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, 2007
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission File Number 1-8864
USG CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 36-3329400
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
550 West Adams Street, Chicago, Illinois 60661-3676
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code (312) 436-4000
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, 2007 was 99,042,373.
TABLE OF CONTENTS
Page
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Statements of Earnings:
Three Months and Nine Months Ended September 30, 2007 and 2006 3
Condensed Consolidated Balance Sheets:
As of September 30, 2007 and December 31, 2006 4
Condensed Consolidated Statements of Cash Flows:
Nine Months Ended September 30, 2007 and 2006 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 24
Item 4. Controls and Procedures 40
Report of Independent Registered Public Accounting Firm 41
PART II OTHER INFORMATION
Item 1. Legal Proceedings 42
Item 2. Unregistered Sales Of Equity Securities And Use Of Proceeds 42
Item 6. Exhibits 42
Signatures 43
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PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
USG CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(DOLLARS IN MILLIONS EXCEPT PER-SHARE DATA)
(UNAUDITED)
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------- -------------------------
2007 2006 2007 2006
----------- ----------- ----------- -----------
Net sales $ 1,335 $ 1,478 $ 4,002 $ 4,516
Cost of products sold 1,217 1,132 3,470 3,413
----------- ----------- ----------- -----------
Gross profit 118 346 532 1,103
Selling and administrative expenses 90 103 306 305
Provision for restructuring 3 -- 18 --
Reversal of asbestos claims reserve -- (17) -- (44)
Chapter 11 reorganization expenses -- 2 -- 10
----------- ----------- ----------- -----------
Operating profit 25 258 208 832
Interest expense 22 16 85 539
Interest income (5) (16) (18) (23)
Other income, net (2) (2) (4) (2)
----------- ----------- ----------- -----------
Earnings before income taxes 10 260 145 318
Income taxes 3 107 41 130
----------- ----------- ----------- -----------
Net earnings $ 7 $ 153 $ 104 $ 188
=========== =========== =========== ===========
Earnings per Common Share:
Basic $ 0.07 $ 1.71 $ 1.07 $ 3.03
Diluted 0.07 1.71 1.07 3.03
Average common shares 98,998,334 89,849,117 96,435,985 62,120,058
Average diluted common shares 99,214,635 89,907,436 96,721,553 62,227,119
See accompanying Notes to Condensed Consolidated Financial Statements.
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USG CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
(UNAUDITED)
AS OF AS OF
SEPTEMBER 30, DECEMBER 31,
2007 2006
------------- ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 353 $ 565
Restricted cash -- 6
Receivables (net of reserves - $18 and $16) 546 448
Inventories 379 348
Income taxes receivable 36 1,102
Deferred income taxes 42 169
Other current assets 78 69
------- -------
Total current assets 1,434 2,707
Property, plant and equipment (net of accumulated
depreciation and depletion - $1,209 and $1,108) 2,477 2,210
Deferred income taxes 270 187
Goodwill 228 154
Other assets 262 107
------- -------
Total Assets $ 4,671 $ 5,365
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 348 $ 303
Accrued expenses 258 358
Income taxes payable 5 38
Short-term debt -- 1,065
------- -------
Total current liabilities 611 1,764
Long-term debt 1,238 1,439
Deferred income taxes 10 11
Other liabilities 684 617
Commitments and contingencies
Stockholders' Equity:
Preferred stock -- --
Common stock 10 9
Treasury stock (204) (208)
Capital received in excess of par value 2,605 2,176
Accumulated other comprehensive (loss) (78) (136)
Retained earnings (deficit) (205) (307)
------- -------
Total stockholders' equity 2,128 1,534
------- -------
Total Liabilities and Stockholders' Equity $ 4,671 $ 5,365
======= =======
See accompanying Notes to Condensed Consolidated Financial Statements.
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USG CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2007 2006
------- ------
OPERATING ACTIVITIES:
Net earnings $ 104 $ 188
Adjustments to reconcile net earnings to net cash:
Reversal of asbestos claims reserve -- (44)
Depreciation, depletion and amortization 133 101
Share-based compensation expense 18 7
Deferred income taxes 26 358
(Increase) decrease in working capital (net of
acquisitions):
Receivables (24) (117)
Income taxes receivable 1,065 (264)
Inventories 5 (32)
Payables (2) 53
Accrued expenses (41) 11
Increase in other assets (43) (33)
Increase in other liabilities 28 29
Payment to Section 524(g) asbestos trust -- (890)
Reorganization distribution - other (40) (656)
Liabilities subject to compromise -- 521
Other, net 19 3
------- ------
Net cash provided by (used for) operating
activities 1,248 (765)
------- ------
INVESTING ACTIVITIES:
Capital expenditures (341) (237)
Acquisitions of businesses, net of cash acquired (280) (74)
Return of restricted cash 6 73
Net proceeds from asset dispositions 1 1
Purchases of marketable securities -- (112)
Sales or maturities of marketable securities -- 677
------- ------
Net cash (used for) provided by investing
activities (614) 328
------- ------
FINANCING ACTIVITIES:
Repayment of debt (1,765) --
Issuance of debt, net of discount 499 --
Proceeds from equity offering, net of fees 422 --
Payment of debt issuance fees (3) (22)
Tax benefit of share-based payments (6) 6
Issuances of common stock upon exercise of stock
options -- 13
Proceeds from rights offering, net of fees -- 1,720
Reorganization distribution - debt principal -- (766)
------- ------
Net cash (used for) provided by financing
activities (853) 951
------- ------
Effect of exchange rate changes on cash 7 3
Net (decrease) increase in cash and cash
equivalents (212) 517
Cash and cash equivalents at beginning of period 565 936
------- ------
Cash and cash equivalents at end of period $ 353 $1,453
======= ======
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Interest paid $ 70 $ 541
Income taxes (refunded) paid, net (1,046) 41
See accompanying Notes to Condensed Consolidated Financial Statements.
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USG CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In the following Notes to Condensed Consolidated Financial Statements, "USG,"
"we," "our" and "us" refer to USG Corporation, a Delaware corporation, and its
subsidiaries included in the consolidated financial statements, except as
otherwise indicated or as the context otherwise requires.
1. PREPARATION OF FINANCIAL STATEMENTS
We prepared the accompanying unaudited condensed consolidated financial
statements of USG Corporation 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 our management, the financial
statements reflect all adjustments, which are of a normal recurring nature,
necessary for a fair presentation of our financial results for the interim
periods. These financial statements and notes are to be read in conjunction with
the financial statements and notes included in USG's Annual Report on Form 10-K
for the fiscal year ended December 31, 2006, which we filed with the Securities
and Exchange Commission on February 16, 2007.
2. ACQUISITIONS
We record acquisitions using the purchase method of accounting and, accordingly,
include the results of operations of the businesses acquired in our consolidated
results as of the date of acquisition. We allocate the purchase price of
acquisitions to the tangible assets, liabilities and intangible assets acquired
based on fair values. The excess purchase price over those fair values is
recorded as goodwill. The fair value assigned to assets acquired is based on
valuations using management's estimates and assumptions. Pro forma combined
results of operations for the 2007 and 2006 periods would not be materially
different as a result of the acquisitions described below and therefore are not
presented.
2007 ACQUISITIONS
California Wholesale Material Supply, Inc.: On March 30, 2007, L&W Supply
Corporation, or L&W Supply, which makes up the Building Products Distribution
operating segment, purchased the outstanding stock of California Wholesale
Material Supply, Inc. and related entities (referred to collectively as CALPLY)
for approximately $267 million. This amount includes debt repaid at closing and
acquisition-related expenses and is net of CALPLY's cash at closing. Subsequent
to March 30, 2007, we paid approximately $1 million of additional
acquisition-related expenses. CALPLY sells building products and
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provides services to acoustical contractors, drywall contractors, plaster
contractors, roofing companies, manufactured housing companies, countertop
fabricators, government institutions and exporters from its 30 locations in
seven Western states and Mexico. This acquisition was part of L&W Supply's
strategy to profitably grow its specialty dealer business.
During the third quarter of 2007, we allocated the purchase price of CALPLY to
its tangible and identifiable intangible assets acquired and liabilities assumed
based on their estimated fair values at the acquisition date using information
available at that time. As a result, we may continue to adjust the purchase
price allocation after obtaining more information regarding, among other things,
asset valuations, liabilities assumed and revisions of preliminary estimates.
The excess of the purchase price over the aggregate estimated fair values was
recorded as goodwill, which is amortizable for tax purposes. The allocation of
the purchase price for CALPLY is summarized below and reflects estimated fair
values that are preliminary and subject to adjustment.
(millions)
----------
Cash $ 4
Accounts receivable 74
Inventories 37
Property, plant and equipment 6
Goodwill 84
Intangible assets 115
Other assets acquired 4
----
Total assets acquired $324
----
Total liabilities assumed $ 52
----
Total net assets acquired $272
----
The amount shown for intangible assets consists principally of $58 million
related to customer relationships, which is amortizable over ten years, and $56
million related to trade names, which have an indefinite life.
Grupo Supremo: On March 28, 2007, USG Mexico, S.A. de C.V., or USG Mexico, an
indirect, wholly owned subsidiary of USG Corporation, purchased the assets of
Grupo Supremo, located in the central north region of Mexico, whose businesses
include extracting gypsum rock from several mines and manufacturing plaster
products. The total purchase price was approximately $12 million including
acquisition-related expenses. Of this amount, $6 million was allocated to
intangible assets subject to amortization over periods of ten to 20 years.
2006 ACQUISITIONS
During the third quarter of 2007, we adjusted the allocation of the purchase
price for certain acquisitions made in 2006, resulting in a reclassification of
$17 million from goodwill to intangible assets. This amount consisted of $12
million related to customer relationships, which is amortizable over ten years,
and $5 million related to trade names, which have an indefinite life.
-7-
3. GOODWILL AND OTHER INTANGIBLE ASSETS
The change in the net carrying amount of goodwill by operating segment was as
follows:
North Building
American Products Worldwide
(millions) Gypsum Distribution Ceilings Total
---------- -------- ------------ --------- -----
Balance as of January 1, 2007 $-- $ 154 $-- $ 154
Acquisitions 6 197 -- 203
Purchase accounting adjustments -- 8 -- 8
Reclassification between segments -- (12) 12 --
Reclassification to other intangible assets (5) (132) -- (137)
--- ----- --- -----
Balance as of September 30, 2007 $ 1 $ 215 $12 $ 228
=== ===== === =====
Goodwill increased $74 million in the first nine months of 2007 primarily as a
result of the first quarter acquisitions of CALPLY by L&W Supply and the assets
of Grupo Supremo by USG Mexico. See Note 2 above for information related to
these acquisitions.
Other intangible assets, which are included in other assets on the condensed
consolidated balance sheets, are summarized as follows:
As of September 30, 2007 As of December 31, 2006
------------------------------ -----------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
(millions) Amount Amortization Net Amount Amortization Net
---------- -------- ------------ ---- -------- ------------ ---
INTANGIBLE ASSETS WITH
FINITE LIVES:
Customer relationships $ 70 $ 4 $ 66 $ 1 $ 1 $--
Other 10 2 8 -- -- --
---- --- ---- --- --- ---
Subtotal 80 6 74 1 1 --
---- --- ---- --- --- ---
INTANGIBLE ASSETS WITH
INDEFINITE LIVES:
Trade names 69 -- 69 8 -- 8
Other 8 -- 8 -- -- --
---- --- ---- --- --- ---
Subtotal 77 -- 77 8 -- 8
---- --- ---- --- --- ---
Total $157 $ 6 $151 $ 9 $ 1 $ 8
==== === ==== === === ===
Total amortization expense for other intangible assets was $4 million for the
third quarter of 2007 and $5 million for the first nine months of 2007. The
amounts for the 2006 periods were immaterial. Estimated annual amortization
expense for other intangible assets is $7 million for 2007, $8 million for each
of the years 2008 through 2011 and $7 million for 2012.
-8-
4. PROVISION FOR RESTRUCTURING
In the second quarter of 2007, we recorded provisions totaling $15 million
pretax ($9 million after-tax) for restructuring activities that included a
salaried workforce reduction program and the shutdown of a framing products
manufacturing plant. We implemented these actions in response to current market
conditions. In the third quarter of 2007, we recorded an additional provision of
$3 million pretax ($2 million after-tax) related to the salaried workforce
reduction program. Through the first nine months of 2007, the total provision
for restructuring was $17.5 million pretax ($11 million after-tax).
The number of employees terminated and open positions eliminated under the
salaried workforce reduction program as of September 30, 2007 was approximately
470. Included in the provision for restructuring for the first nine months of
2007 is a charge of $14 million pretax ($9 million after-tax) for severance and
related costs for the employees terminated as of September 30, 2007. We expect
to record approximately $600 thousand of additional charges during the fourth
quarter of 2007 for severance and related costs for several additional employees
whose employment will be terminated as part of the program, but who are
continuing to provide services after September 30th. Most of the payments
associated with this program are being made in 2007.
In June 2007, we shut down our plant in Tuscaloosa, Alabama that manufactured
framing products. Included in the provision for restructuring for the first nine
months of 2007 is a charge of $4 million pretax ($2 million after-tax) related
to this shutdown. This charge primarily reflects a writedown of property, plant
and equipment and lease-termination costs.
A restructuring reserve of $4 million is included in accrued expenses on the
condensed consolidated balance sheet as of September 30, 2007. This reserve is
summarized as follows:
Writedown of
Assets to Net Cash
(millions) Provisions Realizable Value Payments Total
---------- ---------- ---------------- -------- -----
Salaried workforce reduction $14 $-- $(11) $3
Shutdown of Tuscaloosa plant 4 (3) -- 1
--- --- ---- --
Balance as of September 30, 2007 $18 $(3) $(11) $4
=== === ==== ==
Including the approximately $600 thousand of additional charges related to the
salaried workforce reduction program that we expect to record during the fourth
quarter of 2007, our estimate of total restructuring expenses for 2007 is
approximately $18 million. On an operating segment basis, approximately $14
million of this amount relates to North American Gypsum, approximately $2
million relates to Worldwide Ceilings and approximately $1 million relates to
each of Building Products Distribution and Corporate.
-9-
5. OPERATING SEGMENTS
Our 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) Building Products Distribution, which distributes gypsum wallboard, drywall
metal, ceiling products, joint compound and other building products in the
United States and Mexico and (iii) Worldwide Ceilings, which manufactures
ceiling tile in the United States and ceiling grid in the United States, Canada,
Europe and the Asia-Pacific region. Operating segment results were as follows:
Three Months Nine Months
ended ended
September 30, September 30,
--------------- ---------------
(millions) 2007 2006 2007 2006
---------- ------ ------ ------ ------
NET SALES:
North American Gypsum $ 698 $ 909 $2,209 $2,817
Building Products Distribution 614 642 1,772 1,926
Worldwide Ceilings 207 191 614 576
Eliminations (184) (264) (593) (803)
------ ------ ------ ------
Total USG Corporation $1,335 $1,478 $4,002 $4,516
====== ====== ====== ======
OPERATING PROFIT:
North American Gypsum $ (2) $ 219 $ 133 $ 697
Building Products Distribution 22 53 93 164
Worldwide Ceilings 23 18 54 64
Corporate (18) (29) (79) (81)
Eliminations -- (1) 7 (2)
Chapter 11 reorganization expenses -- (2) -- (10)
------ ------ ------ ------
Total USG Corporation $ 25 $ 258 $ 208 $ 832
====== ====== ====== ======
Operating profit for the 2007 periods includes provisions for restructuring of
$3 million pretax for the third quarter and $17.5 million pretax for the first
nine months. On an operating segment basis, $14 million of the nine-months
charge relates to North American Gypsum, $1.5 million relates to Worldwide
Ceilings and $1 million relates to each of Building Products Distribution and
Corporate. See Note 4 above for additional information related to the
restructuring program and the estimated full-year provision by operating
segment.
Operating profit for the 2006 periods for North American Gypsum includes
reversals of an asbestos claims reserve. These reversals increased operating
profit by $17 million during the third quarter of 2006 and $44 million during
the first nine months of 2006.
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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, or RSUs, performance shares and outstanding stock options. Average common
shares and average diluted common shares outstanding for the third quarter and
first nine months of 2006 reflect the effect of a rights offering we completed
in the third quarter of 2006. 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
Earnings (000) Amount
-------- ------ ---------
THREE MONTHS ENDED SEPTEMBER 30,
2007:
Basic earnings $ 7 98,998 $0.07
Dilutive effect of stock options 217
---- ------ -----
Diluted earnings $ 7 99,215 $0.07
==== ====== =====
2006:
Basic earnings $153 89,849 $1.71
Dilutive effect of stock options 58
---- ------ -----
Diluted earnings $153 89,907 $1.71
==== ====== =====
NINE MONTHS ENDED SEPTEMBER 30,
2007:
Basic earnings $104 96,436 $1.07
Dilutive effect of stock options 286
---- ------ -----
Diluted earnings $104 96,722 $1.07
==== ====== =====
2006:
Basic earnings $188 62,120 $3.03
Dilutive effect of stock options 107
---- ------ -----
Diluted earnings $188 62,227 $3.03
==== ====== =====
Options, RSUs and performance shares with respect to 1.6 million common shares
were not included in the computation of diluted earnings per share for the third
quarter and first nine months of 2007 because they were anti-dilutive. Options
and RSUs with respect to 1.5 million common shares were not included in the
computation of diluted earnings per share for the third quarter and first nine
months of 2006 because they were anti-dilutive.
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7. DEBT
Total debt consisted of the following:
As of As of
September 30, December 31,
(millions) 2007 2006
---------- ------------- ------------
7.75% senior notes $ 499 $ --
6.3% senior notes 500 500
Industrial revenue bonds 239 239
Term loan -- 700
Tax bridge term loan -- 1,065
------ ------
Total $1,238 $2,504
====== ======
7.75% SENIOR NOTES DUE 2018
In the third quarter of 2007, we sold $500 million of 7.75% senior unsecured
notes maturing in January 2018 in an underwritten public offering. We recorded
the notes on the condensed consolidated balance sheet at $499 million, which is
net of debt discount of $1 million. In addition, we recorded $4 million of
deferred financing fees related to the issuance of the notes. The interest rate
payable on the notes is subject to adjustment from time to time by up to 2% in
the aggregate if the debt ratings assigned to the notes decrease or thereafter
increase. The notes are senior unsecured obligations and rank equally with all
of our other existing and future unsecured senior indebtedness. The indenture
governing the notes contains certain restrictions, including a limitation that
restricts our ability and the ability of certain of our subsidiaries to create
or incur secured indebtedness. We used the net proceeds from the sale of the
notes, together with cash on hand, to repay the $500 million balance outstanding
under our term loan facility described below plus accrued interest on that
balance.
6.3% SENIOR NOTES DUE 2016
In the second quarter of 2007, we completed the exchange of registered 6.3%
senior unsecured notes maturing in November 2016 for the $500 million of
privately placed 6.3% senior unsecured notes, also due in 2016, that we issued
in November 2006.
CREDIT FACILITIES
In the third quarter of 2006, we entered into a credit agreement with a
syndicate of banks. JPMorgan Chase Bank, N.A. serves as administrative agent
under the agreement. The credit agreement currently consists only of a $650
million unsecured revolving credit facility with a $250 million sublimit for
letters of credit. This facility is available to fund working capital needs and
for other general corporate purposes. As of September 30, 2007, we had not drawn
upon the revolving credit facility except for approximately $78 million of
outstanding letters of credit.
The credit agreement originally included a $1 billion term loan facility and a
$1.15 billion tax bridge term loan facility, both of which have been terminated.
The term loan facility was available to us in a single drawing of up to $1
billion, and the tax bridge facility was available to us in a single drawing of
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up to $1.15 billion, in each case to be made on or before January 31, 2007. In
December 2006, we borrowed $700 million under the term loan facility and $1.065
billion under the tax bridge facility. These borrowings, along with the net
proceeds from the 6.3% senior note offering described above and cash on hand,
were used to fund a $3.05 billion payment in December 2006 to the asbestos trust
created in connection with our plan of reorganization (see Notes 16 and 17
below).
In the first quarter of 2007, we received a $1.057 billion federal tax refund as
a result of tax deductions generated by the payments made to the asbestos trust.
This refund, along with cash on hand, was used in March 2007 to repay the
outstanding borrowing of $1.065 billion under the tax bridge facility. We also
repaid $200 million of the outstanding borrowing under the term loan facility in
March. As a result of these repayments, we recorded a charge to interest expense
in the first quarter of 2007 of $10 million pretax ($6 million after-tax) to
write off deferred financing fees associated with these borrowings.
In the third quarter of 2007, the credit agreement was amended and restated to:
- eliminate the requirement that our material domestic subsidiaries guarantee
our obligations under the credit agreement,
- extend the maturity of the facility by one year to August 2, 2012,
- reduce the margin on borrowings and the facility fee on the revolving
credit facility (which are based on the credit facilities' credit rating),
- reduce the maximum leverage ratio (as defined in the credit agreement)
covenant from 4.50-to-1.00 to 4.25-to-1.00 after December 31, 2008, and
- allow for an increase in the amount of the revolving credit facility to $1
billion, subject to the availability of additional commitments.
As mentioned above, in the third quarter of 2007, we repaid the remaining $500
million outstanding under the term loan using the net proceeds from the sale of
the 7.75% senior unsecured notes and cash on hand. As a result of this
repayment, we recorded a charge to interest expense in the third quarter of 2007
of $4 million pretax ($3 million after-tax) to write off deferred financing fees
associated with this borrowing.
The credit agreement requires that we meet and maintain certain financial ratios
and tests and contains events of default and covenants that are customary for
similar transactions and may limit our ability to take various actions. As of
September 30, 2007, we were in compliance with all financial ratios, tests and
covenants.
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8. INVENTORIES
Total inventories consisted of the following:
As of As of
September 30, December 31,
(millions) 2007 2006
---------- ------------- ------------
Finished goods and work in progress $297 $254
Raw materials 82 94
---- ----
Total $379 $348
==== ====
9. ASSET RETIREMENT OBLIGATIONS
Changes in the liability for asset retirement obligations consisted of the
following:
Nine Months
ended September
30,
---------------
(millions) 2007 2006
---------- ---- ----
Balance as of January 1 $78 $71
Accretion expense 4 3
Liabilities incurred 1 3
Foreign currency translation 2 1
--- ---
Balance as of September 30 $85 $78
=== ===
10. PUBLIC EQUITY OFFERING
In March 2007, we completed a public offering of 9,063,373 shares of our common
stock at a price of $48.60 per share. The net proceeds of the offering, after
deducting underwriting discounts and commissions and offering expenses, were
approximately $422 million. We used the net proceeds of the equity offering to
pay for the CALPLY acquisition and for general corporate purposes.
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11. DERIVATIVE INSTRUMENTS
We use derivative instruments to manage selected commodity price and foreign
currency exposures. We do not use derivative instruments for speculative trading
purposes. All derivative instruments must be recorded on the balance sheet at
fair value. For derivatives designated as fair value hedges, the changes in the
fair values of both the derivative instrument and the hedged item are recognized
in earnings in the current period. For derivatives designated as cash flow
hedges, the effective portion of changes in the fair value of the derivative is
recorded to accumulated other comprehensive income, or AOCI, 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,
we record changes in value to AOCI. For derivatives not classified as fair
value, cash flow or net investment hedges, all changes in market value are
recorded to earnings.
COMMODITY DERIVATIVE INSTRUMENTS
Currently, we are using swap contracts to hedge a portion of our anticipated
purchases of natural gas to be used in our manufacturing operations. We review
our positions regularly and make 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, 2007, we had swap contracts to exchange
monthly payments on notional amounts of natural gas amounting to $153 million.
As of September 30, 2007, the fair value of these swap contracts, which remained
in AOCI, was a $15 million unrealized loss.
FOREIGN CURRENCY DERIVATIVE INSTRUMENTS
We have cross-currency swaps and foreign exchange forward agreements in place to
hedge changes in the value of intercompany loans to certain foreign subsidiaries
due to changes in foreign exchange rates. The notional amount of these hedges is
$63 million, and all contracts mature by March 31, 2009. As of September 30,
2007, the fair value of these hedges was a $1 million pretax loss that was
recorded to earnings. We also have foreign currency forward agreements to hedge
a portion of our net investment in certain foreign subsidiaries. The notional
amount of these hedges is $48 million, and all contracts mature by June 8, 2012.
As of September 30, 2007, the fair value of these hedges, which was a loss of $2
million, was recorded to AOCI.
COUNTERPARTY RISK
We are exposed to credit losses in the event of nonperformance by the
counterparties on our financial instruments. All counterparties have investment
grade credit ratings; accordingly, we anticipate that these counterparties will
be able to fully satisfy their obligations under the contracts. We receive
collateral from our counterparties based on the provisions in certain credit
support agreements. Similarly, we may be required to post collateral under
certain conditions. Currently, we have no collateral requirement. We enter into
master agreements which contain netting arrangements that minimize counterparty
credit exposure.
-15-
12. COMPREHENSIVE INCOME
The components of comprehensive income are summarized in the following table:
Three Months Nine Months
ended September 30, ended September 30,
------------------- -------------------
(millions) 2007 2006 2007 2006
---------- -------- -------- -------- --------
Net earnings $ 7 $153 $104 $ 188
--- ---- ---- -----
Pretax gain (loss) on derivatives -- (31) 24 (149)
Income tax benefit (expense) -- 12 (10) 58
--- ---- ---- -----
After-tax gain (loss) on derivatives -- (19) 14 (91)
--- ---- ---- -----
Loss on unrecognized pension and
postretirement benefit costs, net of tax* -- -- (3) --
--- ---- ---- -----
Foreign currency translation 20 3 47 9
Unrealized gain on marketable
securities, net of tax -- -- -- 1
--- ---- ---- -----
Total comprehensive income $27 $137 $162 $ 107
=== ==== ==== =====
* Includes the impact of the actual results of the 2007 actuarial valuations
for the pension and postretirement benefit plans.
There was no tax impact on the foreign currency translation adjustments.
AOCI consisted of the following:
As of As of
September 30, December 31,
(millions) 2007 2006
---------- ------------- ------------
Loss on derivatives, net of tax $ (12) $ (26)
Unrecognized pension and postretirement benefit
costs, net of tax (137) (134)
Foreign currency translation 71 24
----- -----
Total $ (78) $(136)
===== =====
Reclassifications of net after-tax gains or losses from AOCI to earnings during
the third quarter of 2007 were as follows:
(millions)
----------
Loss on derivatives, net of tax of $5 million $ (9)
Loss on unrecognized pension and postretirement benefit
costs, net of tax of $1 million (2)
----
Total $(11)
====
As of September 30, 2007, we estimate the net after-tax gains or losses that we
will reclassify from AOCI to earnings within the next 12 months to be a $9
million loss on derivatives and a $5 million loss on unrecognized pension and
postretirement benefit costs.
-16-
13. EMPLOYEE RETIREMENT PLANS
The components of net pension and postretirement benefits costs are summarized
in the following table:
Three Months Nine Months
ended September 30, ended September 30,
------------------- -------------------
(millions) 2007 2006 2007 2006
---------- -------- -------- ------- ---------
PENSION:
Service cost of benefits earned $ 10 $ 10 $ 30 $ 29
Interest cost on projected benefit obligation 17 15 50 46
Expected return on plan assets (18) (15) (54) (47)
Net amortization 3 4 8 14
---- ---- ---- ----
Net cost $ 12 $ 14 $ 34 $ 42
==== ==== ==== ====
POSTRETIREMENT:
Service cost of benefits earned $ 3 $ 3 $ 11 $ 11
Interest cost on projected benefit obligation 6 5 18 16
Recognized loss -- -- (2) (2)
---- ---- ---- ----
Net cost $ 9 $ 8 $ 27 $ 25
==== ==== ==== ====
In accordance with our funding policy, we currently plan to contribute
approximately $68 million of cash to our pension plans in 2007.
14. SHARE-BASED COMPENSATION
We recognize compensation expense on all share-based grants over the service
period, which is the shorter of the period until the employees' retirement
eligibility date or the service period of the award.
STOCK OPTIONS
We granted options to purchase 551,895 shares of common stock under our
Long-Term Incentive Plan, or LTIP, during the first quarter of 2007 with an
exercise price of $49.61 per share, which was the closing price of a share of
USG common stock on the date of grant. The options generally become exercisable
in four equal annual installments beginning one year from the date of grant, or
earlier in the event of death, disability, retirement or a change in control.
The options generally expire 10 years from the date of grant, or earlier in the
event of death, disability or retirement. Expense is recognized, net of
estimated forfeitures, over the vesting period of the options.
We estimated the fair value of each stock option granted under the LTIP to be
$21.73 on the date of grant using a Black-Scholes option valuation model that
uses the assumptions noted below. We based expected volatility on a 50%
weighting of peer volatilities and 50% weighting of implied volatility of our
common stock. We did not consider historical volatility of our common stock
-17-
price to be an appropriate measure of future volatility because of the impact of
our Chapter 11 proceedings on our 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.
The assumptions used in the valuation were as follows: expected volatility
35.5%, risk-free rate 4.55%, expected term (in years) 6.25, expected annual
forfeitures 2.5% and expected dividends 0.
RESTRICTED STOCK UNITS
We granted RSUs under the LTIP with respect to 140,755 shares of common stock
during the first quarter of 2007 and 2,000 shares of common stock during the
second quarter of 2007. The RSUs generally vest in four equal annual
installments beginning one year from the date of grant, except that 64,000 of
the RSUs were granted as special retention awards that generally will vest 100%
after either four or five years. Generally, all RSUs may vest earlier in the
case of death, disability, retirement or a change in control. Each RSU is
settled in a share of our stock after the vesting period. The fair value of each
RSU granted is equal to the closing market price of our common stock on the date
of grant. Expense is generally recognized, net of estimated forfeitures, using
the straight-line method over the vesting period of the award.
PERFORMANCE SHARES
We granted 87,160 performance shares under the LTIP during the first quarter of
2007. The performance shares generally vest after a three-year period based on
our total stockholder return relative to the performance of the Dow Jones U.S.
Construction and Materials Index, with adjustments in certain circumstances, for
the three-year period. Vesting will be pro-rated based on the number of full
months employed during the performance period in the case of death, disability,
retirement or a change-in-control, and pro-rated awards earned will be paid out
at the end of the three-year period. The number of performance shares earned
will vary from 0 to 200% of the number of performance shares awarded depending
on that relative performance. Each performance share earned will be settled in a
share of our common stock. Expense is recognized, net of estimated forfeitures,
over the vesting period of the performance shares.
We estimated the fair value of each performance share granted under the LTIP to
be $45.17 on the date of grant using a Monte Carlo simulation that uses the
assumptions noted below. Expected volatility is based on implied volatility of
our common stock. The risk-free rate was based on zero coupon U.S. government
issues at the time of grant. The expected term represents the period from the
grant date to the end of the performance period.
The assumptions used in the valuation were as follows: expected volatility
30.7%, risk-free rate 4.55%, expected term (in years) 2.78, expected annual
forfeitures 2.5% and expected dividends 0.
-18-
15. INCOME TAXES
Income tax expense was $41 million in the first nine months of 2007, including a
$6.6 million favorable tax adjustment in the first quarter and a $6.7 million
unfavorable tax adjustment in the third quarter resulting from corrections to
deferred tax balances from prior years. The net effect of these adjustments for
the first nine months of 2007 is immaterial.
In the first quarter of 2007, we received a $1.057 billion federal tax refund as
a result of tax deductions generated by the payments made to the asbestos trust
in 2006 and the carryback of the resulting federal net operating loss to the 10
preceding taxable years. Additionally, in the first quarter of 2007, we received
a $14 million federal tax refund resulting from the overpayment of our 2005
federal income taxes. These refunds reduced the $1.102 billion of income taxes
receivable reported on our consolidated balance sheet as of December 31, 2006.
We have net operating loss and tax credit carryforwards in varying amounts in
the U.S. and numerous U.S. state and foreign jurisdictions. As a result of the
federal income tax deduction for amounts paid to the asbestos trust in 2006, we
incurred a federal and state net operating loss, or NOL, in 2006. While most of
the federal NOL was carried back and offset against the federal taxable income
we reported in the 10 preceding taxable years, $447 million of the NOL will be
carried forward and offset against federal taxable income arising in 2007 and
later years. In addition, the carryback of the 2006 federal NOL resulted in the
carryforward of $81 million of federal tax credits (primarily alternative
minimum tax and foreign tax credits) that can be offset against federal income
tax in future years. The federal NOL can be carried forward for 20 years; the
alternative minimum tax credits can be carried forward indefinitely; and the
foreign tax credits can be carried forward for 10 years from the date of origin.
At the state level, most of the 2006 state NOL will be carried forward since
most states do not allow the carryback of a NOL in any significant amount. The
2006 state NOL, as well as other NOL and tax credit carryforwards arising in
prior years in various state and foreign jurisdictions, will expire over periods
ranging from five to 20 years from the date of origin.
We have a valuation allowance for deferred tax assets relating to certain U.S.
federal and state and foreign net operating loss and tax credit carryforwards
due to uncertainty regarding their ultimate realization. During the third
quarter of 2007, we decreased our valuation allowance for deferred tax assets by
a total of $2 million due to a change in our judgment about the realizability of
the deferred tax assets relating to certain foreign and U.S. state net operating
loss and tax credit carryforwards in future years. Of the total valuation
allowance as of September 30, 2007, $66 million relates to U.S. state net
operating loss and tax credit carryforwards, $11 million relates to foreign net
operating loss and tax credit carryforwards and $1 million relates to U.S.
federal foreign tax credit carryforwards.
-19-
In June 2006, the Financial Accounting Standards Board, or FASB, issued
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an
Interpretation of Financial Accounting Standards Board Statement No. 109." This
interpretation clarifies the accounting and disclosures relating to the
uncertainty about whether a tax return position will ultimately be sustained by
the respective tax authorities. We adopted this interpretation on January 1,
2007. As part of the adoption, we recorded an increase in our liability for
unrecognized tax benefits of $19 million, $18 million of which was accounted for
as an increase in long-term deferred taxes and $1 million of which reduced our
January 1, 2007 balance of retained earnings. As of the date of adoption, the
total amount of our unrecognized tax benefits was $55 million and the total
amount of interest and penalties recognized on our condensed consolidated
balance sheet was $7 million. We classify interest expense and penalties related
to unrecognized tax benefits and interest income on tax overpayments as
components of income tax expense. The total amount of unrecognized tax benefits
that, if recognized, would affect our effective tax rate is $36 million.
Our U.S. income tax returns for 2004 and prior years have been audited by the
Internal Revenue Service, or the IRS. The U.S. federal statute of limitations
remains open for the year 2003 and later years. The IRS commenced an audit of
the federal income tax returns filed by USG and its subsidiaries for the years
2005 and 2006 and is expected to complete the audit by June 30, 2008. The IRS
has not proposed any material adjustments for 2005 or 2006 as of September 30,
2007. We are also under examination currently in various U.S. state and foreign
jurisdictions. Foreign and U.S. state jurisdictions have statutes of limitations
generally ranging from 3 to 5 years.
It is reasonably possible that the amount of our unrecognized tax benefits will
change in the next 12 months as a result of the expected completion of the IRS
audit. At this time, an estimate of a change, if any, to the amount of
unrecognized tax benefits cannot be made. However, based on the information
available at this time, we do not expect any change to have a significant impact
on our results of operations, financial position or cash flows.
16. RESOLUTION OF USG'S REORGANIZATION PROCEEDINGS
In the second quarter of 2006, USG Corporation and 10 of its United States
subsidiaries, collectively referred to as the debtors, emerged from Chapter 11
reorganization proceedings as a result of a plan of reorganization that was
confirmed by the United States Bankruptcy Court for the District of Delaware and
the United States District Court for the District of Delaware.
Pursuant to the plan of reorganization, we resolved the present and future
asbestos personal injury liabilities of the debtors by creating and funding a
trust under Section 524(g) of the United States Bankruptcy Code. In 2006, we
made payments totaling $3.95 billion to the asbestos trust. We have no further
payment obligations to the trust.
-20-
The following subsidiaries were debtors in the Chapter 11 proceedings: United
States Gypsum Company, or U.S. Gypsum; USG Interiors, Inc.; USG Interiors
International, Inc.; L&W Supply; Beadex Manufacturing, LLC, or Beadex; B-R
Pipeline Company; La Mirada Products Co., Inc.; Stocking Specialists, Inc.; USG
Industries, Inc.; and USG Pipeline Company.
FINANCIAL STATEMENT PRESENTATION
During the time the debtors were operating under the protection of Chapter 11 of
the United States Bankruptcy Code, our consolidated financial statements were
prepared in accordance with American Institute of Certified Public Accountants
Statement of Position 90-7.
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, these liabilities were
reclassified on our condensed consolidated balance sheet.
Interest expense for the third quarter of 2006 included charges for
post-petition interest and fees totaling $8 million ($5 million after-tax)
related to pre-petition obligations. Interest expense for the first nine months
of 2006 included charges for post-petition interest and fees totaling $528
million ($326 million after-tax) related to pre-petition obligations.
17. LITIGATION
ASBESTOS LITIGATION
Asbestos Personal Injury Litigation: Our plan of reorganization confirmed in
2006 resolved the debtors' liability for all present and future asbestos
personal injury and related claims. Pursuant to the plan, we created and funded
a trust under Section 524(g) of the Bankruptcy Code for the payment of all of
the present and future asbestos personal injury liabilities of the debtors. In
2006, we made payments totaling $3.95 billion to the asbestos personal injury
trust. We have no further payment obligations to the trust.
The asbestos personal injury trust 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.
A key component of our plan of reorganization is the channeling injunction which
provides that all present and future asbestos personal injury claims against the
debtors must be brought against the trust and no one may bring such a claim
against the 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., which was formerly one of our
subsidiaries. Our plan of reorganization and the
-21-
channeling injunction do not apply to any of our non-U.S. subsidiaries, any
companies we acquired during our reorganization proceedings, or any companies
that we acquired or may acquire after our emergence from reorganization.
Asbestos Property Damage Litigation: Asbestos property damage claims against the
debtors were not part of the asbestos trust or the channeling injunction. Our
plan of reorganization provided that all settled or otherwise resolved asbestos
property damage claims that were timely filed in our reorganization proceedings
would be paid in full. During our reorganization proceedings, the court entered
an order requiring that asbestos property damage claims against the debtors be
filed by January 15, 2003. In response to that deadline, approximately 1,400
asbestos property damage claims were timely filed in the debtors' Chapter 11
proceedings and an additional 70 claims were filed after the deadline. During
our reorganization proceedings, more than 950 claims were disallowed or
withdrawn, leaving approximately 520 claims pending.
In 2006 and 2007, we reached agreements to settle all of the remaining asbestos
property damage claims filed in our reorganization proceedings. In 2006, we made
total payments of approximately $99 million for certain of these asbestos
property damage settlements. Based on our evaluation of our asbestos property
damage settlements, we reversed $27 million of our reserve for asbestos-related
claims in the second quarter of 2006 and an additional $17 million in the third
quarter of 2006.
In 2007 to date, we made total payments of approximately $40 million for
asbestos property damage settlements. The current estimate of the cost of the
remaining asbestos property damage settlements that have not yet been paid, and
associated legal fees, is approximately $8 million and is included in accrued
expenses and other liabilities on the condensed consolidated balance sheet as of
September 30, 2007.
ENVIRONMENTAL LITIGATION
We 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, our involvement is expected to be minimal. We believe that appropriate
reserves have been established for our potential liability in connection with
all Superfund sites, but we continue to review our accruals as additional
information becomes available. Our reserves take into account all known or
estimated undiscounted costs associated with these sites, including site
investigations and feasibility costs, site cleanup and remediation, certain
legal costs, and fines and penalties, if any. In addition, environmental costs
connected with other site cleanups on property we own are covered by reserves we
establish based on these same considerations.
We believe that neither the environmental or asbestos-related matters discussed
above nor any other litigation involving USG will have a material adverse effect
upon our results of operations, financial position or cash flows.
-22-
18. NEW ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued Statement of Financial Accounting Standards,
or SFAS, No. 157, "Fair Value Measurements." This statement 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. We are currently reviewing this pronouncement to determine the
impact that it may have on our financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities - Including an Amendment of FASB
Statement No. 115." This statement permits entities to choose to measure many
financial instruments and certain other items at fair value. This statement is
effective as of the beginning of the first fiscal year beginning after November
15, 2007. We are currently reviewing this pronouncement to determine the impact
that it may have on our financial statements.
-23-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
In the following Management's Discussion and Analysis of Financial Condition and
Results of Operations, "USG," "we," "our" and "us" refer to USG Corporation, a
Delaware corporation, and its subsidiaries included in the condensed
consolidated financial statements, except as otherwise indicated or as the
context otherwise requires.
OVERVIEW
FINANCIAL INFORMATION
Consolidated net sales in the third quarter of 2007 were $1.335 billion, down
10% from the third quarter of 2006. Operating profit was $25 million, down from
$258 million for the prior-year period. Net earnings were $7 million, or $0.07
per diluted share, for the third quarter of 2007 compared with net earnings of
$153 million, or $1.71 per diluted share, for the third quarter of 2006.
For the third quarter of 2007, housing starts dropped 24% compared with the
third quarter of 2006 as the inventory of unsold homes continued to build and
the availability of mortgage financing tightened. The residential repair and
remodeling market softened as well. As expected, this has led to lower wallboard
shipments and prices and has significantly reduced our sales and profits
compared to last year.
Shipments of United States Gypsum Company's SHEETROCK(R) brand gypsum wallboard
in the third quarter of 2007 were down 10% compared with the third quarter of
2006. Capacity utilization rates for our gypsum wallboard plants were
approximately 80% for the third quarter of 2007. These plants operated at 90% of
capacity during the third quarter of 2006. The decrease in demand caused U.S.
Gypsum's nationwide average realized selling price for SHEETROCK(R) brand gypsum
wallboard to fall to $122.68 per thousand square feet for the third quarter of
2007 compared with $141.97 for the second quarter of 2007 and $188.37 for the
third quarter of 2006. Gypsum wallboard selling prices trended downward during
the third quarter, but at a slower rate compared to earlier in the year. Prices
have continued to trend downward since quarter-end and remain under pressure.
During the third quarter of 2007, manufacturing costs for SHEETROCK(R) brand
gypsum wallboard were adversely affected by higher prices for energy, wastepaper
and other raw materials compared to 2006, but these costs have decreased since
the first quarter of this year.
MARKET TRENDS AND OUTLOOK
Industry shipments of gypsum wallboard in the United States were an estimated
7.80 billion square feet in the third quarter of 2007, an 11% decrease from 8.75
billion square feet in the third quarter of 2006 and a 4% decrease from 8.16
billion square feet in the second quarter of 2007.
-24-
The housing market continued to deteriorate during the third quarter of 2007.
Market conditions suggest that new residential construction will remain weak
during the remainder of the year and at least through 2008. Residential repair
and remodeling expenditures also are expected to decline due to lower sales of
existing homes and weakness in housing prices. We expect low single-digit growth
in the non-residential markets to continue well into 2008, although the growth
will not be sufficient to significantly offset the effects of lower demand for
wallboard from the residential construction and repair and remodeling markets.
Demand for gypsum wallboard in the fourth quarter of 2007 is expected to be
lower than in the fourth quarter of 2006. Overall, we expect industry demand for
gypsum wallboard in 2007 to be down approximately 13% from last year. Industry
capacity utilization rates are expected to be below 80% for the year. At these
levels of capacity utilization, we expect to see continued pressure on wallboard
selling prices.
We have responded to the lower level of demand for our products by balancing
wallboard production volumes and pricing in an effort to maximize operating
results. We have also made significant adjustments to our manufacturing capacity
by idling or closing approximately 2.6 billion square feet of mostly older,
higher-cost wallboard capacity from operations in the last year. This figure
includes wallboard capacity that was previously curtailed at our New Orleans,
Louisiana plant. In the fourth quarter of 2007, we will idle the remainder of
the wallboard capacity at the New Orleans plant. We have also eliminated 1,100
hourly and salaried positions and closed four L&W Supply locations. We will
continue adjusting our operations as conditions warrant.
STRATEGIC ACTIONS
We intend to continue to seek opportunities to grow our business and improve
operating results by:
- enhancing customer service through information technology investments that
enhance operations and customer satisfaction and the introduction of new
products and systems that complement our current product lines;
- continuing to invest in new, low-cost gypsum wallboard manufacturing
capacity to improve operating margins, replacing older, higher-cost
capacity and reducing costs by improving production efficiencies;
- making selective acquisitions to grow our Building Products Distribution
business;
- making selective acquisitions and entering into joint ventures to grow our
non-U.S. businesses; and
- adjusting our workforce in response to market conditions.
-25-
CONSOLIDATED RESULTS OF OPERATIONS
The following is a summary of our condensed consolidated statements of earnings:
Increase
(dollars in millions, except per-share data) 2007 2006 (Decrease)
-------------------------------------------- ------ ------ ----------
THREE MONTHS ENDED SEPTEMBER 30:
Net sales $1,335 $1,478 (10)%
Cost of products sold 1,217 1,132 8%
Gross profit 118 346 (66)%
Selling and administrative expenses 90 103 (13)%
Provision for restructuring 3 -- --
Reversal of asbestos claims reserve -- (17) --
Chapter 11 reorganization expenses -- 2 --
Operating profit 25 258 (90)%
Interest expense 22 16 38%
Interest income (5) (16) (69)%
Other income, net (2) (2) --
Income taxes 3 107 (97)%
Net earnings 7 153 (95)%
Diluted earning per share 0.07 1.71 (96)%
NINE MONTHS ENDED SEPTEMBER 30:
Net sales $4,002 $4,516 (11)%
Cost of products sold 3,470 3,413 2%
Gross profit 532 1,103 (52)%
Selling and administrative expenses 306 305 --
Provision for restructuring 18 -- --
Reversal of asbestos claims reserve -- (44) --
Chapter 11 reorganization expenses -- 10 --
Operating profit 208 832 (75)%
Interest expense 85 539 (84)%
Interest income (18) (23) (22)%
Other income, net (4) (2) 100%
Income taxes 41 130 (68)%
Net earnings 104 188 (45)%
Diluted earnings per share 1.07 3.03 (65)%
NET SALES
Consolidated net sales in the third quarter and first nine months of 2007
declined 10% and 11% from the respective 2006 periods primarily due to decreased
demand for building products and lower selling prices for gypsum wallboard. As
explained below under Core Business Results of Operations, net sales in the
third quarter and first nine months of 2007 for North American Gypsum and
Building Products Distribution decreased compared with the same periods in 2006.
Net sales in the third quarter and first nine months of 2007 for Worldwide
Ceilings improved compared with the respective prior-year periods.
-26-
COST OF PRODUCTS SOLD
Cost of products sold increased 8% in the third quarter of 2007 compared with
the third quarter of 2006 and 2% in the first nine months of 2007 compared with
the same period in 2006. These increases primarily reflect higher prices for
energy, wastepaper and other raw materials, partially offset by lower product
volumes.
GROSS PROFIT
Gross profit for the third quarter and first nine months of 2007 decreased 66%
and 52% from the respective 2006 periods primarily due to lower demand for
gypsum wallboard, lower gypsum wallboard selling prices and higher manufacturing
costs. The gross margin percentage was 8.8% in the third quarter of 2007, down
from 23.4% in the third quarter of 2006. For the first nine months of 2007, the
gross margin percentage was 13.3%, down from 24.4% for the first nine months of
2006.
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses for the third quarter of 2007 decreased 13%
from the third quarter of 2006 primarily due to lower levels of incentive
compensation, the impact of our salaried workforce reduction program and the
company-wide emphasis on reducing expenses. As a percent of net sales, selling
and administrative expenses were 6.7% for the third quarter of 2007, down from
7.0% for the third quarter of 2006.
Selling and administrative expenses for the first nine months of 2007 increased
$1 million from the first nine months of 2006 primarily due to higher levels of
compensation and benefits and costs associated with our first quarter 2007 move
to a new corporate office, largely offset by lower accruals for incentive
compensation and a company-wide emphasis on reducing expenses. As a percent of
net sales, selling and administrative expenses were 7.6% for the first nine
months of 2007, up from 6.8% for the first nine months of 2006.
PROVISION FOR RESTRUCTURING
In the third quarter of 2007, we recorded a provision of $3 million pretax ($2
million after-tax) related to our salaried workforce reduction program. Through
the first nine months of 2007, the total provision for restructuring was $17.5
million pretax ($11 million after-tax). Our restructuring activities include the
salaried workforce reduction program and the shutdown of a framing products
manufacturing plant. We implemented these actions beginning in the second
quarter of 2007 in response to current market conditions. See Note 4 to the
Condensed Consolidated Financial Statements for additional information related
to this restructuring program.
REVERSAL OF ASBESTOS CLAIMS RESERVE
In the third quarter of 2006, we reversed $17 million pretax ($10 million
after-tax) of a reserve for asbestos-related claims. This reversal, which is
reflected as income in the condensed consolidated statements of earnings, was
based on our evaluation of our asbestos property damage settlements and the
remaining unresolved asbestos property damage claims at that time. Through the
first nine months of 2006, a total of $44 million pretax ($27 million after-
-27-
tax) of the reserve for asbestos-related claims was reversed.
CHAPTER 11 REORGANIZATION EXPENSES
In connection with our bankruptcy proceedings that concluded in 2006, we
recorded Chapter 11 reorganization expenses of $2 million in the third quarter
of 2006 and $10 million for the first nine months of 2006.
INTEREST EXPENSE
Interest expense of $22 million for the third quarter of 2007 included a charge
of $4 million pretax ($3 million after-tax) to write off deferred financing fees
due to the repayment of our bank term loan. Interest expense of $85 million for
the first nine months of 2007 included charges totaling $14 million pretax ($9
million after-tax) to write off deferred financing fees primarily due to the
first quarter repayment of our tax bridge loan and the third quarter repayment
of the bank term loan.
Interest expense of $16 million for the third quarter of 2006 included charges
for post-petition interest and fees totaling $8 million pretax ($5 million
after-tax) related to pre-petition obligations. Interest expense of $539 million
for the first nine months of 2006 included charges for post-petition interest
and fees totaling $528 million pretax ($326 million after-tax) related to
pre-petition obligations.
INCOME TAXES
Income tax expense was $3 million for the third quarter of 2007 compared with
$107 million for the third quarter of 2006. The effective tax rate was 27.8% for
the third quarter of 2007 compared with 40.9% for last year's third quarter. The
difference in the third quarter effective tax rates is primarily attributable to
a larger portion of our consolidated operating earnings arising in lower taxed
non-U.S. jurisdictions and lower state income tax expense in 2007, offset in
part by a $6.7 million unfavorable tax adjustment described below.
Income tax expense was $41 million for first nine months of 2007 compared with
$130 million for the corresponding 2006 period. The effective tax rates were
28.2% for the first nine months of 2007 and 40.7% for the first nine months of
2006. The difference in the nine months effective tax rates is primarily
attributable to a larger portion of our consolidated operating earnings arising
in lower taxed non-U.S. jurisdictions and lower state income tax expense in
2007, the favorable effects of state tax law changes enacted in the first nine
months of 2007 and a tax expense of $4 million related to post-petition interest
on pre-petition tax obligations that was recorded in the first quarter of 2006.
In addition, a $6.6 million favorable tax adjustment was recorded in the first
quarter of 2007 and a $6.7 million unfavorable tax adjustment was recorded in
the third quarter of 2007 resulting from corrections to deferred tax balances
from prior years.
-28-
NET EARNINGS
2007: Net earnings for the third quarter of 2007 were $7 million, or $0.07 per
diluted share. Net earnings for the first nine months of 2007 were $104 million,
or $1.07 per diluted share.
Net earnings and earnings per share for the 2007 periods include charges for the
restructuring program described above. These charges, on an after-tax basis,
were $2 million, or $0.02 per diluted share, for the third quarter of 2007 and
$11 million, or $0.11 per diluted share, for the first nine months of 2007.
Net earnings and earnings per share for the 2007 periods also include charges
for the write-off of deferred financing fees described above. These charges, on
an after-tax basis, were $3 million, or $0.03 per diluted share, for the third
quarter of 2007 and $9 million, or $0.09 per diluted share, for the first nine
months of 2007.
In addition, a $6.7 million, or $0.07 per diluted share, unfavorable tax
adjustment was recorded in the third quarter of 2007. In the first quarter of
2007, we recorded a $6.6 million, or $0.07 per diluted share, favorable tax
adjustment. These adjustments resulted from corrections of the deferred tax
balances from prior years.
2006: For the third quarter of 2006, net earnings were $153 million, or $1.71
per diluted share. For the first nine months of 2006, net earnings totaled $188
million, or $3.03 per diluted share.
Net earnings and earnings per share for the 2006 periods include the charges for
post-petition interest and fees related to pre-petition obligations described
above. These charges, on an after-tax basis, 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 also include the
reversals of a reserve for asbestos-related claims described above. The
after-tax income from the reversals amounted to $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.
-29-
CORE BUSINESS RESULTS OF OPERATIONS
Three Months Nine Months
(millions) ended September 30, ended September 30,
---------- ------------------- -------------------
2007 2006 2007 2006
-------- -------- ------- ---------
NET SALES:
NORTH AMERICAN GYPSUM:
United States Gypsum Company $ 592 $ 801 $1,908 $2,513
CGC Inc. (gypsum) 79 85 235 262
USG Mexico, S.A. de C.V. 52 47 142 130
Other subsidiaries* 22 25 61 70
Eliminations (47) (49) (137) (158)
------ ------ ------ ------
Total $ 698 $ 909 $2,209 $2,817
------ ------ ------ ------
BUILDING PRODUCTS DISTRIBUTION:
L&W Supply Corporation 614 642 1,772 1,926
------ ------ ------ ------
WORLDWIDE CEILINGS:
USG Interiors, Inc. 136 124 396 388
USG International 66 64 206 177
CGC Inc. (ceilings) 15 14 45 44
Eliminations (10) (11) (33) (33)
------ ------ ------ ------
Total $ 207 $ 191 $ 614 $ 576
------ ------ ------ ------
Eliminations (184) (264) (593) (803)
------ ------ ------ ------
Total USG Corporation $1,335 $1,478 $4,002 $4,516
====== ====== ====== ======
OPERATING PROFIT**:
NORTH AMERICAN GYPSUM:
United States Gypsum Company $ (14) $ 192 $ 97 $ 623
CGC Inc. (gypsum) -- 13 7 39
USG Mexico, S.A. de C.V. 7 8 20 23
Other subsidiaries* 5 6 9 12
------ ------ ------ ------
Total $ (2) $ 219 $ 133 $ 697
------ ------ ------ ------
BUILDING PRODUCTS DISTRIBUTION:
L&W Supply Corporation 22 53 93 164
------ ------ ------ ------
WORLDWIDE CEILINGS:
USG Interiors, Inc. 17 11 37 42
USG International 4 5 10 13
CGC Inc. (ceilings) 2 2 7 9
------ ------ ------ ------
Total $ 23 $ 18 $ 54 $ 64
------ ------ ------ ------
Corporate (18) (29) (79) (81)
Eliminations -- (1) 7 (2)
Chapter 11 reorganization expenses -- (2) -- (10)
------ ------ ------ ------
Total USG Corporation $ 25 $ 258 $ 208 $ 832
====== ====== ====== ======
* Includes Gypsum Transportation Limited, a shipping company in Bermuda, and
USG Canadian Mining Ltd., a mining operation in Nova Scotia.
** Operating profit for the 2007 periods includes provisions for restructuring
of $3 million pretax for the third quarter and $17.5 million pretax for the
first nine months. On an operating segment basis, $14 million of the
nine-months charge relates to North American Gypsum, $1.5 million relates
Worldwide Ceilings and $1 million relates to each of Building Products
Distribution and Corporate.
Operating profit for the 2006 periods for North American Gypsum includes
reversals of an asbestos claims reserve. These reversals amounted to $17
million for the third quarter and $44 million for the first nine months of
2006.
-30-
NORTH AMERICAN GYPSUM
Net sales of $698 million in the third quarter of 2007 were down 23% from the
third quarter of 2006, while an operating loss of $2 million compared with
operating profit of $219 million for the prior-year period. For the first nine
months of 2007, net sales of $2.209 billion were down 22% and operating profit
of $133 million dropped 81% compared with the first nine months of 2006.
Operating profit in 2007 for North American Gypsum included restructuring
charges of $2 million for the third quarter and $14 million for the first nine
months. Operating profit in 2006 was favorably affected by reversals of a
reserve for asbestos-related claims. These reversals amounted to $17 million for
the third quarter and $44 million for the first nine months of 2006.
United States Gypsum Company: Third quarter 2007 net sales for U.S. Gypsum
decreased $209 million, or 26%, compared with the third quarter of 2006. An
operating loss of $14 million was recorded in the third quarter of 2007 compared
with operating profit of $192 in the third quarter of 2006. The decline in
operating results largely reflected lower shipments, lower average realized
selling prices and higher manufacturing costs for SHEETROCK(R) brand gypsum
wallboard. U.S. Gypsum's operating loss for the third quarter of 2007 included a
restructuring charge of $1 million related to our salaried workforce reduction
program. Operating profit for the third quarter of 2006 was favorably affected
by the $17 million reversal of a reserve for asbestos-related claims.
Shipments of SHEETROCK(R) brand gypsum wallboard totaled 2.35 billion square
feet during the third quarter of 2007, down 10% from 2.60 billion square feet in
the third quarter of 2006. U.S. Gypsum's wallboard plants operated at
approximately 80% of capacity in the third quarter of 2007 compared with 90% of
capacity in the third quarter of 2006. Industry shipments of gypsum wallboard in
the United States were down approximately 11% from the third quarter of 2006.
The decrease in demand caused U.S. Gypsum's nationwide average realized selling
price for SHEETROCK(R) brand gypsum wallboard to fall to $122.68 per thousand
square feet for the third quarter of 2007, a 35% drop compared to the all-time
record average price of $188.37 attained in the third quarter of 2006 and a 14%
decrease from the average price of $141.97 for the second quarter of 2007.
Gypsum wallboard prices trended downward during the third quarter of 2007, but
at a slower rate compared to earlier in the year. Prices have continued to trend
downward since quarter-end and remain under pressure.
During the third quarter of 2007, manufacturing costs for SHEETROCK(R) brand
gypsum wallboard were adversely affected by higher prices for energy, wastepaper
and other raw materials. Gypsum wallboard unit costs were up 6% in the third
quarter of 2007 compared with last year's third quarter.
Third quarter 2007 sales and profit for DUROCK(R) brand cement board and
FIBEROCK(R) brand gypsum fiber panels improved versus last year's third quarter
due to higher selling prices and lower costs. Pricing also improved for
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SHEETROCK(R) brand joint treatment products, but this improvement was offset by
higher manufacturing costs and lower shipments for those products.
During the third quarter of 2007, U.S. Gypsum successfully opened two new
manufacturing facilities on the East coast. A new, low-cost wallboard facility
in Norfolk, Virginia replaced a high-cost 50-year-old line at the same location.
The company also opened a new joint treatment facility in Baltimore, Maryland
during the quarter. These facilities are expected to improve customer service in
the Mid-Atlantic region and reduce costs.
CGC Inc.: Third quarter 2007 net sales for the gypsum business of Canada-based
CGC Inc. fell $6 million, or 7%, compared to the third quarter of 2006.
Operating profit was break-even for the third quarter of 2007 compared with $13
million for last year's third quarter. The decline in net sales was largely
attributable to lower selling prices for SHEETROCK(R) brand gypsum wallboard and
lower wallboard shipments, particularly to the United States. Operating profit
also was adversely affected by higher gypsum wallboard manufacturing costs,
especially higher paper and other raw material costs. Operating profit for the
third quarter of 2007 also included a restructuring charge of $1 million related
to our salaried workforce reduction program.
USG Mexico, S.A. de C.V.: Net sales in the third quarter of 2007 for our
Mexico-based subsidiary were up $5 million, or 11%, compared with the third
quarter of 2006 largely due to increased sales of complementary products such as
construction plasters and DUROCK(R) brand cement board. However, operating
profit was down $1 million from the comparable 2006 period largely due to higher
energy and raw materials costs. A new gypsum wallboard manufacturing facility in
Tecoman, Colima, Mexico began operations in the third quarter of 2007 and is
serving Western Mexico and Latin America.
BUILDING PRODUCTS DISTRIBUTION
L&W Supply Corporation's net sales in the third quarter of 2007 were $614
million, down $28 million, or 4%, compared with the third quarter of 2006. This
decline was primarily attributable to lower product volumes and gypsum wallboard
selling prices resulting from the weak residential construction market. The
impact of recent acquisitions and increased sales related to non-residential
construction activity partially offset these results.
Overall, gypsum wallboard shipments declined 5%, while sales of other products
increased 22% compared with last year's third quarter. The modest decline in
wallboard shipments and the increase in sales of non-wallboard products reflects
the positive impact of recently acquired businesses. L&W Supply's sales of
ceilings products were up 53% compared to the third quarter of 2006, also
largely due to recent acquisitions. Acquisitions completed in the past year,
including California Wholesale Material Supply, Inc., which was acquired in late
March, and All Interiors Supply, which was acquired in the fourth quarter of
2006, contributed $154 million to third quarter 2007 net sales. Driven by lower
product volumes and gypsum wallboard prices, same-location net sales for the
third quarter of 2007 decreased 28% compared with the third quarter of 2006.
-32-
Operating profit in the third quarter of 2007 was $22 million, down $31 million,
or 58%, compared with $53 million for the third quarter of 2006. The declines in
gypsum wallboard shipments and profit margins that resulted from the weak
residential construction market were the primary reasons for the lower level of
operating profit. Profit margins for most other product lines experienced only
modest declines. Amortization expense related to intangible assets associated
with recent acquisitions was $4 million in the third quarter of 2007 and further
reduced operating profit. There was no comparable charge in the third quarter of
2006.
For the first nine months of 2007, net sales of $1.772 billion were down 8% and
operating profit of $93 million was down 43% compared with the first nine months
of 2006. On a same-location basis, net sales in the first nine months of 2007
declined 25% versus the first nine months of 2006. During the first nine months
of 2007, L&W Supply closed four locations in response to weak market conditions,
but it continues to serve their customers in these markets from other locations.
L&W Supply operated 248 locations in the United States and Mexico as of
September 30, 2007 compared with 212 locations in the United States only as of
September 30, 2006.
WORLDWIDE CEILINGS
Net sales of $207 million in the third quarter of 2007 were up 8% from the third
quarter of 2006, while operating profit increased 28% to $23 million. For the
first nine months of 2007, net sales of $614 million increased 7%, while
operating profit of $54 million fell 16% compared with the first nine months of
2006. Worldwide Ceilings operating profit for the first nine months of 2007
included a restructuring charge of $1.5 million related to our salaried
workforce reduction program.
USG Interiors, Inc.: USG Interiors reported third quarter 2007 net sales of $136
million and operating profit of $17 million. These results compared favorably
with net sales of $124 million and operating profit of $11 million in the third
quarter of 2006. The improved results for the 2007 period primarily reflect
higher average realized selling prices for ceiling tile and increased shipments
of ceiling grid, partially offset by higher ceiling tile and grid manufacturing
costs.
USG International: USG International reported net sales of $66 million and
operating profit of $4 million in the third quarter of 2007. This compared with
net sales of $64 million and operating profit of $5 million for the same period
a year ago. The improvement in net sales primarily reflected increased demand
for ceiling grid and joint treatment in Europe and the favorable effects of
currency translation. Operating profit fell largely due to lower volume and
selling prices in Latin America and higher selling and administrative expenses.
CGC Inc.: The ceilings division of CGC Inc. reported net sales of $15 million
and operating profit of $2 million in the third quarter of 2007. Net sales and
-33-
operating profit for the same period a year ago were $14 million and $2 million,
respectively. Improved pricing for ceiling grid was partially offset by lower
selling prices for ceiling tile and higher grid manufacturing costs.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
As of September 30, 2007, we had cash and cash equivalents of $353 million
compared with $380 million as of June 30, 2007 and $565 million of as of
December 31, 2006. We believe that cash on hand, cash available from future
operations and the other sources of liquidity described below will provide
sufficient liquidity to allow our businesses to carry on normal operations.
Normal-course cash requirements include, among other things, capital
expenditures, working capital needs and contractual obligations. Additionally,
from time to time we consider selective strategic transactions that we believe
will create value and improve performance, including acquisitions, joint
ventures, partnerships, restructurings and dispositions. Transactions of these
types may result in material cash expenditures or proceeds.
We have a credit agreement, which was amended and restated in the third quarter
of 2007, with a syndicate of banks that includes a $650 million revolving credit
facility with a $250 million sublimit for letters of credit. As of September 30,
2007, we had not drawn upon the revolving credit facility except for
approximately $78 million of outstanding letters of credit. See Note 7 to the
Condensed Consolidated Financial Statements for information regarding the credit
agreement as amended and restated.
We plan to fund future growth projects from cash on hand, future cash available
from operations and, if determined to be appropriate and they are available,
borrowings under our revolving credit facility. Also to fund future growth
projects, we may from time to time consider other debt or equity financing
alternatives to supplement, or as an alternative to, financing under the
revolving credit facility.
CASH FLOWS
The following table presents a summary of our cash flows:
Nine Months ended September 30
------------------------------
(millions) 2007 2006
---------- ------ -----
Net cash provided by (used for):
Operating activities $1,248 $(765)
Investing activities (614) 328
Financing activities (853) 951
Effect of exchange rate changes on cash 7 3
------ -----
Net (decrease) increase in cash and cash equivalents $ (212) $ 517
====== =====
-34-
Operating Activities: The variation between the 2007 and 2006 periods primarily
reflects our first quarter 2007 receipt of the federal tax refund of $1.057
billion and our second quarter 2006 payment of $890 million to the asbestos
trust.
Investing Activities: The variation between the 2007 and 2006 periods primarily
reflects increased spending in 2007 for acquisitions (up $206 million) and
capital projects (up $104 million) and a cash inflow of $565 million in the
first nine months of 2006 from the net sales of marketable securities.
Financing Activities: The variation between the 2007 and 2006 periods primarily
reflects 2007 repayments of a $1.065 billion borrowing under our tax bridge
facility and $700 million of borrowings under our term loan facility. These
repayments were partially offset by the issuance of $499 million of 7.75% senior
notes, net of discount, in the third quarter of 2007 and the net proceeds of
$422 million from a public equity offering that we completed in the first
quarter of 2007.
CAPITAL EXPENDITURES
Capital spending amounted to $341 million in the first nine months of 2007
compared with $237 million in the corresponding 2006 period. As of September 30,
2007, capital expenditure commitments for the replacement, modernization and
expansion of operations amounted to $443 million compared with $494 million as
of December 31, 2006. We expect to fund our capital expenditures program with
cash from operations and, if determined to be appropriate and they are
available, borrowings under our revolving credit facility or other alternative
financings. Capital projects commenced as of September 30, 2007 include the
following projects with the total estimated costs indicated:
- approximately $210 million for a new low-cost gypsum wallboard plant in
Washingtonville, Pennsylvania that will serve the Northeastern United
States region. Construction of this plant began in late 2006 and is
expected to be completed in 2008;
- approximately $110 million for the acquisition of a paper mill in Otsego,
Michigan in 2006 and to subsequently 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 expected
to lower the delivered cost of gypsum rock to East Coast wallboard plants.
The new ship is expected to become operational in 2008; and
- approximately $220 million for a new, low-cost gypsum wallboard plant in
Stockton, California that will serve Northern California. Construction of
this plant is scheduled to begin in 2008 and is scheduled to be completed
in 2010.
-35-
WORKING CAPITAL
As of September 30, 2007, working capital (current assets less current
liabilities) amounted to $825 million, and the ratio of current assets to
current liabilities was 2.35-to-1. As of December 31, 2006, working capital
amounted to $943 million, and the ratio of current assets to current liabilities
was 1.53-to-1.
Receivables increased to $546 million as of September 30, 2007 from $448 million
as of December 31, 2006. During the same period, inventories increased to $379
million from $348 million, and accounts payable increased to $348 million from
$303 million. These increases were attributable in part to additional
receivables, inventories and payables from businesses acquired in 2007. The
higher level of receivables also reflected a 7% increase in net sales for the
month of September 2007 compared with December 2006. Accrued expenses decreased
to $258 million as of September 30, 2007 from $358 million as of December 31,
2006 largely due to payments made in 2007 for asbestos property damage
settlements and employee incentive compensation.
DEBT
Total debt amounted to $1.238 billion as of September 30, 2007 compared with
$2.504 billion as of December 31, 2006. In the third quarter of 2007, we sold
$500 million of 7.75% senior unsecured notes due January 2018 in an underwritten
public offering. We used the net proceeds from the sale of the notes, together
with cash on hand, to repay the $500 million balance outstanding under our term
loan facility. See Note 7 to the Condensed Consolidated Financial Statements for
additional information on our debt.
REALIZATION OF DEFERRED TAX ASSET
Our condensed consolidated balance sheet as of September 30, 2007 includes a
gross deferred tax asset of $425 million relating to the U.S. federal, state and
foreign income tax benefits expected to be realized in future periods with
respect to various net operating loss and tax credit carryforwards arising in
2006 and prior years primarily as a result of the amounts paid to the asbestos
trust in 2006. We have concluded, based on the weight of available evidence,
that all but $78 million of these tax benefits are more likely than not to be
realized in the future.
In arriving at this conclusion, we considered both future reversals of existing
taxable temporary differences and, where appropriate, projections of future
taxable income. As a result of U.S. federal taxable income projected to be
realized in future years, we expect to utilize all but $1 million of the $193
million of federal income tax benefits relating to our federal net operating
loss and tax credit carryforwards.
In contrast to the results under the federal 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 resulting from the amounts
paid to the asbestos trust in 2006 will be realized through a reduction of
future state income tax liabilities by offsetting the net operating losses
resulting from our payments to the asbestos trust against future state taxable
-36-
income. Based on projections of future taxable income (consistent with
historical results and anticipated future trends) in the U.S. states in which we
conduct business operations and the loss carryforward periods allowed by current
state laws (generally five to 20 years), we have concluded that all but $66
million of the $220 million of state income tax benefits relating to our state
net operating loss and tax credit carryforwards is more likely than not to be
realized.
We also have net operating loss and tax credit carryforwards in various foreign
jurisdictions that, as a result of significant losses and limited tax
liabilities in recent years in those jurisdictions, are doubtful of being
utilized. As a result, we have concluded that $1 million of the $12 million of
income tax benefits relating to our foreign net operating loss and tax credit
carryforwards is more likely than not to be realized.
During the third quarter of 2007, we decreased our valuation allowance for
deferred tax assets by a total of $2 million due to a change in our judgment
about the realizability of the deferred tax assets relating to certain foreign
and U.S. state net operating loss and tax credit carryforwards in future years.
LEGAL CONTINGENCIES
USG 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. See Note 17 to the Condensed Consolidated Financial
Statements for additional information on environmental litigation and for
information concerning asbestos and related bankruptcy litigation. We believe
that neither the environmental, asbestos-related matters nor any other
litigation involving USG will have a material adverse effect upon our results of
operations, financial position or cash flows.
CRITICAL ACCOUNTING POLICIES
The preparation of our financial statements requires us to make estimates,
judgments and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses during the periods presented. USG's Annual
Report on Form 10-K for the fiscal year ended December 31, 2006, which we filed
on February 16, 2007, includes a summary of the critical accounting policies we
believe are the most important to aid in understanding our financial results.
There have been no material changes to these critical accounting policies that
impacted our reported amounts of assets, liabilities, revenues or expenses
during the first nine months of 2007.
-37-
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2006, the Financial Accounting Standards Board, or FASB, issued
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an
Interpretation of Financial Accounting Standards Board Statement No. 109." This
interpretation clarifies the accounting and disclosures relating to the
uncertainty about whether a tax return position will ultimately be sustained by
the respective tax authorities. We adopted this interpretation on January 1,
2007. As part of the adoption, we recorded an increase in our liability for
unrecognized tax benefits of $19 million, $18 million of which was accounted for
as an increase in long-term deferred taxes and $1 million of which reduced our
January 1, 2007 balance of retained earnings. As of the date of adoption, the
total amount of our unrecognized tax benefits was $55 million and the total
amount of interest and penalties recognized on our condensed consolidated
balance sheet was $7 million. We classify interest expense and penalties related
to unrecognized tax benefits and interest income on tax overpayments as
components of income tax expense. The total amount of unrecognized tax benefits
that, if recognized, would affect our effective tax rate is $36 million. It is
reasonably possible that the amount of our unrecognized tax benefits will change
in the next 12 months as a result of the expected completion of the IRS's audit
of our 2005 and 2006 federal income tax returns. At this time, an estimate of a
change, if any, to the amount of unrecognized tax benefits cannot be made.
However, based on the information available at this time, we do not expect any
change to have a significant impact on our results of operations, financial
position or cash flows.
In September 2006, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards, or SFAS, No. 157, "Fair Value
Measurements." This statement 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. We are
currently reviewing this pronouncement to determine the impact that it may have
on our financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities - Including an Amendment of FASB
Statement No. 115." This statement permits entities to choose to measure many
financial instruments and certain other items at fair value. This statement is
effective as of the beginning of the first fiscal year beginning after November
15, 2007. We are currently reviewing this pronouncement to determine the impact
that it may have on our financial statements.
-38-
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
our 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, the availability of mortgage financing,
mortgage and other interest rates, housing affordability and supply,
currency exchange rates and consumer confidence;
- competitive conditions, such as price, service and product competition;
- shortages in raw materials;
- increases in raw material, energy, transportation and employee benefit
costs;
- the timing of commencement of operation of new and upgraded manufacturing
facilities;
- the loss of one or more major customers;
- capacity utilization rates;
- capital markets conditions and the availability of borrowings under our
credit agreement;
- the results of a review by the Congressional Joint Committee on Taxation
relating to the tax refund we received related to the payments we made to
the asbestos trust;
- our success in integrating acquired businesses;
- changes in laws or regulations, including environmental and safety
regulations;
- the effects of acts of terrorism or war upon domestic and international
economies and financial markets; and
- acts of God.
We assume no obligation to update any forward-looking information contained in
this report.
-39-
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
Our Chief Executive Officer and Chief Financial Officer, after evaluating the
effectiveness of our "disclosure controls and procedures" (as defined in Rule
13a-15(e) promulgated under the Securities Exchange Act of 1934, or the Act),
have concluded that, as of the end of the quarter covered by this report, our
disclosure controls and procedures were effective to provide reasonable
assurance that information required to be disclosed by us in the reports that we
file or submit under the Act is recorded, processed, summarized and reported
within the time periods specified in the Securities and Exchange 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.
During the third quarter of 2007, we completed the roll out of a new supply
chain management system in the United States and Canada. On July 1, 2007, we
began to roll out a new human resource and payroll system in the United States
and Canada. The human resource and payroll system roll out is expected to
continue into the first quarter of 2008.
Changes related to the new systems represented the only changes in our "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 fiscal quarter
ended September 30, 2007 that has materially affected, or is reasonably likely
to materially affect, our internal control over financial reporting.
We anticipate that we will continue to have future investments in many of our
technology systems and will continue to review the impact of any future changes
to our internal controls over financial reporting as the new systems are
implemented.
California Wholesale Material Supply, Inc., or CALPLY, has accounting processes
and internal controls different from those at USG. We do not consider the
acquisition of CALPLY to materially affect our internal control over financial
reporting and we do not expect to extend our Sarbanes-Oxley Section 404
attestation to include CALPLY until 2008.
-40-
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of USG Corporation:
We have reviewed the accompanying condensed consolidated balance sheet of USG
Corporation and subsidiaries (the "Corporation") as of September 30, 2007, and
the related condensed consolidated statements of earnings for the three-month
and nine-month periods ended September 30, 2007 and 2006 and of cash flows for
the nine-month periods ended September 30, 2007 and 2006. These interim
financial statements are the responsibility of the Corporation's management.
We conducted our review 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 review, we are not aware of any material modifications that should
be made to such consolidated interim financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
As discussed in Note 15, the Corporation adopted Financial Accounting Standards
Board Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an
Interpretation of Financial Accounting Standards Board Statement No. 109"
effective January 1, 2007.
We have previously audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheet of USG Corporation and subsidiaries as of December 31, 2006, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for the year then ended (not presented herein); and in our report dated
February 13, 2007, we expressed an unqualified opinion (which included an
explanatory paragraph concerning a change in the method of accounting due to the
Corporation's adoption of Financial Accounting Standards Board Interpretation
No. 47, "Accounting for Conditional Asset Retirements" in 2005, Statement of
Financial Accounting Standards No. 123(R), "Share-Based Payment", and Statement
of Financial Accounting Standards No. 158, "Employers' Accounting for Defined
Benefit Pension and Other Postretirement Plans" in 2006) on those consolidated
financial statements. In our opinion, the information set forth in the
accompanying condensed consolidated balance sheet as of December 31, 2006 is
fairly stated, in all material respects, in relation to the consolidated balance
sheet from which it has been derived.
/s/ DELOITTE & TOUCHE LLP
Chicago, Illinois
October 26, 2007
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Part I, Item 1, Note 17, Litigation, for information concerning asbestos and
related bankruptcy litigation and environmental litigation.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) Pursuant to the Corporation's Stock Compensation Program for Non-Employee
Directors, on July 1, 2007, the Corporation's non-employee directors were
entitled to receive an $80,000 annual grant, payable at their election in
cash or common stock with an equivalent value. Pursuant to this provision,
effective July 1, 2007, a total of 9,752 shares of common stock were issued
to eight non-employee directors based on the fair market value of a share
of common stock on June 29, 2007. 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.
ITEM 6. EXHIBITS
4. Form of 7.75% Senior Note due 2018 (incorporated by reference to Exhibit
4.1 to USG Corporation's Current Report on Form 8-K filed September 26,
2007)
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,
Senior Vice President and Controller
October 26, 2007
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