation's view that no change should be made
at this time to the previously recorded reserve for asbestos claims,
except to reflect certain minor asbestos-related costs incurred since
the Filing.

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However, it is possible that the cost of resolving asbestos claims in
the Chapter 11 Cases will be greater than that set forth in the high
end of the range estimated in 2000. Counsel for the Official Committee
of Asbestos Personal Injury Claimants and counsel for the legal
representative for future asbestos personal injury claimants, appointed
in the Chapter 11 Cases, have indicated that they believe that the
liabilities for pending and future asbestos claims exceed the value of
Debtors' assets, and, therefore, are significantly greater than both
the reserved amount and the high end of the range estimated in 2000. As
the Chapter 11 Cases proceed, and the court addresses the issues
relating to estimation of Debtors' asbestos liabilities, the Debtors
likely will gain more information from which a reasonable estimate of
the Debtors' probable asbestos liability may be determined. If such
estimate differs from the existing reserve, the reserve will be
adjusted to reflect the estimate, and it is possible that a charge to
results of operations will be necessary at that time. It is also
possible that, in such a case, the Debtors' asbestos liability may vary
significantly from the recorded estimate of liability and that this
difference could be material to the Corporation's financial position,
results of operations and cash flows in the period recorded.

BOND TO SECURE CERTAIN CCR OBLIGATIONS: In January 2001, U.S. Gypsum
obtained a performance bond from Safeco Insurance Company of America
("Safeco") in the amount of $60.3 million to secure certain obligations
of U.S. Gypsum for extended payout settlements of Personal Injury Cases
and other obligations owed by U.S. Gypsum to the Center. The bond is
secured by an irrevocable letter of credit obtained by the Corporation
in the amount of $60.3 million and issued by Chase Manhattan Bank to
Safeco. After the Filing, by letter dated July 6, 2001, the Center
stated that certain amounts allegedly covered by the bond, totaling
approximately $15.7 million, were overdue from U.S. Gypsum to the
Center. In subsequent letters dated November 19, 2001, and December 11,
2001, the Center stated that additional amounts allegedly covered by
the bond totaling approximately $14 million and $113 million,
respectively, were also overdue from U.S. Gypsum. The amounts for which
the Center made demand were for the payment of, among other things,
settlements of Personal Injury Cases that were entered into
pre-petition. By letter dated November 16, 2001, the Center made a
demand to Safeco for payment of $15.7 million under the bond, and by
letter dated December 28, 2001, the Center made a demand to Safeco for
payment of approximately $127 million under the bond. The total amount
demanded by the Center under the bond, approximately $143 million,
exceeds the original penal sum of the bond, which is $60.3 million.
Safeco has not made any payment under the bond.

On November 30, 2001, the Corporation and U.S. Gypsum filed an
Adversary Complaint in the Chapter 11 Cases to, among other things,
enjoin the Center from drawing on the bond and enjoin Safeco from
paying on the bond during the pendency of these bankruptcy proceedings.
This Adversary Proceeding is pending in the United States Bankruptcy
Court for the District of Delaware

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and is captioned USG Corporation and United States Gypsum Company v.
Center for Claims Resolution, Inc. and Safeco Insurance Company of
America, No. 01-08932. Judge Wolin has consolidated the Adversary
Proceeding with similar adversary proceedings brought by Federal-Mogul
Corp., et al., and Armstrong World Industries, Inc., et al., in their
bankruptcy proceedings. 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, Judge Wolin issued an order and memorandum opinion which
granted in part and denied in part the CCR's motion for summary
judgment. Although the court ruled that Safeco is not required to remit
any surety bond proceeds to the CCR 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 due 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 will be substantially less than the
full amount of the bond. To the extent that Safeco were to pay any
portion of the bond, it is likely that Safeco would draw down the Chase
letter of credit to cover the bond payment and Chase would assert a
pre-petition claim in a corresponding amount against the Corporation in
the bankruptcy proceeding.

CONCLUSION: There are many uncertainties associated with the resolution
of asbestos liability in the bankruptcy proceeding. These uncertainties
include, among others, the number of asbestos-related claims that will
be filed against the Debtors in the proceeding; the number of future
claims that will be estimated in connection with preparing a plan of
reorganization; how the Long-Term Settlements will be treated in the
bankruptcy proceeding and plan of reorganization, and whether those
settlements will be set aside; how claims for punitive damages and
claims by persons with no asbestos-related physical impairment will be
treated and whether such claims will be allowed; the impact historical
settlement values for asbestos claims may have on the estimation of
asbestos liability in the bankruptcy proceeding; the results of the
estimation proceeding regarding asbestos personal injury claims
alleging cancer; the treatment of asbestos property damage claims in
the bankruptcy proceeding; and the impact any relevant potential
federal legislation may have on the proceeding (see Note 2. Voluntary
Reorganization Under Chapter 11 - Potential Federal Legislation
Regarding Asbestos Personal Injury Claims). The Corporation has not
revised its previously recorded reserve for asbestos liability. The
Corporation will continue to review its asbestos liability as the
Chapter 11 Cases progress. When a reasonable estimate can be made of
the Debtors' probable liability for asbestos claims, if such estimate
differs from the existing reserve, the reserve will be adjusted

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to reflect the estimate, and it is possible that a charge to results of
operations will be necessary at that time. It is possible that the
Corporation's asbestos liability may vary significantly from the
recorded estimate of liability and that this difference could be
material to the Corporation's financial position, results of operations
and cash flows in the period recorded.

ENVIRONMENTAL LITIGATION

The Corporation and certain of its subsidiaries have been notified by
state and federal environmental protection agencies of possible
involvement as one of numerous "potentially responsible parties" in a
number of so-called "Superfund" sites in the United States. In most of
these sites, the involvement of the Corporation or its subsidiaries is
expected to be minimal. The Corporation believes that appropriate
reserves have been established for its potential liability in
connection with all Superfund sites but is continuing to review its
accruals as additional information becomes available. Such reserves
take into account all known or estimated, 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 proceeding regarding environmental matters
will have a material adverse effect upon its financial position,
results of operations or cash flows.

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

VOLUNTARY REORGANIZATION UNDER CHAPTER 11

On June 25, 2001 (the "Petition Date"), the parent company (the "Parent
Company") of the Corporation and the 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"). The chapter 11 cases of the Debtors (collectively, the
"Chapter 11 Cases") are being 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; USG Interiors, Inc.; USG Interiors
International, Inc.; L&W Supply Corporation; Beadex Manufacturing, LLC; B-R
Pipeline Company; La Mirada Products Co., Inc.; Stocking Specialists, Inc.; USG
Industries, Inc.; and USG Pipeline Company.

This action was taken to resolve asbestos-related claims in a fair and equitable
manner, to protect the long-term value of the Debtors' businesses and to
maintain the Debtors' leadership positions in their markets.

BACKGROUND OF THE FILING

U.S. Gypsum, a subsidiary of the Parent Company, is a defendant in asbestos
lawsuits alleging both property damage and personal injury. Since 1994, U.S.
Gypsum has been named in more than 250,000 asbestos personal injury claims and
made cash payments of approximately $575 million (before insurance recoveries)
to manage and resolve asbestos-related claims. During 2000 and early 2001,
chapter 11 filings by other companies subject to asbestos litigation caused a
dramatic increase in U.S. Gypsum's asbestos costs beyond its legitimate
liabilities. Plaintiffs in asbestos lawsuits substantially increased their
settlement demands to U.S. Gypsum to replace the expected payments of the
bankruptcy defendants. Although the Corporation has been and continues to be
committed to finding a legislative solution to the increase in asbestos costs,
it became apparent in 2001 that a timely resolution to the problem through
legislation was not feasible. The Corporation determined that voluntary
protection under chapter 11 would be the best alternative for obtaining a fair
and final resolution of U.S. Gypsum's asbestos liability and the best way to
preserve value for stakeholders. See Part I, Item 1. Note 12. Litigation, for
additional information on asbestos litigation.

Based on an independent study conducted in 2000 and on U.S. Gypsum's historical
experience of litigating asbestos claims in the tort system, the Corporation
estimated that U.S. Gypsum's probable liability for costs associated with
asbestos cases pending as of December 31, 2000, and expected to be filed through
2003 to be between $889 million and $1,281 million, including defense costs. In
the fourth quarter of 2000, U.S. Gypsum recorded a noncash, pretax provision of
$850 million, increasing its total accrued reserve for asbestos claims to $1,185

-42-

million as of December 31, 2000. Substantially all of this reserve related to
personal injury claims and reflected management's expectation that U.S. Gypsum's
average cost per case would increase, at least in the short term, due to
distortions in the tort system resulting from the bankruptcies of other
defendants that led to increased settlement demands from asbestos plaintiffs.
Less than 10% of the reserve related to defense and administrative costs.
Between January 1, 2001, and the Petition Date, according to the Center for
Claims Resolution (the "Center"), U.S. Gypsum was served with more than 26,000
new claims. On a cash basis, U.S. Gypsum's asbestos-related personal injury
costs (before insurance) rose from $30 million in 1997 to $162 million in 2000
and, absent the Filing, were expected to exceed $275 million in 2001.

Because of the Filing, there is greater uncertainty concerning the liability
associated with asbestos cases. As a result, it is the Corporation's view that
no change should be made at this time to the previously recorded reserve for
asbestos claims, except to reflect certain minor asbestos-related costs incurred
since the Filing. However, it is possible that the cost of resolving asbestos
claims in the Chapter 11 Cases will be greater than that set forth in the high
end of the range estimated in 2000. Counsel for the Official Committee of
Asbestos Personal Injury Claimants and counsel for the legal representative for
future asbestos personal injury claimants, appointed in the Chapter 11 Cases,
have indicated that they believe that the liabilities for pending and future
asbestos claims exceed the value of Debtors' assets, and, therefore, are
significantly greater than both the reserved amount and the high end of the
range estimated in 2000. As the Chapter 11 Cases proceed, and the court
addresses the issues relating to estimation of Debtors' asbestos liabilities,
the Debtors likely will gain more information from which a reasonable estimate
of the Debtors' probable asbestos liability may be determined. If such estimate
differs from the existing reserve, the reserve will be adjusted to reflect the
estimate, and it is possible that a charge to results of operations will be
necessary at that time. It is also possible that, in such a case, the Debtors'
asbestos liability may vary significantly from the recorded estimate of
liability and that this difference could be material to the Corporation's
financial position, results of operations and cash flows in the period recorded.

CONSEQUENCES OF THE FILING

The Debtors are operating their businesses without interruption as
debtors-in-possession subject to the provisions of the Bankruptcy Code. All
vendors are being paid for all goods furnished and services provided after the
Filing. However, as a consequence of the Filing, pending litigation against the
Debtors as of the Petition Date is stayed, and no party may take any action to
pursue or collect pre-petition claims except pursuant to an order of the
Bankruptcy Court.

Three creditors' committees, one representing asbestos personal injury
claimants, another representing asbestos property damage claimants, and a third
representing general unsecured creditors, were appointed as official committees
in the Chapter 11 Cases and, in accordance with the provisions of the Bankruptcy
Code, will have the right to be heard on all matters that come before the
Bankruptcy Court. The

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Bankruptcy Court also appointed the Honorable Dean M. Trafelet as the legal
representative for future asbestos claimants in the Debtors' bankruptcy
proceeding. Mr. Trafelet was formerly a judge of the Circuit Court of Cook
County, Illinois. The Debtors expect that the appointed committees, together
with Mr. Trafelet, will play important roles in the Chapter 11 Cases and the
negotiation of the terms of any plan of reorganization.

Debtors intend to address all pending and future asbestos personal injury claims
as well as all other pre-petition claims in a plan or plans of reorganization
confirmed by the Bankruptcy Court. Debtors expect that the plan will include the
creation of one or more independently administered trusts under Section 524(g)
of the Bankruptcy Code, which will be funded by Debtors to allow payment of
present and future asbestos personal injury claims and demands. Debtors also
expect that the plan of reorganization will address Debtors' liability for
asbestos property damage claims, whether by including those liabilities in a
Section 524(g) trust or by other means.

It is anticipated that, as a result of creation and funding of the Section
524(g) trust(s), the Bankruptcy Court will issue a permanent injunction barring
the assertion of present and future asbestos claims against Debtors, their
successors, and their affiliates, and channeling those claims to the trust(s)
for payment in whole or in part. Section 524(g) contains specific requirements
for issuance of such a permanent injunction, including the requirement that the
trust must own, or have the right to own upon the occurrence of contingencies
specified in the plan of reorganization, a majority of the voting shares of the
debtor or its parent. Section 524(g) also requires that the plan be approved by
75% of the voting asbestos claimants whose claims are addressed by the trust.
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 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 Debtors, and/or their
successors and affiliates. In addition, if federal legislation addressing
asbestos personal injury claims is passed, which is extremely speculative at
this time, such legislation may affect the manner in which asbestos personal
injury claims are to be addressed in Debtors' Chapter 11 Cases and may affect
whether the Debtors establish a trust under Section 524(g). (see Potential
Federal Legislation Regarding Asbestos Personal Injury Claims, below)

Pursuant to the Bankruptcy Code, the Debtors had the exclusive right to propose
a plan of reorganization for 120 days following the Petition Date, unless
extended. The Bankruptcy Court has granted requests by the Debtors to extend the
period of exclusivity, which currently runs through September 1, 2003. The
Debtors intend to seek one or more additional extensions depending upon
developments in the Chapter 11 Cases. If the Debtors fail to file a plan of
reorganization during such extension period, or if such plan is not accepted by
the requisite numbers of creditors and equity holders entitled to vote on the
plan, other parties in interest in the Chapter 11 Cases may be permitted to

-44-

propose their own plan(s) of reorganization for the Debtors.

While it is the Debtors' intention to seek a full recovery for their creditors,
it is not possible to predict how the plan of reorganization will treat asbestos
and other pre-petition claims and what impact any plan may have on the value of
the shares of the Corporation's common stock and other outstanding securities.
Under the Bankruptcy Code, a plan of reorganization, including a plan creating a
Section 524(g) trust, may be confirmed without the consent of non-asbestos
creditors and equity security holders if certain requirements of the Code are
met. There is no assurance that there will be sufficient assets to satisfy the
Debtors' pre-petition liabilities in whole or in part, and the pre-petition
creditors of some Debtors may be treated differently from the pre-petition
creditors of other Debtors. The payment rights and other entitlements of
pre-petition creditors and USG shareholders may be substantially altered by any
plan or plans of reorganization confirmed in the Chapter 11 Cases. Pre-petition
creditors may receive under the plan of reorganization less than 100% of the
face value of their claims, and the interests of the Corporation's equity
security holders are likely to be substantially diluted or cancelled in whole or
in part.

It is also not possible to predict at this time 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. These arrangements, transactions, and
relationships may be challenged by various parties in the Chapter 11 Cases, and
the outcome of those challenges, if any, may have an impact on the treatment of
various claims under any plan of reorganization.

Whether the Corporation's equity has significant value and Debtors' non-asbestos
creditors recover the full value of their claims depend upon the outcome of the
analysis of the amount of Debtors' assets and liabilities, especially asbestos
liabilities, that must be funded under the plan. Counsel for the Official
Committee of Asbestos Personal Injury Claimants and counsel for the legal
representative for future asbestos personal injury claimants have advised the
court that is presiding over the Chapter 11 Cases that they believe Debtors'
asbestos liabilities exceed the value of Debtors' assets and that Debtors are
insolvent. The Debtors have advised the court that they believe they are solvent
if their asbestos liabilities are fairly and appropriately valued. Toward that
end, the Debtors filed a motion with the court requesting the court to begin
proceedings to estimate the value of Debtors' asbestos personal injury
liabilities.

In response to the Debtors' motion requesting an estimation of asbestos personal
injury liabilities, the court issued an order and memorandum opinion on February
19, 2003, setting forth a procedure for estimating Debtors' liability for
asbestos personal injury claims alleging cancer. (See Part I, Item 1. Note 12.
Litigation, for additional information on this procedure.) The court has not set
a timetable for this process. Thus, Debtors do not know when estimation of
Debtors' liability for these cancer claims will occur, what the outcome of that

-45-

proceeding will be, what impact that proceeding will have on estimating Debtors'
liability for asbestos personal injury claims alleging other diseases, and
whether the estimation proceeding will lead to a negotiated resolution of
Debtors' asbestos personal injury liabilities. Debtors also cannot predict at
this time the estimated cost of resolving asbestos property damage claims (See
Part I, Item 1. Note 12. Litigation, for additional information.) If the amount
of the Debtors' asbestos liabilities cannot be resolved through negotiation or
is not addressed by legislation (see Potential Federal Legislation Regarding
Asbestos Personal Injury Claims, below), the outcome of the estimation
proceedings regarding Debtors' liability for cancer claims, as provided in the
Court's order, likely will be a significant component of determining Debtors'
asbestos personal injury liability, Debtors' solvency, and the recovery of
Debtors' pre-petition creditors and equity security holders under any plan or
plans of reorganization.

As a result of this uncertainty, it is not possible at this time to predict the
timing or outcome of the Chapter 11 Cases, the terms and provisions of any plan
or plans of reorganization, or the effect of the chapter 11 reorganization
process on the claims of pre-petition creditors of the Debtors or the interests
of the Corporation's equity security holders. There can be no assurance as to
the value of any distributions that might be made under any plan or plans of
reorganization with respect to such pre-petition claims, equity interests, or
other outstanding securities. Recent developments in the Corporation's
bankruptcy proceeding are discussed in Part I, Item 1. Note 12. Litigation.

POTENTIAL FEDERAL LEGISLATION REGARDING ASBESTOS PERSONAL INJURY CLAIMS

The Corporation has for many years actively supported proposals for federal
legislation addressing asbestos personal injury claims. On July 10, 2003, the
Judiciary Committee of the United States Senate narrowly approved the Fairness
in Asbestos Injury Resolution Act of 2003 (Senate Bill 1125, the "FAIR Bill"),
which is intended to establish a nationally administered trust to compensate
asbestos personal injury claimants. This bill has not been approved by the
Senate, has not been introduced in the House of Representatives, and is not law.

Under the terms of the FAIR Bill as approved by the Judiciary Committee,
companies that have been defendants in asbestos personal injury litigation, as
well as insurance companies, are to contribute amounts to a national trust on a
periodic basis to fund payment of claims filed by asbestos personal injury
claimants who qualify for payment under the FAIR Bill based on an allocation
methodology specified in the FAIR Bill. The FAIR Bill also provides, among other
things, that the national fund would terminate if the administrator could not
certify that 95% of the previous year's eligible claimants had been paid, in
which case the claimants and defendants would return to the tort system on a
retroactive basis. There are many other provisions in the FAIR Bill that would
affect its impact on the Corporation and its Chapter 11 Cases.

It is not possible to determine whether the FAIR Bill will ever be presented for
a vote or passed by the full Senate or the House of Representatives, or whether

-46-

the FAIR Bill will be signed into law. Nor is it possible at this time to
predict the final terms or cost of any bill that might become law or its impact
on the Corporation or the Chapter 11 Cases. The Corporation anticipates that,
during the legislative process, the terms of the FAIR Bill as approved by the
Judiciary Committee will change and that any such changes may be material to the
FAIR Bill's impact on the Corporation. It is possible that the level of funding
required from insurers and defendants, including the Corporation, would
increase. Many organized labor organizations, including the AFL-CIO, have
indicated their opposition to the FAIR Bill, and the American Insurance
Association, a national organization of insurance companies, has also expressed
opposition to the FAIR Bill in the form passed by the Judiciary Committee. In
light of such opposition, as well as other factors, there is no assurance that
any legislation will be enacted.

Enactment of the FAIR Bill or other legislation addressing the financial
contributions of USG Corporation for asbestos personal injury claims would have
a material impact on the Corporation's Chapter 11 Cases. Legislation such as the
FAIR Bill would have a material impact on the amount of the Corporation's
asbestos personal injury liability that must be addressed in Debtors' Chapter 11
Cases. Such legislation may also affect the manner in which such liability may
be addressed in Debtors' Chapter 11 Cases. As noted above (see Consequences of
the Filing, above), the amount of Debtors' asbestos personal injury liability is
a principal factor in determining the payment rights and other entitlements of
the Corporation's pre-petition creditors and its shareholders. At this time,
however, the outcome of the legislative process is extremely speculative, and
there can be no assurance that national legislation will be enacted or what the
terms of any such legislation might be. During this process, the Corporation
anticipates that the Chapter 11 Cases, including the proceedings regarding
estimation of the Corporation's asbestos personal injury liabilities, will
continue. (See Consequences of the Filing, above, and Part I, Item 1. Note 12.
Litigation.)

CHAPTER 11 FINANCING

On July 31, 2001, a $350 million debtor-in-possession financing facility (the
"DIP Facility") was approved by the Bankruptcy Court to supplement liquidity and
fund operations during the reorganization process. The DIP Facility was provided
by a syndicate of lenders led by JPMorgan Chase Bank (formerly The Chase
Manhattan Bank) as agent. In January 2003, the Corporation reduced the size of
the DIP Facility to $100 million and subsequently terminated the DIP Facility in
June 2003. These actions were taken at the election of the Corporation due to
the levels of cash and marketable securities on hand and to eliminate costs
associated with the DIP Facility. The DIP Facility was used largely for the
issuance of standby letters of credit needed to support business operations. 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. See Available Liquidity below for additional
information on the DIP Facility.

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ACCOUNTING IMPACT

The Corporation is required to follow AICPA Statement of Position 90-7 ("SOP
90-7"), "Financial Reporting by Entities in Reorganization under the Bankruptcy
Code." Pursuant to SOP 90-7, the Corporation's pre-petition liabilities that are
subject to compromise are reported separately on the consolidated balance sheet.
Virtually all of the Corporation's pre-petition debt is currently in default and
was recorded at face value and classified within liabilities subject to
compromise. U.S. Gypsum's asbestos liability also is classified within
liabilities subject to compromise. See Part I, Item 1. Note 2. Voluntary
Reorganization Under Chapter 11, which includes information related to financial
statement presentation, the debtor-in-possession statements and detail of
liabilities subject to compromise and chapter 11 reorganization expenses.

CONSOLIDATED RESULTS

NET SALES

Net sales in the second quarter of 2003 were $914 million, up 3% from $885
million in the second quarter of 2002. For the first six months of 2003, net
sales totaled $1,776 million, up 4% from $1,714 million in the comparable 2002
period. North American Gypsum and Building Products Distribution reported
increased net sales in the second quarter and first six months of 2003, while
net sales for Worldwide Ceilings were down slightly for each period.

COST OF PRODUCTS SOLD

Cost of products sold in the second quarter and first six months of 2003 were up
9% and 8%, respectively, versus the respective 2002 periods. Key factors for
these increases were rising costs related to energy, raw materials, employee
benefits and insurance premiums.

SELLING AND ADMINISTRATIVE EXPENSES

Year-on year variations in selling and administrative expenses were minimal. For
the second quarter, the expenses amounted to $81 million (8.9% of net sales),
compared with $80 million (9.0% of net sales) in 2002. For the first six months,
these expenses were $161 million (9.1% of net sales), versus $162 million (9.5%
of net sales) a year ago.

CHAPTER 11 REORGANIZATION EXPENSES

Chapter 11 reorganization expenses consist of the following (dollars in
millions):

THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------------------------------------------------------------
2003 2002 2003 2002
----------------------------------------------------------------------

Legal and financial advisory fees $ 5 $ 9 $ 9 $ 13
Bankruptcy-related interest income (2) (2) (4) (4)
- -------------------------------------------------------------------------------------------------------------------------
Total chapter 11 reorganization expenses 3 7 5 9
=========================================================================================================================

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OPERATING PROFIT

Operating profit declined 38% to $50 million in the second quarter of 2003 and
was down 34% to $85 million for first six months of 2003 versus the respective
2002 periods primarily due to the increased levels of cost of products sold.

INTEREST EXPENSE

Interest expense of $2 million and $3 million was incurred in the second quarter
and first six months of 2003, respectively. 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. For the second quarter and first six months of 2003,
contractual interest expense not accrued or recorded on pre-petition debt
totaled $18 million and $36 million, respectively. Although no post-petition
accruals are required to be made for such contractual interest expense,
debtholders may seek to recover such amounts in the Chapter 11 Cases.

INTEREST INCOME

Interest income was $1 million in the second quarter and $2 million in the first
six months of 2003.

INCOME TAXES

Income taxes amounted to $23 million and $36 million in the second quarter and
first six months of 2003, respectively, compared with $33 million and $54
million in the corresponding 2002 periods. The effective tax rates were 39.9%
and 42.3% for the first six months of 2003 and 2002, respectively. The decrease
in the effective tax rate was primarily due to the benefit of a tax rate change
applicable to one of the Corporation's foreign subsidiaries.

CUMULATIVE EFFECT OF ACCOUNTING CHANGES

On January 1, 2003, the Corporation adopted Statement of Financial Accounting
Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations." This
standard requires the recording of the fair value of a liability for an asset
retirement obligation in the period in which it is incurred. The Corporation's
asset retirement obligations include reclamation requirements as regulated by
government authorities related principally to assets such as the Corporation's
mines, quarries, landfills, ponds and wells. The impact of adopting SFAS No. 143
was an increase in the Corporation's assets and liabilities of $14 million and
$30 million, respectively. A noncash, after-tax charge of $16 million ($27
million pretax) was reflected on the consolidated statement of earnings as a
cumulative effect of a change in accounting principle as of January 1, 2003.

On January 1, 2002, USG Corporation adopted SFAS No. 142, "Goodwill and Other
Intangible Assets." In accordance with the provisions of SFAS No. 142, the
Corporation determined that goodwill for its North American Gypsum segment was
impaired and recorded a noncash, nontaxable impairment charge of $96 million.
This charge, which includes a $6 million deferred currency translation
write-off, is reflected on the Corporation's consolidated statement of earnings
as a cumulative effect of a change in accounting principle as of January 1,
2002.

-49-

NET EARNINGS (LOSS)

Net earnings of $31 million, or $0.73 per share, were reported for the second
quarter of 2003 compared with $48 million, or $1.11 per share, for the second
quarter of 2002. For the first six months of 2003, net earnings totaled $37
million, or $0.86 per share, compared with a net loss of $22 million, or $0.52
per share, for the first six months of 2002.

CORE BUSINESS RESULTS
(dollars in millions)

THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------------------------------
2003 2002 2003 2002
----------------------------------------

NET SALES:

NORTH AMERICAN GYPSUM:
U.S. Gypsum Company $ 512 $ 503 $ 1,008 $ 986
CGC Inc. (gypsum) 62 56 119 106
Other subsidiaries* 35 34 63 64
Eliminations (43) (42) (82) (80)
- -----------------------------------------------------------------------------------
Total 566 551 1,108 1,076
- -----------------------------------------------------------------------------------
WORLDWIDE CEILINGS:
USG Interiors, Inc. 114 117 224 228
USG International 42 44 82 86
CGC Inc. (ceilings) 12 11 22 21
Eliminations (14) (14) (27) (29)
- -----------------------------------------------------------------------------------
Total 154 158 301 306
- -----------------------------------------------------------------------------------
BUILDING PRODUCTS DISTRIBUTION:
L&W Supply Corporation 325 306 620 581
- -----------------------------------------------------------------------------------
Eliminations (131) (130) (253) (249)
- -----------------------------------------------------------------------------------
Total USG Corporation 914 885 1,776 1,714
===================================================================================

OPERATING PROFIT (LOSS):

NORTH AMERICAN GYPSUM:
U.S. Gypsum Company 36 68 66 114
CGC Inc. (gypsum) 7 7 12 13
Other subsidiaries* 4 6 7 12
- -----------------------------------------------------------------------------------
Total 47 81 85 139
- -----------------------------------------------------------------------------------
WORLDWIDE CEILINGS:
USG Interiors, Inc. 7 11 13 18
USG International 1 (2) 2 (5)
CGC Inc. (ceilings) 1 2 2 3
- -----------------------------------------------------------------------------------
Total 9 11 17 16
- -----------------------------------------------------------------------------------
BUILDING PRODUCTS DISTRIBUTION:
L&W Supply Corporation 16 13 24 20
- -----------------------------------------------------------------------------------
Corporate (18) (17) (36) (37)
Chapter 11 reorganization expenses (3) (7) (5) (9)
Eliminations (1) (1) - (1)
- -----------------------------------------------------------------------------------
Total USG Corporation 50 80 85 128
===================================================================================

*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.

-50-

NORTH AMERICAN GYPSUM

Net sales of $566 million increased 3% from the second quarter of 2002, while
operating profit of $47 million was down 42%. First six months net sales of
$1,108 million reflect an increase of 3% from a year ago, while operating profit
of $85 million fell 39%.

For the second quarter of 2003, U.S. Gypsum reported a 2% increase in net sales,
but a 47% decrease in operating profit versus the second quarter of 2002. The
increase in net sales largely reflected record second quarter shipments of
complementary products such as SHEETROCK(R) brand joint compounds, DUROCK(R)
brand cement board and FIBEROCK(R) brand gypsum fiber panels. However, results
for SHEETROCK(R) brand gypsum wallboard were adversely affected by lower selling
prices and higher manufacturing costs, while shipments were unchanged.

U.S. Gypsum sold 2.6 billion square feet of SHEETROCK(R) brand gypsum wallboard
during the second quarters of both 2003 and 2002. U.S. Gypsum's wallboard plants
operated at 90% of capacity in the second quarter of 2003 versus 95% for the
same period in 2002. The lower 2003 utilization rate reflects increases in
wallboard capacity at several U.S. Gypsum plants as a result of process
improvements. Industry shipments of gypsum wallboard were up approximately 3%
from the second quarter of 2002.

U.S. Gypsum's nationwide average realized price for gypsum wallboard was $100.47
per thousand square feet in the second quarter of 2003. This price was down 2%
from $102.13 in the second quarter of 2002, but up 3% from $97.13 in the first
quarter of 2003.

The higher manufacturing costs for gypsum wallboard primarily reflected higher
energy and wastepaper costs. The increase in energy costs related to wallboard
manufacturing accounted for a $10 million increase to cost of products sold in
the second quarter of 2003. Higher energy and material costs also had an adverse
affect on profit margins for U.S. Gypsum's complementary products.

The gypsum business of Canada-based CGC Inc. reported an 11% increase in second
quarter net sales, while operating profit of $7 million was unchanged from year
ago. Most of the increase in CGC's net sales was attributable to strengthening
of the Canadian dollar versus the U.S. dollar. However, the favorable currency
impact on operating profit was offset by higher operating costs.

WORLDWIDE CEILINGS

Second quarter 2003 net sales of $154 million fell 3%, while operating profit
declined to $9 million from $11 million for the second quarter of 2002. For the
first six months of 2003, net sales of $301 million were down 2%, while
operating profit increased to $17 million from $16 million a year ago.

USG Interiors, Inc., the Corporation's domestic ceilings business, reported
second quarter declines in net sales and operating profit. Net sales were down
primarily due to continued lower levels of demand for commercial ceiling

-51-

products. The decline in profitability was largely due to lower shipments, an
increase in the cost of steel, and higher energy costs. Profit margins for USG
Interiors remain under pressure due to these cost increases, which have been
partially offset by higher selling prices and improved operating efficiencies.

Net sales for USG International were down $2 million versus the second quarter
of 2002. However, operating profit of $1 million was reported for the second
quarter of 2003 compared with an operating loss of $2 million in the prior-year
period. Profitability for USG International improved following the shutdown of
the Aubange, Belgium, ceiling tile plant and other downsizing activities in the
fourth quarter of 2002.

The ceilings business of CGC Inc. reported a $1 million increase in net sales
and a $1 million decrease in operating profit for the second quarter of 2003.

BUILDING PRODUCTS DISTRIBUTION

L&W Supply Corporation, the leading specialty building products distribution
business in the United States, reported second quarter net sales of $325 million
and operating profit of $16 million, representing increases of 6% and 23%,
respectively, from the second quarter of 2002. For the first six months of 2003,
net sales of $620 million and operating profit of $24 million increased 7% and
20%, respectively, versus the first six months of 2002.

Second quarter results for L&W Supply reflected record shipments of gypsum
wallboard (up 8% versus the second quarter of 2002), improved operating
efficiencies and increased sales of complementary building products, primarily
drywall metal, joint treatment, ceiling products and roofing.

As of June 30, 2003, L&W Supply operated 183 locations in the United States
distributing a variety of gypsum, ceilings and related building materials.

MARKET CONDITIONS AND OUTLOOK

The outlook for the Corporation's markets for the remainder of the year is
mixed. Industry demand for gypsum wallboard is expected to remain strong due to
continued high demand for new homes and favorable levels of activity in the
residential remodeling market. Despite the strong level of demand, the gypsum
wallboard industry continues to experience a large amount of excess capacity.
Industry utilization rates are expected to remain in the mid-80% range while
pricing pressures continue. Nonresidential construction, the principal market
for the Corporation's ceiling products and a major market for its distribution
business, is expected to remain weak. In addition, the Corporation, like many
other companies, faces cost pressures in areas such as energy and raw material
costs, employee benefits and insurance premiums. In this environment, the
Corporation is focusing its management attention and investments on improving
customer service, manufacturing costs and operating efficiencies, as well as
selectively investing to grow its businesses. In addition, the Corporation will

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diligently continue its attempt to resolve the chapter 11 proceedings,
consistent with the goal of achieving a fair, comprehensive and final resolution
to its asbestos liability.

LIQUIDITY AND CAPITAL RESOURCES

WORKING CAPITAL

Working capital (current assets less current liabilities) as of June 30, 2003,
amounted to $994 million, and the ratio of current assets to current liabilities
was 3.39-to-1. As of December 31, 2002, working capital amounted to $955
million, and the ratio of current assets to current liabilities was 3.18-to-1.

Cash, cash equivalents, restricted cash and marketable securities as of June 30,
2003, amounted to $788 million, compared with $830 million as of December 31,
2002. During the first six months of 2003, net cash flows used for operating
activities totaled $4 million. Net cash flows used for investing activities
totaled $95 million and consisted of $57 million for the purchases of marketable
securities, net of sales or maturities, $36 million for capital expenditures and
$2 million for the acquisition of a business.

During the first six months of 2003, the Corporation increased its investments
in marketable securities to $238 million as of June 30, 2003 ($172 million in
long-term marketable securities and $66 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 sheet.

Receivables increased to $369 million as of June 30, 2003, from $284 million as
of December 31, 2002, largely reflecting a 17% increase in net sales for the
month of June 2003 as compared with December 2002. Inventories and payables also
were up from December 31, 2002, primarily due to the increased level of
business. Inventories increased to $287 million from $270 million, and accounts
payable increased to $200 million from $170 million. Accrued expenses declined
to $189 million from $243 million as of December 31, 2002, primarily due to
payments associated with accrued employee benefits and compensation.

DEBT

As of June 30, 2003, total debt amounted to $1,007 million, of which $1,005
million was included in liabilities subject to compromise. These amounts were
unchanged from the December 31, 2002 levels and do not include any accruals for
post-petition contractual interest expense. (See Part I, Item 1. Note 2.
Voluntary Reorganization Under Chapter 11 - Interest Expense.)

AVAILABLE LIQUIDITY

As of June 30, 2003, the Corporation had on a consolidated basis $788 million of
cash (including $21 million of restricted cash as explained below) and
marketable securities, of which $165 million was held by non-Debtor
subsidiaries.

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In January 2003, the Corporation reduced the size of the DIP Facility to $100
million and subsequently terminated the DIP Facility in June 2003. These actions
were taken at the election of the Corporation due to the levels of cash and
marketable securities on hand and to eliminate costs associated with the DIP
Facility.

The DIP Facility was used largely for the issuance of standby letters of credit
needed to support business operations. As of June 30, 2003, $15.2 million of
standby letters of credit remained outstanding under the DIP Facility. Following
the termination of the DIP Facility, the Corporation has been required to cash
collateralize 105% of these outstanding letters of credit until the letters of
credit either expire or are returned by the beneficiary. The Corporation expects
the collateral related to the DIP Facility to be released during the third
quarter of 2003.

In June 2003, the Corporation entered a three-year, $100 million credit
agreement with LaSalle Bank to be used exclusively to support the issuance of
standby letters of credit. As of June 30, 2003, $4.5 million of standby letters
of credit, which are cash collateralized at 103%, had been issued under this
facility to replace those to be surrendered by the beneficiaries in connection
with the termination of the DIP Facility.

As of June 30, 2003, a total of $21 million in cash collateral was posted to
back up letters of credit as indicated above and was reported as restricted cash
on the consolidated balance sheet.

CAPITAL EXPENDITURES

Capital spending amounted to $36 million in the first six months of 2003
compared with $38 million in the corresponding 2002 period. As of June 30, 2003,
remaining capital expenditure commitments for the replacement, modernization and
expansion of operations amounted to $53 million, compared with $56 million as of
December 31, 2002.

During the bankruptcy proceeding, the Corporation expects to 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.

EXIT ACTIVITIES

2002 DOWNSIZING PLAN: In the fourth quarter of 2002, the Corporation recorded a
nontaxable charge of $11 million related to the shutdown of the Aubange,
Belgium, ceiling tile plant and other downsizing activities in Europe to address
the continuing weakness of the commercial ceilings market in Europe. The charge
was included in cost of products sold and reflected severance of $6 million
related to a workforce reduction of over 50 positions (salaried and hourly),
equipment writedowns of $3 million and other reserves of $2 million. The other
reserves

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primarily related to lease cancellations, inventories and receivables. As of
June 30, 2003, 53 employees were terminated. The Aubange, Belgium, plant ceased
operations in December 2002. The reserve for the 2002 downsizing plan was
included in accrued expenses on the consolidated balance sheets. Charges against
the reserve included the $3 million write-off of equipment in 2002 and payments
totaling $6 million in the first six months of 2003. All payments associated
with the 2002 downsizing plan are being funded with cash from operations.

2001 RESTRUCTURING PLAN: In the fourth quarter of 2001, the Corporation recorded
a charge of $12 million pretax ($10 million after-tax) related to a
restructuring plan that included the shutdown of a gypsum wallboard plant in
Fremont, Calif., a drywall steel plant in Prestice, Czech Republic, a ceiling
tile plant in San Juan Ixhuatepec, Mexico, a ceiling tile manufacturing line in
Greenville, Miss., and other restructuring activities. Included in the $12
million pretax charge was $8 million for severance related to a workforce
reduction of more than 350 positions (primarily hourly positions), $2 million
for the write-off of property, plant and equipment, and $2 million for line
shutdown and removal and contract cancellations. The 2001 restructuring was
intended to allow the Corporation to optimize its manufacturing operations.

A total of 348 employees were terminated, and 26 open positions were eliminated,
and a ceiling tile manufacturing line at Greenville, Miss., and the plants in
San Juan Ixhuatepec, Mexico, and Prestice, Czech Republic, were shut down. The
Fremont, Calif., plant ceased production in the second quarter of 2002. Annual
savings from the full implementation of the 2001 restructuring initiatives are
estimated at $11 million. The reserve for the 2001 restructuring plan was
included in accrued expenses on the consolidated balance sheets. Charges against
the reserve in 2001 included the $2 million write-off of property, plant and
equipment and payments totaling $2 million. An additional $3 million of payments
were made and charged against the reserve in 2002. The remaining $5 million of
payments were made and charged against the reserve in the first quarter of 2003.
All payments associated with the 2001 restructuring plan were funded with cash
from operations.

See Part I, Item 1. Note 3. Exit Activities for additional information related
to payments and reserve balances.

OTHER MATTERS

LEGAL CONTINGENCIES

As a result of the Filing, all pending asbestos lawsuits against U.S. Gypsum and
other subsidiaries are stayed, and no party may take any action to pursue or
collect on such asbestos claims absent specific authorization of the Bankruptcy
Court. See Part I, Item 1. Note 2. Voluntary Reorganization Under Chapter 11 and
Note 12. Litigation for recent developments in the Corporation's reorganization
proceedings. See Part I. Item 1. Note 12. Litigation for additional information
on asbestos litigation.

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The Corporation and certain of its subsidiaries have been notified by state and
federal environmental protection agencies of possible involvement as one of
numerous "potentially responsible parties" in a number of so-called "Superfund"
sites in the United States. The Corporation believes that neither these matters
nor any other known governmental proceeding regarding environmental matters will
have a material adverse effect upon its results of operations or financial
position. See Part I, Item 1. Note 12. Litigation for additional information on
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 2002 Annual Report on Form 10-K, which was filed on February 27,
2003, includes a summary of the critical accounting policies the Corporation
believes are the most important to aid in understanding its financial results.
There have been no material changes to these critical accounting policies that
impacted the Corporation's reported amounts of assets, liabilities, revenues or
expenses during the first half of 2003. Effective in 2003, critical accounting
policies also include the following:

Adoption of SFAS No. 143: On January 1, 2003, the Corporation adopted SFAS No.
143, "Accounting for Asset Retirement Obligations." This standard requires the
recording of the fair value of a liability for an asset retirement obligation in
the period in which it is incurred. The Corporation's asset retirement
obligations include reclamation requirements as regulated by government
authorities related principally to assets such as the Corporation's mines,
quarries, landfills, ponds and wells. The accounting for asset retirement
obligations requires a number of estimates by management as to the timing of
asset retirements, the cost of retirement obligations, discount and inflation
rates used in the determination of fair values and the methods of remediation
associated with the Corporation's asset retirement obligations. The Corporation
generally utilizes assumptions and estimates reflective of the most likely
remediation method on a site by site basis. See Part I, Item 1. Note 6. Adoption
of SFAS No. 143 for additional information related to the impact of this change
in accounting principle.

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements related to management's
expectations about future conditions. The effects of the Filing and the conduct,
outcome and costs of the Chapter 11 Cases, as well as the ultimate costs
associated with the Corporation's asbestos litigation, may differ from
management's expectations. Actual business or other conditions may also differ
significantly from management's expectations and accordingly affect the
Corporation's sales and profitability or other results. Actual results may
differ due to various other factors, including economic conditions such as the
levels

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of construction activity, interest rates, currency exchange rates and consumer
confidence; competitive conditions such as price and product competition;
shortages in raw materials; increases in raw material and energy costs; possible
impact of asbestos-related legislation; and the unpredictable effects of the
global war on terrorism upon domestic and international economies and financial
markets. The Corporation assumes no obligation to update any forward-looking
information contained in this report.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures.

The Corporation's chief executive officer and chief financial officer,
after evaluating the effectiveness of the Corporation's "disclosure
controls and procedures" (as defined in Rule 13a-15(e) of the
Securities Exchange Act of 1934), have concluded that, as of the end of
the fiscal quarter covered by this report on Form 10-Q, the
Corporation's disclosure controls and procedures were adequate and
designed to ensure that material information relating to the
Corporation and its consolidated subsidiaries would be made known to
them by others within those entities.

(b) Changes in internal control over financial reporting.

There was no change in the Corporation's "internal control over
financial reporting" (as defined in Rule 13a-15(e) 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 PUBLIC ACCOUNTANTS

To the Stockholders and Board of Directors of USG Corporation:

We have reviewed the accompanying consolidated balance sheet of USG Corporation
and subsidiaries as of June 30, 2003 and the related consolidated statements of
earnings and cash flows for the three month and six month periods ended June 30,
2003 and 2002. These interim financial statements are the responsibility of the
Corporation's management.

We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and of making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States of
America, the objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.

Based on our reviews, we are not aware of any material modifications that should
be made to such consolidated financial statements for them to be in conformity
with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of USG
Corporation and subsidiaries as of December 31, 2002, and the related
consolidated statements of income, stockholders' equity, and cash flows for the
year then ended (not presented herein); and in our report dated February 3, 2003
(February 19, 2003 as to paragraphs 13, 14 and 15 of Note 18), we expressed an
unqualified opinion on those consolidated financial statements and included
explanatory paragraphs concerning (i) the Corporation's Chapter 11 bankruptcy
filing, (ii) matters that raised substantial doubt about the Corporation's
ability to continue as a going concern, and (iii) transitional disclosures
related to the change in accounting for goodwill. In our opinion, the
information set forth in the accompanying condensed consolidated balance sheet
as of December 31, 2002 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, 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

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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 12 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 12 to the financial statements. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.

/s/ DELOITTE & TOUCHE LLP

DELOITTE & TOUCHE LLP

Chicago, Illinois
July 28, 2003

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

See Part I, Item 1. Note 12. Litigation for information concerning the asbestos
and related bankruptcy litigation and environmental litigation.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

(a) In accordance with the Corporation's notice and proxy
statement dated April 4, 2003, the matter set forth in
paragraph (b) below was submitted to a vote of stockholders at
its May 14, 2003 annual meeting of stockholders.

(b) The four director-nominees who received the highest vote
totals, who were each re-elected to a three-year term of
office, and whose terms in office will expire in 2006 were:
Keith A. Brown, James C. Cotting, W. Douglas Ford and John B.
Schwemm. The directors whose terms of office continued after
the annual meeting of stockholders were: Robert L. Barnett,
Lawrence M. Crutcher, William C. Foote, David W. Fox, Valerie
B. Jarrett, Marvin E. Lesser and Judith A. Sprieser.

Votes Abstentions
Votes Withheld and Broker
For or Against Non-Votes
----------------------------------------------

Election of Directors:

Keith A. Brown 39,380,766 353,906 -
James C. Cotting 39,383,189 351,483 -
W. Douglas Ford 39,383,526 351,146 -
John B. Schwemm 39,367,743 366,929 -

(c) The following proposal was recommended by the Corporation's
Board of Directors and was approved by a majority of the
shares voted.

Votes Abstentions
Votes Withheld and Broker
For or Against Non-Votes
----------------------------------------

Ratification of Appointment of
Deloitte & Touche LLP as Independent
Public Accountants 39,407,053 183,957 143,662

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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits:

10. Master Letter of Credit Agreement, Rider to Master
Letter of Credit Agreement, and Related Pledge
Agreement, Acknowledgement Agreement if Collateral
Held at LaSalle Bank National Association Trust
Department, LaSalle Bank National Association Trust
Department Internal, Pledge Agreement between USG
Corporation and LaSalle Bank National Association,
dated June 11, 2003.

15. Letter from Deloitte & Touche LLP regarding unaudited
financial information.

31.1 Certifications of USG Corporation's Chief Executive
Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.

31.2 Certifications of USG Corporation's Chief Financial
Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.

32.1 Certifications of USG Corporation's Chief Executive
Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.

32.2 Certifications of USG Corporation's Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.

(b) Reports on Form 8-K:

On April 24, 2003, USG Corporation filed with the SEC a Form 8-K for
the purpose of disclosing, under "Item 12. Results of Operations and
Financial Condition", its press release containing earnings information
for its first quarter of 2003.

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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,

August 5, 2003

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