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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 March 31, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 1-8864
USG CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 36-3329400
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
125 South Franklin Street, Chicago, Illinois 60606-4678
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (312) 606-4000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes X No
----- -----
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes X No
----- -----
The number of shares outstanding of the registrant's common stock as of March
31, 2005, was 43,343,283.
TABLE OF CONTENTS
Page
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Statements of Earnings:
Three Months Ended March 31, 2005 and 2004 3
Consolidated Balance Sheets:
As of March 31, 2005 and December 31, 2004 4
Consolidated Statements of Cash Flows:
Three Months Ended March 31, 2005 and 2004 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Results
of Operations and Financial Condition 38
Item 4. Controls and Procedures 50
Report of Independent Registered Public Accounting Firm 52
PART II OTHER INFORMATION
Item 1. Legal Proceedings 54
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 54
Item 5. Other Information 54
Item 6. Exhibits 55
Signatures 56
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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
ENDED MARCH 31,
-------------------------
2005 2004
----------- -----------
Net sales $ 1,173 $ 1,020
Cost of products sold 959 849
----------- -----------
Gross profit 214 171
Selling and administrative expenses 89 77
Chapter 11 reorganization expenses 1 2
----------- -----------
Operating profit 124 92
Interest expense 1 1
Interest income (2) (1)
Other expense, net -- 2
----------- -----------
Earnings before income taxes 125 90
Income taxes 48 33
----------- -----------
Net earnings 77 57
=========== ===========
Basic earnings per common share 1.77 1.33
Diluted earnings per common share 1.77 1.33
Average common shares 43,327,008 43,022,719
Average diluted common shares 43,506,597 43,023,995
See accompanying Notes to Consolidated Financial Statements.
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USG CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
(UNAUDITED)
AS OF AS OF
MARCH 31, DECEMBER 31,
2005 2004
--------- ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 669 $ 756
Short-term marketable securities 178 138
Restricted cash 42 43
Receivables (net of reserves - $15 and $14) 523 413
Inventories 346 338
Income taxes receivable 23 24
Deferred income taxes 7 25
Other current assets 94 53
------ ------
Total current assets 1,882 1,790
Long-term marketable securities 310 312
Property, plant and equipment (net of accumulated
depreciation and depletion - $903 and $878) 1,856 1,853
Deferred income taxes 134 152
Goodwill 43 43
Other assets 150 128
------ ------
Total Assets 4,375 4,278
====== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable 268 270
Accrued expenses 194 224
Current portion of long-term debt 1 1
Income taxes payable 94 75
------ ------
Total current liabilities 557 570
Deferred income taxes 26 25
Other liabilities 417 417
Liabilities subject to compromise 2,241 2,242
Commitments and contingencies
Stockholders' Equity:
Preferred stock -- --
Common stock 5 5
Treasury stock (256) (256)
Capital received in excess of par value 418 417
Accumulated other comprehensive income 49 17
Retained earnings 918 841
------ ------
Total stockholders' equity 1,134 1,024
------ ------
Total Liabilities and Stockholders' Equity 4,375 4,278
====== ======
See accompanying Notes to Consolidated Financial Statements.
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USG CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
THREE MONTHS
ENDED MARCH 31,
---------------
2005 2004
----- -----
OPERATING ACTIVITIES:
Net earnings $ 77 $ 57
Adjustments to reconcile net earnings to net cash:
Depreciation, depletion and amortization 30 28
Deferred income taxes 15 12
(Increase) decrease in working capital:
Receivables (110) (130)
Income taxes receivable 1 1
Inventories (8) (24)
Payables 17 62
Accrued expenses (26) (26)
(Increase) decrease in other assets (9) 6
Increase in other liabilities 2 2
Change in asbestos receivable -- 10
Decrease in liabilities subject to compromise (1) (1)
Other, net (2) --
----- -----
Net cash used for operating activities (14) (3)
----- -----
INVESTING ACTIVITIES:
Capital expenditures (33) (20)
Purchases of marketable securities (184) (115)
Sales or maturities of marketable securities 144 78
Net proceeds from asset dispositions -- 6
Acquisition of business -- (4)
Return (deposit) of restricted cash 1 (12)
----- -----
Net cash used for investing activities (72) (67)
----- -----
FINANCING ACTIVITIES:
Issuances of common stock 1 --
----- -----
Net cash provided by financing activities 1 --
----- -----
Effect of exchange rate changes on cash (2) (1)
Net decrease in cash and cash equivalents (87) (71)
Cash and cash equivalents at beginning of period 756 700
----- -----
Cash and cash equivalents at end of period 669 629
===== =====
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Interest paid 1 --
Income taxes paid, net 15 8
See accompanying Notes to Consolidated Financial Statements.
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USG CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) PREPARATION OF FINANCIAL STATEMENTS
The accompanying unaudited consolidated financial statements of USG
Corporation ("the Corporation") have been prepared in accordance with
applicable United States Securities and Exchange Commission guidelines
pertaining to interim financial information. The preparation of financial
statements in conformity with accounting principles generally accepted in
the United States of America requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses. Actual results could differ from those estimates. In
the opinion of management, the financial statements reflect all
adjustments, which are of a normal recurring nature, necessary for a fair
presentation of the Corporation's financial results for the interim
periods. These financial statements and notes are to be read in conjunction
with the financial statements and notes included in the Corporation's 2004
Annual Report on Form 10-K which was filed on February 18, 2005.
(2) VOLUNTARY REORGANIZATION UNDER CHAPTER 11
On June 25, 2001 (the "Petition Date"), the Corporation and the 10 United
States subsidiaries listed below (collectively, the "Debtors") filed
voluntary petitions for reorganization (the "Filing") under chapter 11 of
the United States Bankruptcy Code (the "Bankruptcy Code") in the United
States Bankruptcy Court for the District of Delaware (the "Bankruptcy
Court"). This action was taken to resolve asbestos claims in a fair and
equitable manner, to protect the long-term value of the Debtors'
businesses, and to maintain the Debtors' leadership positions in their
markets.
The chapter 11 cases of the Debtors (collectively, the "Chapter 11 Cases")
are 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 ("U.S. Gypsum"); USG Interiors,
Inc. ("USG Interiors"); USG Interiors International, Inc.; L&W Supply
Corporation ("L&W Supply"); Beadex Manufacturing, LLC; B-R Pipeline
Company; La Mirada Products Co., Inc.; Stocking Specialists, Inc.; USG
Industries, Inc.; and USG Pipeline Company.
The background of asbestos litigation, developments in the Corporation's
reorganization proceedings and estimated cost are discussed in Note 12,
Litigation.
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CONSEQUENCES OF THE FILING
As a consequence of the Filing, all asbestos lawsuits and other lawsuits
pending against the Debtors as of the Petition Date are stayed, and no
party may take any action to pursue or collect pre-petition claims except
pursuant to an order of the Bankruptcy Court. Since the Filing, the Debtors
have ceased making both cash payments and accruals with respect to asbestos
lawsuits. The Debtors are operating their businesses without interruption
as debtors-in-possession subject to the provisions of the Bankruptcy Code,
and vendors are being paid for goods furnished and services provided after
the Filing.
The Debtors' Chapter 11 Cases are assigned to Judge Judith K. Fitzgerald, a
bankruptcy court judge, and Judge Joy Flowers Conti, a district court
judge. Judge Conti will hear matters relating to estimation of the Debtors'
liability for asbestos personal injury claims. Other matters will be heard
by Judge Fitzgerald. Three creditors' committees, one representing asbestos
personal injury claimants (the "Official Committee of Asbestos Personal
Injury Claimants"), another representing asbestos property damage claimants
(the "Official Committee of Asbestos Property Damage Claimants"), and a
third representing unsecured creditors (the "Official Committee of
Unsecured Creditors"), were appointed as official committees in the Chapter
11 Cases. In addition, the Bankruptcy Court also appointed Dean M. Trafelet
as the legal representative for future asbestos claimants in the Debtors'
bankruptcy proceedings. Mr. Trafelet was formerly a judge of the Circuit
Court of Cook County, Illinois. Recently, an Official Committee of Equity
Security Holders of the Corporation was also appointed. The appointed
committees, together with Mr. Trafelet, will play significant roles in the
Chapter 11 Cases and resolution of the terms of any plan of reorganization.
The Debtors intend to address their liability for all present and future
asbestos claims, as well as all other pre-petition claims, in a plan or
plans of reorganization approved by the Bankruptcy Court. The Debtors
currently have the exclusive right to file a plan of reorganization until
June 30, 2005. The Debtors may seek one or more additional extensions of
the exclusive period depending upon developments in the Chapter 11 Cases.
Any plan of reorganization ultimately approved by the Bankruptcy Court may
include one or more independently administered trusts under Section 524(g)
of the Bankruptcy Code, which may be funded by the Debtors to allow payment
of present and future asbestos personal injury claims. If the confirmed
plan of reorganization includes the creation and funding of a Section
524(g) trust relating to one or more of the Debtors, the Bankruptcy Court
will issue a permanent injunction barring the assertion of present and
future asbestos claims against the relevant Debtors, their successors, and
their affiliates, and channeling those claims to the trust for payment in
whole or in part.
There are several requirements for confirmation of a plan of reorganization
containing an asbestos trust with all of the features set
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forth in Section 524(g). One of the requirements is that the court
determine that the asbestos trust will be structured and funded so as to be
in a financial position to pay present claims and future demands that
involve similar claims in substantially the same manner. Another
requirement is that a class or classes of asbestos claimants affected by
the trust vote to approve the plan by at least 75% of those voting. Section
524(g) also requires that such trust own (or have the right to acquire if
specified contingencies occur) a majority of the voting stock of each
relevant Debtor, its parent corporation, or a subsidiary that is also a
Debtor. A plan of reorganization, including a plan creating a Section
524(g) trust, may be confirmed without the consent of non-asbestos
creditors and stockholders if certain requirements of the Bankruptcy Code
are met.
The Debtors also expect that the plan of reorganization will address the
Debtors' liability for asbestos property damage claims, whether by
including those liabilities in a Section 524(g) trust or by other means.
Similar plans of reorganization containing Section 524(g) trusts have been
confirmed in the chapter 11 cases of other companies with asbestos
liabilities, but there is no guarantee that the Bankruptcy Court in the
Debtors' Chapter 11 Cases will approve creation of a Section 524(g) trust
or issue a permanent injunction channeling to the trust all asbestos claims
against the Debtors and/or their successors and affiliates. In addition, if
federal legislation addressing asbestos personal injury claims is passed,
which is extremely speculative, such legislation may affect whether the
Debtors establish a trust under Section 524(g). See Potential Federal
Legislation Regarding Asbestos Personal Injury Claims, below.
A key factor in determining whether or to what extent there will be any
recovery for pre-petition creditors or stockholders under any plan of
reorganization is the amount that must be provided in the plan of
reorganization to address the Debtors' liability for present and future
asbestos claims. The amount of Debtors' asbestos liabilities has not yet
been determined and is subject to substantial dispute and uncertainty. The
Official Committee of Asbestos Personal Injury Claimants and the legal
representative for future asbestos claimants have indicated in a court
filing that they estimate that the net present value of the Debtors'
liability for present and future asbestos personal injury claims is
approximately $5.5 billion and that the Debtors are insolvent. The Debtors
have stated that they believe they are solvent if their asbestos
liabilities are fairly and appropriately valued. If the amount of Debtors'
asbestos liabilities is not resolved through negotiation in the Chapter 11
Cases or addressed by federal legislation, the amount of these liabilities
may be determined through litigation proceedings before Judge Conti. See
Note 12, Litigation, for additional information regarding Debtors' asbestos
liabilities and their estimated cost.
While it is the Debtors' intention to seek a full recovery for their
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creditors, it is not possible to predict the amount that will have to be
provided in the plan of reorganization to address present and future
asbestos claims, how the plan of reorganization will treat other
pre-petition claims, whether there will be sufficient assets to satisfy the
Debtors' pre-petition liabilities, and what impact any plan may have on the
value of the shares of the Corporation's common stock. The payment rights
and other entitlements of pre-petition creditors and the Corporation's
stockholders may be substantially altered by any plan of reorganization
confirmed in the Chapter 11 Cases. Pre-petition creditors may receive under
the plan of reorganization less than 100% of the face value of their
claims, the pre-petition creditors of some Debtors may be treated
differently from the pre-petition creditors of other Debtors, and the
interests of the Corporation's stockholders are likely to be substantially
diluted or cancelled in whole or in part. There can be no assurance as to
the value of any distributions that might be made under any plan of
reorganization with respect to such pre-petition claims or equity
interests.
It is also not possible to predict how the plan of reorganization will
treat intercompany indebtedness, licenses, transfers of goods and services,
and other intercompany arrangements, transactions and relationships that
were entered into before the Petition Date. Certain of these intercompany
transactions have been challenged by various parties in these Chapter 11
Cases, and other arrangements, transactions and relationships may be
challenged by parties to these Chapter 11 Cases. The outcome of such
challenges may have an impact on the treatment of various claims under any
plan of reorganization.
In connection with the Filing, the Corporation implemented a Bankruptcy
Court-approved key employee retention plan that commenced on July 1, 2001,
and continued until June 30, 2004. Effective July 1, 2004, the key employee
retention plan, in an amended form, was extended until December 31, 2005.
Under the amended plan, participants continue to earn awards semiannually.
The amendments introduce a performance feature for the last two (of four)
payments to be made under the extended plan which could increase the final
two payments up to a maximum of 25% above par or eliminate them altogether.
Expenses associated with this plan amounted to $5.4 million and $2.7
million in the first quarter of 2005 and 2004, respectively. Expense was
lower in 2004 primarily due to accruals in 2003 and 2002 of amounts that
were paid in 2004.
POTENTIAL FEDERAL LEGISLATION REGARDING ASBESTOS PERSONAL INJURY CLAIMS
On April 19, 2005, Senator Arlen Specter (R. Pa.) introduced in the United
States Senate legislation addressing compensation and administration of
asbestos personal injury claims. The legislation is titled the Fairness in
Asbestos Injury Resolution Act of 2005 (Senate Bill 852, the "FAIR Bill").
The FAIR Bill is co-sponsored by three Democratic Senators and four
Republican Senators. The FAIR Bill has been referred to the Senate
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Committee on the Judiciary. The FAIR Bill has not been approved by the
Senate Committee on the Judiciary or the full Senate, has not been
considered by the House of Representatives, and is not law.
The FAIR Bill introduced in the Senate is intended to establish a
nationally administered trust fund to compensate asbestos personal injury
claimants. In the FAIR Bill's current form, companies that have made past
payments for asbestos personal injury claims would be required to
contribute amounts to a national trust fund on a periodic basis that would
pay the claims of qualifying asbestos personal injury claimants. The
nationally administered trust fund would be the exclusive remedy for
asbestos personal injury claims, and such claims could not be brought in
state or federal court as long as such claims are being compensated under
the national trust fund. A copy of the FAIR Bill as introduced is available
at http://thomas.loc.gov (type in "S. 852" in the search field).
In the FAIR Bill's current form, the amounts to be paid to the national
trust fund are based on an allocation methodology set forth in the FAIR
Bill. The amounts that participants, including the Debtors, would be
required to pay are not dischargeable in a bankruptcy proceeding. In
addition, the FAIR Bill, in its current form, requires affected companies
currently in chapter 11, including the Debtors, to make their first payment
to the national trust fund not later than 60 days after enactment of the
FAIR Bill, notwithstanding the fact that the companies are still in chapter
11 proceedings. The FAIR Bill also provides, among other things, that if it
is determined that the money in the trust fund is not sufficient to
compensate eligible claimants, the claimants and defendants (including
current chapter 11 debtors) would return to the court system to resolve
claims not paid by the national trust fund.
The outcome of the legislative process is inherently speculative, and it
cannot be known whether the FAIR Bill or similar legislation will ever be
enacted or, even if enacted, what the terms of the final legislation might
be. Previously, in April 2004, a similar, but not identical, bill (the
"Fairness in Asbestos Injury Resolution Act of 2004") was introduced in the
Senate and was approved by the Senate Committee on the Judiciary, but the
full Senate defeated a motion to proceed with floor consideration of the
bill. Even if the recently-introduced FAIR Bill is enacted, the terms of
the enacted legislation may differ from those of the FAIR Bill as
introduced, and those differences may be material to the FAIR Bill's impact
on the Corporation.
Enactment of the FAIR Bill or similar legislation addressing the financial
contributions of the Debtors for asbestos personal injury claims would have
a material impact on the amount of the Debtors' asbestos personal injury
liability and the Debtors' Chapter 11 Cases.
During the legislative process, proceedings in the Chapter 11 Cases will
continue. See Consequences of the Filing, above, and Note 12, Litigation.
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PRE-PETITION LIABILITIES OTHER THAN ASBESTOS PERSONAL INJURY CLAIMS
Subsequent to the Filing, the Debtors received approval from the Bankruptcy
Court to pay or otherwise honor certain of their pre-petition obligations,
including employee wages, salaries, benefits and other employee
obligations, and from limited available funds, pre-petition claims of
certain critical vendors, real estate taxes, environmental obligations,
certain customer programs and warranty claims, and certain other
pre-petition claims.
Pursuant to the Bankruptcy Code, schedules were filed by the Debtors with
the Bankruptcy Court on October 23, 2001, and certain of the schedules were
amended on May 31, 2002, December 13, 2002, and September 30, 2004, setting
forth the assets and liabilities of the Debtors as of the date of the
Filing. The Bankruptcy Court established a bar date of January 15, 2003, by
which date proofs of claim were required to be filed against the Debtors
for all claims other than asbestos-related personal injury claims as
defined in the Bankruptcy Court's order.
Approximately 5,000 proofs of claim for general unsecured creditors
(including pre-petition debtholders and contingent claims, but excluding
asbestos-related claims) totaling approximately $8.7 billion were filed by
the bar date. Of this amount, $5.7 billion worth of claims have been
withdrawn from the case by creditors. The Debtors have been analyzing the
remaining proofs of claim and determined that many of them are duplicates
of other proofs of claim or of liabilities previously scheduled by the
Debtors. In addition, many claims were filed against multiple Debtors or
against an incorrect Debtor, or were incorrectly claiming a priority level
higher than general unsecured or an incorrect dollar amount. To date, the
court has expunged 264 claims totaling $29.5 million as duplicates;
expunged 471 claims totaling $232.4 million as amended or superceded;
allowed the reduction of 816 claims by a total of $20.7 million; and
allowed the correction of the Debtors on 1,520 claims and the
reclassification of 290 claims to general unsecured claims. The Debtors
continue to analyze and reconcile filed claims. In addition to the general
unsecured claims described in this paragraph, approximately 1,400 asbestos
property damage claims were filed as of the bar date. Those claims are
described in Note 11, Litigation, Developments in the Reorganization
Proceeding.
The deadline to bring avoidance actions in the Chapter 11 Cases was June
25, 2003. Avoidance actions could include claims to avoid alleged
preferences made during the 90-day period prior to the filing (or one-year
period for insiders) and other transfers made or obligations incurred which
could be alleged to be constructive or actual fraudulent conveyances under
applicable law. Effective prior to the avoidance action deadline, the
Bankruptcy Court granted the motion of the committee representing the
unsecured creditors to file a complaint seeking to avoid and recover as
preferences certain pre-petition payments made by the Debtors to 206
creditors, where such payments, in most cases, exceeded $500,000. The
Bankruptcy Court also granted the committee's request to extend the time
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by which the summons and complaint are served upon each named defendant
until 90 days after confirmation of a plan of reorganization filed in
connection with the Chapter 11 Cases.
In addition, prior to the deadline for filing avoidance actions, certain of
the Debtors entered into a Tolling Agreement pursuant to which the Debtors
voluntarily agreed to extend the time during which actions could be brought
to avoid certain intercompany transactions that occurred during the
one-year period prior to the filing of the Chapter 11 Cases. The
transactions as to which the Tolling Agreement applies are the creation of
liens on certain assets of Debtor subsidiaries in favor of the Corporation
in connection with intercompany loan agreements; a transfer by U.S. Gypsum
to the Corporation of a 9% interest in the equity of CGC Inc., the
principal Canadian subsidiary of the Corporation; and transfers made by the
Corporation to USG Foreign Investments, Ltd., a non-Debtor subsidiary. The
Bankruptcy Court approved the Tolling Agreement in June 2003.
The Debtors expect to address claims for general unsecured creditors
through liquidation, estimation or disallowance of the claims. In
connection with this process, the Debtors will make adjustments to their
schedules and financial statements as appropriate. Any such adjustments
could be material to the Corporation's consolidated financial position,
cash flows and results of operations in any given period. At this time, it
is not possible to estimate the Debtors' liability for these claims.
However, it is likely that the Debtors' liability for these claims will be
different from the amounts now recorded by the Debtors. Proofs of claim
alleging asbestos property damage claims are discussed in Note 12,
Litigation, under Developments in the Reorganization Proceeding.
FINANCIAL STATEMENT PRESENTATION
The accompanying consolidated financial statements have been prepared in
accordance with American Institute of Certified Public Accountants
("AICPA") Statement of Position 90-7 ("SOP 90-7"), "Financial Reporting by
Entities in Reorganization Under the Bankruptcy Code," and on a
going-concern basis, which contemplates continuity of operations,
realization of 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
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reorganization could materially change the amounts and classifications in
the historical consolidated financial statements.
The Corporation's ability to continue as a going concern is dependent upon,
among other things, (i) the ability of the Corporation to maintain adequate
cash on hand, (ii) the ability of the Corporation to generate cash from
operations, (iii) confirmation of a plan of reorganization under the
Bankruptcy Code and (iv) the Corporation's ability to achieve profitability
following such confirmation. The Corporation believes that cash and
marketable securities on hand and future cash available from operations
will provide sufficient liquidity to allow its businesses to operate in the
normal course without interruption for the duration of the chapter 11
proceedings. This includes its ability to meet post-petition obligations of
the Debtors and to meet obligations of the non-Debtor subsidiaries.
LIABILITIES SUBJECT TO COMPROMISE
As reflected in the consolidated financial statements, liabilities subject
to compromise refers to the Debtors' liabilities incurred prior to the
commencement of the Chapter 11 Cases. The amounts of the various
liabilities that are subject to compromise are set forth in the table
below. These amounts represent the Debtors' estimate of known or potential
pre-petition claims to be resolved in connection with the Chapter 11 Cases.
Such claims remain subject to future adjustments. Adjustments may result
from (i) negotiations, (ii) actions of the Bankruptcy Court, (iii) further
developments with respect to disputed claims, (iv) rejection of executory
contracts and unexpired leases, (v) the determination as to the value of
any collateral securing claims, (vi) proofs of claim, including unaccrued
and unrecorded post-petition interest expense, (vii) effect of any
legislation which may be enacted or (viii) other events.
The amount shown below for the asbestos reserve reflects the Corporation's
pre-petition estimate of liability associated with asbestos claims and
those expected to be filed in the tort system through 2003. This liability,
as well as liability for post-2003 claims, is the subject of significant
legal proceedings and negotiation in the Chapter 11 Cases. See Note 12.
Litigation for additional information on the background of asbestos
litigation, developments in the Corporation's reorganization proceeding and
estimated cost.
As of the date of this report, virtually all of the Corporation's
pre-petition debt is in default due to the Filing and included in
liabilities subject to compromise. This includes debt outstanding of $469
million under the pre-petition bank credit facilities and $536 million of
other outstanding debt.
Payment terms for liabilities subject to compromise will be established as
part of a plan of reorganization under the Chapter 11 Cases. Liabilities
subject to compromise in the consolidated and debtor-in-possession balance
sheets consisted of the following items (dollars in millions):
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As of As of
March 31, December 31,
2005 2004
--------- ------------
Asbestos reserve $1,061 $1,061
Debt 1,005 1,005
Accounts payable 169 169
Accrued expenses 36 37
Other long-term liabilities 13 13
------ ------
Subtotal 2,284 2,285
Elimination of intercompany accounts payable (43) (43)
------ ------
Total liabilities subject to compromise 2,241 2,242
====== ======
INTERCOMPANY TRANSACTIONS
In the normal course of business, the Corporation (also referred to as the
"Parent Company" in the following discussion of intercompany transactions)
and the operating subsidiaries engage in intercompany transactions. To
document the relations created by these transactions, the Parent Company
and the operating subsidiaries, from the formation of the Corporation in
1985, have been parties to intercompany loan agreements that evidence their
obligations as borrowers or rights as lenders arising out of intercompany
cash transfers and various allocated intercompany charges (the
"Intercompany Corporate Transactions").
The Corporation operates a consolidated cash management system under which
the cash receipts of the domestic operating subsidiaries are ultimately
concentrated in Parent Company accounts. Cash disbursements for those
operating subsidiaries originate from those Parent Company concentration
accounts. Allocated intercompany charges from the Parent Company to the
operating subsidiaries primarily include expenses related to rent, property
taxes, information technology, and research and development, while
allocated intercompany charges between certain operating subsidiaries
primarily include expenses for shared marketing, sales, 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 March 31, 2005, U.S. Gypsum and USG Interiors had net pre-petition
payable balances to the Parent Company for Intercompany Corporate
Transactions of $295 million and $109 million, respectively. L&W Supply had
a net pre-petition receivable balance from the Parent Company of $33
million. These pre-petition balances are subject to the provisions of the
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Tolling Agreement discussed above. See Pre-Petition Liabilities Other Than
Asbestos Personal Injury Claims, above.
As of March 31, 2005, U.S. Gypsum and L&W Supply had net post-petition
receivable balances from the Parent Company for Intercompany Corporate
Transactions of $354 million and $227 million, respectively. USG Interiors
had a net post-petition payable balance to the Parent Company of $5
million.
In addition to the above transactions, the operating subsidiaries engage in
ordinary course purchase and sale of products with other operating
subsidiaries (the "Intercompany Trade Transactions"). Detailed accounting
records also are maintained of all such transactions, and settlements are
made on a monthly basis. Certain Intercompany Trade Transactions between
U.S. and non-U.S. operating subsidiaries are settled via wire transfer
payments utilizing several payment systems.
CHAPTER 11 REORGANIZATION EXPENSES
Chapter 11 reorganization expenses in the consolidated and
debtor-in-possession statements of earnings consisted of the following
(dollars in millions):
Three Months ended
March 31,
------------------
2005 2004
---- ----
Legal and financial advisory fees $ 6 $ 4
Bankruptcy-related interest income (5) (2)
--- ---
Total chapter 11 reorganization expenses 1 2
=== ===
INTEREST EXPENSE
Contractual interest expense not accrued or recorded on pre-petition debt
totaled $19 million in the first quarter of 2005. From the Petition Date
through March 31, 2005, contractual interest expense not accrued or
recorded on pre-petition debt totaled $276 million. This calculation
assumes that all such interest was paid when required at the applicable
contractual interest rate (after giving effect to any applicable default
rate). However, the calculation excludes the impact of any compounding of
interest on unpaid interest that may be payable under the relevant
contractual obligations, as well as any interest that may be payable under
a plan of reorganization to trade or other creditors that are not otherwise
entitled to interest under the express terms of their claims. The impact of
compounding alone would have increased the contractual interest expense
reported above by $6 million in the first quarter of 2005 and $40 million
from the Petition Date through March 31, 2005. For financial reporting
purposes, no post-petition accruals have been made for contractual interest
expense not accrued or recorded on pre-petition debt.
On April 11, 2005, the Unsecured Creditors Committee filed a motion with
the bankruptcy court requesting that the Debtors make interest payments to
-15-
all non-asbestos unsecured creditors for interest accrued from January 1, 2005,
on liquidated, undisputed pre-petition claims (including accrued unpaid interest
through December 31, 2004). If approved, this would require the Debtors to make
interest payments of approximately $84 million on an annual basis.
DIP FINANCIAL STATEMENTS
Under the Bankruptcy Code, the Corporation is required to file periodically with
the Bankruptcy Court various documents including financial statements of the
Debtors (the Debtor-In-Possession or "DIP" financial statements). The
Corporation cautions that these financial statements are prepared according to
requirements under the Bankruptcy Code. While these financial statements
accurately provide information required under the Bankruptcy Code, they are
nonetheless unconsolidated, unaudited and prepared in a format different from
that used in the Corporation's consolidated financial statements filed under the
securities laws. Accordingly, the Corporation believes the substance and format
do not allow meaningful comparison with the Corporation's regular publicly
disclosed consolidated financial statements.
The Debtors consist of the Corporation and the following wholly owned
subsidiaries: U.S. Gypsum; USG Interiors; USG Interiors International, Inc.; L&W
Supply; Beadex Manufacturing, LLC; B-R Pipeline Company; La Mirada Products Co.,
Inc.; Stocking Specialists, Inc.; USG Industries, Inc.; and USG Pipeline
Company. The condensed financial statements of the Debtors are presented as
follows:
USG CORPORATION
DEBTOR-IN-POSSESSION STATEMENT OF EARNINGS
(DOLLARS IN MILLIONS)
(UNAUDITED)
THREE MONTHS
ENDED MARCH 31,
---------------
2005 2004
------ ----
Net sales $1,058 $918
Cost of products sold 877 795
Selling and administrative expenses 76 65
Chapter 11 reorganization expenses 1 2
Interest expense 1 1
Interest income (1) --
Other income, net (1) --
------ ----
Earnings before income taxes 105 55
Income taxes 43 26
------ ----
Net earnings 62 29
====== ====
-16-
USG CORPORATION
DEBTOR-IN-POSSESSION BALANCE SHEETS
(DOLLARS IN MILLIONS)
(UNAUDITED)
AS OF AS OF
MARCH 31, DECEMBER 31,
2005 2004
--------- ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 462 $ 516
Short-term marketable securities 168 135
Restricted cash 39 38
Receivables (net of reserves - $11 and $10) 448 373
Inventories 283 275
Income taxes receivable 23 24
Deferred income taxes 7 25
Other current assets 85 45
------ ------
Total current assets 1,515 1,431
Long-term marketable securities 278 276
Property, plant and equipment (net of accumulated
depreciation and depletion - $751 and $728) 1,607 1,604
Deferred income taxes 134 152
Goodwill 43 43
Other assets 381 361
------ ------
Total Assets 3,958 3,867
====== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable 232 237
Accrued expenses 174 203
Income taxes payable 86 58
------ ------
Total current liabilities 492 498
Other liabilities 391 391
Liabilities subject to compromise 2,241 2,242
Stockholders' Equity:
Preferred stock -- --
Common stock 5 5
Treasury stock (256) (256)
Capital received in excess of par value 101 101
Accumulated other comprehensive income 39 3
Retained earnings 945 883
------ ------
Total stockholders' equity 834 736
------ ------
Total Liabilities and Stockholders' Equity 3,958 3,867
====== ======
-17-
USG CORPORATION
DEBTOR-IN-POSSESSION STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
THREE MONTHS
ENDED MARCH 31,
---------------
2005 2004
----- -----
OPERATING ACTIVITIES:
Net earnings $ 62 $ 29
Adjustments to reconcile net earnings to net cash:
Depreciation, depletion and amortization 26 23
Deferred income taxes 14 12
(Increase) decrease in working capital:
Receivables (75) (107)
Income taxes receivable 1 (1)
Inventories (8) (23)
Payables 23 64
Accrued expenses (25) (26)
Decrease in post-petition intercompany receivable -- 12
(Increase) decrease in other assets (5) 7
Increase in other liabilities 2 1
Change in asbestos receivables -- 10
Decrease in liabilities subject to compromise (1) (1)
Other, net (4) (1)
----- -----
Net cash provided by (used for) operating activities 10 (1)
----- -----
INVESTING ACTIVITIES:
Capital expenditures (28) (17)
Purchases of marketable securities (176) (115)
Sale or maturities of marketable securities 140 78
Net proceeds from asset dispositions -- 1
Acquisition of business -- (4)
Deposit of restricted cash (1) (12)
----- -----
Net cash used for investing activities (65) (69)
----- -----
FINANCING ACTIVITIES:
Issuances of common stock 1 --
----- -----
Net cash provided by financing activities 1 --
----- -----
Net decrease in cash and cash equivalents (54) (70)
Cash and cash equivalents at beginning of period 516 489
----- -----
Cash and cash equivalents at end of period 462 419
===== =====
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Interest paid -- --
Income taxes paid, net 1 4
-18-
(3) EARNINGS PER SHARE
Basic earnings per share are based on the weighted average number of common
shares outstanding. Diluted earnings per share are based on the weighted
average number of common shares outstanding and the dilutive effect of the
potential exercise of outstanding stock options. Diluted earnings per share
exclude the potential exercise of outstanding stock options for any period
in which such exercise would have an anti-dilutive effect. The
reconciliation of basic earnings per share to diluted earnings per share is
shown in the following table (dollars in millions, except share data):
Weighted
Average
Net Shares Per-Share
Three Months Ended March 31, Earnings (000) Amount
- ---------------------------- -------- ------ ---------
2005:
Basic earnings $77 43,327 $1.77
Dilutive effect of stock options 180
--- ------ -----
Diluted earnings 77 43,507 1.77
=== ====== =====
2004:
Basic earnings 57 43,023 1.33
Dilutive effect of stock options 1
--- ------ -----
Diluted earnings 57 43,024 1.33
=== ====== =====
(4) ASSET RETIREMENT OBLIGATIONS
Changes in the liability for asset retirement obligations consisted of the
following (dollars in millions):
Three Months ended March 31
---------------------------
2005 2004
---- ----
Balance as of January 1 $43 $35
Accretion expense -- --
Liabilities incurred -- --
Liabilities settled -- --
Foreign currency translation -- --
--- ---
Balance as of March 31 43 35
=== ===
-19-
(5) MARKETABLE SECURITIES
The Corporation's investments in marketable securities consisted of the
following (dollars in millions):
As of As of
March 31, 2005 December 31, 2004
---------------- -----------------
Amortized Amortized
Cost FMV Cost FMV
--------- ---- --------- ----
Asset-backed securities $179 $178 $174 $173
U.S. government and agency securities 146 145 121 121
Municipal securities 30 30 36 36
Corporate securities 131 131 112 112
Time deposits 4 4 8 8
---- ---- ---- ----
Total marketable securities 490 488 451 450
==== ==== ==== ====
Contractual maturities of marketable securities as of March 31, 2005, were
as follows (dollars in millions):
Fair
Amortized Market
Cost Value
--------- ------
Due in 1 year or less $175 $174
Due in 1-5 years 89 89
Due in 5-10 years 3 3
Due after 10 years 44 44
---- ----
311 310
Asset-backed securities 179 178
---- ----
Total marketable securities 490 488
==== ====
The average duration of the portfolio is less than one year because a
majority of the longer-term securities have paydown or put features and
liquidity facilities.
Investments in marketable securities that were in an unrealized loss
position for less than 12 months consisted of the following (dollars in
millions):
As of As of
March 31, 2005 December 31, 2004
---------------- -----------------
Asset-backed securities $145 $149
U.S. government and agency securities 129 83
Corporate securities 47 34
---- ----
Total FMV 321 266
---- ----
Aggregate amount of unrealized losses 2 1
==== ====
-20-
The fair market value of investments that had been in a continuous
unrealized loss position for a period greater than 12 months amounted to
$13 million and $2 million as of March 31, 2005 and December 31, 2004,
respectively. The unrealized losses for those investments were not
material.
(6) DERIVATIVE INSTRUMENTS
The Corporation uses derivative instruments to manage selected commodity
price and foreign currency exposures. The Corporation does not use
derivative instruments for trading purposes. All derivative instruments are
recorded on the balance sheet at fair value. For derivatives designated as
fair value hedges, the changes in the fair values of both the derivative
instrument and the hedged item are recognized in earnings in the current
period. For derivatives designated as cash flow hedges, the effective
portion of changes in the fair value of the derivative is recorded to
accumulated other comprehensive income ("OCI") on the balance sheet and is
reclassified to earnings when the underlying transaction has an impact on
earnings. The ineffective portion of changes in the fair value of the
derivative is reported in cost of products sold. The amount of
ineffectiveness amounted to a pretax gain of $1.6 million in the first
quarter of 2005. As of March 31, 2005, the Corporation had no foreign
currency contracts.
COMMODITY DERIVATIVE INSTRUMENTS
The Corporation uses swap contracts to hedge most anticipated purchases of
natural gas to be used in its manufacturing operations. As of March 31,
2005, the Corporation had swap contracts to exchange monthly payments on
notional amounts of natural gas amounting to $266 million. These contracts
mature by December 31, 2007. As of March 31, 2005, the fair value of these
swap contracts, which remained in OCI, was a $67 million ($41 million
after-tax) unrealized gain.
Net after-tax gains or losses resulting from the termination of natural gas
swap contracts are recorded to OCI and reclassified into earnings in the
period in which the hedged forecasted transactions are scheduled to occur.
As of March 31, 2005, $2 million ($1 million after-tax) of such gains are
included in OCI.
COUNTERPARTY RISK
The Corporation is exposed to credit losses in the event of nonperformance
by the counterparties on its financial instruments. All counterparties have
investment grade credit standing; accordingly, the Corporation anticipates
that these counterparties will be able to satisfy fully their obligations
under the contracts. The Corporation does not generally obtain collateral
or other security to support financial instruments subject to credit risk.
However, the Corporation may be required to post collateral if aggregate
payables exceed certain limits. Currently, there is no collateral
requirement. The Corporation enters into master agreements which contain
netting arrangements that minimize counterparty credit exposure.
-21-
(7) COMPREHENSIVE INCOME
The components of comprehensive income are summarized in the following
table (dollars in millions):
Three Months
ended March 31
--------------
2005 2004
---- ----
Net earnings $ 77 $57
---- ---
Pretax gain on derivatives 59 13
Income tax expense (23) (5)
---- ---
After-tax gain on derivative 36 8
---- ---
Foreign currency translation (4) (2)
---- ---
Unrealized gain (loss) on marketable
securities -- --
---- ---
Total comprehensive income 109 63
==== ===
There was no tax impact on the foreign currency translation adjustments.
OCI consisted of the following (dollars in millions):
As of As of
March 31, 2005 December 31, 2004
---------------- -----------------
Gain on derivatives, net of tax $42 $ 6
Foreign currency translation 11 15
Minimum pension liability, net of tax (3) (3)
Unrealized loss on marketable
securities, net of tax (1) (1)
--- ---
Total 49 17
=== ===
During the first quarter of 2005, accumulated net after-tax gains of $2
million ($3 million pretax) on derivatives were reclassified from OCI to
earnings. As of March 31, 2005, the estimated net after-tax gain expected
to be reclassified within the next 12 months from OCI to earnings is $33
million.
-22-
(8) EMPLOYEE RETIREMENT PLANS
The components of net pension and postretirement benefits costs for the
three months ended March 31, 2005 and 2004 are summarized in the following
table (dollars in millions):
Three Months ended
March 31
------------------
2005 2004
---- ----
PENSION:
Service cost of benefits earned $ 9 $ 7
Interest cost on projected
benefit obligation 14 13
Expected return on plan assets (14) (13)
Net amortization 5 5
---- ----
Net cost 14 12
==== ====
POSTRETIREMENT:
Service cost of benefits earned $ 3 $ 4
Interest cost on projected
benefit obligation 5 5
Net amortization (1) --
---- ----
Net cost 7 9
==== ====
In accordance with the Corporation's funding policy, the Corporation and
its subsidiaries contributed cash of $21 million during the first quarter
of 2005 and expect to contribute cash of approximately $70 million during
the full year 2005 to their pension plans.
(9) STOCK-BASED COMPENSATION
The Corporation accounts for stock-based compensation using the intrinsic
value method, which measures compensation cost as the quoted market price
of the stock at the date of grant less the grant price, if any, that the
employee is required to pay. If the Corporation had elected to recognize
compensation cost for stock-based compensation grants using the fair value
method, net earnings and net earnings per common share would not have
changed because stock options issued prior to the Filing are fully vested
and no stock options have been issued subsequent to the Filing.
As of March 31, 2005, common shares totaling 1,898,350 were reserved for
future issuance in conjunction with existing stock option grants. In
addition, 3,009,370 common shares were reserved for future grants. Shares
issued in option exercises may be from original issue or available treasury
shares.
-23-
(10) OPERATING SEGMENTS
The Corporation's operations are organized into three operating segments:
(i) North American Gypsum, which manufactures SHEETROCK(R) brand gypsum
wallboard and joint compound, DUROCK(R) brand cement board, FIBEROCK(R)
brand gypsum fiber panels and other related building products in the United
States, Canada and Mexico; (ii) Worldwide Ceilings, which manufactures
ceiling tile in the United States and ceiling grid in the United States,
Canada, Europe and the Asia-Pacific region; and (iii) Building Products
Distribution, which distributes gypsum wallboard, drywall metal, ceiling
products, joint compound and other building products throughout the United
States. Operating segment results were as follows (dollars in millions):
Net Sales Operating Profit
--------------- ----------------
Three Months Ended March 31, 2005 2004 2005 2004
- ---------------------------- ------ ------ ---- ----
North American Gypsum $ 725 $ 639 $107 $ 81
Worldwide Ceilings 170 166 12 15
Building Products Distribution 456 362 26 14
Eliminations (178) (147) 3 --
Corporate -- -- (23) (16)
Chapter 11 reorganization expenses -- -- (1) (2)
------ ------ ---- ----
Total 1,173 1,020 124 92
====== ====== ==== ====
(11) INCOME TAXES
On October 22, 2004, the President signed the American Jobs Creation Act of
2004 (the "Act"). The Act creates a temporary incentive for U.S.
corporations to repatriate accumulated income earned abroad by providing an
85% dividends received deduction for certain dividends from controlled
foreign corporations. The deduction is subject to several limitations, and
currently, uncertainty remains as to how to interpret numerous provisions
in the Act. As a result, the Corporation is not yet able to determine
whether, and to what extent, it will repatriate foreign earnings that have
not yet been remitted to the United States. Based on the Corporation's
analysis to date, however, it is reasonably possible that the Corporation
may repatriate between zero and $50 million of unremitted foreign earnings
as a result of the repatriation provision. It is not possible at this time
to estimate the range of income tax effects of any such repatriation. The
Corporation expects to complete its evaluation of this matter within a
reasonable period of time after the current uncertainty in the law is
resolved.
-24-
(12) LITIGATION
ASBESTOS AND RELATED BANKRUPTCY LITIGATION
One of the Corporation's subsidiaries, U.S. Gypsum, is among many
defendants in more than 100,000 asbestos lawsuits alleging personal injury
or property damage liability. Most of the asbestos lawsuits against U.S.
Gypsum seek compensatory and, in many cases, punitive damages for personal
injury allegedly resulting from exposure to asbestos-containing products
(the "Personal Injury Cases"). Certain of the asbestos lawsuits seek to
recover compensatory and, in many cases, punitive damages for costs
associated with the maintenance or removal and replacement of
asbestos-containing products in buildings (the "Property Damage Cases").
U.S. Gypsum's asbestos liability derives from its sale of certain
asbestos-containing products beginning in the late 1920s. In most cases,
the products were discontinued or asbestos was removed from the formula by
1972, and no asbestos-containing products were produced after 1978.
In addition to the Personal Injury Cases pending against U.S. Gypsum, two
other Debtors, L&W Supply and Beadex Manufacturing, LLC ("Beadex"), have
been named as defendants in a small number of asbestos personal injury
cases. The Official Committee of Asbestos Personal Injury Claimants, the
legal representative for future asbestos claimants, and the Official
Committee of Asbestos Property Damage Claimants have also asserted in a
court filing that the Debtors are liable for the asbestos liabilities of
A.P. Green Refractories Co. ("A.P. Green").
More information regarding the Property Damage and Personal Injury Cases
against U.S. Gypsum and the asbestos personal injury cases against L&W
Supply, Beadex, and A.P. Green is set forth below.
The amount of the Debtors' present and future asbestos liabilities is the
subject of significant dispute in Debtors' Chapter 11 Cases. If the amount
of the Debtors' asbestos liabilities is not resolved through negotiation in
the Chapter 11 Cases or addressed by federal legislation, the amount of
those liabilities may be determined through litigation proceedings in the
Chapter 11 Cases.
DEVELOPMENTS IN THE REORGANIZATION PROCEEDING: The Debtors' Chapter 11
Cases are assigned to Judge Judith K. Fitzgerald, a bankruptcy court judge,
and Judge Joy Flowers Conti, a district court judge, who was assigned to
the Debtors' Chapter 11 Cases in September 2004. Judge Conti will hear
matters relating to estimation of the Debtors' liability for asbestos
personal injury claims. Other matters will be heard by Judge Fitzgerald.
The Debtors have requested the Court to conduct hearings to estimate
Debtors' asbestos personal injury liability, taking into account the legal
and
-25-
scientific issues that govern the validity of claims. In 2002, the Debtors
filed a motion requesting Judge Wolin, the district court judge then
assigned to Debtors' Chapter 11 Cases, to conduct such estimation hearings.
The Debtors requested that the Court hear evidence and make rulings
regarding the characteristics of valid asbestos personal injury claims
against the Debtors and then estimate the Debtors' liability for present
and future asbestos personal injury claims based upon these rulings. Key
liability issues include: whether claimants who do not have objective
evidence of asbestos-related disease have valid claims and are entitled to
be compensated by the Debtors or whether such claimants are entitled to
compensation only if and when they develop asbestos-related disease; what
are the characteristics and number of present and future claimants who are
likely to have had any, or sufficient, exposure to the Debtors' products;
whether the particular type of asbestos present in certain of the Debtors'
products during the relevant time has been shown to cause cancer; and what
are the appropriate claim values to apply in the estimation process.
The Official Committee of Asbestos Personal Injury Claimants and the legal
representative for future asbestos claimants oppose the type of estimation
hearings proposed by the Debtors. The committee and the legal
representative contend that the Debtors' liability for present and future
asbestos personal injury claims should be based on extrapolation from the
settlement history of such claims and not on litigating liability issues in
the bankruptcy proceedings. The committee and the legal representative also
contend that the Bankruptcy Court does not have the power to deny recovery
to claimants on the grounds that they do not have objective evidence of
disease or do not have adequate exposure to the Debtors' products where
such claimants, or claimants with similar characteristics, are compensated
in the tort system outside of bankruptcy.
In response to the Debtors' motion seeking substantive estimation of the
Debtors' asbestos personal injury liability, Judge Wolin issued a
Memorandum Opinion and Order (the "Order") on February 19, 2003, setting
forth a procedure for estimating the Debtors' liability for present and
future asbestos personal injury claims alleging cancer. The Order provided
that the Court would hold an estimation hearing regarding these cancer
claims, at which time the "debtors will be permitted to present their
defenses."
No timetable was set for implementation of the Order or any hearing on
estimation of the Debtors' liability for cancer claims.
In 2002, the Debtors also filed a motion requesting a ruling that putative
claimants who cannot satisfy objective standards of asbestos-related
disease are not entitled to vote on a Section 524(g) plan. To date, there
has been no ruling or hearing on the motion.
In May 2004, in response to a motion by Debtors and the Official Committee
of Unsecured Creditors, the Third Circuit Court of Appeals issued an
opinion and
-26-
order directing Judge Wolin to remove himself from presiding over Debtors'
Chapter 11 Cases.
In September 2004, the Third Circuit Court of Appeals assigned Judge Conti
to Debtors' Chapter 11 Cases to replace Judge Wolin.
After the assignment of Judge Conti to Debtors' Chapter 11 Cases, the
Debtors renewed their request that the court conduct substantive estimation
hearings regarding Debtors' asbestos personal injury liability and that
these hearings relate to all asbestos personal injury claims, not just
those alleging cancer. The Official Committee of Asbestos Personal Injury
Claimants and the legal representative for future asbestos personal injury
claimants renewed their request that estimation of Debtors' asbestos
personal injury liability be based solely on extrapolation from U.S.
Gypsum's settlement history.
Judge Conti has not yet made a decision as to when she will conduct a
hearing to estimate Debtors' asbestos personal injury liability, which
issues she will consider in estimating Debtors' liability, or whether she
will address the validity and voting rights of non-malignant claims where
there is no objective evidence of asbestos-related disease.
In the third quarter of 2004, the parties, including the committees,
engaged in non-binding mediation relating to the Debtors' asbestos personal
injury liability and the potential terms of a plan of reorganization. The
mediation did not result in an agreement regarding the Debtors' asbestos
liability or the terms of a plan of reorganization.
In the fourth quarter of 2004, the Debtors other than U.S. Gypsum filed a
complaint for declaratory relief in the Bankruptcy Court requesting a
ruling that the assets of the Debtors other than U.S. Gypsum are not
available to satisfy the asbestos liabilities of U.S. Gypsum. The Official
Committee of Unsecured Creditors has joined the Debtors in this action. In
opposition, the Official Committee of Asbestos Personal Injury Claimants,
the legal representative for future asbestos personal injury claimants, and
the Official Committee of Asbestos Property Damage Claimants filed
counterclaims asserting that the assets of all Debtors should be available
to satisfy the asbestos liabilities of U.S. Gypsum under various asserted
legal grounds, including successor liability, piercing the corporate veil,
and substantive consolidation. If the assets of all Debtors are pooled for
the payment of all liabilities, including the asbestos liabilities of U.S.
Gypsum, this could materially and adversely affect the recovery rights of
creditors of Debtors other than U.S. Gypsum as well as the holders of the
Corporation's equity. The Official Committee of Asbestos Personal Injury
Claimants, the legal representative for future asbestos claimants, and the
Official Committee of Asbestos Property Damage Claimants have also asserted
claims seeking a declaratory judgment that L&W Supply has direct liability
for asbestos personal injury claims on the asserted grounds that L&W Supply
distributed asbestos-containing products and assumed the liabilities of
former U.S.
-27-
Gypsum subsidiaries that distributed such products.
The Official Committee of Asbestos Personal Injury Claimants, the legal
representative for future asbestos claimants, and the Official Committee of
Asbestos Property Damage Claimants also have asserted in a court filing
that the Debtors are liable for claims arising from the sale of
asbestos-containing products by A.P. Green Refractories Co. ("A.P. Green").
They allege that U.S. Gypsum is liable for A.P. Green's liabilities due to
U.S. Gypsum's acquisition by merger of A.P. Green in 1967 and that,
pursuant to the merger documents, U.S. Gypsum assumed A.P. Green's
liabilities. They also allege that the other Debtors are liable for U.S.
Gypsum's liabilities, including the alleged liabilities of A.P. Green,
under various asserted legal grounds, including successor liability,
piercing the corporate veil, and substantive consolidation.
A.P. Green, which manufactured and sold products used in refractories, was
acquired through a merger of A.P. Green into U.S. Gypsum on December 29,
1967. On the next business day, January 2, 1968, U.S. Gypsum conveyed A.P.
Green's assets and liabilities to a newly formed Delaware corporation and
wholly owned subsidiary of U.S. Gypsum, also called A.P. Green Refractories
Co. (this newly formed corporation is also referred to herein as "A.P.
Green"). A.P. Green was operated as a wholly owned subsidiary of U.S.
Gypsum until 1985, at which time A.P. Green became a wholly owned
subsidiary of USG Corporation. In 1988, A.P. Green became a publicly traded
company when its shares were distributed to the stockholders of USG
Corporation. In February 2002, A.P. Green (now known as A.P. Green
Industries, Inc.) as well as its parent company, Global Industrial
Technologies, Inc., and other affiliates filed voluntary petitions for
reorganization through which A.P. Green and its affiliates seek to resolve
their asbestos liabilities. The A.P. Green reorganization proceeding is
pending in the United States Bankruptcy Court for the Western District of
Pennsylvania and is captioned In re: Global Industrial Technologies, Inc.
(Case No. 02-21626). The draft disclosure statement filed in July 2003 by
the debtors in the A.P. Green reorganization proceedings indicates that, in
early 2002, there were 235,757 asbestos personal injury claims pending
against A.P. Green as well as about 59,000 such claims pending against an
A.P. Green affiliate, and that A.P. Green estimates that several hundred
thousand additional claims will be asserted against it and/or its
affiliate. The disclosure statement also indicates that, in early 2002,
A.P. Green had approximately $492 million in unpaid pre-petition
settlements and judgments relating to asbestos personal injury claims. The
disclosure statement does not provide an estimate of the cost of resolving
A.P. Green's liability for pending or future asbestos claims.
The Corporation does not have sufficient information to predict whether or
how any plan of reorganization in the Debtors' Chapter 11 Cases might
address any liability based on sales of asbestos-containing products by
A.P. Green. The Corporation also does not have sufficient information to
estimate the amount, or range of amounts, of A.P. Green's asbestos
liabilities. If U.S. Gypsum is determined to be liable for the sale of
asbestos-containing products by A.P. Green or its affiliates, this result
likely would materially increase the amount of U.S. Gypsum's present and
future asbestos liabilities. Such a result could materially and adversely
affect the recovery of other Debtors' pre-petition creditors and the
Corporation's stockholders, depending upon, among other things, the amount
of A.P. Green's alleged asbestos
-28-
liabilities and whether the other Debtors are determined to be liable for
U.S. Gypsum's liabilities, including A.P. Green liabilities.
With regard to asbestos property damage claims, the Bankruptcy Court
established a bar date requiring all such claims against the Debtors to be
filed by January 15, 2003. Approximately 1,400 asbestos property damage
claims were filed, representing more than 2,000 buildings. In contrast, as
of the Petition Date, 11 Property Damage Cases were pending against U.S.
Gypsum. Approximately 500 of the asbestos property damage claims filed by
the bar date assert a specific dollar amount of damages, and the total
damages alleged in those claims is approximately $1.6 billion. However,
this amount reflects numerous duplicate claims filed against multiple
Debtors. Approximately 900 claims do not specify a damage amount. Recently,
counsel for the Official Committee of Asbestos Property Damage Claimants
stated in a court hearing that the committee believes that the amount of
the asbestos property damage claims will reach $1 billion.
Most of the asbestos property damage claims filed do not provide evidence
that the Debtors' products were ever installed in any of the buildings at
issue. Certain of the proof of claim forms purport to file claims on behalf
of two classes of claimants that were the subject of pre-petition class
actions. One of these claim forms was filed on behalf of a class of
colleges and universities that was certified for certain purposes in a
pre-petition lawsuit filed in federal court in South Carolina. However,
many of the putative members of this class also filed individual claim
forms. Four of the claim forms were filed by a claimant allegedly on behalf
of putative members of certified and uncertified classes in connection with
a pre-petition lawsuit pending in South Carolina state court.
The Debtors believe that they have substantial defenses to many of the
property damage claims, including the lack of evidence that the Debtors'
products were ever installed in the buildings at issue, the failure to file
the claims within the applicable statutes of limitation, and the lack of
evidence that the claimants have any injury or damages. The Debtors intend
to address many of these claims through an objection and disallowance
process in the Bankruptcy Court. Beginning in late 2004, the Debtors began
filing objections to asbestos property damage claims that did not provide
any evidence that the Debtors' products were installed in the buildings at
issue. To date, in response to these objections, the Court has disallowed
approximately 395 asbestos property damage claims for failure to provide
sufficient product identification evidence. Debtors expect to file
additional objections to claims that have not provided product
identification evidence and also expect to file objections to asbestos
property damage claims on additional grounds, including, without
limitation, that the claims are barred by the applicable statutes of
limitations. Because of the preliminary nature of the objection process,
the Corporation cannot predict the outcome of these proceedings or the
impact the proceedings may have on the estimated cost of resolving asbestos
property damage claims. See Estimated Cost, below.
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The following is a summary of the Personal Injury and Property Damage Cases
pending against U.S. Gypsum and certain other Debtors as of the Petition
Date.
PERSONAL INJURY CASES: As reported by the Center for Claims Resolution (the
"Center"), U.S. Gypsum was a defendant in more than 100,000 pending
Personal Injury Cases as of the Petition Date, as well as an additional
approximately 52,000 Personal Injury Cases that may be the subject of
settlement agreements. 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.
Prior to the Filing, U.S. Gypsum managed the handling and settlement of
Personal Injury Cases through its membership in the Center. From 1988 up to
February 1, 2001, the Center administered and arranged for the defense and
settlement of Personal Injury Cases against U.S. Gypsum and other Center
members. During that period, costs of defense and settlement of Personal
Injury Cases were shared among the members of the Center pursuant to
predetermined sharing formulas. Effective February 1, 2001, the Center
members, including U.S. Gypsum, ended their prior settlement-sharing
arrangement. Up until the Petition Date, the Center continued to administer
and arrange for the defense and settlement of the Personal Injury Cases,
but liability payments were not shared among the Center members.
In 2000 and years prior, U.S. Gypsum and other Center members negotiated a
number of settlements with plaintiffs' law firms that included agreements
to resolve over time the firms' pending Personal Injury Cases as well as
certain future claims (the "Long-Term Settlements"). With regard to future
claims, these Long-Term Settlements typically provided that the plaintiffs'
firms would recommend to their future clients that they defer filing, or
accept nominal payments on, personal injury claims that do not meet
established disease criteria and, with regard to those claims meeting
established disease criteria, that the future clients agree to settle those
claims for specified amounts. These Long-Term Settlements typically
resolved claims for amounts consistent with historical per-claim settlement
costs paid to the plaintiffs' firms involved. As a result of the Filing,
cash payments by U.S. Gypsum under these Long-Term Settlements have ceased,
and U.S. Gypsum expects that its obligations under these settlements will
be determined in the bankruptcy proceedings and plan of reorganization.
In 2000, U.S. Gypsum closed approximately 57,000 Personal Injury Cases.
U.S. Gypsum's cash payments in 2000 to defend and resolve Personal Injury
Cases totaled $162 million, of which $90 million was paid or reimbursed by
insurance. In 2000, the average settlement per case was approximately
$2,600, exclusive of defense costs. U.S. Gypsum made cash payments of $100
million in 1999 and $61 million in 1998 to resolve Personal Injury Cases,
of which $85 million and $45.5 million, respectively, were paid or
reimbursed by insurance.
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During late 2000 and in 2001, following the bankruptcy filings of other
defendants in asbestos personal injury litigation, plaintiffs substantially
increased their settlement demands to U.S. Gypsum. In response to these
increased settlement demands, U.S. Gypsum attempted to manage its asbestos
liability by contesting, rather than settling, a greater number of cases
that it believed to be non-meritorious. As a result, in the first and
second quarters of 2001, U.S. Gypsum agreed to settle fewer Personal Injury
Cases, but at a significantly higher cost per case.
In the first half of 2001, up to the Petition Date, U.S. Gypsum closed
approximately 18,900 Personal Injury Cases. In the first half of 2001, up
to the Petition Date, U.S. Gypsum's total asbestos-related cash payments,
including defense costs, were approximately $124 million, of which
approximately $10 million was paid or reimbursed by insurance. A portion of
these payments were for settlements agreed to in prior periods. As of March
31, 2001, U.S. Gypsum had estimated that cash expenditures for Personal
Injury Cases in 2001 would total approximately $275 million before
insurance recoveries of approximately $37 million.
In addition to the Personal Injury Cases pending against U.S. Gypsum, one
of the Corporation's subsidiaries and a Debtor in the bankruptcy
proceedings, L&W Supply, was named as a defendant in approximately 21
pending Personal Injury Cases as of the Petition Date. L&W Supply, a
distributor of building products manufactured by U.S. Gypsum and other
building products manufacturers, has not made any payments in the past to
resolve Personal Injury Cases.
One of U.S. Gypsum's subsidiaries and a Debtor in the bankruptcy
proceedings, Beadex, manufactured and sold joint compound containing
asbestos from 1963 through 1978 in the northwestern 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 L&W Supply
and Beadex will be addressed in the plan of reorganization. However,
because of, among other things, the small number of Personal Injury Cases
pending against L&W Supply and Beadex to date, the Corporation does not
have sufficient information at this time to predict how any plan of
reorganization will address any asbestos-related liability of L&W Supply
and Beadex.
PROPERTY DAMAGE CASES: As of the Petition Date, U.S. Gypsum was a defendant
in 11 Property Damage Cases, most of which involved multiple buildings. One
of the cases is a conditionally certified class action comprising all
colleges and universities in the United States, which certification is
presently limited to the resolution of certain allegedly "common" liability
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issues (Central Wesleyan College v. W.R. Grace & Co., et al., U.S.D.C.
S.C.). As a result of the Filing, all Property Damage Cases are stayed
against U.S. Gypsum. U.S. Gypsum's estimated cost of resolving the Property
Damage Cases is discussed in Estimated Cost, below.
INSURANCE COVERAGE: As of March 31, 2005, all prior receivables relating to
insurance remaining to cover asbestos-related costs had been collected by
U.S. Gypsum.
ESTIMATED COST: In 2000, prior to the Filing, an independent consultant
completed an actuarial study of U.S. Gypsum's current and potential future
asbestos liabilities. This study was based on the assumption that U.S.
Gypsum's asbestos liability would continue to be resolved in the tort
system.
As part of this study, the Corporation and its independent consultant
considered various factors that would impact the amount of U.S. Gypsum's
asbestos personal injury liability. These factors included the number,
disease, age, and occupational characteristics of claimants in the Personal
Injury Cases; the jurisdiction and venue in which such cases were filed;
the viability of claims for conspiracy or punitive damages; the elimination
of indemnity-sharing among Center members, including U.S. Gypsum, for
future settlements and its negative impact on U.S. Gypsum's ability to
continue to resolve claims at historical or acceptable levels; the adverse
impact on U.S. Gypsum's settlement costs of recent bankruptcies of
co-defendants; the possibility of additional bankruptcies of other
defendants; the possibility of significant adverse verdicts due to recent
changes in settlement strategies and related effects on liquidity; the
inability or refusal of former Center members to fund their share of
existing settlements and its effect on such settlement agreements;
allegations that U.S. Gypsum and the other Center members are responsible
for the share of certain settlement agreements that was to be paid by
former members that have refused or are unable to pay; the continued
ability to negotiate settlements or develop other mechanisms that defer or
reduce claims from unimpaired claimants; the possibility that federal
legislation addressing asbestos litigation would be enacted;
epidemiological data concerning the incidence of past and projected future
asbestos-related diseases; trends in the propensity of persons alleging
asbestos-related disease to sue U.S. Gypsum; the pre-agreed settlement
recommendations in, and the viability of, the Long-Term Settlements;
anticipated trends in recruitment of non-malignant or unimpaired claimants
by plaintiffs' law firms; and future defense costs. The study attempted to
weigh relevant variables and assess the impact of likely outcomes on future
case filings and settlement costs.
In connection with the Property Damage Cases, the Corporation considered,
among other things, the extent to which claimants could identify the
manufacturer of any alleged asbestos-containing products in the buildings
at issue in each case; the amount of asbestos-containing products at issue;
the claimed damages; the viability of statute of limitations and other
defenses;
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the amount for which such cases can be resolved, which normally (but not
uniformly) has been substantially lower than the claimed damages; and the
viability of claims for punitive and other forms of multiple damages.
Based upon the results of the actuarial study, the Corporation determined
that, although substantial uncertainty remained, it was probable that
asbestos claims then pending against U.S. Gypsum and future asbestos claims
to be filed against it through 2003 (both property damage and personal
injury) could be resolved in the tort system for an amount between $889
million and $1,281 million, including defense costs, and that within this
range the most likely estimate was $1,185 million. Consistent with this
analysis, in the fourth quarter of 2000, the Corporation recorded a
noncash, pretax charge of $850 million to results of operations, which,
combined with the previously existing reserve, increased U.S. Gypsum's
reserve for asbestos claims to $1,185 million. These amounts are stated
before tax benefit and are not discounted to present value. Less than 10%
of the reserve was attributable to defense and administrative costs. At the
time of recording this reserve, it was expected that the reserve amounts
would be expended over a period extending several years beyond 2003,
because asbestos cases in the tort system historically had been resolved an
average of three years after filing. The Corporation concluded that it did
not have adequate information to allow it to reasonably estimate U.S.
Gypsum's liability for asbestos claims to be filed after 2003.
Because of the Filing and activities relating to potential federal
legislation addressing asbestos personal injury claims, the Corporation
believes that there is greater uncertainty in estimating the reasonably
possible range of the Debtors' liability for pending and future asbestos
claims as well as the most likely estimate of liability within this range.
There are significant differences in the treatment of asbestos claims in a
bankruptcy proceeding as compared to the tort litigation system. The
factors that impact the estimation of liability for pending and future
asbestos claims in a bankruptcy proceeding and the amount that must be
provided in the plan of reorganization for such liabilities include: (i)
the number of present and future asbestos claims that will be addressed in
the plan of reorganization; (ii) the value that will be paid to present and
future claims, including the impact historical settlement values for
asbestos claims may have on the estimation of asbestos liability in the
bankruptcy proceedings; (iii) how claims by individuals who have no
objective evidence of impairment will be treated in the bankruptcy
proceedings and plan of reorganization; (iv) how the Long-Term Settlements
will be treated in the plan of reorganization and whether those settlements
will be set aside; (v) how claims for punitive damages will be treated;
(vi) the results of any litigation proceedings in the Chapter 11 Cases
regarding the estimated number or value of present and future asbestos
personal injury claims; (vii) the treatment of asbestos property damage
claims in the bankruptcy proceedings; (viii) the potential asbestos
liability of L&W, Beadex, A.P. Green or any other past or present
affiliates of the Debtors and how any such liability
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will be addressed in the bankruptcy proceedings and plan of reorganization;
(ix) whether the assets of all of the Debtors are determined to be
available to satisfy the asbestos liabilities of U.S. Gypsum; (x) how the
requirement of Section 524(g) that 75% of the voting asbestos claimants
approve the plan of reorganization will impact the amount that must be
provided in the plan of reorganization for pending and future asbestos
claims and (xi) the impact any relevant potential federal legislation may
have on the proceedings. See Note 2. Voluntary Reorganization Under Chapter
11 - Potential Federal Legislation Regarding Asbestos Personal Injury
Claims. In addition, the estimates of the Debtors' asbestos liability that
would be recorded as a result of the bankruptcy proceedings or potential
federal legislation are likely to include all expected future asbestos
cases to be brought against the Debtors (as opposed to the cases filed over
a three-year period) and are likely to be computed using the present value
of the estimated liability. These factors, as well as the uncertainties
discussed above in connection with the resolution of asbestos cases in the
tort system, increase the uncertainty of any estimate of asbestos
liability.
Because of the uncertainties associated with estimating the Debtors'
asbestos liability at this stage of the proceedings, no change has been
made at this time to the previously recorded reserve for asbestos claims,
except to reflect certain minor asbestos-related costs incurred since the
Filing. The reserve as of March 31, 2005, was $1,061 million.
Because the Filing and possible federal legislation have changed the basis
upon which the Debtors' asbestos liability would be estimated, there can be
no assurance that the current reserve accurately reflects the Debtors'
ultimate liability for pending and future asbestos claims. At the time the
reserve was increased to its current level in December 2000, the reserve
was an estimate of the cost of resolving in the tort system U.S. Gypsum's
asbestos liability for then-pending claims and those expected to be filed
through 2003. Because of the Filing and the stay of pre-petition asbestos
lawsuits, the Debtors have not participated in the tort system since June
2001 and thus cannot measure the recorded reserve against actual
experience. However, the reserve is generally consistent with the amount
the Corporation estimates that the Debtors would be required to pay to
resolve all of their asbestos liability if the FAIR Bill, in its current
form, is enacted. On April 19, 2005, Senator Arlen Specter (R. Pa.)
introduced in the United States Senate legislation addressing compensation
and administration of asbestos personal injury claims. The legislation is
titled the Fairness in Asbestos Injury Resolution Act of 2005 (Senate Bill
852, the "FAIR Bill"). The FAIR Bill is co-sponsored by three Democratic
Senators and four Republican Senators. The FAIR Bill has not been approved
by the Senate Committee on the Judiciary or the full Senate, has not been
considered by the House of Representatives, and is not law.
As the Chapter 11 Cases and the legislation process proceed, the Debtors
likely will gain more information from which a reasonable estimate of the
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Debtors' probable liability for present and future asbestos claims can be
determined. If the FAIR Bill or similar legislation is not enacted, the
Debtors' asbestos liability, as determined through the bankruptcy
proceedings, could be materially greater than the accrued reserve. The
Official Committee of Asbestos Personal Injury Claimants and the legal
representative for future asbestos personal injury claimants have indicated
in a court filing that they estimate that the net present value of the
Debtors' liability for present and future asbestos personal injury claims
is approximately $5.5 billion and that the Debtors are insolvent. The
Debtors have stated that they believe they are solvent if their asbestos
liabilities are fairly and appropriately valued. When the Debtors determine
that there is a reasonable basis for revision of the estimate of their
asbestos liability, the reserve will be adjusted, and it is possible that a
charge to results of operations will be necessary at that time. In such a
case, the Debtors' asbestos liability could vary significantly from the
recorded estimate of liability and could be greater than the high end of
the range estimated in 2000. This difference could be material to the
Corporation's financial position, cash flows and results of operations in
the period recorded.
BOND TO SECURE CERTAIN CENTER OBLIGATIONS: In January 2001, U.S. Gypsum
obtained a performance bond from Safeco Insurance Company of America
("Safeco") in the amount of $60.3 million to secure certain obligations of
U.S. Gypsum for extended payout settlements of Personal Injury Cases and
other obligations owed by U.S. Gypsum to the Center. The bond is secured by
an irrevocable letter of credit obtained by the Corporation in the amount
of $60.3 million and issued by JPMorgan Chase Bank (formerly Chase
Manhattan Bank) ("JPMorgan Chase") to Safeco. After the Filing, by a letter
dated November 16, 2001, the Center made a demand to Safeco for payment of
$15.7 million under the bond, and, by a letter dated December 28, 2001, the
Center made a demand to Safeco for payment of approximately $127 million
under the bond. The amounts for which the Center made demand were for the
payment of, among other things, settlements of Personal Injury Cases that
were entered into pre-petition. The total amount demanded by the Center
under the bond, approximately $143 million, exceeds the original penal sum
of the bond, which is $60.3 million. Safeco has not made any payment under
the bond.
On November 30, 2001, the Corporation and U.S. Gypsum filed an Adversary
Complaint in the Chapter 11 Cases to, among other things, enjoin the Center
from drawing on the bond and enjoin Safeco from paying on the bond during
the pendency of these bankruptcy proceedings. This Adversary Proceeding is
pending in the United States Bankruptcy Court for the District of Delaware
and is captioned USG Corporation and United States Gypsum Company v. Center
for Claims Resolution, Inc. and Safeco Insurance Company of America, No.
01-08932. Judge Wolin 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
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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 Center's motion for summary
judgment. Although the court ruled that Safeco is not required to remit any
surety bond proceeds to the Center at this time, the court stated that
certain settlements that were completed before U.S. Gypsum's Petition Date
likely are covered by the surety bond but that the bond does not cover
settlement payments that were not yet completed as of the Petition Date.
The court did not rule on whether the bond covers other disputed
obligations and reserved these issues to a subsequent phase of the
litigation. As a result of the court's decision, it is likely that, absent
a settlement of this matter, some portion of the bond may be drawn but that
the amount drawn may be substantially less than the full amount of the
bond. To the extent that Safeco were to pay all or any portion of the bond,
it is likely that Safeco would draw down the JPMorgan Chase letter of
credit to cover the bond payment and JPMorgan Chase would assert a
pre-petition claim in a corresponding amount against the Corporation in the
bankruptcy proceedings.
It is expected that the Center bond litigation will be addressed by either
Judge Fitzgerald or Judge Conti, who was appointed to replace Judge Wolin.
CONCLUSION: There are many uncertainties associated with the resolution of
the asbestos liability in the bankruptcy proceeding. The Corporation will
continue to review its asbestos liability as the Chapter 11 Cases progress
and as issues relating to the estimation of the Debtors' asbestos
liabilities are addressed. If, after any such review, the Debtors' estimate
of the probable liability for present and future asbestos claims is
different from the existing reserve, the reserve will be adjusted, and such
adjustment could be material to the Corporation's financial position, cash
flows and results of operations in the period recorded.
SILICA LITIGATION
During the 10 years prior to the Filing, Debtor U.S. Gypsum was named as a
defendant in approximately 10 lawsuits claiming personal injury from
exposure to silica allegedly from U.S. Gypsum products. The claims against
U.S. Gypsum in silica personal injury lawsuits pending at the time of the
Filing were stayed as a result of the Filing. Only one proof of claim
alleging silica personal injury liability was filed against any of the
Debtors as of the bar date in the Bankruptcy Case. However, it has been
estimated that tens of thousands of silica personal injury lawsuits have
been filed against other defendants nationwide in recent years.
In the fourth quarter of 2004, U.S. Gypsum was served with 17 complaints
involving more that 400 plaintiffs alleging personal injury resulting from
exposure to silica. These complaints were filed in various Mississippi
state courts, and each names from 178 to 195 defendants. U.S. Gypsum
believes that the claims against it in these lawsuits are stayed as a
result of the Filing. The Corporation does not have sufficient information
to estimate the likely
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cost of resolving these claims. However, the Corporation believes that it
has significant defenses to these claims if they are allowed to proceed.
The Corporation has provided notice of these recent complaints to its
insurance carriers.
ENVIRONMENTAL LITIGATION
The Corporation and certain of its subsidiaries have been notified by state
and federal environmental protection agencies of possible involvement as
one of numerous "potentially responsible parties" in a number of so-called
"Superfund" sites in the United States. In most of these sites, the
involvement of the Corporation or its subsidiaries is expected to be
minimal. The Corporation believes that appropriate reserves have been
established for its potential liability in connection with all Superfund
sites but is continuing to review its accruals as additional information
becomes available. Such reserves take into account all known or estimated
undiscounted costs associated with these sites, including site
investigations and feasibility costs, site cleanup and remediation, legal
costs, and fines and penalties, if any. In addition, environmental costs
connected with site cleanups on Corporation-owned property also are covered
by reserves established in accordance with the foregoing. The Debtors have
been given permission by the Bankruptcy Court to satisfy environmental
obligations up to $12 million. The Corporation believes that neither these
matters nor any other known governmental proceedings regarding
environmental matters will have a material adverse effect upon its
financial position, cash flows or results of operations.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
OVERVIEW
USG Corporation (the "Corporation") and 10 of its United States subsidiaries
(collectively, the "Debtors") are currently operating under chapter 11 of the
United States Bankruptcy Code (the "Bankruptcy Code"). The Debtors took this
action to resolve asbestos claims in a fair and equitable manner, to protect the
long-term value of the Debtors' businesses, and to maintain the Debtors'
leadership positions in their markets. To properly understand the Corporation
and its businesses, investors, creditors or other readers of this report should
first understand the nature of this voluntary reorganization process under
chapter 11 and the potential impacts the reorganization may have on their rights
and interests in the Corporation as described in more detail below. At this
point, there is great uncertainty as to the amount of the Debtors' asbestos
liability and thus the value of any recovery for pre-petition creditors or
stockholders under any final plan of reorganization. No plan of reorganization
has thus far been proposed by the Debtors.
The Corporation had $1,199 million of cash, cash equivalents, restricted cash
and marketable securities as of March 31, 2005, and management believes that
this liquidity plus expected operating cash flows will meet the Corporation's
cash needs, including making regular capital investments to maintain and enhance
its businesses, throughout the chapter 11 proceedings.
The Corporation's net sales for the first quarter of 2005 were a record level
for any first quarter in its history and represented a 15% increase from the
same period in 2004. Demand for products sold by the Corporation's North
American Gypsum and Building Products Distribution operating segments was strong
in the first quarter of 2005 due to continued growth in the new housing and
repair and remodel markets. Shipments of gypsum wallboard remained at
historically high levels for the Corporation and the industry in the first
quarter of 2005 and are expected to be strong for the remainder of the year.
United States Gypsum Company ("U.S. Gypsum") shipped more wallboard in March
than in any other month in that company's history. The favorable level of
activity in the aforementioned markets and industry capacity utilization rates
in excess of 90% have resulted in the continuing rise in market selling prices
for gypsum wallboard. The nationwide average realized selling price for U.S.
Gypsum's SHEETROCK(R) brand gypsum wallboard was up 21% from the first quarter
of 2004. The Corporation's Worldwide Ceilings operating segment reported a
modest increase in net sales for the first quarter of 2005. However, operating
profit for that segment fell primarily due to higher manufacturing costs.
The Corporation's gross margin percentage (gross profit as a percent of net
sales) was 18.2% in the first quarter of 2005, up from 16.8% in the first
quarter of 2004. This improvement was primarily the result of higher selling
prices for SHEETROCK(R) brand gypsum wallboard. However, profit margins have
been pressured by high levels of costs related to the prices of natural gas (a
major source of energy for the Corporation) and raw materials, employee medical
insurance and the implementation
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of a new enterprise-wide software system.
VOLUNTARY REORGANIZATION UNDER CHAPTER 11
On June 25, 2001 (the "Petition Date"), the Debtors filed voluntary petitions
for reorganization (the "Filing") under the Bankruptcy Code. The Debtors'
bankruptcy cases (the "Chapter 11 Cases") are pending in the United States
Bankruptcy Court for the District of Delaware (the "Bankruptcy Court").
The Debtors intend to address their liability for all present and future
asbestos claims, as well as all other pre-petition claims, in a plan or plans of
reorganization approved by the Bankruptcy Court. The Debtors currently have the
exclusive right to file a plan of reorganization until June 30, 2005. The
Debtors may seek one or more additional extensions of the exclusive period
depending upon developments in the Chapter 11 Cases.
A key factor in determining whether or to what extent there will be any recovery
for pre-petition creditors or stockholders under any plan of reorganization is
the amount that must be provided in the plan of reorganization to address the
Debtors' liability for present and future asbestos claims. The amount of the
Debtors' asbestos liabilities has not yet been determined and is subject to
substantial uncertainty.
The Corporation's Annual Report on Form 10-K, filed on February 18, 2005,
discusses the background and impact of the Filing, developments in the
reorganization proceeding, proceedings relating to estimation of Debtors'
liability for asbestos personal injury claims, and potential federal legislation
regarding asbestos personal injury claims. Since the filing of the Form 10-K,
there have been additional developments in the Debtors' Chapter 11 proceedings.
On April 21, 2005, the United States Trustee appointed an Official Committee of
the Equity Security Holders of the Corporation. This committee, along with the
three official committees representing various creditors of the Debtors, are
expected to play significant roles in the Chapter 11 Cases.
During the first quarter of 2005, there have also been developments regarding
potential federal legislation. See Potential Federal Legislation Regarding
Asbestos Personal Injury Claims, below. See also, Item 1, Note 2, Voluntary
Reorganization Under Chapter 11, and Note 12, Litigation, for additional
information on the background of asbestos litigation, developments in the
Corporation's reorganization proceedings, and estimated cost.
POTENTIAL FEDERAL LEGISLATION REGARDING ASBESTOS PERSONAL INJURY CLAIMS
On April 19, 2005, Senator Arlen Specter (R. Pa.) introduced in the United
States Senate legislation addressing compensation and administration of asbestos
personal injury claims. The legislation is titled the Fairness in Asbestos
Injury Resolution Act of 2005 (Senate Bill 852, the "FAIR Bill"). The FAIR Bill
is co-sponsored by three Democratic Senators and four Republican Senators. The
FAIR Bill has been referred to the Senate Committee on the Judiciary. The FAIR
Bill has not been approved by the Senate Committee on the Judiciary or the full
Senate, has not been
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considered by the House of Representatives, and is not law.
The FAIR Bill introduced in the Senate is intended to establish a nationally
administered trust fund to compensate asbestos personal injury claimants. In the
FAIR Bill's current form, companies that have made past payments for asbestos
personal injury claims would be required to contribute amounts to a national
trust fund on a periodic basis that would pay the claims of qualifying asbestos
personal injury claimants. The nationally administered trust fund would be the
exclusive remedy for asbestos personal injury claims, and such claims could not
be brought in state or federal court as long as such claims are being
compensated under the national trust fund. A copy of the FAIR Bill as introduced
is available at http://thomas.loc.gov (type in "S. 852" in the search field).
In the FAIR Bill's current form, the amounts to be paid to the national trust
fund are based on an allocation methodology set forth in the FAIR Bill. The
amounts that participants, including the Debtors, would be required to pay are
not dischargeable in a bankruptcy proceeding. In addition, the FAIR Bill, in its
current form, requires affected companies currently in chapter 11, including the
Debtors, to make their first payment to the national trust fund not later than
60 days after enactment of the FAIR Bill, notwithstanding the fact that the
companies are still in chapter 11 proceedings. The FAIR Bill also provides,
among other things, that if it is determined that the money in the trust fund is
not sufficient to compensate eligible claimants, the claimants and defendants
(including current chapter 11 debtors) would return to the court system to
resolve claims not paid by the national trust fund.
The outcome of the legislative process is inherently speculative, and it cannot
be known whether the FAIR Bill or similar legislation will ever be enacted or,
even if enacted, what the terms of the final legislation might be. Previously,
in April 2004, a similar, but not identical, bill (the "Fairness in Asbestos
Injury Resolution Act of 2004") was introduced in the Senate and was approved by
the Senate Committee on the Judiciary, but the full Senate defeated a motion to
proceed with floor consideration of the bill. Even if the FAIR Bill is enacted,
the terms of the enacted legislation may differ from those of the FAIR Bill as
introduced, and those differences may be material to the FAIR Bill's impact on
the Corporation.
Enactment of the FAIR Bill or similar legislation addressing the financial
contributions of the Debtors for asbestos personal injury claims would have a
material impact on the amount of the Debtors' asbestos personal injury liability
and the Debtors' Chapter 11 Cases.
ESTIMATED COST OF ASBESTOS LIABILITY
Prior to the Filing, in the fourth quarter of 2000, U.S. Gypsum recorded a
noncash, pretax provision of $850 million, increasing to $1,185 million its
total accrued reserve for resolving in the tort system the asbestos claims
pending as of December 31, 2000, and expected to be filed through 2003. At that
time, the estimated range of U.S. Gypsum's probable liability for such claims
was between $889 million and $1,281 million, including defense costs. These
amounts are stated before tax
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benefit and are not discounted to present value. As of March 31, 2005, the
Corporation's accrued reserve for asbestos claims totaled $1,061 million.
Because of the uncertainties associated with estimating the Debtors' liability
for present and future asbestos claims at this stage of the bankruptcy
proceedings, no change has been made to the previously recorded reserve except
to reflect certain minor asbestos-related costs incurred since the Filing.
Because the Filing and possible federal legislation have changed the basis upon
which the Debtors' asbestos liability would be estimated, there can be no
assurance that the current reserve accurately reflects the Debtors' ultimate
liability for pending and future asbestos claims. At the time the reserve was
increased to its current level in December 2000, the reserve was an estimate of
the cost of resolving in the tort system U.S. Gypsum's asbestos liability for
then-pending claims and those expected to be filed through 2003. Because of the
Filing and the stay of pre-petition asbestos lawsuits, the Debtors have not
participated in the tort system since June 2001 and thus cannot measure the
recorded reserve against actual experience. However, the reserve is generally
consistent with the amount the Corporation estimates that the Debtors would be
required to pay to resolve all of their asbestos liability if the FAIR Bill, in
its current form, is enacted.
As the Chapter 11 Cases and the legislation process proceed, the Debtors likely
will gain more information from which a reasonable estimate of the Debtors'
probable liability for present and future asbestos claims can be determined. If
such estimate differs from the existing reserve, the reserve will be adjusted,
and it is possible that a charge to results of operations will be necessary at
that time. In such a case, the Debtors' asbestos liability could vary
significantly from the recorded estimate of liability and could be greater than
the high end of the range estimated in 2000. This difference could be material
to the Corporation's financial position, cash flows and results of operations in
the period recorded.
POTENTIAL OUTCOMES OF THE FILING
While it is the Debtors' intention to seek a full recovery for their creditors,
it is not possible to predict the amount that will have to be provided in the
plan of reorganization to address present and future asbestos claims, how the
plan of reorganization will treat other pre-petition claims, whether there will
be sufficient assets to satisfy the Debtors' pre-petition liabilities, and what
impact any plan may have on the value of the shares of the Corporation's common
stock. The payment rights and other entitlements of pre-petition creditors and
the Corporation's stockholders may be substantially altered by any plan of
reorganization confirmed in the Chapter 11 Cases. Pre-petition creditors may
receive under the plan of reorganization less than 100% of the face value of
their claims, the pre-petition creditors of some Debtors may be treated
differently from the pre-petition creditors of other Debtors, and the interests
of the Corporation's stockholders are likely to be substantially diluted or
cancelled in whole or in part. There can be no assurance as to the value of any
distributions that might be made under any plan of reorganization with respect
to such pre-petition claims or equity interests.
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It is also not possible to predict how the plan of reorganization will treat
intercompany indebtedness, licenses, transfers of goods and services, and other
intercompany arrangements, transactions and relationships that were entered into
before the Petition Date. Certain of these intercompany transactions have been
challenged by various parties in these Chapter 11 Cases (see Developments in the
Reorganization Proceeding, above), and other arrangements, transactions and
relationships may be challenged by parties to these Chapter 11 Cases. The
outcome of such challenges may have an impact on the treatment of various claims
under any plan of reorganization.
ACCOUNTING IMPACT
The Corporation is required to follow American Institute of Certified Public
Accountants ("AICPA") Statement of Position 90-7 ("SOP 90-7"), "Financial
Reporting by Entities in Reorganization under the Bankruptcy Code." Pursuant to
SOP 90-7, the Corporation's pre-petition liabilities that are subject to
compromise are reported separately on the consolidated balance sheet. Virtually
all of the Corporation's pre-petition debt is currently in default and was
recorded at face value and classified within liabilities subject to compromise.
U.S. Gypsum's asbestos liability also is classified within liabilities subject
to compromise. See Item 1, Note 2, Voluntary Reorganization Under Chapter 11,
which includes information related to financial statement presentation, the
debtor-in-possession statements and detail of liabilities subject to compromise
and chapter 11 reorganization expenses.
CONSOLIDATED RESULTS OF OPERATIONS
NET SALES
Net sales in the first quarter of 2005 totaled $1,173 million, a record for any
first quarter in the Corporation's history and a 15% increase from $1,020
million in the first quarter of 2004. Net sales increased largely due to higher
selling prices for SHEETROCK(R) brand gypsum wallboard and other related
products. See Core Business Results of Operations below for an explanation of
product line results by segment.
COST OF PRODUCTS SOLD
Cost of products sold in the first quarter of 2005 was $959 million, up 13% from
$849 million a year ago. Key factors for this variation were higher costs
related to the prices of natural gas and raw materials, employee medical
insurance and the implementation of a new enterprise-wide software system.
GROSS PROFIT
Gross profit in the first quarter of 2005 was $214 million, a 25% increase from
$171 million in the first quarter of 2004. The gross margin percentage was 18.2%
in the first quarter of 2005, up from 16.8% in the first quarter of 2004.
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SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses in the first quarter of 2005 were $89
million, up 16% from $77 million in the first quarter of 2004. Expenses were up
in the 2005 period primarily due to an increased accrual related to the
Bankruptcy Court-approved key employee retention plan, increased levels of
compensation and benefits and higher funding for growth initiatives. As a
percent of net sales, selling and administrative expenses were 7.6% in the first
quarter of 2005, up from 7.5% in the comparable 2004 period.
CHAPTER 11 REORGANIZATION EXPENSES
In connection with the Filing, the Corporation recorded chapter 11
reorganization expenses of $1 million in the first quarter of 2005, down from $2
million in the first quarter of 2004. For the first quarter of 2005 and 2004
respectively, these expenses consisted of legal and financial advisory fees of
$6 million and $4 million, partially offset by bankruptcy-related interest
income of $5 million and $2 million, respectively.
INTEREST EXPENSE
Interest expense of $1 million was incurred in the first quarter of 2005 and
2004. Under SOP 90-7, virtually all of the Corporation's outstanding debt is
classified as liabilities subject to compromise, and interest expense on this
debt has not been accrued or recorded since the Petition Date.
Contractual interest expense not accrued or recorded on pre-petition debt
totaled $19 million in the first quarter of 2005. From the Petition Date through
March 31, 2005, contractual interest expense not accrued or recorded on
pre-petition debt totaled $276 million. This calculation assumes that all such
interest was paid when required at the applicable contractual interest rate
(after giving effect to any applicable default rate). However, the calculation
excludes the impact of any compounding of interest on unpaid interest that may
be payable under the relevant contractual obligations, as well as any interest
that may be payable under a plan of reorganization to trade or other creditors
that are not otherwise entitled to interest under the express terms of their
claims. The impact of compounding alone would have increased the contractual
interest expense reported above by $6 million in the first quarter of 2005 and
$40 million from the Petition Date through March 31, 2005. For financial
reporting purposes, no post-petition accruals have been made for contractual
interest expense not accrued or recorded on pre-petition debt.
On April 11, 2005, the Unsecured Creditors Committee filed a motion with the
bankruptcy court requesting that the Debtors make interest payments to all
non-asbestos unsecured creditors for interest accrued from January 1, 2005, on
liquidated, undisputed pre-petition claims (including accrued unpaid interest
through December 31, 2004). If approved, this would require the Debtors to make
interest payments of approximately $84 million on an annual basis.
INTEREST INCOME
Non-bankruptcy related interest income of $2 million and $1 million was recorded
in the first quarter of 2005 and 2004, respectively.
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INCOME TAXES
Income tax expense amounted to $48 million and $33 million in the first quarter
of 2005 and 2004, respectively. The effective tax rates were 38.8% and 36.6% for
the respective periods. The increase in the effective tax rate was primarily due
to a reduction in the Corporation's tax reserves in the first quarter of 2004
resulting from the impact of finalized IRS regulations on the Chapter 11
reorganization expenses incurred by the Corporation and a lower level of
projected permanent book-tax differences in 2005, including the U.S. federal tax
deduction for qualified production activities.
NET EARNINGS
Net earnings in the first quarter of 2005 were $77 million, up $20 million, or
35%, from $57 million in the first quarter of 2004. Diluted earnings per share
were $1.77 and $1.33 for the respective periods.
CORE BUSINESS RESULTS OF OPERATIONS
Net Sales Operating Profit
(dollars in millions) --------------- ----------------
Three Months Ended March 31, 2005 2004 2005 2004
- ---------------------------- ------ ------ ---- ----
NORTH AMERICAN GYPSUM:
U.S. Gypsum Company $ 654 $ 574 $ 93 $ 61
CGC Inc. (gypsum) 75 73 12 13
Other subsidiaries* 40 36 2 7
Eliminations (44) (44) -- --
------ ------ ---- ----
Total 725 639 107 81
------ ------ ---- ----
WORLDWIDE CEILINGS:
USG Interiors, Inc. 117 120 6 12
USG International 51 46 3 1
CGC Inc. (ceilings) 13 13 3 2
Eliminations (11) (13) -- --
------ ------ ---- ----
Total 170 166 12 15
------ ------ ---- ----
BUILDING PRODUCTS DISTRIBUTION:
L&W Supply Corporation 456 362 26 14
------ ------ ---- ----
Corporate -- -- (23) (16)
Chapter 11 reorganization expenses -- -- (1) (2)
Eliminations (178) (147) 3 --
------ ------ ---- ----
Total USG Corporation 1,173 1,020 124 92
====== ====== ==== ====
* 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.
-44-
NORTH AMERICAN GYPSUM
Net sales of $725 million increased 13% from the first quarter of 2004, while
operating profit increased 32% to $107 million.
United States Gypsum Company: Net sales for U.S. Gypsum increased $80 million,
or 14%, compared with the first quarter of 2004, while operating profit rose $32
million, or 52%. These increases primarily reflected higher selling prices for
SHEETROCK(R) brand gypsum wallboard.
U.S. Gypsum's nationwide average realized selling price for SHEETROCK(R) brand
gypsum wallboard was $133.73 per thousand square feet in the first quarter of
2005. This price represented a 21% increase from $110.33 in the first quarter of
2004. However, the benefit of improved pricing was partially offset by higher
costs, including higher energy and raw material prices.
Shipments of SHEETROCK(R) brand gypsum wallboard totaled 2.7 billion square feet
during the first quarters of 2005 and 2004. Wallboard plants operated at 91% of
capacity in the first quarter of 2005 compared with 93% in the first quarter of
2004. Industry shipments of gypsum wallboard were up approximately 2% from the
first quarter of 2004.
Shipments of DUROCK(R) brand cement board and FIBEROCK(R) brand gypsum fiber
panels were the highest for any first quarter in U.S. Gypsum's history.
CGC Inc.: Net sales for the gypsum business of Canada-based CGC Inc. increased
3% versus the first quarter of 2004 primarily due to the favorable effects of
currency translation and higher selling prices for SHEETROCK(R) brand gypsum
wallboard. However, operating profit declined slightly to $12 million from $13
million largely as a result of higher manufacturing costs.
WORLDWIDE CEILINGS
Net sales of $170 million increased 2%, while operating profit of $12 million
declined 20% from the first quarter of 2004.
USG Interiors, Inc.: The Corporation's domestic ceilings business, USG
Interiors, Inc. reported first quarter 2005 net sales and operating profit of
$117 million and $6 million, respectively. This compared with net sales of $120
million and operating profit of $12 million in the first quarter of 2004.
The decline in net sales was largely due to lower shipments of ceiling grid and
tile. In last year's first quarter, market concerns over a shortage of steel
used to make grid and related increases in steel costs contributed to unusually
strong demand for grid products. Grid demand in the first quarter of 2005 was
more in line with overall industry opportunity.
Higher manufacturing costs, primarily related to energy and raw materials, for
both ceiling grid and tile also contributed to lower operating profit in the
first
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quarter of 2005. These cost pressures during the period were partially offset by
higher pricing for both ceiling tile and grid.
USG International: Net sales for USG International increased 11% compared with
the first quarter of 2004, while operating profit rose to $3 million from $1
million. These improvements primarily reflected increased demand for ceiling
systems and gypsum-related products in Europe and Latin America.
CGC Inc.: The ceilings business of CGC Inc. reported $13 million in net sales,
which was unchanged from the first quarter of 2004, while operating profit rose
to $3 million from $2 million.
BUILDING PRODUCTS DISTRIBUTION
L&W Supply Corporation ("L&W Supply"), the leading specialty building products
distribution business in the United States, reported net sales of $456 million,
a first quarter record and a 26% increase versus the first quarter of 2004.
Operating profit for the company rose to $26 million from $14 million. These
increases reflect record first quarter shipments of gypsum wallboard and
complementary building products. Complementary building products include such
products as drywall metal, ceiling products, joint compound and roofing.
Shipments of L&W Supply's gypsum wallboard were up 7% versus the first quarter
of 2004. These results also benefited from improved selling prices for gypsum
wallboard, which increased 19%.
L&W Supply operated 185 locations in the United States as of March 31, 2005,
compared with 184 locations as of March 31, 2004.
MARKET CONDITIONS AND OUTLOOK
Industry shipments of gypsum wallboard in the United States were an estimated
8.8 billion square feet in the first quarter of 2005, a 2% increase from 8.6
billion square feet in the first quarter of 2004. The robust level of activity
in the new housing and residential repair and remodel markets, which together
account for nearly two-thirds of all demand for gypsum wallboard, and
utilization rates in excess of 90% for the industry, have resulted in a rise of
market selling prices for gypsum wallboard.
The outlook for the remainder of 2005 is positive. The strong new housing and
residential repair and remodel markets are expected to keep demand for the
Corporation's gypsum wallboard products high. However, rising interest rates and
tightening lending standards may bring demand levels down slightly from last
year's level. The commercial construction market (the principal market for the
Corporation's ceilings products), while still soft, is showing some signs of
improvement. These factors, combined with the Corporation's continued focus on
margin improvement and select growth opportunities, should produce strong
results in 2005. U.S. Gypsum continues to make investments to meet its
customers' needs, satisfy the growing demand for SHEETROCK(R) brand gypsum
wallboard and improve its cost position. The recently announced state-of-the-art
modernization of its Norfolk, Virginia, gypsum wallboard facility will increase
capacity, reduce
-46-
production costs and improve service to customers in the Mid-Atlantic market.
However, the Corporation, like many other companies, faces many ongoing cost
pressures such as higher prices for natural gas and raw materials and increased
costs for employee benefits.
In this environment, the Corporation continues to focus its management attention
and investments on improving customer service, manufacturing costs and operating
efficiencies, as well as investing to grow its businesses. In addition, the
Corporation will diligently continue its attempt to resolve the chapter 11
proceedings, consistent with the goal of achieving a fair, comprehensive and
final resolution to its asbestos liability.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
As of March 31, 2005, the Corporation had $1,199 million of cash, cash
equivalents, restricted cash and marketable securities. This amount was down $50
million, or 4%, from $1,249 million as of December 31, 2004, primarily due to
payments of customer rebates, employee incentive compensation and other seasonal
working capital needs in the first quarter. Of the total amount of $1,199
million as of March 31, 2005, $252 million was held by non-Debtor subsidiaries.
Since the Petition Date, the Corporation's level of liquidity has increased due
to strong operating cash flows and the absence of cash payments related to
asbestos settlements and interest on pre-petition debt. Contractual interest
expense not accrued or recorded on pre-petition debt was $19 million in the
first quarter of 2005 and $276 million since the Petition Date. See Interest
Expense, above, for a full discussion of contractual interest not accrued or
recorded.
CASH FLOWS
As shown on the consolidated statement of cash flows, cash and cash equivalents
decreased $87 million during the first quarter of 2005. The primary source of
cash in the first quarter of 2005 was earnings from operations. Primary uses of
cash were: (i) working capital of $126 million (primarily increases in
receivables and inventory costs, the aforementioned payments of customer rebates
and employee incentive compensation, and other seasonal needs), (ii) net
purchases of marketable securities of $40 million, (iii) capital spending of $33
million and (iv) pension funding of $21 million.
Comparing the first quarter of 2005 with the first quarter of 2004, net cash
used for operating activities was $14 million in the 2005 period compared with
$3 million a year ago. This variation was primarily attributable to higher
levels of pension funding and seasonal working capital needs, partially offset
by increased net earnings. Net cash used for investing activities increased to
$72 million from $67 million primarily reflecting increases in capital spending
and net purchases of marketable securities, partially offset by restricted cash
deposits in the first quarter of 2004. Net cash of $1 million provided by
financing activities during the first quarter of 2005 reflected the exercise of
stock options.
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CAPITAL EXPENDITURES
Capital spending amounted to $33 million in the first quarter of 2005, compared
with $20 million in the corresponding 2004 period. As of March 31, 2005,
remaining capital expenditure commitments for the replacement, modernization and
expansion of operations amounted to $268 million, compared with $283 million as
of December 31, 2004.
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.
WORKING CAPITAL
Total working capital (current assets less current liabilities) as of March 31,
2005, amounted to $1,325 million, and the ratio of current assets to current
liabilities was 3.38-to-1. As of December 31, 2004, working capital amounted to
$1,220 million, and the ratio of current assets to current liabilities was
3.14-to-1.
Receivables increased to $523 million as of March 31, 2005, from $413 million as
of December 31, 2004, primarily reflecting first quarter payments of customer
rebates and a 14% increase in net sales for the month of March 2005 as compared
with December 2004. Inventories increased to $346 million from $338. Accounts
payable decreased to $268 million from $270 million. Accrued expenses declined
to $194 million from $224 million as of December 31, 2004, primarily due to the
payment of employee incentive compensation during the first quarter.
MARKETABLE SECURITIES
As of March 31, 2005, $488 million was invested in marketable securities, up $38
million from $450 million as of December 31, 2004. Of the first quarter 2005
amount, $310 million was invested in long-term marketable securities and $178
million in short-term marketable securities. The Corporation's marketable
securities are classified as available-for-sale securities and reported at fair
market value with unrealized gains and losses excluded from earnings and
reported in accumulated other comprehensive income (loss) on the consolidated
balance sheets.
RESTRICTED CASH AND LETTERS OF CREDIT
As of March 31, 2005, a total of $42 million was reported as restricted cash on
the consolidated balance sheet. Restricted cash primarily represented collateral
to support outstanding letters of credit.
As of March 31, 2005, the Corporation had a $100 million credit agreement, which
was to expire April 30, 2006, with LaSalle Bank N.A. (the "LaSalle Facility") to
be used exclusively to support the issuance of letters of credit needed to
support business operations. As of March 31, 2005, $36 million of letters of
credit under
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the LaSalle Facility, which are cash collateralized at 103%, were outstanding.
In March 2005, the Corporation asked the Bankruptcy court to approve amendments
to the LaSalle Facility to extend the term of the facility until April 30, 2008,
and to increase the credit line to $175 million. In the same motion, the
Corporation asked for permission to replace certain standby letters of credit,
which had been issued under a pre-petition credit facility but were expiring in
the near future due to that credit facility's expiration, with new ones issued
under the LaSalle Facility. The Bankruptcy court approved the Corporation's
requests on April 15, 2005. The amendments were thereafter made effective as of
April 29, 2005.
DEBT
As of March 31, 2005, total debt amounted to $1,006 million, of which $1,005
million was included in liabilities subject to compromise. These amounts were
unchanged from the December 31, 2004, levels and do not include any accruals for
post-petition contractual interest expense.
LEGAL CONTINGENCIES
As a result of the Filing, all pending asbestos lawsuits against the Debtors are
stayed, and no party may take any action to pursue or collect on such asbestos
claims absent specific authorization of the Bankruptcy Court.
U.S. Gypsum has also been named as a defendant in lawsuits claiming personal
injury from exposure to silica allegedly from U.S. Gypsum products. Pre-petition
claims against U.S. Gypsum in silica personal injury lawsuits are also stayed as
a result of the Filing.
The Corporation and certain of its subsidiaries have been notified by state and
federal environmental protection agencies of possible involvement as one of
numerous "potentially responsible parties" in a number of so-called "Superfund"
sites in the United States. The Corporation believes that neither these matters
nor any other known governmental proceeding regarding environmental matters will
have a material adverse effect upon its financial position, cash flows or
results of operations.
See Item 1, Note 12, Litigation, for additional information on (i) the
background of asbestos litigation, developments in the Corporation's
reorganization proceeding and estimated cost, (ii) silica litigation and (iii)
environmental litigation.
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CRITICAL ACCOUNTING POLICIES
The preparation of the Corporation's financial statements requires management to
make estimates, judgments and assumptions that affect the reported amounts of
assets, liabilities, revenues and expenses during the periods presented. The
Corporation's 2004 Annual Report on Form 10-K, which was filed on February 18,
2005, includes a summary of the critical accounting policies the Corporation
believes are the most important to aid in understanding its financial results.
There have been no material changes to these critical accounting policies that
impacted the Corporation's reported amounts of assets, liabilities, revenues or
expenses during the first three months of 2005.
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements related to management's
expectations about future conditions. The effects of the Filing and the conduct,
outcome and costs of the Chapter 11 Cases, as well as the ultimate costs
associated with the Corporation's asbestos litigation, including the possible
impact of any asbestos-related legislation, may differ from management's
expectations. Actual business, market or other conditions may also differ from
management's expectations and accordingly affect the Corporation's sales and
profitability or other results. Actual results may differ due to various other
factors, including economic conditions such as the levels of construction
activity, employment levels, interest rates, currency exchange rates and
consumer confidence; competitive conditions such as price and product
competition and competition for procurement of synthetic gypsum; shortages in
raw materials and energy; increases in raw material, energy and employee benefit
costs; loss of one or more significant customers; and the unpredictable effects
of acts of terrorism or war upon domestic and international economies and
financial markets. The Corporation assumes no obligation to update any
forward-looking information contained in this report.
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.
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There was no change in the Corporation's "internal control over financial
reporting" (as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934)
identified in connection with the evaluation required by Rule 13a-15(d) of the
Securities Exchange Act of 1934 that occurred during the fiscal quarter covered
by this report on Form 10-Q that has materially affected, or is reasonably
likely to materially affect, the Corporation's internal control over financial
reporting.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of USG Corporation:
We have reviewed the accompanying consolidated balance sheet of USG Corporation
and subsidiaries as of March 31, 2005 and the related consolidated statements of
earnings and cash flows for each of the three month periods ended March 31, 2005
and 2004. These interim financial statements are the responsibility of the
Corporation's management.
We conducted our reviews in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board (United States), the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying consolidated interim financial statements for them
to be in conformity with accounting principles generally accepted in the United
States of America.
We have previously audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheets of USG Corporation and subsidiaries as of December 31, 2004 and 2003, and
the related consolidated statements of earnings, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 2004 (not
presented herein); and in our report dated February 8, 2005 we expressed an
unqualified opinion on those consolidated financial statements and included
explanatory paragraphs concerning (i) matters which raise substantial doubt
about the Corporation's ability to continue as a going concern; (ii) changes in
methods of accounting for asset retirement obligations and goodwill and other
intangible assets due to the Corporation's adoption of Statement of Financial
Accounting Standards (SFAS) No. 143, "Accounting for Asset Retirement
Obligations" in 2003, and SFAS No. 142, "Goodwill and Other Intangible Assets"
in 2002; In our opinion, the information set forth in the accompanying
consolidated balance sheet as of December 31, 2004 is fairly stated, in all
material respects, in relation to the consolidated balance sheet from which it
has been derived.
As discussed in Note 2 to the consolidated financial statements, USG Corporation
and certain subsidiaries voluntarily filed for Chapter 11 bankruptcy protection
on June 25, 2001. The accompanying consolidated financial statements do not
purport to reflect or provide for the consequences of the bankruptcy
proceedings. In particular, such financial statements do not purport to show (a)
as to assets, their realizable value on a liquidation basis or their
availability to satisfy
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liabilities; (b) as to pre-petition liabilities, the amounts that may be allowed
for claims or contingencies, or the status and priority thereof; (c) as to
stockholder accounts, the effect of any changes that may be made in the
capitalization of the Corporation; or (d) as to operations, the effect of any
changes that may be made in its business.
The accompanying consolidated financial statements have been prepared assuming
that the Corporation will continue as a going concern. As discussed in Notes 2
and 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
April 26, 2005
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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, silica litigation and environmental
litigation.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(c) Total Number of (c) Maximum Number (or
Shares (or Units) Approximate Dollar Value)
(a) Total Number of (b) Average Price Purchased as Part of of Shares (or Units)
2005 of Shares (or Units) Paid per Share Publicly Announced that May Yet Be Purchased
Period Purchased (or Unit) Plans or Programs Under the Plans or Programs
- ------ -------------------- ----------------- -------------------- ---------------------------
January -- -- -- --
February -- -- -- --
March -- -- -- --
--- --- --- ---
Total 1st Quarter -- -- -- --
=== === === ===
(a) Reflects shares reacquired to provide for tax withholdings on shares issued
to employees under the terms of the USG Corporation 1995 Long-Term Equity
Plan, 1997 Management Incentive Plan or 2000 Omnibus Management Incentive
Plan.
(b) The price per share is based upon the mean of the high and the low prices
for a USG Corporation common share on the NYSE on the date of the tax
withholding transaction.
(c) The Corporation currently does not have in place a share repurchase plan or
program.
ITEM 5. OTHER INFORMATION
As of March 31, 2005, the Corporation had a $100 million credit agreement, which
was to expire April 30, 2006, with LaSalle Bank N.A. (the "LaSalle Facility") to
be used exclusively to support the issuance of letters of credit needed to
support business operations. In March 2005, the Corporation asked the Bankruptcy
court to approve amendments to the LaSalle Facility to extend the term of the
facility until April 30, 2008, and to increase the credit line to $175 million.
In the same motion, the Corporation asked for permission to replace certain
standby letters of credit, which had been issued under a pre-petition credit
facility but were expiring in the near future due to that credit facility's
expiration, with new ones issued under the LaSalle Facility. The Bankruptcy
court approved the Corporation's requests on April 15, 2005. The LaSalle
Facility amendments, titled First Amendment to Master Letter of Credit Agreement
and First Amendment to Pledge Agreement, dated April 29, 2005, are filed with
this Form 10-Q as Exhibit 10.
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ITEM 6. EXHIBITS
10. First Amendment to Master Letter of Credit Agreement and First Amendment
to Pledge Agreement.
15. Letter from Deloitte & Touche LLP regarding unaudited financial
information.
31.1 Rule 13a - 14(a) Certifications of USG Corporation's Chief Executive
Officer
31.2 Rule 13a - 14(a) Certifications of USG Corporation's Chief Financial
Officer
32.1 Section 1350 Certifications of USG Corporation's Chief Executive Officer
32.2 Section 1350 Certifications of USG Corporation's Chief Financial Officer
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
USG CORPORATION
By /s/ William C. Foote
-------------------------------------
William C. Foote,
Chairman, Chief Executive Officer
and President
By /s/ Richard H. Fleming
-------------------------------------
Richard H. Fleming,
Executive Vice President and
Chief Financial Officer
By /s/ D. Rick Lowes
-------------------------------------
D. Rick Lowes,
Vice President and Controller
May 3, 2005
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