UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 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 June 30,
2007 was 98,942,347.
TABLE OF CONTENTS
Page
----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Statements of Earnings:
Three Months and Six Months Ended June 30, 2007 and 2006 3
Condensed Consolidated Balance Sheets:
As of June 30, 2007 and December 31, 2006 4
Condensed Consolidated Statements of Cash Flows:
Six Months Ended June 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 41
Report of Independent Registered Public Accounting Firm 42
PART II OTHER INFORMATION
Item 1. Legal Proceedings 43
Item 4. Submission of Matters to a Vote of Security Holders 43
Item 5. Other Information 43
Item 6. Exhibits 44
Signatures 45
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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 SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------- -------------------------
2007 2006 2007 2006
----------- ----------- ----------- -----------
Net sales $ 1,408 $ 1,573 $ 2,667 $ 3,038
Cost of products sold 1,206 1,173 2,253 2,281
----------- ----------- ----------- -----------
Gross profit 202 400 414 757
Selling and administrative expenses 99 103 216 202
Provision for restructuring 15 -- 15 --
Reversal of asbestos claims reserve -- (27) -- (27)
Chapter 11 reorganization expenses -- 6 -- 8
----------- ----------- ----------- -----------
Operating profit 88 318 183 574
Interest expense 19 37 63 523
Interest income (5) (4) (13) (7)
Other (income) expense, net (2) -- (2) --
----------- ----------- ----------- -----------
Earnings before income taxes 76 285 135 58
Income taxes 20 109 38 23
----------- ----------- ----------- -----------
Net earnings 56 176 97 35
=========== =========== =========== ===========
Earnings per Common Share:
Basic 0.56 3.03 1.01 0.60
Diluted 0.56 3.03 1.01 0.60
Average common shares 98,933,442 57,940,444 95,154,810 57,830,385
Average diluted common shares 99,285,127 58,036,034 95,475,012 57,933,191
See accompanying Notes to Condensed Consolidated Financial Statements.
-3-
USG CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS)
(UNAUDITED)
AS OF AS OF
JUNE 30, DECEMBER 31,
2007 2006
-------- ------------
ASSETS
Current Assets:
Cash and cash equivalents $ 380 $ 565
Restricted cash -- 6
Receivables (net of reserves - $19 and $16) 611 448
Inventories 369 348
Income taxes receivable 34 1,102
Deferred income taxes 74 169
Other current assets 98 69
------- -------
Total current assets 1,566 2,707
Property, plant and equipment (net of accumulated
depreciation and depletion - $1,188 and $1,108) 2,386 2,210
Deferred income taxes 253 187
Goodwill 358 154
Other assets 103 107
------- -------
Total Assets 4,666 5,365
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable 364 303
Accrued expenses 255 358
Short-term debt -- 1,065
Income taxes payable 5 38
------- -------
Total current liabilities 624 1,764
Long-term debt 1,239 1,439
Deferred income taxes 12 11
Other liabilities 687 617
Commitments and contingencies
Stockholders' Equity:
Preferred stock -- --
Common stock 10 9
Treasury stock (207) (208)
Capital received in excess of par value 2,611 2,176
Accumulated other comprehensive (loss) (98) (136)
Retained earnings (deficit) (212) (307)
------- -------
Total stockholders' equity 2,104 1,534
------- -------
Total Liabilities and Stockholders' Equity 4,666 5,365
======= =======
See accompanying Notes to Condensed Consolidated Financial Statements.
-4-
USG CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN MILLIONS)
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
----------------
2007 2006
------- ------
OPERATING ACTIVITIES:
Net earnings $ 97 $ 35
Adjustments to reconcile net earnings to net cash:
Reversal of asbestos claims reserve -- (27)
Depreciation, depletion and amortization 87 66
Share-based compensation expense 15 1
Deferred income taxes 18 326
(Increase) decrease in working capital (net of acquisitions):
Receivables (88) (149)
Income taxes receivable 1,068 (324)
Inventories 15 (36)
Payables 15 52
Accrued expenses (43) (35)
Increase in other assets (35) (11)
Increase in other liabilities 30 17
Payment to Section 524(g) asbestos trust -- (890)
Reorganization distribution - other (40) (177)
Liabilities subject to compromise -- 521
Other, net 12 --
------- ------
Net cash provided by (used for) operating activities 1,151 (631)
------- ------
INVESTING ACTIVITIES:
Capital expenditures (224) (150)
Acquisitions of businesses, net of cash acquired (279) (74)
Return of restricted cash 6 71
Net proceeds from asset dispositions 1 1
Purchases of marketable securities -- (112)
Sales or maturities of marketable securities -- 608
------- ------
Net cash (used for) provided by investing activities (496) 344
------- ------
FINANCING ACTIVITIES:
Repayment of debt (1,265) --
Proceeds from equity offering, net of fees 422 --
Reorganization distribution - debt principal -- (16)
Payment of rights offering fees -- (68)
Issuances of common stock upon exercise of stock options -- 13
Tax benefit of share-based payments -- 6
------- ------
Net cash used for financing activities (843) (65)
------- ------
Effect of exchange rate changes on cash 3 3
Net decrease in cash and cash equivalents (185) (349)
Cash and cash equivalents at beginning of period 565 936
------- ------
Cash and cash equivalents at end of period 380 587
======= ======
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Interest paid 55 109
Income taxes (refunded) paid, net (1,046) 28
See accompanying Notes to Condensed Consolidated Financial Statements.
-5-
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.
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.
-6-
CALPLY sells building products and 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. The following table presents
the preliminary allocation of the purchase price for CALPLY as of the date
of acquisition.
(millions)
Cash $ 4
Accounts receivable 74
Inventories 37
Property, plant and equipment 6
Goodwill 197
Other assets acquired 4
----
Total assets acquired 322
----
Total liabilities assumed 51
----
Total net assets acquired 271
----
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.
The allocation of the purchase prices for these acquisitions is preliminary
because they are subject to (i) the valuation of tangible and intangible
assets for both CALPLY and Grupo Supremo, (ii) a working capital settlement
related to the Grupo Supremo acquisition and (iii) tax-related and other
liability adjustments. As a result, the purchase prices have been allocated
to the assets acquired and liabilities assumed based on the historical book
values of the acquired companies. Any excess of the purchase prices over
the book value of assets acquired and liabilities assumed has been recorded
as goodwill in the accompanying condensed consolidated statement of
financial position. No allocations have been made at this time to
identifiable intangible assets and no adjustments have been made to
historical book values of tangible assets acquired. Accordingly, the
purchase price allocations are subject to change based on a final
determination of the fair values of assets acquired and liabilities
assumed.
(3) 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
-7-
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.
(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 announced on May 21, 2007 and the
shutdown of a framing products manufacturing plant. We implemented these
actions in response to current market conditions.
Under the salaried workforce reduction program, approximately 200 employees
were terminated and approximately 240 open positions were eliminated as of
June 30, 2007. Included in the provision for restructuring is a charge of
$11 million pretax ($7 million after-tax) for severance and related costs
for the employees terminated as of June 30, 2007. We expect to record
approximately $3 million of additional charges during the second half of
2007 for severance and related costs for approximately 40 more employees
whose employment will be terminated as part of the program, but who are
continuing to provide services after June 30. Most of the payments
associated with this program are expected to be made during the second half
of 2007.
In June 2007, we shut down our plant in Tuscaloosa, Alabama that
manufactured framing products. Included in the provision for restructuring
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 $12 million is included in accrued expenses on
the condensed consolidated balance sheet as of June 30, 2007. This reserve
is summarized as follows:
Writedown of
Assets to Net Cash
(millions) Provisions Realizable Value Payments Total
---------- ---------------- -------- -----
Salaried workforce reduction $11 $-- $-- $11
Shutdown of Tuscaloosa plant 4 (3) -- 1
--- --- --- ---
Balance as of June 30 15 (3) -- 12
=== === === ===
Including the approximately $3 million of additional charges related to the
salaried workforce reduction program that we expect to record during the
second half of 2007, our estimate of total restructuring expenses for 2007
is approximately $18 million. On an operating segment basis, $14 million of
this amount relates to North American Gypsum, $2 million relates to
Worldwide Ceilings and $1 million relates to each of Building Products
Distribution and Corporate.
-8-
(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 Six Months
ended June 30, ended June 30,
--------------- ---------------
(millions) 2007 2006 2007 2006
------ ------ ------ ------
NET SALES:
North American Gypsum $ 754 $ 977 $1,511 $1,908
Building Products Distribution 654 680 1,158 1,284
Worldwide Ceilings 210 199 407 385
Eliminations (210) (283) (409) (539)
------ ------ ------ ------
Total USG Corporation 1,408 1,573 2,667 3,038
====== ====== ====== ======
OPERATING PROFIT:
North American Gypsum 42 267 135 478
Building Products Distribution 45 58 71 111
Worldwide Ceilings 17 26 31 46
Corporate (22) (24) (61) (52)
Eliminations 6 (3) 7 (1)
Chapter 11 reorganization expenses -- (6) -- (8)
------ ------ ------ ------
Total USG Corporation 88 318 183 574
====== ====== ====== ======
Total operating profit for the second quarter and first six months of 2007
includes provisions totaling $15 million pretax for restructuring
activities that included our salaried workforce reduction program and the
shutdown of our Tuscaloosa, Alabama framing products manufacturing plant.
On an operating segment basis, $12 million of the charge relates to North
American Gypsum and $1 million relates to each of Building Products
Distribution, Worldwide Ceilings and Corporate. See Note 4 above for
additional information related to the restructuring program and the
estimated full-year provision by operating segment.
Second quarter and first six months 2006 operating profit for North
American Gypsum includes a $27 million reversal of an asbestos claims
reserve.
-9-
(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 second quarter and first six 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
THREE MONTHS ENDED JUNE 30, Earnings (000) Amount
--------------------------- -------- ------ ---------
2007:
Basic earnings $ 56 98,933 $0.56
Dilutive effect of stock options 352
---- ------ -----
Diluted earnings 56 99,285 0.56
==== ====== =====
2006:
Basic earnings $176 57,940 $3.03
Dilutive effect of stock options 96
---- ------ -----
Diluted earnings 176 58,036 3.03
==== ====== =====
SIX MONTHS ENDED JUNE 30,
2007:
Basic earnings $ 97 95,155 $1.01
Dilutive effect of stock options 320
---- ------ -----
Diluted earnings 97 95,475 1.01
==== ====== =====
2006:
Basic earnings $ 35 57,830 $0.60
Dilutive effect of stock options 103
---- ------ -----
Diluted earnings 35 57,933 0.60
==== ====== =====
Options, RSUs and performance shares with respect to 1.6 million common
shares for the second quarter of 2007 and 1.7 million common shares for the
first six months of 2007 were not included in the computation of diluted
earnings per share for those periods because they were anti-dilutive, the
exercise price of the options was greater than the average market price of
our stock or, performance requirements for their issuance were not met.
There were no options excluded in the computation of diluted earnings per
share for the second quarter or first six months of 2006.
-10-
(7) INVENTORIES
Total inventories consisted of the following:
As of As of
June 30, December 31,
(millions) 2007 2006
-------- ------------
Finished goods and work in progress $282 $254
Raw materials 87 94
---- ----
Total 369 348
==== ====
(8) GOODWILL AND OTHER INTANGIBLE ASSETS
Total goodwill consisted of the following:
Building North
Products American
(millions) Distribution Gypsum Total
------------ -------- -----
Balance as of January 1 $154 $-- $154
Acquisitions 197 6 203
Currency translation -- 1 1
---- --- ----
Balance as of June 30 351 7 358
==== === ====
Goodwill increased in the first six months of 2007 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 principally trade names, totaled $9
million as of June 30, 2007. As of that date, $1 million of these other
intangible assets was subject to amortization over a five-year life
concluding in 2010. Other intangible assets are included in other assets on
the condensed consolidated balance sheets.
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(9) DEBT
Total debt consisted of the following:
As of As of
June 30, December 31,
(millions) 2007 2006
-------- ------------
Term loan $ 500 $ 700
6.3% senior notes 500 500
Industrial revenue bonds 239 239
Tax bridge term loan -- 1,065
------ ------
Total 1,239 2,504
====== ======
CREDIT FACILITIES
In August 2006, we entered into a $2.8 billion credit agreement with a
syndicate of banks. JPMorgan Chase Bank, N.A. serves as administrative
agent under the agreement. The credit agreement consists of a $650 million
revolving credit facility with a $250 million sublimit for letters of
credit and a term loan facility that originally was $1 billion but has been
reduced to the $500 million outstanding balance under that facility. It
also included a $1.15 billion tax bridge term loan facility that has been
terminated.
The revolving credit facility is available to fund working capital needs
and for other general corporate purposes. As of June 30, 2007, we had not
drawn upon the revolving credit facility except for approximately $78
million of outstanding letters of credit. The term loan facility was
available to us in a single drawing of up to $1.0 billion, and the tax
bridge facility was available to us in a single drawing of 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 and $1.065 billion under
the tax bridge facility. These borrowings, along with proceeds from the
$500 million senior note offering described below 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 $10 million pretax charge to interest expense in the first
quarter of 2007 to write off deferred financing fees associated with these
borrowings. As of June 30, 2007, the borrowing rate on the term loan
facility was 6.125%.
-12-
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 June 30, 2007, we were in compliance with those
financial ratios, tests and covenants.
Credit Agreement Amendment and Restatement: In July 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 term loans, revolving credit facility 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.
6.3% SENIOR NOTES DUE 2016
In November 2006, we issued in a private placement $500 million of 6.3%
senior unsecured notes that mature in November 2016. In the second quarter
of 2007, we completed an offer to exchange registered 6.3% senior unsecured
notes also maturing in 2016 for the privately placed notes.
(10) 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
-13-
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 June 30, 2007,
we had swap contracts to exchange monthly payments on notional amounts of
natural gas amounting to $144 million. As of June 30, 2007, the fair value
of these swap contracts, which remained in AOCI, was a $18 million ($11
million after-tax) 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 $59 million, and all contracts mature by March
31, 2009. As of June 30, 2007, the fair value of these hedges was a $1
million 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 June 30, 2007, the fair value of these hedges, which was less than $0.1
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 if aggregate payables exceed certain limits.
Currently, we have no collateral requirement. We enter into master
agreements which contain netting arrangements that minimize counterparty
credit exposure.
-14-
(11) COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss) are summarized in the
following table:
Three Months Six Months
ended ended
June 30, June 30,
------------ ------------
(millions) 2007 2006 2007 2006
---- ----- ---- -----
Net earnings $ 56 $ 176 $ 97 $ 35
---- ----- ---- -----
Pretax gain (loss) on derivatives (12) (18) 24 (118)
Income tax benefit (expense) 5 7 (10) 46
---- ----- ---- -----
After-tax gain (loss) on derivatives (7) (11) 14 (72)
---- ----- ---- -----
Loss on unrecognized pension and
postretirement benefit costs, net of tax* (4) -- (3) --
---- ----- ---- -----
Foreign currency translation 25 9 27 6
Unrealized gain on marketable
securities, net of tax -- -- -- 1
---- ----- ---- -----
Total comprehensive income (loss) 70 174 135 (30)
==== ===== ==== =====
* 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
June 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 51 24
---- ----
Total (98) (136)
==== ====
Reclassifications of net after-tax gains or losses from AOCI to earnings
during the second quarter of 2007 were as follows:
(millions)
Loss on derivatives, net of tax of $2 million $(3)
Loss on unrecognized pension and postretirement benefit
costs, net of tax of $1 million (3)
---
Total (6)
===
-15-
As of June 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 $11
million loss on derivatives and a $4 million loss on unrecognized pension
and postretirement benefit costs.
(12) ASSET RETIREMENT OBLIGATIONS
Changes in the liability for asset retirement obligations consisted of the
following:
Six Months ended June 30
------------------------
(millions) 2007 2006
---- ----
Balance as of January 1 $78 $71
Accretion expense 2 2
Foreign currency translation 1 1
--- ---
Balance as of June 30 81 74
=== ===
(13) EMPLOYEE RETIREMENT PLANS
The components of net pension and postretirement benefits costs are
summarized in the following table:
Three Months Six Months
ended June 30, ended June 30,
-------------- --------------
(millions) 2007 2006 2007 2006
---- ---- ---- ----
PENSION:
Service cost of benefits earned $ 10 $ 10 $ 20 $ 19
Interest cost on projected
benefit obligation 17 16 33 31
Expected return on plan assets (18) (16) (36) (32)
Net amortization 2 6 5 10
---- ---- ---- ----
Net cost 11 16 22 28
==== ==== ==== ====
POSTRETIREMENT:
Service cost of benefits earned 4 5 8 8
Interest cost on projected
benefit obligation 6 6 12 11
Recognized loss (1) (1) (2) (2)
---- ---- ---- ----
Net cost 9 10 18 17
==== ==== ==== ====
In accordance with our funding policy, we currently plan to contribute
approximately $66 million of cash to our pension plans in 2007.
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(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 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
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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 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. 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.
(15) INCOME TAXES
Income tax expense was $38 million in the first six months of 2007 and
included a $6.6 million favorable tax adjustment resulting from a
correction of the December 31, 2006 deferred tax balances. This correction
reduced the effective tax rate for the first six months of 2007 to 28.2%.
Without the adjustment, the effective tax rate for the first six months of
2007 would have been 33.1%.
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 December 31, 2006 consolidated balance sheet.
We have net operating loss and tax credit carryforwards in varying
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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 second quarter of 2007, we increased 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 our
federal foreign tax credit and certain U.S. state credit carryforwards in
future years. Of the total valuation allowance as of June 30, 2007, $66
million relates to U.S. state net operating loss and tax credit
carryforwards, $12 million relates to foreign net operating loss and tax
credit carryforwards and $1 million relates to U.S. federal foreign tax
credit carryforwards.
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 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
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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 adjustments for 2005
or 2006 as of June 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.
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.
-20-
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 the consolidated balance sheet.
Interest expense for the second quarter of 2006 included charges for
post-petition interest and fees totaling $36 million ($21 million
after-tax) related to pre-petition obligations. Interest expense for the
first six months of 2006 included charges for post-petition interest and
fees totaling $520 million ($321 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
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 are not part of the asbestos trust or the channeling
injunction. Our plan of reorganization provided that all settled or
-21-
otherwise resolved asbestos property damage claims that were timely filed
in our reorganization proceedings will 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, we reached agreements to settle all of the remaining asbestos
property damage claims filed in our reorganization proceedings, with the
exception of one small claim brought by a homeowner. In 2006, we made total
payments of approximately $99 million for these asbestos property damage
settlements. Based on our evaluation of our asbestos property damage
settlements and the remaining unresolved asbestos property damage claims,
in the second quarter of 2006, we reversed $27 million of our reserve for
asbestos-related claims.
At the end of the first quarter of 2007, our estimate of the cost of
asbestos property damage settlements that had not been paid, and associated
legal fees, was approximately $48 million and was included in accrued
expenses and other liabilities on the consolidated balance sheet as of
March 31, 2007. In the second quarter of 2007, we made payments totaling
approximately $40 million for previously settled asbestos property damage
claims. As a result, the current estimate of the cost of remaining asbestos
property damage settlements that have not 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 June
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
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material adverse effect upon our results of operations, financial position
or cash flows.
(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.
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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 second quarter of 2007 were $1.4 billion, down 10%
from the second quarter of 2006. Operating profit of $88 million declined 72%
from the prior-year period. Net earnings were $56 million, or $0.56 per diluted
share, for the second quarter of 2007 compared with net earnings of $176
million, or $3.03 per diluted share, for the second quarter of 2006.
During the second quarter of 2007, housing construction activity was
substantially below the strong levels experienced a year earlier. As we
anticipated, this has led to lower second quarter 2007 sales and earnings
compared to last year.
Shipments of United States Gypsum Company's SHEETROCK(R) brand gypsum wallboard
in the second quarter of 2007 were down 20% from the record level of the second
quarter of 2006. Capacity utilization rates for our gypsum wallboard plants were
approximately 82% for the second quarter of 2007. These plants operated at full
capacity during the second 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 an average of $141.97 per thousand square feet for the
second quarter of 2007 compared with $164.12 for the first quarter of 2007 and
$182.65 for the second quarter of 2006. Gypsum wallboard selling prices trended
downward throughout the second quarter of 2007. That trend has continued since
quarter-end, and prices remain under pressure. Manufacturing costs for
SHEETROCK(R) brand gypsum wallboard were adversely affected by higher prices for
energy, wastepaper and other raw materials, and by the unfavorable effects of
lower production levels.
MARKET TRENDS AND OUTLOOK
Industry shipments of gypsum wallboard in the United States were an estimated
8.2 billion square feet in the second quarter of 2007, a 17% decrease from 9.9
billion square feet in the second quarter of 2006.
The housing market continued to deteriorate during the second quarter of 2007.
High levels of unsold homes suggest that new residential construction will
remain weak during the second half of the year and into 2008 in what could
be a multi-year downturn in housing. We expect low single-digit growth in
the non-residential markets this year, although the growth will not be
sufficient to significantly offset the effects of lower demand for wallboard
from residential construction. Overall, we expect
-24-
industry demand for gypsum wallboard in 2007 to be down approximately 10% from
last year. Industry capacity utilization rates are expected to be close to 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 profitability.
We have also made significant adjustments to our manufacturing capacity by
removing approximately 2.5 billion square feet of mostly older, higher-cost
wallboard capacity from operations in the last year, and we will shut down an
additional 350 million square feet of wallboard capacity at our Detroit,
Michigan plant later in the third quarter of this year. We have also eliminated
approximately 480 salaried positions as discussed below. 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:
- 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;
- 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;
- enhancing customer service;
- introducing new products and systems that complement our current product
lines;
- completing information technology initiatives to enhance operations and
customer satisfaction; and
- adjusting our workforce in response to current market conditions.
-25-
CONSOLIDATED RESULTS OF OPERATIONS
The following is a summary of our condensed consolidated statements of earnings:
% Increase
(millions) 2007 2006 (Decrease)
------ ------ ----------
THREE MONTHS ENDED JUNE 30:
Net sales $1,408 $1,573 (10)%
Cost of products sold 1,206 1,173 3%
Gross profit 202 400 (50)%
Selling and administrative expenses 99 103 (4)%
Provision for restructuring 15 -- --
Reversal of asbestos claims reserve -- (27) --
Chapter 11 reorganization expenses -- 6 --
Operating profit 88 318 (72)%
Interest expense 19 37 (49)%
Interest income (5) (4) 25%
Other (income) expense, net (2) -- --
Income taxes 20 109 (82)%
Net earnings 56 176 (68)%
Diluted earning per share 0.56 3.03 (82)%
SIX MONTHS ENDED JUNE 30:
Net sales 2,667 3,038 (12)%
Cost of products sold 2,253 2,281 (1)%
Gross profit 414 757 (45)%
Selling and administrative expenses 216 202 7%
Provision for restructuring 15 -- --
Reversal of asbestos claims reserve -- (27) --
Chapter 11 reorganization expenses -- 8 --
Operating profit 183 574 (68)%
Interest expense 63 523 (88)%
Interest income (13) (7) 86%
Other (income) expense, net (2) -- --
Income taxes 38 23 65%
Net earnings 97 35 177%
Diluted earnings per share 1.01 0.60 68%
NET SALES
Consolidated net sales in the second quarter and first six months of 2007
declined 10% and 12% 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
second quarter and first six months of 2007 for North American Gypsum and
Building Products Distribution decreased compared with the same periods in 2006.
Net sales in the second quarter and first six months of 2007 for Worldwide
Ceilings improved compared with the respective prior-year periods.
-26-
COST OF PRODUCTS SOLD
Cost of products sold in the second quarter of 2007 increased 3% compared with
the second quarter of 2006 primarily due to higher prices for energy and raw
materials. Cost of products sold in the first six months of 2007 were down 1%
compared with the same 2006 period primarily due to lower volumes, partially
offset by higher prices for energy and raw materials.
GROSS PROFIT
Gross profit for the second quarter and first six months of 2007 decreased 50%
and 45% 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 14.3% in the second quarter of 2007, down
from 25.4% in the second quarter of 2006. For the first six months of 2007, the
gross margin percentage was 15.5%, down from 24.9% for the prior-year period.
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses for the second quarter of 2007 decreased 4%
from the second quarter of 2006 primarily due to a lower level of accruals for
incentive compensation. As a percent of net sales, selling and administrative
expenses were 7.0% for the second quarter of 2007, up from 6.5% for the second
quarter of 2006.
Selling and administrative expenses for the first six months of 2007 increased
7% from the first six months of 2006 primarily due to higher levels of overall
compensation and benefits and costs associated with our move to a new corporate
office in March 2007. As a percent of net sales, selling and administrative
expenses were 8.1% for the first six months of 2007, up from 6.6% for the
corresponding period in 2006.
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 announced on May 21, 2007 and the shutdown
of a framing products manufacturing plant. We implemented these actions in
response to current market conditions.
Under the salaried workforce reduction program, approximately 200 employees were
terminated and approximately 240 open positions were eliminated as of June 30,
2007. Included in the provision for restructuring is a charge of $11 million
pretax ($7 million after-tax) for severance and related costs for the employees
terminated as of June 30, 2007. We expect to record approximately $3 million of
additional charges during the second half of 2007 for severance and related
costs for approximately 40 more employees whose employment will be terminated as
part of the program, but who are continuing to provide services after June 30.
Most of the payments associated with this program are expected to be made during
the second half of 2007.
-27-
In June 2007, we shut down our plant in Tuscaloosa, Alabama that manufactured
framing products. Included in the provision for restructuring is a charge of $4
million pretax ($2 million after-tax) related to the shutdown. This charge
primarily reflects a writedown of property, plant and equipment and
lease-termination costs.
See Note 4 to the Condensed Consolidated Financial Statements for additional
information related to this restructuring program.
REVERSAL OF ASBESTOS CLAIMS RESERVE
In the second quarter of 2006, we reversed $27 million pretax ($17 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.
CHAPTER 11 REORGANIZATION EXPENSES
In connection with our bankruptcy proceedings that concluded in 2006, we
recorded Chapter 11 reorganization expenses of $6 million in the second quarter
of 2006 and $8 million for the first six months of 2006.
INTEREST EXPENSE
Interest expense amounted to $19 million for the second quarter of 2007 and $63
million for the first six months of 2007. Interest expense for the second
quarter was down $25 million compared with the first quarter of this year
primarily due to lower average debt levels following the first quarter
repayments of borrowings under our credit facility. Also contributing to the
decrease was the absence in the second quarter of a first-quarter pretax charge
of $10 million ($6 million after-tax) to write off deferred financing fees
primarily due to the repayment of our tax bridge loan.
Interest expense of $37 million for the second quarter of 2006 included charges
for post-petition interest and fees totaling $36 million ($21 million after-tax)
related to pre-petition obligations. Interest expense of $523 million for the
first six months of 2006 included charges for post-petition interest and fees
totaling $520 million ($321 million after-tax) related to pre-petition
obligations.
INCOME TAXES
Income tax expense was $20 million for the second quarter of 2007 compared with
$109 million for the second quarter of 2006. The effective tax rate was 26.7%
for the second quarter of 2007 compared with 38.2% for last year's second
quarter. The difference in the second quarter effective tax rates is primarily
attributable to a lower projected effective tax rate on operating earnings in
2007 and the favorable effects of state tax law changes enacted in the second
quarter of 2007.
Income tax expense was $38 million for first six months of 2007 compared with
$23 million for the corresponding 2006 period. The effective tax rates were
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28.2% for the first six months of 2007 and 40.1% for the first six months of
2006. The difference in the six months effective tax rates is primarily
attributable to a lower projected effective tax rate on operating earnings in
2007, the favorable effects of state tax law changes enacted in the first six
months of 2007, 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 and
a $6.6 million favorable tax adjustment recorded in the first quarter of 2007
resulting from a correction of the December 31, 2006 deferred tax balances.
NET EARNINGS
Net earnings in the second quarter of 2007 were $56 million, or $0.56 per
diluted share. Net earnings in the first six months of 2007 were $97 million, or
$1.01 per diluted share. Net earnings for the second quarter and first six
months of 2007 include the after-tax charge of $9 million for the restructuring
program described above. The earnings-per-share impact of the restructuring
program was $0.09 per diluted share for the second quarter and $0.10 per diluted
share for the first six-month period.
For the second quarter of 2006, net earnings were $176 million, or $3.03 per
diluted share. For the first six months of 2006, net earnings totaled $35
million, or $0.60 per diluted share. Net earnings and earnings per share for the
2006 periods include charges for post-petition interest and fees related to
pre-petition obligations as described above. These charges, on an after-tax
basis, were $21 million, or $0.36 per diluted share, for the second quarter of
2006 and $321 million, or $5.54 per diluted share, for the first six months of
2006. Net earnings and earnings per share for the 2006 periods also include the
reversal of a reserve for asbestos-related claims described above. The after-tax
income from this reversal amounted to $17 million, or $0.29 per diluted share.
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CORE BUSINESS RESULTS OF OPERATIONS
Three Months Six Months
ended June 30, ended June 30,
--------------- ---------------
(millions) 2007 2006 2007 2006
------ ------ ------ ------
NET SALES:
NORTH AMERICAN GYPSUM:
United States Gypsum Company $ 655 $ 878 $1,316 $1,712
CGC Inc. (gypsum) 79 91 156 177
USG Mexico, S.A. de C.V. 47 40 90 83
Other subsidiaries* 22 24 39 45
Eliminations (49) (56) (90) (109)
------ ------ ------ ------
Total 754 977 1,511 1,908
------ ------ ------ ------
BUILDING PRODUCTS DISTRIBUTION:
L&W Supply Corporation 654 680 1,158 1,284
------ ------ ------ ------
WORLDWIDE CEILINGS:
USG Interiors, Inc. 135 137 260 264
USG International 71 59 140 113
CGC Inc. (ceilings) 15 14 30 30
Eliminations (11) (11) (23) (22)
------ ------ ------ ------
Total 210 199 407 385
------ ------ ------ ------
Eliminations (210) (283) (409) (539)
------ ------ ------ ------
Total USG Corporation 1,408 1,573 2,667 3,038
====== ====== ====== ======
OPERATING PROFIT**:
NORTH AMERICAN GYPSUM:
United States Gypsum Company 30 242 111 431
CGC Inc. (gypsum) 1 14 7 26
USG Mexico, S.A. de C.V. 6 7 13 15
Other subsidiaries* 5 4 4 6
------ ------ ------ ------
Total 42 267 135 478
------ ------ ------ ------
BUILDING PRODUCTS DISTRIBUTION:
L&W Supply Corporation 45 58 71 111
------ ------ ------ ------
WORLDWIDE CEILINGS:
USG Interiors, Inc. 12 17 20 31
USG International 2 5 6 8
CGC Inc. (ceilings) 3 4 5 7
------ ------ ------ ------
Total 17 26 31 46
------ ------ ------ ------
Corporate (22) (24) (61) (52)
Eliminations 6 (3) 7 (1)
Chapter 11 reorganization expenses -- (6) -- (8)
------ ------ ------ ------
Total USG Corporation 88 318 183 574
====== ====== ====== ======
* Includes Gypsum Transportation Limited, a shipping company in Bermuda, and
USG Canadian Mining Ltd., a mining operation in Nova Scotia.
** Total operating profit for the second quarter and first six months of 2007
includes provisions totaling $15 million pretax for restructuring
activities that included a salaried workforce reduction program and the
shutdown of our Tuscaloosa, Alabama framing products manufacturing plant.
On an operating segment basis, $12 million of the charge relates to North
American Gypsum and $1 million relates to each of Building Products
Distribution, Worldwide Ceilings and Corporate.
-30-
NORTH AMERICAN GYPSUM
Net sales of $754 million in the second quarter of 2007 were down 23% from the
second quarter of 2006, while operating profit fell 84% to $42 million. For the
first six months of 2007, net sales of $1.511 billion were down 21% and
operating profit of $135 million dropped 72% compared with the first six months
of 2006. Operating profit for the second quarter and first six months of 2007
for North American Gypsum included restructuring charges totaling $12 million.
Operating profit for the second quarter and first six months of 2006 was
favorably affected by the $27 million reversal of a reserve for asbestos-related
claims discussed above.
United States Gypsum Company: Second quarter 2007 net sales for U.S. Gypsum
decreased $223 million, or 25%, compared with the second quarter of 2006, while
operating profit fell $212 million, or 88%. The decline in operating profit
largely reflected lower demand for gypsum wallboard, lower gypsum wallboard
selling prices and higher manufacturing costs. In addition, U.S Gypsum's
operating profit for the second quarter of 2007 included a restructuring charge
of $10 million which consists of $6 million for our salaried workforce reduction
program and $4 million for the shutdown of our Tuscaloosa, Alabama framing
products manufacturing plant. Operating profit for the second quarter of 2006
was favorably affected by the $27 million reversal of a reserve for
asbestos-related claims.
Shipments of SHEETROCK(R) brand gypsum wallboard totaled 2.4 billion square feet
during the second quarter of 2007, down 20% from the record level of 3.0 billion
square feet in the second quarter of 2006. U.S. Gypsum's wallboard plants
operated at approximately 82% of capacity in the second quarter of 2007 compared
with full capacity in the second quarter of 2006. Industry shipments of gypsum
wallboard in the United States were down approximately 17% from the second
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 an average of $141.97
per thousand square feet for the second quarter of 2007, a 22% drop compared to
the average price of $182.65 for the second quarter of 2006 and a 13% decrease
from the average price of $164.12 for the first quarter of 2007. Prices
continued to trend downward throughout the second quarter of 2007 reflecting
continued weakness in new residential housing construction and lower industry
demand for gypsum wallboard. That trend has continued since quarter-end, and
prices remain under pressure. Throughout this cycle, U.S. Gypsum intends to
focus on maximizing profitability by balancing its gypsum wallboard volume and
selling prices.
During the second quarter of 2007, manufacturing costs for SHEETROCK(R) brand
gypsum wallboard were adversely affected by higher prices for energy, wastepaper
and other raw materials, and by the unfavorable effects of lower production
levels. Gypsum wallboard unit costs were up 12% in the second quarter of 2007
compared with last year's second quarter, but have stabilized since the first
quarter of this year.
-31-
U.S. Gypsum's complementary product lines, SHEETROCK(R) brand joint compound,
DUROCK(R) brand cement board, FIBEROCK(R) brand gypsum fiber panels and
industrial gypsum products, reported improved selling prices during the second
quarter of 2007 compared with the same period a year ago. However, benefits from
these results were partially offset by higher manufacturing costs for joint
compound and gypsum fiber panels and lower shipments of joint compound.
CGC Inc.: Second quarter 2007 net sales for the gypsum business of Canada-based
CGC Inc. fell $12 million, or 13%, compared to the second quarter of 2006.
Operating profit was $1 million in the second quarter of 2007 compared with $14
million for last year's second 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 wastepaper and other raw material costs. Operating profit for
the second quarter of 2007 also included a restructuring charge of $2 million
for our salaried workforce reduction program.
USG Mexico, S.A. de C.V.: Net sales in the second quarter of 2007 for our
Mexico-based subsidiary were up $7 million, or 18%, 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 raw materials costs.
BUILDING PRODUCTS DISTRIBUTION
L&W Supply Corporation's net sales in the second quarter of 2007 were $654
million, down $26 million, or 4%, compared with the second quarter of 2006. This
decline was primarily attributable lower product volumes and gypsum wallboard
selling prices resulting from the weak residential construction market.
Partially offsetting these results were the impact of recent acquisitions and
improved non-residential market opportunity. Overall, gypsum wallboard shipments
declined 11% while sales of other products increased 21%, compared with last
year's second quarter. Acquisitions completed in the past year, including
California Wholesale Material Supply, Inc., which was acquired in late March,
contributed $155 million to second quarter 2007 net sales. Driven by the lower
product volumes and gypsum wallboard prices, same-location net sales for the
second quarter of 2007 decreased 27% compared with the second quarter of 2006.
Operating profit in the second quarter of 2007 was $45 million, down $13
million, or 22%, compared with the record level of $58 million for the second
quarter of 2006. The decreases in gypsum wallboard shipments and selling prices
that resulted from the weak residential construction market were the primary
factors behind the lower level of operating profit. Profit margins for most
product lines experienced only modest declines as the cost of goods sold fell
along with selling prices. Operating profit for the second quarter of 2007 also
included a $1 million restructuring charge for our salaried
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workforce reduction program.
For the first six months of 2007, net sales of $1.158 billion were down 10% and
operating profit of $71 million was down 36% compared with the first six months
of 2006. On a same-location basis, net sales in the first six months of 2007
declined 31% versus the first six months of 2006.
L&W Supply operated 249 locations in the United States and Mexico as of June 30,
2007 compared with 211 locations only in the United States as of June 30, 2006.
WORLDWIDE CEILINGS
Net sales of $210 million in the second quarter of 2007 were up 6% from the
second quarter of 2006, while operating profit declined 35% to $17 million. For
the first six months of 2007, net sales of $407 million increased 6% while
operating profit of $31 million fell 33% compared with the first six months of
2006. Second quarter and first six months 2007 operating profit for Worldwide
Ceilings included a restructuring charge of $1 million.
USG Interiors, Inc.: USG Interiors reported second quarter 2007 net sales of
$135 million and operating profit of $12 million. These results compared with
net sales of $137 million and operating profit of $17 million in the second
quarter of 2006. The decline in net sales was primarily attributable to lower
shipments of ceiling grid, which were partially offset by higher domestic
ceiling tile shipments and improved selling prices for ceiling tile and grid.
The decline in operating profit reflects higher manufacturing costs for ceiling
grid. Market prices for steel used in the production of ceiling grid rose
dramatically during the second quarter of 2007. Second quarter 2007 operating
profit for USG Interiors also included the $1 million restructuring charge for
our salaried workforce reduction program.
USG International: Net sales for the second quarter of 2007 increased $12
million, or 20%, compared with the second quarter of 2006. The improvement in
net sales was attributable to improved sales in most regions, particularly in
Europe due to increased demand for joint treatment and ceiling grid and in the
Middle East due to higher sales of ceiling grid. Sales in Latin America were up
primarily due to the sales contribution from All Interiors Supply which was
acquired late last year. The favorable effects of currency translation also
contributed to the higher level of net sales in the 2007 period. Operating
profit was $2 million for the second quarter of 2007 compared with $5 million
for the second quarter of 2006. The decline in operating profit was primarily
attributable to lower selling prices due to competitive pressures in Latin
America and higher selling and administrative expenses.
CGC Inc.: The ceilings business of CGC Inc. reported a $1 million increase in
net sales, but a $1 million decrease in operating profit, in the second quarter
of 2007 compared with the second quarter of 2006.
-33-
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
As of June 30, 2007, we had cash and cash equivalents of $380 million compared
with $411 million as of March 31, 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 with a syndicate of banks that includes:
- a $650 million revolving credit facility with a $250 million sublimit for
letters of credit. As of June 30, 2007, we had not drawn upon the revolving
credit facility except for approximately $78 million of outstanding letters
of credit; and
- a term loan facility that was available to us in a single drawing of up to
$1.0 billion. In the fourth quarter of 2006, we borrowed $700 million under
this facility to fund a portion of our Chapter 11 reorganization
obligations. In the first quarter of 2007, we repaid $200 million of this
borrowing.
The credit agreement also included a tax bridge term loan facility that was
available to us in a single drawing of up to $1.15 billion. In the fourth
quarter of 2006, we borrowed $1.065 billion under this facility to fund a
portion of our Chapter 11 reorganization obligations. In the first quarter of
2007, we repaid the full amount using a $1.057 billion federal tax refund we
received and cash on hand. The federal tax refund resulted from tax deductions
generated by the payments made in 2006 to the asbestos trust created pursuant to
our plan of reorganization. The tax bridge facility has been terminated.
The credit agreement was recently amended and restated to, among other things,
extend its maturity for one year and reduce the margin on borrowings under the
agreement. See Note 9 to the Condensed Consolidated Financial Statements for
additional information regarding the amendment and restatement of the credit
agreement.
We plan to fund future growth projects from cash on hand, future cash available
from operations and, if determined to be appropriate, borrowings under our
revolving credit facility. Also to fund future growth projects, we
-34-
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:
Six Months ended June 30
------------------------
(millions) 2007 2006
------ -----
Net cash provided by (used for):
Operating activities $1,151 $(631)
Investing activities (496) 344
Financing activities (843) (65)
Effect of exchange rate changes on cash 3 3
------ -----
Net decrease in cash and cash equivalents (185) (349)
====== =====
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 $205 million) and
capital projects (up $74 million) and a cash inflow of $496 million in the first
six months of 2006 from the net sales of marketable securities.
Financing Activities: The variation between the 2007 and 2006 periods primarily
reflects our first quarter 2007 repayments of the $1.065 billion borrowing under
our tax bridge facility and $200 million of borrowings under our term loan
facility. These repayments were partially offset by net proceeds of $422 million
from a public equity offering that we completed in March 2007.
CAPITAL EXPENDITURES
Capital spending amounted to $224 million in the first six months of 2007
compared with $150 million in the corresponding 2006 period. As of June 30,
2007, capital expenditure commitments for the replacement, modernization and
expansion of operations amounted to $524 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, borrowings under our
revolving credit facility or other alternative financings. Capital projects
commenced as of June 30, 2007 include the following projects with the total
estimated costs indicated:
- approximately $160 million to replace existing capacity at U.S. Gypsum's
Norfolk, Virginia gypsum wallboard plant with a new low-cost wallboard line
designed to position the company for profitable growth in the mid-Atlantic
region. Construction on this project began in 2005 and is expected to be
completed in 2007;
-35-
- approximately $70 million for a new gypsum wallboard plant in Tecoman,
Colima, Mexico. This facility will serve Western Mexico and export gypsum
wallboard to Latin America. Construction of this plant began in 2006 and it
became operational early in the third quarter of 2007;
- 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 intended
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 expected to be completed in
2010.
WORKING CAPITAL
As of June 30, 2007, working capital (current assets less current liabilities)
amounted to $942 million, and the ratio of current assets to current liabilities
was 2.51-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 $611 million as of June 30, 2007 from $448 million as
of December 31, 2006. During the same period, inventories increased to $369
million from $348 million, and accounts payable increased to $364 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 23% increase in net sales for the
month of June 2007 compared with December 2006. Accrued expenses decreased to
$255 million as of June 30, 2007 from $358 million as of December 31, 2006
largely due to the payment of employee incentive compensation in the first
quarter.
DEBT
Total debt amounted to $1.239 billion as of June 30, 2007 compared with $2.504
billion as of December 31, 2006. See Note 9 to the Consolidated Financial
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Statements for additional information on our debt.
REALIZATION OF DEFERRED TAX ASSET
Our consolidated balance sheet as of June 30, 2007 includes a gross deferred tax
asset of $423 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 $79 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 $192
million of federal income tax benefits relating to our federal net operating
loss and tax credit carryforwards. If certain specified changes in our ownership
should occur, there could be an annual limitation on the amount of the
carryforwards that can be utilized; however, based on our current equity value,
we do not believe that this limitation (if it occurs) would impair our ability
to fully utilize these carryforwards. As a result, it is more likely than not
that we will realize all but $1 million of the federal deferred tax asset
relating to these 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
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 $218 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 none 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.
-37-
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. We believe that neither these matters nor any other known
governmental proceeding regarding environmental matters will have a material
adverse effect upon our results of operations, financial position or cash flows.
See Note 17 to the Condensed Consolidated Financial Statements for additional
information on environmental litigation and for information concerning asbestos
and related bankruptcy litigation.
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 six months of 2007.
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 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
-38-
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.
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, mortgage interest rates, housing
affordability, 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;
-39-
- 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.
-40-
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.
On October 1, 2005, we began to roll out a new supply chain management system in
the United States and Canada. The rollout is being undertaken in phases and is
currently planned to be completed in 2007. Management expects that the new
system will enhance operational efficiencies and help us better serve our
customers. The changes related to the new system represented the only change 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 June 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.
-41-
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 June 30, 2007, and the
related condensed consolidated statements of earnings and cash flows for the
three-month and six-month periods ended June 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 December 31, 2006 (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, Financial Accounting Standards No. 123(R), "Share-Based Payment", and
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 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
July 27, 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our 2007 annual meeting of stockholders on May 9, 2007. At the meeting,
Lawrence M. Crutcher, William C. Foote, Steven F. Leer and Judith A. Sprieser
were elected to serve on our Board of Directors for three-year terms expiring in
2010 and the stockholders ratified the appointment by the Audit Committee of our
Board of Directors of Deloitte & Touche LLP as our independent registered public
accountants for 2007. The votes on these matters were as follows:
For Withheld
---------- ----------
1. Election of Directors
Lawrence M. Crutcher 72,521,020 10,009,590
William C. Foote 72,490,223 10,040,386
Steven F. Leer 72,566,193 9,964,417
Judith A. Sprieser 72,507,666 10,022,913
For Against Abstain
---------- ---------- -------
2. Ratification of Appointment of
Deloitte & Touche LLP as
Independent Registered Public
Accountants for 2007 82,117,874 315,398 97,337
ITEM 5. OTHER INFORMATION
On July 31, 2007, we amended and restated our credit agreement with a syndicate
of banks. See Part I, Item 1, Note 9, Debt, for a description of the principal
changes to the credit agreement effected by the amendment and restatement, which
description is incorporated herein by reference.
Effective July 31, 2007, the Guarantee Agreement entered into by us, certain of
our subsidiaries and JPMorgan Chase Bank, N.A., as Administrative Agent, in
connection with the credit agreement was terminated.
-43-
ITEM 6. EXHIBITS
10.1 Amended and Restated Credit Agreement, dated as of July 31, 2007, among USG
Corporation, the Lenders Party thereto, JPMorgan Chase Bank, N.A., as
Administrative Agent, and Goldman Sachs Credit Partners L.P., as
Syndication Agent*
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
----------
* The schedules and exhibits to the Amended and Restated Credit Agreement
have been omitted. A copy of any omitted schedule or exhibit will be
furnished to the Commission supplementally upon request.
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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
July 31, 2007
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