-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, S6hdP2bOZgvPWQ0v0dpzLAdUzfQKUHemD6iUwA0bV1Zrsu1SoBv5UYXga0GHEtN1 MB7wz9d417baB90HqXnAQQ== 0000950137-05-005305.txt : 20050503 0000950137-05-005305.hdr.sgml : 20050503 20050503153540 ACCESSION NUMBER: 0000950137-05-005305 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20050331 FILED AS OF DATE: 20050503 DATE AS OF CHANGE: 20050503 FILER: COMPANY DATA: COMPANY CONFORMED NAME: USG CORP CENTRAL INDEX KEY: 0000757011 STANDARD INDUSTRIAL CLASSIFICATION: CONCRETE GYPSUM PLASTER PRODUCTS [3270] IRS NUMBER: 363329400 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-08864 FILM NUMBER: 05794905 BUSINESS ADDRESS: STREET 1: 125 SOUTH FRANKLIN STREET STREET 2: DEPARTMENT 188 CITY: CHICAGO STATE: IL ZIP: 60606 BUSINESS PHONE: 312-606-4000 MAIL ADDRESS: STREET 1: DEPARTMENT #188 STREET 2: 125 SOUTH FRANKLIN STREET CITY: CHICAGO STATE: IL ZIP: 60606 10-Q 1 c94755e10vq.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, 2005 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission File Number 1-8864 USG CORPORATION (Exact name of registrant as specified in its charter) Delaware 36-3329400 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.)
125 South Franklin Street, Chicago, Illinois 60606-4678 (Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (312) 606-4000 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes X No ----- ----- Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes X No ----- ----- The number of shares outstanding of the registrant's common stock as of March 31, 2005, was 43,343,283. TABLE OF CONTENTS
Page ---- PART I FINANCIAL INFORMATION Item 1. Financial Statements: Consolidated Statements of Earnings: Three Months Ended March 31, 2005 and 2004 3 Consolidated Balance Sheets: As of March 31, 2005 and December 31, 2004 4 Consolidated Statements of Cash Flows: Three Months Ended March 31, 2005 and 2004 5 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 38 Item 4. Controls and Procedures 50 Report of Independent Registered Public Accounting Firm 52 PART II OTHER INFORMATION Item 1. Legal Proceedings 54 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 54 Item 5. Other Information 54 Item 6. Exhibits 55 Signatures 56
-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, ------------------------- 2005 2004 ----------- ----------- Net sales $ 1,173 $ 1,020 Cost of products sold 959 849 ----------- ----------- Gross profit 214 171 Selling and administrative expenses 89 77 Chapter 11 reorganization expenses 1 2 ----------- ----------- Operating profit 124 92 Interest expense 1 1 Interest income (2) (1) Other expense, net -- 2 ----------- ----------- Earnings before income taxes 125 90 Income taxes 48 33 ----------- ----------- Net earnings 77 57 =========== =========== Basic earnings per common share 1.77 1.33 Diluted earnings per common share 1.77 1.33 Average common shares 43,327,008 43,022,719 Average diluted common shares 43,506,597 43,023,995
See accompanying Notes to Consolidated Financial Statements. -3- USG CORPORATION CONSOLIDATED BALANCE SHEETS (DOLLARS IN MILLIONS) (UNAUDITED)
AS OF AS OF MARCH 31, DECEMBER 31, 2005 2004 --------- ------------ ASSETS Current Assets: Cash and cash equivalents $ 669 $ 756 Short-term marketable securities 178 138 Restricted cash 42 43 Receivables (net of reserves - $15 and $14) 523 413 Inventories 346 338 Income taxes receivable 23 24 Deferred income taxes 7 25 Other current assets 94 53 ------ ------ Total current assets 1,882 1,790 Long-term marketable securities 310 312 Property, plant and equipment (net of accumulated depreciation and depletion - $903 and $878) 1,856 1,853 Deferred income taxes 134 152 Goodwill 43 43 Other assets 150 128 ------ ------ Total Assets 4,375 4,278 ====== ====== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable 268 270 Accrued expenses 194 224 Current portion of long-term debt 1 1 Income taxes payable 94 75 ------ ------ Total current liabilities 557 570 Deferred income taxes 26 25 Other liabilities 417 417 Liabilities subject to compromise 2,241 2,242 Commitments and contingencies Stockholders' Equity: Preferred stock -- -- Common stock 5 5 Treasury stock (256) (256) Capital received in excess of par value 418 417 Accumulated other comprehensive income 49 17 Retained earnings 918 841 ------ ------ Total stockholders' equity 1,134 1,024 ------ ------ Total Liabilities and Stockholders' Equity 4,375 4,278 ====== ======
See accompanying Notes to Consolidated Financial Statements. -4- USG CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN MILLIONS) (UNAUDITED)
THREE MONTHS ENDED MARCH 31, --------------- 2005 2004 ----- ----- OPERATING ACTIVITIES: Net earnings $ 77 $ 57 Adjustments to reconcile net earnings to net cash: Depreciation, depletion and amortization 30 28 Deferred income taxes 15 12 (Increase) decrease in working capital: Receivables (110) (130) Income taxes receivable 1 1 Inventories (8) (24) Payables 17 62 Accrued expenses (26) (26) (Increase) decrease in other assets (9) 6 Increase in other liabilities 2 2 Change in asbestos receivable -- 10 Decrease in liabilities subject to compromise (1) (1) Other, net (2) -- ----- ----- Net cash used for operating activities (14) (3) ----- ----- INVESTING ACTIVITIES: Capital expenditures (33) (20) Purchases of marketable securities (184) (115) Sales or maturities of marketable securities 144 78 Net proceeds from asset dispositions -- 6 Acquisition of business -- (4) Return (deposit) of restricted cash 1 (12) ----- ----- Net cash used for investing activities (72) (67) ----- ----- FINANCING ACTIVITIES: Issuances of common stock 1 -- ----- ----- Net cash provided by financing activities 1 -- ----- ----- Effect of exchange rate changes on cash (2) (1) Net decrease in cash and cash equivalents (87) (71) Cash and cash equivalents at beginning of period 756 700 ----- ----- Cash and cash equivalents at end of period 669 629 ===== ===== SUPPLEMENTAL CASH FLOW DISCLOSURES: Interest paid 1 -- Income taxes paid, net 15 8
See accompanying Notes to Consolidated Financial Statements. -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 2004 Annual Report on Form 10-K which was filed on February 18, 2005. (2) VOLUNTARY REORGANIZATION UNDER CHAPTER 11 On June 25, 2001 (the "Petition Date"), the Corporation and the 10 United States subsidiaries listed below (collectively, the "Debtors") filed voluntary petitions for reorganization (the "Filing") under chapter 11 of the United States Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"). This action was taken to resolve asbestos claims in a fair and equitable manner, to protect the long-term value of the Debtors' businesses, and to maintain the Debtors' leadership positions in their markets. The chapter 11 cases of the Debtors (collectively, the "Chapter 11 Cases") are being jointly administered as In re: USG Corporation et al. (Case No. 01-2094). The Chapter 11 Cases do not include any of the Corporation's non-U.S. subsidiaries. The following subsidiaries filed chapter 11 petitions: United States Gypsum Company ("U.S. Gypsum"); USG Interiors, Inc. ("USG Interiors"); USG Interiors International, Inc.; L&W Supply Corporation ("L&W Supply"); Beadex Manufacturing, LLC; B-R Pipeline Company; La Mirada Products Co., Inc.; Stocking Specialists, Inc.; USG Industries, Inc.; and USG Pipeline Company. The background of asbestos litigation, developments in the Corporation's reorganization proceedings and estimated cost are discussed in Note 12, Litigation. -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. The Debtors are operating their businesses without interruption as debtors-in-possession subject to the provisions of the Bankruptcy Code, and vendors are being paid for goods furnished and services provided after the Filing. The Debtors' Chapter 11 Cases are assigned to Judge Judith K. Fitzgerald, a bankruptcy court judge, and Judge Joy Flowers Conti, a district court judge. Judge Conti will hear matters relating to estimation of the Debtors' liability for asbestos personal injury claims. Other matters will be heard by Judge Fitzgerald. Three creditors' committees, one representing asbestos personal injury claimants (the "Official Committee of Asbestos Personal Injury Claimants"), another representing asbestos property damage claimants (the "Official Committee of Asbestos Property Damage Claimants"), and a third representing unsecured creditors (the "Official Committee of Unsecured Creditors"), were appointed as official committees in the Chapter 11 Cases. In addition, the Bankruptcy Court also appointed Dean M. Trafelet as the legal representative for future asbestos claimants in the Debtors' bankruptcy proceedings. Mr. Trafelet was formerly a judge of the Circuit Court of Cook County, Illinois. Recently, an Official Committee of Equity Security Holders of the Corporation was also appointed. The appointed committees, together with Mr. Trafelet, will play significant roles in the Chapter 11 Cases and resolution of the terms of any plan of reorganization. The Debtors intend to address their liability for all present and future asbestos claims, as well as all other pre-petition claims, in a plan or plans of reorganization approved by the Bankruptcy Court. The Debtors currently have the exclusive right to file a plan of reorganization until June 30, 2005. The Debtors may seek one or more additional extensions of the exclusive period depending upon developments in the Chapter 11 Cases. Any plan of reorganization ultimately approved by the Bankruptcy Court may include one or more independently administered trusts under Section 524(g) of the Bankruptcy Code, which may be funded by the Debtors to allow payment of present and future asbestos personal injury claims. If the confirmed plan of reorganization includes the creation and funding of a Section 524(g) trust relating to one or more of the Debtors, the Bankruptcy Court will issue a permanent injunction barring the assertion of present and future asbestos claims against the relevant Debtors, their successors, and their affiliates, and channeling those claims to the trust for payment in whole or in part. There are several requirements for confirmation of a plan of reorganization containing an asbestos trust with all of the features set -7- forth in Section 524(g). One of the requirements is that the court determine that the asbestos trust will be structured and funded so as to be in a financial position to pay present claims and future demands that involve similar claims in substantially the same manner. Another requirement is that a class or classes of asbestos claimants affected by the trust vote to approve the plan by at least 75% of those voting. Section 524(g) also requires that such trust own (or have the right to acquire if specified contingencies occur) a majority of the voting stock of each relevant Debtor, its parent corporation, or a subsidiary that is also a Debtor. A plan of reorganization, including a plan creating a Section 524(g) trust, may be confirmed without the consent of non-asbestos creditors and stockholders if certain requirements of the Bankruptcy Code are met. The Debtors also expect that the plan of reorganization will address the Debtors' liability for asbestos property damage claims, whether by including those liabilities in a Section 524(g) trust or by other means. Similar plans of reorganization containing Section 524(g) trusts have been confirmed in the chapter 11 cases of other companies with asbestos liabilities, but there is no guarantee that the Bankruptcy Court in the Debtors' Chapter 11 Cases will approve creation of a Section 524(g) trust or issue a permanent injunction channeling to the trust all asbestos claims against the Debtors and/or their successors and affiliates. In addition, if federal legislation addressing asbestos personal injury claims is passed, which is extremely speculative, such legislation may affect whether the Debtors establish a trust under Section 524(g). See Potential Federal Legislation Regarding Asbestos Personal Injury Claims, below. A key factor in determining whether or to what extent there will be any recovery for pre-petition creditors or stockholders under any plan of reorganization is the amount that must be provided in the plan of reorganization to address the Debtors' liability for present and future asbestos claims. The amount of Debtors' asbestos liabilities has not yet been determined and is subject to substantial dispute and uncertainty. The Official Committee of Asbestos Personal Injury Claimants and the legal representative for future asbestos claimants have indicated in a court filing that they estimate that the net present value of the Debtors' liability for present and future asbestos personal injury claims is approximately $5.5 billion and that the Debtors are insolvent. The Debtors have stated that they believe they are solvent if their asbestos liabilities are fairly and appropriately valued. If the amount of Debtors' asbestos liabilities is not resolved through negotiation in the Chapter 11 Cases or addressed by federal legislation, the amount of these liabilities may be determined through litigation proceedings before Judge Conti. See Note 12, Litigation, for additional information regarding Debtors' asbestos liabilities and their estimated cost. While it is the Debtors' intention to seek a full recovery for their -8- creditors, it is not possible to predict the amount that will have to be provided in the plan of reorganization to address present and future asbestos claims, how the plan of reorganization will treat other pre-petition claims, whether there will be sufficient assets to satisfy the Debtors' pre-petition liabilities, and what impact any plan may have on the value of the shares of the Corporation's common stock. The payment rights and other entitlements of pre-petition creditors and the Corporation's stockholders may be substantially altered by any plan of reorganization confirmed in the Chapter 11 Cases. Pre-petition creditors may receive under the plan of reorganization less than 100% of the face value of their claims, the pre-petition creditors of some Debtors may be treated differently from the pre-petition creditors of other Debtors, and the interests of the Corporation's stockholders are likely to be substantially diluted or cancelled in whole or in part. There can be no assurance as to the value of any distributions that might be made under any plan of reorganization with respect to such pre-petition claims or equity interests. It is also not possible to predict how the plan of reorganization will treat intercompany indebtedness, licenses, transfers of goods and services, and other intercompany arrangements, transactions and relationships that were entered into before the Petition Date. Certain of these intercompany transactions have been challenged by various parties in these Chapter 11 Cases, and other arrangements, transactions and relationships may be challenged by parties to these Chapter 11 Cases. The outcome of such challenges may have an impact on the treatment of various claims under any plan of reorganization. In connection with the Filing, the Corporation implemented a Bankruptcy Court-approved key employee retention plan that commenced on July 1, 2001, and continued until June 30, 2004. Effective July 1, 2004, the key employee retention plan, in an amended form, was extended until December 31, 2005. Under the amended plan, participants continue to earn awards semiannually. The amendments introduce a performance feature for the last two (of four) payments to be made under the extended plan which could increase the final two payments up to a maximum of 25% above par or eliminate them altogether. Expenses associated with this plan amounted to $5.4 million and $2.7 million in the first quarter of 2005 and 2004, respectively. Expense was lower in 2004 primarily due to accruals in 2003 and 2002 of amounts that were paid in 2004. POTENTIAL FEDERAL LEGISLATION REGARDING ASBESTOS PERSONAL INJURY CLAIMS On April 19, 2005, Senator Arlen Specter (R. Pa.) introduced in the United States Senate legislation addressing compensation and administration of asbestos personal injury claims. The legislation is titled the Fairness in Asbestos Injury Resolution Act of 2005 (Senate Bill 852, the "FAIR Bill"). The FAIR Bill is co-sponsored by three Democratic Senators and four Republican Senators. The FAIR Bill has been referred to the Senate -9- Committee on the Judiciary. The FAIR Bill has not been approved by the Senate Committee on the Judiciary or the full Senate, has not been considered by the House of Representatives, and is not law. The FAIR Bill introduced in the Senate is intended to establish a nationally administered trust fund to compensate asbestos personal injury claimants. In the FAIR Bill's current form, companies that have made past payments for asbestos personal injury claims would be required to contribute amounts to a national trust fund on a periodic basis that would pay the claims of qualifying asbestos personal injury claimants. The nationally administered trust fund would be the exclusive remedy for asbestos personal injury claims, and such claims could not be brought in state or federal court as long as such claims are being compensated under the national trust fund. A copy of the FAIR Bill as introduced is available at http://thomas.loc.gov (type in "S. 852" in the search field). In the FAIR Bill's current form, the amounts to be paid to the national trust fund are based on an allocation methodology set forth in the FAIR Bill. The amounts that participants, including the Debtors, would be required to pay are not dischargeable in a bankruptcy proceeding. In addition, the FAIR Bill, in its current form, requires affected companies currently in chapter 11, including the Debtors, to make their first payment to the national trust fund not later than 60 days after enactment of the FAIR Bill, notwithstanding the fact that the companies are still in chapter 11 proceedings. The FAIR Bill also provides, among other things, that if it is determined that the money in the trust fund is not sufficient to compensate eligible claimants, the claimants and defendants (including current chapter 11 debtors) would return to the court system to resolve claims not paid by the national trust fund. The outcome of the legislative process is inherently speculative, and it cannot be known whether the FAIR Bill or similar legislation will ever be enacted or, even if enacted, what the terms of the final legislation might be. Previously, in April 2004, a similar, but not identical, bill (the "Fairness in Asbestos Injury Resolution Act of 2004") was introduced in the Senate and was approved by the Senate Committee on the Judiciary, but the full Senate defeated a motion to proceed with floor consideration of the bill. Even if the recently-introduced FAIR Bill is enacted, the terms of the enacted legislation may differ from those of the FAIR Bill as introduced, and those differences may be material to the FAIR Bill's impact on the Corporation. Enactment of the FAIR Bill or similar legislation addressing the financial contributions of the Debtors for asbestos personal injury claims would have a material impact on the amount of the Debtors' asbestos personal injury liability and the Debtors' Chapter 11 Cases. During the legislative process, proceedings in the Chapter 11 Cases will continue. See Consequences of the Filing, above, and Note 12, Litigation. -10- PRE-PETITION LIABILITIES OTHER THAN ASBESTOS PERSONAL INJURY CLAIMS Subsequent to the Filing, the Debtors received approval from the Bankruptcy Court to pay or otherwise honor certain of their pre-petition obligations, including employee wages, salaries, benefits and other employee obligations, and from limited available funds, pre-petition claims of certain critical vendors, real estate taxes, environmental obligations, certain customer programs and warranty claims, and certain other pre-petition claims. Pursuant to the Bankruptcy Code, schedules were filed by the Debtors with the Bankruptcy Court on October 23, 2001, and certain of the schedules were amended on May 31, 2002, December 13, 2002, and September 30, 2004, setting forth the assets and liabilities of the Debtors as of the date of the Filing. The Bankruptcy Court established a bar date of January 15, 2003, by which date proofs of claim were required to be filed against the Debtors for all claims other than asbestos-related personal injury claims as defined in the Bankruptcy Court's order. Approximately 5,000 proofs of claim for general unsecured creditors (including pre-petition debtholders and contingent claims, but excluding asbestos-related claims) totaling approximately $8.7 billion were filed by the bar date. Of this amount, $5.7 billion worth of claims have been withdrawn from the case by creditors. The Debtors have been analyzing the remaining proofs of claim and determined that many of them are duplicates of other proofs of claim or of liabilities previously scheduled by the Debtors. In addition, many claims were filed against multiple Debtors or against an incorrect Debtor, or were incorrectly claiming a priority level higher than general unsecured or an incorrect dollar amount. To date, the court has expunged 264 claims totaling $29.5 million as duplicates; expunged 471 claims totaling $232.4 million as amended or superceded; allowed the reduction of 816 claims by a total of $20.7 million; and allowed the correction of the Debtors on 1,520 claims and the reclassification of 290 claims to general unsecured claims. The Debtors continue to analyze and reconcile filed claims. In addition to the general unsecured claims described in this paragraph, approximately 1,400 asbestos property damage claims were filed as of the bar date. Those claims are described in Note 11, Litigation, Developments in the Reorganization Proceeding. The deadline to bring avoidance actions in the Chapter 11 Cases was June 25, 2003. Avoidance actions could include claims to avoid alleged preferences made during the 90-day period prior to the filing (or one-year period for insiders) and other transfers made or obligations incurred which could be alleged to be constructive or actual fraudulent conveyances under applicable law. Effective prior to the avoidance action deadline, the Bankruptcy Court granted the motion of the committee representing the unsecured creditors to file a complaint seeking to avoid and recover as preferences certain pre-petition payments made by the Debtors to 206 creditors, where such payments, in most cases, exceeded $500,000. The Bankruptcy Court also granted the committee's request to extend the time -11- by which the summons and complaint are served upon each named defendant until 90 days after confirmation of a plan of reorganization filed in connection with the Chapter 11 Cases. In addition, prior to the deadline for filing avoidance actions, certain of the Debtors entered into a Tolling Agreement pursuant to which the Debtors voluntarily agreed to extend the time during which actions could be brought to avoid certain intercompany transactions that occurred during the one-year period prior to the filing of the Chapter 11 Cases. The transactions as to which the Tolling Agreement applies are the creation of liens on certain assets of Debtor subsidiaries in favor of the Corporation in connection with intercompany loan agreements; a transfer by U.S. Gypsum to the Corporation of a 9% interest in the equity of CGC Inc., the principal Canadian subsidiary of the Corporation; and transfers made by the Corporation to USG Foreign Investments, Ltd., a non-Debtor subsidiary. The Bankruptcy Court approved the Tolling Agreement in June 2003. The Debtors expect to address claims for general unsecured creditors through liquidation, estimation or disallowance of the claims. In connection with this process, the Debtors will make adjustments to their schedules and financial statements as appropriate. Any such adjustments could be material to the Corporation's consolidated financial position, cash flows and results of operations in any given period. At this time, it is not possible to estimate the Debtors' liability for these claims. However, it is likely that the Debtors' liability for these claims will be different from the amounts now recorded by the Debtors. Proofs of claim alleging asbestos property damage claims are discussed in Note 12, Litigation, under Developments in the Reorganization Proceeding. FINANCIAL STATEMENT PRESENTATION The accompanying consolidated financial statements have been prepared in accordance with American Institute of Certified Public Accountants ("AICPA") Statement of Position 90-7 ("SOP 90-7"), "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code," and on a going-concern basis, which contemplates continuity of operations, realization of assets and liquidation of liabilities in the ordinary course of business. However, as a result of the Filing, such realization of assets and liquidation of liabilities, without substantial adjustments and/or changes of ownership, are subject to uncertainty. Given this uncertainty, there is substantial doubt about the Corporation's ability to continue as a going concern. Such doubt includes, but is not limited to, a possible change in control of the Corporation, as well as a potential change in the composition of the Corporation's business portfolio. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. While operating as debtors-in-possession under the protection of chapter 11 of the Bankruptcy Code and subject to Bankruptcy Court approval or otherwise as permitted in the ordinary course of business, the Debtors, or any of them, may sell or otherwise dispose of assets and liquidate or settle liabilities for amounts other than those reflected in the consolidated financial statements. Further, a plan of -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 and those expected to be filed in the tort system through 2003. This liability, as well as liability for post-2003 claims, is the subject of significant legal proceedings and negotiation in the Chapter 11 Cases. See Note 12. Litigation for additional information on the background of asbestos litigation, developments in the Corporation's reorganization proceeding and estimated cost. As of the date of this report, virtually all of the Corporation's pre-petition debt is in default due to the Filing and included in liabilities subject to compromise. This includes debt outstanding of $469 million under the pre-petition bank credit facilities and $536 million of other outstanding debt. Payment terms for liabilities subject to compromise will be established as part of a plan of reorganization under the Chapter 11 Cases. Liabilities subject to compromise in the consolidated and debtor-in-possession balance sheets consisted of the following items (dollars in millions): -13-
As of As of March 31, December 31, 2005 2004 --------- ------------ Asbestos reserve $1,061 $1,061 Debt 1,005 1,005 Accounts payable 169 169 Accrued expenses 36 37 Other long-term liabilities 13 13 ------ ------ Subtotal 2,284 2,285 Elimination of intercompany accounts payable (43) (43) ------ ------ Total liabilities subject to compromise 2,241 2,242 ====== ======
INTERCOMPANY TRANSACTIONS In the normal course of business, the Corporation (also referred to as the "Parent Company" in the following discussion of intercompany transactions) and the operating subsidiaries engage in intercompany transactions. To document the relations created by these transactions, the Parent Company and the operating subsidiaries, from the formation of the Corporation in 1985, have been parties to intercompany loan agreements that evidence their obligations as borrowers or rights as lenders arising out of intercompany cash transfers and various allocated intercompany charges (the "Intercompany Corporate Transactions"). The Corporation operates a consolidated cash management system under which the cash receipts of the domestic operating subsidiaries are ultimately concentrated in Parent Company accounts. Cash disbursements for those operating subsidiaries originate from those Parent Company concentration accounts. Allocated intercompany charges from the Parent Company to the operating subsidiaries primarily include expenses related to rent, property taxes, information technology, and research and development, while allocated intercompany charges between certain operating subsidiaries primarily include expenses for shared marketing, sales, customer service, engineering and accounting services. Detailed accounting records are maintained of all cash flows and intercompany charges through the system in either direction. Net balances, receivables or payables of such cash transactions are reviewed on a regular basis with interest earned or accrued on the balances. During the first six months of 2001, the Corporation took steps to secure the obligations from each of the principal domestic operating subsidiaries under the intercompany loan agreements when it became clear that the asbestos liability claims of U.S. Gypsum were becoming an increasingly greater burden on the Corporation's cash resources. As of March 31, 2005, U.S. Gypsum and USG Interiors had net pre-petition payable balances to the Parent Company for Intercompany Corporate Transactions of $295 million and $109 million, respectively. L&W Supply had a net pre-petition receivable balance from the Parent Company of $33 million. These pre-petition balances are subject to the provisions of the -14- Tolling Agreement discussed above. See Pre-Petition Liabilities Other Than Asbestos Personal Injury Claims, above. As of March 31, 2005, U.S. Gypsum and L&W Supply had net post-petition receivable balances from the Parent Company for Intercompany Corporate Transactions of $354 million and $227 million, respectively. USG Interiors had a net post-petition payable balance to the Parent Company of $5 million. In addition to the above transactions, the operating subsidiaries engage in ordinary course purchase and sale of products with other operating subsidiaries (the "Intercompany Trade Transactions"). Detailed accounting records also are maintained of all such transactions, and settlements are made on a monthly basis. Certain Intercompany Trade Transactions between U.S. and non-U.S. operating subsidiaries are settled via wire transfer payments utilizing several payment systems. CHAPTER 11 REORGANIZATION EXPENSES Chapter 11 reorganization expenses in the consolidated and debtor-in-possession statements of earnings consisted of the following (dollars in millions):
Three Months ended March 31, ------------------ 2005 2004 ---- ---- Legal and financial advisory fees $ 6 $ 4 Bankruptcy-related interest income (5) (2) --- --- Total chapter 11 reorganization expenses 1 2 === ===
INTEREST EXPENSE Contractual interest expense not accrued or recorded on pre-petition debt totaled $19 million in the first quarter of 2005. From the Petition Date through March 31, 2005, contractual interest expense not accrued or recorded on pre-petition debt totaled $276 million. This calculation assumes that all such interest was paid when required at the applicable contractual interest rate (after giving effect to any applicable default rate). However, the calculation excludes the impact of any compounding of interest on unpaid interest that may be payable under the relevant contractual obligations, as well as any interest that may be payable under a plan of reorganization to trade or other creditors that are not otherwise entitled to interest under the express terms of their claims. The impact of compounding alone would have increased the contractual interest expense reported above by $6 million in the first quarter of 2005 and $40 million from the Petition Date through March 31, 2005. For financial reporting purposes, no post-petition accruals have been made for contractual interest expense not accrued or recorded on pre-petition debt. On April 11, 2005, the Unsecured Creditors Committee filed a motion with the bankruptcy court requesting that the Debtors make interest payments to -15- all non-asbestos unsecured creditors for interest accrued from January 1, 2005, on liquidated, undisputed pre-petition claims (including accrued unpaid interest through December 31, 2004). If approved, this would require the Debtors to make interest payments of approximately $84 million on an annual basis. DIP FINANCIAL STATEMENTS Under the Bankruptcy Code, the Corporation is required to file periodically with the Bankruptcy Court various documents including financial statements of the Debtors (the Debtor-In-Possession or "DIP" financial statements). The Corporation cautions that these financial statements are prepared according to requirements under the Bankruptcy Code. While these financial statements accurately provide information required under the Bankruptcy Code, they are nonetheless unconsolidated, unaudited and prepared in a format different from that used in the Corporation's consolidated financial statements filed under the securities laws. Accordingly, the Corporation believes the substance and format do not allow meaningful comparison with the Corporation's regular publicly disclosed consolidated financial statements. The Debtors consist of the Corporation and the following wholly owned subsidiaries: U.S. Gypsum; USG Interiors; USG Interiors International, Inc.; L&W Supply; Beadex Manufacturing, LLC; B-R Pipeline Company; La Mirada Products Co., Inc.; Stocking Specialists, Inc.; USG Industries, Inc.; and USG Pipeline Company. The condensed financial statements of the Debtors are presented as follows: USG CORPORATION DEBTOR-IN-POSSESSION STATEMENT OF EARNINGS (DOLLARS IN MILLIONS) (UNAUDITED)
THREE MONTHS ENDED MARCH 31, --------------- 2005 2004 ------ ---- Net sales $1,058 $918 Cost of products sold 877 795 Selling and administrative expenses 76 65 Chapter 11 reorganization expenses 1 2 Interest expense 1 1 Interest income (1) -- Other income, net (1) -- ------ ---- Earnings before income taxes 105 55 Income taxes 43 26 ------ ---- Net earnings 62 29 ====== ====
-16- USG CORPORATION DEBTOR-IN-POSSESSION BALANCE SHEETS (DOLLARS IN MILLIONS) (UNAUDITED)
AS OF AS OF MARCH 31, DECEMBER 31, 2005 2004 --------- ------------ ASSETS Current Assets: Cash and cash equivalents $ 462 $ 516 Short-term marketable securities 168 135 Restricted cash 39 38 Receivables (net of reserves - $11 and $10) 448 373 Inventories 283 275 Income taxes receivable 23 24 Deferred income taxes 7 25 Other current assets 85 45 ------ ------ Total current assets 1,515 1,431 Long-term marketable securities 278 276 Property, plant and equipment (net of accumulated depreciation and depletion - $751 and $728) 1,607 1,604 Deferred income taxes 134 152 Goodwill 43 43 Other assets 381 361 ------ ------ Total Assets 3,958 3,867 ====== ====== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable 232 237 Accrued expenses 174 203 Income taxes payable 86 58 ------ ------ Total current liabilities 492 498 Other liabilities 391 391 Liabilities subject to compromise 2,241 2,242 Stockholders' Equity: Preferred stock -- -- Common stock 5 5 Treasury stock (256) (256) Capital received in excess of par value 101 101 Accumulated other comprehensive income 39 3 Retained earnings 945 883 ------ ------ Total stockholders' equity 834 736 ------ ------ Total Liabilities and Stockholders' Equity 3,958 3,867 ====== ======
-17- USG CORPORATION DEBTOR-IN-POSSESSION STATEMENTS OF CASH FLOWS (DOLLARS IN MILLIONS) (UNAUDITED)
THREE MONTHS ENDED MARCH 31, --------------- 2005 2004 ----- ----- OPERATING ACTIVITIES: Net earnings $ 62 $ 29 Adjustments to reconcile net earnings to net cash: Depreciation, depletion and amortization 26 23 Deferred income taxes 14 12 (Increase) decrease in working capital: Receivables (75) (107) Income taxes receivable 1 (1) Inventories (8) (23) Payables 23 64 Accrued expenses (25) (26) Decrease in post-petition intercompany receivable -- 12 (Increase) decrease in other assets (5) 7 Increase in other liabilities 2 1 Change in asbestos receivables -- 10 Decrease in liabilities subject to compromise (1) (1) Other, net (4) (1) ----- ----- Net cash provided by (used for) operating activities 10 (1) ----- ----- INVESTING ACTIVITIES: Capital expenditures (28) (17) Purchases of marketable securities (176) (115) Sale or maturities of marketable securities 140 78 Net proceeds from asset dispositions -- 1 Acquisition of business -- (4) Deposit of restricted cash (1) (12) ----- ----- Net cash used for investing activities (65) (69) ----- ----- FINANCING ACTIVITIES: Issuances of common stock 1 -- ----- ----- Net cash provided by financing activities 1 -- ----- ----- Net decrease in cash and cash equivalents (54) (70) Cash and cash equivalents at beginning of period 516 489 ----- ----- Cash and cash equivalents at end of period 462 419 ===== ===== SUPPLEMENTAL CASH FLOW DISCLOSURES: Interest paid -- -- Income taxes paid, net 1 4
-18- (3) EARNINGS PER SHARE Basic earnings per share are based on the weighted average number of common shares outstanding. Diluted earnings per share are based on the weighted average number of common shares outstanding and the dilutive effect of the potential exercise of outstanding stock options. Diluted earnings per share exclude the potential exercise of outstanding stock options for any period in which such exercise would have an anti-dilutive effect. The reconciliation of basic earnings per share to diluted earnings per share is shown in the following table (dollars in millions, except share data):
Weighted Average Net Shares Per-Share Three Months Ended March 31, Earnings (000) Amount - ---------------------------- -------- ------ --------- 2005: Basic earnings $77 43,327 $1.77 Dilutive effect of stock options 180 --- ------ ----- Diluted earnings 77 43,507 1.77 === ====== ===== 2004: Basic earnings 57 43,023 1.33 Dilutive effect of stock options 1 --- ------ ----- Diluted earnings 57 43,024 1.33 === ====== =====
(4) ASSET RETIREMENT OBLIGATIONS Changes in the liability for asset retirement obligations consisted of the following (dollars in millions):
Three Months ended March 31 --------------------------- 2005 2004 ---- ---- Balance as of January 1 $43 $35 Accretion expense -- -- Liabilities incurred -- -- Liabilities settled -- -- Foreign currency translation -- -- --- --- Balance as of March 31 43 35 === ===
-19- (5) MARKETABLE SECURITIES The Corporation's investments in marketable securities consisted of the following (dollars in millions):
As of As of March 31, 2005 December 31, 2004 ---------------- ----------------- Amortized Amortized Cost FMV Cost FMV --------- ---- --------- ---- Asset-backed securities $179 $178 $174 $173 U.S. government and agency securities 146 145 121 121 Municipal securities 30 30 36 36 Corporate securities 131 131 112 112 Time deposits 4 4 8 8 ---- ---- ---- ---- Total marketable securities 490 488 451 450 ==== ==== ==== ====
Contractual maturities of marketable securities as of March 31, 2005, were as follows (dollars in millions):
Fair Amortized Market Cost Value --------- ------ Due in 1 year or less $175 $174 Due in 1-5 years 89 89 Due in 5-10 years 3 3 Due after 10 years 44 44 ---- ---- 311 310 Asset-backed securities 179 178 ---- ---- Total marketable securities 490 488 ==== ====
The average duration of the portfolio is less than one year because a majority of the longer-term securities have paydown or put features and liquidity facilities. Investments in marketable securities that were in an unrealized loss position for less than 12 months consisted of the following (dollars in millions):
As of As of March 31, 2005 December 31, 2004 ---------------- ----------------- Asset-backed securities $145 $149 U.S. government and agency securities 129 83 Corporate securities 47 34 ---- ---- Total FMV 321 266 ---- ---- Aggregate amount of unrealized losses 2 1 ==== ====
-20- The fair market value of investments that had been in a continuous unrealized loss position for a period greater than 12 months amounted to $13 million and $2 million as of March 31, 2005 and December 31, 2004, respectively. The unrealized losses for those investments were not material. (6) DERIVATIVE INSTRUMENTS The Corporation uses derivative instruments to manage selected commodity price and foreign currency exposures. The Corporation does not use derivative instruments for trading purposes. All derivative instruments are recorded on the balance sheet at fair value. For derivatives designated as fair value hedges, the changes in the fair values of both the derivative instrument and the hedged item are recognized in earnings in the current period. For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is recorded to accumulated other comprehensive income ("OCI") on the balance sheet and is reclassified to earnings when the underlying transaction has an impact on earnings. The ineffective portion of changes in the fair value of the derivative is reported in cost of products sold. The amount of ineffectiveness amounted to a pretax gain of $1.6 million in the first quarter of 2005. As of March 31, 2005, the Corporation had no foreign currency contracts. COMMODITY DERIVATIVE INSTRUMENTS The Corporation uses swap contracts to hedge most anticipated purchases of natural gas to be used in its manufacturing operations. As of March 31, 2005, the Corporation had swap contracts to exchange monthly payments on notional amounts of natural gas amounting to $266 million. These contracts mature by December 31, 2007. As of March 31, 2005, the fair value of these swap contracts, which remained in OCI, was a $67 million ($41 million after-tax) unrealized gain. Net after-tax gains or losses resulting from the termination of natural gas swap contracts are recorded to OCI and reclassified into earnings in the period in which the hedged forecasted transactions are scheduled to occur. As of March 31, 2005, $2 million ($1 million after-tax) of such gains are included in OCI. COUNTERPARTY RISK The Corporation is exposed to credit losses in the event of nonperformance by the counterparties on its financial instruments. All counterparties have investment grade credit standing; accordingly, the Corporation anticipates that these counterparties will be able to satisfy fully their obligations under the contracts. The Corporation does not generally obtain collateral or other security to support financial instruments subject to credit risk. However, the Corporation may be required to post collateral if aggregate payables exceed certain limits. Currently, there is no collateral requirement. The Corporation enters into master agreements which contain netting arrangements that minimize counterparty credit exposure. -21- (7) COMPREHENSIVE INCOME The components of comprehensive income are summarized in the following table (dollars in millions):
Three Months ended March 31 -------------- 2005 2004 ---- ---- Net earnings $ 77 $57 ---- --- Pretax gain on derivatives 59 13 Income tax expense (23) (5) ---- --- After-tax gain on derivative 36 8 ---- --- Foreign currency translation (4) (2) ---- --- Unrealized gain (loss) on marketable securities -- -- ---- --- Total comprehensive income 109 63 ==== ===
There was no tax impact on the foreign currency translation adjustments. OCI consisted of the following (dollars in millions):
As of As of March 31, 2005 December 31, 2004 ---------------- ----------------- Gain on derivatives, net of tax $42 $ 6 Foreign currency translation 11 15 Minimum pension liability, net of tax (3) (3) Unrealized loss on marketable securities, net of tax (1) (1) --- --- Total 49 17 === ===
During the first quarter of 2005, accumulated net after-tax gains of $2 million ($3 million pretax) on derivatives were reclassified from OCI to earnings. As of March 31, 2005, the estimated net after-tax gain expected to be reclassified within the next 12 months from OCI to earnings is $33 million. -22- (8) EMPLOYEE RETIREMENT PLANS The components of net pension and postretirement benefits costs for the three months ended March 31, 2005 and 2004 are summarized in the following table (dollars in millions):
Three Months ended March 31 ------------------ 2005 2004 ---- ---- PENSION: Service cost of benefits earned $ 9 $ 7 Interest cost on projected benefit obligation 14 13 Expected return on plan assets (14) (13) Net amortization 5 5 ---- ---- Net cost 14 12 ==== ==== POSTRETIREMENT: Service cost of benefits earned $ 3 $ 4 Interest cost on projected benefit obligation 5 5 Net amortization (1) -- ---- ---- Net cost 7 9 ==== ====
In accordance with the Corporation's funding policy, the Corporation and its subsidiaries contributed cash of $21 million during the first quarter of 2005 and expect to contribute cash of approximately $70 million during the full year 2005 to their pension plans. (9) STOCK-BASED COMPENSATION The Corporation accounts for stock-based compensation using the intrinsic value method, which measures compensation cost as the quoted market price of the stock at the date of grant less the grant price, if any, that the employee is required to pay. If the Corporation had elected to recognize compensation cost for stock-based compensation grants using the fair value method, net earnings and net earnings per common share would not have changed because stock options issued prior to the Filing are fully vested and no stock options have been issued subsequent to the Filing. As of March 31, 2005, common shares totaling 1,898,350 were reserved for future issuance in conjunction with existing stock option grants. In addition, 3,009,370 common shares were reserved for future grants. Shares issued in option exercises may be from original issue or available treasury shares. -23- (10) OPERATING SEGMENTS The Corporation's operations are organized into three operating segments: (i) North American Gypsum, which manufactures SHEETROCK(R) brand gypsum wallboard and joint compound, DUROCK(R) brand cement board, FIBEROCK(R) brand gypsum fiber panels and other related building products in the United States, Canada and Mexico; (ii) Worldwide Ceilings, which manufactures ceiling tile in the United States and ceiling grid in the United States, Canada, Europe and the Asia-Pacific region; and (iii) Building Products Distribution, which distributes gypsum wallboard, drywall metal, ceiling products, joint compound and other building products throughout the United States. Operating segment results were as follows (dollars in millions):
Net Sales Operating Profit --------------- ---------------- Three Months Ended March 31, 2005 2004 2005 2004 - ---------------------------- ------ ------ ---- ---- North American Gypsum $ 725 $ 639 $107 $ 81 Worldwide Ceilings 170 166 12 15 Building Products Distribution 456 362 26 14 Eliminations (178) (147) 3 -- Corporate -- -- (23) (16) Chapter 11 reorganization expenses -- -- (1) (2) ------ ------ ---- ---- Total 1,173 1,020 124 92 ====== ====== ==== ====
(11) INCOME TAXES On October 22, 2004, the President signed the American Jobs Creation Act of 2004 (the "Act"). The Act creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain dividends from controlled foreign corporations. The deduction is subject to several limitations, and currently, uncertainty remains as to how to interpret numerous provisions in the Act. As a result, the Corporation is not yet able to determine whether, and to what extent, it will repatriate foreign earnings that have not yet been remitted to the United States. Based on the Corporation's analysis to date, however, it is reasonably possible that the Corporation may repatriate between zero and $50 million of unremitted foreign earnings as a result of the repatriation provision. It is not possible at this time to estimate the range of income tax effects of any such repatriation. The Corporation expects to complete its evaluation of this matter within a reasonable period of time after the current uncertainty in the law is resolved. -24- (12) LITIGATION ASBESTOS AND RELATED BANKRUPTCY LITIGATION One of the Corporation's subsidiaries, U.S. Gypsum, is among many defendants in more than 100,000 asbestos lawsuits alleging personal injury or property damage liability. Most of the asbestos lawsuits against U.S. Gypsum seek compensatory and, in many cases, punitive damages for personal injury allegedly resulting from exposure to asbestos-containing products (the "Personal Injury Cases"). Certain of the asbestos lawsuits seek to recover compensatory and, in many cases, punitive damages for costs associated with the maintenance or removal and replacement of asbestos-containing products in buildings (the "Property Damage Cases"). U.S. Gypsum's asbestos liability derives from its sale of certain asbestos-containing products beginning in the late 1920s. In most cases, the products were discontinued or asbestos was removed from the formula by 1972, and no asbestos-containing products were produced after 1978. In addition to the Personal Injury Cases pending against U.S. Gypsum, two other Debtors, L&W Supply and Beadex Manufacturing, LLC ("Beadex"), have been named as defendants in a small number of asbestos personal injury cases. The Official Committee of Asbestos Personal Injury Claimants, the legal representative for future asbestos claimants, and the Official Committee of Asbestos Property Damage Claimants have also asserted in a court filing that the Debtors are liable for the asbestos liabilities of A.P. Green Refractories Co. ("A.P. Green"). More information regarding the Property Damage and Personal Injury Cases against U.S. Gypsum and the asbestos personal injury cases against L&W Supply, Beadex, and A.P. Green is set forth below. The amount of the Debtors' present and future asbestos liabilities is the subject of significant dispute in Debtors' Chapter 11 Cases. If the amount of the Debtors' asbestos liabilities is not resolved through negotiation in the Chapter 11 Cases or addressed by federal legislation, the amount of those liabilities may be determined through litigation proceedings in the Chapter 11 Cases. DEVELOPMENTS IN THE REORGANIZATION PROCEEDING: The Debtors' Chapter 11 Cases are assigned to Judge Judith K. Fitzgerald, a bankruptcy court judge, and Judge Joy Flowers Conti, a district court judge, who was assigned to the Debtors' Chapter 11 Cases in September 2004. Judge Conti will hear matters relating to estimation of the Debtors' liability for asbestos personal injury claims. Other matters will be heard by Judge Fitzgerald. The Debtors have requested the Court to conduct hearings to estimate Debtors' asbestos personal injury liability, taking into account the legal and -25- scientific issues that govern the validity of claims. In 2002, the Debtors filed a motion requesting Judge Wolin, the district court judge then assigned to Debtors' Chapter 11 Cases, to conduct such estimation hearings. The Debtors requested that the Court hear evidence and make rulings regarding the characteristics of valid asbestos personal injury claims against the Debtors and then estimate the Debtors' liability for present and future asbestos personal injury claims based upon these rulings. Key liability issues include: whether claimants who do not have objective evidence of asbestos-related disease have valid claims and are entitled to be compensated by the Debtors or whether such claimants are entitled to compensation only if and when they develop asbestos-related disease; what are the characteristics and number of present and future claimants who are likely to have had any, or sufficient, exposure to the Debtors' products; whether the particular type of asbestos present in certain of the Debtors' products during the relevant time has been shown to cause cancer; and what are the appropriate claim values to apply in the estimation process. The Official Committee of Asbestos Personal Injury Claimants and the legal representative for future asbestos claimants oppose the type of estimation hearings proposed by the Debtors. The committee and the legal representative contend that the Debtors' liability for present and future asbestos personal injury claims should be based on extrapolation from the settlement history of such claims and not on litigating liability issues in the bankruptcy proceedings. The committee and the legal representative also contend that the Bankruptcy Court does not have the power to deny recovery to claimants on the grounds that they do not have objective evidence of disease or do not have adequate exposure to the Debtors' products where such claimants, or claimants with similar characteristics, are compensated in the tort system outside of bankruptcy. In response to the Debtors' motion seeking substantive estimation of the Debtors' asbestos personal injury liability, Judge Wolin issued a Memorandum Opinion and Order (the "Order") on February 19, 2003, setting forth a procedure for estimating the Debtors' liability for present and future asbestos personal injury claims alleging cancer. The Order provided that the Court would hold an estimation hearing regarding these cancer claims, at which time the "debtors will be permitted to present their defenses." No timetable was set for implementation of the Order or any hearing on estimation of the Debtors' liability for cancer claims. In 2002, the Debtors also filed a motion requesting a ruling that putative claimants who cannot satisfy objective standards of asbestos-related disease are not entitled to vote on a Section 524(g) plan. To date, there has been no ruling or hearing on the motion. In May 2004, in response to a motion by Debtors and the Official Committee of Unsecured Creditors, the Third Circuit Court of Appeals issued an opinion and -26- order directing Judge Wolin to remove himself from presiding over Debtors' Chapter 11 Cases. In September 2004, the Third Circuit Court of Appeals assigned Judge Conti to Debtors' Chapter 11 Cases to replace Judge Wolin. After the assignment of Judge Conti to Debtors' Chapter 11 Cases, the Debtors renewed their request that the court conduct substantive estimation hearings regarding Debtors' asbestos personal injury liability and that these hearings relate to all asbestos personal injury claims, not just those alleging cancer. The Official Committee of Asbestos Personal Injury Claimants and the legal representative for future asbestos personal injury claimants renewed their request that estimation of Debtors' asbestos personal injury liability be based solely on extrapolation from U.S. Gypsum's settlement history. Judge Conti has not yet made a decision as to when she will conduct a hearing to estimate Debtors' asbestos personal injury liability, which issues she will consider in estimating Debtors' liability, or whether she will address the validity and voting rights of non-malignant claims where there is no objective evidence of asbestos-related disease. In the third quarter of 2004, the parties, including the committees, engaged in non-binding mediation relating to the Debtors' asbestos personal injury liability and the potential terms of a plan of reorganization. The mediation did not result in an agreement regarding the Debtors' asbestos liability or the terms of a plan of reorganization. In the fourth quarter of 2004, the Debtors other than U.S. Gypsum filed a complaint for declaratory relief in the Bankruptcy Court requesting a ruling that the assets of the Debtors other than U.S. Gypsum are not available to satisfy the asbestos liabilities of U.S. Gypsum. The Official Committee of Unsecured Creditors has joined the Debtors in this action. In opposition, the Official Committee of Asbestos Personal Injury Claimants, the legal representative for future asbestos personal injury claimants, and the Official Committee of Asbestos Property Damage Claimants filed counterclaims asserting that the assets of all Debtors should be available to satisfy the asbestos liabilities of U.S. Gypsum under various asserted legal grounds, including successor liability, piercing the corporate veil, and substantive consolidation. If the assets of all Debtors are pooled for the payment of all liabilities, including the asbestos liabilities of U.S. Gypsum, this could materially and adversely affect the recovery rights of creditors of Debtors other than U.S. Gypsum as well as the holders of the Corporation's equity. The Official Committee of Asbestos Personal Injury Claimants, the legal representative for future asbestos claimants, and the Official Committee of Asbestos Property Damage Claimants have also asserted claims seeking a declaratory judgment that L&W Supply has direct liability for asbestos personal injury claims on the asserted grounds that L&W Supply distributed asbestos-containing products and assumed the liabilities of former U.S. -27- Gypsum subsidiaries that distributed such products. The Official Committee of Asbestos Personal Injury Claimants, the legal representative for future asbestos claimants, and the Official Committee of Asbestos Property Damage Claimants also have asserted in a court filing that the Debtors are liable for claims arising from the sale of asbestos-containing products by A.P. Green Refractories Co. ("A.P. Green"). They allege that U.S. Gypsum is liable for A.P. Green's liabilities due to U.S. Gypsum's acquisition by merger of A.P. Green in 1967 and that, pursuant to the merger documents, U.S. Gypsum assumed A.P. Green's liabilities. They also allege that the other Debtors are liable for U.S. Gypsum's liabilities, including the alleged liabilities of A.P. Green, under various asserted legal grounds, including successor liability, piercing the corporate veil, and substantive consolidation. A.P. Green, which manufactured and sold products used in refractories, was acquired through a merger of A.P. Green into U.S. Gypsum on December 29, 1967. On the next business day, January 2, 1968, U.S. Gypsum conveyed A.P. Green's assets and liabilities to a newly formed Delaware corporation and wholly owned subsidiary of U.S. Gypsum, also called A.P. Green Refractories Co. (this newly formed corporation is also referred to herein as "A.P. Green"). A.P. Green was operated as a wholly owned subsidiary of U.S. Gypsum until 1985, at which time A.P. Green became a wholly owned subsidiary of USG Corporation. In 1988, A.P. Green became a publicly traded company when its shares were distributed to the stockholders of USG Corporation. In February 2002, A.P. Green (now known as A.P. Green Industries, Inc.) as well as its parent company, Global Industrial Technologies, Inc., and other affiliates filed voluntary petitions for reorganization through which A.P. Green and its affiliates seek to resolve their asbestos liabilities. The A.P. Green reorganization proceeding is pending in the United States Bankruptcy Court for the Western District of Pennsylvania and is captioned In re: Global Industrial Technologies, Inc. (Case No. 02-21626). The draft disclosure statement filed in July 2003 by the debtors in the A.P. Green reorganization proceedings indicates that, in early 2002, there were 235,757 asbestos personal injury claims pending against A.P. Green as well as about 59,000 such claims pending against an A.P. Green affiliate, and that A.P. Green estimates that several hundred thousand additional claims will be asserted against it and/or its affiliate. The disclosure statement also indicates that, in early 2002, A.P. Green had approximately $492 million in unpaid pre-petition settlements and judgments relating to asbestos personal injury claims. The disclosure statement does not provide an estimate of the cost of resolving A.P. Green's liability for pending or future asbestos claims. The Corporation does not have sufficient information to predict whether or how any plan of reorganization in the Debtors' Chapter 11 Cases might address any liability based on sales of asbestos-containing products by A.P. Green. The Corporation also does not have sufficient information to estimate the amount, or range of amounts, of A.P. Green's asbestos liabilities. If U.S. Gypsum is determined to be liable for the sale of asbestos-containing products by A.P. Green or its affiliates, this result likely would materially increase the amount of U.S. Gypsum's present and future asbestos liabilities. Such a result could materially and adversely affect the recovery of other Debtors' pre-petition creditors and the Corporation's stockholders, depending upon, among other things, the amount of A.P. Green's alleged asbestos -28- liabilities and whether the other Debtors are determined to be liable for U.S. Gypsum's liabilities, including A.P. Green liabilities. With regard to asbestos property damage claims, the Bankruptcy Court established a bar date requiring all such claims against the Debtors to be filed by January 15, 2003. Approximately 1,400 asbestos property damage claims were filed, representing more than 2,000 buildings. In contrast, as of the Petition Date, 11 Property Damage Cases were pending against U.S. Gypsum. Approximately 500 of the asbestos property damage claims filed by the bar date assert a specific dollar amount of damages, and the total damages alleged in those claims is approximately $1.6 billion. However, this amount reflects numerous duplicate claims filed against multiple Debtors. Approximately 900 claims do not specify a damage amount. Recently, counsel for the Official Committee of Asbestos Property Damage Claimants stated in a court hearing that the committee believes that the amount of the asbestos property damage claims will reach $1 billion. Most of the asbestos property damage claims filed do not provide evidence that the Debtors' products were ever installed in any of the buildings at issue. Certain of the proof of claim forms purport to file claims on behalf of two classes of claimants that were the subject of pre-petition class actions. One of these claim forms was filed on behalf of a class of colleges and universities that was certified for certain purposes in a pre-petition lawsuit filed in federal court in South Carolina. However, many of the putative members of this class also filed individual claim forms. Four of the claim forms were filed by a claimant allegedly on behalf of putative members of certified and uncertified classes in connection with a pre-petition lawsuit pending in South Carolina state court. The Debtors believe that they have substantial defenses to many of the property damage claims, including the lack of evidence that the Debtors' products were ever installed in the buildings at issue, the failure to file the claims within the applicable statutes of limitation, and the lack of evidence that the claimants have any injury or damages. The Debtors intend to address many of these claims through an objection and disallowance process in the Bankruptcy Court. Beginning in late 2004, the Debtors began filing objections to asbestos property damage claims that did not provide any evidence that the Debtors' products were installed in the buildings at issue. To date, in response to these objections, the Court has disallowed approximately 395 asbestos property damage claims for failure to provide sufficient product identification evidence. Debtors expect to file additional objections to claims that have not provided product identification evidence and also expect to file objections to asbestos property damage claims on additional grounds, including, without limitation, that the claims are barred by the applicable statutes of limitations. Because of the preliminary nature of the objection process, the Corporation cannot predict the outcome of these proceedings or the impact the proceedings may have on the estimated cost of resolving asbestos property damage claims. See Estimated Cost, below. -29- The following is a summary of the Personal Injury and Property Damage Cases pending against U.S. Gypsum and certain other Debtors as of the Petition Date. PERSONAL INJURY CASES: As reported by the Center for Claims Resolution (the "Center"), U.S. Gypsum was a defendant in more than 100,000 pending Personal Injury Cases as of the Petition Date, as well as an additional approximately 52,000 Personal Injury Cases that may be the subject of settlement agreements. In the first half of 2001, up to the Petition Date, approximately 26,200 new Personal Injury Cases were filed against U.S. Gypsum, as reported by the Center, as compared to 27,800 new filings in the first half of 2000. Prior to the Filing, U.S. Gypsum managed the handling and settlement of Personal Injury Cases through its membership in the Center. From 1988 up to February 1, 2001, the Center administered and arranged for the defense and settlement of Personal Injury Cases against U.S. Gypsum and other Center members. During that period, costs of defense and settlement of Personal Injury Cases were shared among the members of the Center pursuant to predetermined sharing formulas. Effective February 1, 2001, the Center members, including U.S. Gypsum, ended their prior settlement-sharing arrangement. Up until the Petition Date, the Center continued to administer and arrange for the defense and settlement of the Personal Injury Cases, but liability payments were not shared among the Center members. In 2000 and years prior, U.S. Gypsum and other Center members negotiated a number of settlements with plaintiffs' law firms that included agreements to resolve over time the firms' pending Personal Injury Cases as well as certain future claims (the "Long-Term Settlements"). With regard to future claims, these Long-Term Settlements typically provided that the plaintiffs' firms would recommend to their future clients that they defer filing, or accept nominal payments on, personal injury claims that do not meet established disease criteria and, with regard to those claims meeting established disease criteria, that the future clients agree to settle those claims for specified amounts. These Long-Term Settlements typically resolved claims for amounts consistent with historical per-claim settlement costs paid to the plaintiffs' firms involved. As a result of the Filing, cash payments by U.S. Gypsum under these Long-Term Settlements have ceased, and U.S. Gypsum expects that its obligations under these settlements will be determined in the bankruptcy proceedings and plan of reorganization. In 2000, U.S. Gypsum closed approximately 57,000 Personal Injury Cases. U.S. Gypsum's cash payments in 2000 to defend and resolve Personal Injury Cases totaled $162 million, of which $90 million was paid or reimbursed by insurance. In 2000, the average settlement per case was approximately $2,600, exclusive of defense costs. U.S. Gypsum made cash payments of $100 million in 1999 and $61 million in 1998 to resolve Personal Injury Cases, of which $85 million and $45.5 million, respectively, were paid or reimbursed by insurance. -30- During late 2000 and in 2001, following the bankruptcy filings of other defendants in asbestos personal injury litigation, plaintiffs substantially increased their settlement demands to U.S. Gypsum. In response to these increased settlement demands, U.S. Gypsum attempted to manage its asbestos liability by contesting, rather than settling, a greater number of cases that it believed to be non-meritorious. As a result, in the first and second quarters of 2001, U.S. Gypsum agreed to settle fewer Personal Injury Cases, but at a significantly higher cost per case. In the first half of 2001, up to the Petition Date, U.S. Gypsum closed approximately 18,900 Personal Injury Cases. In the first half of 2001, up to the Petition Date, U.S. Gypsum's total asbestos-related cash payments, including defense costs, were approximately $124 million, of which approximately $10 million was paid or reimbursed by insurance. A portion of these payments were for settlements agreed to in prior periods. As of March 31, 2001, U.S. Gypsum had estimated that cash expenditures for Personal Injury Cases in 2001 would total approximately $275 million before insurance recoveries of approximately $37 million. In addition to the Personal Injury Cases pending against U.S. Gypsum, one of the Corporation's subsidiaries and a Debtor in the bankruptcy proceedings, L&W Supply, was named as a defendant in approximately 21 pending Personal Injury Cases as of the Petition Date. L&W Supply, a distributor of building products manufactured by U.S. Gypsum and other building products manufacturers, has not made any payments in the past to resolve Personal Injury Cases. One of U.S. Gypsum's subsidiaries and a Debtor in the bankruptcy proceedings, Beadex, manufactured and sold joint compound containing asbestos from 1963 through 1978 in the northwestern United States. As of the Petition Date, Beadex was a named defendant in approximately 40 Personal Injury Cases pending primarily in the states of Washington and Oregon. Beadex has approximately $11 million in primary or umbrella insurance coverage available to pay asbestos-related costs, as well as $15 million in available excess coverage. The Corporation expects that any asbestos-related liability of L&W Supply and Beadex will be addressed in the plan of reorganization. However, because of, among other things, the small number of Personal Injury Cases pending against L&W Supply and Beadex to date, the Corporation does not have sufficient information at this time to predict how any plan of reorganization will address any asbestos-related liability of L&W Supply and Beadex. PROPERTY DAMAGE CASES: As of the Petition Date, U.S. Gypsum was a defendant in 11 Property Damage Cases, most of which involved multiple buildings. One of the cases is a conditionally certified class action comprising all colleges and universities in the United States, which certification is presently limited to the resolution of certain allegedly "common" liability -31- issues (Central Wesleyan College v. W.R. Grace & Co., et al., U.S.D.C. S.C.). As a result of the Filing, all Property Damage Cases are stayed against U.S. Gypsum. U.S. Gypsum's estimated cost of resolving the Property Damage Cases is discussed in Estimated Cost, below. INSURANCE COVERAGE: As of March 31, 2005, all prior receivables relating to insurance remaining to cover asbestos-related costs had been collected by U.S. Gypsum. ESTIMATED COST: In 2000, prior to the Filing, an independent consultant completed an actuarial study of U.S. Gypsum's current and potential future asbestos liabilities. This study was based on the assumption that U.S. Gypsum's asbestos liability would continue to be resolved in the tort system. As part of this study, the Corporation and its independent consultant considered various factors that would impact the amount of U.S. Gypsum's asbestos personal injury liability. These factors included the number, disease, age, and occupational characteristics of claimants in the Personal Injury Cases; the jurisdiction and venue in which such cases were filed; the viability of claims for conspiracy or punitive damages; the elimination of indemnity-sharing among Center members, including U.S. Gypsum, for future settlements and its negative impact on U.S. Gypsum's ability to continue to resolve claims at historical or acceptable levels; the adverse impact on U.S. Gypsum's settlement costs of recent bankruptcies of co-defendants; the possibility of additional bankruptcies of other defendants; the possibility of significant adverse verdicts due to recent changes in settlement strategies and related effects on liquidity; the inability or refusal of former Center members to fund their share of existing settlements and its effect on such settlement agreements; allegations that U.S. Gypsum and the other Center members are responsible for the share of certain settlement agreements that was to be paid by former members that have refused or are unable to pay; the continued ability to negotiate settlements or develop other mechanisms that defer or reduce claims from unimpaired claimants; the possibility that federal legislation addressing asbestos litigation would be enacted; epidemiological data concerning the incidence of past and projected future asbestos-related diseases; trends in the propensity of persons alleging asbestos-related disease to sue U.S. Gypsum; the pre-agreed settlement recommendations in, and the viability of, the Long-Term Settlements; anticipated trends in recruitment of non-malignant or unimpaired claimants by plaintiffs' law firms; and future defense costs. The study attempted to weigh relevant variables and assess the impact of likely outcomes on future case filings and settlement costs. In connection with the Property Damage Cases, the Corporation considered, among other things, the extent to which claimants could identify the manufacturer of any alleged asbestos-containing products in the buildings at issue in each case; the amount of asbestos-containing products at issue; the claimed damages; the viability of statute of limitations and other defenses; -32- the amount for which such cases can be resolved, which normally (but not uniformly) has been substantially lower than the claimed damages; and the viability of claims for punitive and other forms of multiple damages. Based upon the results of the actuarial study, the Corporation determined that, although substantial uncertainty remained, it was probable that asbestos claims then pending against U.S. Gypsum and future asbestos claims to be filed against it through 2003 (both property damage and personal injury) could be resolved in the tort system for an amount between $889 million and $1,281 million, including defense costs, and that within this range the most likely estimate was $1,185 million. Consistent with this analysis, in the fourth quarter of 2000, the Corporation recorded a noncash, pretax charge of $850 million to results of operations, which, combined with the previously existing reserve, increased U.S. Gypsum's reserve for asbestos claims to $1,185 million. These amounts are stated before tax benefit and are not discounted to present value. Less than 10% of the reserve was attributable to defense and administrative costs. At the time of recording this reserve, it was expected that the reserve amounts would be expended over a period extending several years beyond 2003, because asbestos cases in the tort system historically had been resolved an average of three years after filing. The Corporation concluded that it did not have adequate information to allow it to reasonably estimate U.S. Gypsum's liability for asbestos claims to be filed after 2003. Because of the Filing and activities relating to potential federal legislation addressing asbestos personal injury claims, the Corporation believes that there is greater uncertainty in estimating the reasonably possible range of the Debtors' liability for pending and future asbestos claims as well as the most likely estimate of liability within this range. There are significant differences in the treatment of asbestos claims in a bankruptcy proceeding as compared to the tort litigation system. The factors that impact the estimation of liability for pending and future asbestos claims in a bankruptcy proceeding and the amount that must be provided in the plan of reorganization for such liabilities include: (i) the number of present and future asbestos claims that will be addressed in the plan of reorganization; (ii) the value that will be paid to present and future claims, including the impact historical settlement values for asbestos claims may have on the estimation of asbestos liability in the bankruptcy proceedings; (iii) how claims by individuals who have no objective evidence of impairment will be treated in the bankruptcy proceedings and plan of reorganization; (iv) how the Long-Term Settlements will be treated in the plan of reorganization and whether those settlements will be set aside; (v) how claims for punitive damages will be treated; (vi) the results of any litigation proceedings in the Chapter 11 Cases regarding the estimated number or value of present and future asbestos personal injury claims; (vii) the treatment of asbestos property damage claims in the bankruptcy proceedings; (viii) the potential asbestos liability of L&W, Beadex, A.P. Green or any other past or present affiliates of the Debtors and how any such liability -33- will be addressed in the bankruptcy proceedings and plan of reorganization; (ix) whether the assets of all of the Debtors are determined to be available to satisfy the asbestos liabilities of U.S. Gypsum; (x) how the requirement of Section 524(g) that 75% of the voting asbestos claimants approve the plan of reorganization will impact the amount that must be provided in the plan of reorganization for pending and future asbestos claims and (xi) the impact any relevant potential federal legislation may have on the proceedings. See Note 2. Voluntary Reorganization Under Chapter 11 - Potential Federal Legislation Regarding Asbestos Personal Injury Claims. In addition, the estimates of the Debtors' asbestos liability that would be recorded as a result of the bankruptcy proceedings or potential federal legislation are likely to include all expected future asbestos cases to be brought against the Debtors (as opposed to the cases filed over a three-year period) and are likely to be computed using the present value of the estimated liability. These factors, as well as the uncertainties discussed above in connection with the resolution of asbestos cases in the tort system, increase the uncertainty of any estimate of asbestos liability. Because of the uncertainties associated with estimating the Debtors' asbestos liability at this stage of the proceedings, no change has been made at this time to the previously recorded reserve for asbestos claims, except to reflect certain minor asbestos-related costs incurred since the Filing. The reserve as of March 31, 2005, was $1,061 million. Because the Filing and possible federal legislation have changed the basis upon which the Debtors' asbestos liability would be estimated, there can be no assurance that the current reserve accurately reflects the Debtors' ultimate liability for pending and future asbestos claims. At the time the reserve was increased to its current level in December 2000, the reserve was an estimate of the cost of resolving in the tort system U.S. Gypsum's asbestos liability for then-pending claims and those expected to be filed through 2003. Because of the Filing and the stay of pre-petition asbestos lawsuits, the Debtors have not participated in the tort system since June 2001 and thus cannot measure the recorded reserve against actual experience. However, the reserve is generally consistent with the amount the Corporation estimates that the Debtors would be required to pay to resolve all of their asbestos liability if the FAIR Bill, in its current form, is enacted. On April 19, 2005, Senator Arlen Specter (R. Pa.) introduced in the United States Senate legislation addressing compensation and administration of asbestos personal injury claims. The legislation is titled the Fairness in Asbestos Injury Resolution Act of 2005 (Senate Bill 852, the "FAIR Bill"). The FAIR Bill is co-sponsored by three Democratic Senators and four Republican Senators. The FAIR Bill has not been approved by the Senate Committee on the Judiciary or the full Senate, has not been considered by the House of Representatives, and is not law. As the Chapter 11 Cases and the legislation process proceed, the Debtors likely will gain more information from which a reasonable estimate of the -34- Debtors' probable liability for present and future asbestos claims can be determined. If the FAIR Bill or similar legislation is not enacted, the Debtors' asbestos liability, as determined through the bankruptcy proceedings, could be materially greater than the accrued reserve. The Official Committee of Asbestos Personal Injury Claimants and the legal representative for future asbestos personal injury claimants have indicated in a court filing that they estimate that the net present value of the Debtors' liability for present and future asbestos personal injury claims is approximately $5.5 billion and that the Debtors are insolvent. The Debtors have stated that they believe they are solvent if their asbestos liabilities are fairly and appropriately valued. When the Debtors determine that there is a reasonable basis for revision of the estimate of their asbestos liability, the reserve will be adjusted, and it is possible that a charge to results of operations will be necessary at that time. In such a case, the Debtors' asbestos liability could vary significantly from the recorded estimate of liability and could be greater than the high end of the range estimated in 2000. This difference could be material to the Corporation's financial position, cash flows and results of operations in the period recorded. BOND TO SECURE CERTAIN CENTER OBLIGATIONS: In January 2001, U.S. Gypsum obtained a performance bond from Safeco Insurance Company of America ("Safeco") in the amount of $60.3 million to secure certain obligations of U.S. Gypsum for extended payout settlements of Personal Injury Cases and other obligations owed by U.S. Gypsum to the Center. The bond is secured by an irrevocable letter of credit obtained by the Corporation in the amount of $60.3 million and issued by JPMorgan Chase Bank (formerly Chase Manhattan Bank) ("JPMorgan Chase") to Safeco. After the Filing, by a letter dated November 16, 2001, the Center made a demand to Safeco for payment of $15.7 million under the bond, and, by a letter dated December 28, 2001, the Center made a demand to Safeco for payment of approximately $127 million under the bond. The amounts for which the Center made demand were for the payment of, among other things, settlements of Personal Injury Cases that were entered into pre-petition. The total amount demanded by the Center under the bond, approximately $143 million, exceeds the original penal sum of the bond, which is $60.3 million. Safeco has not made any payment under the bond. On November 30, 2001, the Corporation and U.S. Gypsum filed an Adversary Complaint in the Chapter 11 Cases to, among other things, enjoin the Center from drawing on the bond and enjoin Safeco from paying on the bond during the pendency of these bankruptcy proceedings. This Adversary Proceeding is pending in the United States Bankruptcy Court for the District of Delaware and is captioned USG Corporation and United States Gypsum Company v. Center for Claims Resolution, Inc. and Safeco Insurance Company of America, No. 01-08932. Judge Wolin consolidated the Adversary Proceeding with similar adversary proceedings brought by Federal-Mogul Corp., et al., and Armstrong World Industries, Inc., et al., in their bankruptcy proceedings. The parties filed cross-motions for summary judgment in the consolidated -35- proceedings. On March 28, 2003, in response to the cross-motions for summary judgment, Judge Wolin issued an order and memorandum opinion which granted in part and denied in part the Center's motion for summary judgment. Although the court ruled that Safeco is not required to remit any surety bond proceeds to the Center at this time, the court stated that certain settlements that were completed before U.S. Gypsum's Petition Date likely are covered by the surety bond but that the bond does not cover settlement payments that were not yet completed as of the Petition Date. The court did not rule on whether the bond covers other disputed obligations and reserved these issues to a subsequent phase of the litigation. As a result of the court's decision, it is likely that, absent a settlement of this matter, some portion of the bond may be drawn but that the amount drawn may be substantially less than the full amount of the bond. To the extent that Safeco were to pay all or any portion of the bond, it is likely that Safeco would draw down the JPMorgan Chase letter of credit to cover the bond payment and JPMorgan Chase would assert a pre-petition claim in a corresponding amount against the Corporation in the bankruptcy proceedings. It is expected that the Center bond litigation will be addressed by either Judge Fitzgerald or Judge Conti, who was appointed to replace Judge Wolin. CONCLUSION: There are many uncertainties associated with the resolution of the asbestos liability in the bankruptcy proceeding. The Corporation will continue to review its asbestos liability as the Chapter 11 Cases progress and as issues relating to the estimation of the Debtors' asbestos liabilities are addressed. If, after any such review, the Debtors' estimate of the probable liability for present and future asbestos claims is different from the existing reserve, the reserve will be adjusted, and such adjustment could be material to the Corporation's financial position, cash flows and results of operations in the period recorded. SILICA LITIGATION During the 10 years prior to the Filing, Debtor U.S. Gypsum was named as a defendant in approximately 10 lawsuits claiming personal injury from exposure to silica allegedly from U.S. Gypsum products. The claims against U.S. Gypsum in silica personal injury lawsuits pending at the time of the Filing were stayed as a result of the Filing. Only one proof of claim alleging silica personal injury liability was filed against any of the Debtors as of the bar date in the Bankruptcy Case. However, it has been estimated that tens of thousands of silica personal injury lawsuits have been filed against other defendants nationwide in recent years. In the fourth quarter of 2004, U.S. Gypsum was served with 17 complaints involving more that 400 plaintiffs alleging personal injury resulting from exposure to silica. These complaints were filed in various Mississippi state courts, and each names from 178 to 195 defendants. U.S. Gypsum believes that the claims against it in these lawsuits are stayed as a result of the Filing. The Corporation does not have sufficient information to estimate the likely -36- cost of resolving these claims. However, the Corporation believes that it has significant defenses to these claims if they are allowed to proceed. The Corporation has provided notice of these recent complaints to its insurance carriers. ENVIRONMENTAL LITIGATION The Corporation and certain of its subsidiaries have been notified by state and federal environmental protection agencies of possible involvement as one of numerous "potentially responsible parties" in a number of so-called "Superfund" sites in the United States. In most of these sites, the involvement of the Corporation or its subsidiaries is expected to be minimal. The Corporation believes that appropriate reserves have been established for its potential liability in connection with all Superfund sites but is continuing to review its accruals as additional information becomes available. Such reserves take into account all known or estimated undiscounted costs associated with these sites, including site investigations and feasibility costs, site cleanup and remediation, legal costs, and fines and penalties, if any. In addition, environmental costs connected with site cleanups on Corporation-owned property also are covered by reserves established in accordance with the foregoing. The Debtors have been given permission by the Bankruptcy Court to satisfy environmental obligations up to $12 million. The Corporation believes that neither these matters nor any other known governmental proceedings regarding environmental matters will have a material adverse effect upon its financial position, cash flows or results of operations. -37- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION OVERVIEW USG Corporation (the "Corporation") and 10 of its United States subsidiaries (collectively, the "Debtors") are currently operating under chapter 11 of the United States Bankruptcy Code (the "Bankruptcy Code"). The Debtors took this action to resolve asbestos claims in a fair and equitable manner, to protect the long-term value of the Debtors' businesses, and to maintain the Debtors' leadership positions in their markets. To properly understand the Corporation and its businesses, investors, creditors or other readers of this report should first understand the nature of this voluntary reorganization process under chapter 11 and the potential impacts the reorganization may have on their rights and interests in the Corporation as described in more detail below. At this point, there is great uncertainty as to the amount of the Debtors' asbestos liability and thus the value of any recovery for pre-petition creditors or stockholders under any final plan of reorganization. No plan of reorganization has thus far been proposed by the Debtors. The Corporation had $1,199 million of cash, cash equivalents, restricted cash and marketable securities as of March 31, 2005, and management believes that this liquidity plus expected operating cash flows will meet the Corporation's cash needs, including making regular capital investments to maintain and enhance its businesses, throughout the chapter 11 proceedings. The Corporation's net sales for the first quarter of 2005 were a record level for any first quarter in its history and represented a 15% increase from the same period in 2004. Demand for products sold by the Corporation's North American Gypsum and Building Products Distribution operating segments was strong in the first quarter of 2005 due to continued growth in the new housing and repair and remodel markets. Shipments of gypsum wallboard remained at historically high levels for the Corporation and the industry in the first quarter of 2005 and are expected to be strong for the remainder of the year. United States Gypsum Company ("U.S. Gypsum") shipped more wallboard in March than in any other month in that company's history. The favorable level of activity in the aforementioned markets and industry capacity utilization rates in excess of 90% have resulted in the continuing rise in market selling prices for gypsum wallboard. The nationwide average realized selling price for U.S. Gypsum's SHEETROCK(R) brand gypsum wallboard was up 21% from the first quarter of 2004. The Corporation's Worldwide Ceilings operating segment reported a modest increase in net sales for the first quarter of 2005. However, operating profit for that segment fell primarily due to higher manufacturing costs. The Corporation's gross margin percentage (gross profit as a percent of net sales) was 18.2% in the first quarter of 2005, up from 16.8% in the first quarter of 2004. This improvement was primarily the result of higher selling prices for SHEETROCK(R) brand gypsum wallboard. However, profit margins have been pressured by high levels of costs related to the prices of natural gas (a major source of energy for the Corporation) and raw materials, employee medical insurance and the implementation -38- of a new enterprise-wide software system. VOLUNTARY REORGANIZATION UNDER CHAPTER 11 On June 25, 2001 (the "Petition Date"), the Debtors filed voluntary petitions for reorganization (the "Filing") under the Bankruptcy Code. The Debtors' bankruptcy cases (the "Chapter 11 Cases") are pending in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"). The Debtors intend to address their liability for all present and future asbestos claims, as well as all other pre-petition claims, in a plan or plans of reorganization approved by the Bankruptcy Court. The Debtors currently have the exclusive right to file a plan of reorganization until June 30, 2005. The Debtors may seek one or more additional extensions of the exclusive period depending upon developments in the Chapter 11 Cases. A key factor in determining whether or to what extent there will be any recovery for pre-petition creditors or stockholders under any plan of reorganization is the amount that must be provided in the plan of reorganization to address the Debtors' liability for present and future asbestos claims. The amount of the Debtors' asbestos liabilities has not yet been determined and is subject to substantial uncertainty. The Corporation's Annual Report on Form 10-K, filed on February 18, 2005, discusses the background and impact of the Filing, developments in the reorganization proceeding, proceedings relating to estimation of Debtors' liability for asbestos personal injury claims, and potential federal legislation regarding asbestos personal injury claims. Since the filing of the Form 10-K, there have been additional developments in the Debtors' Chapter 11 proceedings. On April 21, 2005, the United States Trustee appointed an Official Committee of the Equity Security Holders of the Corporation. This committee, along with the three official committees representing various creditors of the Debtors, are expected to play significant roles in the Chapter 11 Cases. During the first quarter of 2005, there have also been developments regarding potential federal legislation. See Potential Federal Legislation Regarding Asbestos Personal Injury Claims, below. See also, Item 1, Note 2, Voluntary Reorganization Under Chapter 11, and Note 12, Litigation, for additional information on the background of asbestos litigation, developments in the Corporation's reorganization proceedings, and estimated cost. POTENTIAL FEDERAL LEGISLATION REGARDING ASBESTOS PERSONAL INJURY CLAIMS On April 19, 2005, Senator Arlen Specter (R. Pa.) introduced in the United States Senate legislation addressing compensation and administration of asbestos personal injury claims. The legislation is titled the Fairness in Asbestos Injury Resolution Act of 2005 (Senate Bill 852, the "FAIR Bill"). The FAIR Bill is co-sponsored by three Democratic Senators and four Republican Senators. The FAIR Bill has been referred to the Senate Committee on the Judiciary. The FAIR Bill has not been approved by the Senate Committee on the Judiciary or the full Senate, has not been -39- considered by the House of Representatives, and is not law. The FAIR Bill introduced in the Senate is intended to establish a nationally administered trust fund to compensate asbestos personal injury claimants. In the FAIR Bill's current form, companies that have made past payments for asbestos personal injury claims would be required to contribute amounts to a national trust fund on a periodic basis that would pay the claims of qualifying asbestos personal injury claimants. The nationally administered trust fund would be the exclusive remedy for asbestos personal injury claims, and such claims could not be brought in state or federal court as long as such claims are being compensated under the national trust fund. A copy of the FAIR Bill as introduced is available at http://thomas.loc.gov (type in "S. 852" in the search field). In the FAIR Bill's current form, the amounts to be paid to the national trust fund are based on an allocation methodology set forth in the FAIR Bill. The amounts that participants, including the Debtors, would be required to pay are not dischargeable in a bankruptcy proceeding. In addition, the FAIR Bill, in its current form, requires affected companies currently in chapter 11, including the Debtors, to make their first payment to the national trust fund not later than 60 days after enactment of the FAIR Bill, notwithstanding the fact that the companies are still in chapter 11 proceedings. The FAIR Bill also provides, among other things, that if it is determined that the money in the trust fund is not sufficient to compensate eligible claimants, the claimants and defendants (including current chapter 11 debtors) would return to the court system to resolve claims not paid by the national trust fund. The outcome of the legislative process is inherently speculative, and it cannot be known whether the FAIR Bill or similar legislation will ever be enacted or, even if enacted, what the terms of the final legislation might be. Previously, in April 2004, a similar, but not identical, bill (the "Fairness in Asbestos Injury Resolution Act of 2004") was introduced in the Senate and was approved by the Senate Committee on the Judiciary, but the full Senate defeated a motion to proceed with floor consideration of the bill. Even if the FAIR Bill is enacted, the terms of the enacted legislation may differ from those of the FAIR Bill as introduced, and those differences may be material to the FAIR Bill's impact on the Corporation. Enactment of the FAIR Bill or similar legislation addressing the financial contributions of the Debtors for asbestos personal injury claims would have a material impact on the amount of the Debtors' asbestos personal injury liability and the Debtors' Chapter 11 Cases. ESTIMATED COST OF ASBESTOS LIABILITY Prior to the Filing, in the fourth quarter of 2000, U.S. Gypsum recorded a noncash, pretax provision of $850 million, increasing to $1,185 million its total accrued reserve for resolving in the tort system the asbestos claims pending as of December 31, 2000, and expected to be filed through 2003. At that time, the estimated range of U.S. Gypsum's probable liability for such claims was between $889 million and $1,281 million, including defense costs. These amounts are stated before tax -40- benefit and are not discounted to present value. As of March 31, 2005, the Corporation's accrued reserve for asbestos claims totaled $1,061 million. Because of the uncertainties associated with estimating the Debtors' liability for present and future asbestos claims at this stage of the bankruptcy proceedings, no change has been made to the previously recorded reserve except to reflect certain minor asbestos-related costs incurred since the Filing. Because the Filing and possible federal legislation have changed the basis upon which the Debtors' asbestos liability would be estimated, there can be no assurance that the current reserve accurately reflects the Debtors' ultimate liability for pending and future asbestos claims. At the time the reserve was increased to its current level in December 2000, the reserve was an estimate of the cost of resolving in the tort system U.S. Gypsum's asbestos liability for then-pending claims and those expected to be filed through 2003. Because of the Filing and the stay of pre-petition asbestos lawsuits, the Debtors have not participated in the tort system since June 2001 and thus cannot measure the recorded reserve against actual experience. However, the reserve is generally consistent with the amount the Corporation estimates that the Debtors would be required to pay to resolve all of their asbestos liability if the FAIR Bill, in its current form, is enacted. As the Chapter 11 Cases and the legislation process proceed, the Debtors likely will gain more information from which a reasonable estimate of the Debtors' probable liability for present and future asbestos claims can be determined. If such estimate differs from the existing reserve, the reserve will be adjusted, and it is possible that a charge to results of operations will be necessary at that time. In such a case, the Debtors' asbestos liability could vary significantly from the recorded estimate of liability and could be greater than the high end of the range estimated in 2000. This difference could be material to the Corporation's financial position, cash flows and results of operations in the period recorded. POTENTIAL OUTCOMES OF THE FILING While it is the Debtors' intention to seek a full recovery for their creditors, it is not possible to predict the amount that will have to be provided in the plan of reorganization to address present and future asbestos claims, how the plan of reorganization will treat other pre-petition claims, whether there will be sufficient assets to satisfy the Debtors' pre-petition liabilities, and what impact any plan may have on the value of the shares of the Corporation's common stock. The payment rights and other entitlements of pre-petition creditors and the Corporation's stockholders may be substantially altered by any plan of reorganization confirmed in the Chapter 11 Cases. Pre-petition creditors may receive under the plan of reorganization less than 100% of the face value of their claims, the pre-petition creditors of some Debtors may be treated differently from the pre-petition creditors of other Debtors, and the interests of the Corporation's stockholders are likely to be substantially diluted or cancelled in whole or in part. There can be no assurance as to the value of any distributions that might be made under any plan of reorganization with respect to such pre-petition claims or equity interests. -41- It is also not possible to predict how the plan of reorganization will treat intercompany indebtedness, licenses, transfers of goods and services, and other intercompany arrangements, transactions and relationships that were entered into before the Petition Date. Certain of these intercompany transactions have been challenged by various parties in these Chapter 11 Cases (see Developments in the Reorganization Proceeding, above), and other arrangements, transactions and relationships may be challenged by parties to these Chapter 11 Cases. The outcome of such challenges may have an impact on the treatment of various claims under any plan of reorganization. ACCOUNTING IMPACT The Corporation is required to follow American Institute of Certified Public Accountants ("AICPA") Statement of Position 90-7 ("SOP 90-7"), "Financial Reporting by Entities in Reorganization under the Bankruptcy Code." Pursuant to SOP 90-7, the Corporation's pre-petition liabilities that are subject to compromise are reported separately on the consolidated balance sheet. Virtually all of the Corporation's pre-petition debt is currently in default and was recorded at face value and classified within liabilities subject to compromise. U.S. Gypsum's asbestos liability also is classified within liabilities subject to compromise. See Item 1, Note 2, Voluntary Reorganization Under Chapter 11, which includes information related to financial statement presentation, the debtor-in-possession statements and detail of liabilities subject to compromise and chapter 11 reorganization expenses. CONSOLIDATED RESULTS OF OPERATIONS NET SALES Net sales in the first quarter of 2005 totaled $1,173 million, a record for any first quarter in the Corporation's history and a 15% increase from $1,020 million in the first quarter of 2004. Net sales increased largely due to higher selling prices for SHEETROCK(R) brand gypsum wallboard and other related products. See Core Business Results of Operations below for an explanation of product line results by segment. COST OF PRODUCTS SOLD Cost of products sold in the first quarter of 2005 was $959 million, up 13% from $849 million a year ago. Key factors for this variation were higher costs related to the prices of natural gas and raw materials, employee medical insurance and the implementation of a new enterprise-wide software system. GROSS PROFIT Gross profit in the first quarter of 2005 was $214 million, a 25% increase from $171 million in the first quarter of 2004. The gross margin percentage was 18.2% in the first quarter of 2005, up from 16.8% in the first quarter of 2004. -42- SELLING AND ADMINISTRATIVE EXPENSES Selling and administrative expenses in the first quarter of 2005 were $89 million, up 16% from $77 million in the first quarter of 2004. Expenses were up in the 2005 period primarily due to an increased accrual related to the Bankruptcy Court-approved key employee retention plan, increased levels of compensation and benefits and higher funding for growth initiatives. As a percent of net sales, selling and administrative expenses were 7.6% in the first quarter of 2005, up from 7.5% in the comparable 2004 period. CHAPTER 11 REORGANIZATION EXPENSES In connection with the Filing, the Corporation recorded chapter 11 reorganization expenses of $1 million in the first quarter of 2005, down from $2 million in the first quarter of 2004. For the first quarter of 2005 and 2004 respectively, these expenses consisted of legal and financial advisory fees of $6 million and $4 million, partially offset by bankruptcy-related interest income of $5 million and $2 million, respectively. INTEREST EXPENSE Interest expense of $1 million was incurred in the first quarter of 2005 and 2004. Under SOP 90-7, virtually all of the Corporation's outstanding debt is classified as liabilities subject to compromise, and interest expense on this debt has not been accrued or recorded since the Petition Date. Contractual interest expense not accrued or recorded on pre-petition debt totaled $19 million in the first quarter of 2005. From the Petition Date through March 31, 2005, contractual interest expense not accrued or recorded on pre-petition debt totaled $276 million. This calculation assumes that all such interest was paid when required at the applicable contractual interest rate (after giving effect to any applicable default rate). However, the calculation excludes the impact of any compounding of interest on unpaid interest that may be payable under the relevant contractual obligations, as well as any interest that may be payable under a plan of reorganization to trade or other creditors that are not otherwise entitled to interest under the express terms of their claims. The impact of compounding alone would have increased the contractual interest expense reported above by $6 million in the first quarter of 2005 and $40 million from the Petition Date through March 31, 2005. For financial reporting purposes, no post-petition accruals have been made for contractual interest expense not accrued or recorded on pre-petition debt. On April 11, 2005, the Unsecured Creditors Committee filed a motion with the bankruptcy court requesting that the Debtors make interest payments to all non-asbestos unsecured creditors for interest accrued from January 1, 2005, on liquidated, undisputed pre-petition claims (including accrued unpaid interest through December 31, 2004). If approved, this would require the Debtors to make interest payments of approximately $84 million on an annual basis. INTEREST INCOME Non-bankruptcy related interest income of $2 million and $1 million was recorded in the first quarter of 2005 and 2004, respectively. -43- INCOME TAXES Income tax expense amounted to $48 million and $33 million in the first quarter of 2005 and 2004, respectively. The effective tax rates were 38.8% and 36.6% for the respective periods. The increase in the effective tax rate was primarily due to a reduction in the Corporation's tax reserves in the first quarter of 2004 resulting from the impact of finalized IRS regulations on the Chapter 11 reorganization expenses incurred by the Corporation and a lower level of projected permanent book-tax differences in 2005, including the U.S. federal tax deduction for qualified production activities. NET EARNINGS Net earnings in the first quarter of 2005 were $77 million, up $20 million, or 35%, from $57 million in the first quarter of 2004. Diluted earnings per share were $1.77 and $1.33 for the respective periods. CORE BUSINESS RESULTS OF OPERATIONS
Net Sales Operating Profit (dollars in millions) --------------- ---------------- Three Months Ended March 31, 2005 2004 2005 2004 - ---------------------------- ------ ------ ---- ---- NORTH AMERICAN GYPSUM: U.S. Gypsum Company $ 654 $ 574 $ 93 $ 61 CGC Inc. (gypsum) 75 73 12 13 Other subsidiaries* 40 36 2 7 Eliminations (44) (44) -- -- ------ ------ ---- ---- Total 725 639 107 81 ------ ------ ---- ---- WORLDWIDE CEILINGS: USG Interiors, Inc. 117 120 6 12 USG International 51 46 3 1 CGC Inc. (ceilings) 13 13 3 2 Eliminations (11) (13) -- -- ------ ------ ---- ---- Total 170 166 12 15 ------ ------ ---- ---- BUILDING PRODUCTS DISTRIBUTION: L&W Supply Corporation 456 362 26 14 ------ ------ ---- ---- Corporate -- -- (23) (16) Chapter 11 reorganization expenses -- -- (1) (2) Eliminations (178) (147) 3 -- ------ ------ ---- ---- Total USG Corporation 1,173 1,020 124 92 ====== ====== ==== ====
* Includes USG Mexico, S.A. de C.V., a building products business in Mexico, Gypsum Transportation Limited, a shipping company in Bermuda, and USG Canadian Mining Ltd., a mining operation in Nova Scotia. -44- NORTH AMERICAN GYPSUM Net sales of $725 million increased 13% from the first quarter of 2004, while operating profit increased 32% to $107 million. United States Gypsum Company: Net sales for U.S. Gypsum increased $80 million, or 14%, compared with the first quarter of 2004, while operating profit rose $32 million, or 52%. These increases primarily reflected higher selling prices for SHEETROCK(R) brand gypsum wallboard. U.S. Gypsum's nationwide average realized selling price for SHEETROCK(R) brand gypsum wallboard was $133.73 per thousand square feet in the first quarter of 2005. This price represented a 21% increase from $110.33 in the first quarter of 2004. However, the benefit of improved pricing was partially offset by higher costs, including higher energy and raw material prices. Shipments of SHEETROCK(R) brand gypsum wallboard totaled 2.7 billion square feet during the first quarters of 2005 and 2004. Wallboard plants operated at 91% of capacity in the first quarter of 2005 compared with 93% in the first quarter of 2004. Industry shipments of gypsum wallboard were up approximately 2% from the first quarter of 2004. Shipments of DUROCK(R) brand cement board and FIBEROCK(R) brand gypsum fiber panels were the highest for any first quarter in U.S. Gypsum's history. CGC Inc.: Net sales for the gypsum business of Canada-based CGC Inc. increased 3% versus the first quarter of 2004 primarily due to the favorable effects of currency translation and higher selling prices for SHEETROCK(R) brand gypsum wallboard. However, operating profit declined slightly to $12 million from $13 million largely as a result of higher manufacturing costs. WORLDWIDE CEILINGS Net sales of $170 million increased 2%, while operating profit of $12 million declined 20% from the first quarter of 2004. USG Interiors, Inc.: The Corporation's domestic ceilings business, USG Interiors, Inc. reported first quarter 2005 net sales and operating profit of $117 million and $6 million, respectively. This compared with net sales of $120 million and operating profit of $12 million in the first quarter of 2004. The decline in net sales was largely due to lower shipments of ceiling grid and tile. In last year's first quarter, market concerns over a shortage of steel used to make grid and related increases in steel costs contributed to unusually strong demand for grid products. Grid demand in the first quarter of 2005 was more in line with overall industry opportunity. Higher manufacturing costs, primarily related to energy and raw materials, for both ceiling grid and tile also contributed to lower operating profit in the first -45- quarter of 2005. These cost pressures during the period were partially offset by higher pricing for both ceiling tile and grid. USG International: Net sales for USG International increased 11% compared with the first quarter of 2004, while operating profit rose to $3 million from $1 million. These improvements primarily reflected increased demand for ceiling systems and gypsum-related products in Europe and Latin America. CGC Inc.: The ceilings business of CGC Inc. reported $13 million in net sales, which was unchanged from the first quarter of 2004, while operating profit rose to $3 million from $2 million. BUILDING PRODUCTS DISTRIBUTION L&W Supply Corporation ("L&W Supply"), the leading specialty building products distribution business in the United States, reported net sales of $456 million, a first quarter record and a 26% increase versus the first quarter of 2004. Operating profit for the company rose to $26 million from $14 million. These increases reflect record first quarter shipments of gypsum wallboard and complementary building products. Complementary building products include such products as drywall metal, ceiling products, joint compound and roofing. Shipments of L&W Supply's gypsum wallboard were up 7% versus the first quarter of 2004. These results also benefited from improved selling prices for gypsum wallboard, which increased 19%. L&W Supply operated 185 locations in the United States as of March 31, 2005, compared with 184 locations as of March 31, 2004. MARKET CONDITIONS AND OUTLOOK Industry shipments of gypsum wallboard in the United States were an estimated 8.8 billion square feet in the first quarter of 2005, a 2% increase from 8.6 billion square feet in the first quarter of 2004. The robust level of activity in the new housing and residential repair and remodel markets, which together account for nearly two-thirds of all demand for gypsum wallboard, and utilization rates in excess of 90% for the industry, have resulted in a rise of market selling prices for gypsum wallboard. The outlook for the remainder of 2005 is positive. The strong new housing and residential repair and remodel markets are expected to keep demand for the Corporation's gypsum wallboard products high. However, rising interest rates and tightening lending standards may bring demand levels down slightly from last year's level. The commercial construction market (the principal market for the Corporation's ceilings products), while still soft, is showing some signs of improvement. These factors, combined with the Corporation's continued focus on margin improvement and select growth opportunities, should produce strong results in 2005. U.S. Gypsum continues to make investments to meet its customers' needs, satisfy the growing demand for SHEETROCK(R) brand gypsum wallboard and improve its cost position. The recently announced state-of-the-art modernization of its Norfolk, Virginia, gypsum wallboard facility will increase capacity, reduce -46- production costs and improve service to customers in the Mid-Atlantic market. However, the Corporation, like many other companies, faces many ongoing cost pressures such as higher prices for natural gas and raw materials and increased costs for employee benefits. In this environment, the Corporation continues to focus its management attention and investments on improving customer service, manufacturing costs and operating efficiencies, as well as investing to grow its businesses. In addition, the Corporation will diligently continue its attempt to resolve the chapter 11 proceedings, consistent with the goal of achieving a fair, comprehensive and final resolution to its asbestos liability. LIQUIDITY AND CAPITAL RESOURCES LIQUIDITY As of March 31, 2005, the Corporation had $1,199 million of cash, cash equivalents, restricted cash and marketable securities. This amount was down $50 million, or 4%, from $1,249 million as of December 31, 2004, primarily due to payments of customer rebates, employee incentive compensation and other seasonal working capital needs in the first quarter. Of the total amount of $1,199 million as of March 31, 2005, $252 million was held by non-Debtor subsidiaries. Since the Petition Date, the Corporation's level of liquidity has increased due to strong operating cash flows and the absence of cash payments related to asbestos settlements and interest on pre-petition debt. Contractual interest expense not accrued or recorded on pre-petition debt was $19 million in the first quarter of 2005 and $276 million since the Petition Date. See Interest Expense, above, for a full discussion of contractual interest not accrued or recorded. CASH FLOWS As shown on the consolidated statement of cash flows, cash and cash equivalents decreased $87 million during the first quarter of 2005. The primary source of cash in the first quarter of 2005 was earnings from operations. Primary uses of cash were: (i) working capital of $126 million (primarily increases in receivables and inventory costs, the aforementioned payments of customer rebates and employee incentive compensation, and other seasonal needs), (ii) net purchases of marketable securities of $40 million, (iii) capital spending of $33 million and (iv) pension funding of $21 million. Comparing the first quarter of 2005 with the first quarter of 2004, net cash used for operating activities was $14 million in the 2005 period compared with $3 million a year ago. This variation was primarily attributable to higher levels of pension funding and seasonal working capital needs, partially offset by increased net earnings. Net cash used for investing activities increased to $72 million from $67 million primarily reflecting increases in capital spending and net purchases of marketable securities, partially offset by restricted cash deposits in the first quarter of 2004. Net cash of $1 million provided by financing activities during the first quarter of 2005 reflected the exercise of stock options. -47- CAPITAL EXPENDITURES Capital spending amounted to $33 million in the first quarter of 2005, compared with $20 million in the corresponding 2004 period. As of March 31, 2005, remaining capital expenditure commitments for the replacement, modernization and expansion of operations amounted to $268 million, compared with $283 million as of December 31, 2004. During the bankruptcy proceeding, the Corporation expects to have limited ability to access capital other than its own cash, marketable securities and future cash flows to fund potential future growth opportunities such as new products, acquisitions and joint ventures. Nonetheless, the Corporation expects to be able to maintain a program of capital spending aimed at maintaining and enhancing its businesses. WORKING CAPITAL Total working capital (current assets less current liabilities) as of March 31, 2005, amounted to $1,325 million, and the ratio of current assets to current liabilities was 3.38-to-1. As of December 31, 2004, working capital amounted to $1,220 million, and the ratio of current assets to current liabilities was 3.14-to-1. Receivables increased to $523 million as of March 31, 2005, from $413 million as of December 31, 2004, primarily reflecting first quarter payments of customer rebates and a 14% increase in net sales for the month of March 2005 as compared with December 2004. Inventories increased to $346 million from $338. Accounts payable decreased to $268 million from $270 million. Accrued expenses declined to $194 million from $224 million as of December 31, 2004, primarily due to the payment of employee incentive compensation during the first quarter. MARKETABLE SECURITIES As of March 31, 2005, $488 million was invested in marketable securities, up $38 million from $450 million as of December 31, 2004. Of the first quarter 2005 amount, $310 million was invested in long-term marketable securities and $178 million in short-term marketable securities. The Corporation's marketable securities are classified as available-for-sale securities and reported at fair market value with unrealized gains and losses excluded from earnings and reported in accumulated other comprehensive income (loss) on the consolidated balance sheets. RESTRICTED CASH AND LETTERS OF CREDIT As of March 31, 2005, a total of $42 million was reported as restricted cash on the consolidated balance sheet. Restricted cash primarily represented collateral to support outstanding letters of credit. As of March 31, 2005, the Corporation had a $100 million credit agreement, which was to expire April 30, 2006, with LaSalle Bank N.A. (the "LaSalle Facility") to be used exclusively to support the issuance of letters of credit needed to support business operations. As of March 31, 2005, $36 million of letters of credit under -48- the LaSalle Facility, which are cash collateralized at 103%, were outstanding. In March 2005, the Corporation asked the Bankruptcy court to approve amendments to the LaSalle Facility to extend the term of the facility until April 30, 2008, and to increase the credit line to $175 million. In the same motion, the Corporation asked for permission to replace certain standby letters of credit, which had been issued under a pre-petition credit facility but were expiring in the near future due to that credit facility's expiration, with new ones issued under the LaSalle Facility. The Bankruptcy court approved the Corporation's requests on April 15, 2005. The amendments were thereafter made effective as of April 29, 2005. DEBT As of March 31, 2005, total debt amounted to $1,006 million, of which $1,005 million was included in liabilities subject to compromise. These amounts were unchanged from the December 31, 2004, levels and do not include any accruals for post-petition contractual interest expense. LEGAL CONTINGENCIES As a result of the Filing, all pending asbestos lawsuits against the Debtors are stayed, and no party may take any action to pursue or collect on such asbestos claims absent specific authorization of the Bankruptcy Court. U.S. Gypsum has also been named as a defendant in lawsuits claiming personal injury from exposure to silica allegedly from U.S. Gypsum products. Pre-petition claims against U.S. Gypsum in silica personal injury lawsuits are also stayed as a result of the Filing. The Corporation and certain of its subsidiaries have been notified by state and federal environmental protection agencies of possible involvement as one of numerous "potentially responsible parties" in a number of so-called "Superfund" sites in the United States. The Corporation believes that neither these matters nor any other known governmental proceeding regarding environmental matters will have a material adverse effect upon its financial position, cash flows or results of operations. See Item 1, Note 12, Litigation, for additional information on (i) the background of asbestos litigation, developments in the Corporation's reorganization proceeding and estimated cost, (ii) silica litigation and (iii) environmental litigation. -49- CRITICAL ACCOUNTING POLICIES The preparation of the Corporation's financial statements requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses during the periods presented. The Corporation's 2004 Annual Report on Form 10-K, which was filed on February 18, 2005, includes a summary of the critical accounting policies the Corporation believes are the most important to aid in understanding its financial results. There have been no material changes to these critical accounting policies that impacted the Corporation's reported amounts of assets, liabilities, revenues or expenses during the first three months of 2005. FORWARD-LOOKING STATEMENTS This report contains forward-looking statements related to management's expectations about future conditions. The effects of the Filing and the conduct, outcome and costs of the Chapter 11 Cases, as well as the ultimate costs associated with the Corporation's asbestos litigation, including the possible impact of any asbestos-related legislation, may differ from management's expectations. Actual business, market or other conditions may also differ from management's expectations and accordingly affect the Corporation's sales and profitability or other results. Actual results may differ due to various other factors, including economic conditions such as the levels of construction activity, employment levels, interest rates, currency exchange rates and consumer confidence; competitive conditions such as price and product competition and competition for procurement of synthetic gypsum; shortages in raw materials and energy; increases in raw material, energy and employee benefit costs; loss of one or more significant customers; and the unpredictable effects of acts of terrorism or war upon domestic and international economies and financial markets. The Corporation assumes no obligation to update any forward-looking information contained in this report. ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures. The Corporation's chief executive officer and chief financial officer, after evaluating the effectiveness of the Corporation's "disclosure controls and procedures" (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934), have concluded that, as of the end of the fiscal quarter covered by this report on Form 10-Q, the Corporation's disclosure controls and procedures were adequate and designed to ensure that material information relating to the Corporation and its consolidated subsidiaries would be made known to them by others within those entities. (b) Changes in internal control over financial reporting. -50- 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. -51- REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Stockholders and Board of Directors of USG Corporation: We have reviewed the accompanying consolidated balance sheet of USG Corporation and subsidiaries as of March 31, 2005 and the related consolidated statements of earnings and cash flows for each of the three month periods ended March 31, 2005 and 2004. These interim financial statements are the responsibility of the Corporation's management. We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our reviews, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America. We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of USG Corporation and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of earnings, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2004 (not presented herein); and in our report dated February 8, 2005 we expressed an unqualified opinion on those consolidated financial statements and included explanatory paragraphs concerning (i) matters which raise substantial doubt about the Corporation's ability to continue as a going concern; (ii) changes in methods of accounting for asset retirement obligations and goodwill and other intangible assets due to the Corporation's adoption of Statement of Financial Accounting Standards (SFAS) No. 143, "Accounting for Asset Retirement Obligations" in 2003, and SFAS No. 142, "Goodwill and Other Intangible Assets" in 2002; In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2004 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. As discussed in Note 2 to the consolidated financial statements, USG Corporation and certain subsidiaries voluntarily filed for Chapter 11 bankruptcy protection on June 25, 2001. The accompanying consolidated financial statements do not purport to reflect or provide for the consequences of the bankruptcy proceedings. In particular, such financial statements do not purport to show (a) as to assets, their realizable value on a liquidation basis or their availability to satisfy -52- liabilities; (b) as to pre-petition liabilities, the amounts that may be allowed for claims or contingencies, or the status and priority thereof; (c) as to stockholder accounts, the effect of any changes that may be made in the capitalization of the Corporation; or (d) as to operations, the effect of any changes that may be made in its business. The accompanying consolidated financial statements have been prepared assuming that the Corporation will continue as a going concern. As discussed in Notes 2 and 12 to the consolidated financial statements, there is significant uncertainty as to the resolution of the Corporation's asbestos litigation, which, among other things, may lead to possible changes in the composition of the Corporation's business portfolio, as well as changes in the ownership of the Corporation. This uncertainty raises substantial doubt about the Corporation's ability to continue as a going concern. Management's plans in regard to these matters are also described in Notes 2 and 12 to the financial statements. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ DELOITTE & TOUCHE LLP DELOITTE & TOUCHE LLP Chicago, Illinois April 26, 2005 -53- PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS See Part I, Item 1, Note 12, Litigation, for information concerning the asbestos and related bankruptcy litigation, silica litigation and environmental litigation. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(c) Total Number of (c) Maximum Number (or Shares (or Units) Approximate Dollar Value) (a) Total Number of (b) Average Price Purchased as Part of of Shares (or Units) 2005 of Shares (or Units) Paid per Share Publicly Announced that May Yet Be Purchased Period Purchased (or Unit) Plans or Programs Under the Plans or Programs - ------ -------------------- ----------------- -------------------- --------------------------- January -- -- -- -- February -- -- -- -- March -- -- -- -- --- --- --- --- Total 1st Quarter -- -- -- -- === === === ===
(a) Reflects shares reacquired to provide for tax withholdings on shares issued to employees under the terms of the USG Corporation 1995 Long-Term Equity Plan, 1997 Management Incentive Plan or 2000 Omnibus Management Incentive Plan. (b) The price per share is based upon the mean of the high and the low prices for a USG Corporation common share on the NYSE on the date of the tax withholding transaction. (c) The Corporation currently does not have in place a share repurchase plan or program. ITEM 5. OTHER INFORMATION As of March 31, 2005, the Corporation had a $100 million credit agreement, which was to expire April 30, 2006, with LaSalle Bank N.A. (the "LaSalle Facility") to be used exclusively to support the issuance of letters of credit needed to support business operations. In March 2005, the Corporation asked the Bankruptcy court to approve amendments to the LaSalle Facility to extend the term of the facility until April 30, 2008, and to increase the credit line to $175 million. In the same motion, the Corporation asked for permission to replace certain standby letters of credit, which had been issued under a pre-petition credit facility but were expiring in the near future due to that credit facility's expiration, with new ones issued under the LaSalle Facility. The Bankruptcy court approved the Corporation's requests on April 15, 2005. The LaSalle Facility amendments, titled First Amendment to Master Letter of Credit Agreement and First Amendment to Pledge Agreement, dated April 29, 2005, are filed with this Form 10-Q as Exhibit 10. -54- ITEM 6. EXHIBITS 10. First Amendment to Master Letter of Credit Agreement and First Amendment to Pledge Agreement. 15. Letter from Deloitte & Touche LLP regarding unaudited financial information. 31.1 Rule 13a - 14(a) Certifications of USG Corporation's Chief Executive Officer 31.2 Rule 13a - 14(a) Certifications of USG Corporation's Chief Financial Officer 32.1 Section 1350 Certifications of USG Corporation's Chief Executive Officer 32.2 Section 1350 Certifications of USG Corporation's Chief Financial Officer
-55- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. USG CORPORATION By /s/ William C. Foote ------------------------------------- William C. Foote, Chairman, Chief Executive Officer and President By /s/ Richard H. Fleming ------------------------------------- Richard H. Fleming, Executive Vice President and Chief Financial Officer By /s/ D. Rick Lowes ------------------------------------- D. Rick Lowes, Vice President and Controller May 3, 2005 -56- EX-10 2 c94755exv10.txt FIRST AMENDMENT TO MASTER LETTER OF CREDIT AGREEMENT EXHIBIT 10 FIRST AMENDMENT TO MASTER LETTER OF CREDIT AGREEMENT This First Amendment to Master Letter of Credit Agreement (this "Amendment") is dated as of April 29, 2005 by and between USG CORPORATION, a Delaware corporation ("Applicant"), and LASALLE BANK NATIONAL ASSOCIATION ("Bank"). WITNESSETH: WHEREAS, Applicant and Bank are parties to that certain Master Letter of Credit Agreement, dated as of June 11, 2003 (as it has been and may further be amended, restated, modified or supplemented and in effect from time to time, the "Agreement"); WHEREAS, Applicant is a debtor and debtor-in-possession in Chapter 11 case (case no. 01-2094) in the United States Bankruptcy Court (the "Court") for the District of Delaware; WHEREAS, Applicant has requested that Bank amend the Agreement in certain respects, as more fully set forth herein, and Bank is agreeable to such request subject to the terms and conditions set forth herein; NOW, THEREFORE, the parties hereto hereby agree as follows: 1. DEFINITIONS. Capitalized terms used in this Amendment and not otherwise defined herein are used with the meanings given such terms in the Agreement. 2. AMENDMENTS. The Agreement is hereby amended as follows: (a) By amending and restating Section R-1 as follows: "R-1 Letter of Credit Commitment. (a) Prior to April 30, 2008 and provided that no Event of Default then exists, Bank will issue Letters of Credit with an aggregate stated amount not in excess of $175,000,000.00 at any one time (the "Letter of Credit Commitment") in each case containing such terms and conditions as are reasonably satisfactory to Bank, provided, however, no Letter of Credit shall have an expiry date later than the earlier to occur of (a) one year after the date of issuance thereof, and (b) April 30, 2009." (b) At Applicant's option, the Letter of Credit Commitment shall terminate on the effective date of Applicant's chapter 11 plan of reorganization (the "Early Termination Date"). Applicant may exercise such termination option by issuing written notice to Bank of Applicant's intent to terminate the Letter of Credit Commitment at least three business days' before the effective date of such chapter 11 plan of reorganization. Notwithstanding anything to the contrary herein, no fees payable under Subsection R-2(b) hereof shall accrue after the Early Termination Date. All Required Collateral held by Bank for any Letter of Credit shall be promptly returned to Applicant promptly after Bank receives such outstanding Letter of Credit and a signed letter from the applicable beneficiary, in the form of EXHIBIT A attached hereto or such other evidence in form reasonably acceptable to Bank, which evidences such beneficiary's consent to cancel such Letter of Credit." (b) By amending and restating Subsections R-2(a) and (b) as follows: "(a) LC Fee. One-half of one percent (0.5%) of the undrawn amount of each Letter of Credit (computed for the actual number of days elapsed on the basis of a year of 360 days), payable in arrears on the last day of each quarter and on April 30, 2009 (for any period then ending for which such fee shall not have previously been paid). Notwithstanding anything to the contrary herein, no fees payable under this Subsection R-2(a) shall accrue for any Letter of Credit after the date Bank receives such Letter of Credit and a signed letter from the applicable beneficiary, in the form of EXHIBIT A attached hereto or such other evidence in form reasonably acceptable to Bank, which evidences such beneficiary's consent to cancel such Letter of Credit." "(b) Non-Use Fee. One-quarter of one percent (0.25%) of the unused amount of the Letter of Credit Commitment, payable in arrears on the last day of each quarter and on April 30, 2009 (for any period then ending for which such non-use fee shall not have previously been paid). For purposes of calculating usage under this subsection, the Letter of Credit Commitment shall be deemed used to the extent of the stated face amount of all Letters of Credit. The non-use fee shall be computed for the actual number of days elapsed on the basis of a year of 360 days." (c) By amending and restating Subsection R-3(a) as follows: "(a) The obligation of Bank to issue any Letters of Credit is subject to the following: (i) Applicant pledging cash collateral in a trust account with Bank (time deposit open account or certificate of deposit) to Bank for all outstanding Letters of Credit pursuant to documentation satisfactory to Bank in the amount of 103% of the face amount of all outstanding Letters of Credit; provided, however, for cash collateral requirements in excess of $125,000,000, at Bank's sole discretion, Bank will permit the pledge of Cash Equivalent Investments (in lieu of cash) maintained in a trust account with Bank pursuant to documentation satisfactory to Bank which, when multiplied by the Bank's advance rates for collateral of such type (as from time to time determined by the Bank), will equal or exceed 103% of the face amount of all outstanding Letters of Credit. As used herein, "Cash Equivalent Investments" shall mean, at any time, (a) any evidence of -2- debt, maturing not more than one year after such time, issued by the United States Government, (b) any certificate of deposit, maturing not more than six months after such time, that are issued or sold by LaSalle Bank or its holding company or, upon Bank's sole discretion, by a commercial banking institution that is a member of the Federal Reserve System and has combined capital and surplus and undivided profits of not less than $500,000,000 and rated at least A by Standard & Poor's Ratings Group or A or A-1 by Moody's Investors Service, Inc., and (c) any mutual fund that is regulated by the Investment Company Act of 1940 which invests solely in the investments described in clauses (a) or (b) above. (ii) The representations and warranties of the Applicant shall be true and correct as of such requested date as though made on the date thereof. (iii) No Event of Default or Unmatured Event of Default shall have then occurred and be continuing or will result from such issuance. For the elimination of any doubt, the Bank's obligation to issue any Letter of Credit is subject to the condition precedent that the Applicant deliver cash collateral to Bank in the amount of 103% of the face amount of the proposed Letter of Credit (the "Required Collateral"). Any commitment the Bank may have to issue a particular Letter of Credit hereunder is unconditionally cancelable by the Bank absent the prior delivery by the Applicant to the Bank of the Required Collateral. 3. CONDITIONS TO EFFECTIVENESS. This Amendment shall become effective on the date on which the Bank shall have receiving all of the following: (a) This Amendment, which has been duly executed and delivered by Applicant. (b) That certain First Amendment to Pledge Agreement dated the date hereof by and between Applicant and Bank, which has been duly executed and delivered by Applicant. (c) a certificate of the Secretary of Applicant stating that there has been no change in the Certificate of Incorporation or By-Laws of Applicant since such documents were last delivered to the Bank and that there has been no change in the officers of Applicant since the last incumbency certificate for Applicant was delivered to the Bank. (d) good standing certificates for Applicant from the State of Illinois and the State of Delaware. (e) Payment by Applicant of all fees, costs and expenses to the extent then due and payable. -3- (f) a copy of an order from the Court, which approves the Agreement, as amended by this Amendment and that certain Pledge Agreement dated as of June 11, 2003 by and between Applicant and Bank, as amended, and no notice of appeal has been filed. 4. MISCELLANEOUS. (a) Applicant hereby agrees to pay all of Bank's costs and reasonable expenses, including, without limitation, reasonable attorneys' fees, related to this Amendment. (b) This Amendment may be executed in one or more counterparts, each of which shall be deemed to be an original, but all of which shall together constitute but one and the same document. (c) This Amendment shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns. (d) Section captions and headings used in this Amendment are for convenience only and are not part of and shall not affect the construction of this Amendment. (e) This Amendment shall be a contract made under and governed by the laws of the State of Illinois, without regard to conflict of laws principles. Whenever possible, each provision of this Amendment shall be interpreted in such a manner as to be effective and valid under applicable law, but if any provision of this Amendment shall be prohibited by or invalid under such law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Amendment. (f) From and after the date of execution of this Amendment, any reference to the Agreement contained in any notice, request, certificate or other instrument, document or agreement shall be deemed to include this Amendment unless the context shall otherwise require. (g) Except as expressly set forth herein, nothing in this Amendment is intended to or shall be deemed to have amended the Agreement, which is hereby reaffirmed in all respects. The Agreement, as amended hereby, and each of the other related agreements remain in full force and effect and are hereby reaffirmed in all respects. IN WITNESS WHEREOF, the parties have executed this Amendment as of the date first set forth above. USG CORPORATION, a Delaware LASALLE BANK NATIONAL ASSOCIATION, corporation a national banking association By: /s/ Karen L. Leets By: /s/ William B. McKinley --------------------------------- ------------------------------------ Its: Vice President and Treasurer William B. McKinley First Vice President -4- FIRST AMENDMENT TO PLEDGE AGREEMENT This First Amendment to Pledge Agreement (this "Amendment") is dated as of April 29, 2005 by and between USG CORPORATION, a Delaware corporation (the"Assignor"), and LASALLE BANK NATIONAL ASSOCIATION (the "Bank"). WITNESSETH: WHEREAS, Assignor and the Bank are parties to that certain Pledge Agreement, dated as of June 11, 2003 (as it has been and may further be amended, restated, modified or supplemented and in effect from time to time, the "Pledge Agreement"); WHEREAS, Assignor has requested that the Bank amend the Pledge Agreement in certain respects, as more fully set forth herein, and the Bank is agreeable to such request subject to the terms and conditions set forth herein; NOW, THEREFORE, the parties hereto hereby agree as follows: 1. DEFINITIONS. Capitalized terms used in this Amendment and not otherwise defined herein are used with the meanings given such terms in the Pledge Agreement. 2. AMENDMENT. Section 3(a) of the Pledge Agreement is hereby amended and restated as follows: "(a) At all times the assets of the Account shall be held in cash or Cash Equivalent Investments. As used herein, "Cash Equivalent Investments" shall mean, at any time, (i) any evidence of debt, maturing not more than one year after such time, issued by the United States Government, (ii) any certificate of deposit, maturing not more than six months after such time, that are issued or sold by LaSalle Bank or its holding company or, upon Bank's sole discretion, by a commercial banking institution that is a member of the Federal Reserve System and has combined capital and surplus and undivided profits of not less than $500,000,000 and rated at least A by Standard & Poor's Ratings Group or A or A-1 by Moody's Investors Service, Inc., and (iii) any mutual fund that is regulated by the Investment Company Act of 1940 which invests solely in the investments described in clauses (i) or (ii) above." 3. MISCELLANEOUS. (a) Assignor hereby agrees to pay all of the Bank's costs and reasonable expenses, including, without limitation, attorneys' fees, related to this Amendment. (b) This Amendment may be executed in one or more counterparts, each of which shall be deemed to be an original, but all of which shall together constitute but one and the same document. (c) This Amendment shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns. -5- (d) Section captions and headings used in this Amendment are for convenience only and are not part of and shall not affect the construction of this Amendment. (e) This Amendment shall be a contract made under and governed by the laws of the State of Illinois, without regard to conflict of laws principles. Whenever possible, each provision of this Amendment shall be interpreted in such a manner as to be effective and valid under applicable law, but if any provision of this Amendment shall be prohibited by or invalid under such law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Amendment. (f) From and after the date of execution of this Amendment, any reference to the Pledge Agreement contained in any notice, request, certificate or other instrument, document or agreement shall be deemed to include this Amendment unless the context shall otherwise require. (g) Except as expressly set forth herein, nothing in this Amendment is intended to or shall be deemed to have amended the Pledge Agreement, which is hereby reaffirmed in all respects. The Pledge Agreement, as amended hereby, and each of the other related agreements remain in full force and effect and are hereby reaffirmed in all respects. IN WITNESS WHEREOF, the parties have executed this Amendment as of the date first set forth above. USG CORPORATION, a Delaware LASALLE BANK NATIONAL ASSOCIATION, corporation a national banking association By: /s/ Karen L. Leets By: /s/ William B. McKinley --------------------------------- ------------------------------------ Its: Vice President and Treasurer William B. McKinley First Vice President -6- EX-15 3 c94755exv15.txt LETTER FROM DELOITTE & TOUCHE LLP EXHIBIT 15 May 3, 2005 USG Corporation 125 South Franklin Street Chicago, Illinois 60606 We have made a review, in accordance with the standards of the Public Company Accounting Oversight Board (United States), of the unaudited interim financial information of USG Corporation and subsidiaries for the quarters ended March 31, 2005 and 2004, as indicated in our report dated April 26, 2005; because we did not perform an audit, we expressed no opinion on that information. We are aware that our report referred to above, which is included in your Quarterly Report on Form 10-Q for the quarter ended March 31, 2005, is incorporated by reference in Registration Statement Nos. 33-40136, 33-64217, and 33-60563 (as amended) on Form S-3, Registration Statement Nos. 33-22581 (as amended), 33-22930, 33-36303, 33-52715, 33-63554, and 33-65383 on Form S-8, and Registration Statement Nos. 33-52573 on Form S-1. We also are aware that the aforementioned report, pursuant to Rule 436(c) under the Securities Act of 1933, is not considered a part of the Registration Statements prepared or certified by an accountant or a report prepared or certified by an accountant within the meaning of Sections 7 and 11 of that Act. /s/ DELOITTE & TOUCHE LLP DELOITTE & TOUCHE LLP Chicago, Illinois EX-31.1 4 c94755exv31w1.txt CERTIFICATIONS OF CHIEF EXECUTIVE OFFICER EXHIBIT 31.1 CERTIFICATIONS I, William C. Foote, certify that: 1. I have reviewed this quarterly report on Form 10-Q of USG Corporation (the "Corporation"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Corporation as of, and for, the periods presented in this report; 4. The Corporation's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act rules 13a-15(f) and 15(d)-15(f)) for the Corporation and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Corporation, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the Corporation's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the Corporation's internal control over financial reporting that occurred during the Corporation's most recent fiscal quarter (the Corporation's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Corporation's internal control over financial reporting; and 5. The Corporation's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Corporation's auditors and the audit committee of the Corporation's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Corporation's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Corporation's internal controls over financial reporting. May 3, 2005 /s/ William C. Foote ---------------------------------------- William C. Foote Chairman, Chief Executive Officer and President EX-31.2 5 c94755exv31w2.txt CERTIFICATION OF CHIEF FINANCIAL OFFICER EXHIBIT 31.2 CERTIFICATIONS I, Richard H. Fleming, certify that: 1. I have reviewed this quarterly report on Form 10-Q of USG Corporation (the "Corporation"); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Corporation as of, and for, the periods presented in this report; 4. The Corporation's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act rules 13a-15(f) and 15(d)-15(f)) for the Corporation and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Corporation, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the Corporation's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the Corporation's internal control over financial reporting that occurred during the Corporation's most recent fiscal quarter (the Corporation's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Corporation's internal control over financial reporting; and 5. The Corporation's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Corporation's auditors and the audit committee of the Corporation's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Corporation's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Corporation's internal controls over financial reporting. May 3, 2005 /s/ Richard H. Fleming ---------------------------------------- Richard H. Fleming Executive Vice President and Chief Financial Officer EX-32.1 6 c94755exv32w1.txt SECTION 1350 CERTIFICATION OF CHIEF EXECUTIVE OFFICER EXHIBIT 32.1 SECTION 1350 CERTIFICATIONS In connection with the Quarterly Report of USG Corporation (the "Corporation") on Form 10-Q, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, William C. Foote, Chairman, Chief Executive Officer and President of the Corporation, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation. May 3, 2005 /s/ William C. Foote ---------------------------------------- William C. Foote Chairman, Chief Executive Officer and President EX-32.2 7 c94755exv32w2.txt SECTION 1350 CERTIFICATION OF CHIEF FINANCIAL OFFICER EXHIBIT 32.2 SECTION 1350 CERTIFICATIONS In connection with the Quarterly Report of USG Corporation (the "Corporation") on Form 10-Q, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Richard H. Fleming, Executive Vice President and Chief Financial Officer of the Corporation, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation. May 3, 2005 /s/ Richard H. Fleming ---------------------------------------- Richard H. Fleming Executive Vice President and Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----