-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, G/ExnDTDHgMZnqMsq0t7YG9rp4fmUfcNMhoHbuirLwX2W9BZEM19hzHeMJJ9yZwu KXDzu3FdFcHtF9DjtLJivQ== 0000950137-02-004370.txt : 20020813 0000950137-02-004370.hdr.sgml : 20020813 20020813113203 ACCESSION NUMBER: 0000950137-02-004370 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20020630 FILED AS OF DATE: 20020813 FILER: COMPANY DATA: COMPANY CONFORMED NAME: USG CORP CENTRAL INDEX KEY: 0000757011 STANDARD INDUSTRIAL CLASSIFICATION: CONCRETE GYPSUM PLASTER PRODUCTS [3270] IRS NUMBER: 363329400 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-08864 FILM NUMBER: 02728399 BUSINESS ADDRESS: STREET 1: 125 S FRANKLIN ST STREET 2: DEPT. 188 CITY: CHICAGO STATE: IL ZIP: 60606 BUSINESS PHONE: 3126064000 10-Q 1 c71075e10vq.txt QUARTERLY REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2002 ------------- 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 June 30, 2002, 43,250,238 shares of USG common stock were outstanding. TABLE OF CONTENTS Page -------- PART I FINANCIAL INFORMATION Item 1. Financial Statements: Consolidated Statements of Earnings: Three Months and Six Months Ended June 30, 2002 and 2001 3 Consolidated Balance Sheets: As of June 30, 2002 and December 31, 2001 4 Consolidated Statements of Cash Flows: Six Months Ended June 30, 2002 and 2001 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 35 Reports of Independent Public Accountants 48 PART II OTHER INFORMATION Item 1. Legal Proceedings 51 Item 4. Submission of Matters to a Vote of Security Holders 51 Item 6. Exhibits and Reports on Form 8-K 52 SIGNATURES 53 -2- PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS USG CORPORATION CONSOLIDATED STATEMENTS OF EARNINGS (DOLLARS IN MILLIONS EXCEPT PER SHARE DATA) (UNAUDITED)
THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, ------------------------ ------------------------ 2002 2001 2002 2001 ----------- ----------- ----------- ----------- Net sales $ 885 $ 806 $ 1,714 $ 1,632 Cost of products sold 718 736 1,415 1,462 Selling and administrative expenses 80 65 162 133 Chapter 11 reorganization expenses 7 10 9 10 ----------- ----------- ----------- ----------- Operating profit (loss) 80 (5) 128 27 Interest expense 2 16 3 30 Interest income (1) (2) (2) (3) Other (income) expense, net (2) (1) (1) - ----------- ----------- ----------- ----------- Earnings (loss) before income taxes and cumulative effect of accounting change 81 (18) 128 - Income taxes (benefit) 33 (5) 54 2 ----------- ----------- ----------- ----------- Earnings (loss) before cumulative effect of accounting change 48 (13) 74 (2) ----------- ----------- ----------- ----------- Cumulative effect of accounting change for SFAS No. 142 - - (96) - ----------- ----------- ----------- ----------- Net earnings (loss) 48 (13) (22) (2) =========== =========== =========== =========== EARNINGS (LOSS) PER COMMON SHARE: Basic and diluted before cumulative effect of accounting change 1.11 (0.29) 1.71 (0.04) Cumulative effect of accounting change for SFAS No. 142 - - (2.22) - ----------- ----------- ----------- ----------- Basic and diluted 1.11 (0.29) (0.52) (0.04) =========== =========== =========== =========== Dividends paid per common share - - - 0.025 Average common shares 43,250,655 43,430,957 43,309,735 43,413,691 Average diluted common shares 43,250,655 43,430,957 43,309,735 43,431,296
See accompanying Notes to Consolidated Financial Statements. -3- USG CORPORATION CONSOLIDATED BALANCE SHEETS (DOLLARS IN MILLIONS) (UNAUDITED) AS OF AS OF JUNE 30, DECEMBER 31, 2002 2001 ----------- ----------- ASSETS Current Assets: Cash and cash equivalents $ 615 $ 493 Receivables (net of reserves - $18 and $17) 330 274 Inventories 281 254 Income taxes receivable 61 76 Deferred income taxes 59 66 Other current assets 42 34 ----------- ----------- Total current assets 1,388 1,197 Property, plant and equipment (net of reserves for depreciation and depletion - $641 and $592) 1,786 1,800 Deferred income taxes 215 243 Other assets 131 224 ----------- ----------- Total Assets 3,520 3,464 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable 183 140 Accrued expenses 215 181 ----------- ----------- Total current liabilities 398 321 Long-term debt 2 2 Other liabilities 348 339 Liabilities subject to compromise 2,287 2,311 Stockholders' Equity: Preferred stock - - Common stock 5 5 Treasury stock (256) (255) Capital received in excess of par value 411 408 Accumulated other comprehensive loss (16) (31) Retained earnings 341 364 ----------- ----------- Total stockholders' equity 485 491 ----------- ----------- Total Liabilities and Stockholders' Equity 3,520 3,464 =========== =========== See accompanying Notes to Consolidated Financial Statements. -4- USG CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN MILLIONS) (UNAUDITED) SIX MONTHS ENDED JUNE 30, ------------------------ 2002 2001 ----------- ----------- OPERATING ACTIVITIES: Net loss $ (22) $ (2) Adjustments to reconcile net loss to net cash: Cumulative effect of accounting change 96 - Depreciation, depletion and amortization 51 53 Deferred income taxes 33 94 (Increase) decrease in working capital: Receivables (41) (91) Inventories (27) 13 Payables 43 1 Accrued expenses 37 (39) Increase in other assets (8) (19) Increase in other liabilities 9 6 Increase (decrease) in asbestos reserve, net of receivables 11 (114) Decrease in liabilities subject to compromise (24) - Other, net 1 33 ----------- ----------- Net cash from (to) operating activities 159 (65) ----------- ----------- INVESTING ACTIVITIES: Capital expenditures (38) (57) Net proceeds from asset dispositions 1 1 ----------- ----------- Net cash to investing activities (37) (56) ----------- ----------- FINANCING ACTIVITIES: Issuance of debt - 262 Repayment of debt - (71) Short-term borrowings, net - 165 Cash dividends paid - (1) ----------- ----------- Net cash from financing activities - 355 ----------- ----------- Net increase in cash and cash equivalents 122 234 Cash and cash equivalents at beginning of period 493 70 ----------- ----------- Cash and cash equivalents at end of period 615 304 =========== =========== SUPPLEMENTAL CASH FLOW DISCLOSURES: Interest paid 1 30 Income taxes paid (refunded), net 6 (7) See accompanying Notes to Consolidated Financial Statements. -5- USG CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (1) PREPARATION OF FINANCIAL STATEMENTS The accompanying unaudited consolidated financial statements of USG Corporation and its subsidiaries ("the Corporation") have been prepared in accordance with applicable United States Securities and Exchange Commission guidelines pertaining to interim financial information. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results could differ from those estimates. In the opinion of management, the financial statements reflect all adjustments, which are of a normal recurring nature, necessary for a fair presentation of the Corporation's financial results for the interim periods. These financial statements and notes are to be read in conjunction with the financial statements and notes included in the Corporation's 2001 Annual Report on Form 10-K dated March 1, 2002. (2) VOLUNTARY REORGANIZATION UNDER CHAPTER 11 On June 25, 2001 (the "Petition Date"), the parent company (the "Parent Company") of the Corporation and the 10 United States subsidiaries listed below (collectively, the "Debtors") filed voluntary petitions for reorganization (the "Filing") under chapter 11 of the United States Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"). The chapter 11 cases of the Debtors (collectively, the "Chapter 11 Cases") have been consolidated for purposes of joint administration as In re: USG Corporation et al. (case no. 01-2094). The Chapter 11 Cases do not include any of the Corporation's non-U.S. subsidiaries. The following subsidiaries filed chapter 11 petitions: United States Gypsum Company USG Interiors, Inc. USG Interiors International, Inc. L&W Supply Corporation Beadex Manufacturing, LLC B-R Pipeline Company La Mirada Products Co., Inc. Stocking Specialists, Inc. USG Industries, Inc. USG Pipeline Company This action was taken to resolve asbestos-related claims in a fair and equitable manner, to protect the long-term value of the Debtors' businesses and to maintain the Debtors' leadership positions in their markets. -6- CONSEQUENCES OF THE FILING The Debtors are operating their businesses without interruption as debtors-in-possession subject to the provisions of the Bankruptcy Code. All vendors are being paid for all goods furnished and services provided after the Filing. However, as a consequence of the Filing, all pending litigation against the Debtors as of the Petition Date is stayed, and no party may take any action to pursue or collect pre-petition claims except pursuant to an order of the Bankruptcy Court. It is the Debtors' intention to address all pending and future asbestos-related claims and all other pre-petition claims in a plan of reorganization. However, it is impossible to predict currently how the plan will treat asbestos and other pre-petition claims and what impact any reorganization plan may have on the shares of the Corporation's common stock and other outstanding securities. The formulation and implementation of the plan of reorganization could take a significant period of time. Three creditors' committees, one representing asbestos personal injury claimants, another representing asbestos property damage claimants, and a third representing general unsecured creditors, were organized in 2001. These committees have been appointed as official committees in the Chapter 11 Cases and, in accordance with the provisions of the Bankruptcy Code, will have the right to be heard on all matters that come before the Bankruptcy Court. By order dated July 14, 2002, the Bankruptcy Court appointed the Hon. Dean M. Trafelet as the legal representative for future asbestos claimants in the Debtors' bankruptcy proceeding. Mr. Trafelet was formerly a judge of the Circuit Court of Cook County, Illinois. The Corporation expects that the appointed committees, together with Mr. Trafelet, will play important roles in the Chapter 11 Cases and the negotiation of the terms of any plan of reorganization. Pursuant to the Bankruptcy Code, the Debtors initially had the exclusive right to propose a plan of reorganization for 120 days following the Petition Date, until October 23, 2001, unless extended. The Bankruptcy Court has granted requests by the Debtors to extend the period of exclusivity, initially until May 1, 2002, and later until November 1, 2002. The Debtors are likely to seek one or more additional extensions of the exclusivity period depending on developments in the Chapter 11 Cases. If the Debtors fail to file a plan of reorganization during such extension period, or if such plan is not accepted by the requisite numbers of creditors and equity holders entitled to vote on the plan, other parties in interest in the Chapter 11 Cases may be permitted to propose their own plan(s) of reorganization for the Debtors. The Corporation is unable to predict at this time what the treatment of creditors and equity security holders of the respective Debtors will be under any proposed plan or plans of reorganization. Such plan or plans may provide, among other things, that all present and future asbestos-related liabilities of the Debtors will be discharged and assumed and resolved by one or more independently administered trusts established in compliance with Section 524(g) of the Bankruptcy Code. Section 524(g) of the Bankruptcy Code provides that, -7- if certain specified conditions are satisfied, a court may issue, in connection with the confirmation of a plan of reorganization, a permanent injunction barring the assertion of present and future asbestos-related claims against the reorganized company and channeling those claims to an independent trust for payment in whole or in part. Among other things, the trust must own, or have the right to own upon the occurrence of contingencies specified in the plan of reorganization, a majority of the voting shares of the debtor or its parent, and the plan must be approved by 75% of the voting asbestos claimants whose claims are addressed by the trust. Similar plans of reorganization have been confirmed in chapter 11 cases of other companies involved in asbestos-related litigation. However, there is no assurance that such creation of a trust for the Debtors under Section 524(g), or the issuance of such a permanent injunction, will be approved by the Bankruptcy Court. The Corporation is unable to predict at this time what treatment will be accorded under any such reorganization plan or plans to intercompany indebtedness, licenses, transfers of goods and services, and other intercompany arrangements, transactions and relationships that were entered into prior to the Petition Date. These arrangements, transactions and relationships may be challenged by various parties in the Chapter 11 Cases, and the outcome of those challenges, if any, may have an impact on the treatment of various claims under such plan or plans. The Bankruptcy Court may confirm a plan of reorganization only upon making certain findings required by the Bankruptcy Code, and a plan may be confirmed over the dissent of non-accepting creditors and equity security holders if certain requirements of the Bankruptcy Code are met. The payment rights and other entitlements of pre-petition creditors and USG shareholders may be substantially altered by any plan or plans of reorganization confirmed in the Chapter 11 Cases. There is no assurance that there will be sufficient assets to satisfy the Debtors' pre-petition liabilities in whole or in part, and the pre-petition creditors of some Debtors may be treated differently than those of other Debtors. While it is the Corporation's intent to seek a full recovery for its creditors, pre-petition creditors may receive under a plan or plans less than 100% of the face value of their claims, and the interests of the Corporation's equity security holders are likely to be substantially diluted or cancelled in whole or in part. As noted above, it is not possible at this time to predict the outcome of the Chapter 11 Cases, the terms and provisions of any plan or plans of reorganization, or the effect of the chapter 11 reorganization process on the claims of the pre-petition creditors of the Debtors or the interests of the Corporation's equity security holders. The Corporation urges that appropriate caution be exercised with respect to existing and future investments in these claims and/or securities. Recent developments in the Corporation's bankruptcy proceeding are discussed in Part I, Item 1. Financial Statements, Note 11. Litigation. In connection with the Filing, the Corporation implemented a Bankruptcy Court-approved key employee retention plan that commenced on July 1, 2001, and -8- continues until the date the Corporation emerges from bankruptcy, or June 30, 2004, whichever occurs first. Under the plan, participants receive semiannual payments that began in January 2002. Expenses associated with this plan are being accrued pro rata over the term of the plan and amounted to $12 million in 2001, $5.6 million in the second quarter of 2002 and $11 million in the first six months of 2002. CHAPTER 11 FINANCING A $350 million debtor-in-possession financing facility from JP Morgan Chase (the "DIP Facility") was approved by the Bankruptcy Court on July 31, 2001. The DIP Facility, which matures on June 25, 2004, is available to supplement liquidity and fund operations during the reorganization process. Borrowing availability under the DIP Facility is based primarily on accounts receivable and inventory levels and, to a lesser extent, property, plant and equipment. Given these levels, as of June 30, 2002, the Corporation had the capacity to borrow up to $344 million. There were no outstanding borrowings under the DIP Facility as of June 30, 2002. However, $14 million of standby letters of credit were issued, leaving $330 million of unused borrowing capacity available as of June 30, 2002. FINANCIAL STATEMENT PRESENTATION The accompanying consolidated financial statements have been prepared in accordance with AICPA Statement of Position 90-7 ("SOP 90-7"), "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code," and on a going-concern basis, which contemplates continuity of operations, realization of assets and liquidation of liabilities in the ordinary course of business. However, as a result of the Filing, such realization of assets and liquidation of liabilities, without substantial adjustments and/or changes of ownership, are subject to uncertainty. Given this uncertainty, there is doubt about continuing the going-concern basis of presentation. 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 some of them, may sell or otherwise dispose of assets and liquidate or settle liabilities for amounts other than those reflected in the consolidated financial statements. Further, a plan of reorganization could materially change the amounts and classifications in the historical consolidated financial statements. As of the date of this report, virtually all of the Corporation's pre-petition debt is in default due to the Filing. As described below, the accompanying consolidated financial statements present the Debtors' pre-petition debt under the caption "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. The Corporation accelerated the amortization of its debt-related costs attributable to the Debtors and recorded a pretax expense of $2 million during the second quarter of 2001, which was included under the caption "Chapter 11 Reorganization Expenses." -9- As reflected in the consolidated financial statements, liabilities subject to compromise refers to Debtors' liabilities incurred prior to the commencement of the Chapter 11 Cases. The amounts of the various liabilities that are subject to compromise are set forth below. These amounts represent the Corporation's 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 or (vii) other events. Payment terms for these amounts will be established in connection with the Chapter 11 Cases. 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 and filed with the Bankruptcy Court on May 31, 2002, setting forth the assets and liabilities of the Debtors as of the date of the Filing. Differences between amounts recorded by the Debtors and claims filed by creditors will be investigated and resolved as part of the proof-of-claim process in the Chapter 11 Cases. The Bankruptcy Court has approved a bar date of January 15, 2003, by which proofs of claim must be filed against the Debtors for all claims 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. For the second quarter and first six months of 2002, contractual interest expense not accrued or recorded on pre-petition debt totaled $19 and $37 million, respectively. From the Petition Date through June 30, 2002, contractual interest expense not accrued or recorded on pre-petition debt totaled $78 million. The Corporation believes that cash available from operations and the DIP Facility will provide sufficient liquidity to allow its businesses to operate in the normal course without interruption. This includes its ability to meet post-petition obligations of the Debtors and to meet obligations of the non-debtor subsidiaries. The appropriateness of using the going-concern basis for the Corporation's financial statements is dependent upon, among other things, (i) the Corporation's ability to comply with the terms of the DIP Facility and the cash management order entered by the Bankruptcy Court in connection with the Chapter 11 Cases (ii) the ability of the Corporation to maintain adequate cash on hand (iii) the ability of the Corporation to generate cash from operations (iv) confirmation of a plan or plans of reorganization under the Bankruptcy Code and (v) the Corporation's ability to achieve profitability -10- following such confirmation. Liabilities subject to compromise in the consolidated and DIP balance sheets consist of the following items as of June 30, 2002 (dollars in millions): Accounts payable $ 158 Accrued expenses 68 Debt 1,005 Asbestos reserve 1,061 Other long-term liabilities 36 ----------- Subtotal 2,328 Elimination of intercompany accounts payable (41) ----------- Total liabilities subject to compromise 2,287 =========== Chapter 11 reorganization expenses in the consolidated and DIP statements of earnings consist of the following for the quarter and six months ended June 30, 2002 (dollars in millions): Three Months Six Months ----------- ----------- Legal and financial advisory fees $ 9 $ 13 Interest income (2) (4) ----------- ----------- Total Chapter 11 reorganization expenses 7 9 =========== =========== DIP FINANCIAL STATEMENTS Under the Bankruptcy Code, the Corporation is required to file periodically with the Bankruptcy Court various documents including financial statements of the Debtors (the "Debtor-In-Possession" or "DIP" financial statements). The Corporation cautions that these financial statements are prepared according to requirements under the Bankruptcy Code. While these financial statements accurately provide information required under the Bankruptcy Code, they are nonetheless unconsolidated, unaudited and prepared in a format different from that used in the Corporation's consolidated financial statements filed under the securities laws. Accordingly, the Corporation believes the substance and format do not allow meaningful comparison with the Corporation's regular publicly disclosed consolidated financial statements. The Debtors consist of the Parent Company and the following wholly owned subsidiaries: United States Gypsum Company; USG Interiors, Inc.; USG Interiors International, Inc.; L&W Supply Corporation; Beadex Manufacturing, LLC; B-R Pipeline Company; La Mirada Products Co., Inc.; Stocking Specialists, Inc.; USG Industries, Inc.; and USG Pipeline Company. On March 1, 2002, USG Funding, a non-debtor subsidiary of USG Corporation, declared a dividend in the amount of $50 million (subsequently -11- reduced to $30 million in the second quarter) payable to the Parent Company, which was paid in effect by eliminating the intercompany payable from USG Corporation. This payment is included in other (income) expense, net in the DIP statement of earnings for the six months ended June 30, 2002. The condensed financial statements of the Debtors are presented as follows: USG CORPORATION DEBTOR-IN-POSSESSION STATEMENTS OF EARNINGS (DOLLARS IN MILLIONS) (UNAUDITED)
THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, ------------------------ -------------------------- 2002 2001 2002 2001 ----------- ----------- ----------- ------------- Net sales $ 798 $ 721 $ 1,548 $ 1,460 Cost of products sold 658 675 1,298 1,335 Selling and administrative expenses 69 53 140 111 Chapter 11 reorganization expenses 7 10 9 10 Interest expense 1 14 3 26 Other (income) expense, net 19 4 (31) 5 ----------- ----------- ----------- ------------- Earnings (loss) before income taxes and cumulative effect of accounting change 44 (35) 129 (27) Income taxes (benefit) 29 (10) 47 (6) ----------- ----------- ----------- ------------- Earnings (loss) before cumulative effect of accounting change 15 (25) 82 (21) Cumulative effect of accounting change for SFAS No. 142 - - (41) - ----------- ----------- ----------- ------------- Net earnings (loss) 15 (25) 41 (21) =========== =========== =========== =============
-12- USG CORPORATION DEBTOR-IN-POSSESSION BALANCE SHEETS (DOLLARS IN MILLIONS) (UNAUDITED) AS OF AS OF JUNE 30, DECEMBER 31, 2002 2001 ----------- ----------- ASSETS Cash and cash equivalents $ 459 $ 346 Receivables (net of reserves - $13 and $13) 276 234 Inventories 240 215 Income taxes receivable 62 77 Deferred income taxes 59 66 Other current assets 42 33 ----------- ----------- Total current assets 1,138 971 Property, plant and equipment (net of reserves for depreciation and depletion - $521 and $481) 1,569 1,581 Deferred income taxes 230 258 Other assets 472 494 ----------- ----------- Total Assets 3,409 3,304 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable 156 112 Accrued expenses 185 153 ----------- ----------- Total current liabilities 341 265 Other liabilities 340 333 Liabilities subject to compromise 2,287 2,311 Stockholders' Equity: Preferred stock - - Common stock 5 5 Treasury stock (256) (255) Capital received in excess of par value 98 95 Accumulated other comprehensive income 15 12 Retained earnings 579 538 ----------- ----------- Total stockholders' equity 441 395 ----------- ----------- Total Liabilities and Stockholders' Equity 3,409 3,304 =========== =========== -13- USG CORPORATION DEBTOR-IN-POSSESSION STATEMENTS OF CASH FLOWS (DOLLARS IN MILLIONS) (UNAUDITED) SIX MONTHS ENDED JUNE 30, ------------------------ 2002 2001 ----------- ----------- OPERATING ACTIVITIES: Net earnings (loss) $ 41 $ (21) Adjustments to reconcile net earnings (loss) to net cash: Cumulative effect of accounting change 41 - Depreciation, depletion and amortization 42 44 Deferred income taxes 34 94 (Increase) decrease in working capital: Receivables (27) (66) Inventories (25) 10 Payables 44 2 Accrued expenses 34 (32) Increase in post-petition intercompany receivable (52) (233) Decrease (increase) in other assets 23 (42) Increase in other liabilities 8 6 Increase (decrease) in asbestos reserve, net of receivables 11 (114) Decrease in liabilities subject to compromise (24) - Other, net (7) 47 ----------- ----------- Net cash from (to) operating activities 143 (305) ----------- ----------- INVESTING ACTIVITIES: Capital expenditures (31) (32) Net proceeds from asset dispositions 1 1 ----------- ----------- Net cash to investing activities (30) (31) ------------ ----------- FINANCING ACTIVITIES: Issuance of debt - 262 Repayment of debt - (56) Short-term borrowings, net - 200 Cash dividends paid - (1) ----------- ----------- Net cash from financing activities - 405 ----------- ----------- Net increase (decrease) in cash and cash equivalents 113 69 Cash and cash equivalents at beginning of period 346 37 ----------- ----------- Cash and cash equivalents at end of period 459 106 =========== =========== SUPPLEMENTAL CASH FLOW DISCLOSURES: Interest paid 1 26 Income taxes refunded, net (1) (16) -14- INTERCOMPANY TRANSACTIONS In the normal course of business, the operating subsidiaries and the Parent Company engage in intercompany transactions. To document the relationships created by these transactions, the Parent Company and the operating subsidiaries, from the formation of USG Corporation in 1985, have been parties to intercompany loan agreements that evidence their obligations as borrowers or rights as lenders arising out of intercompany cash transfers and various allocated intercompany charges (the "Intercompany Corporate Transactions"). During the first six months of 2001, the Parent Company took steps to secure the obligations from each of the principal operating subsidiaries under the intercompany loan agreements when it became clear that U.S. Gypsum's asbestos liability claims were becoming an increasingly greater burden on the Corporation's cash resources. 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 tracked on a regular basis, with interest earned or paid on the balances. As of June 30, 2002, U.S. Gypsum's net pre-petition payable balance to the Parent Company for Intercompany Corporate Transactions was $311 million. USG Interiors, Inc.'s net pre-petition payable balance to the Parent Company was $110 million. L&W Supply Corporation had a net pre-petition receivable balance from the Parent Company of $43 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. -15- (3) EARNINGS PER SHARE Basic earnings (loss) per share are based on the weighted average number of common shares outstanding for the period. 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. 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 (loss) per share to diluted earnings (loss) per share is shown in the following table (dollars in millions except share data):
NET SHARES PER SHARE THREE MONTHS ENDED JUNE 30, EARNINGS (LOSS) (000) AMOUNT ------------------------------------------------------------------------------------------ 2002: Basic earnings $ 48 43,251 $ 1.11 Dilutive effect of stock options - ------------------------------------------------------------------------------------------ Diluted earnings 48 43,251 1.11 ========================================================================================== 2001: Basic loss (13) 43,431 (0.29) Dilutive effect of stock options - ------------------------------------------------------------------------------------------ Diluted loss (13) 43,431 (0.29) ========================================================================================== SIX MONTHS ENDED JUNE 30, ------------------------------------------------------------------------------------------ 2002: Basic loss (22) 43,310 (0.52) Dilutive effect of stock options - ------------------------------------------------------------------------------------------ Diluted loss (22) 43,310 (0.52) ========================================================================================== 2001: Basic loss (2) 43,414 (0.04) Dilutive effect of stock options 17 ------------------------------------------------------------------------------------------ Diluted loss (2) 43,431 (0.04) ==========================================================================================
(4) STOCK OPTION GRANTS As of June 30, 2002, common shares totaling 2,726,075 were reserved for future issuance in conjunction with existing stock option grants. In addition, 1,954,337 common shares were reserved for future grants. Shares issued in option exercises may be from original issue or available treasury shares. -16- (5) Operating Segments 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):
THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, ------------------------------------------------------------------ 2002 2001 2002 2001 NET SALES: ------------------------------------------------------------------ North American Gypsum $ 551 $ 458 $ 1,076 $ 941 Worldwide Ceilings 158 170 306 343 Building Products Distribution 306 287 581 573 Eliminations (130) (109) (249) (225) ------------------------------------------------------------------------------------------------------------ Total USG Corporation 885 806 1,714 1,632 ============================================================================================================ OPERATING PROFIT (LOSS): North American Gypsum 81 (20) 139 (5) Worldwide Ceilings 11 9 16 18 Building Products Distribution 13 22 20 37 Corporate (17) (7) (37) (15) Chapter 11 reorganization expenses (7) (10) (9) (10) Eliminations (1) 1 (1) 2 ------------------------------------------------------------------------------------------------------------ Total USG Corporation 80 (5) 128 27 ============================================================================================================
(6) COMPREHENSIVE INCOME (LOSS) The components of comprehensive income (loss) are summarized in the following tables (dollars in millions):
THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, ------------------------------------------------------------------ 2002 2001 2002 2001 ------------------------------------------------------------------ TOTAL COMPREHENSIVE INCOME (LOSS): Net earnings (loss) $ 48 $ (13) $ (22) $ (2) Other comprehensive income (loss) 2 (24) 15 15 ------------------------------------------------------------------------------------------------------------ Total 50 (37) (7) 13 ============================================================================================================ OTHER COMPREHENSIVE INCOME (LOSS): After-tax gain (loss) on derivatives (5) (31) 3 18 Deferred currency translation 7 7 12 (3) ------------------------------------------------------------------------------------------------------------ Total 2 (24) 15 15 ============================================================================================================
-17- The tax benefit on the loss on derivatives was $3 million for the second quarter of 2002 and $20 million for the second quarter of 2001. The tax expense on the gain on derivatives was $2 million for the first six months of 2002 and $11 million for the first six months of 2001. There was no tax impact on the foreign currency translation adjustments. Accumulated other comprehensive loss was $16 million as of June 30, 2002, and $31 million as of December 31, 2001. Included in accumulated other comprehensive loss were net after-tax derivative gains of $19 million and $16 million as of the respective dates. During the second quarter of 2002, $5 million of accumulated net after-tax gains ($8 million pretax) were reclassified from accumulated other comprehensive loss to earnings. As of June 30, 2002, the estimated net after-tax gain expected to be reclassified within the next 12 months from accumulated other comprehensive loss into earnings is $11 million. (7) FINANCIAL INSTRUMENTS The Corporation uses derivative instruments to manage well-defined commodity price and foreign currency exposures. The Corporation does not use derivative instruments for trading purposes. Under Statement of Financial Accounting Standards ("SFAS") No. 133, as amended, all derivative instruments must be recorded on the balance sheet at fair value. For derivatives designated as fair value hedges, the changes in the fair values of both the derivative instrument and the hedged item are recognized in earnings in the current period. For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is recorded to accumulated other comprehensive income (loss) and is reclassified to earnings when the underlying transaction has an impact on earnings. Commodity Derivative Instruments: The Corporation uses swap contracts to hedge anticipated purchases of natural gas to be used in its manufacturing operations. These contracts are designated as cash flow hedges, and changes in fair value are recorded in accumulated other comprehensive income (loss) until the hedged transaction occurs, at which time it is reclassified to earnings. During the second quarter of 2001, the Corporation received proceeds of $35 million ($21 million after-tax) from the termination of natural gas swap contracts scheduled to mature through 2005. In accordance with SFAS No. 133, the net after-tax gain resulting from the termination of these contracts remains in accumulated other comprehensive loss and is reclassified into earnings in the period which the hedged forecasted transactions are scheduled to occur. As of June 30, 2002, $24 million ($15 million after-tax) remained in accumulated other comprehensive loss. -18- During the first half of 2002, the Corporation entered into additional natural gas swap contracts. The fair value of all outstanding natural gas swap contracts was $8 million as of June 30, 2002, and all of these contracts mature by December 31, 2003. The Corporation also had swap agreements, maturing through 2003, with Enron to hedge the cost of wastepaper. During the second quarter of 2002, the Corporation paid $2.1 million to terminate all outstanding wastepaper swaps. Effective with Enron's bankruptcy filing in December 2001, the Corporation discontinued hedge accounting with respect to these swap contracts and changes in the fair value of these hedges were recognized in earnings during the period in which the change occurred. The fair value of the outstanding contracts in accumulated other comprehensive loss as of Enron's bankruptcy filing on December 2, 2001, was $2.4 million. In accordance with SFAS No. 133, this amount will be reclassified into earnings in the period when the hedged forecasted transactions are scheduled to occur. As of June 30, 2002, the amount remaining in accumulated other comprehensive loss was $1.5 million ($0.9 million after-tax). Foreign Exchange Derivative Instruments: The Corporation has operations in a number of countries and uses forward contracts from time to time to hedge the risk of changes in cash flows resulting from forecasted intercompany and third-party sales or purchases in foreign currencies. These contracts are designated as cash flow hedges, and changes in fair value are recorded in accumulated other comprehensive income (loss) until the underlying transaction has an impact on earnings. As of June 30, 2002, the Corporation had no outstanding forward contracts. Interest Rate Derivative Instruments: The Corporation is exposed to interest rate changes and uses swap agreements from time to time to manage this exposure. As of June 30, 2002, the Corporation had no outstanding interest rate swap agreements. (8) RESTRUCTURING 2001 Restructuring Plan: In the fourth quarter of 2001, the Corporation recorded a pretax charge of $12 million related to a restructuring plan that included the shutdown of a gypsum wallboard plant in Fremont, Calif., a drywall steel plant in Prestice, Czech Republic, a ceiling tile plant in San Juan Ixhuatepec, Mexico, a ceiling tile manufacturing line in Greenville, Miss., and other restructuring activities. The restructuring plan, which is expected to be completed in 2002, is intended to allow the Corporation to optimize its manufacturing operations. Included in the $12 million charge was $8 million for severance related to a workforce reduction of more than 350 positions (primarily hourly positions), $2 million for the write-off of property, plant and equipment, -19- and $2 million for line shutdown and removal and contract cancellations. The reserve for this plan is included in accrued expenses on the consolidated balance sheets. Fourth quarter 2001 charges against the reserve included the $2 million write-off of property, plant and equipment and payments totaling $2 million. An additional $2 million of payments were charged against the reserve in the first six months of 2002. All payments for the 2001 restructuring plan are being funded with cash from normal operations. As of June 30, 2002, the ceiling tile manufacturing line at Greenville, Miss., and the plants in San Juan Ixhuatepec, Mexico, and Prestice, Czech Republic, have been shutdown and 258 employees have been terminated, and 26 open positions have been eliminated. The Fremont, Calif., plant ceased production in April 2002. 2000 Restructuring Plan: In the fourth quarter of 2000, the Corporation recorded a pretax charge of $50 million related to a restructuring plan that included a salaried workforce reduction and the shutdown of three gypsum wallboard manufacturing lines and other operations. This restructuring was designed to streamline operations and improve business efficiency. Included in the $50 million charge was $16 million for severance related to the salaried workforce reduction of more than 500 positions, $15 million for the write-off of property, plant and equipment, $12 million for razing buildings and equipment, $5 million for line shutdown and removal, and $2 million for contract cancellations and severance for more than 100 hourly positions. An additional restructuring-related charge of $4 million was included in cost of products sold for the writedown of certain inventory. During the third quarter of 2001, the Corporation reversed $9 million pretax of the restructuring reserve recorded in the fourth quarter of 2000 due to changes from previous estimates and to reflect a change in the scope of restructuring activities undertaken. The primary change involved a decision made in September to eliminate a portion of the closure activities originally planned at the Alabaster, Mich., facility. The reserve for the 2000 restructuring was included in liabilities subject to compromise on the consolidated balance sheets and payments totaling $22 million were charged against this reserve through December 31, 2001. The remaining $4 million was charged against this reserve in the first six months of 2002. All payments for this plan were funded with cash from normal operations. The salaried workforce reduction program was completed as of June 30, 2001, with the termination of 394 salaried employees and the elimination of 179 open salaried positions. In addition, 73 hourly employees were terminated, and 44 open hourly positions were eliminated. Closure of the three gypsum -20- wallboard manufacturing lines and other operations was completed by December 31, 2001. The following table details the restructuring reserves and first six months 2002 activity (dollars in millions):
Writedown of Provisions Assets to Net Reversal Reserve for Realizable Cash of Balance Restructuring Value Payments Reserve 6/30/02 ----------------------------------------------------------------------------------------------------------- 2001 RESTRUCTURING: Severance (primarily hourly) $ 8 $ - $ (3) $ - $ 5 Property, plant and equipment write-off 2 (2) - - - Line shutdown/removal and contract cancellations 2 - (1) - 1 ----------------------------------------------------------------------------------------------------------- Subtotal 12 (2) (4) - 6 ----------------------------------------------------------------------------------------------------------- 2000 RESTRUCTURING: Severance (salaried) 16 - (16) - - Property, plant and equipment write-off 15 (15) - - - Razing buildings and equipment 12 - (6) (6) - Line shutdown and removal 5 - (3) (2) - Contract cancellations and severance (hourly) 2 - (1) (1) - ----------------------------------------------------------------------------------------------------------- Subtotal 50 (15) (26) (9) - ----------------------------------------------------------------------------------------------------------- Total 62 (17) (30) (9) 6 ===========================================================================================================
(9) NEW ACCOUNTING PRONOUNCEMENTS The Corporation adopted three new accounting standards in the first quarter of 2002. SFAS No. 141, "Business Combinations," requires all business combinations initiated after June 30, 2001, to be accounted for using the purchase method. This standard, which became effective for the Corporation on January 1, 2002, had no impact on its financial statements upon adoption. SFAS No. 142, "Goodwill and Other Intangible Assets," eliminates the amortization of goodwill over its estimated useful life. See Note 10, "Adoption of SFAS No. 142" for information regarding the adoption of this standard and the resulting impairment charge. SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," supersedes SFAS No. 121 and a portion of APB Opinion No. 30. This -21- statement establishes a single accounting model for the disposal of long-lived assets and resolves significant implementation issues related to SFAS No. 121. This standard, which became effective for the Corporation on January 1, 2002, had no impact on its financial statements upon adoption. The Corporation will adopt SFAS No. 143, "Accounting for Asset Retirement Obligations," in January 2003. This standard requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. This standard becomes effective January 1, 2003, and is likely to have an impact on the Corporation's financial statements. However, as of the date of this report, the Corporation has not determined what impact the adoption of this standard may have on its financial statements. (10) ADOPTION OF SFAS NO. 142 On January 1, 2002, the Corporation adopted SFAS No. 142, "Goodwill and Other Intangible Assets." Although SFAS No. 142 eliminates the amortization of goodwill and certain other intangible assets, it initiates an annual assessment of goodwill for impairment. During the second quarter of 2002, the Corporation completed its transition date assessment of goodwill. The assessment was performed for each reporting unit (as defined by SFAS No. 142) that has goodwill. For the Corporation, the reporting units with goodwill were the North American Gypsum and the Building Products Distribution operating segments. The Corporation determined that goodwill for its Building Products Distribution segment was not impaired, but will be reviewed at least annually for impairment. However, goodwill for its North American Gypsum segment was impaired. This impairment was attributable to U.S. Gypsum's asbestos liability and related filing for bankruptcy protection on June 25, 2001. As a result, the Corporation recorded a noncash, nontaxable impairment charge of $96 million. This charge, which includes a $6 million deferred currency translation write-off, is reflected on the Corporation's consolidated statement of earnings as a cumulative effect of a change in accounting principle as of January 1, 2002. In accordance with SFAS No. 142, the Corporation is reflecting this charge in its financial statements for the three months ended March 31, 2002. The reconciliation of pro forma net earnings, basic earnings per share and diluted earnings per share for the three months and six months ended June 30, 2001, is shown in the following table (dollars in millions except per-share data): -22-
THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, --------------------------------------------------------------- 2002 2001 2002 2001 --------------------------------------------------------------- NET EARNINGS (LOSS): Reported net earnings (loss) $ 48 $ (13) $ (22) $ (2) Add back: Goodwill amortization, net of tax - 1 - 2 Cumulative effect of accounting change for SFAS No. 142 - - 96 - ------------------------------------------------------------------------------------------------------------ Pro forma net earnings (loss) 48 (12) 74 - ============================================================================================================ BASIC AND DILUTED EARNINGS (LOSS) PER SHARE: Reported basic and diluted 1.11 (0.29) (0.52) (0.04) Add back: Goodwill amortization - 0.02 - 0.04 Cumulative effect of accounting change for SFAS No. 142 - - 2.22 - ------------------------------------------------------------------------------------------------------------ Pro forma basic and diluted 1.11 (0.27) 1.71* - ============================================================================================================
* The sum of the per-share components is not the same as the total. (11) LITIGATION ASBESTOS AND RELATED BANKRUPTCY LITIGATION One of the Corporation's subsidiaries, U.S. Gypsum, is among many defendants in lawsuits arising out of the manufacture and sale of asbestos-containing materials. On June 25, 2001 (the "Petition Date"), U.S. Gypsum, the Parent Company, and other domestic subsidiaries (the "Debtors") filed voluntary petitions for relief under chapter 11 of the U.S. Bankruptcy Code (the "Filing") to manage the growing costs of resolving asbestos claims and to achieve a fair and final resolution of liability for both pending and future asbestos claims. The Chapter 11 Cases are being jointly administered under Case No. 01-2094 in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"). U.S. Gypsum's asbestos liability derives from its sale of certain asbestos-containing products beginning in the late 1920s; in most cases, the products were discontinued or asbestos was removed from the formula by 1972, and no asbestos-containing products were produced after 1978. Certain of the asbestos lawsuits against U.S. Gypsum seek to recover compensatory and, in many cases, punitive damages for costs associated with the maintenance or removal and replacement of asbestos-containing products in buildings (the "Property Damage Cases"). Other asbestos lawsuits seek compensatory and, in many cases, punitive damages for personal injury allegedly resulting from exposure to asbestos-containing products (the "Personal Injury Cases"). A -23- more detailed description of the Property Damage and Personal Injury Cases is set forth below. As a result of the Filing, all pending Personal Injury and Property Damage Cases against U.S. Gypsum are stayed, and no party may take any action to pursue or collect on such asbestos lawsuits absent specific authorization of the Bankruptcy Court. Since the Filing, U.S. Gypsum has ceased making both cash payments and accruals with respect to asbestos lawsuits, including cash payments and accruals pursuant to settlements of asbestos lawsuits. The Bankruptcy Court has approved creditors' committees that represent claimants in Personal Injury and Property Damage Cases and, as noted below, a legal representative for future asbestos claimants. As part of the bankruptcy proceeding, it will be determined which asbestos claims should be allowed, or compensated, and the aggregate value of such claims. U.S. Gypsum anticipates that its liability for pending and future asbestos claims will be addressed in a plan of reorganization developed and approved in the bankruptcy proceeding. The Debtors' exclusive right to propose such a plan of reorganization has been extended by the Bankruptcy Court to November 1, 2002. The Debtors are likely to seek one or more additional extensions of the exclusivity period. It is the Debtors' intention that the plan of reorganization will include the creation of a trust under Section 524(g) of the Bankruptcy Code which will be funded to allow payment of present and future asbestos claims, and, as a result of creation of the trust, the Bankruptcy Court will issue a permanent injunction channeling all asbestos-related claims to the trust and barring the assertion of pending or future asbestos-related claims against the reorganized companies. However, there is no assurance that creation of a trust under Section 524(g) or the issuance of such a permanent injunction will be approved by the Bankruptcy Court. It is anticipated that the plan or plans of reorganization ultimately approved will include all Debtors in the final resolution of asbestos-related claims that are or might be asserted against U.S. Gypsum, the Corporation, and all other Debtor affiliates. Recent Developments in the Reorganization Proceeding: During the fourth quarter of 2001, the Corporation's bankruptcy proceeding, along with four other asbestos-related bankruptcy proceedings pending in the federal courts in the District of Delaware, were assigned to the Honorable Alfred M. Wolin of the United States District Court for the District of New Jersey. This assignment was accomplished through orders of the United States Court of Appeals for the Third Circuit and the United States District Court for the District of Delaware dated November 27 and November 29, 2001, respectively. In orders subsequent to the reassignment, Judge Wolin has indicated that he will handle all issues relating to asbestos personal injury claims and that other bankruptcy claims and issues in the Chapter 11 Cases, including issues relating to asbestos property damage claims, will remain assigned to Bankruptcy Judge Randall J. Newsome in the United States Bankruptcy Court -24- for the District of Delaware. The Debtors have filed a motion requesting Judge Wolin to conduct hearings to substantively estimate the Debtors' liability for asbestos personal injury claims. The Debtors propose that, in these substantive estimation hearings, the court will hear evidence and make rulings regarding the characteristics of valid asbestos personal injury claims against the Debtors, and the Court will then estimate the Debtors' liability for present and future asbestos personal injury claims based upon these rulings. The committee representing asbestos personal injury claimants opposes the substantive estimation hearings proposed by Debtors. The committee contends that U.S. Gypsum's liability for present and future asbestos personal injury claims should be based on extrapolation from U.S. Gypsum's settlement history of such claims and not on litigating liability issues in the bankruptcy proceeding. Pursuant to a schedule set by Judge Wolin, the Debtors and the committees are to complete the submission of briefs to the court on the issue of estimation hearings in late August 2002. At present, it is not known whether Judge Wolin will conduct the hearings requested by the Debtors or when these hearings might be held. The estimated amount of the Debtors' liability for present and future asbestos personal injury claims could be significantly different depending upon whether the estimated liability is based on substantive estimation, as proposed by Debtors, or based on the estimation protocol proposed by the committee representing the asbestos personal injury claimants. If the hearings on liability issues relating to asbestos personal injury claims do not go forward, or a consensual resolution is not reached as a result of the hearings or otherwise, the Corporation will employ other means to resolve the Debtors' asbestos personal injury liability. These other means may include, but are not limited to, setting a bar date for filing asbestos personal injury claims and determining which of the claims are entitled to vote on and participate in an asbestos trust under 11 U.S.C. ss.524(g) of the Bankruptcy Code. A bar date proceeding likely would lengthen the bankruptcy case significantly. By order dated July 14, 2002, the Bankruptcy Court appointed the Hon. Dean M. Trafelet as the legal representative for future asbestos claimants in the Debtors' bankruptcy proceeding. Mr. Trafelet was formerly a judge of the Circuit Court of Cook County, Illinois. The Corporation expects that U.S. Gypsum's liability for asbestos property damage claims will also be resolved in the reorganization proceeding, whether by including those liabilities in a ss.524(g) trust or by other means. Toward that end, the Bankruptcy Court has set a bar date of January 15, 2003, by which all entities with asbestos property damage claims or any other types of claims (except asbestos personal injury claims or claims derivative thereof) must file their claims against the Debtors in the bankruptcy proceeding. The Debtors have mailed and published notice of the -25- claims bar date to potential asbestos property damage claimants as well as other claimants affected by the bar date. The Official Committee of Asbestos Property Damage Claimants has appealed the Bankruptcy Court's order establishing a bar date for property damage claims. The appeal is pending before Judge Wolin, and he has not yet ruled on the appeal. Given the current status of the Chapter 11 Cases, the Corporation is unable to forecast with any reasonable degree of certainty the timing or substance of the resolution of the Debtors' asbestos-related liability or the reorganization proceeding. The following is a summary of the Property Damage and Personal Injury Cases pending against U.S. Gypsum as of the Petition Date. Property Damage Cases: As of the Petition Date, U.S. Gypsum was a defendant in eleven Property Damage Cases, most of which involved multiple buildings. One of the cases is a conditionally certified class action comprising all colleges and universities in the United States, which certification is presently limited to the resolution of certain allegedly "common" liability issues. (Central Wesleyan College v. W.R. Grace & Co., et al., U.S.D.C. S.C.). On June 15, 2001, a Property Damage Case was filed by The County of Orange, Texas, in the district court of Orange County, Texas, naming as defendants U.S. Gypsum and other manufacturers of asbestos-containing materials. This was the first Property Damage case filed against U.S. Gypsum since June 1998. The Orange County case is a putative class action brought by The County of Orange on behalf of an alleged class comprising the State of Texas, its public colleges and universities, and all political subdivisions of the State of Texas. As to U.S. Gypsum, the putative class also includes all private and/or non-public colleges, universities, junior colleges, community colleges, and elementary and secondary schools in the State of Texas. The Orange County action seeks recovery of the costs of removing and replacing asbestos-containing materials in buildings at issue as well as punitive damages. The complaint does not specify how many buildings are at issue. As a result of the Filing, all Property Damage Cases, including the Central Wesleyan and Orange County cases, are stayed against U.S. Gypsum. U.S. Gypsum's estimated cost of resolving the Property Damage Cases is discussed below (see "Estimated Cost"). Personal Injury Cases: As reported by the Center for Claims Resolution (the "Center"), as described below, U.S. Gypsum was a defendant in approximately 106,000 pending Personal Injury Cases as of the Petition Date, as well as an additional approximately 52,000 Personal Injury Cases that are the subject of settlement agreements. In the first half of 2001, up to the Petition Date, approximately 26,200 new Personal Injury Cases were filed against U.S. Gypsum, as reported by the Center, as compared to 27,800 new filings in the first half of 2000. Filings of new Personal Injury Cases totaled approximately 53,000 claims in 2000, 48,000 claims in 1999, and 80,000 claims in 1998. -26- Prior to the Filing, U.S. Gypsum managed the handling and settlement of Personal Injury Cases through its membership in the Center. From 1988 up to February 1, 2001, the Center administered, and arranged for the defense and settlement of, Personal Injury cases against U.S. Gypsum and other Center members. During that period, costs of defense and settlement of Personal Injury Cases were shared among the members of the Center pursuant to predetermined sharing formulae. Effective February 1, 2001, the Center members, including U.S. Gypsum, ended their prior settlement sharing arrangement. The Center continued to administer and arrange for the defense and settlement of the Personal Injury Cases, but liability payments were not shared among the Center members. As of the Petition Date and as a result of the stay of asbestos lawsuits against U.S. Gypsum, U.S. Gypsum no longer requires the services of the Center in negotiating or defending Personal Injury Cases. In 2000 and years prior, U.S. Gypsum and other Center members negotiated a number of settlements with plaintiffs' law firms that included agreements to resolve over time the firms' pending Personal Injury Cases as well as certain future claims ("Long-Term Settlements"). With regard to future claims, these Long-Term Settlements typically provide that the plaintiffs' firms will recommend to their future clients that they defer filing, or accept nominal payments on, personal injury claims that do not meet established disease criteria, and, with regard to those claims meeting established disease criteria, that the future clients accept specified amounts to settle those claims. These Long-Term Settlements typically resolve claims for amounts consistent with historical per claim settlement costs paid to the plaintiffs' firms involved. As a result of the Filing, cash payments by U.S. Gypsum under these Long-Term Settlements have ceased, and U.S. Gypsum expects that its obligations under these settlements will be determined in the bankruptcy proceeding and plan of reorganization. In 2000, U.S. Gypsum closed approximately 57,000 Personal Injury Cases. U.S. Gypsum's cash payments in 2000 to defend and resolve Personal Injury Cases totaled $162 million, of which $90 million was paid or reimbursed by insurance. In 2000, the average settlement per case was approximately $2,600, exclusive of defense costs. U.S. Gypsum made cash payments of $100 million in 1999 and $61 million in 1998 to resolve Personal Injury Cases, of which $85 million and $45.5 million, respectively, were paid or reimbursed by insurance. In the first and second quarters of 2001, prior to the Filing, cash payments to resolve Personal Injury Cases increased dramatically, primarily as a result of the bankruptcy filings of other defendants in asbestos personal injury lawsuits. As a result of these bankruptcy filings, plaintiffs substantially increased their settlement demands to the remaining defendants, including U.S. Gypsum, to replace the expected payments of the bankrupt defendants. In response to these increased settlement demands, U.S. Gypsum attempted to manage its asbestos liability by contesting, rather than -27- 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 was 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. As a result of these increasing settlement demands and the concern that federal legislation addressing the asbestos litigation problem likely would not be enacted within the necessary timeframe, U.S. Gypsum concluded that it would not be able to manage and resolve its asbestos liability in the tort system, and, on June 25, 2001, the Debtors filed a voluntary petition under Chapter 11 of the Bankruptcy Code. As a result of the Filing, all Personal Injury Cases are stayed against U.S. Gypsum, new cases may not be filed due to the automatic stay, and payments relating to settlements of Personal Injury Cases before the Filing may not be made. In addition to the Personal Injury Cases pending against U.S. Gypsum, one of the Corporation's subsidiaries and a Debtor in the bankruptcy proceeding, L&W Supply Corporation, was named as a defendant in approximately 21 pending Personal Injury Cases as of the Petition Date. L&W, 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. It is believed that L&W has been named as a defendant in Personal Injury Cases based on its role as a distributor of U.S. Gypsum products. Therefore, the Corporation expects that any asbestos-related liability of L&W would be derivative of the liability of U.S. Gypsum, and that any plan or plans of reorganization should reflect that L&W's liability, if any, rests with U.S. Gypsum as the manufacturer. However, because of the small number of Personal Injury Cases against L&W to date and the lack of development of the cases against L&W, the Corporation does not have sufficient information at this time to predict as to how any plan or plans of reorganization will address any asbestos-related liability of L&W and whether any such liability will be limited to L&W's role as a distributor of U.S. Gypsum products. One of U.S. Gypsum's subsidiaries and a Debtor in the bankruptcy proceeding, Beadex Manufacturing, LLC ("Beadex"), manufactured and sold joint compound containing asbestos from 1963 through 1978 in the northwest United States. As of the Petition Date, Beadex was a named defendant in approximately 40 -28- Personal Injury Cases pending primarily in the states of Washington and Oregon. Beadex has approximately $11 million in primary or umbrella insurance coverage available to pay asbestos-related costs, as well as $15 million in available excess coverage. The Corporation expects that any asbestos-related liability of Beadex will be addressed in the plan of reorganization. However, because of the small number of Personal Injury Cases pending against Beadex to date, the Corporation does not have sufficient information at this time to predict as to how any plan or plans of reorganization will address any asbestos-related liability of Beadex. Insurance Coverage: As of the Petition Date, after deducting insurance used to date, U.S. Gypsum had approximately $76.3 million of insurance remaining to cover asbestos-related costs. After insurance payments to U.S. Gypsum in the third and fourth quarters of 2001, approximately $52 million remained as of December 31, 2001. After insurance payments of approximately $11 million in the first six months of 2002, approximately $41 million remained as of June 30, 2002. This insurance is scheduled to be paid over a period of approximately three years through 2004. Estimated Cost: In evaluating U.S. Gypsum's estimated asbestos liability prior to the Filing, the Corporation considered numerous uncertainties that made it difficult to estimate reliably U.S. Gypsum's asbestos liability in the tort system for both pending and future asbestos claims. In the Property Damage Cases, such uncertainties included, but were not limited to, the identification and volume of asbestos-containing products in the buildings at issue in each case, which is often disputed; the claimed damages associated therewith; the viability of statute of limitations, product identification and other defenses, which varies depending upon the facts and jurisdiction of each case; the amount for which such cases can be resolved, which normally (but not uniformly) has been substantially lower than the claimed damages; and the viability of claims for punitive and other forms of multiple damages. Uncertainties in the Personal Injury Cases included, but were not limited to, the number, disease and occupational characteristics, and venue of Personal Injury Cases that are filed against U.S. Gypsum; the age and level of physical impairment of claimants; the viability of claims for conspiracy or punitive damages; the elimination of indemnity sharing among Center members for future settlements and its negative impact on U.S. Gypsum's ability to continue to resolve claims at historical or acceptable levels; the adverse impact on U.S. Gypsum's settlement costs of recent bankruptcies of co-defendants; the continued solvency of other defendants and the possibility of additional bankruptcies; the possibility of significant adverse verdicts due to recent changes in settlement strategies and related effects on liquidity; the inability or refusal of former Center members to fund their share of existing settlements and its effect on such settlement agreements; the continued ability to negotiate settlements or develop other -29- mechanisms that defer or reduce claims from unimpaired claimants; and the possibility that federal legislation addressing asbestos litigation will be enacted. The Corporation reported that adverse developments with respect to any of these uncertainties could have a material impact on U.S. Gypsum's settlement costs and could materially increase the cost above the estimated range discussed below. Prior to the fourth quarter of 2000, the Corporation, in the opinion of management, was unable to reasonably estimate the probable cost of resolving future asbestos claims in the tort system, although the Corporation had estimated and reserved for costs associated with then-pending claims. However, in 1999 and increasingly in 2000, as U.S. Gypsum entered into Long-Term Settlements of Personal Injury Cases, the Corporation undertook a detailed, independent study of U.S. Gypsum's current and potential future asbestos liability. This analysis was based on the assumption that U.S. Gypsum's asbestos liability would continue to be resolved in the tort system. The analysis was completed in the fourth quarter of 2000. As part of this analysis, the Corporation reviewed, among other things, historical case filings and increasing settlement costs; the type of products sold by U.S. Gypsum and the occupations of claimants expected to bring future asbestos-related claims; epidemiological data concerning the incidence of past and projected future asbestos-related diseases; trends in the propensity of persons alleging asbestos-related disease to sue U.S. Gypsum; the adverse effect on settlement costs of historical reductions in the number of solvent defendants available to pay claims, including reductions in membership of the Center; the pre-agreed settlement recommendations in, and the continued viability of, the Long-Term Settlements described above; and anticipated trends in recruitment by plaintiffs' law firms of non-malignant or unimpaired claimants. The study attempted to weigh relevant variables and assess the impact of likely outcomes on future case filings and settlement costs. In addition, the Corporation considered future defense costs, as well as allegations that U.S. Gypsum and the other Center members bear joint liability for the share of certain settlement agreements that was to be paid by former members that now have refused or are unable to pay. In the fourth quarter of 2000, the Corporation concluded that it was possible to provide a reasonable estimate of U.S. Gypsum's liability in the tort system for asbestos cases to be filed through 2003 as well as those currently pending. Based on an independent study, the Corporation determined that, although substantial uncertainty remained, it was probable that asbestos claims currently pending against U.S. Gypsum and future asbestos claims to be filed against it through 2003 (both property damage and personal injury) could be resolved in the tort system for an amount between $889 million and $1,281 million, including defense costs, and that within this range the most likely estimate was $1,185 million. Consistent with this analysis, in the fourth quarter of 2000, the Corporation recorded a pretax -30- non-cash charge of $850 million to results of operations, which, combined with the previously existing reserve, increased U.S. Gypsum's reserve for asbestos claims to $1,185 million. Substantially all of this reserve relates to the estimated costs of resolving then-pending asbestos personal injury claims and those expected to be filed through 2003, and the reserve reflected management's expectation that U.S. Gypsum's average payment per asbestos personal injury claim would increase at least in the short term due to distortions caused by the bankruptcy filings of other asbestos personal injury defendants discussed above. Less than 10 percent of the reserve is attributable to defense and administrative costs. At the time of recording this reserve, it was expected that the reserve amounts would be expended over a period extending several years beyond 2003, because asbestos cases have historically been resolved an average of three years after filing. The Corporation concluded that it did not have adequate information to allow it to reasonably estimate the number of claims to be filed after 2003, or the liability associated with such claims. During 2001 up to the Filing, U.S. Gypsum's cash payments for asbestos claims and related legal fees totaled approximately $124 million, reducing its reserve for asbestos claims to $1,061 million as of June 30, 2001. The reserve remained at $1,061 million as of June 30, 2002. Insurance recoveries during 2001 totaled $34 million, leaving U.S. Gypsum with a receivable from insurance carriers (the estimated portion of the reserved amount that is expected to be paid or reimbursed by insurance) of approximately $52 million as of December 31, 2001. Insurance recoveries in the first six months of 2002 totaled approximately $11 million, leaving U.S. Gypsum with a receivable from insurance carriers of approximately $41 million as of June 30, 2002. The above amounts are stated before tax benefit and are not discounted to present value. It is the Corporation's view that, as a result of the Filing, there is even greater uncertainty in estimating the reasonably possible range of asbestos liability for pending and future claims as well as the most likely estimate of liability within this range. There are significant differences in the treatment of asbestos claims in a bankruptcy proceeding as compared to the tort litigation system. Among other things, these uncertainties include how the Long-Term Settlements will be treated in the bankruptcy proceeding and plan of reorganization, and whether those settlements will be set aside; the number of asbestos-related claims that will be filed in the proceeding; the number of future claims that will be estimated in connection with preparing a plan of reorganization; how claims for punitive damages and claims by persons with no asbestos-related physical impairment will be treated and whether such claims will be allowed; the impact historical settlement values for asbestos claims may have on the estimation of asbestos liability in the bankruptcy proceeding; and the impact any relevant potential federal legislation may have on the proceeding. These factors, as well as the uncertainties discussed above in connection with the resolution of asbestos -31- cases in the tort system, increase the uncertainty of any estimate of asbestos liability. As a result of the increased uncertainty of estimating asbestos liability due to the Filing, it is the Corporation's view that no change should be made at this time to the previously recorded reserve for asbestos claims. However, it is possible that the cost of resolving asbestos claims will be greater than that set forth in the high end of the estimated reserve range. As the bankruptcy proceeding continues, it is expected that the Corporation will obtain additional information that may provide greater certainty to the expected range of liability. When a reasonable estimate can be made of the Debtors' probable liability for asbestos claims and such estimate differs from the existing reserve, the reserve will be adjusted to reflect the estimate, and it is possible that a charge to results of operations will be necessary at that time. Bond to Secure Certain CCR Obligations: In January 2001, U.S. Gypsum obtained a performance bond from Safeco Insurance Company of America ("Safeco") in the amount of $60.3 million to secure certain obligations of U.S. Gypsum for extended payout settlements of Personal Injury Cases and other obligations owed by U.S. Gypsum to the Center. The bond is secured by an irrevocable letter of credit obtained by the Corporation in the amount of $60.3 million and issued by Chase Manhattan Bank to Safeco. After the Filing, by letter dated July 6, 2001, the Center stated that certain amounts allegedly covered by the bond, totaling approximately $15.7 million, were overdue from U.S. Gypsum to the Center. In subsequent letters dated November 19, 2001, and December 11, 2001, the Center stated that additional amounts allegedly covered by the bond totaling approximately $14 million and $113 million, respectively, were also overdue from U.S. Gypsum. The amounts for which the Center made demand were for the payment of, among other things, settlements of Personal Injury Cases that were entered into pre-petition. By letter dated November 16, 2001, the Center made a demand to Safeco for payment of $15.7 million under the bond, and by letter dated December 28, 2001, the Center made a demand to Safeco for payment of approximately $127 million under the bond. The total amount demanded by the Center under the bond, approximately $143 million, exceeds the original penal sum of the bond, which is $60.3 million. Safeco has not made any payment under the bond, but, to the extent that Safeco were to pay any portion of the bond, it is likely that Safeco would draw down the Chase letter of credit to cover the bond payment and Chase would assert a pre-petition claim in a corresponding amount against the Corporation in the bankruptcy proceeding. 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 -32- 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 has consolidated the Adversary Proceeding with similar adversary proceedings brought by Federal-Mogul Corp., et al., and Armstrong World Industries, Inc., et al., in their bankruptcy proceedings. Due to the status of the Adversary Proceeding, the Corporation cannot predict whether or when any portion of the bond proceeds will be paid, what amount, if any, will be paid, and whether the letter of credit will be drawn. Conclusion: There are many uncertainties associated with the resolution of asbestos liability in the bankruptcy proceeding. These uncertainties include, among others, the number of asbestos-related claims that will be filed against the Debtors in the proceeding; the number of future claims that will be estimated in connection with preparing a plan of reorganization; how the Long-Term Settlements will be treated in the bankruptcy proceeding and plan of reorganization, and whether those settlements will be set aside; how claims for punitive damages and claims by persons with no asbestos-related physical impairment will be treated and whether such claims will be allowed; the impact historical settlement values for asbestos claims may have on the estimation of asbestos liability in the bankruptcy proceeding; and the impact any relevant potential federal legislation may have on the proceeding. The Corporation has not revised its previously recorded reserve for asbestos liability. The Corporation will continue to review its asbestos liability as the Chapter 11 Cases progress. When a reasonable estimate can be made of the Debtors' probable liability for asbestos claims, if such estimate differs from the existing reserve, the reserve will be adjusted, and it is possible that a charge to results of operations will be necessary at that time. It is possible that the Corporation's asbestos liability may vary significantly from the recorded estimate of liability and that this difference could be material to the results of operations in the period recorded. ENVIRONMENTAL LITIGATION The Corporation and certain of its subsidiaries have been notified by state and federal environmental protection agencies of possible involvement as one of numerous "potentially responsible parties" in a number of so-called "Superfund" sites in the United States. In most of these sites, the involvement of the Corporation or its subsidiaries is expected to be minimal. The Corporation believes that appropriate reserves have been established for its potential liability in connection with all Superfund sites but is continuing to review its accruals as additional information becomes available. Such reserves take into account all known or estimated 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 -33- Corporation-owned property also are covered by reserves established in accordance with the foregoing. The Debtors have been given permission by the Bankruptcy Court to satisfy environmental obligations up to $12 million. The Corporation believes that neither these matters nor any other known governmental proceeding regarding environmental matters will have a material adverse effect upon its results of operations or financial position. -34- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION VOLUNTARY REORGANIZATION UNDER CHAPTER 11 On June 25, 2001 (the "Petition Date"), the parent company (the "Parent Company") of the Corporation and the 10 United States subsidiaries listed below (collectively, the "Debtors") filed voluntary petitions for reorganization (the "Filing") under chapter 11 of the United States Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"). The chapter 11 cases of the Debtors (collectively, the "Chapter 11 Cases") have been consolidated for purposes of joint administration as In re: USG Corporation et al. (case no. 01-2094). The Chapter 11 Cases do not include any of the Corporation's non-U.S. subsidiaries. The following subsidiaries filed chapter 11 petitions: United States Gypsum Company USG Interiors, Inc. USG Interiors International, Inc. L&W Supply Corporation Beadex Manufacturing, LLC B-R Pipeline Company La Mirada Products Co., Inc. Stocking Specialists, Inc. USG Industries, Inc. USG Pipeline Company This action was taken to resolve asbestos-related claims in a fair and equitable manner, to protect the long-term value of the Debtors' businesses and to maintain the Debtors' leadership positions in their markets. BACKGROUND OF THE FILING U.S. Gypsum is a defendant in asbestos lawsuits alleging both property damage and personal injury. Chapter 11 filings during 2000 and early 2001 by other companies subject to asbestos litigation dramatically increased U.S. Gypsum's asbestos costs beyond its legitimate liability. The Corporation has been and continues to be committed to finding a legislative solution to the increase in asbestos costs. However, in 2001 it became apparent that a timely resolution to the problem through legislation was not feasible. The Corporation determined that voluntary protection under chapter 11 would be the best alternative for obtaining a fair and final resolution of U.S. Gypsum's asbestos liability and the best way to preserve value for stakeholders. See Part II, Item 1. "Legal Proceedings" for additional information on asbestos litigation. USG was the eighth major company with a large number of asbestos claims that filed a chapter 11 petition in the 18 months prior to the Petition Date. Since 1994, U.S. Gypsum has been named in more than 250,000 asbestos-related personal injury -35- claims and made cash payments of approximately $575 million (before insurance recoveries) to manage and resolve asbestos-related litigation. Based on an independent study conducted in 2000 and on U.S. Gypsum's historical experience of litigating asbestos claims in the tort system, the Corporation estimated that U.S. Gypsum's probable liability for costs associated with asbestos cases pending as of December 31, 2000, and expected to be filed through 2003 to be between $889 million and $1,281 million. In the fourth quarter of 2000, U.S. Gypsum recorded a noncash, pretax provision of $850 million, increasing its total accrued reserve for asbestos claims to $1,185 million as of December 31, 2000. Substantially all of this reserve related to personal injury claims and reflected management's expectation that U.S. Gypsum's average cost per case would increase, at least in the short term, due to distortions in the tort system resulting from the bankruptcies of other defendants that led to increased settlement demands from asbestos plaintiffs. Less than 10% of the reserve related to defense and administrative costs. Between January 1, 2001, and the Petition Date, according to the Center for Claims Resolution, U.S. Gypsum was served with more than 26,000 new claims. On a cash basis, U.S. Gypsum's asbestos-related personal injury costs (before insurance) rose from $30 million in 1997 to $162 million in 2000 and, absent the Filing, were expected to exceed $275 million in 2001. Because of the Filing, there is greater uncertainty concerning the liability associated with asbestos cases, as discussed below. CONSEQUENCES OF THE FILING The Debtors are operating their businesses as debtors-in-possession subject to the provisions of the Bankruptcy Code. All vendors are being paid for all goods furnished and services provided after the Filing. However, as a consequence of the Filing, all pending litigation against the Debtors as of the Petition Date is stayed, and no party may take any action to pursue or collect pre-petition claims except pursuant to an order of the Bankruptcy Court. It is the Debtors' intention to address all pending and future asbestos-related claims and all other pre-petition claims in a plan of reorganization. However, it is impossible to predict currently how the plan will treat asbestos and other pre-petition claims and what impact any reorganization plan may have on the shares of the Corporation's common stock and other outstanding securities. The formulation and implementation of the plan of reorganization could take a significant period of time. Three creditors' committees, one representing asbestos personal injury claimants, another representing asbestos property damage claimants, and a third representing general unsecured creditors, were organized in 2001. These committees have been appointed as official committees in the Chapter 11 Cases and, in accordance with the provisions of the Bankruptcy Code, will have the right to be heard on all matters that come before the Bankruptcy Court. By order dated July 14, 2002, the Bankruptcy Court appointed the Hon. Dean M. Trafelet as the legal representative for future asbestos claimants in the Debtors' bankruptcy proceeding. Mr. Trafelet was formerly a judge of the Circuit Court of Cook County, Illinois. The Corporation expects that the appointed committees, together with Mr. Trafelet, will play important roles in the Chapter 11 Cases and the negotiation of the terms of any plan of reorganization. Recent -36- developments in the Corporation's bankruptcy proceeding are discussed in Part I, Item 1. Note 11. "Litigation." CHAPTER 11 FINANCING A $350 million debtor-in-possession financing facility from JP Morgan Chase (the "DIP Facility") was approved by the Bankruptcy Court on July 31, 2001. The DIP Facility is available to supplement liquidity and fund operations during the reorganization process. The Corporation believes that cash available from operations and the DIP Facility will provide sufficient liquidity to allow its businesses to operate in the normal course without interruption. The DIP Facility matures on June 25, 2004. See "Available Liquidity" below for more information on the DIP Facility. ACCOUNTING IMPACT The Corporation is required to follow AICPA Statement of Position 90-7 ("SOP 90-7"), "Financial Reporting by Entities in Reorganization under the Bankruptcy Code." Pursuant to SOP 90-7, the Corporation's pre-petition liabilities that are subject to compromise are reported separately on the consolidated balance sheet. Virtually all of the Corporation's pre-petition debt is currently in default and was recorded at face value and classified within liabilities subject to compromise. U.S. Gypsum's asbestos liability also is classified within liabilities subject to compromise. See Part I, Item 1. Note 2. "Voluntary Reorganization Under Chapter 11," which includes information related to financial statement presentation, the debtor-in-possession statements and detail of the liabilities subject to compromise and chapter 11 reorganization expenses. OUTCOME OF THE FILING The Corporation is unable to predict at this time what the treatment of creditors and equity holders of the respective Debtors will be under any proposed plan or plans of reorganization. While it is the Corporation's intent to seek a full recovery for its creditors, pre-petition creditors may receive under a plan or plans less than 100% of the face value of their claims, and the interests of the Corporation's equity security holders are likely to be substantially diluted or cancelled in whole or in part. It is not possible at this time to predict the outcome of the Chapter 11 Cases, the terms and provisions of any plan or plans of reorganization, or the effect of the Chapter 11 reorganization process on the claims of the pre-petition creditors of the Debtors, or the interests of the Corporation's equity security holders. CONSOLIDATED RESULTS NET SALES Net sales in the second quarter of 2002 were $885 million, up 10% from $806 million in the second quarter of 2001. For the first six months of 2002, net sales totaled $1,714 million, up 5% from $1,632 million in the comparable 2001 period. Increased demand for gypsum wallboard from the new housing and residential remodeling markets in 2002 resulted in higher operating rates in the gypsum -37- industry and higher selling prices for gypsum wallboard. These factors led to increased net sales for the Corporation's North American Gypsum and Building Products Distribution segments in the second quarter and first six months of 2002. However, demand for ceiling tile and grid has weakened in Europe and other foreign markets. Consequently, net sales declined for Worldwide Ceilings primarily due to lower export shipments of ceiling tile and lower shipments of internationally-produced ceiling tile and grid. COST OF PRODUCTS SOLD Cost of products sold in the second quarter and first six months of 2002 were down 2% and 3%, respectively, versus the respective 2001 periods primarily due to lower energy and raw material costs and improved operating efficiencies for the North American Gypsum segment. SELLING AND ADMINISTRATIVE EXPENSES Selling and administrative expenses increased $15 million, or 23%, for the second quarter and $29 million, or 22%, for the first six months of 2002 versus the comparable 2001 periods. A large portion of these increases related to a Bankruptcy-Court-approved key employee retention program. Expenses for this program, which began in the third quarter of 2001, amounted to $5.6 million in the second quarter and $11 million in the first six months of 2002. Higher expenses in 2002 also reflect a higher level of accruals for incentive compensation programs. As a percent of net sales, selling and administrative expenses for the quarter increased to 9.0% from 8.1% a year ago. For the first six months, expenses were 9.5% of net sales compared with 8.1% last year. CHAPTER 11 REORGANIZATION EXPENSES In connection with the Filing, the Corporation recorded pretax chapter 11 reorganization expenses of $7 million and $9 million in the second quarter and first six months of 2002, respectively. These expenses consisted of legal and financial advisory fees, partially offset by bankruptcy-related interest income. Comparable expenses of $10 million, including accelerated amortization of debt issuance costs of $2 million were recorded in the second quarter of 2001. OPERATING PROFIT (LOSS) Operating profit in the second quarter of 2002 was $80 million, up from an operating loss of $5 million in the second quarter of 2001. During the first six months of 2002, operating profit was $128 million compared with $27 million during the first six months of 2001. These increases primarily reflect higher volume, increased selling prices and lower manufacturing costs for SHEETROCK brand gypsum wallboard. INTEREST EXPENSE Interest expense of $2 million and $3 million was incurred in the second quarter and first six months of 2002, respectively. Interest expense amounted to $16 million and $30 million in the respective 2001 periods. Under SOP 90-7, virtually all of the Corporation's outstanding debt is classified as liabilities subject to compromise, and interest expense on this debt has not been accrued or -38- recorded since the Petition Date. Consequently, comparisons of interest expense for 2002 and 2001 are not meaningful. For the second quarter and first six months of 2002, contractual interest expense not accrued or recorded on pre-petition debt totaled $19 million and $37 million, respectively. INTEREST INCOME Interest income was $1 million in the second quarter and $2 million in the first six months of 2002. These amounts represent interest earned on cash held by non-debtor subsidiaries. INCOME TAXES (BENEFIT) Income tax expense amounted to $33 million in the second quarter of 2002, compared with a benefit of $5 million in the second quarter of 2001. For the first six months, income tax expense amounted to $54 million in 2002 and $2 million in 2001. The Corporation's effective tax rate was 42.3% for the first six months of 2002. Because the Corporation's earnings before income taxes for the first six months of 2001 was zero, a comparison of the effective tax rates for the first six months of 2002 and 2001 is not meaningful. CUMULATIVE EFFECT OF ACCOUNTING CHANGE FOR SFAS NO. 142 On January 1, 2002, USG Corporation adopted Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." In accordance with the provisions of SFAS No. 142, the Corporation determined that goodwill for its North American Gypsum segment was impaired and recorded a noncash, nontaxable impairment charge of $96 million. This charge, which includes a $6 million deferred currency translation write-off, is reflected on the Corporation's consolidated statement of earnings as a cumulative effect of a change in accounting principle as of January 1, 2002. See Recent Accounting Pronouncements below for more information related to the adoption of SFAS No. 142. NET EARNINGS (LOSS) Net earnings in the second quarter of 2002 were $48 million, or $1.11 per share, compared with a net loss of $13 million, or $0.29 per share, in the second quarter of 2001. For the first six months of 2002, a net loss of $22 million, or $0.52 per share, was recorded. This loss included the goodwill impairment charge of $96 million, or $2.22 per share, described above. Excluding the goodwill impairment charge, pro forma net earnings for the first six months of 2002 were $74 million, or $1.71 per share. A net loss of $2 million, or $0.04 per share, was recorded in the first half of 2001. -39- CORE BUSINESS RESULTS (dollars in millions) THREE MONTHS SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, ------------------------------------------ NET SALES: 2002 2001 2002 2001 ------------------------------------------ NORTH AMERICAN GYPSUM: U.S. Gypsum Company $ 503 $ 420 $ 986 $ 862 CGC Inc. (gypsum) 56 49 106 99 Other subsidiaries* 34 29 64 53 Eliminations (42) (40) (80) (73) - -------------------------------------------------------------------------------- Total 551 458 1,076 941 - -------------------------------------------------------------------------------- WORLDWIDE CEILINGS: USG Interiors, Inc. 117 124 228 250 USG International 44 54 86 108 CGC Inc. (ceiling) 11 10 21 21 Eliminations (14) (18) (29) (36) - -------------------------------------------------------------------------------- Total 158 170 306 343 - -------------------------------------------------------------------------------- BUILDING PRODUCTS DISTRIBUTION: L&W Supply Corporation 306 287 581 573 - -------------------------------------------------------------------------------- Eliminations (130) (109) (249) (225) - -------------------------------------------------------------------------------- Total USG Corporation 885 806 1,714 1,632 ================================================================================ OPERATING PROFIT (LOSS): NORTH AMERICAN GYPSUM: U.S. Gypsum Company 68 (32) 114 (27) CGC Inc. (gypsum) 7 5 13 11 Other subsidiaries* 6 7 12 11 - -------------------------------------------------------------------------------- Total 81 (20) 139 (5) - -------------------------------------------------------------------------------- WORLDWIDE CEILINGS: USG Interiors, Inc. 11 10 18 18 USG International (2) (2) (5) (2) CGC Inc. (ceiling) 2 1 3 2 - -------------------------------------------------------------------------------- Total 11 9 16 18 - -------------------------------------------------------------------------------- BUILDING PRODUCTS DISTRIBUTION: L&W Supply Corporation 13 22 20 37 - -------------------------------------------------------------------------------- Corporate (17) (7) (37) (15) Chapter 11 reorganization expenses (7) (10) (9) (10) Eliminations (1) 1 (1) 2 - -------------------------------------------------------------------------------- Total USG Corporation 80 (5) 128 27 ================================================================================ *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. -40- NORTH AMERICAN GYPSUM Second quarter net sales of $551 million reflect an increase of 20% from the second quarter of 2001, while operating profit rose to $81 million from an operating loss of $20 million in the second quarter of 2001. First six months net sales of $1,076 million reflect an increase of 14% from the first six months of 2001. Operating profit for the first six months of 2002 was $139, compared with an operating loss of $5 million during the first half of 2001. Second quarter net sales for U.S. Gypsum increased 20% reflecting increased shipments and higher selling prices for SHEETROCK brand gypsum wallboard. U.S. Gypsum sold 2.6 billion square feet of SHEETROCK brand gypsum wallboard during the second quarter of 2002, a second quarter record for the company and a 4% increase over 2.5 billion square feet sold in the second quarter of 2001. The average realized price per thousand square feet (selling price less freight to the customer) was $102.13 in the second quarter of 2002. This price was up 41% from the average realized price of $72.42 in the second quarter of 2001, and up 7% from $95.84 in the first quarter of 2002. Net sales for U.S. Gypsum also reflect record second quarter shipments of SHEETROCK brand joint compounds and DUROCK brand cement board. Second quarter 2002 operating profit for U.S. Gypsum increased to $68 million from an operating loss of $32 million in the second quarter of 2001. Most of this improvement was attributable to higher selling prices for gypsum wallboard. Increased shipments and lower manufacturing costs also were contributing factors. Manufacturing costs for gypsum wallboard were down primarily due to lower energy and raw material costs and improved operating efficiencies. U.S. Gypsum's wallboard plants operated at 95% of capacity in the second quarter of 2002 versus an estimated average rate of 84% for the U.S. wallboard industry. This compares with operating rates for the second quarter of 2001 of 88% for U.S. Gypsum and an estimated 80% for the industry. Industry shipments of gypsum wallboard in the second quarter of 2002 were up approximately 1% versus the same period in 2001. Improved results also were recorded for the gypsum business of Canada-based CGC Inc. Second quarter net sales of $56 million and operating profit of $7 million represented increases of 14% and 40%, respectively, compared to 2001. For the first six months, net sales of $106 million and operating profit of $13 million were up 7% and 18%, respectively. These favorable results primarily reflect a higher level of shipments of wallboard in Canada due to a strong level of housing starts in the first half of 2002 and growth in Canadian repair and remodeling. WORLDWIDE CEILINGS Second quarter 2002 net sales of $158 million declined 7% versus the second quarter of 2001, while operating profit increased to $11 million from $9 million. For the first six months, net sales of $306 million and operating profit of $16 million each were down 11% from the comparable 2001 period. -41- USG's domestic ceilings business, USG Interiors, Inc., reported a 6% drop in second quarter 2002 net sales as compared with the second quarter of 2001. This decline was largely attributable to a 26% decrease in export shipments of ceiling tile primarily due to lower demand in Europe where the market for commercial ceiling products has weakened. Domestic shipments of ceiling tile increased slightly (up 1%). Shipments of ceiling grid, which are primarily to U.S. customers, were down 1%. Operating profit for USG Interiors increased to $11 million from $10 million a year ago primarily due to lower costs. Cost reductions resulted from lower energy and raw material cost and from the closure of a high-cost ceiling tile production line in the fourth quarter of 2001. Sales for USG International were down primarily due to lower demand for ceiling tile and grid in Europe. An operating loss for USG International of $2 million was experienced in the second quarter of 2002, unchanged from a year ago. Net sales and operating profit for the ceilings division of CGC Inc. each increased by $1 million compared with the second quarter of 2001. BUILDING PRODUCTS DISTRIBUTION L&W Supply Corporation, the leading specialty building products distribution business in the United States, reported second quarter 2002 net sales of $306 million, a 7% increase over the comparable 2001 period. However, operating profit of $13 million for the quarter declined 41%. The higher level of net sales was attributable to increases in L&W Supply's wallboard shipments (up 2%) and selling prices (up 12%). The decline in operating profit resulted from a 26% increase in wallboard unit costs, which primarily reflects manufacturers' selling prices. For the first six months of 2002, net sales of $581 million rose 1%, while operating profit of $20 million fell 46% compared with the first six months of 2001. These results primarily reflect increased wallboard shipments (up 2%), higher selling prices (up 4%) and higher unit costs (up 12%). L&W Supply currently operates 179 locations in the United States distributing a variety of gypsum, ceilings and related building materials. MARKET CONDITIONS AND OUTLOOK During 2001, excess industry capacity led to significant declines in market prices for gypsum wallboard. However, market conditions for gypsum wallboard improved somewhat during the second half of 2001 due to growth in demand, the closure of some excess industry capacity and reduced operations by the Corporation and other gypsum wallboard manufacturers. The new housing market has remained strong through the first six months of 2002. Growth in new housing and a strong level of residential remodeling resulted in first and second quarter records for gypsum wallboard shipments. The favorable levels of activity in these markets, which together account for nearly two-thirds -42- of all demand for gypsum wallboard, and increased operating rates in the gypsum industry allowed selling prices to rise. Continued strength in these markets is uncertain and will depend on favorable demand factors such as levels of consumer confidence, interest rates and home affordability. Commercial construction has been affected by reduced corporate earnings, resulting in lower investments in office and other commercial space. Commercial construction is expected to continue to decline in 2002. During the second half of 2002, the Corporation will remain focused on managing the fundamentals of its businesses such as customer satisfaction, costs and profitability and 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 WORKING CAPITAL Working capital (current assets less current liabilities) as of June 30, 2002, amounted to $990 million, and the ratio of current assets to current liabilities was 3.49-to-1. As of December 31, 2001, working capital amounted to $876 million, and the ratio of current assets to current liabilities was 3.73-to-1. Cash and cash equivalents as of June 30, 2002, amounted to $615 million, compared with $493 million as of December 31, 2001. During the first six months of 2002, net cash flows from operating activities totaled $159 million. Net cash flows to investing activities totaled $37 million and consisted of capital spending of $38 million, offset slightly by proceeds of $1 million from asset sales. Because of the Filing, there were no financing activities during the first half of 2002. Receivables increased to $330 million as of June 30, 2002, from $274 million as of December 31, 2001, primarily reflecting a 17% increase in net sales for the month of June 2002 as compared with December 2001. Inventories and payables also were up from December 31, 2001, primarily due to the increased level of business. Inventories increased to $281 million from $254 million, and accounts payable increased to $183 million from $140 million. DEBT As of June 30, 2002, total debt amounted to $1,007 million, of which $1,005 million was included in liabilities subject to compromise. These amounts were unchanged from the December 31, 2001, levels. AVAILABLE LIQUIDITY A $350 million DIP Facility is available to supplement liquidity and fund operations during the reorganization process. Borrowing availability under the DIP Facility is based primarily on accounts receivable and inventory levels and, to a lesser extent, property, plant and equipment. As of June 30, 2002, the -43- Corporation had the capacity to borrow up to $344 million. There were no outstanding borrowings under the DIP Facility as of June 30, 2002. However, $14 million of standby letters of credit were issued, leaving $330 million of unused borrowing capacity available as of June 30, 2002. The Corporation believes that cash available from operations and the DIP Facility will provide sufficient liquidity to allow its businesses to operate in the normal course without interruption. As of June 30, 2002, the Corporation had $615 million of cash and cash equivalents on a consolidated basis. Of this amount, $156 million was in the possession of non-Debtor subsidiaries. CAPITAL EXPENDITURES Capital spending amounted to $38 million in the first six months of 2002 compared with $57 million in the corresponding 2001 period. In response to demand for joint compounds and cement board, new production facilities are under construction. A plant to produce SHEETROCK brand joint compounds is under construction in Glendale, Arizona, and a production line to manufacture DUROCK brand cement board is being built at U.S. Gypsum's Baltimore, Maryland, plant. As of June 30, 2002, remaining capital expenditure commitments for the replacement, modernization and expansion of operations amounted to $67 million, compared with $63 million as of December 31, 2001. During the bankruptcy proceeding, the Corporation expects to have limited ability to access capital other than its own cash flows to fund potential future growth opportunities such as new products, acquisitions and joint ventures. In addition, one of the terms of the DIP Facility limits capital spending. RESTRUCTURING ACTIVITIES 2001 Restructuring Plan: In the fourth quarter of 2001, the Corporation recorded a pretax charge of $12 million related to a restructuring plan that included the shutdown of a gypsum wallboard plant in Fremont, Calif., a drywall steel plant in Prestice, Czech Republic, a ceiling tile plant in San Juan Ixhuatepec, Mexico, a ceiling tile manufacturing line in Greenville, Miss., and other restructuring activities. The restructuring plan, which is expected to be completed in 2002, is intended to allow the Corporation to optimize its manufacturing operations. Included in the $12 million charge was $8 million for severance related to a workforce reduction of more than 350 positions (primarily hourly positions), $2 million for the write-off of property, plant and equipment, and $2 million for line shutdown and removal and contract cancellations. The reserve for this plan is included in accrued expenses on the consolidated balance sheets. Fourth quarter 2001 charges against the reserve included the $2 million write-off of property, plant and equipment and payments totaling $2 million. An additional $2 million of payments were charged against the reserve in the first six months of 2002. All payments for the 2001 restructuring plan are being funded with cash from normal operations. -44- As of June 30, 2002, the ceiling tile manufacturing line at Greenville, Miss., and the plants in San Juan Ixhuatepec, Mexico, and Prestice, Czech Republic, have been shutdown and 258 employees have been terminated, and 26 open positions have been eliminated. The Fremont, Calif., plant ceased production in April 2002. Annual savings from the full implementation of the 2001 restructuring initiatives are estimated at $11 million. 2000 Restructuring Plan: In the fourth quarter of 2000, the Corporation recorded a pretax charge of $50 million related to a restructuring plan that included a salaried workforce reduction and the shutdown of three gypsum wallboard manufacturing lines and other operations. This restructuring was designed to streamline operations and improve business efficiency. Included in the $50 million charge was $16 million for severance related to the salaried workforce reduction of more than 500 positions, $15 million for the write-off of property, plant and equipment, $12 million for razing buildings and equipment, $5 million for line shutdown and removal, and $2 million for contract cancellations and severance for more than 100 hourly positions. An additional restructuring-related charge of $4 million was included in cost of products sold for the writedown of certain inventory. During the third quarter of 2001, the Corporation reversed $9 million pretax of the restructuring reserve recorded in the fourth quarter of 2000 due to changes from previous estimates and to reflect a change in the scope of restructuring activities undertaken. The primary change involved a decision made in September to eliminate a portion of the closure activities originally planned at the Alabaster, Mich., facility. The reserve for the 2000 restructuring was included in liabilities subject to compromise on the consolidated balance sheets and payments totaling $22 million were charged against this reserve through December 31, 2001. The remaining $4 million was charged against this reserve in the first six months of 2002. All payments for this plan were funded with cash from normal operations. The salaried workforce reduction program was completed as of June 30, 2001, with the termination of 394 salaried employees and the elimination of 179 open salaried positions. In addition, 73 hourly employees were terminated, and 44 open hourly positions were eliminated. Closure of the three gypsum wallboard manufacturing lines and other operations was completed by December 31, 2001. Annual savings from the 2000 restructuring initiatives are estimated at $40 million. See Part I, Item 1. Note 8. "Restructuring" for additional information related to restructuring payments and reserve balances. -45- OTHER MATTERS LEGAL CONTINGENCIES As a result of the Filing, all pending asbestos lawsuits against U.S. Gypsum are stayed, and no party may take any action to pursue or collect on such asbestos claims absent specific authorization of the Bankruptcy Court. Since the Filing, U.S. Gypsum has ceased making both cash payments and accruals with respect to asbestos lawsuits, including cash payments and accruals pursuant to settlements of asbestos lawsuits. U.S. Gypsum continues to receive payments from its insurance carriers pursuant to previous settlements. Creditors' committees have been appointed representing asbestos personal injury and property damage claimants with pending claims against U.S. Gypsum, and the Bankruptcy Court has appointed the Hon. Dean M. Trafelet as the legal representative for the interests of potential future asbestos claimants. As part of the bankruptcy proceeding, it will be determined which present and future asbestos claims should be allowed, or compensated, and the aggregate value of such claims. The Corporation is unable to predict the value that the court will assign to such claims. The Corporation and certain of its subsidiaries have been notified by state and federal environmental protection agencies of possible involvement as one of numerous "potentially responsible parties" in a number of so-called "Superfund" sites in the United States. The Corporation believes that neither these matters nor any other known governmental proceeding regarding environmental matters will have a material adverse effect upon its results of operations or financial position. See Part I, Item 1. Note 11. "Litigation" for additional information on asbestos and environmental litigation. RECENT ACCOUNTING PRONOUNCEMENTS The Corporation adopted three new accounting standards in the first quarter of 2002. On January 1, 2002, the Corporation adopted SFAS No. 142, "Goodwill and Other Intangible Assets." Although SFAS No. 142 eliminates the amortization of goodwill and certain other intangible assets, it initiates an annual assessment of goodwill for impairment. During the second quarter of 2002, the Corporation completed its transition date assessment of goodwill. The assessment was performed for each reporting unit (as defined by SFAS No. 142) that has goodwill. For the Corporation, the reporting units with goodwill were the North American Gypsum and the Building Products Distribution operating segments. The Corporation determined that goodwill for its Building Products Distribution segment was not impaired, but will be reviewed at least annually for impairment. However, goodwill for its North American Gypsum segment was impaired. This impairment was attributable to U.S. Gypsum's asbestos liability and related filing for bankruptcy protection on June 25, 2001. As a result, the Corporation recorded a noncash, nontaxable impairment charge of $96 million. This charge, which includes a $6 million deferred currency translation write-off, is reflected on the Corporation's consolidated statement of earnings as a cumulative effect of a change in accounting principle as of January 1, 2002. In accordance with SFAS No. 142, the Corporation is reflecting -46- this charge in its financial statements for the three months ended March 31, 2002. SFAS No. 141, "Business Combinations," requires all business combinations initiated after June 30, 2001, to be accounted for using the purchase method. This standard, which became effective for the Corporation on January 1, 2002, had no impact on its financial statements upon adoption. SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," supersedes SFAS No. 121 and a portion of APB Opinion No. 30. This statement establishes a single accounting model for the disposal of long-lived assets and resolves significant implementation issues related to SFAS No. 121. This standard, which became effective for the Corporation on January 1, 2002, had no impact on the Corporation's financial statements upon adoption. The Corporation will adopt SFAS No. 143, "Accounting for Asset Retirement Obligations," in January 2003. This standard requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. This standard becomes effective January 1, 2003, and is likely to have an impact on the Corporation's financial statements. However, as of the date of this report, the Corporation has not determined what impact the adoption of this standard may have on its financial statements. FORWARD-LOOKING STATEMENTS This report contains forward-looking statements related to management's expectations about future conditions. The effects of the Filing and the conduct, outcome and costs of the Chapter 11 Cases, as well as the ultimate costs associated with the Corporation's asbestos litigation, may differ from management's expectations. Actual business or other conditions may also differ significantly from management's expectations and accordingly affect the Corporation's sales and profitability or other results. Actual results may differ due to various other factors, including economic conditions such as the levels of construction activity, interest rates and consumer confidence; competitive conditions such as price and product competition; increases in raw material and energy costs; and the unpredictable effects of the global war on terrorism upon domestic and international economies and financial markets. The Corporation assumes no obligation to update any forward-looking information contained in this report. -47- REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors of USG Corporation: We have reviewed the accompanying consolidated balance sheet of USG Corporation and subsidiaries as of June 30, 2002, and the related consolidated statements of earnings for the three and six month periods ended June 30, 2002 and the consolidated statement of cash flows for the six-month period ended June 30, 2002. 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 of making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to such consolidated financial statements for them to be in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements have been prepared assuming that the Corporation will continue as a going concern. As discussed in Notes 2 and 11 to the consolidated financial statements, certain conditions raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Notes 2 and 11 to the financial statements. /s/ DELOITTE & TOUCHE LLP - ------------------------- DELOITTE & TOUCHE LLP Chicago, Illinois July 26, 2002 -48- INFORMATION REGARDING PREDECESSOR INDEPENDENT PUBLIC ACCOUNTANTS' REVIEW REPORTS This is a copy of a review report previously issued by Arthur Andersen LLP ("Andersen"). The report has not been reissued by Andersen nor has Andersen provided an awareness letter for the inclusion of its report in this Current Report on Form 10-Q. 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 March 31, 2002, and the related condensed consolidated statements of earnings for the three-month periods ended March 31, 2002 and 2001 and the condensed consolidated statements of cash flows for the three-month periods ended March 31, 2002 and 2001. 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. The accompanying condensed consolidated financial statements have been prepared assuming that the Corporation will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Corporation voluntarily filed for Chapter 11 bankruptcy protection on June 25, 2001. Management's plans in regard to these matters are also described in Note 2. This action, which was taken primarily as a result of asbestos litigation as discussed in Note 11 to the condensed consolidated financial statements, raises 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. /s/ ARTHUR ANDERSEN LLP ----------------------- ARTHUR ANDERSEN LLP Chicago, Illinois April 24, 2002 -49- INFORMATION REGARDING PREDECESSOR INDEPENDENT PUBLIC ACCOUNTANTS' REVIEW REPORTS This is a copy of a review report previously issued by Andersen. The report has not been reissued by Andersen nor has Andersen provided an awareness letter for the inclusion of its report in this Current Report on Form 10-Q. 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 June 30, 2001, and the related condensed consolidated statements of earnings for the three-month and six-month periods ended June 30, 2001 and 2000 and the condensed consolidated statements of cash flows for the six-month periods ended June 30, 2001 and 2000. 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. The accompanying condensed consolidated financial statements have been prepared assuming that the Corporation will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Corporation voluntarily filed for Chapter 11 bankruptcy protection on June 25, 2001. Management's plans in regard to these matters are also described in Note 2. This action, which was taken primarily as a result of asbestos litigation as discussed in Note 9 to the condensed consolidated financial statements, raises 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. /s/ ARTHUR ANDERSEN LLP ----------------------- ARTHUR ANDERSEN LLP Chicago, Illinois July 24, 2001 -50- PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS See Part I, Item 1. Note 11. "Litigation" for information concerning the asbestos and related bankruptcy litigation and environmental litigation. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (a) In accordance with the Corporation's notice and proxy statement dated March 29, 2002, the matter set forth in paragraph (b) below was submitted to a vote of stockholders at the annual meeting of stockholders held on May 8, 2002. (b) The four director-nominees who received the highest vote totals, who were each re-elected to a three-year term of office, and whose terms in office will expire in 2005 were: Robert L. Barnett, David W. Fox, Valerie B. Jarrett and Marvin E. Lesser. The directors whose terms of office continued after the annual meeting of stockholders were: Keith A. Brown, James C. Cotting, Lawrence M. Crutcher, William C. Foote, W. Douglas Ford, John B. Schwemm and Judith A. Sprieser. Votes Abstentions Votes Withheld and Broker For or Against Non-Votes ------------------------------------------ Election of Directors: Robert L. Barnett 38,667,146 307,464 - David W. Fox 38,651,851 322,759 - Valerie B. Jarrett 38,661,997 312,613 - Marvin E. Lesser 38,647,050 327,560 - -51- ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 15. Letter from Deloitte & Touche LLP regarding unaudited financial information. (b) Reports on Form 8-K: A Form 8-K was filed on May 13, 2002, to report under Item 4 "Changes in Registrant's Certifying Accountant" that the Corporation dismissed Arthur Andersen LLP as its independent public accountants and engaged Deloitte & Touche LLP to serve as the Corporation's independent public accountants for the year ending December 31, 2002. A Form 8-K/A was filed on May 17, 2002, as an amendment of the Form 8-K that was filed on May 13, 2002. A Form 8-K was filed on July 18, 2002, to report under Item 5 "Other Events" that the Corporation, in accordance with SFAS No. 142 "Goodwill and Other Intangible Assets," recorded a goodwill impairment charge of $96 million that was reported as a cumulative effect of a change in accounting principle as of January 1, 2002. -52- 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, President and Chief Executive Officer By /s/ Richard H. Fleming --------------------------------- Richard H. Fleming Executive Vice President and Chief Financial Officer, By /s/ Raymond T. Belz --------------------------------- Raymond T. Belz, Senior Vice President and Controller, August 13, 2002 -53- EX-15 3 c71075exv15.txt LETTER REGARDING UNAUDITED INTERIM FINANCIAL INFO. Exhibit (15) August 13, 2002 USG Corporation 125 South Franklin Street Chicago, Illinois 60606 We have made a review, in accordance with standards established by the American Institute of Certified Public Accountants, of the unaudited interim financial information of USG Corporation and subsidiaries for the period ended June 30, 2002, as indicated in our report dated July 26, 2002; because we did not perform an audit, we expressed no opinion on that information. We are aware that our report referred to above, which is included in your Quarterly Report on Form 10-Q for the quarter ended June 30, 2002, is incorporated by reference in Registration Statement Nos. 33-40136, 33-64217, and 33-60563 on Form S-3 and Registration Statement Nos. 33-22581 (as amended), 33-22930, 33-36303, 33-52573, 33-52715, 33-63554, and 33-65383 on Form S-8. We also are aware that the aforementioned report, pursuant to Rule 436(c) under the Securities Act of 1933, is not considered a part of the Registration Statements prepared or certified by an accountant or a report prepared or certified by an accountant within the meaning of Sections 7 and 11 of that Act. /s/ DELOITTE & TOUCHE LLP - ------------------------- DELOITTE & TOUCHE LLP Chicago, Illinois -54- -----END PRIVACY-ENHANCED MESSAGE-----