10-Q 1 c58339e10-q.txt QUARTERLY REPORT 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2000 ------------------ OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ----------- ----------- Commission File Number 1-8864 USG CORPORATION ------------------------------------------------------------------------------ (Exact name of registrant as specified in its charter) Delaware 36-3329400 ------------------------------------------------------------------------------ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 125 South Franklin Street, Chicago, Illinois 60606-4678 ------------------------------------------------------------------------------ (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code (312) 606-4000 -------------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes X No ----- ----- As of September 30, 2000, 43,388,552 shares of USG common stock were outstanding. 2 TABLE OF CONTENTS Page -------- PART I FINANCIAL INFORMATION Item 1. Financial Statements: Consolidated Statement of Earnings: Three Months and Nine Months Ended September 30, 2000 and 1999 3 Consolidated Balance Sheet: As of September 30, 2000 and December 31, 1999 4 Consolidated Statement of Cash Flows: Nine Months Ended September 30, 2000 and 1999 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 11 Report of Independent Public Accountants 19 PART II OTHER INFORMATION Item 1. Legal Proceedings 20 Item 6. Exhibits and Reports on Form 8-K 25 SIGNATURES 26 -2- 3 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS USG CORPORATION CONSOLIDATED STATEMENT OF EARNINGS (DOLLARS IN MILLIONS EXCEPT PER SHARE DATA) (UNAUDITED)
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, -------------------------- -------------------------- 2000 1999 2000 1999 ----------- ----------- ----------- ----------- Net sales $ 895 $ 952 $ 2,772 $ 2,670 Cost of products sold 700 669 2,065 1,891 ----------- ----------- ----------- ----------- Gross profit 195 283 707 779 Selling and administrative expenses 73 85 236 244 ----------- ----------- ----------- ----------- Operating profit 122 198 471 535 Interest expense 13 13 38 40 Interest income (1) (3) (4) (6) Other expense, net 3 1 4 2 ----------- ----------- ----------- ----------- Earnings before income taxes 107 187 433 499 Income taxes 42 71 169 193 ----------- ----------- ----------- ----------- Net earnings 65 116 264 306 =========== =========== =========== =========== Basic earnings per common share 1.48 2.34 5.68 6.16 Diluted earnings per common share 1.48 2.32 5.66 6.09 Dividends paid per common share 0.15 0.10 0.45 0.30 Average common shares 43,948,520 49,623,637 46,524,166 49,764,386 Average diluted common shares 44,086,452 50,165,592 46,716,812 50,352,316
See accompanying Notes to Consolidated Financial Statements. -3- 4 USG CORPORATION CONSOLIDATED BALANCE SHEET (DOLLARS IN MILLIONS) (UNAUDITED)
AS OF AS OF SEPTEMBER 30, DECEMBER 31, 2000 1999 ------------- ------------ ASSETS Current Assets: Cash and cash equivalents $ 21 $ 197 Receivables (net of reserves - $18 and $18) 362 361 Inventories 282 256 Deferred income taxes 76 80 ------- ------- Total current assets 741 894 Property, plant and equipment (net of reserves for depreciation and depletion - $416 and $373) 1,796 1,568 Other assets 300 332 ------- ------- Total Assets 2,837 2,794 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable 211 172 Accrued expenses 255 303 Taxes on income 21 21 Notes payable 12 16 Current portion of long-term debt 150 -- ------- ------- Total current liabilities 649 512 Long-term debt 505 577 Deferred income taxes -- 138 Other liabilities 692 700 Stockholders' Equity: Preferred stock -- -- Common stock 5 5 Treasury stock (257) (56) Capital received in excess of par value 410 316 Deferred currency translation (46) (33) Reinvested earnings 879 635 ------- ------- Total stockholders' equity 991 867 ------- ------- Total Liabilities and Stockholders' Equity 2,837 2,794 ======= ======= See accompanying Notes to Consolidated Financial Statements
-4- 5 USG CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS (DOLLARS IN MILLIONS) (UNAUDITED) NINE MONTHS ENDED SEPTEMBER 30, ------------------- 2000 1999 ------- -------- OPERATING ACTIVITIES: Net earnings $ 264 $ 306 Adjustments to reconcile net earnings to net cash: Depreciation, depletion and amortization 74 68 Current and deferred income taxes 10 4 Gain on asset dispositions (1) -- (Increase) decrease in working capital: Receivables (1) (44) Inventories (26) (4) Payables 28 21 Accrued expenses (48) 44 Increase in other assets (50) (32) Increase in other liabilities 39 92 Other, net (6) (6) ------ ----- Net cash from operating activities 283 449 ------ ----- INVESTING ACTIVITIES: Capital expenditures (310) (273) Net proceeds from asset dispositions 2 2 ------ ----- Net cash to investing activities (308) (271) ------ ----- FINANCING ACTIVITIES: Issuance of debt 137 56 Repayment of debt (105) (49) Short-term borrowings, net 44 (15) Cash dividends paid (20) (15) Issuances of common stock -- 11 Purchases of common stock (207) (45) ------ ----- Net cash to financing activities (151) (57) ------ ----- Net increase/(decrease) in cash and cash equivalents (176) 121 Cash and cash equivalents at beginning of period 197 152 ------ ----- Cash and cash equivalents at end of period 21 273 ====== ===== SUPPLEMENTAL CASH FLOW DISCLOSURES: Interest paid 45 50 Income taxes paid 206 192 See accompanying Notes to Consolidated Financial Statements. -5- 6 USG CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (1) The consolidated financial statements of USG Corporation and its subsidiaries ("USG" or the "Corporation") included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. The preparation of financial statements in conformity with generally accepted accounting principles 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 statements reflect all adjustments, which are of a normal recurring nature, necessary to present fairly the Corporation's financial position as of September 30, 2000, and December 31, 1999, results of operations for the three months and nine months ended September 30, 2000 and 1999 and cash flows for the nine months ended September 30, 2000 and 1999. Certain amounts in the prior year financial statements have been reclassified to conform with the 2000 presentation. While these interim financial statements and accompanying notes are unaudited, they have been reviewed by Arthur Andersen LLP, the Corporation's independent public accountants. These financial statements and notes are to be read in conjunction with the financial statements and notes included in the Corporation's 1999 Annual Report on Form 10-K dated February 29, 2000. (2) Total comprehensive income, consisting of net earnings and foreign currency translation adjustments, amounted to $61 million and $251 million in the three months and nine months ended September 30, 2000, respectively. For the respective 1999 periods, total comprehensive income amounted to $119 million and $305 million. There was no tax impact on the foreign currency translation adjustments. (3) As of September 30, 2000, common shares totaling 2,074,975 were reserved for future issuance in conjunction with existing stock option grants. In addition, 2,472,770 common shares were reserved for future grants. Shares issued in option exercises may be from original issue or available treasury shares. -6- 7 (4) Basic earnings per share were computed by dividing net earnings by the weighted average number of common shares outstanding for the period. The dilutive effect of the potential exercise of outstanding options to purchase shares of common stock is calculated using the treasury stock method. The reconciliation of basic earnings per share to diluted earnings per share is shown in the following table (dollars in millions except share data): NET SHARES PER SHARE THREE MONTHS ENDED SEPTEMBER 30, EARNINGS (000) AMOUNT ----------------------------------------------------------------------- 2000 Basic earnings $ 65 43,949 $ 1.48 Dilutive effect of stock options 137 ----------------------------------------------------------------------- Diluted earnings 65 44,086 1.48 ======================================================================= 1999 Basic earnings $ 116 49,624 $ 2.34 Dilutive effect of stock options 542 ----------------------------------------------------------------------- Diluted earnings 116 50,166 2.32 ======================================================================= NINE MONTHS ENDED SEPTEMBER 30, ----------------------------------------------------------------------- 2000 Basic earnings $ 264 46,524 $ 5.68 Dilutive effect of stock options 193 ----------------------------------------------------------------------- Diluted earnings 264 46,717 5.66 ======================================================================= 1999 Basic earnings $ 306 49,764 $ 6.16 Dilutive effect of stock options 588 ----------------------------------------------------------------------- Diluted earnings 306 50,352 6.09 ======================================================================= -7- 8 (5) USG's operations are organized into three operating segments: North American Gypsum, which manufactures and markets gypsum wallboard and related products in the United States, Canada and Mexico; Worldwide Ceilings, which manufactures and markets ceiling tile, ceiling grid and other interior systems products worldwide; and Building Products Distribution, which distributes gypsum wallboard, drywall metal, ceiling products, joint compound and other building products throughout the United States. Operating segment results were as follows (dollars in millions):
NET SALES OPERATING PROFIT --------------------------------------------------------------------------- THREE MONTHS ENDED SEPTEMBER 30, 2000 1999 2000 1999 --------------------------------------------------------------------------- North American Gypsum $ 509 $ 575 $ 78 $ 165 Worldwide Ceilings 171 172 18 18 Building Products Distribution 346 362 33 31 Corporate - - (8) (16) Eliminations (131) (157) 1 - --------------------------------------------------------------------------- Total 895 952 122 198 =========================================================================== NINE MONTHS ENDED SEPTEMBER 30, 2000 1999 2000 1999 --------------------------------------------------------------------------- North American Gypsum $1,614 $1,602 $ 361 $ 467 Worldwide Ceilings 505 490 53 48 Building Products Distribution 1,070 999 88 65 Corporate - - (34) (45) Eliminations (417) (421) 3 - --------------------------------------------------------------------------- Total 2,772 2,670 471 535 ===========================================================================
(6) The Corporation uses derivative instruments to manage well-defined interest rate, energy cost and foreign currency exposures. The Corporation does not use derivative instruments for trading purposes. The criteria used to determine if hedge accounting treatment is appropriate are (i) the designation of the hedge to an underlying exposure (ii) whether or not overall uncertainty is being reduced and (iii) if there is a correlation between the value of the derivative instrument and the underlying obligation. -8- 9 Interest Rate Derivative Instruments: The Corporation utilizes interest rate swap agreements to manage the impact of interest rate changes on its underlying floating-rate debt. These agreements are designated as hedges and qualify for hedge accounting. Amounts payable or receivable under these swap agreements are accrued as an increase or decrease to interest expense on a current basis. To the extent the underlying floating-rate debt is reduced, the Corporation terminates swap agreements accordingly so as not to be in an overhedged position. In such cases, the Corporation recognizes gains and/or losses in the period in which the agreement is terminated. Energy Derivative Instruments: The Corporation uses swap and option contracts to hedge anticipated purchases of fuel to be utilized in the manufacturing processes for gypsum wallboard and ceiling tile. These contracts are designated as hedges and qualify for hedge accounting. Unrealized gains and losses and option premiums are deferred and included in net earnings as part of the underlying transaction. Foreign Exchange Derivative Instruments: The Corporation has operations in a number of countries and due to intercompany and third-party transactions is exposed to changes in foreign currency exchange rates. The Corporation manages these exposures on a consolidated basis, which allows netting of certain exposures to take advantage of any natural offsets. To the extent the net exposures are hedged, forward and/or option contracts are used. Gains and/or losses on these foreign currency hedges are included in net earnings in the period in which the exchange rates change. (7) One of the Corporation's subsidiaries, United States Gypsum Company ("U.S. Gypsum"), is a defendant in asbestos lawsuits alleging both property damage and personal injury. See Part II, Item 1. "Legal Proceedings" for information concerning the asbestos 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. The Corporation believes that neither these matters nor any other known governmental proceeding regarding environmental matters will have a material adverse effect upon its results of operations or financial position. See Part II, Item 1. "Legal Proceedings" for additional information on environmental litigation. -9- 10 (8) Under a revolving accounts receivable facility, the trade receivables of U.S. Gypsum and USG Interiors, Inc. are being purchased by USG Funding Corporation and transferred to a trust administered by Chase Manhattan Bank as trustee. Certificates representing an ownership interest of up to $130 million in the trust have been issued to an affiliate of Citicorp North America, Inc. USG Funding, a special-purpose subsidiary of USG Corporation, is a separate corporate entity with its own separate creditors that will be entitled to be satisfied out of USG Funding's assets prior to any value in USG Funding becoming available to its shareholder. Receivables and, when applicable, debt outstanding in connection with the receivables facility remain in receivables and long-term debt, respectively, on the Corporation's consolidated balance sheet. (9) In the second quarter of 2000, USG entered into new revolving credit facilities totaling $600 million with a syndicate of banks. A five-year, multi-currency revolving credit facility permits the Corporation to borrow up to $400 million, including borrowing capacity for its Canadian subsidiaries of up to $75 million in equivalent Canadian dollars. In addition, a $200 million, 364-day facility was executed. These facilities contain two financial covenants that require the Corporation to maintain a minimum interest coverage ratio of 3.25x and a maximum leverage ratio of 3.75x. These facilities replace the $500 million U.S. and C$110 million Canadian revolving credit facilities that were scheduled to mature in 2002. (10) The Corporation's income tax reserves were reduced by $103 million in the third quarter of 2000 to reflect the settlement of various tax audits. The benefit realized from the reduction of these reserves was credited to equity in accordance with AICPA Statement of Position 90-7, "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code." The reduction of these reserves had no impact on the results of operations or cash flows of the Corporation. (11) Effective January 1, 2001, the Corporation will adopt Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities." These statements establish accounting and reporting standards requiring that every derivative instrument be recorded on the balance sheet as either an asset or a liability measured at its fair value. The statements require that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Based upon initial review, the Corporation has determined that the adoption of SFAS No. 133 and SFAS No. 138 will not have a material impact on its financial statements. -10- 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION CONSOLIDATED RESULTS NET SALES Net sales in the third quarter of 2000 were $895 million, down 6% from $952 million in the third quarter of 1999. This decrease in sales reflects the gypsum wallboard market's continued transition from short supply to excess supply and the resulting decline in wallboard selling prices. For the first nine months of 2000, net sales totaled $2,772 million, up 4% from $2,670 million in the comparable 1999 period. GROSS PROFIT Gross profit as a percent of net sales was 21.8% and 25.5% in the third quarter and first nine months of 2000, respectively, down from 29.7% and 29.2% in the respective 1999 periods. The lower margins in 2000 reflect the combination of significantly lower selling prices and higher energy and raw material costs for USG's SHEETROCK brand gypsum wallboard. SELLING AND ADMINISTRATIVE EXPENSES Selling and administrative expenses decreased 14% versus the third quarter of 1999 due to lower charges for incentive compensation programs and a company-wide emphasis on reducing expenses. For the first nine months of 2000, expenses decreased 3% from the comparable 1999 period. As a percent of net sales, selling and administrative expenses were 8.2% and 8.5% in the third quarter and first nine months of 2000, respectively, down from 8.9% and 9.1% for the corresponding 1999 periods. INTEREST EXPENSE Interest expense of $13 million was incurred in both the third quarter of 2000 and the third quarter of 1999. Interest expense amounted to $38 million in the first nine months of 2000, down from $40 million in the first nine months of 1999. INCOME TAXES Income tax expense was $42 million and $169 million in the three months and nine months ended September 30, 2000, respectively, compared with $71 million and $193 million for the prior-year periods. NET EARNINGS Net earnings in the third quarter of 2000 were $65 million, down 44% from $116 million in the prior-year period. Diluted earnings per share decreased 36% to $1.48 from $2.32 a year ago. For the first nine months of 2000, net earnings were $264 million, down 14% from $306 million in the first nine months of 1999, and diluted earnings per share decreased to $5.66 from $6.09. -11- 12 CORE BUSINESS RESULTS (dollars in millions) NET SALES OPERATING PROFIT -------------------------------------------------------------------------------- THREE MONTHS ENDED SEPTEMBER 30, 2000 1999 2000 1999 -------------------------------------------------------------------------------- NORTH AMERICAN GYPSUM: U.S. Gypsum Company $ 465 $ 536 $ 64 $ 149 CGC Inc. (gypsum) 48 41 9 8 Other subsidiaries* 30 29 5 8 Eliminations (34) (31) - - -------------------------------------------------------------------------------- Total 509 575 78 165 -------------------------------------------------------------------------------- WORLDWIDE CEILINGS: USG Interiors, Inc. 124 121 17 17 USG International 56 55 - - CGC Inc. (ceilings) 11 11 1 1 Eliminations (20) (15) - - -------------------------------------------------------------------------------- Total 171 172 18 18 -------------------------------------------------------------------------------- BUILDING PRODUCTS DISTRIBUTION: L&W Supply Corporation 346 362 33 31 -------------------------------------------------------------------------------- Corporate - - (8) (16) Eliminations (131) (157) 1 - -------------------------------------------------------------------------------- Total USG Corporation 895 952 122 198 ================================================================================ NET SALES OPERATING PROFIT -------------------------------------------------------------------------------- NINE MONTHS ENDED SEPTEMBER 30, 2000 1999 2000 1999 -------------------------------------------------------------------------------- NORTH AMERICAN GYPSUM: U.S. Gypsum Company $1,486 $1,500 $ 319 $ 428 CGC Inc. (gypsum) 143 115 26 19 Other subsidiaries* 81 78 16 20 Eliminations (96) (91) - - -------------------------------------------------------------------------------- Total 1,614 1,602 361 467 -------------------------------------------------------------------------------- WORLDWIDE CEILINGS: USG Interiors, Inc. 365 345 49 46 USG International 166 159 1 - CGC Inc. (ceilings) 32 29 3 2 Eliminations (58) (43) - - -------------------------------------------------------------------------------- Total 505 490 53 48 -------------------------------------------------------------------------------- BUILDING PRODUCTS DISTRIBUTION: L&W Supply Corporation 1,070 999 88 65 -------------------------------------------------------------------------------- Corporate - - (34) (45) Eliminations (417) (421) 3 - -------------------------------------------------------------------------------- Total USG Corporation 2,772 2,670 471 535 ================================================================================ *Includes Yeso Panamericano, 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. -12- 13 NORTH AMERICAN GYPSUM USG's North American gypsum business recorded net sales of $509 million and operating profit of $78 million in the third quarter of 2000. These amounts represent decreases of 11% and 53%, respectively, from the third quarter of 1999. First nine months 2000 net sales of $1,614 million increased 1%, but operating profit of $361 million was down 23% versus 1999. United States Gypsum Company's third quarter 2000 net sales and operating profit declined 13% and 57%, respectively, from the third quarter of 1999. This performance reflects the gypsum wallboard market's transition from short supply, as experienced in 1999, to excess supply in 2000. Shipments of SHEETROCK brand gypsum wallboard totaled 2.4 billion square feet during the third quarter of 2000, virtually unchanged from the record level reported for the third quarter of 1999. However, lower net sales and operating profit primarily reflected lower selling prices for the company's SHEETROCK brand gypsum wallboard. Realized selling prices averaged $121.13 per thousand square feet, representing decreases of 23% from the third quarter of 1999 and 17% from the second quarter of 2000. The average price for the month of September 2000 fell to about $112.00 per thousand square feet. Profitability was also affected by higher production and asbestos-related costs. Production costs rose primarily due to rising prices for paper fiber and energy. Asbestos-related charges totaled $27 million during the third quarter of 2000, an increase of $7 million from the third quarter of 1999. Through the first nine months, asbestos-related charges totaled $77.0 million, up $14.5 million from the same period in 1999. See "Legal Contingencies" below and Part II, Item 1. "Legal Proceedings" for additional information on asbestos litigation. The gypsum business of Canada-based CGC Inc. reported a 17% increase in net sales and a 13% increase in operating profit compared with the third quarter of 1999. These increases primarily reflect additional results in 2000 for Sybex Inc.'s Canadian facilities which were acquired on November 30, 1999. WORLDWIDE CEILINGS Net sales in the third quarter of 2000 were $171 million, down $1 million from the third quarter of 1999, while operating profit was unchanged at $18 million. First nine months 2000 net sales of $505 million and operating profit of $53 million were up 3% and 10%, respectively, from the comparable 1999 levels. USG's domestic ceilings business, USG Interiors, Inc., reported a 2% increase in net sales, while operating profit of $17 million was unchanged from the third quarter of 1999. Domestic shipments were at near-record levels, while international markets experienced little improvement over the past year. The ceilings division of CGC Inc. contributed $1 million in operating profit, the same as last year. USG International had breakeven results in the third quarter of both 2000 and 1999. -13- 14 BUILDING PRODUCTS DISTRIBUTION L&W Supply, the leading specialty building products distribution business in the United States, reported third-quarter 2000 net sales of $346 million, a decrease of 4% versus the third quarter of 1999. However, operating profit of $33 million was the highest level for any quarter in L&W Supply's history and represented a 6% increase over a year ago. These results were driven by record shipments of gypsum wallboard and strong sales of complementary building products. L&W Supply currently operates out of 193 locations in the United States, up from 191 locations a year ago, distributing a variety of gypsum, ceilings and related building materials. MARKET CONDITIONS AND OUTLOOK Housing starts during the first nine months of 2000 ran at a strong level. USG is currently forecasting U.S. housing starts in 2000 to be about 1.6 million units, down slightly from the 1.667 million units in 1999. The repair and remodel market has been the fastest growing segment for USG, accounting for the second-largest portion of its sales. Record 1999 sales of existing homes of 5.2 million units is supporting residential repair and remodeling in 2000. This, combined with strong nonresidential repair and remodeling, provides solid opportunity in this market segment. Sales of USG products to the new nonresidential construction market have been solid in 2000. Future demand for USG products from new nonresidential construction is determined by floor space for which contracts are signed. Installation of gypsum and ceilings products follows signing of construction contracts by about a year. Floor space for which contracts were signed rose 3% in 1999. The U.S. market for gypsum wallboard transitioned from short supply, as experienced in 1999, to excess supply in 2000. Also, new industry capacity is being added in 2000 and 2001. As a result, management anticipates continued softness in its gypsum wallboard results for the remainder of 2000 and into 2001. In light of the excess supply conditions, USG recently announced the closure of its wallboard production line in Gypsum, Ohio, the fourth old, high-cost line that the Corporation has closed in the past year. Pressure on gypsum wallboard pricing is likely to continue until more capacity in the industry is closed. In the meantime, USG's management remains committed to its strategies to improve operating efficiencies, grow in profitable markets and manage its asbestos liability. LIQUIDITY AND CAPITAL RESOURCES FINANCIAL STRATEGY USG has been focused on building long-term stockholder value through dividends, stock repurchases and the five elements of its strategic growth plan. -14- 15 Dividends: USG paid cash dividends of $0.15 per share in the first, second and third quarters of 2000. In 1999, USG paid cash dividends of $0.10 per share in the first, second and third quarters, and $0.15 in the fourth quarter. Stock Repurchases: Through September 30, 2000, USG had been allocating a percentage of its free cash flow to stock repurchases. This percentage varied from quarter to quarter depending on the price of USG's stock, the level of USG's cash flow and alternate uses of cash. During the third quarter of 2000, the Corporation purchased 1.0 million shares of its stock bringing the total for the first nine months of 2000 to 5.6 million shares. Since the program began in the fourth quarter of 1998, USG had purchased 7.3 million shares, completing an initial 5-million-share authorization and purchasing 2.3 million shares of an additional 5-million-share program authorized by USG's Board of Directors in the first quarter of 2000. Share repurchases have been made in the open market or through privately negotiated transactions and were funded with available cash from operations. In light of the uncertainties involving asbestos litigation as discussed below under Legal Contingencies and in Part II, Item 1. "Legal Proceedings," USG does not anticipate making any further repurchases of common stock at this time. Strategic Growth Plan: USG is investing in its businesses under five central strategies - building for growth by adding capacity and lowering production costs, leading in product innovation, expanding its building products distribution business, enhancing customer service and promoting its brand names. CAPITAL EXPENDITURES Capital spending amounted to $310 million in the first nine months of 2000, compared with $273 million in the corresponding 1999 period. As of September 30, 2000, capital expenditure commitments for the replacement, modernization and expansion of operations amounted to $131 million, compared with $260 million as of December 31, 1999. In the second quarter of 2000, U.S. Gypsum successfully opened its new wallboard plant in Aliquippa, Pa. In the third quarter of 2000, a new wallboard production line at U.S. Gypsum's Plaster City, Calif., plant began operation. USG's current capital spending program includes construction of new gypsum wallboard plants in Rainier, Ore., and Monterrey, Mexico. The startup of the new Rainier plant is expected in the fourth quarter of this year, while startup of the Monterrey facility is anticipated to occur in the third quarter of 2001. USG also evaluates potential acquisitions of companies in the building products industry, as well as divestitures and joint ventures, on an ongoing basis. USG has external sources of capital available and adequate financial resources and liquidity to fund future growth opportunities such as new products, acquisitions and joint ventures. WORKING CAPITAL Working capital (current assets less current liabilities) as of September 30, 2000, amounted to $92 million, compared with $382 million as of December 31, -15- 16 1999. The ratio of current assets to current liabilities was 1.14 to 1 as of September 30, 2000, compared with 1.75 to 1 as of December 31, 1999. Cash and cash equivalents as of September 30, 2000, amounted to $21 million compared with $197 million as of December 31, 1999. During the first nine months of 2000, net cash flows from operating activities totaled $283 million. Net cash flows to investing activities were $308 million, reflecting capital expenditures of $310 million, offset slightly by net proceeds from asset dispositions. Net cash flows to financing activities of $151 million primarily reflect $207 million used for stock repurchases and $20 million used for cash dividends, partially offset by a $74 million increase in debt. Receivables increased slightly to $362 million as of September 30, 2000, from $361 million as of December 31, 1999. Inventories increased to $282 million from $256 million, and accounts payable rose to $211 million from $172 million. These variations reflect normal seasonal fluctuations. In the third quarter of 2000, $150 million of 9.25% senior notes due 2001 were reclassified from long-term debt to current liabilities due to their maturity in less than one year. DEBT As of September 30, 2000, total debt amounted to $667 million, up $74 million from December 31, 1999. This increase reflects $127 million of industrial revenue bonds issued in connection with USG's capital spending program, partially offset by repayments of $30 million on the accounts receivable facility, $19 million on the credit facilities and $4 million on various notes payable. AVAILABLE LIQUIDITY The Corporation has additional liquidity available through several financing arrangements. In the second quarter of 2000, USG entered into new revolving credit facilities totaling $600 million with a syndicate of banks. A five-year, multi-currency revolving credit facility permits the Corporation to borrow up to $400 million, including borrowing capacity for its Canadian subsidiaries of up to $75 million in equivalent Canadian dollars. In addition, a $200 million, 364-day facility was executed. These facilities replaced the $500 million U.S. and C$110 million Canadian revolving credit facilities that were scheduled to mature in 2002. USG also maintains a $20 million revolving credit facility in Europe. As of September 30, 2000, total outstanding revolving loans amounted to $52 million and letters of credit issued and outstanding amounted to $16 million, leaving the Corporation with $552 million of unused and available credit. USG had additional borrowing capacity of $80 million as of September 30, 2000, under a revolving accounts receivable facility (see Note 8). A shelf registration statement filed with the Securities and Exchange Commission allows the Corporation to offer from time to time debt securities, shares of preferred and common stock or warrants to purchase shares of common stock, all having an aggregate initial offering price not to exceed $300 million. As of the date of this report, no securities had been issued pursuant to this registration. -16- 17 OTHER MATTERS EURO CURRENCY CONVERSION Effective January 1, 1999, 11 of the 15 countries that are members of the European Union introduced a new, single currency unit, the euro. Prior to full implementation of the new currency for the participating countries on January 1, 2002, there is a three-year transition period during which parties may use either the existing currencies or the euro. However, during the transition period, all exchanges between currencies of the participating countries are required to be first converted through the euro. USG has conducted a comprehensive analysis to address the euro currency issue. USG's efforts are focused on two phases. The first phase addresses USG's European operations during the transition period. The second phase covers full conversion of these operations to the euro. The Corporation was ready for the transition period that began on January 1, 1999, and expects to be ready for full conversion by January 1, 2002, the mandatory conversion date. USG also is prepared to deal with its critical suppliers and customers during the transition period and will communicate with them as appropriate. The Corporation does not expect the introduction of the euro currency to have a material adverse impact on its business, results of operations or financial position. LEGAL CONTINGENCIES One of the Corporation's subsidiaries, U.S. Gypsum, is a defendant in asbestos lawsuits alleging both property damage and personal injury. In the third quarter of 2000, U.S. Gypsum recorded a charge of $27.0 million, reflecting new filings during the quarter. This compares to a $20.0 million charge taken in the third quarter of 1999. Accrued asbestos charges for the first nine months of 2000 total $77.0 million compared with $62.5 million for the same period in 1999. Asbestos charges to results of operations were higher in 1999 and 2000 than 1998 because the estimated cost of resolving cases pending during 1998 will, when expended, consume all of U.S. Gypsum's remaining insurance; as a result, the estimated liability from new case filings is currently being charged against reported earnings. Accordingly, the Company expects that additional periodic charges will be necessary in the future, in amounts that could be higher or lower than recent quarters, and which could be material to the period in which they are taken. The amount of future periodic charges will depend upon factors that include, but may not be limited to, the rate at which new asbestos-related claims are filed, the potential imposition of medical criteria, the impact of reductions and potential future reductions in membership of the Center for Claims Resolution (the "Center"), the continued solvency of other defendants and the impact of recent and possible future bankruptcies of other defendants, changes in U.S. Gypsum's settlement cost and the estimated cost of resolving pending claims, and the necessity of higher-cost settlements in particular jurisdictions. In addition, U.S. Gypsum continues to evaluate whether its probable liability for future Personal Injury Cases can be reasonably estimated. The ability to make such an -17- 18 estimate requires an assessment of the impact on future case filings and settlement values of the uncertainties identified above, including the outcome and status of negotiations currently underway between the Center and certain plaintiffs' firms concerning settlements that would, among other things, apply medical criteria to the firm's future Personal Injury Cases. When such an estimate can be made, an additional charge to results of operations will be necessary. Although the timing and amount of the resulting charge cannot presently be determined with certainty, the charge may be taken in the fourth quarter of 2000 and the amount is expected to be material to results of operations and stockholders' equity in the period in which it is taken. The amount of such charges and the impact of the asbestos litigation on the Corporation's liquidity and financial position may be affected by recent bankruptcies of other defendants and any further bankruptcies of other defendants, particularly current or former members of the Center. However, it is management's opinion, taking into account currently available information concerning U.S. Gypsum's liabilities, reserves and probable insurance coverage, that the asbestos litigation will not have a material adverse effect on the liquidity or financial position of the Corporation. See Part II, Item 1. "Legal Proceedings" for additional information on asbestos 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. The Corporation believes that neither these matters nor any other known governmental proceeding regarding environmental matters will have a material adverse effect upon its results of operations or financial position. See Part II, Item 1. "Legal Proceedings" for additional information on environmental litigation. FORWARD-LOOKING STATEMENTS This report contains forward-looking statements related to management's expectations about future conditions. Actual business or other conditions may differ significantly from management's expectations and accordingly affect the Corporation's sales and profitability or other results. Actual results may differ due to factors over which the Corporation has no control, including economic activity such as new housing construction, interest rates and consumer confidence; competitive activity such as price and product competition; increases in raw material and energy costs; euro currency issues such as the ability and willingness of third parties to convert affected systems in a timely manner and the actions of governmental agencies or other third parties; and the outcome of contested asbestos-related litigation, the rate of new asbestos-related filings, the solvency of co-defendants in the asbestos-related litigation and the other factors described herein. The Corporation assumes no obligation to update any forward-looking information contained in this report. -18- 19 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors of USG Corporation: We have reviewed the accompanying condensed consolidated balance sheet of USG CORPORATION (a Delaware corporation) AND SUBSIDIARIES as of September 30, 2000, and the related condensed consolidated statements of earnings for the three-month and nine-month periods ended September 30, 2000 and 1999 and the condensed consolidated statement of cash flows for the nine-month periods ended September 30, 2000 and 1999. These financial statements are the responsibility of the Corporation's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States. /s/ ARTHUR ANDERSEN LLP ARTHUR ANDERSEN LLP Chicago, Illinois October 17, 2000 -19- 20 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS ASBESTOS AND RELATED INSURANCE LITIGATION One of the Corporation's subsidiaries, U.S. Gypsum, is among many defendants in lawsuits arising out of the manufacture and sale of asbestos-containing materials. U.S. Gypsum sold certain asbestos-containing products beginning in the 1930's; in most cases, the products were discontinued or asbestos was removed from the formula by 1972, and no asbestos-containing products were produced after 1977. Some of these 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"). Others seek compensatory and in many cases punitive damages for personal injury allegedly resulting from exposure to asbestos-containing products (the "Personal Injury Cases"). It is anticipated that additional asbestos-related suits will be filed. SUMMARY - The following is a brief summary; see Note 16 to the financial statements in the Corporation's 1999 Annual Report for additional information about the asbestos litigation. U.S. Gypsum is a defendant in 10 Property Damage Cases, many of which involve multiple buildings. One of the cases is a conditionally certified class action comprised of all colleges and universities in the United States, which certification is presently limited to the resolution of certain allegedly "common" liability issues. (Central Wesleyan College v. W.R. Grace & Co., et al., U.S.D.C.S.C.). During the years 1997-1999, three new Property Damage Cases were filed against U.S. Gypsum while 16 were closed; the Company spent an average of $14 million per year on the defense and settlement of Property Damage Cases, but received a total of $61.5 million over the three-year period from insurance carriers, including reimbursement for expenditures in prior years. No new Property Damage Cases have been filed against U. S. Gypsum for more than two years. U.S. Gypsum's estimated cost of resolving pending Property Damage Cases is discussed below. (See "Estimated Cost.") U.S. Gypsum is also a defendant in Personal Injury Cases brought by approximately 83,800 claimants, as well as an additional 65,000 claims that have been settled but will be closed over time. U. S. Gypsum was named in approximately 15,000 new Personal Injury Cases in the third quarter of 2000, 15,300 in the second quarter and 12,300 in the first quarter. Filings of new Personal Injury Cases totaled approximately 48,000 claims in 1999, compared to 80,000 claims in 1998 and 23,500 claims in 1997. The Company believes that the higher rate of personal injury case filings in 1998 resulted, at least in part, from a Supreme Court ruling striking down a class action settlement that included an injunction against the filing of -20- 21 certain Personal Injury Cases from September 1994 until July 1997. It is anticipated that Personal Injury Cases will continue to be filed in substantial numbers for the foreseeable future, although the percentage of such cases filed by claimants with little or no physical impairment is expected to remain high. During the years 1997-1999, U.S. Gypsum expended an average of $64.2 million per year on Personal Injury Cases (including $100 million in 1999), of which an average of $52 million ($85 million in 1999) was paid by insurance. U.S. Gypsum is a member, together with 14 other former producers of asbestos-containing products, of the Center for Claims Resolution (the "Center"), which has assumed the handling of all Personal Injury Cases pending against U.S. Gypsum and the other members of the Center. Costs of defense and settlement are shared among the members of the Center pursuant to predetermined sharing formulae. Most of U.S. Gypsum's personal injury liability and defense costs have been paid by insurance, but current and future costs will be paid largely by U.S. Gypsum due to exhaustion of most available insurance. U.S. Gypsum and other Center members are pursing alternatives to the current tort system, including settlements with plaintiffs' firms that include agreements to resolve over time the firms' pending claims, as well as the firms' agreement to recommend to their future clients that they defer filing, or accept nominal payments on, personal injury claims that do not meet established disease criteria. The Center reached several such agreements in 1999 and 2000 and will continue to attempt to negotiate similar agreements in the future. These agreements typically resolve claims for amounts consistent with historical per-claim settlement costs. However, settlement costs for cases resolved outside such agreements have been increasing, reflecting higher settlement demands to all defendants for more serious cases, particularly in certain jurisdictions, as well as the impact of the reductions in membership of the Center described below. During 1999, three companies and an asbestos claims trust left the Center and the membership of another company was terminated by the Center's Board. The terminated member and the asbestos claims trust have refused to pay their share of certain settlements agreed to by the Center while they were members. Although to date plaintiffs in such cases have been successful in obtaining orders requiring the terminated former member to pay its share of the settlements, continued defaults may increase the cost of resolving these cases for the remaining Center members, including U.S. Gypsum. In some cases, plaintiffs may argue that the remaining Center members are required to fund the entire settlement; there are strong defenses to such claims. In other cases, the plaintiffs have certain rights to nullify the settlement as to any unpaid portion. In addition, if one or more additional members of the Center that pay significant shares of settlement and defense costs either withdraw, become insolvent or file a bankruptcy petition, it is possible that the viability of the Center and its settlement program will be jeopardized. Such a development would be likely to increase U.S. Gypsum's costs of resolving the cases. During 2000, three defendants in the Personal Injury Cases (not members of the Center) have filed bankruptcy petitions, and it is possible that others may also file. The -21- 22 absence of these defendants from the litigation is likely to increase the cost of resolving Personal Injury Cases for other defendants, including U. S. Gypsum and the remaining Center members. The amount of the potential increased costs and other adverse impacts that would result from the above developments cannot presently be ascertained. U.S. Gypsum's estimated cost of resolving pending Personal Injury Cases is discussed below. (See "Estimated Cost.") U.S. Gypsum sued its insurance carriers in 1983 to obtain coverage for asbestos cases (the "Coverage Action") and has settled all disputes with its solvent carriers. As of September 30, 2000, after deducting insolvent coverage and insurance paid out to date, approximately $66 million of insurance remained with carriers that have agreed, subject to certain limitations and conditions, to cover asbestos-related costs. In addition, U.S. Gypsum is pursuing claims for reimbursement from estates of certain insolvent carriers and may recover additional reimbursement in amounts that are presently indeterminable but are not expected to be material. Through September 30, U. S. Gypsum's asbestos payments for the first nine months of 2000 were approximately $125 million, or $43 million after insurance reimbursement. Insurance payments to U.S. Gypsum for all asbestos-related matters, including property damage, personal injury, insurance coverage litigation and related expenses, exceeded asbestos-related expenses by $6 million for 1999 and $0.7 million in 1997 due primarily to nonrecurring reimbursement for amounts expended in prior years. However, U.S. Gypsum's total asbestos-related expenditures exceeded aggregate insurance payments by $24 million in 1998. ESTIMATED COST - The asbestos litigation involves numerous uncertainties that affect U.S. Gypsum's ability to estimate reliably its probable liability in the Personal Injury and Property Damage Cases. In the Property Damage Cases, such uncertainties include, but may not be limited to, the identification and volume of asbestos-containing products in the buildings at issue in each case, which is often disputed; the claimed damages associated therewith; the viability of statute of limitations, product identification and other defenses, which varies depending upon the facts and jurisdiction of each case; the amount for which such cases can be resolved, which normally (but not uniformly) has been substantially lower than the claimed damages; and the viability of claims for punitive and other forms of multiple damages. Uncertainties in the Personal Injury Cases include, but may not be limited to the number, characteristics and venue of Personal Injury Cases that are filed against U.S. Gypsum; the Center's continued viability in its present form and its ability to continue to resolve claims at historical or acceptable levels; the level of physical impairment of claimants; the viability of claims for conspiracy or punitive damages; the effect of recent reductions in membership in the Center and any future reductions in Center membership on the Center and its settlement program; the continued solvency of other defendants and the impact of recent and possible future bankruptcies of -22- 23 other defendants; the refusal of the former Center members described above to fund their share of existing settlements; and the continued ability to negotiate settlements or develop other mechanisms that defer or reduce claims from unimpaired claimants. As a result, any estimate of U.S. Gypsum's liability, while based upon the best information currently available, may not be an accurate prediction of actual costs and is subject to revision as additional information becomes available and developments occur. Subject to the above uncertainties, and based in part on information provided by the Center, U.S. Gypsum estimates that it is probable that Property Damage and Personal Injury Cases pending at September 30, 2000, can be resolved for an amount totaling between $315 million and $490 million, including defense costs. Most of these amounts are expected to be expended over the next two to five years. Insurance funding is available for a portion of these costs, as detailed below, although resolution of the pending cases will consume U.S. Gypsum's remaining insurance. At this time, U.S. Gypsum does not believe that the number and severity of asbestos-related cases that ultimately will be filed in the future can be predicted with sufficient accuracy to provide the basis for a reasonable estimate of the liability that will be associated with such cases, although, as noted below, the Company is actively engaged in examining the feasibility of such an estimate with the objective of providing such information when possible. Accounting for Asbestos Liability: As of September 30, 2000, U.S. Gypsum had reserved $315 million for liability from pending Property Damage and Personal Injury Cases (equaling the lower end of the estimated range of costs provided above). U.S. Gypsum had a corresponding receivable from insurance carriers of approximately $66 million, the estimated portion of the reserved amount that is expected to be paid or reimbursed by insurance. As of September 30, 2000, U.S. Gypsum had an additional $32 million reserved for asbestos liabilities and asbestos-related expenses. U.S. Gypsum compares its estimates of liability to then-existing reserves and available insurance assets and from time to time adjusts its reserves as appropriate. U.S. Gypsum charged results of operations a total of $26 million in 1998 and $80.5 million in 1999 for asbestos-related costs, based largely on new filings during those years. In the quarters ended March 31, June 30, and September 30, 2000, the Company accrued charges of $22 million, $28 million, and $27 million, respectively, reflecting new filings during those quarters. Asbestos charges to results of operations were higher in 1999 and 2000 than 1998 because the estimated cost of resolving cases pending during 1998 will, when expended, consume all of U.S. Gypsum's remaining insurance; as a result, the estimated liability from new case filings is currently being charged against reported earnings. Accordingly, the Company expects that additional periodic charges will be necessary in the future, in amounts that could be higher or lower than recent quarters, and which could be material to the period in which they are taken. The amount of future periodic charges will depend upon factors that include, but may not be limited to, the rate at which new asbestos-related claims are filed, the -23- 24 potential imposition of medical criteria, the impact of reductions in membership of the Center, the continued solvency of other defendants, changes in U.S. Gypsum's settlement cost and the estimated cost of resolving pending claims, and the necessity of higher-cost settlements in particular jurisdictions. In addition, U.S. Gypsum continues to evaluate whether its probable liability for future Personal Injury Cases can be reasonably estimated. The ability to make such an estimate requires an assessment of the impact on future case filings and settlement values of the uncertainties identified above, including the outcome and status of negotiations currently underway between the Center and certain plaintiffs' firms concerning settlements that would, among other things, apply medical criteria to the firms' future Personal Injury Cases. When such an estimate can be made, an additional charge to results of operations will be necessary. Although the timing and amount of the resulting charge cannot presently be determined with certainty, the charge may be taken in the fourth quarter of 2000, and the amount is expected to be material to the Corporation's results of operations and stockholders' equity in the period in which it is taken. CONCLUSION - The above estimates and reserves are re-evaluated periodically as additional information becomes available. Additional charges to results of operations will be necessary in light of future events, and such charges are expected to be material to results of operations and stockholders' equity in the period in which they are taken. The amount of such charges, and the impact of the asbestos litigation on the Corporation's liquidity and financial position, may be affected by recent bankruptcies of other defendants and any further bankruptcies of other defendants, particularly current or former members of the Center. However, it is management's opinion, taking into account currently available information concerning U.S. Gypsum's liabilities, reserves and probable insurance coverage, that the asbestos litigation will not have a material adverse effect on the liquidity or financial position of the Corporation. 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 continuously reviews its accruals as additional information becomes available. Such reserves take into account all known or estimated costs associated with these sites, including site investigations and feasibility costs, site cleanup and remediation, legal costs, and fines and penalties, if any. In addition, environmental costs connected with site cleanups on USG-owned property also are covered by reserves established in accordance with the foregoing. The Corporation believes that neither these matters nor any other known governmental proceeding regarding environmental matters will have a material adverse effect upon its results of operations or financial position. -24- 25 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (4a) Amended and Restated By-laws of USG Corporation, dated as of September 22, 2000. (10a) Second Amendment to Management Performance Plan, dated as of June 27, 2000. (10b) First Amendment to 1995 Long-Term Equity Plan of USG Corporation, dated as of June 27, 2000. (10c) Second Amendment to Omnibus Management Incentive Plan of USG Corporation, dated as of June 27, 2000. (15) Letter from Arthur Andersen LLP regarding unaudited financial information. (27) Financial Data Schedule. -25- 26 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/ Dean H. Goossen ----------------------------------- Dean H. Goossen, Corporate Secretary, USG Corporation By /s/ Raymond T. Belz ----------------------------------- November 6, 2000 Raymond T. Belz, Senior Vice President and Controller, USG Corporation -26-