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USG > SEC Filings for USG > Form 10-Q on 24-Oct-2013All Recent SEC Filings

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Form 10-Q for USG CORP


24-Oct-2013

Quarterly Report


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 consolidated financial statements, except as otherwise indicated or as the context otherwise requires.
Overview
SEGMENTS
We are a leading manufacturer and distributor of building materials. We produce a wide range of products for use in new residential, new nonresidential, and residential and nonresidential repair and remodel construction as well as products used in certain industrial processes. We estimate that during the first nine months of 2013
• residential and nonresidential repair and remodel activity accounted for approximately 51% of our net sales,

• new residential construction accounted for approximately 25% of our net sales,

• new nonresidential construction accounted for approximately 23% of our net sales, and

• other activities accounted for approximately 1% of our net sales.

Our operations are organized into three reportable segments: North American Gypsum, Worldwide Ceilings and Building Products Distribution.
North American Gypsum: North American Gypsum manufactures and markets gypsum and related products in the United States, Canada and Mexico. It includes United States Gypsum Company, or U.S. Gypsum, in the United States, the gypsum business of CGC Inc., or CGC, in Canada, and USG Mexico, S.A. de C.V., or USG Mexico. North American Gypsum's products are used in a variety of building applications to finish the walls, ceilings and floors in residential, commercial and institutional construction and in certain industrial applications. Its major product lines include SHEETROCK® brand gypsum wallboard, a line of joint compounds used for finishing wallboard joints also sold under the SHEETROCK® brand name, DUROCK® brand cement board, FIBEROCK® brand gypsum fiber panels and SECUROCK® brand glass mat sheathing used for building exteriors and gypsum fiber and glass mat panels used as roof cover board.
Worldwide Ceilings: Worldwide Ceilings manufactures and markets interior systems products in the United States, Canada, Mexico, Latin America and the Asia-Pacific region. It includes USG Interiors, LLC, or USG Interiors, the international interior systems business managed as USG International, and the ceilings business of CGC. Worldwide Ceilings is a leading supplier of interior ceilings products used primarily in commercial applications. Worldwide Ceilings manufactures ceiling tile in the United States and ceiling grid in the United States, Canada and the Asia-Pacific region. It markets ceiling tile and ceiling grid in the United States, Canada, Mexico, Latin America and the Asia-Pacific region. It also manufactures and markets joint compound in Latin America and the Asia-Pacific region.
During the third quarter of 2012, our former European business operations were classified as discontinued operations; therefore, their results are reflected as discontinued operations in the consolidated financial statements and footnotes presented in this report. In addition, the segment results for Worldwide Ceilings exclude the results of these operations. On December 27, 2012, the sale was consummated and we received net proceeds of $73 million resulting in a gain of $55 million. See Note 2 to the consolidated financial statements for additional information related to discontinued operations.
Building Products Distribution: Building Products Distribution consists of L&W Supply Corporation and its subsidiaries, or L&W Supply, the leading distributor of gypsum wallboard and other building materials in the United States. It is a service-oriented business that stocks a wide range of construction materials. It delivers less-than-truckload quantities of construction materials to job sites and places them in areas where work is being done, thereby reducing the need for handling by contractors.
Geographic Information: For the first nine months of 2013, approximately 80% of our net sales were attributable to the United States, Canada accounted for approximately 11% of our net sales and other foreign countries accounted for the remaining 9%.


Table of Contents

RECENT DEVELOPMENTS
On October 16, 2013, we and certain of our subsidiaries entered into two share sale and subscription agreements (the "Subscription Agreements") with Boral Limited ("Boral") and certain of its subsidiaries. Pursuant to the Subscription Agreements and a shareholders agreement (the "Shareholders Agreement") that we expect to enter into upon the consummation of the Subscription Agreements, we and Boral plan to establish a joint venture (the "USG Boral Joint Venture") to manufacture, distribute and sell certain building products, mine raw gypsum and sell natural and synthetic gypsum throughout Asia, Australasia and the Middle East (the "Territory"). The products that USG and Boral expect to manufacture and distribute through the USG Boral Joint Venture include products for wall, ceiling, floor lining and exterior systems that utilize gypsum, wallboard, mineral fiber ceiling tiles, steel grid and studs, joint compound and other products.
The USG Boral Joint Venture would target the distribution of 50% of combined after tax profits to USG and Boral in proportion to their respective ownership interests; provided, however, that the USG Boral Joint Venture would not pay dividends if such payments are, among other things, restricted pursuant to the terms of any credit facilities maintained by the USG Boral Joint Venture, inconsistent with the then-applicable strategic plan, or illegal. It is anticipated that the balance of the combined after tax profits would be retained for reinvestment in the business of the USG Boral Joint Venture. If the USG Boral Joint Venture requires additional funding for its operations and has exhausted all other reasonable alternatives, the shareholders, by unanimous vote of those shareholders holding at least a 37.5% interest in the USG Boral Joint Venture, may approve a capital call, provided that generally no shareholder will be obligated to provide additional funding, and provided further that any shareholder that does not provide additional funding in response to an approved capital call may be subject to dilution.
We expect to fund our investment in the USG Boral Joint Venture through a $500 million cash payment to Boral, the contribution to the USG Boral Joint Venture of certain USG businesses located in the Territory (including our subsidiaries and joint venture investments in China, Singapore, India, Malaysia, New Zealand, Australia and the Middle East, including our joint ventures in Oman) and the grant to the USG Boral Joint Venture of a license to use certain USG intellectual property rights in the Territory. In the event certain performance targets are satisfied by the USG Boral Joint Venture, we will also pay Boral scheduled earnout payments in an aggregate amount up to $75 million. Boral will fund its investment in the USG Boral Joint Venture through the contribution of the Boral Business and the grant to the USG Boral Joint Venture of a license of certain Boral intellectual property rights.
We intend to fund the cash portion of our investment in the USG Boral Joint Venture with up to $150 million of cash on hand and $350 million of long term debt. In addition, on October 16, 2013, we entered into a bridge commitment letter (the "Bridge Commitment Letter") with Goldman Sachs Lending Partners LLC and JPMorgan Chase Bank, N.A. (collectively, the "Bridge Commitment Lenders") and J.P. Morgan Securities LLC, pursuant to which the Bridge Commitment Lenders have committed to provide, in the event necessary, unsecured senior increasing rate bridge loans in an aggregate principal amount of $350 million on the terms and subject to the conditions set forth in the Bridge Commitment Letter. The obligation of the Bridge Commitment Lenders to provide any debt financing under the Bridge Commitment Letter is subject to certain customary conditions and terminates on February 17, 2014. We will not draw any bridge loans under the facility contemplated by the Bridge Commitment Letter if we secure a sufficient amount of long-term debt financing necessary to fund the cash portion of the investment from other sources. If we are unable to secure sufficient long-term debt financing and draw bridge loans under the Bridge Commitment Letter, we will be required to obtain alternative financing or use a substantial portion of our cash on hand to fund our investment in the USG Boral Joint Venture, which could have an adverse effect on our liquidity and limit our ability to use our cash on hand for other purposes, including, without limitation, capital expenditures or the repayment of our indebtedness.
The USG Boral Joint Venture would be operated in accordance with the terms of the Shareholders Agreement. As an ongoing operation, it is intended that the USG Boral Joint Venture will be funded from its net cash flow from operations and third-party financing.
We currently expect to close on the USG Boral Joint Venture transaction in the first quarter of 2014, with a targeted closing date of January 31, 2014. The closing of the USG Boral Joint Venture transaction is subject to certain customary conditions precedent, including, among other things, receipt of necessary regulatory approvals and third party consents.


Table of Contents

MARKET CONDITIONS AND OUTLOOK
Our businesses are cyclical in nature and sensitive to changes in general economic conditions, including, in particular, conditions in the North American construction-based markets, which are our most significant markets. The markets we serve can be broadly categorized as new residential construction, new nonresidential construction and repair and remodel activity, which includes both residential and nonresidential construction.
For the new residential construction market, housing starts are a very good indicator of demand for our gypsum products. Installation of our gypsum products typically follows the start of construction by one to two months. In August 2013, the seasonally-adjusted annualized rate of housing starts was reported by the U.S. Census Bureau to have increased to 891,000 compared to 883,000 units reported for July 2013 and 835,000 units reported for June 2013. In comparison, the August 2012 seasonally-adjusted annualized rate of housing starts was 750,000 units. Industry analysts believe that the level of new home construction will increase as the recovery in new residential construction continues, although the recovery over the next few years may be uneven and modest, and that over the longer term housing starts will begin to approach historical averages. However, the rate of recovery still remains uncertain and will depend on broader economic issues such as employment, foreclosures, house price trends, availability of mortgage financing, interest rates, income tax policy and consumer confidence. Industry analysts' forecasts for housing starts in the United States in 2013 are for a range of from 860,000 to 1,010,000 units. We currently estimate that 2013 housing starts in the U.S. will be around the middle of that range.
Demand for our products from new nonresidential construction is determined by floor space for which contracts are signed. Installation of gypsum and ceilings products typically follows signing of construction contracts by about 12 to 18 months. According to McGraw-Hill Construction's most recent construction market forecast, total floor space for which new nonresidential construction contracts were signed in the United States increased 9% in 2012 compared with 2011. This followed a 3% increase in 2011 compared with 2010 and a 12% decrease in 2010 compared with 2009. McGraw-Hill Construction forecasts that total floor space for which new nonresidential construction contracts in the United States are signed will increase approximately 5% in 2013 from the 2012 level. McGraw-Hill's forecast includes several building types which do not generate significant demand for our products; therefore, we anticipate new nonresidential construction growth in our business sectors in 2013 compared to 2012 will be in the low single digits.
The repair and remodel market includes renovation of both residential and nonresidential buildings. As a result of the low levels of new home construction in recent years, this market currently accounts for the largest portion of our sales. Many buyers begin to remodel an existing home within two years of purchase. According to the National Association of Realtors, sales of existing homes in the United States increased to approximately 4.66 million units in 2012, the highest level in five years, reflecting a 9.4% increase from the 2011 level of 4.26 million units. The seasonally adjusted annual rate of existing home sales was 5.29 million units in September 2013. This was 1.9% lower than the August 2013 rate of 5.39 million units, but 10.7% higher than the September 2012 rate of 4.78 million units. The generally rising levels of existing home sales and home resale values in 2012, and continuing into 2013, have contributed to an increase in demand for our products from the residential repair and remodel market. Nonresidential repair and remodel activity is driven by factors including lease turnover rates, discretionary business investment, job growth and governmental building-related expenditures. We currently estimate that overall repair and remodel spending in 2013 will be approximately 7% above the 2012 level. However, the recovery in the repair and remodel market also depends on broader economic issues such as employment, foreclosures, house price trends, availability of financing, interest rates and consumer confidence.
We expect improvement over the next twelve months in the construction industries in our largest international markets, primarily Canada and Mexico. Emerging markets, including those that will be included in the USG Boral Joint Venture, as discussed above under Recent Developments, provide opportunities for our operations to serve the increased demand for products in these regions, although the rate of growth in certain emerging markets has slowed.
The housing and construction-based markets we serve are affected by economic conditions, the availability of credit, lending practices, interest rates, the unemployment rate and consumer confidence. An increase in interest rates, high levels of unemployment, restrictive lending practices, a decrease in consumer confidence or other adverse economic conditions could have a material adverse effect on our business, financial condition, results of operations and cash flows. Our businesses are also affected by a variety of other factors beyond our control, including the inventory of unsold homes, the level of foreclosures, home resale rates, housing affordability, office and retail vacancy rates and foreign currency exchange rates. Since we operate in a variety of geographic markets, our businesses are subject to the economic conditions in each of these geographic markets. General economic downturns or localized downturns or financial concerns in the regions where we have operations may have a material adverse effect on our business, financial condition, results of operations and cash flows.


Table of Contents

Industry shipments of gypsum board in the United States (including gypsum wallboard, other gypsum-related paneling products and imports), as reported by the Gypsum Association, were an estimated 15.0 billion square feet in the first nine months of 2013, up approximately 7% compared with 14.0 billion square feet in the first nine months of 2012. We estimate that industry shipments in the United States for all of 2013 will be approximately 20.5 billion square feet, up approximately 6% from 19.3 billion square feet in 2012.
U.S. Gypsum shipped 3.76 billion square feet of SHEETROCK® brand gypsum wallboard in the first nine months of 2013, a 7% increase from 3.50 billion square feet in the first nine months of 2012. U.S. Gypsum's share of the gypsum board market in the United States (which includes for comparability its shipments of SHEETROCK® brand gypsum wallboard, FIBEROCK® brand gypsum fiber panels and SECUROCK® brand glass mat sheathing), based on industry shipments as reported by the Gypsum Association, was approximately 26% in the third quarter of 2013 and 27% in the first nine months of 2013, compared to 25% in the third quarter of 2012, 26% in the first nine months of 2012, and 26% in the second quarter of 2013.
There is significant excess wallboard production capacity industry-wide in the United States. Industry capacity in the United States was approximately 32.7 billion square feet as of January 1, 2013. We estimate that the industry capacity utilization rate was approximately 61% during the first nine months of 2013 compared to 57% during the first nine months of 2012, and 63% in the fourth quarter of 2012. We project that the industry capacity utilization rate will remain at approximately its current level for the balance of 2013. Despite our realization of improvement in our average wallboard selling price, we could experience pressure on gypsum wallboard selling prices and our gross margins at such low levels of capacity utilization. We plan to increase our U.S. wallboard price effective January 1, 2014 and to advise our customers of their increased price later this year. That increased price will be effective for all of 2014.


Table of Contents

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