10-Q 1 c85040e10vq.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 March 31, 2004 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ---------- ---------- Commission File Number 1-8864 USG CORPORATION ------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 36-3329400 ------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 125 South Franklin Street, Chicago, Illinois 60606-4678 ------------------------------------------------------------------------------- (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code (312) 606-4000 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes (X) No ( ) Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes (X) No ( ) Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes (X) No ( ) As of March 31, 2004, 43,017,397 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 Ended March 31, 2004 and 2003 3 Consolidated Balance Sheets: As of March 31, 2004 and December 31, 2003 4 Consolidated Statements of Cash Flows: Three Months Ended March 31, 2004 and 2003 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 37 Item 4. Controls and Procedures 48 Report of Independent Public Accountants 49 PART II OTHER INFORMATION Item 1. Legal Proceedings 51 Item 6. Exhibits and Reports on Form 8-K 51 SIGNATURES 52
-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 ENDED MARCH 31, ------------------------------- 2004 2003 ------------ ------------- Net sales $ 1,020 $ 862 Cost of products sold 849 745 Selling and administrative expenses 77 80 Chapter 11 reorganization expenses 2 2 ------------ ------------ Operating profit 92 35 Interest expense 1 1 Interest income (1) (1) Other expense, net 2 - ------------ ------------ Earnings before income taxes and cumulative effect of accounting change 90 35 Income taxes 33 13 ------------ ------------ Earnings before cumulative effect of accounting change 57 22 Cumulative effect of accounting change, net of tax - (16) ------------ ------------ Net earnings 57 6 ============ ============ EARNINGS PER COMMON SHARE: Basic and diluted before cumulative effect of accounting change 1.33 0.50 Cumulative effect of accounting change - (0.37) ------------ ------------ Basic and diluted 1.33 0.13 ============ ============ Dividends paid per common share - - Average common shares 43,022,719 43,137,883 Average diluted common shares 43,023,995 43,137,883
See accompanying Notes to Consolidated Financial Statements. -3- USG CORPORATION CONSOLIDATED BALANCE SHEETS (DOLLARS IN MILLIONS) (UNAUDITED)
AS OF AS OF MARCH 31, DECEMBER 31, 2004 2003 --------- ------------ ASSETS Current Assets: Cash and cash equivalents $ 629 $ 700 Short-term marketable securities 41 64 Restricted cash 19 7 Receivables (net of reserves - $16 and $15) 451 321 Inventories 304 280 Income taxes receivable 25 26 Deferred income taxes 42 43 Other current assets 61 57 --------- -------- Total current assets 1,572 1,498 Long-term marketable securities 236 176 Property, plant and equipment (net of accumulated depreciation and depletion - $839 and $816) 1,804 1,818 Deferred income taxes 162 178 Goodwill 41 39 Other assets 83 90 --------- -------- Total Assets 3,898 3,799 ========= ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable 256 202 Accrued expenses 179 206 Current portion of long-term debt 1 1 Income taxes payable 13 5 --------- -------- Total current liabilities 449 414 Long-term debt 1 1 Deferred income taxes 23 23 Other liabilities 431 429 Liabilities subject to compromise 2,242 2,243 Commitments and contingencies Stockholders' Equity: Preferred stock - - Common stock 5 5 Treasury stock (258) (258) Capital received in excess of par value 414 414 Accumulated other comprehensive income (loss) 5 (1) Retained earnings 586 529 --------- -------- Total stockholders' equity 752 689 --------- -------- Total Liabilities and Stockholders' Equity 3,898 3,799 ========= ========
See accompanying Notes to Consolidated Financial Statements. -4- USG CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN MILLIONS) (UNAUDITED)
THREE MONTHS ENDED MARCH 31, ----------------------- 2004 2003 --------- ------- OPERATING ACTIVITIES: Net earnings $ 57 $ 6 Adjustments to reconcile net earnings to net cash: Cumulative effect of accounting change - 16 Depreciation, depletion and amortization 28 25 Deferred income taxes 12 12 (Increase) decrease in working capital: Receivables (130) (71) Income taxes receivable 1 - Inventories (24) (16) Payables 62 27 Accrued expenses (26) (53) (Increase) decrease in other assets 6 (3) Increase (decrease) in other liabilities 2 (3) Change in asbestos receivable 10 15 Decrease in liabilities subject to compromise (1) (1) Other, net (1) 1 --------- ------- Net cash used for operating activities (4) (45) --------- ------- INVESTING ACTIVITIES: Capital expenditures (20) (17) Purchases of marketable securities (115) (32) Sales or maturities of marketable securities 78 37 Net proceeds from asset dispositions 6 - Acquisition of business (4) - --------- ------- Net cash used for investing activities (55) (12) --------- ------- FINANCING ACTIVITIES: Deposit of restricted cash (12) - --------- ------- Net cash used for financing activities (12) - --------- ------- Net decrease in cash and cash equivalents (71) (57) Cash and cash equivalents at beginning of period 700 649 --------- ------- Cash and cash equivalents at end of period 629 592 ========= ======= SUPPLEMENTAL CASH FLOW DISCLOSURES: Interest paid - - Income taxes paid, net 8 4
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 ("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 2003 Annual Report on Form 10-K which was filed on February 24, 2004. (2) VOLUNTARY REORGANIZATION UNDER CHAPTER 11 On June 25, 2001 (the "Petition Date"), the Corporation and the 10 United States subsidiaries listed below (collectively, the "Debtors") filed voluntary petitions for reorganization (the "Filing") under chapter 11 of the United States Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"). This action was taken to resolve asbestos claims in a fair and equitable manner, to protect the long-term value of the Debtors' businesses, and to maintain the Debtors' leadership positions in their markets. The chapter 11 cases of the Debtors (collectively, the "Chapter 11 Cases") are being jointly administered as In re: USG Corporation et al. (Case No. 01-2094). The Chapter 11 Cases do not include any of the Corporation's non-U.S. subsidiaries. The following subsidiaries filed chapter 11 petitions: United States Gypsum Company ("U.S. Gypsum"); USG Interiors, Inc. ("USG Interiors"); USG Interiors International, Inc.; L&W Supply Corporation ("L&W Supply"); Beadex Manufacturing, LLC; B-R Pipeline Company; La Mirada Products Co., Inc.; Stocking Specialists, Inc.; USG Industries, Inc.; and USG Pipeline Company. The background of asbestos litigation, developments in the Corporation's reorganization proceeding and estimated cost are discussed in Note 13. Litigation. -6- CONSEQUENCES OF THE FILING As a consequence of the Filing, all asbestos lawsuits and other lawsuits pending against the Debtors as of the Petition Date are stayed, and no party may take any action to pursue or collect pre-petition claims except pursuant to an order of the Bankruptcy Court. Since the Filing, the Debtors have ceased making both cash payments and accruals with respect to asbestos lawsuits, including cash payments and accruals pursuant to settlements of asbestos lawsuits. The Debtors are operating their businesses without interruption as debtors-in-possession subject to the provisions of the Bankruptcy Code, and vendors are being paid for goods furnished and services provided after the Filing. The Debtors intend to address their liability for all present and future asbestos claims, as well as all other pre-petition claims, in a plan or plans of reorganization approved by the Bankruptcy Court. The Debtors currently have the exclusive right to propose a plan of reorganization and have filed a motion with the Bankruptcy Court requesting that the exclusive period be extended to September 1, 2004. The committee representing asbestos personal injury claimants and the legal representative for future asbestos claimants oppose this extension of exclusivity. The Court is expected to rule on the motion on May 24, 2004. By operation of bankruptcy law, the Debtors continue to have the exclusive right to propose a plan at least until such time as the Court rules on the Debtors' motion. The Debtors may seek one or more additional exclusivity extensions depending upon developments in the Chapter 11 Cases. The Debtors' Chapter 11 Cases, along with four other asbestos-related bankruptcy proceedings pending in the federal courts in the District of Delaware, have been assigned to Judge Alfred M. Wolin of the United States District Court for the District of New Jersey. Judge Wolin has indicated that he will handle all issues relating to asbestos personal injury claims. Other bankruptcy issues in the Chapter 11 Cases, including issues relating to asbestos property damage claims, will be addressed by Judge Judith K. Fitzgerald, a bankruptcy court judge sitting in the United States Bankruptcy Court for the District of Delaware. Three creditors' committees, one representing asbestos personal injury claimants, another representing asbestos property damage claimants, and a third representing unsecured creditors, were appointed as official committees in the Chapter 11 Cases. The Bankruptcy Court also appointed Mr. 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 appointed committees, together with Mr. Trafelet, will play significant roles in the Chapter 11 Cases and resolution of the terms of any plan of reorganization. The Debtors and the committee representing unsecured creditors filed motions in November 2003 to remove Judge Wolin from the Chapter 11 Cases. The committee representing asbestos personal injury claimants and the -7- legal representative for future asbestos claimants opposed these motions. On February 2, 2004, Judge Wolin denied the motions, and the Debtors and the unsecured creditors committee have appealed Judge Wolin's decision to the Third Circuit Court of Appeals. Additional information regarding these proceedings is discussed in Note 13. Litigation, under Developments in the Reorganization Proceeding. The plan of reorganization ultimately approved by the Bankruptcy Court in the Chapter 11 Cases may include one or more independently administered trusts under Section 524(g) of the Bankruptcy Code, which may be funded by the Debtors to allow payment of present and future asbestos personal injury claims and demands. Under the Bankruptcy Code, a plan of reorganization creating a Section 524(g) trust may be confirmed only if 75% of the asbestos claimants who vote on the plan approve the plan. A plan of reorganization, including a plan creating a Section 524(g) trust, may be confirmed without the consent of non-asbestos creditors and equity security holders if certain requirements of the Bankruptcy Code are met. The Debtors also expect that the plan of reorganization will address the Debtors' liability for asbestos property damage claims, whether by including those liabilities in a Section 524(g) trust or by other means. If the confirmed plan of reorganization includes the creation and funding of a Section 524(g) trust, the Bankruptcy Court will issue a permanent injunction barring the assertion of present and future asbestos claims against the Debtors, their successors, and their affiliates, and channeling those claims to the trust for payment in whole or in part. Similar plans of reorganization containing Section 524(g) trusts have been confirmed in the chapter 11 cases of other companies with asbestos liabilities, but there is no guarantee that the Bankruptcy Court in the Debtors' Chapter 11 Cases will approve creation of a Section 524(g) trust or issue a permanent injunction channeling to the trust all asbestos claims against the Debtors and/or their successors and affiliates. In addition, if federal legislation addressing asbestos personal injury claims is passed, which is extremely speculative at this time, such legislation may affect the amount that will be required to resolve the Debtors' asbestos personal injury liability in the Chapter 11 Cases and may affect whether the Debtors establish a trust under Section 524(g). See Potential Federal Legislation Regarding Asbestos Personal Injury Claims, below. A key factor in determining the recovery of pre-petition creditors and stockholders under any plan of reorganization is the amount that must be provided in the plan to resolve the Debtors' liability for present and future asbestos claims. Counsel for the Official Committee of Asbestos Personal Injury Claimants and counsel for the legal representative for future asbestos personal injury claimants have advised the Court that is presiding over the Chapter 11 Cases that they believe the Debtors' liabilities for present and future asbestos claims exceed the value of the -8- Debtors' assets and that the Debtors are insolvent. The Debtors have advised the Court that they believe they are solvent if their asbestos liabilities are fairly and appropriately valued. The Debtors' asbestos liabilities to be funded under a plan of reorganization have not yet been determined and are subject to substantial uncertainty. While it is the Debtors' intention to seek a full recovery for their creditors, it is not possible to predict the amount that will have to be provided in the plan of reorganization to resolve present and future asbestos claims, how the plan of reorganization will treat other pre-petition claims, whether there will be sufficient assets to satisfy the Debtors' pre-petition liabilities, and what impact any plan may have on the value of the shares of the Corporation's common stock and other outstanding securities. The payment rights and other entitlements of pre-petition creditors and the Corporation's shareholders may be substantially altered by any plan of reorganization confirmed in the Chapter 11 Cases. Pre-petition creditors may receive under the plan of reorganization less than 100% of the face value of their claims, the pre-petition creditors of some Debtors may be treated differently from the pre-petition creditors of other Debtors, and the interests of the Corporation's stockholders are likely to be substantially diluted or cancelled in whole or in part. There can be no assurance as to the value of any distributions that might be made under any plan of reorganization with respect to such pre-petition claims, equity interests, or other outstanding securities. It is also not possible to predict how the plan of reorganization will treat intercompany indebtedness, licenses, transfers of goods and services, and other intercompany arrangements, transactions and relationships that were entered into before the Petition Date. These arrangements, transactions and relationships may be challenged by various parties in the Chapter 11 Cases, and the outcome of those challenges, if any, may have an impact on the treatment of various claims under any plan of reorganization. In connection with the Filing, the Corporation implemented a Bankruptcy Court-approved key employee retention plan that commenced on July 1, 2001, and continues until the date the Corporation emerges from bankruptcy, or June 30, 2004, whichever occurs first. Under the plan, participants receive semi-annual payments that began in January 2002. Expenses associated with this plan amounted to $2.7 million and $5.6 million in the first quarter of 2004 and 2003, respectively. The Corporation expects to propose a form of extension to the key employee retention plan beyond the current expiration date of June 30, 2004. Any such extension is subject to Bankruptcy Court approval. POTENTIAL FEDERAL LEGISLATION REGARDING ASBESTOS PERSONAL INJURY CLAIMS The Corporation has for many years actively supported proposals for federal legislation addressing asbestos personal injury claims. On April 7, 2004, the Fairness in Asbestos Injury Resolution Act of 2004 (Senate -9- Bill 2290, the "FAIR Bill") was introduced in the United States Senate. The FAIR Bill has not been approved by the Senate, has not been introduced in the House of Representatives, and is not law. The FAIR Bill introduced in the Senate is intended to establish a nationally administered trust to compensate asbestos personal injury claimants. In the FAIR Bill's current form, companies that have made past payments for asbestos personal injury claims would be required to contribute amounts to a national trust on a periodic basis to fund claims filed by asbestos personal injury claimants who qualify for payment under the FAIR Bill. The nationally administered trust would be the exclusive remedy for asbestos personal injury claims, and such claims could not be brought in state or federal court during the life of the trust. In the FAIR Bill's current form, the amounts to be paid to the national fund are based on an allocation methodology set forth in the FAIR Bill. The amounts that participants, including the Debtors, would be required to pay are not dischargeable in a bankruptcy proceeding. The FAIR Bill also provides, among other things, that the national fund would terminate if it is determined that the money in the fund is not sufficient to compensate eligible claimants. In such a case, under the terms of the current FAIR Bill, the claimants and defendants would return to the federal court system to resolve claims not paid by the national fund. The text of the FAIR Bill as introduced in the Senate may be found at http://thomas.loc.gov (type in bill number "S.2290"). Enactment of the FAIR Bill or similar legislation addressing the financial contributions of the Debtors for asbestos personal injury claims would have a material impact on the amount of the Debtors' asbestos personal injury liability and Debtors' Chapter 11 Cases. The outcome of the legislative process, however, is inherently speculative, and it cannot be known whether the FAIR Bill or similar legislation will ever be enacted or, even if enacted, what the terms of the final legislation might be. Many labor organizations, including the AFL-CIO, as well as some Senators, have indicated that they oppose the FAIR Bill as introduced because, among other things, it does not provide sufficient compensation to asbestos claimants. On April 22, 2004, the Senate defeated a motion to proceed with floor consideration of the FAIR Bill. Discussions continue regarding possible revisions to the FAIR Bill that would allow it to move forward, but it is unclear whether these discussions will produce agreements on key issues. It is likely that even if the FAIR Bill is enacted, the terms of the enacted legislation will be different from the current FAIR Bill, and those differences may be material to the FAIR Bill's impact on the Corporation. During the legislative process, the Corporation expects that the Chapter 11 Cases, including the proceedings regarding estimation of the Corporation's asbestos personal injury liabilities, will continue, subject to developments in those cases. See Consequences of the Filing, above, and -10- Note 13. Litigation. PRE-PETITION LIABILITIES OTHER THAN ASBESTOS PERSONAL INJURY CLAIMS Subsequent to the Filing, the Debtors received approval from the Bankruptcy Court to pay or otherwise honor certain of their pre-petition obligations, including employee wages, salaries, benefits and other employee obligations, and from limited available funds, pre-petition claims of certain critical vendors, real estate taxes, environmental obligations, certain customer programs and warranty claims, and certain other pre-petition claims. Pursuant to the Bankruptcy Code, schedules were filed by the Debtors with the Bankruptcy Court on October 23, 2001, and certain of the schedules were amended on May 31, 2002, and December 13, 2002, setting forth the assets and liabilities of the Debtors as of the date of the Filing. The Bankruptcy Court established a bar date of January 15, 2003, by which proofs of claim were required to be filed against the Debtors for all claims other than asbestos-related personal injury claims as defined in the Bankruptcy Court's order. Approximately 5,000 proofs of claim for general unsecured creditors (including pre-petition debtholders and contingent claims), totaling approximately $8.7 billion were filed by the bar date. Of this amount, $5.7 billion worth of claims have been withdrawn from the case by creditors. The Debtors have been analyzing the remaining proofs of claim and determined that many of them are duplicates of other proofs of claim or of liabilities previously scheduled by the Debtors. In addition, many claims were filed against multiple Debtors or against an incorrect Debtor, or were incorrectly claiming a priority level higher than general unsecured or an incorrect dollar amount. To date, the court has expunged 260 claims totaling $29.5 million as duplicates; expunged 398 claims totaling $194.7 million as amended or superceded; allowed the reduction of 210 claims by a total of $2.6 million; and allowed the correction of the Debtors on 1,002 claims and the reclassification of 186 claims to general unsecured claims. The Debtors continue to analyze and reconcile filed claims on an ongoing basis. The deadline to bring avoidance actions in the Chapter 11 Cases was June 25, 2003. Avoidance actions could include claims to avoid alleged preferences made during the 90-day period prior to the filing (or one-year period for insiders) and other transfers made or obligations incurred which could be alleged to be constructive or actual fraudulent conveyances under applicable law. Effective prior to the avoidance action deadline, the Bankruptcy Court granted the motion of the committee representing the unsecured creditors to file a complaint seeking to avoid and recover as preferences certain pre-petition payments made by the Debtors to 206 creditors, where such payments, in most cases, exceeded $500,000. The Bankruptcy Court also granted the committee's request to extend the time by which the summons and complaint are served upon each named defendant -11- until 90 days after confirmation of a plan of reorganization filed in connection with the Chapter 11 Cases. In addition, prior to the deadline for filing avoidance actions, certain of the Debtors entered into a Tolling Agreement pursuant to which the Debtors voluntarily agreed to extend the time during which actions could be brought to avoid certain intercompany transactions that occurred during the one-year period prior to the filing of the Chapter 11 Cases. The transactions as to which the Tolling Agreement applies are the creation of liens on certain assets of Debtor subsidiaries in favor of the Corporation in connection with intercompany loan agreements; a transfer by U.S. Gypsum to the Corporation of a 9% interest in the equity of CGC Inc., the principal Canadian subsidiary of the Corporation; and transfers made by the Corporation to USG Foreign Investments, Ltd., a non-Debtor subsidiary. The Bankruptcy Court approved the Tolling Agreement in June 2003. The Debtors expect to address claims for general unsecured creditors through liquidation, estimation or disallowance of the claims. In connection with this process, the Debtors will make adjustments to their schedules and financial statements as appropriate. Any such adjustments could be material to the Corporation's consolidated financial position, cash flows and results of operations in any given period. At this time, it is not possible to estimate the Debtors' liability for these claims. However, it is likely that the Debtors' liability for these claims will be different from the amounts now recorded by the Debtors. Proofs of claim alleging asbestos property damage claims are discussed in Note 13. Litigation under Developments in the Reorganization Proceeding. FINANCIAL STATEMENT PRESENTATION The accompanying consolidated financial statements have been prepared in accordance with American Institute of Certified Public Accountants ("AICPA") Statement of Position 90-7 ("SOP 90-7"), "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code," and on a going-concern basis, which contemplates continuity of operations, realization of assets and liquidation of liabilities in the ordinary course of business. However, as a result of the Filing, such realization of assets and liquidation of liabilities, without substantial adjustments and/or changes of ownership, are subject to uncertainty. Given this uncertainty, there is substantial doubt about the Corporation's ability to continue as a going concern. Such doubt includes, but is not limited to, a possible change in control of the Corporation, as well as a potential change in the composition of the Corporation's business portfolio. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. While operating as debtors-in-possession under the protection of chapter 11 of the Bankruptcy Code and subject to Bankruptcy Court approval or otherwise as permitted in the ordinary course of business, the Debtors, or any of them, may sell or otherwise dispose of assets and liquidate or settle liabilities for amounts other than those reflected in the consolidated financial statements. Further, a plan of -12- reorganization could materially change the amounts and classifications in the historical consolidated financial statements. The Corporation's ability to continue as a going concern is dependent upon, among other things, (i) the ability of the Corporation to maintain adequate cash on hand, (ii) the ability of the Corporation to generate cash from operations, (iii) confirmation of a plan of reorganization under the Bankruptcy Code and (iv) the Corporation's ability to achieve profitability following such confirmation. The Corporation believes that cash and marketable securities on hand and future cash available from operations will provide sufficient liquidity to allow its businesses to operate in the normal course without interruption for the duration of the chapter 11 proceedings. This includes its ability to meet post-petition obligations of the Debtors and to meet obligations of the non-Debtor subsidiaries. LIABILITIES SUBJECT TO COMPROMISE As reflected in the consolidated financial statements, liabilities subject to compromise refers to the Debtors' liabilities incurred prior to the commencement of the Chapter 11 Cases. The amounts of the various liabilities that are subject to compromise are set forth in the table below. These amounts represent the Debtors' estimate of known or potential pre-petition claims to be resolved in connection with the Chapter 11 Cases. Such claims remain subject to future adjustments. Adjustments may result from (i) negotiations, (ii) actions of the Bankruptcy Court, (iii) further developments with respect to disputed claims, (iv) rejection of executory contracts and unexpired leases, (v) the determination as to the value of any collateral securing claims, (vi) proofs of claim, including unaccrued and unrecorded post-petition interest expense, (vii) effect of any legislation which may be enacted or (viii) other events. The amount shown below for the asbestos reserve reflects the Corporation's pre-petition estimate of liability associated with asbestos claims to be filed in the tort system through 2003, and this liability, including liability for post-2003 claims, is the subject of significant legal proceedings and negotiation in the Chapter 11 Cases. See Note 13. Litigation for additional information on the background of asbestos litigation, developments in the Corporation's reorganization proceeding and estimated cost. As of the date of this report, virtually all of the Corporation's pre-petition debt is in default due to the Filing and included in liabilities subject to compromise. This includes debt outstanding of $469 million under the pre-petition bank credit facilities and $536 million of other outstanding debt. Payment terms for liabilities subject to compromise will be established as part of a plan of reorganization under the Chapter 11 Cases. Liabilities subject to compromise in the consolidated and debtor-in-possession balance -13- sheets as of March 31 consisted of the following items (dollars in millions):
As of As of March 31, December 31, 2004 2003 ----------------------------------- Accounts payable $ 163 $ 162 Accrued expenses 43 44 Debt 1,005 1,005 Asbestos reserve 1,061 1,061 Other long-term liabilities 13 14 ---------------------------------------------------------------------------------------------------------- Subtotal 2,285 2,286 Elimination of intercompany accounts payable (43) (43) ---------------------------------------------------------------------------------------------------------- Total liabilities subject to compromise 2,242 2,243 ==========================================================================================================
INTERCOMPANY TRANSACTIONS In the normal course of business, the Corporation (also referred to as the "Parent Company" in the following discussion of intercompany transactions) and the operating subsidiaries engage in intercompany transactions. To document the relations created by these transactions, the Parent Company and the operating subsidiaries, from the formation of the Corporation in 1985, have been parties to intercompany loan agreements that evidence their obligations as borrowers or rights as lenders arising out of intercompany cash transfers and various allocated intercompany charges (the "Intercompany Corporate Transactions"). The Corporation operates a consolidated cash management system under which the cash receipts of the domestic operating subsidiaries are ultimately concentrated in Parent Company accounts. Cash disbursements for those operating subsidiaries originate from those Parent Company concentration accounts. Allocated intercompany charges from the Parent Company to the operating subsidiaries primarily include expenses related to rent, property taxes, information technology, and research and development, while allocated intercompany charges between certain operating subsidiaries primarily include expenses for shared marketing, sales, customer service, engineering and accounting services. Detailed accounting records are maintained of all cash flows and intercompany charges through the system in either direction. Net balances, receivables or payables of such cash transactions are reviewed on a regular basis with interest earned or accrued on the balances. During the first six months of 2001, the Corporation took steps to secure the obligations from each of the principal domestic operating subsidiaries under the intercompany loan agreements when it became clear that the asbestos liability claims of U.S. Gypsum were becoming an increasingly greater burden on the Corporation's cash resources. As of March 31, 2004, U.S. Gypsum and USG Interiors had net pre-petition payable balances to the Parent Company for Intercompany Corporate -14- Transactions of $295 million and $109 million, respectively. L&W Supply had a net pre-petition receivable balance from the Parent Company of $33 million. These pre-petition balances are subject to the provisions of the Tolling Agreement discussed above. See Pre-Petition Liabilities Other Than Asbestos Personal Injury Claims, above. As of March 31, 2004, U.S. Gypsum and L&W Supply had net post-petition receivable balances from the Parent Company for Intercompany Corporate Transactions of $212 million and $178 million, respectively. USG Interiors had a net post-petition payable balance to the Parent Company of $16 million. In addition to the above transactions, the operating subsidiaries engage in ordinary course purchase and sale of products with other operating subsidiaries (the "Intercompany Trade Transactions"). Detailed accounting records also are maintained of all such transactions, and settlements are made on a monthly basis. Certain Intercompany Trade Transactions between U.S. and non-U.S. operating subsidiaries are settled via wire transfer payments utilizing several payment systems. CHAPTER 11 REORGANIZATION EXPENSES Chapter 11 reorganization expenses in the consolidated and debtor-in-possession statements of earnings consisted of the following (dollars in millions):
Three Months ended March 31, ----------------------------- 2004 2003 ----------------------------- Legal and financial advisory fees $ 4 $ 4 Bankruptcy-related interest income (2) (2) -------------------------------------------------------------------------------------------- Total chapter 11 reorganization expenses 2 2 ============================================================================================
INTEREST EXPENSE For the first quarter of 2004, contractual interest expense not accrued or recorded on pre-petition debt totaled $17 million. From the Petition Date through March 31, 2004, contractual interest expense not accrued or recorded on pre-petition debt totaled $203 million. Although no post-petition accruals are required to be made for such contractual interest expense, debtholders may seek to recover such amounts in the Chapter 11 Cases. DIP FINANCIAL STATEMENTS Under the Bankruptcy Code, the Corporation is required to file periodically with the Bankruptcy Court various documents including financial statements of the Debtors (the Debtor-In-Possession or "DIP" financial statements). The Corporation cautions that these financial -15- statements are prepared according to requirements under the Bankruptcy Code. While these financial statements accurately provide information required under the Bankruptcy Code, they are nonetheless unconsolidated, unaudited and prepared in a format different from that used in the Corporation's consolidated financial statements filed under the securities laws. Accordingly, the Corporation believes the substance and format do not allow meaningful comparison with the Corporation's regular publicly disclosed consolidated financial statements. The Debtors consist of the Corporation and the following wholly owned subsidiaries: 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. The condensed financial statements of the Debtors are presented as follows: USG CORPORATION DEBTOR-IN-POSSESSION STATEMENT OF EARNINGS (DOLLARS IN MILLIONS) (UNAUDITED)
THREE MONTHS ENDED MARCH 31, --------------------- 2004 2003 -------- -------- Net sales $ 918 $ 781 Cost of products sold 795 684 Selling and administrative expenses 65 69 Chapter 11 reorganization expenses 2 2 Interest expense 1 1 Interest income - - Other income, net - (2) -------- -------- Earnings before income taxes and cumulative effect of accounting change 55 27 Income taxes 26 12 -------- -------- Earnings before cumulative effect of accounting change 29 15 Cumulative effect of accounting change - (13) -------- -------- Net earnings 29 2 ======== ========
-16- USG CORPORATION DEBTOR-IN-POSSESSION BALANCE SHEETS (DOLLARS IN MILLIONS) (UNAUDITED)
AS OF AS OF MARCH 31, DECEMBER 31, 2004 2003 --------- ------------ ASSETS Current Assets: Cash and cash equivalents $ 419 $ 489 Short-term marketable securities 41 64 Restricted cash 19 7 Receivables (net of reserves - $12 and $11) 383 276 Inventories 255 232 Income taxes receivable 22 21 Deferred income taxes 41 41 Other current assets 50 47 -------- ---------- Total current assets 1,230 1,177 Long-term marketable securities 236 176 Property, plant and equipment (net of accumulated depreciation and depletion - $665 and $645) 1,570 1,576 Deferred income taxes 162 178 Goodwill 41 39 Other assets 339 358 -------- ---------- Total Assets 3,578 3,504 ======== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable 223 168 Accrued expenses 159 186 Income taxes payable 13 4 -------- ---------- Total current liabilities 395 358 Other liabilities 404 403 Liabilities subject to compromise 2,242 2,243 Stockholders' Equity: Preferred stock - - Common stock 5 5 Treasury stock (258) (258) Capital received in excess of par value 102 101 Accumulated other comprehensive income 15 8 Retained earnings 673 644 -------- ---------- Total stockholders' equity 537 500 -------- ---------- Total Liabilities and Stockholders' Equity 3,578 3,504 ======== ==========
-17- USG CORPORATION DEBTOR-IN-POSSESSION STATEMENTS OF CASH FLOWS (DOLLARS IN MILLIONS) (UNAUDITED)
THREE MONTHS ENDED MARCH 31, --------------------- 2004 2003 --------- -------- OPERATING ACTIVITIES: Net earnings $ 29 $ 2 Adjustments to reconcile net earnings to net cash: Cumulative effect of accounting change - 13 Depreciation, depletion and amortization 23 22 Deferred income taxes 12 11 (Increase) decrease in working capital: Receivables (107) (58) Income taxes receivable (1) - Inventories (23) (15) Payables 64 33 Accrued expenses (26) (45) (Increase) decrease in post-petition intercompany receivable 12 (7) Decrease in other assets 7 2 Increase (decrease) increase in other liabilities 1 (5) Change in asbestos receivables 10 15 Decrease in liabilities subject to compromise (1) (1) Other, net (1) (1) --------- -------- Net cash used for operating activities (1) (34) --------- -------- INVESTING ACTIVITIES: Capital expenditures (17) (10) Purchases of marketable securities (115) (32) Sale or maturities of marketable securities 78 37 Net proceeds from asset dispositions 1 - Acquisition of business (4) - --------- -------- Net cash used for investing activities (57) (5) --------- -------- FINANCING ACTIVITIES: Deposit of restricted cash (12) - --------- -------- Net cash used for financing activities (12) - --------- -------- Net decrease in cash and cash equivalents (70) (39) Cash and cash equivalents at beginning of period 489 478 --------- -------- Cash and cash equivalents at end of period 419 439 ========= ======== SUPPLEMENTAL CASH FLOW DISCLOSURES: Interest paid - 1 Income taxes paid, net 4 -
-18- (3) EXIT ACTIVITIES In the fourth quarter of 2003, the Corporation recorded a charge of $3 million pretax ($2 million after-tax) for severance related to a salaried workforce reduction of approximately 70 employees. An additional 56 open positions were eliminated. Payments totaling $1 million were made in the fourth quarter of 2003, and a reserve of $2 million was included in accrued expenses on the consolidated balance sheet as of December 31, 2003. The remaining payments of $2 million were made in the first quarter of 2004. (4) EARNINGS PER SHARE Basic earnings per share are based on the weighted average number of common shares outstanding. Diluted earnings per share are based on the weighted average number of common shares outstanding and the dilutive effect of the potential exercise of outstanding stock options. Diluted earnings per share exclude the potential exercise of outstanding stock options for any period in which such exercise would have an anti-dilutive effect. The reconciliation of basic earnings per share to diluted earnings per share is shown in the following table (dollars in millions, except share data):
Weighted Average Net Shares Per-Share Three Months Ended March 31, Earnings (000) Amount ------------------------------------------------------------------------------------------------------- 2004: Basic earnings $ 57 43,023 $ 1.33 Dilutive effect of stock options 1 ------------------------------------------------------------------------------------------------------- Diluted earnings 57 43,024 1.33 ======================================================================================================= 2003: Basic earnings 6 43,138 0.13 Dilutive effect of stock options - ------------------------------------------------------------------------------------------------------- Diluted earnings 6 43,138 0.13 =======================================================================================================
-19- (5) MARKETABLE SECURITIES As of March 31, 2004 and 2003, the Corporation's investments in marketable securities consisted of the following (dollars in millions):
2004 2003 ---------------------------------------- Amortized Amortized Cost FMV Cost FMV ---------------------------------------- Asset-backed securities $ 116 $ 117 $ 72 $ 72 U.S. government and agency securities 88 88 55 55 Municipal securities 29 29 30 30 Corporate securities 43 43 6 6 Time deposits - - 13 13 ------------------------------------------------------------------------------------------------------------- Total marketable securities 276 277 176 176 =============================================================================================================
Contractual maturities of marketable securities as of March 31, 2004, were as follows (dollars in millions):
Fair Amortized Market Cost Value --------------------------- Due in 1 year or less $ 41 $ 41 Due in 1-5 years 63 63 Due in 5-10 years 17 17 Due after 10 years 39 39 ----------------------------------------------------------------------------------------------------------- 160 160 Asset-backed securities 116 117 ----------------------------------------------------------------------------------------------------------- Total marketable securities 276 277 ===========================================================================================================
The average duration of the portfolio is less than one year because a majority of the longer-term securities have paydown or put features and liquidity facilities. The Corporation had investments in marketable securities with a fair market value of $40 million that were in an unrealized loss position for less than 12 months as of March 31, 2004. These investments were in the following types of securities: $15 million in asset-backed securities, $6 million in government and agency securities and $19 million in corporate securities. The Corporation also had $1 million in government and agency securities that had been in a continuous loss position for a period greater than 12 months as of March 31, 2004. The aggregate amounts of both types of unrealized loss positions were not material. -20- (6) ASSET RETIREMENT OBLIGATIONS On January 1, 2003, the Corporation adopted SFAS No. 143, "Accounting for Asset Retirement Obligations." This standard requires the recording of the fair value of a liability for an asset retirement obligation in the period in which it is incurred. The Corporation's asset retirement obligations include reclamation requirements as regulated by government authorities related principally to assets such as the Corporation's mines, quarries, landfills, ponds and wells. The impact to the Corporation of adopting SFAS No. 143 was an increase in assets of $14 million, which included a $12 million increase in deferred tax assets, and an increase in liabilities of $30 million, which included a $1 million increase in deferred tax liabilities. A noncash, after-tax charge of $16 million ($27 million pretax) was reflected on the consolidated statement of earnings as a cumulative effect of a change in accounting principle as of January 1, 2003. The liability for asset retirement obligations was $35 million as of March 31, 2004, and December 31, 2003. (7) GOODWILL AND OTHER INTANGIBLE ASSETS Total goodwill amounted to $41 million as of March 31, 2004, and $39 million as of December 31, 2003. Goodwill increased by $2 million during the first quarter of 2004 as a result of a business acquisition during the quarter. Other intangible assets amounted to $2 million as of March 31, 2004, and December 31, 2003. As of March 31, 2004, $1 million of this amount was subject to amortization over a five-year life. Other intangible assets are included in other assets on the consolidated balance sheet. -21- (8) DERIVATIVE INSTRUMENTS The Corporation uses derivative instruments to manage selected commodity price and foreign currency exposures. The Corporation does not use derivative instruments for trading purposes. 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. The ineffective portion of changes in the fair value of the derivative is reported in cost of products sold. The amount of ineffectiveness recorded in the first quarter of 2004 amounted to income of $600,000. COMMODITY DERIVATIVE INSTRUMENTS The Corporation uses swap contracts to hedge anticipated purchases of natural gas to be used in its manufacturing operations. The current contracts, all of which mature by December 31, 2005, are generally designated as cash flow hedges, with changes in fair value recorded to accumulated other comprehensive income (loss) until the hedged transaction occurs, at which time it is reclassified to earnings. As of March 31, 2004, the fair value of these swap contracts, which remained in accumulated other comprehensive income (loss), was $22 million ($14 million after-tax). FOREIGN EXCHANGE DERIVATIVE INSTRUMENTS The Corporation has operations in a number of countries and uses forward contracts from time to time to hedge selected risk of changes in cash flows resulting from forecasted intercompany and third-party sales or purchases denominated in non U.S. currencies. These contracts are generally designated as cash flow hedges, for which changes in fair value are recorded to accumulated other comprehensive income (loss) until the underlying transaction has an impact on earnings. As of March 31, 2004, the Corporation had no such foreign currency contracts. COUNTERPARTY RISK The Corporation is exposed to credit losses in the event of nonperformance by the counterparties on its financial instruments. All counterparties have investment grade credit standing; accordingly, the Corporation anticipates that these counterparties will be able to satisfy fully their obligations under the contracts. The Corporation does not generally obtain collateral or other security to support financial instruments subject to credit risk but monitors the credit standing of all counterparties. -22- (9) COMPREHENSIVE INCOME The components of comprehensive income are summarized in the following table (dollars in millions):
Three Months ended March 31 ------------------------ 2004 2003 ------------------------ Net earnings $ 57 $ 6 ------------------------------------------------------------------------------------------------------------ Pretax gain (loss) on derivatives 13 - Income tax benefit (expense) (5) - ------------------------------------------------------------------------------------------------------------ After-tax gain (loss) on derivative 8 - ------------------------------------------------------------------------------------------------------------ Deferred currency translation (2) 11 ------------------------------------------------------------------------------------------------------------ Unrealized gain (loss) on marketable securities - - ------------------------------------------------------------------------------------------------------------ Total comprehensive income 63 17 ============================================================================================================
There was no tax impact on the foreign currency translation adjustments. The components of accumulated other comprehensive income (loss) included on the consolidated balance sheets are summarized in the following table (dollars in millions):
As of As of March 31, December 31, 2004 2003 ----------------------------- Gain on derivatives, net of tax $ 18 $ 10 Deferred currency translation (10) (8) Minimum pension liability, net of tax (3) (3) Unrealized gain (loss) on marketable securities - - -------------------------------------------------------------------------------------------------------- Total accumulated other comprehensive income (loss) 5 (1) ========================================================================================================
During the first quarter of 2004, accumulated net after-tax gains of $3 million ($5 million pretax) on derivatives were reclassified from accumulated other comprehensive income (loss) to earnings. As of March 31, 2004, the estimated net after-tax gain expected to be reclassified within the next 12 months from accumulated other comprehensive income (loss) into earnings is $16 million. -23- (10) EMPLOYEE RETIREMENT PLANS The Corporation adopted SFAS No. 132 (revised 2003), "Employers' Disclosures about Pensions and Other Postretirement Benefits" in December 2003. In accordance with the Corporation's funding policy, the Corporation and its subsidiaries contributed cash of $8 million during the first quarter of 2004 and expect to contribute cash of approximately $72 million during the full year 2004 to their pension plans. The components of net pension and postretirement benefits costs for the three months ended March 31, 2004 and 2003 are summarized in the following table (dollars in millions):
Three Months ended March 31 ------------------------- 2004 2003 ------------------------- PENSION: Service cost of benefits earned $ 7 $ 5 Interest cost on projected benefit obligation 13 13 Expected return on plan assets (13) (13) Net amortization 5 3 --------------------------------------------------------------------------------------------------------- Net cost 12 8 ========================================================================================================= POSTRETIREMENT: Service cost of benefits earned $ 4 $ 3 Interest cost on projected benefit obligation 5 5 --------------------------------------------------------------------------------------------------------- Net cost 9 8 =========================================================================================================
-24- (11) STOCK-BASED COMPENSATION The Corporation accounts for stock-based compensation under the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." APB No. 25 prescribes the use of the intrinsic value method, which measures compensation cost as the quoted market price of the stock at the date of grant less the amount, if any, that the employee is required to pay. If the Corporation had elected to recognize compensation cost for stock-based compensation grants consistent with the fair value method prescribed by SFAS No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure," net earnings and net earnings per common share would have changed to the following pro forma amounts (dollars in millions, except per-share data):
Three Months ended March 31, ----------------------- 2004 2003 ----------------------- NET EARNINGS: Net Earnings: As reported $ 57 $ 6 Deduct: Fair value method of stock -based employee compensation expense, net of tax - - ---------------------------------------------------------------------------------------------------------- Pro forma net earnings 57 6 ========================================================================================================== BASIC AND DILUTED EARNINGS PER SHARE: As reported 1.33 0.13 Pro forma 1.33 0.13 ==========================================================================================================
Subsequent to the Filing, no stock option grants have been issued. As of March 31, 2004, common shares totaling 2,346,500 were reserved for future issuance in conjunction with existing stock option grants. In addition, 2,544,720 common shares were reserved for future grants. Shares issued in option exercises may be from original issue or available treasury shares. -25- (12) OPERATING SEGMENTS The Corporation's operations are organized into three operating segments: North American Gypsum, which manufactures SHEETROCK(R) brand gypsum wallboard and joint compounds, DUROCK(R) brand cement board and other related building products in the United States, Canada and Mexico; Worldwide Ceilings, which manufactures ceiling tile in the United States and ceiling grid in the United States, Canada, Europe and the Asia-Pacific region; and Building Products Distribution, which distributes gypsum wallboard, drywall metal, ceiling products, joint compound and other building products throughout the United States. Operating segment results were as follows (dollars in millions):
Net Sales Operating Profit ------------------------------------------------------------------------------------------------------------- Three Months Ended March 31, 2004 2003 2004 2003 ------------------------------------------------------------------------------------------------------------- North American Gypsum $ 639 $ 542 $ 81 $ 38 Worldwide Ceilings 166 147 15 8 Building Products Distribution 362 295 14 8 Eliminations (147) (122) - 1 Corporate - - (16) (18) Chapter 11 reorganization expenses - - (2) (2) ----------------------------------------------------------------------------------------------------------- Total 1,020 862 92 35 ===========================================================================================================
(13) LITIGATION ASBESTOS AND RELATED BANKRUPTCY LITIGATION One of the Corporation's subsidiaries, U.S. Gypsum, is among many defendants in more than 100,000 asbestos lawsuits alleging personal injury or property damage liability. Most of the asbestos lawsuits against U.S. Gypsum seek compensatory and, in many cases, punitive damages for personal injury allegedly resulting from exposure to asbestos-containing products (the "Personal Injury Cases"). Certain of the asbestos lawsuits seek to recover compensatory and, in many cases, punitive damages for costs associated with the maintenance or removal and replacement of asbestos-containing products in buildings (the "Property Damage Cases"). A more detailed description of the Property Damage and Personal Injury Cases against U.S. Gypsum and asbestos personal injury cases against certain other Debtors is set forth below. 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. If the amount of the Debtors' asbestos liabilities is not resolved through negotiation in the Chapter 11 Cases or addressed by federal legislation, the outcome of litigation proceedings in the Chapter 11 Cases, which is extremely -26- speculative, may determine the Debtors' liability for present and future asbestos claims. Recent developments in the Corporation's bankruptcy proceeding and a more detailed discussion of the Debtors' asbestos liabilities are addressed below. See also Note 2. Voluntary Reorganization Under Chapter 11, above, for additional information on the voluntary reorganization proceeding and potential federal legislation. DEVELOPMENTS IN THE REORGANIZATION PROCEEDING: In 2002, the Debtors filed a motion requesting Judge Wolin, who is presiding over the Debtors Chapter 11 Cases, to conduct hearings to substantively estimate the Debtors' liability for asbestos personal injury claims. The Debtors requested that the Court hear evidence and make rulings regarding the characteristics of valid asbestos personal injury claims against the Debtors and then estimate the Debtors' liability for present and future asbestos personal injury claims based upon these rulings. One of the key liability issues is whether claimants who do not have objective evidence of asbestos-related disease have valid claims and are entitled to be compensated by the Debtors or whether such claimants are entitled to compensation only if and when they develop asbestos-related disease. The Official Committee of Asbestos Personal Injury Claimants opposed the substantive estimation hearings proposed by the Debtors. The committee contends that U.S. Gypsum's liability for present and future asbestos personal injury claims should be based on extrapolation from U.S. Gypsum's settlement history of such claims and not on litigating liability issues in the bankruptcy proceeding. The committee contends that the Bankruptcy Court does not have the power to exclude claimants who do not have objective evidence of asbestos-related disease if such claimants are compensated in the tort system outside of bankruptcy. The Debtors also filed a motion with Judge Wolin requesting a ruling that putative claimants who cannot satisfy objective standards of asbestos-related disease are not entitled to vote on a Section 524(g) plan. The Debtors' motion on this voting issue has been stayed by order of Judge Wolin. It is expected that the Official Committee of Asbestos Personal Injury Claimants will oppose the Debtors' motion. In response to the Debtors' motion seeking substantive estimation of the Debtors' asbestos personal injury liability, Judge Wolin issued a Memorandum Opinion and Order (the "Order") on February 19, 2003, setting forth a procedure for estimating the Debtors' liability for present and future asbestos personal injury claims alleging cancer. The Order provides that the Court will set a bar date for the filing of asbestos personal injury claims alleging cancer and that the Court will hold an estimation hearing regarding these claims under 11 U.S.C. Section 502(c), at which the "debtors will be permitted to present their defenses." -27- The Order contemplates that after the estimation of the Debtors' liability for present and future cancer claims, the Court will determine whether the Debtors' liability for these claims exceeds the Debtors' assets. The Court notes that the Official Committee of Asbestos Personal Injury Claimants has asserted that the Debtors are insolvent and do not have sufficient assets to pay cancer claimants, without regard to the Debtors' liability for non-malignant asbestos personal injury claims. The Court further notes that the Debtors dispute this contention. According to the Order, the determination of whether the Debtors have sufficient assets to pay legitimate cancer claimants will guide the Court in determining whether the Debtors' resources should be spent resolving the issue of the validity of non-malignant claims where there is no objective evidence of asbestos-related disease. Judge Wolin has not yet set a timetable for implementation of the Order or a date for any hearing on estimation of the Debtors' liability for cancer claims. In conferences with the parties after issuing the Order, Judge Wolin made certain statements indicating that he may not implement the Order, and subsequently indicated that the bar date will be limited only to claimants alleging cancer who had filed a lawsuit against the Debtors as of the Filing. In November 2003, the Debtors and the committee representing unsecured creditors in the Chapter 11 Cases filed a motion to recuse, or remove, Judge Wolin from presiding over these cases. The motion states that Judge Wolin should remove himself from presiding over these cases because he has appointed and relied upon advisors to assist him in resolution of these cases who have conflicts of interest and he has had multiple private communications between or among certain parties to these cases, the advisors, and other unidentified persons, without all parties being present and having knowledge of these communications. Certain creditors in other asbestos-related bankruptcies assigned to Judge Wolin filed similar motions for removal. The motions for removal were opposed by the Official Committee of Asbestos Personal Injury Claimants and the legal representative for future claimants. Judge Wolin has ordered that all matters in the Chapter 11 Cases pending before him, including asbestos personal injury matters, be stayed until further order of the court. This stay does not apply to matters pending before Bankruptcy Judge Fitzgerald in the Chapter 11 Cases. On February 2, 2004, Judge Wolin issued a decision denying the motions for removal. The Debtors and the committee representing unsecured creditors have appealed the decision to the Third Circuit Court of Appeals. The outcome of the appeal is not known. If the Court of Appeals does not rule that Judge Wolin should be removed from the Debtors' cases, it is expected that Judge Wolin will continue to preside over the Debtors' cases and address the asbestos personal injury issues in those cases. If the Court of Appeals rules that Judge Wolin should be removed, it is expected that the Debtors' cases will be reassigned to another judge. The stay of proceedings ordered by Judge Wolin has not been lifted. -28- As a result of these developments, the Corporation does not know whether estimation proceedings regarding the Debtors' liability for cancer claims will occur, what the timing or outcome of any such proceedings would be, what impact such proceedings would have on estimating the Debtors' liability for asbestos personal injury claims alleging other diseases, and whether any such estimation proceedings would lead to a negotiated resolution of the Debtors' asbestos personal injury liabilities. The Corporation also does not know whether the Court will ultimately address the validity and voting rights of non-malignant claims where there is no objective evidence of asbestos-related disease. With regard to asbestos property damage claims, the Bankruptcy Court established a bar date requiring all such claims against the Debtors to be filed by January 15, 2003. The Debtors continue to analyze and review the asbestos-related property damage claims received as of the claims bar date. Approximately 1,400 asbestos property damage claims were filed, representing more than 2,000 buildings. In contrast, as of the Petition Date, 11 Property Damage Cases were pending against U.S. Gypsum. Approximately 500 of the asbestos property damage claims filed by the bar date assert a specific dollar amount of damages, and the total damages alleged in those claims is approximately $1.6 billion. However, this amount reflects numerous duplicate claims filed against multiple Debtors. Approximately 900 claims do not specify a damage amount. Most of the filed claims do not provide any evidence that the Debtors' products were ever installed in any of the buildings at issue, and some of the claims are duplicates of other claims. The Debtors believe that they have substantial defenses to many of these property damage claims, including the lack of evidence that the Debtors' products were ever installed in the buildings at issue, the claims are barred by the applicable statutes of limitation, and the claims lack evidence that the claimants have any damages. The Debtors intend to address many of these claims through an objection and disallowance process in the Bankruptcy Court. The Debtors have begun this process by issuing written notices to claimants that failed to provide evidence that any of the Debtors' products were ever installed in the buildings at issue. To date, the Debtors have issued these deficiency notices with regard to more than 1,200 buildings and expect to issue additional notices. Because of the preliminary nature of the objection process, the Corporation cannot predict the outcome of these proceedings or the impact the proceedings may have on the estimated cost of resolving asbestos property damage claims. See Estimated Cost, below. The following is a summary of the Personal Injury and Property Damage Cases pending against U.S. Gypsum and certain other Debtors as of the Petition Date. PERSONAL INJURY CASES: As reported by the Center for Claims Resolution (the "Center"), U.S. Gypsum was a defendant in more than 100,000 pending Personal Injury Cases as of the Petition Date, as well as an additional approximately -29- 52,000 Personal Injury Cases that may be the subject of settlement agreements. In the first half of 2001, up to the Petition Date, approximately 26,200 new Personal Injury Cases were filed against U.S. Gypsum, as reported by the Center, as compared to 27,800 new filings in the first half of 2000. Prior to the Filing, U.S. Gypsum managed the handling and settlement of Personal Injury Cases through its membership in the Center. From 1988 up to February 1, 2001, the Center administered and arranged for the defense and settlement of Personal Injury Cases against U.S. Gypsum and other Center members. During that period, costs of defense and settlement of Personal Injury Cases were shared among the members of the Center pursuant to predetermined sharing formulae. Effective February 1, 2001, the Center members, including U.S. Gypsum, ended their prior settlement-sharing arrangement. Up until the Petition Date, the Center continued to administer and arrange for the defense and settlement of the Personal Injury Cases, but liability payments were not shared among the Center members. In 2000 and years prior, U.S. Gypsum and other Center members negotiated a number of settlements with plaintiffs' law firms that included agreements to resolve over time the firms' pending Personal Injury Cases as well as certain future claims (the "Long-Term Settlements"). With regard to future claims, these Long-Term Settlements typically 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 agree to settle those claims for specified amounts. 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. During late 2000 and in 2001, following the bankruptcy filings of other defendants in asbestos personal injury litigation, plaintiffs substantially increased their settlement demands to U.S. Gypsum. In response to these increased settlement demands, U.S. Gypsum attempted to manage its asbestos liability by contesting, rather than settling, a greater number of cases that it believed to be non-meritorious. As a result, in the first and second quarters of 2001, U.S. Gypsum agreed to settle fewer Personal Injury Cases, -30- but at a significantly higher cost per case. In the first half of 2001, up to the Petition Date, U.S. Gypsum closed approximately 18,900 Personal Injury Cases. In the first half of 2001, up to the Petition Date, U.S. Gypsum's total asbestos-related cash payments, including defense costs, were approximately $124 million, of which approximately $10 million was paid or reimbursed by insurance. A portion of these payments were for settlements agreed to in prior periods. As of March 31, 2001, U.S. Gypsum had estimated that cash expenditures for Personal Injury Cases in 2001 would total approximately $275 million before insurance recoveries of approximately $37 million. In addition to the Personal Injury Cases pending against U.S. Gypsum, one of the Corporation's subsidiaries and a Debtor in the bankruptcy proceeding, L&W Supply, was named as a defendant in approximately 21 pending Personal Injury Cases as of the Petition Date. L&W Supply, a distributor of building products manufactured by U.S. Gypsum and other building products manufacturers, has not made any payments in the past to resolve Personal Injury Cases. Because of the small number of Personal Injury Cases against L&W Supply to date and the lack of development of the cases against L&W Supply, the Corporation does not have sufficient information at this time to predict how any plan of reorganization will address any asbestos-related liability of L&W Supply. 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 northwestern United States. As of the Petition Date, Beadex was a named defendant in approximately 40 Personal Injury Cases pending primarily in the states of Washington and Oregon. Beadex has approximately $11 million in primary or umbrella insurance coverage available to pay asbestos-related costs, as well as $15 million in available excess coverage. The Corporation expects that any asbestos-related liability of 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 how any plan of reorganization will address any asbestos-related liability of Beadex. PROPERTY DAMAGE CASES: As of the Petition Date, U.S. Gypsum was a defendant in 11 Property Damage Cases, most of which involved multiple buildings. One of the cases is a conditionally certified class action comprising all colleges and universities in the United States, which certification is presently limited to the resolution of certain allegedly "common" liability issues (Central Wesleyan College v. W.R. Grace & Co., et al., U.S.D.C. S.C.). As a result of the Filing, all Property Damage Cases are stayed against U.S. Gypsum. U.S. Gypsum's estimated cost of resolving the Property Damage Cases is discussed in Estimated Cost, below. -31- INSURANCE COVERAGE: As of March 31, 2004, U.S. Gypsum had an $800,000 receivable relating to insurance remaining to cover asbestos-related costs. This insurance receivable, included in other current assets on the consolidated balance sheet, was collected in April 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; the viability of statute of limitations and other defenses; the amount for which such cases can be resolved, which normally (but not uniformly) has been substantially lower than the claimed damages; and the viability of claims for punitive and other forms of multiple damages. Uncertainties in the Personal Injury Cases included, but were not limited to, the number, disease, age, and occupational characteristics of claimants in the Personal Injury Cases; the jurisdiction and venue in which such cases are filed; the viability of claims for conspiracy or punitive damages; the elimination of indemnity sharing among Center members for future settlements and its negative impact on U.S. Gypsum's ability to continue to resolve claims at historical or acceptable levels; the adverse impact on U.S. Gypsum's settlement costs of recent bankruptcies of co-defendants; the continued solvency of other defendants and the possibility of additional bankruptcies; the possibility of significant adverse verdicts due to recent changes in settlement strategies and related effects on liquidity; the inability or refusal of former Center members to fund their share of existing settlements and its effect on such settlement agreements; the continued ability to negotiate settlements or develop other mechanisms that defer or reduce claims from unimpaired claimants; and the possibility that federal legislation addressing asbestos litigation would be enacted. The Corporation reported that adverse developments with respect to any of these uncertainties could have a material impact on U.S. Gypsum's settlement costs and could materially increase the cost above the estimated range discussed below. In 2000, an independent actuarial study of U.S. Gypsum's current and potential future asbestos liabilities was completed. This analysis was based on the assumption that U.S. Gypsum's asbestos liability would continue to be resolved in the tort system. As part of this analysis, the Corporation reviewed, among other things, the factors listed above as well as 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 -32- of solvent defendants available to pay claims, including reductions in membership of the Center; the pre-agreed settlement recommendations in, and the viability of, the Long-Term Settlements; anticipated trends in recruitment by plaintiffs' law firms of non-malignant or unimpaired claimants; future defense costs; and 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. The study attempted to weigh relevant variables and assess the impact of likely outcomes on future case filings and settlement costs. Based upon the results of the actuarial study, the Corporation determined that, although substantial uncertainty remained, it was probable that asbestos claims pending against U.S. Gypsum and future asbestos claims to be filed against it through 2003 (both property damage and personal injury) could be resolved in the tort system for an amount between $889 million and $1,281 million, including defense costs, and that within this range the most likely estimate was $1,185 million. Consistent with this analysis, in the fourth quarter of 2000, the Corporation recorded a pretax noncash charge of $850 million to results of operations, which, combined with the previously existing reserve, increased U.S. Gypsum's reserve for asbestos claims to $1,185 million. These amounts are stated before tax benefit and are not discounted to present value. Less than 10% of the reserve was attributable to defense and administrative costs. At the time of recording this reserve, it was expected that the reserve amounts would be expended over a period extending several years beyond 2003, because asbestos cases in the tort system historically have 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. The Corporation believes that, as a result of the Filing and activities relating to potential federal legislation addressing asbestos personal injury claims, there is 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: (i) how the Long-Term Settlements will be treated in the bankruptcy proceeding and plan of reorganization and whether those settlements will be set aside; (ii) the number of asbestos claims that will be filed or addressed in the proceeding; (iii) the number of future claims that will be estimated in connection with preparing a plan of reorganization; (iv) how claims for punitive damages and claims by persons with no objective evidence of asbestos-related disease will be treated and whether such claims will be allowed or compensated; (v) the impact historical settlement values for asbestos claims may have on the estimation of asbestos liability in the -33- bankruptcy proceeding; (vi) the results of any litigation proceedings in the Chapter 11 Cases regarding the estimated value of present and future asbestos personal injury claims alleging cancer or other diseases; (vii) the treatment of asbestos property damage claims in the bankruptcy proceeding; and (viii) the impact any relevant potential federal legislation may have on the proceeding. See Note 2. Voluntary Reorganization Under Chapter 11 - Potential Federal Legislation Regarding Asbestos Personal Injury Claims. These factors, as well as the uncertainties discussed above in connection with the resolution of asbestos cases in the tort system, increase the uncertainty of any estimate of asbestos liability. As a result, it is the Corporation's view that no change should be made at this time to the previously recorded reserve for asbestos claims, except to reflect certain minor asbestos-related costs incurred since the Filing. The reserve as of March 31, 2004, which was determined based on claims expected to be filed against U.S. Gypsum through 2003, was $1,061 million. As the Chapter 11 Cases and legislation process proceed, the Debtors likely will gain more information from which a reasonable estimate of the Debtors' probable liability for present and future asbestos claims can be determined. If such estimate differs from the existing reserve, the reserve will be adjusted, and it is possible that a charge to results of operations will be necessary at that time. In such a case, the Debtors' asbestos liability could vary significantly from the recorded estimate of liability and could be greater than the high end of the range estimated in 2000. This difference could be material to the Corporation's financial position, cash flows and results of operations in the period recorded. BOND TO SECURE CERTAIN CENTER OBLIGATIONS: In January 2001, U.S. Gypsum obtained a performance bond from Safeco Insurance Company of America ("Safeco") in the amount of $60.3 million to secure certain obligations of U.S. Gypsum for extended payout settlements of Personal Injury Cases and other obligations owed by U.S. Gypsum to the Center. The bond is secured by an irrevocable letter of credit obtained by the Corporation in the amount of $60.3 million and issued by JPMorgan Chase Bank (formerly Chase Manhattan Bank) ("JPMorgan Chase") to Safeco. After the Filing, by a letter dated November 16, 2001, the Center made a demand to Safeco for payment of $15.7 million under the bond, and, by a letter dated December 28, 2001, the Center made a demand to Safeco for payment of approximately $127 million under the bond. The amounts for which the Center made demand were for the payment of, among other things, settlements of Personal Injury Cases that were entered into pre-petition. The total amount demanded by the Center under the bond, approximately $143 million, exceeds the original penal sum of the bond, which is $60.3 million. Safeco has not made any payment under the bond. On November 30, 2001, the Corporation and U.S. Gypsum filed an Adversary Complaint in the Chapter 11 Cases to, among other things, enjoin the Center from drawing on the bond and enjoin Safeco from paying on the bond during the pendency of these bankruptcy proceedings. This Adversary Proceeding is -34- 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. The parties filed cross-motions for summary judgment in the consolidated proceedings. On March 28, 2003, in response to the cross-motions for summary judgment, Judge Wolin issued an order and memorandum opinion which granted in part and denied in part the Center's motion for summary judgment. Although the court ruled that Safeco is not required to remit any surety bond proceeds to the Center at this time, the court stated that certain settlements that were completed before U.S. Gypsum's Petition Date likely are covered by the surety bond but that the bond does not cover settlement payments that were not yet completed as of the Petition Date. The court did not rule on whether the bond covers other disputed obligations and reserved these issues to a subsequent phase of the litigation. As a result of the court's decision, it is likely that, absent a settlement of this matter, some portion of the bond may be drawn but that the amount drawn may be substantially less than the full amount of the bond. To the extent that Safeco were to pay all or any portion of the bond, it is likely that Safeco would draw down the JPMorgan Chase letter of credit to cover the bond payment and JPMorgan Chase would assert a pre-petition claim in a corresponding amount against the Corporation in the bankruptcy proceeding. This matter is stayed due to Judge Wolin's November 5, 2003, order. CONCLUSION: There are many uncertainties associated with the resolution of the asbestos liability in the bankruptcy proceeding. The Corporation will continue to review its asbestos liability as the Chapter 11 Cases progress and as issues relating to the estimation of the Debtors' asbestos liabilities are addressed. If such review results in the Debtors' estimate of the probable liability for present and future asbestos claims being different from the existing reserve, the reserve will be adjusted, and such adjustment could be material to the Corporation's financial position, cash flows and results of operations in the period recorded. 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 -35- undiscounted costs associated with these sites, including site investigations and feasibility costs, site cleanup and remediation, legal costs, and fines and penalties, if any. In addition, environmental costs connected with site cleanups on Corporation-owned property also are covered by reserves established in accordance with the foregoing. The Debtors have been given permission by the Bankruptcy Court to satisfy environmental obligations up to $12 million. The Corporation believes that neither these matters nor any other known governmental proceeding regarding environmental matters will have a material adverse effect upon its financial position, cash flows or results of operations. -36- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION OVERVIEW USG Corporation (the "Corporation") and 10 of its United States subsidiaries (collectively, the "Debtors") are currently operating under chapter 11 of the United States Bankruptcy Code (the "Bankruptcy Code"), an action taken to resolve asbestos claims in a fair and equitable manner, to protect the long-term value of the Debtors' businesses, and to maintain the Debtors' leadership positions in their markets. To properly understand the Corporation and its businesses, investors, creditors or other readers of this report should first understand the nature of this voluntary reorganization process under chapter 11 and the potential impacts the reorganization may have on their rights and interests in the Corporation as described in more detail below. At this point, there is great uncertainty as to the amount of the Debtors' asbestos-related liability and thus the value of any recovery for pre-petition creditors or stockholders under any final plan of reorganization. No plan of reorganization has thus far been proposed. The Corporation had $925 million of cash, cash equivalents, restricted cash and marketable securities as of March 31, 2004, and management believes that this available liquidity plus expected operating cash flows will meet the Corporation's cash needs, including making regular capital investments to maintain and enhance its businesses throughout the chapter 11 proceedings. The Corporation's net sales for the first quarter of 2004 were a record level for any quarter in its history and represented an 18% increase from the same period in 2003. Demand for products sold by the Corporation's North American Gypsum and Building Products Distribution operating segments was strong in the first quarter 2004 due to strength in the new housing and repair and remodel markets in the United States. Shipments of gypsum wallboard were at record levels for the Corporation and the industry in the first quarter and are expected to continue at relatively high levels throughout the remainder of 2004. Industry utilization rates exceeded 90% in the first quarter resulting in a rise of market selling prices for gypsum wallboard. U.S. Gypsum's nationwide average realized selling price for SHEETROCK(R) brand gypsum wallboard was up 14% versus the first quarter of 2003. The Corporation's Worldwide Ceilings operating segment also reported increased first quarter sales as compared with the same period in 2003 primarily due to increased nonresidential repair and remodel activity in the United States, new sales and distribution policies and a surge in sales of ceiling grid. Some grid customers increased purchases in anticipation of reduced supply and higher grid prices associated with a global shortage of steel and the related rise in the cost of steel. The Corporation's gross margin was 16.8% in the first quarter of 2004, up from 13.6% in the first quarter of 2003. Gross margin improved as a result of increased shipments and higher selling prices for all major product lines. However, costs related to natural gas, employee benefits (pension and medical insurance for active employees and retirees), other insurance, and wastepaper used in the manufacture of gypsum wallboard continued to rise in the first quarter and are expected to -37- partially offset price improvement gains in 2004. VOLUNTARY REORGANIZATION UNDER CHAPTER 11 On June 25, 2001 (the "Petition Date"), the Debtors filed voluntary petitions for reorganization (the "Filing") under the Bankruptcy Code. These bankruptcy cases (the "Chapter 11 Cases") are pending in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"). The Debtors intend to address their liability for all present and future asbestos claims, as well as all other pre-petition claims, in a plan or plans of reorganization approved by the Bankruptcy Court. The Debtors currently have the exclusive right to propose a plan of reorganization and have filed a motion with the Bankruptcy Court requesting that the exclusive period be extended to September 1, 2004. The committee representing asbestos personal injury claimants and the legal representative for future asbestos claimants oppose this extension of exclusivity. The Court is expected to rule on the motion on May 24, 2004. By operation of bankruptcy law, the Debtors continue to have the exclusive right to propose a plan at least until such time as the Court rules on the Debtors' motion. The Debtors may seek one or more additional exclusivity extensions depending upon developments in the Chapter 11 Cases. A key factor in determining the recovery of pre-petition creditors or stockholders under any plan of reorganization is the amount that must be provided in the plan to resolve the Debtors' liability for present and future asbestos claims. At this time, there is substantial uncertainty as to the amount that will be required to resolve these asbestos claims and thus whether or to what extent there will be any recovery for pre-petition creditors or stockholders under any plan of reorganization. Our Annual Report on Form 10-K, filed February 24, 2004, discusses the background and principal impacts of the Filing as well as potential federal legislation regarding asbestos personal injury claims. During 2004, there have been developments regarding potential federal legislation. On April 7, 2004, the Fairness in Asbestos Injury Resolution Act of 2004 (Senate Bill 2290, the "FAIR Bill") was introduced in the United States Senate. The FAIR Bill has not been approved by the Senate, has not been introduced in the House of Representatives, and is not law. The FAIR Bill introduced in the Senate is intended to establish a nationally administered trust to compensate asbestos personal injury claimants. In the FAIR Bill's current form, companies that have made past payments for asbestos personal injury claims would be required to contribute amounts to a national trust on a periodic basis to fund claims filed by asbestos personal injury claimants who qualify for payment under the FAIR Bill. The nationally administered trust would be the exclusive remedy for asbestos personal injury claims, and such claims could not be brought in state or federal court during the life of the trust. In the FAIR Bill's current form, the amounts to be paid to the national fund are based on an allocation methodology set forth in the FAIR Bill. The amounts that -38- participants, including the Debtors, would be required to pay are not dischargeable in a bankruptcy proceeding. The FAIR Bill also provides, among other things, that the national fund would terminate if it is determined that the money in the fund is not sufficient to compensate eligible claimants. In such a case, under the terms of the current FAIR Bill, the claimants and defendants would return to the federal court system to resolve claims not paid by the national fund. The text of the FAIR Bill as introduced in the Senate may be found at http://thomas.loc.gov (type in bill number "S. 2290"). Enactment of the FAIR Bill or similar legislation addressing the financial contributions of the Debtors for asbestos personal injury claims would have a material impact on the amount of the Debtor's asbestos personal injury liability and Debtors' Chapter 11 Cases. The outcome of the legislative process, however, is inherently speculative, and it cannot be known whether the FAIR Bill or similar legislation will ever be enacted or, even if enacted, what the terms of the final legislation might be. Many labor organizations, including the AFL-CIO, as well as some Senators, have indicated that they oppose the FAIR Bill as introduced because, among other things, it does not provide sufficient compensation to asbestos claimants. On April 22, 2004, the Senate defeated a motion to proceed with floor consideration of the FAIR Bill. Discussions continue regarding possible revisions to the FAIR Bill that would allow it to move forward, but it is unclear whether these discussions will produce agreements on key issues. It is likely that even if the FAIR Bill is enacted, the terms of the enacted legislation will be different from the current FAIR Bill, and those differences may be material to the FAIR Bill's impact on the Corporation. During the legislative process, the Corporation expects that the Chapter 11 Cases, including the proceedings regarding estimation of the Corporation's asbestos personal injury liabilities, will continue, subject to developments in those cases. See Item 1, Note 13. Litigation, for additional information on the background of asbestos litigation, developments in the Corporation's reorganization proceeding, and estimated cost. ACCOUNTING IMPACT The Corporation is required to follow American Institute of Certified Public Accountants ("AICPA") Statement of Position 90-7 ("SOP 90-7"), "Financial Reporting by Entities in Reorganization under the Bankruptcy Code." Pursuant to SOP 90-7, the Corporation's pre-petition liabilities that are subject to compromise are reported separately on the consolidated balance sheet. Virtually all of the Corporation's pre-petition debt is currently in default and was recorded at face value and classified within liabilities subject to compromise. U.S. Gypsum's asbestos liability also is classified within liabilities subject to compromise. See Item 1. Note 2. Voluntary Reorganization Under Chapter 11, which includes information related to financial statement presentation, the debtor-in-possession statements and detail of liabilities subject to compromise and chapter 11 reorganization expenses. -39- CONSOLIDATED RESULTS OF OPERATIONS NET SALES Net sales in the first quarter of 2004 totaled $1,020 million, a record for any quarter in the Corporation's history and an 18% increase from $862 million in the first quarter of 2003. Net sales increased for all three of the Corporation's operating segments primarily due to increased shipments and higher selling prices for all major product lines. See Core Business Results of Operations below for an explanation of product line results by segment. COST OF PRODUCTS SOLD Cost of products sold in the first quarter of 2004 was $849 million, up 14% from $745 million a year ago. Key factors for this variation were increased product volume and higher costs related to natural gas, employee benefits (pension and medical insurance for active employees and retirees), other insurance, and wastepaper used in the manufacture of gypsum wallboard. GROSS PROFIT Gross profit (net sales less cost of products sold) in the first quarter of 2004 was $171 million, a 46% increase from $117 million in the first quarter of 2003. Gross margin (gross profit as a percent of net sales) was 16.8% in the first quarter of 2004, up from 13.6% in the first quarter of 2003. SELLING AND ADMINISTRATIVE EXPENSES Selling and administrative expenses in the first quarter of 2004 were $77 million, down 4% from $80 million in the first quarter of 2003. This reduction primarily reflected a lower accrual related to the Bankruptcy Court-approved key employee retention plan, the impact of a fourth quarter 2003 salaried workforce reduction program and other cost-reduction initiatives that have resulted in lower overall expenses. These favorable factors were offset in part by higher employee benefit costs (pension and medical insurance for active employees and retirees). As a percent of net sales, selling and administrative expenses were 7.5% in the first quarter of 2004, down from 9.3% in the comparable 2003 period. CHAPTER 11 REORGANIZATION EXPENSES In connection with the Filing, the Corporation recorded chapter 11 reorganization expenses of $2 million in the first quarter of 2004 and 2003. For both periods, these expenses consisted of legal and financial advisory fees of $4 million, partially offset by bankruptcy-related interest income of $2 million. OPERATING PROFIT Operating profit in the first quarter of 2004 was $92 million compared with $35 million in the first quarter of 2003. INTEREST EXPENSE Interest expense of $1 million was incurred in the first quarter of 2004 and 2003. 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 -40- been accrued or recorded since the Petition Date. For the first quarter of 2004, contractual interest expense not accrued or recorded on pre-petition debt totaled $17 million. From the Petition Date through March 31, 2004, contractual interest expense not accrued or recorded on pre-petition debt totaled $203 million. Although no post-petition accruals are required to be made for such contractual interest expense, debtholders may seek to recover such amounts in the Chapter 11 Cases. INTEREST INCOME Non-bankruptcy related interest income of $1 million was recorded in the first quarter of 2004 and 2003. INCOME TAXES Income tax expense amounted to $33 million and $13 million in the first quarter of 2004 and 2003, respectively. The effective tax rates were 36.6% and 38.5% for the respective periods. The decrease in the effective tax rate was primarily due to a reduction in the Corporation's tax reserves resulting from the application of recently finalized IRS regulations to the Chapter 11 reorganization expenses incurred by the Corporation through 2003. CUMULATIVE EFFECT OF ACCOUNTING CHANGE On January 1, 2003, the Corporation adopted Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations." A non-cash, after-tax charge of $16 million ($27 million pretax) was reflected on the consolidated statement of earnings as a cumulative effect of a change in accounting principle as of January 1, 2003. See Item 1. Note 6. Asset Retirement Obligations for additional information related to the adoption of SFAS No. 143. NET EARNINGS Net earnings in the first quarter of 2004 were $57 million, or $1.33 per diluted share. First quarter of 2003 net earnings were $6 million, or $0.13 per diluted share. -41- CORE BUSINESS RESULTS OF OPERATIONS
(dollars in millions) Net Sales Operating Profit ------------------------------------------------------------------------------------------------------------------- Three Months Ended March 31, 2004 2003 2004 2003 ------------------------------------------------------------------------------------------------------------------- NORTH AMERICAN GYPSUM: U.S. Gypsum Company $ 574 $ 496 $ 61 $ 30 CGC Inc. (gypsum) 73 57 13 5 Other subsidiaries* 36 28 7 3 Eliminations (44) (39) - - ------------------------------------------------------------------------------------------------------------------- Total 639 542 81 38 ------------------------------------------------------------------------------------------------------------------- WORLDWIDE CEILINGS: USG Interiors, Inc. 120 110 12 6 USG International 46 40 1 1 CGC Inc. (ceilings) 13 10 2 1 Eliminations (13) (13) - - ------------------------------------------------------------------------------------------------------------------- Total 166 147 15 8 ------------------------------------------------------------------------------------------------------------------- BUILDING PRODUCTS DISTRIBUTION: L&W Supply Corporation 362 295 14 8 ------------------------------------------------------------------------------------------------------------------- Corporate - - (16) (18) Chapter 11 reorganization expenses - - (2) (2) Eliminations (147) (122) - 1 ------------------------------------------------------------------------------------------------------------------- Total USG Corporation 1,020 862 92 35 ===================================================================================================================
*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. NORTH AMERICAN GYPSUM Net sales of $639 million increased 18% from the first quarter of 2003, while operating profit more than doubled to $81 million. Net sales for U.S. Gypsum increased $78 million, or 16%, compared with the first quarter of 2003, while operating profit rose $31 million, or 103%. These increases primarily reflected record shipments of SHEETROCK(R) brand gypsum wallboard and joint compounds and higher selling prices for SHEETROCK(R) brand gypsum wallboard. The company also reported higher sales of DUROCK(R) brand cement board and FIBEROCK(R) brand gypsum fiber panels compared with the first quarter of last year. U.S. Gypsum sold 2.7 billion square feet of SHEETROCK(R) brand gypsum wallboard during the first quarter of 2004, a record for any quarter and an 8% increase from 2.5 billion square feet sold in the first quarter of 2003. U.S. Gypsum's wallboard plants operated at 93% of capacity in the first quarter of 2004 compared with 89% in the first quarter of 2003. Industry shipments of gypsum wallboard were up approximately 10% from the first quarter of 2003. U.S. Gypsum's nationwide average realized selling price for SHEETROCK(R) brand gypsum wallboard was $110.33 per thousand square feet in the first quarter of 2004. This price was up 14% from $97.13 in the first quarter of 2003 and up 4% from $106.01 in the fourth quarter of 2003. -42- The improved pricing and record shipments for gypsum wallboard more than offset the unfavorable effects of higher costs for wastepaper (the primary raw material of wallboard paper), natural gas (a major source of energy for the company) and employee benefits. Natural gas costs for the first quarter were up over 14% versus the prior-year period. However, improved production efficiencies at the company's gypsum wallboard plants offset a portion of the cost increase. Net sales for the gypsum business of Canada-based CGC Inc. increased 28% and operating profit more than doubled to $13 million, as compared with the first quarter of 2003. These results were primarily attributable to record shipments and higher selling prices for SHEETROCK(R) brand gypsum wallboard and joint compounds and a stronger Canadian dollar. WORLDWIDE CEILINGS Net sales of $166 million increased 13%, while operating profit of $15 million rose 88% from the first quarter of 2003. USG Interiors, Inc., the Corporation's domestic ceilings business, reported a $10 million, or 9%, increase in net sales compared with the first quarter of 2003, while operating profit doubled to $12 million. Increased shipments and higher selling prices for ceiling grid and ceiling tile reflected an increase in repair and remodel activity within the U.S. nonresidential construction market as well as the impact of the company's new sales and distribution policies. In addition, concerns over the shortage of steel and related increase in steel costs caused a surge in demand for ceiling grid during the first quarter of 2004. It is unclear how long the higher level of demand for ceiling grid will continue, but the Corporation anticipates that such demand will moderate as the year progresses. The Corporation also expects the cost of steel used in the manufacture of ceiling grid to rise significantly in 2004 due to the global shortage of steel. Net sales for USG International improved 15% compared with the first quarter of 2003, primarily due to increased demand for ceiling grid and tile in Europe and Latin America. However, operating profit of $1 million was unchanged. During the first quarter of 2004, the Corporation completed the sale of the Aubange, Belgium, ceiling tile plant. The Aubange plant was shutdown in the fourth quarter of 2002. The ceilings business of CGC Inc. reported a $3 million increase in net sales and a $1 million increase in operating profit for the first quarter of 2004. BUILDING PRODUCTS DISTRIBUTION L&W Supply Corporation ("L&W Supply"), the leading specialty building products distribution business in the United States, reported net sales of $362 million, a first quarter record and a 23% increase versus the first quarter of 2003. Operating profit for the company rose to $14 million from $8 million. These increases reflect record first quarter shipments of gypsum wallboard and complementary building products, such as drywall metal, ceiling products, joint compound and roofing. Shipments of L&W Supply's gypsum wallboard were up 13% versus the first quarter of 2003, while selling prices increased 8%. -43- L&W Supply operated 184 locations in the United States as of March 31, 2004, compared with 181 locations as of March 31, 2003. MARKET CONDITIONS AND OUTLOOK The gypsum industry experienced a record level of wallboard shipments in the first quarter of 2004 attributable to continued strength in the new housing and the residential remodeling markets. Industry utilization rates exceeded 90% in the first quarter resulting in a rise of market selling prices for gypsum wallboard. However, the overall outlook for the remainder of the year is mixed. The strength of the residential market is expected to continue, although the exceptional strength of the first quarter may abate as the year progresses. The level of demand will depend on the direction of demand factors such as consumer confidence, interest rates and home affordability. Commercial construction, the principal market for the Corporation's ceilings products, continues to be affected by high office vacancy rates. In addition, the Corporation, like many other companies, faces many ongoing cost pressures such as higher prices for natural gas and raw materials and increased employee benefits and insurance costs. The Corporation continues to focus its management attention and investments on improving customer service, manufacturing costs and operating efficiencies, as well as selectively investing to grow its businesses. In addition, the Corporation will diligently continue its attempt to resolve the chapter 11 proceedings, consistent with the goal of achieving a fair, comprehensive and final resolution to its asbestos liability. LIQUIDITY AND CAPITAL RESOURCES LIQUIDITY As of March 31, 2004, the Corporation had $925 million of cash, cash equivalents, restricted cash and marketable securities, of which $210 million of cash and cash equivalents was held by non-Debtor subsidiaries. The total amount of $925 million was down $22 million, or 2%, from $947 million as of December 31, 2003, primarily due to payments of customer rebates and employee incentive compensation in the first quarter and other seasonal working capital needs. Since the Petition Date, the Corporation's level of liquidity has increased due to strong operating cash flows and the absence of cash payments related to asbestos settlements and interest on pre-petition debt. Contractual interest expense not accrued or recorded on pre-petition debt was $17 million in the first quarter of 2004 and $203 million since the Petition Date. -44- CASH FLOWS As shown on the consolidated statement of cash flows, cash and cash equivalents decreased $71 million during the first quarter of 2004. The primary source of cash in the first quarter of 2004 was earnings from operations. Primary uses of cash were: (i) working capital of $117 million (primarily the aforementioned customer rebates, employee incentive compensation and other seasonal needs), (ii) net purchases of marketable securities of $37 million, (iii) capital spending of $20 million, (iv) the designation of $12 million as restricted cash representing cash collateral to support outstanding letters of credit, and (v) the use of $4 million for an acquisition. Comparing the first quarter of 2004 with the first quarter of 2003, net cash used for operating activities was $4 million in the 2004 period compared with $45 million a year ago. This variation was primarily attributable to the increase in first quarter 2004 earnings from operations. Net cash used for investing activities increased to $55 million from $12 million primarily due to first quarter 2004 net purchases of marketable securities. Net cash used for financing activities amounted to $12 million during the first quarter of 2004 due to restricted cash associated with letters of credit issued primarily in relation to purchases of steel from foreign suppliers. WORKING CAPITAL Total working capital (current assets less current liabilities) as of March 31, 2004, amounted to $1,123 million, and the ratio of current assets to current liabilities was 3.50-to-1. As of December 31, 2003, working capital amounted to $1,084 million, and the ratio of current assets to current liabilities was 3.62-to-1. Receivables increased to $451 million as of March 31, 2004, from $321 million as of December 31, 2003, primarily reflecting a 31% increase in net sales for the month of March 2004 as compared with December 2003. Inventories and payables also were up from December 31, 2003, primarily due to the increased level of business. Inventories increased to $304 million from $280 million, and accounts payable increased to $256 million from $202 million. Accrued expenses declined to $179 million from $206 million as of December 31, 2003, primarily due to the payment of employee incentive compensation during the first quarter. MARKETABLE SECURITIES As of March 31, 2004, $277 million was invested in marketable securities, up $37 million from $240 million as of December 31, 2003. Of the first quarter 2004 amount, $236 million was invested in long-term marketable securities and $41 million in short-term marketable securities. The Corporation's marketable securities are classified as available-for-sale securities and reported at fair market value with unrealized gains and losses excluded from earnings and reported in accumulated other comprehensive income (loss) on the consolidated balance sheet. -45- CAPITAL EXPENDITURES Capital spending amounted to $20 million in the first quarter of 2004, compared with $17 million in 2003. As of March 31, 2004, remaining capital expenditure commitments for the replacement, modernization and expansion of operations amounted to $124 million, compared with $51 million as of March 31, 2003. During the bankruptcy proceeding, the Corporation expects to have limited ability to access capital other than its own cash, marketable securities and future cash flows to fund potential future growth opportunities such as new products, acquisitions and joint ventures. Nonetheless, the Corporation expects to be able to maintain a program of capital spending aimed at maintaining and enhancing its businesses. LETTERS OF CREDIT In June 2003, the Corporation entered into a three-year, $100 million credit agreement with LaSalle Bank N.A. (the "LaSalle Facility") to be used exclusively to support the issuance of letters of credit needed to support business operations. As of March 31, 2004, $17 million of letters of credit, which are cash collateralized at 103%, were outstanding. As of March 31, 2004, $1 million of standby letters of credit remained outstanding under a prior debtor-in-possession financing facility. Following the termination of such financing facility in June 2003, the Corporation has been required to cash collateralize 105% of these outstanding letters of credit until the letters of credit either expire or are returned by the beneficiary. As of March 31, 2004, a total of $19 million in cash collateral was posted to back up letters of credit as indicated above and was reported as restricted cash on the consolidated balance sheet. DEBT As of March 31, 2004, 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, 2003, levels and do not include any accruals for post-petition contractual interest expense. EXIT ACTIVITIES In the fourth quarter of 2003, the Corporation recorded a charge of $3 million pretax ($2 million after-tax) for severance related to a salaried workforce reduction of approximately 70 employees. An additional 56 open positions were eliminated. Payments totaling $1 million were made in the fourth quarter of 2003, and a reserve of $2 million was included in accrued expenses on the consolidated balance sheet as of December 31, 2003. The remaining payments of $2 million were made in the first quarter of 2004. -46- OTHER MATTERS LEGAL CONTINGENCIES As a result of the Filing, all pending asbestos lawsuits against the Debtors are stayed, and no party may take any action to pursue or collect on such asbestos claims absent specific authorization of the Bankruptcy Court. See Item 1. Note 13. Litigation for additional information on the background of asbestos litigation, developments in the Corporation's reorganization proceeding and estimated cost. The Corporation and certain of its subsidiaries have been notified by state and federal environmental protection agencies of possible involvement as one of numerous "potentially responsible parties" in a number of so-called "Superfund" sites in the United States. The Corporation believes that neither these matters nor any other known governmental proceeding regarding environmental matters will have a material adverse effect upon its financial position, cash flows or results of operations. See Item 1. Note 13. Litigation for additional information on environmental litigation. CRITICAL ACCOUNTING POLICIES The preparation of the Corporation's financial statements requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses during the periods presented. The Corporation's 2003 Annual Report on Form 10-K, which was filed on February 24, 2004, includes a summary of the critical accounting policies the Corporation believes are the most important to aid in understanding its financial results. There have been no material changes to these critical accounting policies that impacted the Corporation's reported amounts of assets, liabilities, revenues or expenses during the first three months of 2004. FORWARD-LOOKING STATEMENTS This report contains forward-looking statements related to management's expectations about future conditions. The effects of the Filing and the conduct, outcome and costs of the Chapter 11 Cases, as well as the ultimate costs associated with the Corporation's asbestos litigation, including the possible impact of any asbestos-related legislation, may differ from management's expectations. Actual business or other conditions may also differ from management's expectations and accordingly affect the Corporation's sales and profitability or other results. Actual results may differ due to various other factors, including economic conditions such as the levels of construction activity, interest rates, currency exchange rates and consumer confidence; competitive conditions such as price and product competition; shortages in raw materials; increases in raw materials and energy costs; and the unpredictable effects of acts of terrorism or war upon domestic and international economies and financial markets. The Corporation assumes no obligation to update any forward-looking information contained in this report. -47- ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures. The Corporation's chief executive officer and chief financial officer, after evaluating the effectiveness of the Corporation's "disclosure controls and procedures" (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934), have concluded that, as of the end of the fiscal quarter covered by this report on Form 10-Q, the Corporation's disclosure controls and procedures were adequate and designed to ensure that material information relating to the Corporation and its consolidated subsidiaries would be made known to them by others within those entities. (b) Changes in internal control over financial reporting. There was no change in the Corporation's "internal control over financial reporting" (as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934) identified in connection with the evaluation required by Rule 13a-15(d) of the Securities Exchange Act of 1934 that occurred during the fiscal quarter covered by this report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, the Corporation's internal control over financial reporting. -48- REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors of USG Corporation: We have reviewed the accompanying consolidated balance sheets of USG Corporation and subsidiaries as of March 31, 2004 and 2003 and the related consolidated statements of earnings and cash flows for each of the three month periods ended March 31, 2004 and 2003. These interim financial statements are the responsibility of the Corporation's management. We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our reviews, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America. We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheets of USG Corporation and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of earnings, stockholders' equity, and cash flows for each of the two years then ended (not presented herein); and in our report dated February 10, 2004 we expressed an unqualified opinion on those consolidated financial statements and included explanatory paragraphs concerning (i) matters which raise substantial doubt about the Corporation's ability to continue as a going concern; (ii) changes in methods of accounting for asset retirement obligations and goodwill and other intangible assets due to the Corporation's adoption of Statement of Financial Accounting Standards (SFAS) No. 143, "Accounting for Asset Retirement Obligations" in 2003, and SFAS No. 142, "Goodwill and Other Intangible Assets" in 2002; and (iii) the application of proecdures relating to certain disclosures of financial statement amounts related to the 2001 financial statements that were audited by other auditors who have ceased operations and for which we have expressed no opinion or other form of assurance other than with respect to such disclosures. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2003 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. As discussed in Note 2 to the consolidated financial statements, USG Corporation and certain subsidiaries voluntarily filed for Chapter 11 bankruptcy protection on -49- June 25, 2001. The accompanying consolidated financial statements do not purport to reflect or provide for the consequences of the bankruptcy proceedings. In particular, such financial statements do not purport to show (a) as to assets, their realizable value on a liquidation basis or their availability to satisfy liabilities; (b) as to pre-petition liabilities, the amounts that may be allowed for claims or contingencies, or the status and priority thereof; (c) as to stockholder accounts, the effect of any changes that may be made in the capitalization of the Corporation; or (d) as to operations, the effect of any changes that may be made in its business. The accompanying consolidated financial statements have been prepared assuming that the Corporation will continue as a going concern. As discussed in Notes 2 and 13 to the consolidated financial statements, there is significant uncertainty as to the resolution of the Corporation's asbestos litigation, which, among other things, may lead to possible changes in the composition of the Corporation's business portfolio, as well as changes in the ownership of the Corporation. This uncertainty raises substantial doubt about the Corporation's ability to continue as a going concern. Management's plans in regard to these matters are also described in Notes 2 and 13 to the financial statements. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ DELOITTE & TOUCHE LLP DELOITTE & TOUCHE LLP Chicago, Illinois April 28, 2004 -50- PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS See Part I, Item 1. Note 13. Litigation for information concerning the asbestos and related bankruptcy litigation and environmental litigation. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 15. Letter from Deloitte & Touche LLP regarding unaudited financial information. 31.1 Rule 13a - 14(a) Certifications of USG Corporation's Chief Executive Officer 31.2 Rule 13a - 14(a) Certifications of USG Corporation's Chief Financial Officer 32.1 Section 1350 Certifications of USG Corporation's Chief Executive Officer 32.2 Section 1350 Certifications of USG Corporation's Chief Financial Officer (b) Reports on Form 8-K: On February 4, 2004, the Corporation furnished to the SEC a Form 8-K for the purpose of disclosing, under "Item 12. Results of Operations and Financial Condition," its press release containing earnings release information for its fourth quarter of 2003. On February 17, 2004, the Corporation furnished to the SEC a Form 8-K for the purpose of disclosing, under "Item 5. Other Events," its amended by-laws and the charters of its Audit, Governance and Compensation and Organization Committees of the Board of Directors. -51- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. USG CORPORATION By /s/ William C. Foote ----------------------------------- William C. Foote, Chairman, Chief Executive Officer and President By /s/ Richard H. Fleming ----------------------------------- Richard H. Fleming, Executive Vice President and Chief Financial Officer By /s/ D. Rick Lowes ----------------------------------- D. Rick Lowes, Vice President and Controller May 4, 2004 -52-