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USG > SEC Filings for USG > Form 10-K on 3-Mar-2014All Recent SEC Filings

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Form 10-K for USG CORP


3-Mar-2014

Annual Report


Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview
SEGMENTS
Through our subsidiaries, 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 2013
• residential and nonresidential repair and remodel activity accounted for approximately 49% of our net sales,

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

• new nonresidential construction accounted for approximately 24% of our net sales, and

• other activities accounted for approximately 2% 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.
As discussed below under Discontinued Operations and in Note 3 to our consolidated financial statements in Item 8, our European business operations were classified as discontinued operations during the third quarter of 2012; therefore, the segment results for Worldwide Ceilings exclude the results of these operations. On December 27, 2012, the sale transaction was consummated and we received net proceeds of $73 million resulting in a gain of $55 million. As discussed below under Key Strategies and Recent Developments, on February 27, 2014, we contributed certain assets to the USG Boral Joint Venture, including our operations in the Asia-Pacific region.
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: In 2013, approximately 81% 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 8%.


Table of Contents

FINANCIAL INFORMATION
Consolidated net sales increased for the third consecutive year in 2013, up $346 million, or 11%, compared to 2012. We had an operating profit of $258 million in 2013 compared to $73 million in 2012. Our income from continuing operations was $48 million, or $0.44 per diluted share, in 2013 compared to an operating loss from continuing operations of $182 million, or $(1.72) per diluted share, in 2012. As of December 31, 2013, we had $952 million of cash and cash equivalents and marketable securities compared with $677 million as of December 31, 2012. Our total liquidity was $1.266 billion as of December 31, 2013 (including $314 million of borrowing availability under our revolving credit facilities) compared to $874 million as of December 31, 2012 (including $197 million of borrowing availability under our revolving credit facilities). Liquidity as of December 31, 2013 included the net proceeds of our $350 million notes offering completed in October 2013, which we used, together with cash on hand, to fund our investment in the USG Boral Joint Venture on February 27, 2014, as further discussed below under Key Strategies and Recent Developments.
KEY STRATEGIES AND RECENT DEVELOPMENTS
We continue to focus on the following strategic priorities:
• strengthen our core businesses;

• diversify our earnings by expanding in select emerging markets and growing our nonwallboard product lines; and

• differentiate USG from our competitors through innovation.

In line with our strategy to diversify our earnings, on February 27, 2014, we and certain of our subsidiaries formed a 50/50 joint venture (the "USG Boral Joint Venture") with Boral Limited ("Boral") and certain of its subsidiaries. The USG Boral Joint Venture manufactures, distributes and sells certain building products, mines raw gypsum and sells natural and synthetic gypsum throughout Asia, Australasia and the Middle East (the "Territory"). The products that USG and Boral 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.
As consideration for our 50% ownership in the USG Boral Joint Venture, we made a $513 million cash payment to Boral, which includes a $500 million base price and $13 million of customary estimated working capital and net debt adjustments, contributed to the USG Boral Joint Venture 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 granted to the USG Boral Joint Venture a license to use certain of our intellectual property rights in the Territory. We funded our cash payment with the net proceeds from our October 2013 issuance of $350 million of 5.875% senior notes and cash on hand. In the event certain performance targets are satisfied by the USG Boral Joint Venture, we will be obligated to pay Boral scheduled earnout payments in an aggregate amount up to $75 million, comprised of $25 million based on performance during the first three years after closing and up to $50 million based on performance during the first five years after closing. The cash portion of the consideration paid to Boral remains subject to customary post-closing adjustments. The USG Boral Joint Venture is targeting 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 will not pay dividends if such payments are, among other things, restricted pursuant to the terms of the credit facilities maintained by the USG Boral Joint Venture, inconsistent with the then-applicable strategic plan, or illegal.
The USG Boral Joint Venture will be operated in accordance with the terms of a shareholders' agreement. As an ongoing operation, it is our intent that USG Boral Joint Venture will be funded from its net cash flow from operations and third-party financing. Our subsidiaries in Singapore, India, Malaysia, New Zealand and Australia and our consolidated joint ventures in Oman that were contributed to the USG Boral Joint Venture had approximately $51 million in net sales and an operating loss of $3 million, and as a result of our contribution of these entities to the USG Boral Joint Venture, the net sales and operating profit (loss) attributable to these entities will no longer be included in those line items on our consolidated statement of operations. Instead, our share of the equity income from the USG Boral Joint Venture will be included separately within operating profit.
Our investment in the USG Boral Joint Venture will be accounted for as an equity method investment and initially measured at cost. Our existing wholly owned subsidiaries and consolidated variable interest entities that were contributed into the joint venture will be deconsolidated.


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 housing and 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. Based on preliminary data reported by the U.S. Census Bureau, housing starts in the United States increased 18.7% in 2013 to 926,800 compared with 780,600 in 2012. This followed a 28.2% increase in 2012 compared with 2011. For December 2013, the seasonally-adjusted annualized rate of housing starts was reported by the U.S. Census Bureau to be 1,048,000 units. While housing starts increased for the fourth consecutive year in 2013, they are still low by historical standards. Industry analysts believe that the recovery in new residential construction will continue, although the recovery over the next few years may be uneven and modest, and that over the longer term housing starts will begin to reach historical averages. Industry analysts' forecasts for 2014 housing starts in the United States included in the most recent Blue Chip Economic Indicators are 1,000,000 to 1,230,000 units, based on the average of the bottom ten and top ten forecasts including in the report, respectively. We currently estimate that 2014 housing starts in the United States will be in the range of 1,000,000 to 1,100,000.
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 5% in 2013 compared with 2012. This followed a 10% increase in 2012 compared with 2011 and a 3% increase in 2011 compared with 2010. McGraw-Hill Construction forecasts that total floor space for which new nonresidential construction contracts in the United States are signed will increase approximately 11% in 2014 from the 2013 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 2014 compared to 2013 will be in the mid-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 5.09 million units in 2013, the highest level since 2006, reflecting a 9.2% increase from the 2012 level of 4.66 million units. The rising levels of existing home sales and home resale values have contributed to an increase in demand for our products from the residential repair and remodel market in 2013. We currently estimate that overall repair and remodel spending in 2013 increased approximately 7% over the 2012 level and that overall repair and remodel spending growth in 2014, compared to 2013, will be in the mid-single digits.
However, the rate of recovery in the new residential construction market, new nonresidential construction market and the repair and remodel market 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, consumer confidence, lease turnover rates, discretionary business investment, job growth and governmental building-related expenditures.
We expect improvement over the next twelve months in the construction industries in our largest international markets, Canada and Mexico. Emerging markets, including those that will be included in the USG Boral Joint Venture, as discussed above under Key Strategies and 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, operating results 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.


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During the last several years, our results of operations have been adversely affected by the economic downturn and uncertainty in the financial markets. Although our North American Gypsum segment has improved in connection with increased activity in residential housing in 2012 and 2013, it continued to be adversely affected by the low level of residential and other construction activity compared to historical averages. Our Building Products Distribution segment, which serves the residential and commercial markets, and our Worldwide Ceilings segment, which primarily serves the commercial markets, have both showed some improvements, however, they continued to be adversely affected by the low levels of new commercial construction activity.
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 20.9 billion square feet in 2013, up approximately 8% from 19.3 billion square feet in 2012.
U.S. Gypsum shipped 5.14 billion square feet of SHEETROCK® brand gypsum wallboard in 2013, a 9% increase from 4.72 billion square feet in 2012. SHEETROCK® Brand UltraLight Panels accounted for approximately 55% of that volume. 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, was approximately 26% in 2013, unchanged from 2012. There is 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, 2014. We estimate that the industry capacity utilization rate was approximately 73% during the fourth quarter of 2013 and approximately 64% during the full year 2013 compared to approximately 63% during the fourth quarter of 2012 and approximately 58% during the full year 2012, respectively. Based on current industry trends and forecasts, demand for gypsum wallboard is expected to increase in 2014, but the magnitude of any increase will be dependent primarily on the levels of housing starts and repair and remodel activity. We project that the industry capacity utilization rate will experience a modest increase in 2014 compared to 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. In early 2014, as it did in 2013 and 2012, U.S. Gypsum implemented a price increase for wallboard with the new price being set for the year. However, it is uncertain that we will be able to maintain the increase in our gypsum wallboard selling prices. If we are unable to maintain our prices increases, our net sales and operating profit may be materially and adversely impacted.
RESTRUCTURING, IMPAIRMENTS AND OTHER INITIATIVES Since January 2007, we have temporarily idled or permanently closed approximately 3.8 billion square feet of our highest-cost wallboard manufacturing capacity and our gypsum quarry and ship loading facility in Windsor, Nova Scotia, Canada. We have eliminated approximately 4,830 salaried and hourly positions from 2007 to 2012. As part of our efforts to reduce the cost structure, we closed a total of 125 distribution branches during that same timeframe. We continue to monitor economic conditions in our markets and will adjust our operations as needed.
Historically, the housing and other construction markets that we serve have been deeply cyclical. Downturns in demand are typically steep and last several years, but they have typically been followed by periods of strong recovery. If the current recovery results in increases in demand similar to those realized in recoveries from past cycles, we believe we will generate significant cash flows when our markets fully recover. However, this recovery could be slower than recoveries in the past, as the most recent downturn was especially steep. We regularly monitor forecasts prepared by external economic forecasters and review our facilities and other assets to determine which of them, if any, are impaired under applicable accounting rules. If the recovery in our markets is delayed, or we experience a future downturn in the housing and construction-based markets, material write-downs or impairment charges may be required in the future. The magnitude, likelihood and timing of those possible charges would be dependent on the severity and duration of the downturn, should the downturn materialize, and cannot be determined at this time. Any material restructuring or impairment charges, including write-downs of property, plant and equipment, would have a material adverse effect on our results of operations and financial condition. We will continue to monitor economic forecasts and their effect on our facilities to determine whether any of our assets are impaired.
Our focus on costs and efficiencies, including capacity closures and overhead reductions, helped to mitigate the effects of the most recent downturn in all of our markets. As economic and market conditions warrant, we will evaluate alternatives to further reduce costs, improve operational efficiency and maintain adequate liquidity. Actions to reduce costs and improve efficiencies could require us to record additional restructuring charges. See Liquidity and Capital Resources below for information regarding our cash position and credit facilities.


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Consolidated Results of Operations

                                                                           Favorable (Unfavorable)
                                                                     2013 vs. 2012          2012 vs. 2011
(dollars in millions, except
per-share data)                 2013        2012        2011          $          %          $          %
Net sales                     $ 3,570     $ 3,224     $ 2,910     $   346        11  %   $  314        11  %
Cost of products sold           2,989       2,829       2,752        (160 )      (6 )%      (77 )      (3 )%
Gross profit                      581         395         158         186        47  %      237       150  %
Selling and administrative
expenses                          320         304         289         (16 )      (5 )%      (15 )      (5 )%
Restructuring and long-lived
asset impairment charges            3          18          75          15        83  %       57        76  %
Operating profit (loss)           258          73        (206 )       185         *         279         *
Interest expense                  203         206         211           3         1  %        5         2  %
Interest income                    (3 )        (4 )        (6 )        (1 )     (25 )%       (2 )     (33 )%
Loss on extinguishment of
debt                                -          41           -          41         *         (41 )       *
Other (income) expense, net        (1 )         -          (1 )         1         *          (1 )    (100 )%
Income (loss) from continuing
operations before income
taxes                              59        (170 )      (410 )       229         *         240        59  %
Income tax expense (benefit)       11          12         (14 )         1         8  %      (26 )    (186 )%
Income (loss) from continuing
operations                         48        (182 )      (396 )       230         *         214        54  %
Income (loss) from
discontinued operations, net
of tax                             (2 )         2           6          (4 )       *          (4 )     (67 )%
Gain on sale of discontinued
operations, net of tax              -          55           -         (55 )       *          55         *
Net income (loss)                  46        (125 )      (390 )       171         *         265        68  %
Less: Net income (loss)
attributable to
noncontrolling interest            (1 )         1           -           2         *          (1 )       *
Net income (loss)
attributable to USG           $    47     $  (126 )   $  (390 )   $   173         *      $  264        68  %
Diluted earnings (loss) per
share - continuing operations $  0.44     $ (1.72 )   $ (3.81 )   $  2.16                $ 2.09

* not meaningful

NET SALES
Consolidated net sales in 2013 increased $346 million, or 11%, compared with 2012. This was our third consecutive year-on-year increase. Net sales increased 15% for our North American Gypsum segment, 4% for our Worldwide Ceilings segment and 9% for our Building Products Distribution segment. The higher levels of net sales for North American Gypsum and Building Products Distribution primarily reflected increased selling prices and higher volume for U.S. Gypsum's SHEETROCK® brand gypsum wallboard. The higher level of net sales for Worldwide Ceilings primarily reflected an increase in net sales for USG International and USG Interiors, primarily driven by higher selling prices for ceiling tile and grid and higher volume for ceiling grid.
Consolidated net sales in 2012 increased $314 million, or 11%, compared with 2011. This was our second year-on-year increase in net sales since 2006. Net sales increased 16% for our North American Gypsum segment, 3% for our Worldwide Ceilings segment and 8% for our Building Products Distribution segment. The higher level of net sales for North American Gypsum and Building Products Distribution primarily reflected increased volume and selling prices for U.S. Gypsum's SHEETROCK® brand gypsum wallboard. The slightly higher level of net sales for Worldwide Ceilings primarily reflected an increase in net sales for USG International and USG Interiors.
GROSS PROFIT
Gross profit was $581 million in 2013, $395 million in 2012 and $158 million in 2011. Gross profit as a percentage of net sales was 16.3% in 2013, 12.3% in 2012 and 5.4% in 2011. The higher percentage for 2013 compared with 2012 was primarily due to higher selling prices for U.S. Gypsum's SHEETROCK® brand gypsum wallboard. The higher percentage for 2012 compared with 2011 was primarily driven by higher selling prices and lower per unit manufacturing costs for U.S. Gypsum's SHEETROCK® brand gypsum wallboard.
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses totaled $320 million in 2013, $304 million in 2012 and $289 million in 2011. The increase for 2013 compared with 2012 primarily reflected increased employee compensation and benefits, marketing expenses related to our new brand roll-out and higher information technology costs, partially offset by lower expense related to our incentive plans. The increase for 2012 compared with 2011 primarily reflected increased expenses related to our incentive plans driven by improved operating results in 2012. As a percentage of net sales, selling and administrative expenses were 9.0% in 2013, 9.4% in 2012 and 9.9% in 2011. The year-over-year decrease in the percentage for 2013 compared with 2012 was primarily attributable to the higher level of net sales partially offset by the increased costs described above. The year-over-year decrease in the percentage for 2012 compared with 2011 was attributable the higher level of net sales partially offset by higher incentive compensation in 2012.


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RESTRUCTURING AND LONG-LIVED ASSET IMPAIRMENT CHARGES
In recent years, we implemented restructuring activities and, as a result, recorded restructuring and long-lived asset impairment charges of $3 million in 2013, $18 million in 2012 and $75 million in 2011. These charges primarily related to the temporary idling or permanent closure of production facilities, the permanent closure of a gypsum quarry and ship loading facility, the closure of distribution branches and salaried workforce reductions. Total cash payments charged against our restructuring reserve in 2013 amounted to $12 million. We expect future payments to be approximately $3 million in 2014, $3 million in 2015 and $5 million after 2015. On a segment basis, $8 million of all expected future payments relate to Building Products Distribution, $1 million to North American Gypsum and $2 million to Corporate. All restructuring-related payments in 2013 were funded with cash on hand. We expect that the future payments will be funded with cash from operations or cash on hand.
See Note 12 to the consolidated financial statements for additional information related to restructuring and long-lived asset impairment charges and restructuring reserves.
INTEREST EXPENSE
Interest expense was $203 million in 2013, $206 million in 2012 and $211 million in 2011. Lower interest expense in 2013 primarily reflects the favorable impact of (a) the conversion of $325 million of our 10% convertible senior notes into common stock in December 2013 resulting in a decrease of $3 million of interest expense, (b) an increase in the amount of interest capitalized in 2013 compared to 2012, driven by higher capital expenditures, which resulted in a decrease of . . .

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