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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2006
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
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(Exact name of registrant as specified in its charter)
Delaware 36-3329400
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
125 South Franklin Street, Chicago, Illinois 60606-4678
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(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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of accelerated
filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X] Accelerated filer [] Non-accelerated filer []
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [] No [X]
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 [] No[] Not applicable. Although the registrant was
involved in bankruptcy proceedings during the preceding five years, it did not
distribute securities under its confirmed plan of reorganization.
The number of shares of the registrant's common stock outstanding as of
September 30, 2006 was 89,849,117.
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TABLE OF CONTENTS
Page
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Statements of Earnings:
Three Months and Nine Months
Ended September 30, 2006 and 2005 3
Consolidated Balance Sheets:
As of September 30, 2006 and December 31, 2005 4
Consolidated Statements of Cash Flows:
Nine Months Ended September 30, 2006 and 2005 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Results
of Operations and Financial Condition 31
Item 4. Controls and Procedures 50
Report of Independent Registered Public Accounting Firm 51
PART II OTHER INFORMATION
Item 1. Legal Proceedings 52
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 52
Item 5. Other Information 54
Item 6. Exhibits 55
Signatures 56
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PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
USG CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS
(DOLLARS IN MILLIONS EXCEPT PER-SHARE DATA)
(UNAUDITED)
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
---------------------------- ----------------------------
2006 2005 2006 2005
------------ ------------ ------------ ------------
Net sales $ 1,478 $ 1,344 $ 4,516 $ 3,804
Cost of products sold 1,132 1,043 3,413 3,022
------------ ------------ ------------ ------------
Gross profit 346 301 1,103 782
Selling and administrative expenses 103 88 305 264
Reversal of asbestos claims reserve (17) - (44) -
Chapter 11 reorganization expenses 2 2 10 2
------------ ------------ ------------ ------------
Operating profit 258 211 832 516
Interest expense 16 1 539 4
Interest income (16) (3) (23) (7)
Other (income) expense, net (2) - (2) 1
------------ ------------ ------------ ------------
Earnings before income taxes 260 213 318 518
Income taxes 107 55 130 173
------------ ------------ ------------ ------------
Net earnings 153 158 188 345
============ ============ ============ ============
Earnings per Common Share:
Basic 1.71 2.77 3.03 6.15
Diluted 1.71 2.77 3.03 6.12
Average common shares 89,849,117 56,803,000 62,120,058 56,147,438
Average diluted common shares 89,907,436 56,941,922 62,227,119 56,368,936
See accompanying Notes to Consolidated Financial Statements.
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USG CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
(UNAUDITED)
AS OF AS OF
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------- -------------
ASSETS
Current Assets:
Cash and cash equivalents $ 1,453 $ 936
Short-term marketable securities - 234
Restricted cash 5 78
Receivables (net of reserves - $16 and $14) 548 453
Inventories 357 315
Income taxes receivable 270 6
Deferred income taxes 1,244 2
Other current assets 78 155
------------ ------------
Total current assets 3,955 2,179
Long-term marketable securities - 329
Property, plant and equipment (net of accumulated
depreciation and depletion - $1,082 and $982) 2,093 1,946
Deferred income taxes - 1,423
Goodwill 105 64
Other assets 210 201
------------ ------------
Total Assets 6,363 6,142
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LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Accounts payable 318 281
Accrued expenses 475 275
Note payable to Section 524(g) asbestos trust 10 -
Contingent note payable to Section 524(g) asbestos trust 3,050 -
Deferred income taxes - 6
Income taxes payable 54 38
------------ ------------
Total current liabilities 3,907 600
Long-term debt 239 -
Deferred income taxes 153 28
Other liabilities 513 476
Liabilities subject to compromise - 5,340
Commitments and contingencies
Stockholders' Equity (Deficit):
Preferred stock - -
Common stock 9 5
Treasury stock (208) (219)
Capital received in excess of par value 2,166 435
Accumulated other comprehensive (loss) income (9) 72
Retained earnings (deficit) (407) (595)
------------ ------------
Total stockholders' equity (deficit) 1,551 (302)
------------ ------------
Total Liabilities and Stockholders' Equity (Deficit) 6,363 6,142
============ ============
See accompanying Notes to Consolidated Financial Statements.
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USG CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
NINE MONTHS
ENDED SEPTEMBER 30,
-------------------
2006 2005
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OPERATING ACTIVITIES:
Net earnings $ 188 $ 345
Adjustments to reconcile net earnings to net cash:
Reversal of asbestos claims reserve (44) -
Depreciation, depletion and amortization 101 92
Share-based compensation expense 7 -
Deferred income taxes 358 (81)
Gain on asset dispositions - (1)
(Increase) decrease in working capital:
Receivables (117) (74)
Income taxes receivable (264) 18
Inventories (32) 9
Payables 53 41
Accrued expenses 11 23
Increase in other assets (33) (30)
Increase in other liabilities 29 16
Payment to Section 524(g) asbestos trust (890) -
Reorganization distribution - other (656) -
Liabilities subject to compromise 521 1
Other, net 3 (12)
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Net cash (used for) provided by operating activities (765) 347
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INVESTING ACTIVITIES:
Capital expenditures (237) (125)
Purchases of marketable securities (112) (489)
Sales or maturities of marketable securities 677 430
Net proceeds from asset dispositions 1 1
Acquisitions of businesses, net of cash acquired (74) (29)
Return (deposit) of restricted cash 73 (34)
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Net cash provided by (used for) investing activities 328 (246)
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FINANCING ACTIVITIES:
Reorganization distribution - debt principal (766) -
Proceeds from rights offering, net of expenses 1,720 -
Issuances of common stock upon exercise of stock options 13 40
Payment of debt issuance fees (22) -
Tax benefit of share-based payments 6 -
------- -------
Net cash provided by financing activities 951 40
------- -------
Effect of exchange rate changes on cash 3 3
Net increase in cash and cash equivalents 517 144
Cash and cash equivalents at beginning of period 936 756
------- -------
Cash and cash equivalents at end of period 1,453 900
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SUPPLEMENTAL CASH FLOW DISCLOSURES:
Interest paid 541 1
Income taxes paid, net 41 209
See accompanying Notes to Consolidated Financial Statements.
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USG CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(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. Earnings-per-share data for all periods have been adjusted to
reflect the effect of the Rights Offering described in Notes 2 and 4
below. These financial statements and notes are to be read in conjunction
with the financial statements and notes included in the Corporation's
Annual Report on Form 10-K for the fiscal year ended December 31, 2005,
which was filed on February 14, 2006.
(2) VOLUNTARY REORGANIZATION UNDER CHAPTER 11 AND CONFIRMATION OF THE PLAN OF
REORGANIZATION
On June 25, 2001 (the "Petition Date"), the Corporation and the 10 United
States subsidiaries listed below (collectively, the "Debtors" or
"Reorganized 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 proceedings were jointly
administered under In re USG Corporation, et al., Case No. 01-2094. By
order entered on June 16, 2006 (the "Confirmation Order"), the Bankruptcy
Court and the United States District Court for the District of Delaware
(the "District Court") confirmed the First Amended Plan of Reorganization
of USG Corporation and its Debtor Subsidiaries (the "Plan" or "Plan of
Reorganization"). The Plan became effective on June 20, 2006 (the
"Effective Date"). The confirmed Plan resolves the Chapter 11 proceedings
and provides for the resolution of all present and future asbestos
personal injury claims against the Debtors.
The following subsidiaries of the Corporation were included in the Chapter
11 proceedings and are included in the confirmed Plan: United States
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Gypsum Company ("U.S. Gypsum"); USG Interiors, Inc. ("USG Interiors"); USG
Interiors International, Inc.; L&W Supply Corporation ("L&W Supply");
Beadex Manufacturing, LLC ("Beadex"); B-R Pipeline Company; La Mirada
Products Co., Inc.; Stocking Specialists, Inc.; USG Industries, Inc.; and
USG Pipeline Company. The Chapter 11 proceedings and the Plan do not
include any of the Corporation's non-U.S. subsidiaries or companies that
were acquired by any of the Debtors after the Filing.
Pursuant to the Plan, a trust was created under Section 524(g) of the
Bankruptcy Code (the "Trust") to pay all qualifying present and future
asbestos personal injury claims against the Debtors. On the Effective
Date, the Reorganized Debtors funded the Trust as follows:
- The Reorganized Debtors paid $890 million to the Trust and issued to
the Trust an interest-bearing note in the amount of $10 million,
payable no later than December 31, 2006; and
- The Reorganized Debtors also issued to the Trust a contingent
payment note in the aggregate principal amount of $3.05 billion,
which, as described more fully below, will be payable to the Trust
depending upon whether the Fairness in Asbestos Injury Resolution
Act of 2005 or substantially similar legislation creating a national
trust or similar fund (collectively, the "FAIR Act") is enacted by
the 10th day (excluding Sundays) after final adjournment of the
current term of Congress (the "Trigger Date"), which is currently
expected to occur no later than December 2006.
The Reorganized Debtors are co-obligors and are jointly and severally
liable under the $10 million promissory note and the $3.05 billion
contingent payment note. Each of the notes is secured by an obligation to
pledge to the Trust shares of the voting stock of the Corporation equal to
51% of the number of shares outstanding. The obligation to pledge those
shares would be triggered by a payment default under the applicable note.
As provided in the Plan, if the FAIR Act is enacted and made law on or
before the Trigger Date and is not subject to, or survives, a
constitutional challenge initiated within 60 days of the Trigger Date, the
contingent payment note will be cancelled and the Reorganized Debtors will
have no further payment obligations to the Trust. In that situation, the
total amount to be paid by the Reorganized Debtors to the Trust will be
the $890 million paid to the Trust on the Effective Date and the
obligations under the $10 million promissory note.
If the FAIR Act is not enacted and made law by the Trigger Date, the
Reorganized Debtors will be obligated to make payments under the
contingent payment note as follows: $1.9 billion will be payable to the
Trust within 30 days after the Trigger Date, with the remaining $1.15
billion payable within 180 days after the Trigger Date. Interest will
accrue on the unpaid balance of the $3.05 billion contingent payment note
beginning on the Trigger Date. The rate of interest is the rate of the
90-
-7-
day LIBOR in effect as of the Trigger Date plus 40 basis points.
If the FAIR Act is enacted by the Trigger Date but is later held
unconstitutional, the Reorganized Debtors will be obligated to make
payments under the $3.05 billion contingent note, as described more fully
below. Specifically, if the FAIR Act is enacted by the Trigger Date and
there is a constitutional challenge to the FAIR Act initiated within 60
days of the Trigger Date, the Debtors will be obligated to make payments
under the $3.05 billion contingent payment note if the constitutional
challenge results in a final, non-appealable court order that the FAIR Act
is (i) unconstitutional in its entirety or (ii) unconstitutional insofar
as it applies to debtors in Chapter 11 cases whose plans of reorganization
had not yet been confirmed and become substantially consummated as of
February 1, 2006. In those circumstances, the Debtors would be obligated
to pay $1.9 billion within 30 days after the date the court order becomes
final and non-appealable and pay the remaining $1.15 billion within 180
days after the date the order becomes final and non-appealable. If the
constitutional challenge is resolved by a final, non-appealable court
order in any manner other than as described above, then the $3.05 billion
contingent payment, including the right of the Trust to own stock of the
Corporation under that note, will be cancelled.
The amounts that the Reorganized Debtors are obligated to pay to the Trust
under the Plan, either $900 million or $3.95 billion, with interest as
described above, are fixed amounts that depend upon passage of the FAIR
Act on or prior to the Trigger Date. These amounts were determined through
settlement negotiations with the Official Committee of Asbestos Personal
Injury Claimants and the legal representative for future asbestos personal
injury cases appointed in the Debtors' Chapter 11 proceedings. The
Reorganized Debtors will not be obligated to make additional payments to
the Trust beyond the payments described above.
The Confirmation Order contains a channeling injunction which provides
that all present and future asbestos personal injury claims against the
Debtors must be brought against the Trust and no individual or entity may
bring such a claim against the Reorganized Debtors. This channeling
injunction applies to all present and future asbestos personal injury
claims for which any Debtor is alleged to be liable, including any
asbestos personal injury claims against the Debtors relating to A.P. Green
Refractories Co., a former subsidiary of U.S. Gypsum and the Corporation.
The Plan also provides for the resolution of other pre-petition claims
against the Debtors. Allowed claims of all other creditors, including
settled asbestos property damage claims, will be, or already have been,
paid in full, with interest as agreed or as provided in the Plan. Any
disputed claims will be resolved in the Bankruptcy Court or other court,
where appropriate. If it is ultimately determined that any amounts are
owed on these disputed claims, those amounts will be paid with interest as
required.
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As a result of confirmation of the Plan of Reorganization, the four
official committees appointed in the Chapter 11 proceedings have been
disbanded. The legal representative for future asbestos personal injury
claimants will continue to act in the same capacity with respect to the
Trust.
Under the Plan, stockholders of the Corporation as of the Effective Date
retained their shares. In addition, on June 30, 2006 (the "Record Date"),
the Corporation issued to its stockholders one transferable right for each
share owned on the Record Date, entitling the holder to purchase one share
of common stock for $40.00 in cash for each right (the "Rights Offering").
These rights expired at 5:00 p.m., New York City time, on July 27, 2006.
In connection with the Rights Offering, Berkshire Hathaway Inc.
("Berkshire Hathaway"), the Corporation's largest stockholder, agreed to
purchase from the Corporation, at $40.00 per share, all of the shares of
common stock offered pursuant to the Rights Offering that were not issued
pursuant to the exercise of rights (the "Backstop Commitment"). In the
first quarter of 2006, the Debtors paid Berkshire Hathaway a fee of $67
million for its Backstop Commitment. On August 2, 2006, the Corporation
issued 6.97 million shares of common stock to Berkshire Hathaway in
accordance with the Backstop Commitment. These shares include 6.5 million
shares underlying rights distributed to Berkshire Hathaway in connection
with the shares it beneficially owned on the Record Date and 0.47 million
shares underlying rights distributed to other stockholders that were not
exercised in the Rights Offering. A total of 44.92 million shares of the
Corporation's common stock were distributed in connection with the Rights
Offering, including the 6.97 million shares issued to Berkshire Hathaway.
The Corporation's net proceeds from the Rights Offering and the Backstop
Commitment were approximately $1.7 billion. The Corporation is using the
net proceeds from the Rights Offering and the Backstop Commitment,
together with other available funds, to make payments contemplated by the
Plan and for general corporate purposes.
The Debtors' financial obligations under the Plan depend upon, among other
things, whether the $3.05 billion contingent payment note becomes due. The
Debtors propose to fund their obligations under the Plan through (i) cash
accumulated since the Petition Date, some of which was used to fund the
$890 million payment to the Trust and other creditor payments, (ii) the
net proceeds of the Rights Offering and Backstop Commitment, (iii)
anticipated tax refunds and (iv) the Corporation's credit facility entered
into on August 2, 2006 or other alternative debt financing.
Information regarding the Corporation's credit facility is set forth below
in Note 3. Additional information about the Rights Offering and the Plan's
treatment of asbestos claims is set forth below in Notes 4 and 13,
respectively.
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
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asbestos personal injury claims. The legislation was titled the Fairness
in Asbestos Injury Resolution Act of 2005 (Senate Bill 852) (the "FAIR Act
of 2005" or the "Act").
The FAIR Act of 2005 was intended to establish a nationally administered
trust fund to compensate asbestos personal injury claimants. The Act
provided that companies that had made past payments for asbestos personal
injury claims would be required to contribute amounts on a periodic basis
to a national trust fund 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 were
being compensated under the national trust fund. The FAIR Act of 2005 has
not been enacted by Congress and is not law.
In late May 2006, an amended version of the Act, called the "Fairness in
Asbestos Injury Resolution Act of 2006" (the "FAIR Act of 2006" or "S.
3274") was introduced by Senator Specter and Senator Patrick Leahy, D-Vt.
The FAIR Act of 2006 also contemplates creation of a national trust to pay
asbestos personal injury claims but contains some modifications from the
FAIR Act of 2005. A copy of the FAIR Act of 2006 as introduced is
available at http://thomas.loc.gov (type in "S. 3274" in the search
field). The current form of the FAIR Act of 2006 does not require
contributions from companies, such as the Reorganized Debtors, that have a
confirmed plan of reorganization under Chapter 11 of the Bankruptcy Code
that is substantially consummated and no longer subject to appeal. The
FAIR Act of 2006 has not been enacted and is not law.
Although the current form of the FAIR Act of 2006 does not require
contributions from the Reorganized Debtors to the proposed national trust,
the amounts that the Reorganized Debtors will be required to pay into the
Trust established under the Debtors' Plan of Reorganization depend on
whether the FAIR Act is enacted by the Trigger Date and either does not
become subject to or survives a subsequent constitutional challenge. Final
adjournment of the current term of Congress, which is the basis for the
Trigger Date, is currently expected to be no later than December 2006. The
outcome of the legislative process is inherently speculative, and it
cannot be known whether the FAIR Act will be enacted by the Trigger Date
or, even if enacted, would survive any subsequent constitutional
challenge.
ASBESTOS PROPERTY DAMAGE CLAIMS
The Plan of Reorganization does not create a trust for asbestos property
damage claims against the Debtors. The Plan provides that settled asbestos
property damage claims will be paid in full and disputed asbestos property
damage claims timely filed in the bankruptcy proceeding will be resolved
either in the Bankruptcy Court or other court, where appropriate. If it is
determined that any amounts are owed for disputed claims, those amounts
will be paid, with interest as required.
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As a result of the bar date for filing asbestos property damage claims in
Debtors' Chapter 11 proceedings, approximately 1,400 asbestos property
damage claims were filed by the bar date and more than 70 such claims were
filed after the bar date. More than 950 claims were disallowed or
withdrawn, leaving approximately 520 claims pending. The Debtors have
reached written agreements or agreements in principle to settle all of the
remaining asbestos property damage claims with the exception of one small
claim brought by a residential homeowner. In October 2006, the Debtors
made approximately $62 million in payments pursuant to asbestos property
damage settlements. The estimated cost of the unpaid settlements of the
remaining asbestos property damage claims, both those for which a written
agreement has been executed and those which have been settled in
principle, and the associated legal fees is included in accrued expenses.
The asbestos property damage claims are also discussed in Note 13.
CORPORATE PERFORMANCE PLAN
On January 10, 2006, the Bankruptcy Court approved the USG Corporation
2006 Corporate Performance Plan (the "CPP"). The terms of the CPP provide
that it is to be effective for eligible participants from January 1, 2006
through December 31, 2006, or through and including the effective date of
a plan of reorganization in the Debtors' Chapter 11 proceedings, whichever
comes first. The CPP provides participants, who hold key positions
identified as eligible, with two cash payments equal to a specified
percentage of their annual base salary. The first payment will be made in
January 2007. The second payment will be made in July 2007 and is subject
to a performance adjustment based on the Corporation's 2006 calendar-year
results, which could increase the second payment up to 50% or eliminate it
altogether.
Because the Plan became effective on June 20, 2006, awards earned under
the CPP were prorated through that date, subject to final adjustments.
Expenses associated with the CPP, prorated through the Effective Date,
amounted to zero and $13.0 million in the third quarter and first nine
months of 2006, respectively. Expenses associated with a comparable
predecessor plan amounted to $6.5 million and $16.9 million in the third
quarter and first nine months of 2005, respectively.
FINANCIAL STATEMENT PRESENTATION
While operating as debtors-in-possession under the protection of Chapter
11 of the Bankruptcy Code, the Corporation's consolidated financial
statements were prepared in accordance with AICPA SOP 90-7, "Financial
Reporting by Entities in Reorganization Under the Bankruptcy Code" ("SOP
90-7"), and on a going-concern basis, which contemplated continuity of
operations, realization of assets and liquidation of liabilities in the
ordinary course of business. During this period, subject to Bankruptcy
Court approval or otherwise as permitted in the ordinary course of
business, the Debtors, or any of them, had the ability to sell or
otherwise dispose of assets and liquidate or settle liabilities for
amounts other than those reflected in the consolidated financial
statements.
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LIABILITIES SUBJECT TO COMPROMISE
While operating as debtors-in-possession under the protection of Chapter
11 of the Bankruptcy Code, the Debtors' estimates of known or potential
pre-petition claims and related post-petition amounts to be resolved in
connection with the Chapter 11 proceedings were reflected in the
consolidated financial statements as liabilities subject to compromise. As
of June 30, 2006, such liabilities were reclassified on the consolidated
balance sheet. This included the reclassification of the Corporation's
remaining asbestos reserve to current liabilities, either as note payable
to Section 524(g) asbestos trust or accrued expenses, as appropriate.
CHAPTER 11 REORGANIZATION EXPENSES
Chapter 11 reorganization expenses in the consolidated statements of
earnings consisted of the following (dollars in millions):
Three Months Nine Months
ended September 30, ended September 30,
-------------------- -------------------
2006 2005 2006 2005
-------------------- -------------------
Legal and financial advisory fees $ 2 $ 11 $ 34 $ 23
Bankruptcy-related interest income - (9) (24) (21)
------------------ -------------------
Total Chapter 11 reorganization expenses 2 2 10 2
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INTEREST EXPENSE
Interest expense for the third quarter and first nine months of 2006
included charges for post-petition interest and fees related to
pre-petition obligations. For the third quarter of 2006, these
post-petition interest and fees were $8 million ($5 million after-tax).
For the first nine months of 2006, these post-petition interest and fees
totaled $528 million ($326 million after-tax). In accordance with SOP
90-7, virtually all of the Corporation's outstanding debt had been
classified as liabilities subject to compromise in prior periods, and from
the Petition Date through December 31, 2005, interest expense on this debt
and other pre-petition obligations had not been accrued or recorded.
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(3) DEBT
CREDIT FACILITIES
On August 2, 2006, the Corporation entered into a $2.8 billion credit
agreement with a syndicate of banks. JPMorgan Chase Bank, N.A. serves as
Administrative Agent under the agreement. The credit agreement consists of
(i) a $650 million revolving credit facility with a $250 million sublimit
for letters of credit, (ii) a $1.0 billion term loan facility and (iii) a
$1.15 billion tax bridge term loan facility (collectively, the "Credit
Facilities").
The Credit Facilities have been assigned credit ratings of Baa3 by Moody's
Investor Service Inc. and BB+ by Standard & Poor's Ratings Services.
The revolving credit facility is available to fund working capital needs
and for other general corporate purposes. Borrowings under the revolving
credit facility bear interest, at the Corporation's option, at either an
alternative base rate or at LIBOR plus a margin, to be determined based on
the Credit Facilities' credit rating. Based on the current ratings of the
Credit Facilities, the margin for LIBOR borrowings would be 0.60%. The
Corporation is also required to pay facility fees on the entire revolving
credit facility, whether drawn or undrawn, and fees on outstanding letters
of credit. These fees are also dependent on the credit rating of the
Credit Facilities. The revolving credit facility matures on August 2,
2011, unless terminated earlier in accordance with its terms. The
revolving credit facility has not been drawn upon as of the date of this
report, except for approximately $90 million of outstanding letters of
credit.
The Corporation intends to use borrowings under the term loan and tax
bridge facilities, together with accumulated cash, to finance the payment
of the contingent payment note in accordance with the Plan. The term loan
and tax bridge facilities bear interest, at the Corporation's option, at
either an alternative base rate or LIBOR plus, in either case, a margin,
to be determined based on the Credit Facilities' credit rating. Based on
the current ratings of the Credit Facilities, the margin is 0.75% for
LIBOR borrowings and 0.00% for alternate base-rate borrowings. The
Corporation is also required to pay fees on the undrawn amount of the term
loan and tax bridge facilities until drawn. These fees are also dependent
on the credit rating of the Credit Facilities. The Corporation is required
to prepay the tax bridge facility upon receipt of tax refunds that the
Corporation anticipates it will receive as a result of tax deductions
generated by the payments being made to the Trust. The term loan facility
matures on August 2, 2011, and the tax bridge facility matures on February
2, 2009.
The term loan is to be made available to the Corporation from the lenders
in a single drawing of up to $1.0 billion, and the tax bridge facility is
to be made available to the Corporation in a single drawing of up to $1.15
billion, in each case to be made on or before January 31, 2007. If
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the Fair Act of 2005, or substantially similar legislation, is enacted but
remains subject to constitutional challenge, the Corporation would be able
to request that the availability of the term loan and tax bridge
facilities be extended. However, the availability of the term loan
facility is not permitted to be extended beyond August 1, 2008, and the
availability of the tax bridge facility is not permitted to be extended
beyond February 1, 2008.
The Corporation has the ability under the terms of the Credit Facilities
to repay amounts outstanding under the revolving credit, term loan and tax
bridge facilities at any time prior to their maturities without paying any
prepayment premium or penalty. Paydowns under the term loan and tax bridge
facilities would be permanent reductions in these facilities. The
Corporation's obligations under the Credit Facilities are guaranteed by
all of its material domestic subsidiaries.
The credit agreement requires that the Corporation meet and maintain
certain financial ratios and tests, including a maximum leverage ratio (as
defined in the credit agreement) of no more than 4.50 to 1.00 and a
minimum interest coverage ratio (as defined in the credit agreement) of
not less than 2.00 to 1.00. The credit agreement contains events of
default and covenants that are customary for similar transactions and may
limit the ability of the Corporation and its subsidiaries to take various
actions.
PRE-PETITION DEBT
Pre-petition debt previously included in liabilities subject to compromise
amounted to $1.005 billion as of the Petition Date. As of September 30,
2006, the Corporation repaid $766 million of this debt and reinstated $239
million in accordance with the Plan and reclassified this amount to
long-term debt.
-14-
(4) RIGHTS OFFERING
In the Rights Offering, the Corporation issued to its stockholders on the
Record Date one transferable right for each share owned on the Record
Date, entitling the holder to purchase one share of common stock for
$40.00 in cash for each right. These rights expired at 5:00 p.m., New York
City time, on July 27, 2006. In connection with the Rights Offering,
Berkshire Hathaway agreed through its Backstop Commitment to purchase from
the Corporation, at $40.00 per share, all of the shares of common stock
offered pursuant to the Rights Offering that were not issued pursuant to
the exercise of rights. In the first quarter of 2006, the Debtors paid
Berkshire Hathaway a fee of $67 million for its Backstop Commitment. On
August 2, 2006, the Corporation issued 6.97 million shares of common stock
to Berkshire Hathaway in accordance with the Backstop Commitment. These
shares include 6.5 million shares underlying rights distributed to
Berkshire Hathaway in connection with the shares it beneficially owned on
the Record Date and 0.47 million shares underlying rights distributed to
other stockholders that were not exercised in the Rights Offering. A total
of 44.92 million shares of the Corporation's common stock were distributed
in connection with the Rights Offering, including the 6.97 million shares
issued to Berkshire Hathaway. The Corporation's net proceeds from the
Rights Offering and the Backstop Commitment were approximately $1.7
billion. The Corporation is using the net proceeds from the Rights
Offering and the Backstop Commitment, together with other available funds,
to make payments contemplated by the Plan and for general corporate
purposes.
In connection with the Backstop Commitment, the Corporation and Berkshire
Hathaway entered into a shareholder's agreement whereby Berkshire Hathaway
agreed, among other things, that for a period of seven years following
completion of the Rights Offering, except in limited circumstances,
Berkshire Hathaway will not acquire beneficial ownership of the
Corporation's voting securities if, after giving effect to the
acquisition, Berkshire Hathaway would own more than 40% of the
Corporation's voting securities on a fully diluted basis. Berkshire
Hathaway further agreed that, during such seven-year period, it will not
solicit proxies with respect to securities of the Corporation or submit a
proposal or offer involving a merger, acquisition or other extraordinary
transaction unless such proposal or offer (i) is requested by the
Corporation's Board of Directors or (ii) is made to the Board of Directors
confidentially, is conditioned on approval by a majority of the voting
securities of the Corporation not owned by Berkshire Hathaway and a
determination by the Board of Directors as to its fairness to stockholders
and, if the proposed transaction is not a tender offer for all shares of
common stock or an offer for the entire company, is accompanied by an
undertaking to offer to acquire all shares of common stock of the
Corporation outstanding after completion of the transaction at the same
price per share as was paid in the transaction. The shareholder's
agreement also provides that, with certain exceptions, any new shares of
common stock acquired by Berkshire Hathaway in excess of those owned on
-15-
the date of the agreement (and shares distributed on those shares,
including in the Rights Offering) will be voted proportionally with all
voting shares. Berkshire Hathaway also agreed that if purchases or sales
of common stock of the Corporation by it or specified affiliates would
prevent the Corporation from carrying back a net operating loss
attributable to a specified payment to the Trust, Berkshire Hathaway will
not, upon notice from the Corporation, make such purchases or sales until
the Corporation has made its first payment under the contingent payment
note issued to the Trust or the Corporation notifies Berkshire Hathaway
that this limitation is no longer needed.
Under the shareholder's agreement, for the same seven-year period, the
Corporation agreed to exempt Berkshire Hathaway from its existing or
future stockholder rights plans to the extent that Berkshire Hathaway
complies with the terms and conditions of the shareholder's agreement. If
there is a stockholder vote on a stockholder rights plan that does not
contain this agreed exemption, Berkshire Hathaway may vote without
restriction all the shares it holds in a stockholder vote to approve or
disapprove the proposed stockholder rights plan. The Corporation also
agreed that, after the seven-year standstill period ends, during the time
that Berkshire Hathaway owns the Corporation's equity securities,
Berkshire Hathaway will be exempted from any stockholder rights plan,
except that the Board of Directors may adopt a stockholder rights plan
that restricts Berkshire Hathaway from acquiring (although it may continue
to hold) beneficial ownership of more than 50% of the voting securities of
the Corporation, on a fully diluted basis, other than pursuant to an offer
to acquire all shares of common stock of the Corporation that is open for
at least 60 calendar days.
The parties also entered into a registration rights agreement whereby the
Corporation granted Berkshire Hathaway registration rights with respect to
its shares of the Corporation's common stock.
(5) ASSET RETIREMENT OBLIGATIONS
Changes in the liability for asset retirement obligations consisted of the
following (dollars in millions):
Nine Months ended September 30,
-------------------------------
2006 2005
---- ----
Balance as of January 1 $71 $43
Accretion expense 3 2
Liabilities incurred 3 8
Foreign currency translation 1 1
---- ----
Balance as of September 30 78 54
==== ====
-16-
(6) 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 restricted stock units ("RSUs") and the potential exercise of
outstanding stock options. In 2006, diluted earnings per share exclude
RSUs and the potential exercise of stock options issued in 2006 as they
would have an anti-dilutive effect. Average common shares and average
diluted common shares outstanding are calculated in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings
Per Share," and reflect the effect of the Rights Offering and Backstop
Commitment described in Notes 2 and 4 above. 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 September 30, Earnings (thousands) Amount
----------------------------------------- -------- ----------- ---------
2006:
Basic earnings $ 153 89,849 $ 1.71
Dilutive effect of RSUs and stock options 58
------- --------- ---------
Diluted earnings 153 89,907 1.71
======= ========= =========
2005:
Basic earnings 158 56,803 2.77
Dilutive effect of stock options 139
------- --------- ---------
Diluted earnings 158 56,942 2.77
======= ========= =========
Nine Months Ended September 30,
-----------------------------------------
2006:
Basic earnings $ 188 62,120 $ 3.03
Dilutive effect of RSUs and stock options 107
------- --------- ---------
Diluted earnings 188 62,227 3.03
======= ========= =========
2005:
Basic earnings 345 56,147 6.15
Dilutive effect of stock options 222
------- --------- ---------
Diluted earnings 345 56,369 6.12
======= ========= =========
-17-
(7) DERIVATIVE INSTRUMENTS
The Corporation uses derivative instruments to manage selected commodity
price and foreign currency exposures. The Corporation does not use
derivative instruments for speculative 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") 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. For
derivatives designated as net investment hedges, changes in value are
recorded in OCI. As of September 30, 2006, the Corporation had no foreign
currency contracts.
COMMODITY DERIVATIVE INSTRUMENTS
The Corporation uses swap contracts to hedge anticipated purchases of
natural gas to be used in its manufacturing operations. Generally, the
Corporation has a substantial majority of its anticipated purchases of
natural gas over the next 12 months hedged; however, the Corporation
reviews its positions regularly and makes adjustments as market conditions
warrant. The current contracts, all of which mature by December 31, 2009,
are designated as cash flow hedges. As of September 30, 2006, the
Corporation had swap contracts to exchange monthly payments on notional
amounts of natural gas amounting to $280 million. The fair value of these
swap contracts as of September 30, 2006 was negative $21 million.
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 fully satisfy their
obligations under the contracts. The Corporation receives collateral from
its counterparties based on the provisions in certain credit support
agreements. Similarly, the Corporation may be required to post collateral
if aggregate payables exceed certain limits. As of September 30, 2006, the
Corporation had posted approximately $4 million in cash collateral. The
Corporation enters into master agreements which contain netting
arrangements that minimize counterparty credit exposure.
-18-
(8) COMPREHENSIVE INCOME
The components of comprehensive income are summarized in the following
table (dollars in millions):
Three Months Nine Months
ended September 30, ended September 30,
--------------------- ---------------------
2006 2005 2006 2005
----- ----- ----- -----
Net earnings $ 153 $ 158 $ 188 $ 345
----- ----- ----- -----
Pretax gain (loss) on derivatives (31) 144 (149) 191
Income tax benefit (expense) 12 (56) 58 (74)
----- ----- ----- -----
After-tax gain (loss) on derivatives (19) 88 (91) 117
----- ----- ----- -----
Pretax minimum pension liability - - - (10)
Income tax benefit - - - 4
----- ----- ----- -----
After-tax minimum pension liability - - - (6)
----- ----- ----- -----
Foreign currency translation 3 13 9 5
Unrealized gain on marketable securities - - 1 -
----- ----- ----- -----
Total comprehensive income 137 259 107 461
===== ===== ===== =====
There was no tax impact on the foreign currency translation adjustments.
OCI consisted of the following (dollars in millions):
As of As of
September 30, December 31,
2006 2005
------------- ------------
Gain (loss) on derivatives, net of tax $(31) $ 60
Foreign currency translation 30 21
Minimum pension liability, net of tax (8) (8)
Unrealized loss on marketable securities, net of tax - (1)
---- ----
Total (9) 72
==== ====
During the third quarter of 2006, accumulated net after-tax losses of $7
million ($11 million pretax) on derivatives were reclassified from OCI to
earnings. As of September 30, 2006, the estimated net after-tax losses
expected to be reclassified within the next 12 months from OCI to earnings
were $25 million.
-19-
(9) EMPLOYEE RETIREMENT PLANS
The components of net pension and postretirement benefits costs for the
three months and nine months ended September 30, 2006 and 2005 are
summarized in the following table (dollars in millions):
Three Months Nine Months
ended September 30, ended September 30,
-------------------- --------------------
2006 2005 2006 2005
-------- -------- -------- --------
PENSION:
Service cost of benefits earned $ 10 $ 9 $ 29 $ 26
Interest cost on projected
benefit obligation 15 14 46 42
Expected return on plan assets (15) (14) (47) (42)
Net amortization 4 4 14 14
-------- -------- -------- --------
Net cost 14 13 42 40
======== ======== ======== ========
POSTRETIREMENT:
Service cost of benefits earned 3 3 11 10
Interest cost on projected
benefit obligation 5 5 16 14
Recognized loss - (1) (2) (3)
-------- -------- -------- --------
Net cost 8 7 25 21
======== ======== ======== ========
In accordance with the Corporation's funding policy, the Corporation and
its subsidiaries contributed cash of $26 million and $53 million to their
pension plans during the third quarter and first nine months of 2006,
respectively, and expect to contribute a total of approximately $76
million during fiscal year 2006.
-20-
(10) SHARE-BASED COMPENSATION
Effective January 1, 2006, the Corporation adopted SFAS No. 123(R),
"Share-Based Payment," as its method to account for share-based
compensation. The cost for share-based compensation was $7 million for
both the three-month and nine-month periods ended September 30, 2006. The
total income tax benefit recognized for share-based compensation
arrangements in the consolidated statements of earnings was $2 million for
both the three-month and nine-month periods ended September 30, 2006.
There were no stock options or other forms of share-based compensation
granted during the Corporation's recent Chapter 11 proceedings. Prior to
the Filing, the Corporation issued stock options to key employees under
plans approved by stockholders. All of the options became exercisable two
years after the grant date and generally expire 10 years from the date of
grant, or earlier in the event of death, disability or retirement. All
stock options issued before the Filing were fully vested prior to the
adoption of SFAS No. 123(R). There are no common shares reserved for
future grants under plans approved prior to the Filing. Prior to the
adoption of SFAS No. 123(R), the Corporation presented tax benefits
associated with the exercise of stock options as operating cash flows in
the consolidated statements of cash flows.
During the second quarter of 2006, the Corporation adjusted the number of
shares underlying the then outstanding stock options and the related
exercise prices pursuant to the terms of the options to account for the
Rights Offering. The adjustments were made in a manner that was designed
to preserve the value of the outstanding stock options without triggering
adverse tax consequences. In accordance with the provisions of SFAS
No.123(R), the adjustments were accounted for as a modification. The
adjustments did not have a material impact on the Corporation's financial
position, cash flows or results of operations.
NEW LONG-TERM INCENTIVE PLAN
The USG Corporation Long-Term Incentive Plan (the "LTIP") was approved by
the Corporation's Board of Directors (the "Board") in March 2006 and by
the stockholders of the Corporation at the annual meeting in May 2006.
There are 8.2 million shares of common stock authorized for grants under
the LTIP. The LTIP authorizes the Board, or the Board's Compensation and
Organization Committee, to provide equity-based compensation in the form
of stock options, stock appreciation rights ("SARs"), restricted stock,
restricted stock units ("RSUs"), performance shares and units, and other
cash and stock-based awards for the purpose of providing the Corporation's
officers and employees performance-based incentives and rewards.
During the third quarter of 2006, grants of stock options, SARs and RSUs
were made under the LTIP, as discussed below. The Corporation will
recognize the cost of these awards on a straight-line attribution basis
over their respective vesting periods, net of estimated forfeitures. As of
September 30, 2006, a total of 6,689,500 common shares were reserved for
-21-
future grants under the LTIP. Common shares issued in option exercises and
upon the vesting of RSUs may be originally issued or from treasury shares.
STOCK OPTIONS
Options to purchase 962,500 shares of common stock were granted under the
LTIP during the third quarter of 2006 with an exercise price of $46.17 per
share, which was the closing price of the Corporation's common stock on
the date of grant. The options generally become exercisable in five equal
annual installments, beginning one year from the date of grant, and
generally expire 10 years from the date of grant, or earlier in the event
of death, disability or retirement.
The fair value of each stock option granted under the LTIP was estimated
on the date of grant using a Black-Scholes option valuation model that
uses the assumptions noted in the following table. Expected volatility was
based on a 50% weighting of peer volatilities and 50% on implied
volatilities. Historical volatility of the Corporation's common stock
price was not considered to be appropriate as a measure of future
volatility due to the impact of the Corporation's recent Chapter 11
proceedings on its historical stock price. The risk-free rate was based on
zero coupon U.S. Government issues at the time of grant. The expected term
was developed using the simplified method, as permitted by the SEC's Staff
Accounting Bulletin No. 107.
Assumptions:
Fair value of options granted $ 23.36
Expected volatility 42.6%
Risk-free rate 4.87%
Expected term (in years) 6.5
Expected annual forfeitures 2.5%
Expected dividends -
A summary of stock option activity under the LTIP and the Corporation's
prior stock option plans as of September 30, 2006 and during the
nine-month period then ended is presented below:
Weighted
Weighted Average Aggregate
Number of Average Remaining Intrinsic
Options Exercise Contractual Value
(thousands) Price Term (years) (millions)
----------- -------- ------------ ----------
Outstanding, January 1, 2006 808 $ 33.67
Granted * 980 46.17
Exercised (387) 33.72
Cancelled (149) 32.26
Outstanding at September 30, 2006 1,252 43.42 8.32 $ 5
Exercisable at September 30, 2006 272 33.47 2.53 4
* Includes 17,900 SARs that are payable in cash upon vesting and, therefore,
are accounted for as a liability on the consolidated balance sheet.
-22-
Intrinsic value for stock options is defined as the difference between the
current market value of the Corporation's common stock and the exercise
price of the stock option. The total intrinsic value of options exercised
during the three-month periods ended September 30, 2006 and 2005 were zero
and $20 million, respectively, and during the nine-month periods ended
September 30, 2006 and 2005 were $14 million and $23 million,
respectively.
As of September 30, 2006, there was $19 million of total unrecognized
compensation cost related to nonvested share-based compensation awards
granted under the LTIP and prior stock option plans. That cost is expected
to be recognized over a weighted average period of 4.85 years. No options
vested during the three-month and nine-month periods ended September 30,
2006 and 2005.
RESTRICTED STOCK UNITS
RSUs with respect to 530,100 shares of common stock were granted under the
LTIP during the third quarter of 2006. The RSUs generally vest in four
equal annual installments, beginning one year from the date of grant,
except that they may vest earlier in the case of death or disability. The
fair value of each RSU granted is equal to the closing market price of the
Corporation's common stock at the date of grant and is expensed using the
straight-line method over the vesting period of the award. The following
is a summary of RSU activity during the nine months ended September 30,
2006:
Weighted Average Shares
(thousands) Grant Date Fair Value
----------------------- ---------------------
Nonvested at January 1, 2006 - $ -
Granted * 530 46.17
Vested - -
Forfeited - -
------- ------
Nonvested at September 30, 2006 * 530 46.17
------- ------
* Includes 9,600 RSUs that are payable in cash upon vesting and, therefore,
are accounted for as a liability on the consolidated balance sheet.
As of September 30, 2006, there was $20 million of total unrecognized
compensation cost related to nonvested share-based compensation awards
represented by RSUs granted under the LTIP. That cost is expected to be
recognized over a weighted average period of 3.85 years.
NON-EMPLOYEE DIRECTOR FEES
Non-employee directors of the Corporation may elect to defer a portion of
their compensation in the form of deferred stock units which increase or
-23-
decrease in value in direct relation to the market price of shares of
common stock and are paid in cash upon termination of board service. As of
September 30, 2006, there were approximately 18,035 deferred stock units
held by non-employee directors. Amounts expensed in the first nine months
of 2006 and 2005 were immaterial.
To account for the Rights Offering, the Corporation adjusted the deferred
stock units held by members of the Board of Directors. These adjustments,
which were made in a manner that was designed to preserve the value of the
deferred stock units without triggering adverse tax consequences, had no
impact on the Corporation's financial position, cash flows or results of
operations.
Pursuant to the Corporation's Stock Compensation Program for Non-Employee
Directors, on July 1, 2006, the Corporation's non-employee directors were
entitled to receive a $30,000 annual grant, payable at their election in
cash or common stock with an equivalent value. Pursuant to this provision,
a total of 2,645 shares of common stock were issued to five non-employee
directors based on the closing market price of a share of common stock on
July 3, 2006.
-24-
(11) INCOME TAXES
Income tax expense recorded by the Corporation in the first nine months of
2006 includes interest expense of $7 million ($4 million after-tax),
representing an accrual for post-petition interest (from the Petition Date
through September 30, 2006) related to pre-petition income tax obligations
which are expected to be paid as outlined in the Plan.
In the third quarter of 2006, the Corporation reduced the amount of its
current deferred income taxes by $7 million as a result of the $17 million
reversal of its reserve for asbestos-related claims. In addition, the
Corporation has recorded an income tax receivable of $270 million as of
September 30, 2006. This amount primarily represents current income tax
benefits relating to the $909 million of payments made by the Corporation
in the second quarter of 2006 for asbestos-related claims and the tax
deduction for post-petition interest and fees relating to pre-petition
obligations that are expected to be realized during the last three months
of 2006 or from a federal income tax refund resulting from the carryback
of a 2006 net operating loss.
The Corporation has a valuation allowance for deferred tax assets relating
to certain foreign and U.S. state net operating loss and tax credit
carryforwards and a portion of the Corporation's liability for asbestos
claims due to uncertainty regarding their ultimate realization. During the
third quarter of 2006, the Corporation increased its valuation allowance
for deferred tax assets by a total of $12 million due to a change in
management's judgment about the realizability of the deferred tax asset
relating to the Corporation's liability for asbestos claims in future
years. Of the total valuation allowance as of September 30, 2006, $52
million relates to the liability for asbestos claims, $12 million relates
to foreign net operating loss and tax credit carryforwards, and $12
million relates to U.S. state net operating loss and tax credit
carryforwards. The Corporation has net operating loss and tax credit
carryforwards in varying amounts in numerous U.S. state and foreign
jurisdictions. Under applicable law, if not used prior thereto, most of
these carryforwards will expire over periods ranging from five to 20 years
from the date of origin.
The Corporation's financial statements include amounts recorded for
contingent tax liabilities with respect to loss contingencies that are
deemed probable of occurrence. These amounts are included in income taxes
payable on the Corporation's consolidated balance sheets. These loss
contingencies relate primarily to tax disputes with various state tax
authorities, costs incurred with respect to the Chapter 11 proceedings and
the taxability of certain foreign income in the United States. The
Corporation's U.S. income tax returns for 2002 and prior years have been
audited by the IRS and are closed.
-25-
(12) OPERATING SEGMENTS AND ACQUISITIONS
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):
Three Months Nine Months
ended September 30, ended September 30,
-------------------- -------------------
2006 2005 2006 2005
-------- -------- -------- --------
NET SALES:
North American Gypsum $ 909 $ 842 $ 2,817 $ 2,371
Worldwide Ceilings 191 181 576 529
Building Products Distribution 642 544 1,926 1,506
Eliminations (264) (223) (803) (602)
-------- -------- -------- --------
Total USG Corporation 1,478 1,344 4,516 3,804
======== ======== ======== ========
OPERATING PROFIT:
North American Gypsum 219 179 697 434
Worldwide Ceilings 18 18 64 47
Building Products Distribution 53 41 164 106
Corporate (29) (23) (81) (68)
Chapter 11 reorganization expenses (2) (2) (10) (2)
Eliminations (1) (2) (2) (1)
-------- -------- -------- --------
Total USG Corporation 258 211 832 516
======== ======== ======== ========
During the first quarter of 2006, L&W Supply purchased the outstanding
stock of several companies located in the midwestern United States for
approximately $74 million, net of cash acquired and subject to final
purchase price adjustments. All of these acquisitions were part of L&W
Supply's strategy to profitably grow its specialty dealer business. These
acquisitions were accounted for under the purchase method of accounting
and, accordingly, included the results of operations in the accompanying
consolidated results of operations from their date of acquisition. Pro
forma combined results of operations for 2005 and 2006 would not be
materially different as a result of these acquisitions and therefore are
not presented. The purchase price of the acquisitions is allocated to the
tangible assets, liabilities and intangible assets acquired, based on
their estimated fair values. L&W Supply has preliminarily recorded
approximately $41 million of goodwill and approximately $4 million of
intangible assets not subject to amortization in connection with these
acquisitions. The remaining $29 million was primarily recorded to accounts
receivable, inventory, and property, plant and equipment, net of current
liabilities.
-26-
In October 2006, L&W Supply purchased a group of distribution businesses
located primarily in the southeastern United States for approximately $55
million, subject to final purchase price adjustments.
(13) LITIGATION
ASBESTOS LITIGATION
ASBESTOS PERSONAL INJURY LITIGATION: The Plan of Reorganization resolved
the Debtors' liability for all present and future asbestos personal injury
and related claims. At the time of the Filing, Debtor U.S. Gypsum was a
defendant in more than 100,000 pending asbestos personal injury claims. In
addition, Debtors L&W Supply and Beadex had been named as defendants in a
small number of asbestos personal injury claims.
Pursuant to the Plan, the Trust was created under Section 524(g) of the
Bankruptcy Code and has assumed all of the asbestos personal injury
liabilities of the Debtors. The Trust was funded by the Reorganized
Debtors and is administered by independent trustees appointed under the
Plan. The Trust will pay qualifying asbestos personal injury and related
claims against the Debtors pursuant to trust distribution procedures that
are part of the confirmed Plan.
The Confirmation Order contains a channeling injunction which provides
that all present and future asbestos personal injury claims against the
Debtors must be brought against the Trust and no individual or entity may
bring such a claim against the Reorganized Debtors. This channeling
injunction applies to all present and future asbestos personal injury
claims for which any Debtor is alleged to be liable, including any
asbestos personal injury claims against U.S. Gypsum, L&W Supply or Beadex,
as well as any asbestos personal injury claims against the Debtors
relating to A.P. Green Refractories Co., a former subsidiary of U.S.
Gypsum and the Corporation.
ASBESTOS PROPERTY DAMAGE LITIGATION: The Plan of Reorganization provides
that all settled or otherwise resolved asbestos property damage claims
filed in the Debtors' Chapter 11 proceedings will be paid in full.
Approximately 1,400 asbestos property damage claims were timely filed in
the Debtors' Chapter 11 proceedings. In addition, more than 70 claims were
filed after the bar date for filing such claims. More than 950 claims were
disallowed or withdrawn, leaving approximately 520 claims pending. The
Debtors have reached written agreements or agreements in principle to
settle all of the remaining asbestos property damage claims with the
exception of one small claim brought by a residential homeowner. In
October 2006, the Debtors made approximately $62 million in payments
pursuant to asbestos property damage settlements. The estimated cost of
the unpaid settlements of the remaining asbestos property damage claims,
both those for which a written agreement has been executed and those which
-27-
have been settled in principle, and the associated legal fees is included
in accrued expenses.
ESTIMATED COST: In the fourth quarter of 2005, the Corporation recorded a
pretax charge of $3.1 billion for all asbestos-related claims, increasing
U.S. Gypsum's reserve for all asbestos-related claims to $4.161 billion.
This reserve included the Debtors' obligations to fund the Trust
established under the Plan (recorded at $3.95 billion based upon the
assumption that the Plan would be confirmed, but that the FAIR Act would
not be enacted by the Trigger Date). This reserve also included the
Debtors' estimate of the cost of resolving asbestos property damage claims
filed in its Chapter 11 proceedings, including estimated legal fees
associated with those claims, and the Debtors' estimate of resolving other
asbestos-related claims and estimated legal expenses associated with those
claims. Such liabilities were reclassified on the consolidated balance
sheet to current liabilities, either as note payable to Section 524(g)
asbestos trust or accrued expenses, as appropriate.
In the second quarter of 2006, the Corporation made total payments of $909
million for asbestos-related claims. These payments included the $890
million payment to the Trust and $19 million of payments related to the
settlement of other asbestos-related claims included within the asbestos
reserve. In the second quarter of 2006, the Corporation also reached
agreements in principle to settle most of the asbestos property damage
claims filed in the Chapter 11 proceedings that had not been disallowed or
withdrawn. Based on these settlements in principle and the Corporation's
assessment of the remaining asbestos property damage claims, in the second
quarter of 2006, the Corporation reversed $27 million of its reserve for
asbestos-related claims. This $27 million reversal was reflected as income
in the consolidated statement of earnings for the second quarter of 2006.
As of the end of the third quarter of 2006, the Corporation had reached
written agreements or agreements in principle to resolve all remaining
asbestos property damage claims with the exception of one small claim
brought by a residential homeowner. In October 2006, the Corporation made
total payments of approximately $62 million pursuant to asbestos property
damage settlements. Although there can be no assurance that all of the
remaining written settlements or settlements in principle will be
completed, based on the Corporation's evaluation of these settlements, in
the third quarter of 2006, the Corporation reversed an additional $17
million of its reserve for asbestos-related claims. This $17 million
reversal is reflected as income in the consolidated statements of
earnings. The Corporation's estimate of the cost of the unpaid asbestos
property damage settlements, both those for which a written agreement has
been executed and those settled in principle, and the associated legal
fees is included in accrued expenses.
Enactment of the FAIR Act would not require increasing the Corporation's
recorded estimated liability for asbestos claims because the amount
accrued assumes that the Corporation will make all contingent payments to
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the Trust. However, if the FAIR Act is enacted by the Trigger Date and
either does not become subject to or survives subsequent constitutional
challenge, the Corporation will not be required to make the contingent
payments of $3.05 billion to the Trust. In that event, $3.05 billion of
the asbestos liability attributable to the contingent payment note, as
reflected on the September 30, 2006 consolidated balance sheet, would be
reversed and taken into income. If the FAIR Act is enacted after the
Trigger Date, the Corporation will still be required to make the
contingent payments to the Trust and therefore its asbestos liability
would not be affected.
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 asbestos personal injury
cases and other obligations owed by U.S. Gypsum to the Center for Claims
Resolution (the "Center"). The Safeco bond was secured by an irrevocable
letter of credit obtained by the Corporation in the amount of $60.3
million and issued by JPMorgan Chase Bank to Safeco. After the Filing, the
Center made demands to Safeco for payment of the bond in the approximate
aggregate amount of $143 million, which exceeds the original penal sum of
the bond.
In the second quarter of 2006, the Center and the Debtors settled
litigation regarding the Safeco bond. The total amount of U.S. Gypsum's
payment obligation under the settlement was $16.5 million, which was paid
by U.S. Gypsum in June 2006. As a result of the settlement, the Safeco
bond and the letter of credit issued by JPMorgan Chase Bank have been
cancelled and are no longer outstanding.
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 are
covered by reserves established in accordance with the foregoing. The
Corporation believes that neither these matters nor any other known
governmental proceedings regarding environmental matters will have a
material adverse effect upon its financial position, cash flows or results
of operations.
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(14) NEW ACCOUNTING PRONOUNCEMENTS
Financial Accounting Standards Board Interpretation No. 48, "Accounting
for Uncertainty in Income Taxes - an interpretation of Financial
Accounting Standards Board Statement No. 109," prescribes a recognition
threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken, or expected to be
taken, in a tax return. The Corporation has not yet determined the impact
of this interpretation, which is effective for fiscal years beginning
after December 15, 2006, on its financial statements.
SFAS No. 157, "Fair Value Measurements" defines fair value in generally
accepted accounting principles and expands disclosures about fair value
measurements that are required or permitted under other accounting
pronouncements. This statement is effective for financial statements
issued for fiscal years beginning after November 15, 2007 and interim
periods within those fiscal years. The Corporation has not yet determined
the impact of this new standard on its financial statements.
SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans," amends certain requirements of SFAS Nos. 87, 88,
106 and 132(R). Under SFAS No. 158, companies will be required to report
the overfunded or underfunded status of a defined benefit postretirement
plan (other than a multi-employer plan) as an asset or liability on their
balance sheets and to recognize changes in that funded status in the year
in which the changes occur through comprehensive income. The new rules are
effective for fiscal years ending after December 15, 2006. The requirement
to measure plan assets and benefit obligations as of the date of the
employer's fiscal year-end balance sheets is effective for fiscal years
ending after December 15, 2008. The Corporation has not yet determined the
impact of this new standard on its financial statements.
-30-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
OVERVIEW
PLAN OF REORGANIZATION
In the second quarter of 2006, USG Corporation (the "Corporation") and 10 of its
United States subsidiaries (collectively, the "Debtors" or "Reorganized
Debtors") emerged from reorganization proceedings under Chapter 11 of the United
States Bankruptcy Code (the "Bankruptcy Code") following confirmation of a plan
of reorganization by the United States Bankruptcy Court for the District of
Delaware (the "Bankruptcy Court") and the United States District Court for the
District of Delaware (the "District Court"), as discussed below. Confirmation of
the plan achieves the Debtors' goals of resolving asbestos claims in a fair and
equitable manner, protecting the long-term value of the Debtors' businesses and
maintaining the Debtors' leadership positions in their markets.
The Corporation's Annual Report on Form 10-K for the fiscal year ended December
31, 2005, which was filed on February 14, 2006, discussed the Debtors' Chapter
11 reorganization proceedings and the agreement among the Debtors, the committee
representing asbestos personal injury claimants and the legal representative for
future asbestos personal injury claimants to resolve the Debtors' present and
future asbestos personal injury liabilities. That agreement led to the Debtors'
First Amended Joint Plan of Reorganization of USG Corporation and its Debtor
Subsidiaries dated March 27, 2006 (as confirmed, the "Plan" or "Plan of
Reorganization"). Significant aspects of the Chapter 11 proceedings and the Plan
of Reorganization include:
- On June 16, 2006, the Debtors' Plan of Reorganization was confirmed by
order (the "Confirmation Order") of the Bankruptcy Court and the District
Court;
- The Plan became effective on June 20, 2006 (the "Effective Date");
- A trust was created and funded under Section 524(g) of the Bankruptcy Code
(the "Trust") for the payment of asbestos personal injury claims against
the Debtors;
- On the Effective Date, the Reorganized Debtors paid $890 million to the
Trust and issued to the Trust an interest-bearing note in the amount of
$10 million, payable no later than December 31, 2006;
- The Reorganized Debtors also issued to the Trust a contingent payment note
in the aggregate principal amount of $3.05 billion, which, as discussed
below, will be payable to the Trust depending upon whether the Fairness in
Asbestos Injury Resolution Act of 2005 or substantially similar
legislation creating a national trust or similar fund (collectively, the
"FAIR Act") is enacted by the 10th day (excluding Sundays) after final
adjournment of the current term of Congress (the "Trigger Date"), which is
currently expected to be no later than December 2006;
-31-
- The Confirmation Order contains a channeling injunction which provides
that all present and future asbestos personal injury claims against the
Debtors must be brought against the Trust and no individual or entity may
bring such a claim against the Reorganized Debtors;
- Pursuant to the Plan, allowed claims of all other creditors, including
allowed claims of general unsecured creditors and resolved asbestos
property damage claims, have been, or will be, paid in full, with interest
as provided in the Plan;
- A rights offering (the "Rights Offering") that provided stockholders as of
June 30, 2006 the right to purchase, at $40.00 per share, one new share of
the Corporation's common stock for each share owned, and in connection
with which Berkshire Hathaway, Inc. ("Berkshire Hathaway") agreed to
purchase all shares subject to unexercised rights at such price, was
completed in the third quarter of 2006, raising net proceeds of
approximately $1.7 billion and resulting in the issuance of 44.92 million
new shares of the Corporation's common stock. The completion of the
transactions contemplated by the Plan of Reorganization, including
borrowings under the Corporation's $2.8 billion credit agreement entered
into on August 2, 2006 with a syndicate of banks (the "Credit Facilities")
and any future financing arrangements, have caused and may continue to
cause significant changes to the Corporation's capital structure; and
- During the third quarter of 2006, the Debtors reached written agreements
or agreements in principle to settle all remaining asbestos property
damage claims with the exception of one small claim brought by a
residential homeowner.
Additional information about the Plan, the Trust, funding relating to the Plan,
the Credit Facilities and the Rights Offering is set forth in Notes 2, 3 and 4
to the Consolidated Financial Statements and below under "Voluntary
Reorganization Proceedings and Confirmation of the Plan of Reorganization" and
"Liquidity and Capital Resources."
FINANCIAL RESULTS
The Corporation's third quarter of 2006 net sales and operating profit were the
highest levels for any third quarter in its history, increasing 10% and 22%,
respectively, compared with the third quarter of 2005. The Corporation's gross
margin percentage (gross profit as a percent of net sales) was 23.4% in the
third quarter of 2006, up from 22.4% in the third quarter of 2005.
While the Corporation's results were historically strong in the third quarter of
2006, the residential construction market has recently been impacted by a steep
drop in new housing starts. Demand for the Corporation's SHEETROCK(R) brand
gypsum wallboard products moderated during the quarter, compared to the
record-setting shipment levels over the last few quarters. This moderation in
demand also caused wallboard market prices to start declining. Despite the
rapidly changing market conditions, all three of the Corporation's core
businesses achieved higher net sales in the third quarter of 2006 as compared
with the third quarter of 2005.
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As of September 30, 2006, the Corporation had $1.458 billion of cash, cash
equivalents and restricted cash on a consolidated basis, down $119 million from
the December 31, 2005 level, which also included marketable securities.
VOLUNTARY REORGANIZATION UNDER CHAPTER 11 AND CONFIRMATION OF THE PLAN OF
REORGANIZATION
On June 25, 2001 (the "Petition Date"), the Debtors filed voluntary petitions
for reorganization (the "Filing") under the Bankruptcy Code in 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
proceedings were jointly administered under In re USG Corporation, et al., Case
No. 01-2094. By order entered on June 16, 2006, the Bankruptcy Court and the
District Court confirmed the Plan. The Plan became effective on June 20, 2006.
The confirmed Plan resolves the Chapter 11 proceedings and provides for the
resolution of all present and future asbestos personal injury claims against the
Debtors.
The following subsidiaries of the Corporation were included in the Chapter 11
proceedings and are included in the confirmed Plan: 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 ("Beadex"); B-R Pipeline Company; La Mirada Products Co.,
Inc.; Stocking Specialists, Inc.; USG Industries, Inc.; and USG Pipeline
Company. The Chapter 11 proceedings and the Plan do not include any of the
Corporation's non-U.S. subsidiaries or companies that were acquired by any of
the Debtors after the Filing.
Pursuant to the Plan, the Trust was created under Section 524(g) of the
Bankruptcy Code to pay all qualifying present and future asbestos personal
injury claims against the Debtors. On the Effective Date, the Reorganized
Debtors funded the Trust as follows:
- The Reorganized Debtors paid $890 million to the Trust and issued to the
Trust an interest-bearing note in the amount of $10 million, payable no
later than December 31, 2006; and
- The Reorganized Debtors also issued to the Trust a contingent payment note
in the aggregate principal amount of $3.05 billion, which, as described
more fully below, will be payable to the Trust depending upon whether the
Fairness in Asbestos Injury Resolution Act of 2005 or substantially
similar legislation creating a national trust or similar fund
(collectively, the "FAIR Act") is enacted by the 10th day (excluding
Sundays) after final adjournment of the current term of Congress (the
"Trigger Date"), which is currently expected to occur no later than
December 2006.
The Reorganized Debtors are co-obligors and are jointly and severally liable
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under the $10 million promissory note and the $3.05 billion contingent payment
note. Each of the notes is secured by an obligation to pledge to the Trust
shares of the voting stock of the Corporation equal to 51% of the number of
shares outstanding. The obligation to pledge those shares would be triggered by
a payment default under the applicable note.
As provided in the Plan, if the FAIR Act is enacted and made law on or before
the Trigger Date and is not subject to, or survives, a constitutional challenge
initiated within 60 days of the Trigger Date, the contingent payment note will
be cancelled and the Reorganized Debtors will have no further payment
obligations to the Trust. In that situation, the total amount to be paid by the
Reorganized Debtors to the Trust will be the $890 million paid to the Trust on
the Effective Date and the obligations under the $10 million promissory note.
If the FAIR Act is not enacted and made law by the Trigger Date, the Reorganized
Debtors will be obligated to make payments under the contingent payment note as
follows: $1.9 billion will be payable to the Trust within 30 days after the
Trigger Date, with the remaining $1.15 billion payable within 180 days after the
Trigger Date. Interest will accrue on the unpaid balance of the $3.05 billion
contingent payment note beginning on the Trigger Date. The rate of interest is
the rate of the 90-day LIBOR in effect as of the Trigger Date plus 40 basis
points.
If the FAIR Act is enacted by the Trigger Date but is later held
unconstitutional, the Reorganized Debtors will be obligated to make payments
under the $3.05 billion contingent note, as described more fully below.
Specifically, if the FAIR Act is enacted by the Trigger Date and there is a
constitutional challenge to the FAIR Act initiated within 60 days of the Trigger
Date, the Debtors will be obligated to make payments under the $3.05 billion
contingent payment note if the constitutional challenge results in a final,
non-appealable court order that the FAIR Act is (i) unconstitutional in its
entirety or (ii) unconstitutional insofar as it applies to debtors in Chapter 11
cases whose plans of reorganization had not yet been confirmed and become
substantially consummated as of February 1, 2006. In those circumstances, the
Debtors would be obligated to pay $1.9 billion within 30 days after the date the
court order becomes final and non-appealable and pay the remaining $1.15 billion
within 180 days after the date the order becomes final and non-appealable. If
the constitutional challenge is resolved by a final, non-appealable court order
in any manner other than as described above, then the $3.05 billion contingent
payment, including the right of the Trust to own stock of the Corporation under
that note, will be cancelled.
The amounts that the Reorganized Debtors are obligated to pay to the Trust under
the Plan, either $900 million or $3.95 billion, with interest as described
above, are fixed amounts that depend upon passage of the FAIR Act on or prior to
the Trigger Date. These amounts were determined through settlement negotiations
with the Official Committee of Asbestos Personal Injury Claimants and the legal
representative for future asbestos personal injury cases appointed in the
Debtors' Chapter 11 proceedings. The Reorganized Debtors will not be obligated
to make additional payments to the Trust beyond the payments described above.
-34-
The Confirmation Order contains a channeling injunction which provides that all
present and future asbestos personal injury claims against the Debtors must be
brought against the Trust and no individual or entity may bring such a claim
against the Reorganized Debtors. This channeling injunction applies to all
present and future asbestos personal injury claims for which any Debtor is
alleged to be liable, including any asbestos personal injury claims against the
Debtors relating to A.P. Green Refractories Co., a former subsidiary of U.S.
Gypsum and the Corporation.
The Plan also provides for the resolution of other pre-petition claims against
the Debtors. Allowed claims of all other creditors, including settled asbestos
property damage claims, will be, or already have been, paid in full, with
interest as agreed or as provided in the Plan. Any disputed claims will be
resolved in the Bankruptcy Court or other court, where appropriate. If it is
ultimately determined that any amounts are owed on these disputed claims, those
amounts will be paid, with interest as required.
As a result of confirmation of the Plan of Reorganization, the four official
committees appointed in the Chapter 11 proceedings have been disbanded. The
legal representative for future asbestos personal injury claimants will continue
to act in the same capacity with respect to the Trust.
Under the Plan, stockholders of the Corporation as of the Effective Date
retained their shares. In addition, on June 30, 2006 (the "Record Date"), the
Corporation issued to its stockholders one transferable right for each share
owned on the Record Date, entitling the holder to purchase one share of common
stock for $40.00 in cash for each right (the "Rights Offering"). These rights
expired at 5:00 p.m., New York City time, on July 27, 2006. In connection with
the Rights Offering, Berkshire Hathaway, the Corporation's largest stockholder,
agreed to purchase from the Corporation, at $40.00 per share, all of the shares
of common stock offered pursuant to the Rights Offering that were not issued
pursuant to the exercise of rights (the "Backstop Commitment"). In the first
quarter of 2006, the Debtors paid Berkshire Hathaway a fee of $67 million for
its Backstop Commitment. On August 2, 2006, the Corporation issued 6.97 million
shares of common stock to Berkshire Hathaway in accordance with the Backstop
Commitment. These shares include 6.5 million shares underlying rights
distributed to Berkshire Hathaway in connection with the shares it beneficially
owned on the Record Date and 0.47 million shares underlying rights distributed
to other stockholders that were not exercised in the Rights Offering. A total of
44.92 million shares of the Corporation's common stock were distributed in
connection with the Rights Offering, including the 6.97 million shares issued to
Berkshire Hathaway. The Corporation's net proceeds from the Rights Offering and
the Backstop Commitment were approximately $1.7 billion. The Corporation is
using the net proceeds from the Rights Offering and the Backstop Commitment,
together with other available funds, to make payments contemplated by the Plan
and for general corporate purposes.
The Debtors' financial obligations under the Plan depend upon, among other
things, whether the $3.05 billion contingent payment note becomes due. The
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Debtors propose to fund their obligations under the Plan through (i) cash
accumulated since the Petition Date, some of which was used to fund the $890
million payment to the Trust and other creditor payments, (ii) the net proceeds
of the Rights Offering and Backstop Commitment, (iii) anticipated tax refunds
and (iv) the Corporation's credit facility entered into on August 2, 2006 or
other alternative debt financing.
Information regarding the Corporation's credit facility is set forth in Note 3
to the Consolidated Financial Statements. Additional information about the
Rights Offering and the Plan's treatment of asbestos claims is set forth in
Notes 4 and 13, respectively, to the Consolidated Financial Statements.
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 was titled the Fairness in Asbestos
Injury Resolution Act of 2005 (Senate Bill 852) (the "FAIR Act of 2005" or the
"Act").
The FAIR Act of 2005 was intended to establish a nationally administered trust
fund to compensate asbestos personal injury claimants. The Act provided that
companies that had made past payments for asbestos personal injury claims would
be required to contribute amounts on a periodic basis to a national trust fund
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 were being compensated under the national trust
fund. The FAIR Act of 2005 has not been enacted by Congress and is not law.
In late May 2006, an amended version of the Act, called the "Fairness in
Asbestos Injury Resolution Act of 2006" (the "FAIR Act of 2006" or "S. 3274")
was introduced by Senator Specter and Senator Patrick Leahy, D-Vt. The FAIR Act
of 2006 also contemplates creation of a national trust to pay asbestos personal
injury claims but contains some modifications from the FAIR Act of 2005. A copy
of the FAIR Act of 2006 as introduced is available at http://thomas.loc.gov
(type in "S. 3274" in the search field). The current form of the FAIR Act of
2006 does not require contributions from companies, such as the Reorganized
Debtors, that have a confirmed plan of reorganization under Chapter 11 of the
Bankruptcy Code that is substantially consummated and no longer subject to
appeal. The FAIR Act of 2006 has not been enacted and is not law.
Although the current form of the FAIR Act of 2006 does not require contributions
from the Reorganized Debtors to the proposed national trust, the amounts that
the Reorganized Debtors will be required to pay into the Trust established under
the Debtors' Plan of Reorganization depend on whether the FAIR Act is enacted by
the Trigger Date and either does not become subject to or survives a subsequent
constitutional challenge. Final adjournment of the current term of Congress,
which is the basis for the Trigger Date, is currently expected to be no later
than December 2006. The outcome of the legislative process is inherently
speculative, and it cannot be known whether the FAIR Act will be enacted by the
-36-
Trigger Date or, even if enacted, would survive any subsequent constitutional
challenge.
ASBESTOS PROPERTY DAMAGE CLAIMS
The Plan of Reorganization does not create a trust for asbestos property damage
claims against the Debtors. The Plan provides that settled asbestos property
damage claims will be paid in full and disputed asbestos property damage claims
timely filed in the bankruptcy proceeding will be resolved either in the
Bankruptcy Court or other court, where appropriate. If it is determined that any
amounts are owed for disputed claims, those amounts will be paid with interest
as required.
As a result of the bar date for filing asbestos property damage claims in
Debtors' Chapter 11 proceedings, approximately 1,400 asbestos property damage
claims were filed by the bar date and more than 70 such claims were filed after
the bar date. More than 950 claims were disallowed or withdrawn, leaving
approximately 520 claims pending. The Debtors have reached written agreements or
agreements in principle to settle all of the remaining asbestos property damage
claims with the exception of one small claim brought by a residential homeowner.
In October 2006, the Debtors made approximately $62 million in payments pursuant
to asbestos property damage settlements. The estimated cost of the unpaid
settlements of the remaining asbestos property damage claims, both those for
which a written agreement has been executed and those which have been settled in
principle, and the associated legal fees is included in accrued expenses. The
asbestos property damage claims are also discussed in Note 13 to the
Consolidated Financial Statements.
CONSOLIDATED RESULTS OF OPERATIONS
NET SALES
Net sales in the third quarter of 2006 totaled $1.478 billion, a record for any
third quarter in the Corporation's history and a 10% increase from $1.344
billion in the third quarter of 2005. Net sales for the first nine months of
2006 were $4.516 billion, an increase of 19% from $3.804 billion in the
comparable 2005 period. The increases for both the three- and nine-month periods
were primarily attributable to higher realized selling prices for all major
product lines. All three of the Corporation's operating segments reported higher
net sales for the third quarter of 2006 as compared with the third quarter of
2005.
COST OF PRODUCTS SOLD
Cost of products sold in the third quarter of 2006 was $1.132 billion, up 9%
from $1.043 billion a year ago. For the first nine months of 2006, cost of
products sold totaled $3.413 billion, up 13% from $3.022 billion in the
comparable 2005 period. These increases were largely attributable to higher
manufacturing costs related to raw materials and energy. The increase in cost of
products sold for the nine-month period also reflects higher volumes for certain
product lines.
GROSS PROFIT
Gross profit in the third quarter of 2006 was $346 million, a 15% increase from
$301 million in the third quarter of 2005. For the first nine months of 2006,
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gross profit totaled $1.103 billion, up 41% from $782 million in the comparable
2005 period. These increases primarily reflected higher selling prices for
SHEETROCK(R) brand gypsum wallboard. The gross margin percentage was 23.4% in
the third quarter of 2006, up from 22.4% in the third quarter of 2005. For the
first nine months of 2006, the gross margin percentage was 24.4%, up from 20.6%
in the comparable 2005 period.
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses in the third quarter of 2006 were $103
million, up 17% from $88 million in the third quarter of 2005. For the first
nine months, these expenses were $305 million compared with $264 million a year
ago. Expenses were up in the 2006 periods primarily due to increased levels of
compensation and benefits and expenses in connection with growth initiatives.
Selling and administrative expenses as a percent of net sales were 7.0% for the
third quarter of 2006 and 6.8% for the first nine months of 2006, compared with
6.5% and 6.9% for the respective 2005 periods.
REVERSALS OF ASBESTOS CLAIMS RESERVE
The Corporation reversed $17 million of a reserve for asbestos-related claims in
the third quarter of 2006. This reversal, which is reflected as income in the
consolidated statements of earnings, was based on the Corporation's evaluation
in the third quarter of the settlements of the remaining asbestos property
damage claims, both those settlements for which written agreements have been
executed and those which have been settled in principle. Through the first nine
months of 2006, a total of $44 million of the reserve for asbestos-related
claims was reversed.
CHAPTER 11 REORGANIZATION EXPENSES
Chapter 11 reorganization expenses in the consolidated statements of earnings
consisted of the following (dollars in millions):
Three Months Nine Months
ended September 30, ended September 30,
------------------- -------------------
2006 2005 2006 2005
------ ------ ------ ------
Legal and financial advisory fees $ 2 $ 11 $ 34 $ 23
Bankruptcy-related interest income - (9) (24) (21)
------ ------ ------ ------
Total Chapter 11 reorganization expenses 2 2 10 2
====== ====== ====== ======
INTEREST EXPENSE
Interest expense for the third quarter and first nine months of 2006 was $16
million and $539 million, respectively. These amounts included charges for
post-petition interest and fees related to pre-petition obligations. For the
third quarter of 2006, these post-petition interest and fees were $8 million ($5
million after-tax). For the first nine months of 2006, these post-petition
interest and fees totaled $528 million ($326 million after-tax). In accordance
with AICPA SOP 90-7, "Financial Reporting by Entities in Reorganization Under
the Bankruptcy Code," virtually all of the Corporation's outstanding debt had
been classified as liabilities subject to compromise in prior periods, and from
the
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Petition Date through December 31, 2005, interest expense on this debt and
other pre-petition obligations had not been accrued or recorded. Interest
expense, other than that related to post-petition interest and fees, was $1
million and $4 million in the third quarter and first nine months of 2005,
respectively.
INTEREST INCOME
Interest income amounted to $16 million in the third quarter and $23 million in
the first nine months of 2006. Interest income for the respective 2005 periods
was $3 million and $7 million. Interest income increased in the 2006 periods
primarily due to the inclusion of interest earned on cash held by the
Reorganized Debtors following the Effective Date. Prior to the Effective Date,
this interest income was included as an offset to Chapter 11 reorganization
expenses in the consolidated statements of earnings.
INCOME TAXES
Income tax expense of $107 million and $130 million was recorded in the third
quarter and first nine months of 2006, respectively, compared with $55 million
and $173 million in the corresponding 2005 periods. The effective tax rates were
40.7% and 33.4% for the first nine months of 2006 and 2005, respectively. The
change in the effective tax rates was primarily attributable to the $25 million
reduction in the Corporation's third quarter 2005 income tax provision in
connection with the Internal Revenue Service's completion of its audit of the
Corporation's federal income tax returns for the years 2000 through 2002.
NET EARNINGS
Net earnings of $153 million, or $1.71 per diluted share, were reported for the
third quarter of 2006 compared with $158 million, or $2.77 per diluted share,
for the third quarter of 2005. For the first nine months of 2006, net earnings
totaled $188 million, or $3.03 per diluted share, compared with $345 million, or
$6.12 per diluted share, for the first nine months of 2005.
Net earnings and earnings per share for the 2006 periods were reduced by charges
for post-petition interest and fees related to pre-petition obligations as
described above. On an after-tax basis, these charges were $5 million, or $0.06
per diluted share, for the third quarter of 2006 and $326 million, or $5.24 per
diluted share, for the first nine months of 2006.
Net earnings and earnings per share for the 2006 periods increased as a result
of the reversals of a reserve for asbestos-related claims described above. On an
after-tax basis, these reversals were $10 million, or $0.11 per diluted share,
for the third quarter of 2006 and $27 million, or $0.43 per diluted share, for
the first nine months of 2006.
Earnings-per-share data for the 2006 periods reflect the issuance of 44.92
million shares of common stock in the third quarter of 2006 in connection with
the Rights Offering and Backstop Commitment. Earnings-per-share data for the
2005 periods have been adjusted to reflect the effect of the issuance of shares
of common stock in connection with the Rights Offering and Backstop Commitment.
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CORE BUSINESS RESULTS OF OPERATIONS
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- -------------------
(dollars in millions) 2006 2005 2006 2005
-------- -------- -------- --------
NET SALES:
NORTH AMERICAN GYPSUM:
U.S. Gypsum Company $ 801 $ 755 $ 2,513 $ 2,129
CGC Inc. (gypsum) 85 81 262 238
Other subsidiaries* 72 62 200 157
Eliminations (49) (56) (158) (153)
------- ------- ------- -------
Total 909 842 2,817 2,371
------- ------- ------- -------
WORLDWIDE CEILINGS:
USG Interiors, Inc. 124 124 388 365
USG International 64 56 177 159
CGC Inc. (ceilings) 14 13 44 40
Eliminations (11) (12) (33) (35)
------- ------- ------- -------
Total 191 181 576 529
------- ------- ------- -------
BUILDING PRODUCTS DISTRIBUTION:
L&W Supply Corporation 642 544 1,926 1,506
------- ------- ------- -------
Eliminations (264) (223) (803) (602)
------- ------- ------- -------
Total USG Corporation 1,478 1,344 4,516 3,804
======= ======= ======= =======
OPERATING PROFIT:
NORTH AMERICAN GYPSUM:
U.S. Gypsum Company 192 153 623 371
CGC Inc. (gypsum) 13 12 39 38
Other subsidiaries* 14 14 35 25
------- ------- ------- -------
Total 219 179 697 434
------- ------- ------- -------
WORLDWIDE CEILINGS:
USG Interiors, Inc. 11 13 42 32
USG International 5 3 13 8
CGC Inc. (ceilings) 2 2 9 7
------- ------- ------- -------
Total 18 18 64 47
------- ------- ------- -------
BUILDING PRODUCTS DISTRIBUTION:
L&W Supply Corporation 53 41 164 106
------- ------- ------- -------
Corporate (29) (23) (81) (68)
Chapter 11 reorganization expenses (2) (2) (10) (2)
Eliminations (1) (2) (2) (1)
------- ------- ------- -------
Total USG Corporation 258 211 832 516
======= ======= ======= =======
* 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.
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NORTH AMERICAN GYPSUM
Net sales of $909 million in the third quarter of 2006 increased 8% from the
comparable period in 2005, while operating profit increased 22% to $219 million.
First nine months 2006 net sales of $2.817 billion were 19% greater than a year
ago, while operating profit of $697 million increased 61%. Operating profit for
the third quarter and first nine months of 2006 included the reversals of a
reserve for asbestos-related claims of $17 million and $44 million,
respectively, as discussed above.
United States Gypsum Company: Third quarter 2006 net sales of $801 million
increased 6% compared with the third quarter of 2005, while operating profit
rose $39 million, or 25%. These increases largely reflected higher selling
prices for SHEETROCK(R) brand gypsum wallboard. Higher selling prices were also
realized for SHEETROCK(R) brand joint treatment products, DUROCK(R) brand cement
board products and FIBEROCK(R) brand gypsum fiber panels. The increase in third
quarter operating profit also reflected the $17 million pretax reversal of a
reserve for asbestos-related claims. These results were partially offset by
higher manufacturing costs related to raw materials and energy and lower
shipments of gypsum wallboard.
U.S. Gypsum's nationwide average realized selling price for SHEETROCK(R) brand
gypsum wallboard was $188.37 per thousand square feet in the third quarter of
2006. This price represented a 27% increase from $147.85 in the third quarter of
2005 and a 3% increase from $182.65 in the second quarter this year. However,
after achieving all-time record levels of pricing early in the third quarter of
2006, selling prices began to decline and averaged about $185 per thousand
square feet in September.
Shipments of SHEETROCK(R) brand gypsum wallboard totaled 2.6 billion square feet
in the third quarter of 2006, down from 2.9 billion square feet in the third
quarter of 2005 and 3.0 billion square feet in the second quarter of 2006. As
demand softened during the third quarter, U.S. Gypsum reduced operating rates at
its wallboard plants. As a result, capacity utilization averaged 90% for the
third quarter of 2006, down from almost 100% in the second quarter. Capacity
utilization averaged 97% in the third quarter of 2005. Industry shipments of
gypsum wallboard were down approximately 9% from the third quarter of 2005.
CGC Inc.: Third quarter 2006 net sales for the gypsum business of Canada-based
CGC Inc. totaled $85 million, which was $4 million higher than sales during last
year's third quarter. Operating profit was $13 million compared with $12 million
in the third quarter of 2005. Improvements in SHEETROCK(R) brand gypsum
wallboard pricing, as well as the favorable effects of currency translation,
were partially offset by higher manufacturing costs related to raw materials and
energy and lower gypsum wallboard shipments.
-41-
WORLDWIDE CEILINGS
Third quarter 2006 net sales of $191 million increased 6% from the prior-year
period, while operating profit was $18 million in both the third quarter of 2006
and 2005. Net sales during the first nine months of 2006 totaled $576 million,
up 9% from a year ago, while operating profit of $64 million rose 36%.
USG Interiors, Inc.: USG Interiors reported third quarter 2006 net sales and
operating profit of $124 million and $11 million, respectively. These results
compared with net sales of $124 million and operating profit of $13 million in
the third quarter of 2005. The decline in operating profit primarily reflected
higher manufacturing costs related to raw materials and energy.
USG International: USG International reported net sales and operating profit of
$64 million and $5 million, respectively, in the third quarter of 2006. These
results compared with net sales of $56 million and operating profit of $3
million for the same period a year ago. This improvement primarily reflected
higher demand for USG ceiling grid in Europe and increased exports to Latin
America.
CGC Inc.: The ceilings business of CGC Inc. reported net sales of $14 million
and operating profit of $2 million in the third quarter of 2006. Net sales and
operating profit for the same period a year ago were $13 million and $2 million,
respectively. Improved pricing for ceiling tile, lower manufacturing costs for
ceiling grid and the favorable effects of currency translation were offset by
lower selling prices for ceiling grid.
BUILDING PRODUCTS DISTRIBUTION
L&W Supply reported third quarter 2006 net sales of $642 million and operating
profit of $53 million, both records for any third quarter in its history. Net
sales rose $98 million, or 18%, while operating profit increased by $12 million,
or 29%, over the third quarter of 2005. The improved results reflected increased
sales of gypsum wallboard which benefited from a 29% increase in selling prices,
partially offset by a 3% decline in shipments, compared with the third quarter
of 2005. In addition, sales of complementary building products, such as drywall
metal, roofing, insulation, ceiling products and joint compound, rose 11%
compared with last year's third quarter.
For the first nine months of 2006, net sales of $1.926 billion and operating
profit of $164 million represented increases of 28% and 55%, respectively,
compared with the first nine months of 2005.
L&W Supply operated 212 locations in the United States as of September 30, 2006,
compared with 193 locations as of September 30, 2005. On a same-location basis,
net sales for the third quarter and first nine months of 2006 increased 15% and
21% from the respective 2005 periods.
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MARKET CONDITIONS AND OUTLOOK
Industry shipments of gypsum wallboard in the United States were an estimated
8.7 billion square feet in the third quarter of 2006, a 9% decrease from 9.6
billion square feet in the third quarter of 2005 and an 11% decrease from the
second quarter of 2006. Industry shipments of gypsum wallboard for the first
nine months of 2006 represented a record, increasing 2% from the first nine
months of 2005.
The outlook for the Corporation's markets for the balance of 2006 is mixed.
Declines in new residential construction caused by fewer new orders at major
homebuilders and excess inventories of unsold homes have resulted in reduced
demand for gypsum wallboard. The lower level of demand for wallboard is likely
to continue during the balance of 2006 and into 2007. When combined with
expected lower industry capacity utilization rates, lower realized prices for
wallboard are anticipated. The fundamentals for repair and remodeling activity
and nonresidential building remain good, and modest growth is expected in these
markets for the remainder of the year.
In this environment, the Corporation remains focused on balancing production
levels with market demand and maintaining high levels of quality, service,
safety and operational efficiency.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
As of September 30, 2006, the Corporation had $1.458 billion of cash, cash
equivalents and restricted cash on a consolidated basis, down $119 million from
the December 31, 2005 level, which also included marketable securities. The
Corporation believes that cash on hand, future cash available from operations
and the other sources of liquidity described below will provide sufficient
liquidity to allow the Corporation's businesses to carry on normal operations
and to allow the Corporation to complete the transactions contemplated by the
Plan. Normal-course cash requirements include, among other things, capital
expenditures, working capital needs and contractual obligations. Additionally,
the Corporation from time to time considers selective strategic transactions to
create value and improve performance. Such transactions may include
acquisitions, joint ventures, partnerships, restructurings and dispositions.
Transactions of these types may result in material cash outlays or proceeds.
The timing of certain cash inflows and outflows related to the Plan will depend
on whether the FAIR Act is enacted prior to the Trigger Date and withstands any
constitutional challenge initiated within 60 days of the Trigger Date. On the
Effective Date, the Reorganized Debtors paid $890 million to the Trust and
issued to the Trust an interest-bearing note in the amount of $10 million,
payable no later than December 31, 2006. The Reorganized Debtors also issued to
the Trust a contingent payment note in the aggregate principal amount of $3.05
billion, which will be payable to the Trust in the event that the FAIR Act has
not been enacted by the Trigger Date or, if enacted, is later held to be
unconstitutional after a challenge initiated within 60 days of the Trigger Date.
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With certain exceptions, outlined above, the Debtors' obligations under the
$3.05 billion contingent payment note will be cancelled if the FAIR Act is
enacted and made law by the Trigger Date. If the FAIR Act is not enacted and
made law by the Trigger Date, or is enacted but declared unconstitutional after
a challenge brought within 60 days after the Trigger Date, the Debtors will be
obligated to make payments under the $3.05 billion contingent payment note to
the Trust as follows: $1.9 billion of the contingent payment note will be
payable within 30 days after the Trigger Date, and the remaining $1.15 billion
of the contingent payment note will be payable within 180 days after the Trigger
Date or the date of a final, non-appealable order declaring the FAIR Act
unconstitutional, as the case may be. Interest will accrue on the unpaid balance
of the $3.05 billion contingent payment note beginning on the Trigger Date at a
per annum rate equal to the 90-day LIBOR in effect as of the Trigger Date plus
40 basis points.
During the period from the Effective Date through September 30, 2006, the
Reorganized Debtors paid $1.4 billion to unsecured creditors in addition to the
$890 million payment to the Trust.
Since the Filing, the Corporation's subsidiaries have completed 12 acquisitions
at a cost of approximately $140 million. Certain of the Corporation's North
American subsidiaries are currently in various stages of discussions with
respect to the potential acquisition of a number of distribution and
manufacturing businesses. A number of these potential acquisitions may be
announced and/or consummated during the fourth quarter of 2006 and first several
quarters of 2007. These potential acquisitions would require investment in an
aggregate amount that the Corporation estimates at approximately $300 million to
$500 million. There can, of course, be no assurance that any of these
acquisitions will be consummated or, if consummated, what the required
investment or timing of their consummation would be.
In addition, the Corporation's Board of Directors has approved capital
expenditures aggregating approximately $250 million for additional projects to
expand wallboard manufacturing and other operations. No spending commitments
have yet been made on these additional projects.
The Corporation is funding these obligations from cash on hand, as well as
future cash available from operations, anticipated tax refunds and debt
financing under the Credit Facilities. The Corporation may from time to time
consider other debt or equity financing alternatives to supplement, or as an
alternative to, financing under the Credit Facilities.
The Credit Facilities include a revolving credit facility, term loan facility
and a tax bridge facility that would be utilized to make payments to the Trust
if the proceeds from tax refunds following the Debtors' contributions to the
Trust are not received prior to the time those payments are due. Assuming that
the $3.05 billion contingent payment note becomes due and payable to the Trust,
the Corporation expects to receive cash tax refunds of about $1.1 billion in the
year following the payment on such note.
See Voluntary Reorganization Under Chapter 11 and Confirmation of the Plan of
Reorganization, above, and Note 3 to the Consolidated Financial Statements for
additional information regarding the Debtors' obligations and the funding of
those obligations under the Plan.
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CASH FLOWS
As shown in the consolidated statements of cash flows, cash and cash equivalents
increased $517 million during the first nine months of 2006. The primary sources
of cash in the first nine months of 2006 were the net proceeds from the Rights
Offering and Backstop Commitment, net sales of marketable securities, earnings
from operations and the return of restricted cash. The primary uses of cash were
(i) the $890 million payment to the Trust and $19 million of payments related to
the settlement of other asbestos-related claims; (ii) the $1.4 billion of
payments to unsecured creditors; (iii) capital spending of $237 million; (iv)
payments of fees related to the Rights Offering, including a $67 million payment
to Berkshire Hathaway in connection with the Backstop Commitment; (v)
acquisitions of businesses, net of cash acquired, of $74 million; and (vi)
pension funding of $53 million.
Comparing the first nine months of 2006 with the first nine months of 2005, net
cash used for operating activities was $765 million in the 2006 period compared
with net cash provided by operating activities of $347 million a year ago. This
variation was primarily attributable to the payments of $890 million to the
Trust, $656 million to unsecured creditors other than debtholders and $19
million related to the settlement of other asbestos-related claims, as discussed
above.
Investing activities in the first nine months of 2006 provided net cash of $328
million, while net cash of $246 million was used in the comparable 2005 period.
This variation primarily reflected net sales of marketable securities of $565
million in 2006 compared with net purchases of marketable securities of $59
million in 2005. In addition, $73 million of restricted cash was returned in the
first nine months of 2006 compared with a deposit of $34 million in the
comparable 2005 period. Capital spending and cash spent to acquire businesses
increased by $112 million and $45 million, respectively, in 2006.
Net cash of $951 million provided by financing activities during the first nine
months of 2006 primarily reflected the net proceeds of $1.7 billion from the
Rights Offering and Backstop Commitment, partially offset by the payment of $766
million related to pre-petition debt principal.
CAPITAL EXPENDITURES
Capital spending amounted to $237 million in the first nine months of 2006
compared with $125 million in the corresponding 2005 period. As of September 30,
2006, remaining capital expenditure commitments for the replacement,
modernization and expansion of operations amounted to $593 million, compared
with $587 million as of December 31, 2005. The Corporation's capital
expenditures program is expected to be funded by cash from operations and, if
determined to be appropriate, borrowings under the revolving credit facility
portion of the Credit Facilities or other alternative debt financings. Capital
expenditure commitments as of September 30, 2006 included:
- approximately $180 million for a new low-cost gypsum wallboard plant in
Washingtonville, Pa., that will serve the Northeast markets. Construction
of this plant will begin in late 2006 and is expected to be completed in
2008.
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- approximately $130 million to replace existing capacity at U.S. Gypsum's
Norfolk, Va., gypsum wallboard plant with a new low-cost wallboard line
designed to position the company for profitable growth in the mid-Atlantic
market. Construction on this project began in 2005 and is expected to be
completed in 2007.
- approximately $109 million to acquire a paper mill in Otsego, Mich., and
convert it to manufacture high-quality, low-cost paper for U.S. Gypsum's
wallboard plants. The plant is expected to begin production in 2008.
- approximately $75 million for a new 40,000-ton self-unloading ship
intended to lower the delivered cost of gypsum rock to East Coast
wallboard plants. The new ship is expected to become operational in 2008.
- approximately $70 million for a new gypsum wallboard plant in Tecoman,
Mexico. This facility will serve markets in western Mexico and export
gypsum wallboard to Latin America. Construction of this plant began in the
third quarter of 2006 and is expected to be completed in 2007.
WORKING CAPITAL
As of September 30, 2006, working capital (current assets less current
liabilities) amounted to $48 million, and the ratio of current assets to current
liabilities was 1.01-to-1. As of December 31, 2005, working capital amounted to
$1.579 billion, and the ratio of current assets to current liabilities was
3.63-to-1. The change primarily reflects the current obligations with respect to
the $3.05 billion contingent payment note issued to the Trust on the Effective
Date.
Receivables increased to $548 million as of September 30, 2006 from $453 million
as of December 31, 2005, primarily reflecting an 8% increase in net sales for
the month of September 2006 as compared with December 2005. Inventories
increased to $357 million from $315 million primarily due to the increased level
of business in the third quarter of 2006 as compared with the fourth quarter of
2005. Accounts payable as of September 30, 2006 increased to $318 million from
$281 million as of December 31, 2005, while accrued expenses increased to $475
million from $275 million. The higher levels of accounts payable and accrued
expenses primarily reflected the reclassification of liabilities subject to
compromise and the increased level of business.
MARKETABLE SECURITIES
As of December 31, 2005, marketable securities totaled $563 million. During the
first nine months of 2006, the Corporation sold its marketable securities and
plans to use the proceeds to fund its obligations under the Plan.
-46-
DEBT
As of December 31, 2005, pre-petition debt, which was included in liabilities
subject to compromise, amounted to $1.005 billion. As of September 30, 2006, the
Corporation repaid $766 million of this debt and reinstated $239 million in
accordance with the Plan and reclassified this amount to long-term debt. On
August 2, 2006, the Corporation entered into the Credit Facilities as described
in Note 3 to the Consolidated Financial Statements.
REALIZATION OF DEFERRED TAX ASSET
The Corporation's consolidated balance sheet as of September 30, 2006 includes a
net current deferred tax asset of $1.244 billion and a net long-term deferred
tax liability of $153 million. Included in these amounts is a deferred tax asset
of $1.3 billion and $32 million, respectively, relating to the U.S. federal and
state income tax benefits expected to be realized in future periods with respect
to the Corporation's asbestos liability and asbestos-related payments made
through September 30, 2006. Management has concluded, based on the weight of
available evidence, that all but $52 million of these tax benefits are more
likely than not to be realized in the future. This amount represents an increase
of $12 million from the valuation allowance of $40 million previously recorded
as of June 30, 2006.
In arriving at its conclusion, management has considered both the federal
taxable income reported by the Corporation for the 1996 through 2005 taxable
years, as well as future reversals of existing taxable temporary differences and
projections of future taxable income. In the taxable year(s) in which the
Corporation's cash contributions to the Trust are made, the related federal
income tax deduction will create a net operating loss. Under the Internal
Revenue Code, a net operating loss resulting from the payment of asbestos
claims, including cash contributions to the Trust, can be carried back and
offset against the Corporation's federal taxable income in the 10 preceding
years, generating a refund of taxes paid in those years. Since the Corporation
has reported federal taxable income of $3.2 billion, in the aggregate, for the
years 1996 through 2005, the carryback of this loss is expected to produce a
refund of federal income taxes paid in those years of approximately $1.1
billion, which the Corporation expects to receive in 2007. Further, as a result
of federal taxable income (excluding tax deductions for asbestos-related
payments) projected to be realized in 2006 through 2008, the Corporation expects
to utilize the remaining $360 million of federal tax benefits relating to its
asbestos liability by the end of 2008. As a result, it is more likely than not
that the Corporation will realize the federal deferred tax asset relating to its
asbestos reserve.
In contrast to the results under the Internal Revenue Code, most U.S. states do
not allow the carryback of a net operating loss in any significant amount. As a
result, most of the state tax benefits relating to the Corporation's payment of
asbestos claims will be realized through a reduction of future state income tax
liabilities by offsetting the net operating losses resulting from the
Corporation's cash contributions to the Trust against future state taxable
income. Based on projections of future taxable income (consistent with
historical results and anticipated future trends) in the U.S. states in which
the Corporation conducts business operations and the loss carryforward periods
-47-
allowed by current state laws (generally five to 20 years), management has
concluded that all but $52 million of the $228 million of state tax benefits
relating to the Corporation's asbestos liability is more likely than not to be
realized.
LEGAL CONTINGENCIES
The confirmed Plan of Reorganization resolves the Debtors' liability for all
present and future asbestos personal injury and related claims. The Plan of
Reorganization also provides that all resolved asbestos property damage claims
will be paid.
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 Note 13 to the Consolidated Financial Statements for additional information
on asbestos and environmental litigation.
CRITICAL ACCOUNTING POLICIES
The preparation of the Corporation's financial statements requires management to
make estimates, judgments and assumptions that affect the reported amounts of
assets, liabilities, revenues and expenses during the periods presented. The
Corporation's Annual Report on Form 10-K for the fiscal year ended December 31,
2005 includes a summary of the critical accounting policies the Corporation
believes are the most important to aid in understanding its financial results.
As a result of the Plan of Reorganization becoming effective on June 20, 2006
and having written agreements or agreements in principle to settle all of the
remaining asbestos property damage claims with the exception of one small claim
brought by a residential homeowner, the accounting policies related to (i)
voluntary reorganization under Chapter 11 and the application of SOP 90-7 and
(ii) the determination of the Corporation's asbestos liability are no longer
deemed critical.
The following is a summary of a new accounting policy that the Corporation
believes is important to aid in understanding its financial results:
Effective January 1, 2006, the Corporation adopted Statement of Financial
Accounting Standards ("SFAS") No. 123(R), "Share Based Payment." Under SFAS No.
123(R), the Corporation uses the Black-Scholes option valuation model to
determine the fair value of its stock options and stock appreciation rights. The
Black-Scholes option valuation model incorporates certain assumptions, such as
-48-
the expected volatility, risk-free interest rate, expected dividend yield and
expected life of options, in order to arrive at a fair value estimate. As a
result, stock-based compensation expense, as calculated and recorded under SFAS
No. 123(R), could have been impacted if other assumptions were used.
Furthermore, if the Corporation uses different assumptions in future periods,
stock-based compensation expense could be impacted in future periods. The
Corporation uses an independent third party to assist in determining these
assumptions. See Note 10 to the Consolidated Financial Statements for additional
information.
Except as discussed above, there were no material changes to the critical
accounting policies reported in the Corporation's Annual Report on Form 10-K for
the fiscal year ended December 31, 2005 that affected the Corporation's reported
amounts of assets, liabilities, revenues or expenses during the first nine
months of 2006.
NEW ACCOUNTING PRONOUNCEMENTS
See Note 14 to the Consolidated Financial Statements for information on new
accounting pronouncements.
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995 related to management's
expectations about future conditions. Actual business, market or other
conditions may differ from management's expectations and accordingly may affect
the Corporation's sales and profitability or other results and liquidity. Actual
results may differ due to various other factors, including economic conditions
such as the levels of new home and other construction activity, employment
levels, mortgage interest rates, housing affordability, currency exchange rates
and consumer confidence; competitive conditions such as price and product
competition; shortages in raw materials; increases in raw material, energy and
employee costs; loss of one or more major customers; capacity constraints;
capital markets conditions; the unpredictable effects of acts of terrorism or
war upon domestic and international economies and financial markets; and acts of
God. The Corporation assumes no obligation to update any forward-looking
information contained in this report.
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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) promulgated under the Securities
Exchange Act of 1934 (the "Act")), have concluded that, as of the end of the
quarter covered by this report on Form 10-Q, the Corporation's disclosure
controls and procedures were effective to provide reasonable assurance that
information required to be disclosed by the Corporation in the reports that it
files or submits under the Act is recorded, processed, summarized and reported
within the time periods specified in the Commission's rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed by an
issuer in the reports that it files or submits under the Act is accumulated and
communicated to the issuer's management, including its principal executive
officer or officers and principal financial officer or officers, or persons
performing similar functions, as appropriate to allow timely decisions regarding
required disclosure.
(b) Changes in internal control over financial reporting.
On October 1, 2005, the Corporation began to roll out a new enterprise resource
planning system in the United States and Canada. The rollout is being undertaken
in phases and is currently planned to be substantially completed in 2007.
Management expects that the new system will enhance operational efficiencies and
help the Corporation better serve its customers. Other than changes related to
the new system, there was no change in the Corporation's "internal control over
financial reporting" (as defined in Rule 13a-15(f) promulgated under the Act)
identified in connection with the evaluation required by Rule 13a-15(d)
promulgated under the Act that occurred during the quarter of the fiscal year
covered by this report on Form 10-Q that has materially affected, or is
reasonably likely to materially affect, the Corporation's internal control over
financial reporting.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of USG Corporation:
We have reviewed the accompanying consolidated balance sheet of USG Corporation
and subsidiaries as of September 30, 2006 and the related consolidated
statements of earnings and cash flows for each of the three month and nine month
periods ended September 30, 2006 and 2005. 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, 2005 and 2004, and
the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 2005
(not presented herein); and in our report dated February 13, 2006 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; and (ii) a
change in the method of accounting for asset retirement obligations due to the
Corporation's adoption of Statement of Financial Accounting Standards (SFAS) No.
143, "Accounting for Asset Retirement Obligations" in 2003, and Financial
Accounting Standards Board Interpretation No. 47, "Accounting for Conditional
Asset Retirements" in 2005. In our opinion, the information set forth in the
accompanying consolidated balance sheet as of December 31, 2005 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's plan of reorganization in its reorganization proceedings under
Chapter 11 was confirmed on June 16, 2006.
/s/ DELOITTE & TOUCHE LLP
DELOITTE & TOUCHE LLP
Chicago, Illinois
October 25, 2006
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Part I, Item 1, Note 13 to the Consolidated Financial Statements for
information concerning asbestos litigation and environmental litigation, which
information is incorporated herein by reference.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) As reported in the Corporation's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2006, and elsewhere in this Report, in connection
with the Rights Offering, Berkshire Hathaway, the Corporation's largest
stockholder, agreed to purchase from the Corporation, at $40.00 per share,
all of the shares of common stock offered pursuant to the Rights Offering
that were not issued pursuant to the exercise of rights. In the first
quarter of 2006, the Corporation paid Berkshire Hathaway a fee of $67
million for its Backstop Commitment. On August 2, 2006, the Corporation
issued 6,969,274 shares of common stock to Berkshire Hathaway in
accordance with the Backstop Commitment. These shares include 6,500,000
shares underlying rights distributed to Berkshire Hathaway in connection
with the shares it beneficially owned on the Record Date and 469,274
shares underlying rights distributed to other stockholders that were not
exercised in the Rights Offering. The aggregate purchase price for the
shares sold to Berkshire Hathaway in accordance with the Backstop
Commitment was approximately $279 million.
The sale of the securities to Berkshire Hathaway pursuant to the
performance of its obligations under the Backstop Commitment was effected
through a private placement under Section 4(2) of the Securities Act of
1933, as amended (the "Securities Act"), and Rule 506 of Regulation D
promulgated thereunder and was exempt from registration under Section 5 of
the Securities Act.
Pursuant to the Corporation's Stock Compensation Program for Non-Employee
Directors, on July 1, 2006, the Corporation's non-employee directors were
entitled to receive a $30,000 annual grant, payable at their election in
cash or common stock with an equivalent value. Pursuant to this provision,
effective July 1, 2006, a total of 2,645 shares of common stock were
issued to five non-employee directors based on the fair market value of a
share of common stock on July 3, 2006. The issuance of these shares was
effected through a private placement under Section 4(2) of the Securities
Act and was exempt from registration under Section 5 of the Securities
Act.
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(c)
(a) Total (c) Total Number of (c) Maximum Number (or
Number of (b) Average Shares (or Units) Approximate Dollar Value)
Shares Price Paid Purchased as Part of of Shares (or Units)
2006 (or Units) 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 - - - -
----- ----- -- --
April - - - -
May (d) 2,015 69.20 - -
June - - - -
----- ----- -- --
Total 2nd Quarter (d) 2,015 69.20 - -
----- ----- -- --
July - - - -
August - - - -
September - - - -
----- ----- -- --
Total 3rd Quarter - - - -
===== ===== == ==
(a) Reflects shares reacquired to provide for tax withholdings on shares
issued to employees under the terms of the Corporation's 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.
(d) Total number of shares and average price paid per share have been adjusted
to reflect the impact of the issuance of shares of the Corporation's
common stock in connection with the Rights Offering and Backstop
Commitment.
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ITEM 5. OTHER INFORMATION
In July 2006, the Corporation's Board of Directors approved forms of
Nonqualified Stock Option Agreement (the "Options Agreement") and Restricted
Stock Units Agreement (the "RSU Agreement") specifying certain of the terms and
conditions of grants of nonqualified stock options and restricted stock units
("RSUs") under the Corporation's Long-Term Incentive Plan (the "LTIP"). The
following are brief descriptions of the material terms and conditions of the
Options Agreement and the RSU Agreement. The descriptions are qualified in their
entity by the full text of the Options Agreement and RSU Agreement, copies of
which were filed as Exhibits 10.9 and 10.10, respectively, to the Corporation's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2006.
OPTIONS AGREEMENT: The Options Agreement provides that an option will become
exercisable in five equal annual installments beginning one year after the date
of grant, except that (1) an option becomes exercisable in full if the option
holder dies or becomes permanently and totally disabled, (2) if an option holder
retires after January 1, 2007, one-half of the unexercisable portion of the
holder's options will be forfeited and (3) an option becomes exercisable in full
if a Change in Control (as defined in the LTIP) occurs.
The Options Agreement also provides that an option will expire 10 years after
the date of grant, or at a specified earlier date in the event of death,
disability, retirement or other termination of employment.
The exercise price of an option may be paid by (1) cash or check, (2) transfer
to the Corporation of shares of its common stock owned by the option holder for
more than six months or (3) by a combination of such methods.
RSU AGREEMENT: The RSU Agreement provides that the RSUs become nonforfeitable in
four equal annual installments beginning one year after the date of grant,
except that (1) RSUs become nonforfeitable if the holder dies or becomes
permanently and totally disabled, (2) if an RSU holder retires after January 1,
2007, one-half of the RSUs that remain forfeitable will be forfeited and (3)
RSUs become nonforfeitable in full upon a Change in Control.
The RSU Agreement provides that, if the Corporation pays a cash dividend on its
common shares, the holder of an RSU will be entitled to an additional number of
RSUs determined by dividing (1) the product of (a) the amount of the dividend
per share and (b) the total number of RSUs held by the holder by (2) the market
value of a share of the Corporation's common stock on the date the dividend is
paid. The additional RSUs will be subject to the same terms and conditions as
the RSUs in respect of which they were credited.
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ITEM 6. EXHIBITS
10.1 Amendment No. 1 to the USG Corporation Long-Term Incentive Plan
(incorporated by reference to Exhibit 10.8 to the Corporation's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2006 (the "10-Q"))
10.2 Form of USG Corporation Nonqualified Stock Option Agreement (incorporated
by reference to Exhibit 10.9 to the 10-Q)
10.3 Form of USG Corporation Restricted Stock Units Agreement (incorporated by
reference to Exhibit 10.10 to the 10-Q)
15 Letter from Deloitte & Touche LLP regarding unaudited financial
information
31.1 Rule 13a-14(a) Certifications of USG Corporation's Chief Executive Officer
31.2 Rule 13a-14(a) Certifications of USG Corporation's Chief Financial Officer
32.1 Section 1350 Certifications of USG Corporation's Chief Executive Officer
32.2 Section 1350 Certifications of USG Corporation's Chief Financial Officer
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
USG CORPORATION
By /s/ William C. Foote
-----------------------------------
William C. Foote,
Chairman and Chief Executive Officer
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
October 30, 2006
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