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Executives

James R. Bencomo - Director of Investor Relations and Pension Investments

William C. Foote - Chairman and Chief Executive Officer

D. Rick Lowes - Senior Vice President and Controller

Richard H. Fleming - Executive Vice President and Chief Financial Officer

Analysts

Garik Shmois - Longbow Research

Daniel Oppenheim - Credit Suisse

Kenneth Zener - Macquarie Capital Securities

Kathryn Thompson - Avondale Partners

Dennis McGill - Zelman & Associates

Michael Rehaut - JPMorgan

John Baugh - Stifel Nicolaus

Jim Barrett - CL King & Associates

Todd Vencil - Davenport & Company Llc

Mark Weintraub - Buckingham Research Group

Jack Kasprzak - BB&T Capital Markets

Trey Grooms - Stephens, Inc.

USG Corp. (USG) Q1 2009 Earnings Call April 21, 2009 11:00 AM ET

Operator

Good morning ladies and gentlemen and welcome to the USG Corporation First Quarter 2009 Earnings Conference Call. At this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.

I will now turn the call over to Mr. James Bencomo, Director, Investor Relations and Pension Investment. Mr. Bencomo, you may begin.

James R. Bencomo

Thank you, Kim. And good morning and welcome to USG Corporation's first quarter 2009 earnings conference call and live webcast. We will be using a slide presentation in conjunction with our call today. It is available by going to the Investor Information section of our website www.usg.com and clicking on the link to the webcast.

Before we proceed, let me remind you that certain statements in this conference call may be forward-looking statements under Securities laws. These statements are made on the basis of management's current views and assumptions about business, market and other conditions and management undertakes no obligation to update these statements. The statements are also subject to a number of factors, including those listed at the end of today's press release and actual results may be different from our current expectations.

With me today to discuss our results and our outlook are Bill Foote, USG's Chairman and CEO; Rick Fleming, Executive Vice President and CFO; and Rick Lowes, Senior Vice President and Controller. Rick will be substituting for Jim Metcalf, USG's President and COO, who is away attending a funeral today.

First, Bill will comment on market conditions and the outlook for our businesses. Rick Lowes will follow with comments on how our operating units are performing and Rick Fleming will conclude with some additional comments on our results and discuss how we are managing our balance sheet and liquidity. We will then open up the call for questions and conclude with a few comments from Bill.

We would like to ensure that everyone has an opportunity to ask questions. So when we get to the Q&A session, callers are asked to limit themselves to one question and one follow-up. Our goal is to be completed within an hour. So let's get started, Bill.

William C. Foote

Thanks Jim, and good morning everyone. Thanks for taking the time to join the call this morning. We appreciate your continuing interest in USG.

The first quarter was another difficult period for the economy and for our businesses. New housings starts hit record lows. Repair and remodeling activity declined further, commercial construction continued the decline that began in the second half of last year and international market generally weakened as well.

Despite these extremely challenging external factors however, this is the first time in the past eight quarters that we are reporting operating results that are better then the comparable quarter one year earlier. I don't mean to make too big deal out of it. And I and team are keenly aware of the fact that we still lost money this quarter and I am not suggesting that we're out of the woods. We most certainly are not. But I am pleased to see that the aggressive actions we have taken throughout the prolonged downturn are evident in our results.

By focusing on the factors within our controllables we have been able to post better results in a deteriorating market. Company wide, our first quarter sales were down significantly compared with the first quarter of last year; about 26% or 300 million. Yet results improved substantially. We cut the operating loss by 30%. For those of you that have been following our performance and our strategy during the downturn, you know that we have focused on customer satisfaction, cost control, operational efficiency, scaling our operations to match market conditions and managing our liquidity. And we're succeeding in each of those areas.

Customer satisfaction performance remains very high. Overhead expenses are significantly lower. For example, we reduced SG&A expenses by 22% in the first quarter compared to the first quarter of last year. That's savings of almost 22 million. We are running our plant network efficiently. We have scaled our operations to market by closing or curtailing wallboard lines, papermills and distribution centers. And we continue to manage our liquidity well.

As we expected the businesses were net users of cash in the first quarter as they usually are, but our cash flow improved and we are comfortable with our liquidity position. Rick Fleming will go into this in greater detail later.

So against the back drop of very weak market conditions the controllables in our businesses are headed in the right direction and our actions to date are positively impacting our results. Like every other company, we are looking for signs of a turnaround in our markets. At this point, there is no hard data that we can point to that will give us confidence that we have reached the bottom. But there are ample (ph) signs that things might be improving.

Some of that -- for example, some of the hardest hit housing market are starting to see active sales. Foreclosed homes are being purchased or moved from the inventory of unsold homes. That's a positive development, but to keep this in perspective, the inventory of unsold and foreclosed homes remains high and will need to be absorbed before we can get a meaningful recovery in housing.

Also in the recent weeks, two of the big publicly traded homebuilders agreed to merge and a third homebuilder successfully accessed the capital markets with a $400 million debt offering. This is the first time in roughly two years that we've seen this kind of activity in the capital markets, in homebuilding.

As I said, these factors are not solid evidence that recovery is at hand, but they are positive signals. While the future's direction of the market remains uncertain we are confident that our efforts to reposition the company during the severe contraction are taking us in the right direction.

Our first quarter results demonstrate that the strategies are working. Obviously, we are not yet where we want to be but we're working hard to return the company to profitability and we can and will take further actions if the market conditions dictate.

Now, I'd like to turn the call over to Rick Lowes, our Controller for more a detailed discussion our business results in the first quarter.

D. Rick Lowes

Thank you, Bill. Hello everyone. I'm filling in for Jim today.

Before I comment on our operations, I like to start with an outstanding statistic that everyone in this company is particularly proud of. In the first quarter of 2009, our U.S. manufacturing operations set an all time company record for safety performance. Our manufacturing units operate about (ph) by a single last time or restricted duty accidents. This is a remarkable achievement and further evidence that we are keenly focused on controllable factors in our operations.

Now I will talk about the performance of each of our major business units, starting with United States Gypsum Company. As you all know, we are operating in a market that is at its historic lows. Taking just one example, new housing starts are now in the 525,000 range compared to a peak annualized level in excess of 2 million units.

We have taken dramatic action to adapt to these conditions. Financial performance at our North American Gypsum business is clearly benefiting from our actions, in prior quarters to remove cost and resize the business in accordance with the market opportunity.

Shipping volumes declined in U.S. in the first quarter, compared to prior quarter and last year's first quarter. United States Gypsum Company shipped 1.3 billion square feet of wallboard in the quarter just ended, compared to 1.44 billion square feet in the fourth quarter and 2.1 billion square feet in the first quarter a year ago.

Despite the lower volume our wallboard price continued to improve. It was up 2%, compared to the last quarter and 16% versus the first quarter a year ago. The average wallboard price for US Gypsum was $121.42 in the first quarter of this year, compared to $118.98 last quarter and $104.41 a year ago.

By removing cost and scaling the business appropriately, US Gypsum Company was able to cut its operating loss by 41 million, compared to the first quarter of last year. The operating loss this quarter was 21 million, compared to 62 million a year ago.

During the first quarter, spread improved, customer satisfaction metrics remained strong, efficiency measures remained high. And as I said earlier, safety performance was outstanding. Other product lines within this business felt the impact of the recession but performed better than the overall market.

Total sales of performance services, including our joint compound products were down about 18% compared to the first quarter last year. Gross profit declined by substantially smaller amount, largely due to the same cost control focus applied to our other businesses. Total sales of performance substrates, which include DUROCK and FIBROCK products fell by about 19% in the quarter, compared to first quarter last year.

LEVELROCK volume products performed well and the product continues to increase market share and post strong margins. Our services and substrates products are benefiting from our excellent customer relationships and strong brand names.

Now I'll discuss our distribution business, L&W Supply which serves both the residential and non-residential construction markets. The positive impact of our cost reduction programs is evident in the improvement in profitability versus the fourth quarter of 2008, despite weaker levels of demand. Also offsetting weaker levels of demand was a modest improvement in wallboard price. Wallboard volumes at L&W were down by about 34% in the first quarter compared to the first quarter last year.

Sales in complementary products, many of which are typically directed to the commercial market declined in the quarter compared to the first quarter of last year, but performed comparatively better than the wallboard side of the business. Overall, sales of the complementary products declined about 26%. Our ceiling sales declined less than 14%.

Next, I'll review the performance of our ceilings business. We have seen signs of contraction in the commercial construction market, but the contraction is developing slowly. At USG Interiors, the domestic segment, sales in the first quarter were down about 17 million or 13% compared to the same quarter last year. That's not bad considering the commercial market was still quite strong in the first half of 2008.

Operating profit declined a relatively modest 2 million reflecting the positive impact of our cost control initiatives in this business unit.

Turning now to the international markets, our businesses felt the impact of lower global demand and the strong U.S. dollar in the first quarter. Markets in Canada and Mexico are following the U.S. in to recession. We have implemented cost reduction programs and are prepared for weaker economic conditions in both markets.

In Canada, weak housing demand in the first quarter and excess supply put downward pressure in our wallboard price. Wallboard shipments declined over 9% compared to the first quarter of last year. We've also experienced a contraction in the Mexican wallboard market and decline in operating profit from both 4 million in the first quarter of last year to 2 million in the first quarter of this year.

Our operations in Europe, Latin America and Asia Pacific all posted positive results for the first quarter despite a contraction in demand. All of our international operations have the same intense focus on cost control as our domestic operations. Overhead spending in international operations decreased by 17% in this year's first quarter, relative to first quarter of last year. We will continue to see cost reduction opportunities in all regions.

Looking back at the quarter, it is clear that our ongoing efforts to resize the company and cut costs are succeeding. Market conditions were considerably worst than last year yet the results have improved. We are not satisfied reporting the losses, but we are pleased that some of the trends have gotten better.

Our costs control efforts are working; we're carefully balancing price and volume in each of our businesses to improve operating results and we're achieving our customer satisfaction metrics. The end result is that our controls are headed in the right direction. We still have work to do to return to profitability and we are committed to do what it takes to achieve that goal.

Now, I'd like to turn the call over to Rick Fleming, for a more detailed discussion of our financial performance and our efforts to manage liquidity during the downturn.

Richard H. Fleming

Thanks Rick. As indicated I'll provide some details on our first quarter financial results, including some comments on how we're managing our finances during these difficult market conditions, but first I'll recap the numbers.

First quarter 2009 net sales were $864 million, down 26% from the first quarter of 2008 net sales level of $1.165 billion. Our first quarter operating loss was $42 million, including $10 million of restructuring and asset impairment cost.

Last year's first quarter we reported an operating loss of $60 million which included $4 million in restructuring charges. Trading net earnings, the first quarter of 2009 net loss was $42 million compared to the net loss of $41 million in last year's first quarter. On EPS basis our net loss per diluted share was $0.42 for the first quarter based on average diluted shares outstanding of 99.2 million.

Last year's first quarter net loss per share was also $0.42. As mentioned, the first quarter 2009 results included restructuring and asset impairment cost of $10 million; $7 million of this was related to the write downs of leasehold improvements, and other costs associated with the reductions in the amount of leased space in our corporate headquarters. The balance of these restructuring charges related to some remaining costs for last year's work force reductions and idling and closing of several manufacturing facilities.

On after tax basis, the first quarter 2009 restructuring and impairment charge was $7 million or $0.07 per share. The first quarter net loss also reflected the benefit of reversing the remaining $10 million of embedded derivative liability related to our convertible senior notes as a result of the approval of the conversion feature of the notes by our stockholders in February. The after tax income of that we guided was $7 million or $0.07 per share.

Regarding our operating performance, both Bill and Rick have highlighted for you that we have made real progress toward our goal of achieving positive cash flow after interest and CapEx. This has been challenging, given that demand for our products and therefore our sales has been falling sharply. There's still way to go but we will be relentless in achieving this objective.

And we're not looking for any help from the marketplace this year, instead we believe we must achieve this goal the old fashion way by taking care of our customers, aggressively managing business unit profitability and managing our costs and capital spending to the penny.

Now I'll add details in the rest of P&L and discuss what we've done to manage capital spending and our balance sheet including liquidity. I will start with interest expense. Interest expense for the first quarter was $42 million, including $7 million in write-offs of deferred financing fees.

We are currently anticipating that our annual interest expense would be about $150 million for all 2009 on a P&L basis and about $138 million on a cash basis. The effective tax benefit rate was 43.6% for the first quarter of 2009, which compared to the rate of 44.1% in last year's first quarter.

Looking ahead to the full year, we're anticipating more normal tax benefit rate of approximately 39% depending on the mix of worldwide income. As a reminder, we have a significant net tax loss carry forward and therefore our cash taxes will be very low in the next few years.

Turning to capital spending; Capital expenses totaled $60 million in the first quarter of 2009, compared to $105 million in the same quarter of last year. CapEx is another area where we've made significant adjustments to match our spending to the current environment.

As you know, we have made major investments in our operations over the past several years. And as such we feel comfortable reducing capital spending in 2009 to approximately $50 million. This is reduction of a $188 million from the 2008 level.

Regarding our cash and debt situation, our cash balance excluding restricted cash as of March 31 was $223 million compared with $471 million at the end of 2008. This decrease in cash of $248 million reflected poor principal uses of cash during the quarter. $190 million was used to repay all the borrowings under our old unsecured revolving credit facility, which was amended and restated in January. Cash interest payments totaled $27 million, as mentioned CapEx was $60 million and $21 million of cash collateral was provided to derivative counterparties, primarily as result of changes in value of our natural gas hedges. It's important to note that this a timing issue, since a majority of this collateral relates to hedges that expired this year.

Total debt was $1.645 billion as of March 31, compared to $1.836 billion at the end of 2008. The reduction in debt reflected repayment in early January, of filings (ph) on the old unsecured revolving credit facility. We currently have nothing borrowed on the new secured credit facility. This new facility is subject to a borrowing base and $206 million is effectively available to us at the end of March, after taking on account, outstanding letters of credit and minimum availability requirement.

This borrowing capacity, when combined with our cash on hand resulted in $429 million of liquidity at the end of first quarter. In addition, we are continuing to add to our liquidity through various actions, including the following. Working capital reductions are targeted in the magnitude of 25 to $30 million for this year.

The second tranche of our ship (ph) financing is targeted to provide 25 to $30 million of additional liquidity. A proposed credit line for CGC, our Canadian subsidiary, which is in the work is presently been sized at about $25 million, which is C$30 million.

And surplus asset sales that total 50 to $100 million over two years and presently have expressions of interest from interested buyers for over $35 million of these assets. So in total, these actions could add over $100 million to our liquidity, using the low-end of our range of estimates.

In summary, these are truly extraordinary times for our industry. The market's analyzed level of housing starts was 510,000 units. This level represented a decline of 75% on the peak start of 2.07 million in 2005. It's also more than 45% more than previous worse fiscal downturn which was 1991, when starts fell 44% from 1.8 million to 1 million units.

In addition to the weakness in housing, we are also seeing an unprecedented weakness in the current modeling, a statement that that we can't recall ever experiencing negative growth for more than one year; much less, three or four years. And as we discussed, the commercial market is now under pressure.

In this environment, we have taken decisive actions to reduce cost, right size the company to current demand levels and increased cash flow. We have lowered our breakeven levels significantly and we believe that we have the liquidity to manage through this extreme downturn.

We don't have today as much demand for our products, but that will change eventually. And when the upturn in the economy finally arrives, we will be lean and mean and extraordinarily well positioned to capture the profitability and cash flow that comes with recovery.

Now we'll be happy to answer any questions you may have.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions). Our first question comes from Daniel Carusco (ph) from Hain Capital. Please go ahead.

Unidentified Analyst

Good morning. Yesterday Lennar filed an 8-K stating that it had been named as a defendant in a case against builders, distributors and manufacturers of Chinese Drywall. It's called Go See et all versus Lennar Corporation et all (ph). News stories pointed to this suit as the main reason Lennar stock dropped about 900 basis points, more yesterday than other builders dropped. This seems to be a major class action. I searched your SEC filings and while USG is the other major U.S. Corporation named in this case, I did not see that you filed an 8-K yet as a result of this suit. When do you expect to file one like the other major U.S. defendant Lennar did?

William Foote

This is Bill Foote. Let me add some bright color on this. I think in our last filing, we mentioned that we had several suits and we will keep it up to date. But let me first give you a broad view of this matter. USG, we have indeed been named of this defendant in several suits. The defective wallboard has a bad odor and is reported to across corporate services growth (ph).

The board was manufactured in China and imported into Florida and the Southeast when domestic wallboard was in very short supply, back in the 2005 timeframe. Let me stress there are absolutely no problem with SHEETROCK brand wallboard, the board that we make in this country. And we, USG did not make any wallboard in China.

L&W, our distribution company did import a small amount of Chinese board from Knauf Tianjin, which is part of the Knauf family of companies based in Germany. L&W's total shipments of Knauf Tianjin board was less than half of 1% of all L&W shipments in Florida in 2006. This is a product problem. It's not a delivery problem. And we expect Knauf and the other Chinese manufacturers to solve it.

Unidentified Analyst

Okay. This is follow-up, if I may. On page 81 of your K you point out that your wholly owned distribution, you just mentioned you sold Chinese manufactured wallboard, is it -- is that contained only to Florida or is that national issue or in several states? And in which years and in what quantities if you know, did you sell the Chinese manufacturer wallboard through your distributor? Thank you.

William Foote

Let me repeat it. It was about half of 1% of our shipments in Florida. And the board was essentially on our Florida, there may have been a bit in other, few other Southeastern states, but the bulk was in Florida.

Unidentified Analyst

Thank you.

Operator

Our next question comes from Garik Shmois from Longbow Research.

Garik Shmois - Longbow Research

Hi thank you. Good quarter. My first question is the 125 million in cost savings that you had announced and started to implement last year, is that fully reflected in the figures or is there still some more cost savings from that program that yet have to be put through?

D. Rick Lowes

The majority of the account cost savings for that program have been in place by the end of first quarter, there is still a little bit to go. But we're continuing to focus on cost savings in all aspects of our business.

Garik Shmois - Longbow Research

Okay. And can you just walk me through, in the U.S. gypsum segment how you were able to improve profitability, $41 million from last year? Some of that would have been SG&A reductions, could you break it down SG&A versus perhaps variable costs?

D. Rick Lowes

Sure, obviously we're very pleased with that result. One of the big things we did in United States Gypsum Company was get the price up year-over-year and you see our price numbers, that's been a big impact. We focused on SG&A that stars significantly in all our business, including United States Gypsum Company. We really carried back all our other costs and spending on IT initiatives, new product development, new business ventures and research.

We've been focused on every cost in this company, we've closed higher cost lines. So, it's a combination of lot of higher work that's showing in the results.

Garik Shmois - Longbow Research

Okay and can you just talk about cost trends going forward what you're anticipating for energy this year and perhaps for paper?

D. Rick Lowes

We have seen some positive results in the first quarter this year on waste paper. We anticipate that will continue. We haven't seen the true impact of the energy right now as we are 50% hedged at around $9.60.

Garik Shmois - Longbow Research

Sure.

D. Rick Lowes

That will roll off as the year progresses and then we'll start to take advantage of energy side.

Garik Shmois - Longbow Research

Okay. Thank you very much.

Operator

Thank you. Our next question comes from Dan Oppenheim from Credit Suisse. Please go ahead.

Daniel Oppenheim - Credit Suisse

Great, thanks very much. I was wondering if you can talk just along those lines little bit more about the cost, I think is impressive what you doing to mitigate declines on the volume side here. As you look through towards the rest of reminder of this year, what are you targeting in terms of just, what areas for reducing cost 90% of do you think is going forward in terms of the operation side and also SG&A?

D. Rick Lowes

We're committed to returning this company to profitability. So we're focused on every cost throughout the organization. We started this in 2006, continued through 2007 and in 2008. So I think you can see a continuation of the same trends you seen in the past.

Daniel Oppenheim - Credit Suisse

Okay, but, how much more you can get out of it?

D. Rick Lowes

I have got no exact number. But obviously we've taken out about today about 400 million and we've been very focused in this area. So we'll continue to look at every cost we have in this company and make the adjustments.

Richard Fleming

This is Rick Fleming. We haven't set a target yet for any additional cost reductions but we've a number of opportunities. I will be happy to talk to you in more detail if you like to after the call. But I can say that we are looking at everything.

Daniel Oppenheim - Credit Suisse

Thanks very much.

Operator

Our next question comes from Ken Zener from Macquarie Capital. Please go ahead.

Kenneth Zener - Macquarie Capital Securities

Good morning.

William Foote

Yes.

Kenneth Zener - Macquarie Capital Securities

The items that you've outlined that were improving your cost savings, obviously price going up year-over-year, IT, new product, cutting some research, how would you kind of quantify that quarter-to-quarter though, because of the $125 million in savings annualized, if I would assume 30 million a quarter, how much of that kind of played into the wallboard part of the business as opposed to these other items?

Richard Fleming

The pricing you can get pretty easily by just taking the difference in price times volume. So I can give you that piece of puzzle. On the cost side savings, wallboard is a big part of our business. A good rule of thumb would be about half the savings went to the wallboard side of the business.

Kenneth Zener - Macquarie Capital Securities

Okay. And then for the ceiling margins, you mentioned price and cost savings, what was kind of a balance there given that margin stayed flat, given the quite weak revenue line?

William Foote

Well, it is a very weak market and again the same focus on cost reduction that we've seen and just as you're seeing on the ceiling business and that and the L&W business and our International business, so its cost aligned. But, we have an ongoing objective to get paid for the value that we provide.

Kenneth Zener - Macquarie Capital Securities

Okay. How much more do you think cash is expected to these derivative counterparties if gas were to stay at its current level?

Richard Fleming

Sure, this is Rick Fleming. Let me give you a little bit of background on the natural gas program and then I'll answer your question. First of all, as you know, we are generally a catcher of our natural gas requirements. We tend to do it on a rolling 12 month basis, depending upon our view of the market, we tend to have a hedge ratio of 50% up to as high as 90%. And given the fact that we felt the market was getting very soft, we have been more in that 55 to 56% category going in to this year for our hedging program.

Our hedges were placed last year at prices that were much higher than today because as you know, gas went all the way up to 12 bucks, but we never bought it at that level but we did as Rick mentioned, putting our hedges at about 960 for what we did do. So about -- roughly about 45% is unhedged and 55% is hedged for this year.

The majority of these hedges all expire during the course of the year. The collateral that's related with the hedges that will be therefore effectively returned when the hedges expire; is about $44 million. It comes in about a pro rata level in each of the next three quarters.

Kenneth Zener - Macquarie Capital Securities

Okay. And if you can make one last comment...

Richard Fleming

Right. By the way it's about 360 is below the cost of reduction, once again, the hedges are about 960. so we don't think there's going to be a lot more downward pressure on gas but, I've learn't one thing over the years never tried to predict it.

Kenneth Zener - Macquarie Capital Securities

It is volatile. And then, could you just comment on the industry operating -- the cash cost given that, obviously capacity has been coming out of the industry. Thank you.

Richard Fleming

Yes. Once again this is the number we shared with you in the past but we believe that cash breakeven or the highest cost plans in this industry are about $130 a thousand. And we've disclosed that number in the past, as mentioned, prices right now are still below that level.

Kenneth Zener - Macquarie Capital Securities

Thank you.

Operator

Our next question comes from Kathryn Thompson from Avondale Partners. Please go ahead.

Kathryn Thompson - Avondale Partners

Hi, thank you. Could you give an update on industry capacity utilization? Your current capacity utilization and also your outlook on taking out additional capacity within your network and for the industry?

D. Rick Lowes

The industry capacity utilization in ours are very similar, they were both in the low 50s right now. And that's an obviously extremely weak environment. We've made a lot of adjustments to capacity in the last several years. We've taken a 3 billion square feet of our idled capacity and curtailed another 3 billion square feet. We'll continue to adopt the business conditions that we're presented with.

Kathryn Thompson - Avondale Partners

And what are you future plans for taking out additional capacity and do you see any other industry participants taking out additional capacity?

D. Rick Lowes

Given these low levels of utilization, you can anticipate that the industry as a whole will need to take out some capacity. We are not in a position right now to announce any further capacity reductions.

Kathryn Thompson - Avondale Partners

Is that something it's not out of the question going forward?

D. Rick Lowes

And there is no adjustments and no other questions going forward.

Kathryn Thompson - Avondale Partners

Assuming trends are unchanged for the next six to nine months. How much capacity in your opinion need to come out of the industry as a whole in order to get back to a 70% to 75% utilization rate?

D. Rick Lowes

You have to do the math on that. I mean right now the industry -- the industry capacity is around 35 billion square feet. We expect that the industry will ship around 20 billion square feet, so you can do the math and figure out how much of that needs to get to be very substantial.

Kathryn Thompson - Avondale Partners

Okay.

D. Rick Lowes

Given no change in demand.

William Foote

Another 7 billion feet to get down to that level.

D. Rick Lowes

7 billion square feet.

Kathryn Thompson - Avondale Partners

In the previous call, you had a nice break out of your expectations about end market, residential housing, repair modeling and commercial, could you review those and just to just that we can understand that if there has been any change in expectations from those three markets?

Richard Fleming

Sure. I'll happy to. I think the last time we told you we thought housing stats to be around 650,000 units. We're now looking at a number that is lower than that given the trends of the first quarter and down the 550 to 600,000 range. Our repayment of Asian market, we thought it would be down, somewhere between 7% and 10% we're still operating within that assumptions this year so far. And we also believe the commercial construction will be down around 20% to 25% and that is unchanged in our view of the first quarter, so down in all the markets.

Kathryn Thompson - Avondale Partners

A final question, any thoughts on the spring price increases are being passed soon in the market?

Richard Fleming

We don't comment on any future price increases.

Kathryn Thompson - Avondale Partners

Or they're just pass through which your thought on the feasible (ph) being successfully pass through?

Richard Fleming

Well, we have an ongoing objective to get paid for the value we are providing, and I can tell you we've now lost our focus on getting price improvement.

Kathryn Thompson - Avondale Partners

Okay.

Richard Fleming

But it's a very difficult environment, $1 or $2 at a time.

Kathryn Thompson - Avondale Partners

Okay. Thank you so much.

Operator

Our next question comes from Dennis McGill from Zelman & Associates. Please go ahead.

Dennis McGill - Zelman & Associates

Good morning guys, thank you.

William Foote

Good morning, Dennis.

Dennis McGill - Zelman & Associates

Hey, I was hoping you could may be tell a little bit more on the ceiling margins, I know you touched on it. But just trying to think about it in terms of where you were in the fourth quarter and what might have been included in the margin there that kind of got reversed out aside from cost cuts? And then kind of in a same way what's been happening with pricing on the ceiling cost?

Richard Fleming

Well as you saw in our fourth quarter results are pretty weak in the ceilings business, it got impacted by the really a break down in the financial banking system and inventories are pulled back. A lot it was volume related, we had very low volumes in the fourth quarter versus the first quarter. And a lot of this is just cost cutting, we have -- we've got margin improvement in all our product lines this year in the ceilings business and that continued in the first quarter.

Dennis McGill - Zelman & Associates

Would you say the improvement sequentially was more driven by cost cutting or kind of a resale of its channel on the bottom side?

Richard Fleming

A little bit of both, but mainly by cost cutting. But again there was a refill of the channel in the first quarter.

D. Rick Lowes

In general product level margins for manufacturing costs improved quarter-on-quarter, for example, grid improved due to the lower steel cost.

Dennis McGill - Zelman & Associates

Okay. Would do you expect moving forward, that you'll have to offset some of the volume this quarter? I know that this was -- that you have some benefit of pull forward that are rolled through in the back half of the year or is that just pay back for the fourth quarter?

Richard Fleming

I think what we continue to focus on the margins of this business, obviously with the market weakening we have to -- it's a tough business environment. But, I think you can see the continuation right now what you see in the first quarter.

Dennis McGill - Zelman & Associates

Okay. And I think you gave us a little bit to work with on the wallboard as far as L&W's exposure. Can you tell us what half of 1% is, what would be in board port fee?

D. Rick Lowes

It would be, it's hard to pin down, its several hundred thousand feet but it -- in that level.

Dennis McGill - Zelman & Associates

Several hundred thousand feet you said?

D. Rick Lowes

Yes.

Dennis McGill - Zelman & Associates

Thanks. And then just lastly, when you guys put through the big cost cutting plan last quarter, would you say that the non-res market has performed in line with what your expectations were when those cost cuts were put in place?

William Foote

Absolutely. We knew the non-residential market was weakening and that hasn't changed in our view. All right.

D. Rick Lowes

And our view on non-res is pretty similar I think to the analyst view of down about 20% to 25% this year.

Dennis McGill - Zelman & Associates

Okay. All right thanks a lot guys.

D. Rick Lowes

Thank you.

Operator

Our next question comes from Michael Rehaut from JPMorgan. Please go ahead.

Michael Rehaut - JPMorgan

Thanks. Good morning, everyone.

William Foote

Hi, Mike.

Michael Rehaut - JPMorgan

First question, I guess there's been a few questions about margins and cost savings. But just so, I fully understand, particularly with the USG margin within the North American Gypsum segment, is it your expectation that as you said before given that most of the cost savings are already in place that the primary driver on a sequential basis with regards to margins over the next quarter or so would more be driven by pricing given that on an incremental basis, most of the cost saves are already kind of flowing through?

Richard Fleming

Well, pricing is an important factor, but even on a unit cost basis we still expect savings there; an example again is in energy, where we're now hedging at 960 when market at three. So we expect that that would flow through also.

Michael Rehaut - JPMorgan

Okay. And so can you give us a sense of -- if you don't mind just, I know you've gone through the math before. But how that kind of flows down on a more per square foot basis?

Richard Fleming

Sure. A dollar per decatherm is worth about $2.25 per MSF cost. So, normally as we said this will allow for a pretty significant improvement on our energy point of our wallboard manufacturing costs.

Michael Rehaut - JPMorgan

Okay. May be I'll call back and drill down on that a little bit further. My next question is just more on the -- I think a broad question on the environment to the extent that you feel comfortable answering and I know you don't comment on future pricing. But given the low, I mean it's been fairly unusual to have a sustained, I guess now four quarters of improved pricing in such a low capacity utilization environment. With that demand continuing to be fairly weak throughout '09, what are your expectations going forward in terms of the sustainability of the price that you have got, particularly, if demand weakens a little bit going forward?

William Foote

Michael, our expectation on demand is, we're going to be about along about where we are, with housing. As I said earlier there's some semantic signs (ph) it may be improving a bit, but there is no trend. Commercial will be weak on our -- both commercial and R&R will be in the range that we forecast. On pricing, Rick Lowes spoke earlier that, we're very focused on getting paid for the value we provide.

Frankly, people get skeptical to your specific questions, skeptical for the past four quarters. We gave price and we've nudged it up a $1 or so at a time. And we remain focused on getting paid. We're not going to make a forecast but we've dealt with skepticism in the past and people remain that way. But we're focused on getting paid for what we do and we'll be vigilant.

Unidentified Analyst

Thank you Michael.

Operator

Thank you. Our next question comes from John Baugh from Stifel Nicolaus. Please go ahead.

John Baugh - Stifel Nicolaus

Yeah, I was curious, maybe a question for Bill. Once we recover to some degree in housing, and this could be say years five through ten from now, where do you expect housing construction to be? And you could lump in commercial activity again, give us recovery through a longer range of what's on demand.

William Foote

Sure, it is been a lot of work down by demographers and we're close to the joint housing (ph) recovery. The demographic need is on the order of 1.5 million houses. We were building well above that in 2004, 5 and 6 timeframe. We're well below that but we would -- assuming we've got normally functioning credit markets, we think we would revert to the main. But it's -- I think you're -- the way you framed the question is right. It's going to take time to get back there.

On the commercial side, unlike the early 90s, when we clearly had a dramatically overbuilt environment, we're not just concerned that we're overbuilt. The issue is really the collapse of the credit market. And we are now seeing the implosion of commercial mortgage market. And so we think that, that's what's got to be worked through. There's been lot of work on residential, on the mortgage side. There needs to be more capacity unfrozen on the commercial mortgage side.

The inventory of houses is at a historic peak. But frankly, with some level of activity and given housing affordability it could be worked off in a reasonable timeframe. We are not unrealistic. We think it's going to take years or more to work off, not a few quarters. But, I think the same will be true on commercial, that what has to happen is in opening up of the credit market and the re-absorption in that space. But the vacancy rates are not weighed our line. They are more a function of cyclical phenomenon.

So, we think that once we have normal credit markets, we can get back to sort of middle of the real numbers, which in housing it'll be about 1.5 million.

John Baugh - Stifel Nicolaus

Thanks, and then on foreclosures, which have been taking up -- we read anecdotally that somebody's houses are trashed and I assume they have to be fixed up before the banks resell. Is there any activity that you're seeing, is that a big enough markets that we can see some lift from that?

William Foote

It's very hard to pass that out, but we've been saying for many years the repair and renovation markets. It's been the fastest growing segment and would be larger than new residential construction and it is larger. And we think that the repair and renovation of those foreclosed homes will only add to that. So, it's only qualitative. But I would think that would be supportive of our business. Thanks for your questions.

John Baugh - Stifel Nicolaus

Thank you.

Operator

Our next question comes from Jim Barrett from CL King & Associates. Please go ahead.

Jim Barrett - CL King & Associates

Good morning, everyone.

William Foote

Good morning, Jim.

Richard Fleming

Good morning, Jim.

Jim Barrett - CL King & Associates

Bill, can you talk about competition for a minute? They have been taking share now for several quarters. Is that confined to a few specific players or is that more of a regional phenomenon or is it a national phenomenon?

William Foote

I'm not going to comment on specific competitive actions, Jim. But, I think we've said in the past that we're going to price to get paid for what we do. And there've been some regions which have been with very weak pricing. We've got our prices, just about where we can make money and we are not the business of taking care of unprofitable market share. So we have got into a spot where we can make money and it's I would say that those adjustments have been made and things have settled down.

Jim Barrett - CL King & Associates

That makes sense. And on a related note your Washingtonville plant, since that has opened up like have you been gaining market share in the Northeast as a result of that plant and can you talk a bit about how the opening of that plant, which is obviously low cost, how that has changed the pricing dynamic in the Northeast?

William Foote

One of my forbearers he used to say cost is something that can burn your pocket, whereas price is area where everyone we've worked on the price side to get paid for what we do and you can see we have made good progress on the cost side and Washingtonville has helped. We were not -- we're managing this for profitability and the cost side of Washingtonville has contributed to that improvement. But we're not, we never priced up the cost, we price up on a cost of a proper value and will continue to do that.

Jim Barrett - CL King & Associates

Okay. And you were operating above your cash cost from what I can tell on the quarter. Is that true for the competitors who are under cutting the company or is it a mixed bag?

William Foote

I think it's a mixed bag, we're getting -- we're probably getting to a spot we are most in clover (ph) but I wouldn't say that's true for everybody.

D. Rick Lowes

Its really not the across all plants.

Jim Barrett - CL King & Associates

Right, hey, thank you both.

William Foote

Thank you.

Operator

Our next question comes from Todd Vencil from Davenport. Please go ahead.

Todd Vencil - Davenport & Company Llc

Thanks guys. Good morning.

William Foote

Good morning Todd.

Todd Vencil - Davenport & Company Llc

All of my questions have been answered. But drilling down a little bit on a couple of them. Can you guys tell us what the price at United States Gypsum was at the end of the quarter?

William Foote

We don't disclose that, the average price for the quarter is reported and 121, whereas at the fourth quarter was about 119.

Todd Vencil - Davenport & Company Llc

Got it, okay. Turning to gas, I know it would be kind of digging in. Let me ask just one question by way which is, the gas sort of stays where it is for the rest of the year, would your sort of cost that you guys perceive stay where it was in the first quarter which is to say, I guess, are you sort of at a linear level, all through the year on the hedges?

Richard Fleming

The hedges are pretty linear through the course of the year, but obviously, we're benefiting from the 40% which is not hedged and then going at 2010, you'll see a big jump.

Todd Vencil - Davenport & Company Llc

Right. Okay. And you guys are not hedged at all for 2010?

Richard Fleming

We're just about a tad hedged, about 16% and we're not adding any hedges right now.

Todd Vencil - Davenport & Company Llc

You can tell with the prices for 2010?

Richard Fleming

That was done actually at higher levels around $9.

Todd Vencil - Davenport & Company Llc

Got it. I guess it's kind of a bigger picture question. You talked about in fact your goal is in fact to be free cash flow positive, after interest and cash debt. What just broadly speaking, what's the -- how long do you think it should take to get there? At the current level of demand and seeing what you're seeing?

William Foote

Well. I mean, as I mentioned in my remarks, we're going to relentless in terms of getting there. We've never promised that we would be there for the full year 2009, but that we have indicated that it's object to be there on run rate, toward the end of this year. Even hopefully the middle part. So we are working aggressively to achieve that objective.

There is still lot of questions, do you have additional opportunities to improve the performance of the company. I guarantee you that we have a team of people looking at every opportunity and one thing that we've learned over the years is, there is no such things as fixed cost. So we are going after every opportunity to further improve our cost performance. We don't expect a lot of help as mentioned from the marketplace this year but we will achieve that objective and it is a management prerogative.

Todd Vencil - Davenport & Company Llc

Great Okay, thanks.

Operator

Our next question comes from MarkWeintraub from Buckingham Research. Please go ahead.

Mark Weintraub - Buckingham Research Group

Thank you. You mentioned that you thought over the long term housing starts might be in the 1.5 million type range. Presumably commercial would also be somewhat stronger than they say. Do you think that under this -- those types of normalized conditions that the current capacity base would be fully absorbed?

William Foote

It will go long ways toward that, the other through at current renovations, But at current capacity when we fully reserve, you be much more better pricing environment you would be around 80% utilization range at that level.

William Foote

Our work has shown that if we got that normalized demand that indeed it would be fully absorbed, particularly with the reduction that have occurred to-date. But clearly we are at not those levels today.

Mark Weintraub - Buckingham Research Group

Okay, just to kind of clarify, so I guess I have two numbers, one was the 80% I am just a little confused there. Yes, fully absorbed that at normalize levels. i.e. 95% type operating rates or--

William Foote

Let me be a little more clear. We write into our model, normalize recurring model, normalized housing starts that's the demographic need and normalized commercial and we come up with what has been basically maintained on the marketplace right now, so 12 to 34-30 billion, 35 billion capacity levels, about 85% utilization.

Mark Weintraub - Buckingham Research Group

Okay. And so you believe that 85% utilization rates would be a fully balanced market?

Richard Fleming

No. It's at that level as particularly as you sort of move toward 90% during the cycle, that you have pricing flexibilities, that's why we look at that threshold.

Mark Weintraub - Buckingham Research Group

Okay, okay. So okay, so I guess one of the things I'm just trying to think through is, the tension that exists between maximizing near term cash performance which might include more closures, and retaining the potential to take advantage of improvement to the fullest extent possible. But it would sound based on the types of modeling that you're doing that there would be more room for capacity closures...

William Foote

Yes, this is Bill. There is no doubt there remain some high cost capacity and we are not expecting this to probably occur for two or more years. So if it's in the eyes of the beholder but if we have competitors who want to preserve that option for the future and book cash losses, that's their prerogative but we would think the pressure would be -- set back from the times we're seeing right are extraordinarily low.

We have never seen a weaker environment and we're pleased with our quarter-to-quarter performance and it's the markets not helping us it's all what we've done on a cost structure. And if all this is done that may be they can sustain at this level, but I think the pressure remains intense on the save cost plans. So, yes the short answer is there is more room for rationalization.

Mark Weintraub - Buckingham Research Group

Okay. And just as such shifting gears I guess the follow up and I'm not sure I'm going to be looking much on that is whether or not there is still space within your system where you've got a range of plans apart some of the higher costs and where that might makes sense and can you give a quick response to that?

William Foote

Well, we have a network optimization model and we're constantly running it as Rick said earlier, we stand ready to take down more capacitive but frankly at this point we've taken that more than anyone and feel our system is in pretty good shape, but we can move quickly if we need it to if there is another down line.

Mark Weintraub - Buckingham Research Group

Great, thank you. And then on the ceilings business I just was trying and understand I was looking at the fourth quarter where there was that very shortfall from profitability, then it picked up quite substantially in the first quarter. Was the fourth quarter essentially an aberration?

And I understand that there were some costs take out etcetera, or should we be looking at fourth quarter effectively as an aberration from a profitability standpoint, because typically you then actually get a take off in the second quarter seasonally from the first quarter, anymore color you can provide?

Richard Fleming

Well I think definitely the fourth quarter of 2008 globally was an aberration and you saw that aberration in ceilings business. So, with weakening commercial market but I want to be more focused on the first quarter of 2009 rather than the fourth quarter of 2008.

Mark Weintraub - Buckingham Research Group

Okay. Thank you.

James Bencomo

Operator let's take two more calls.

Operator

Thank you. Our next question comes from Jack Kasprzak from BB&T Capital Market.

Jack Kasprzak - BB&T Capital Markets

Thanks, good morning guys.

William Foote

Hey Jack.

Richard Fleming

Hi, Jack.

Jack Kasprzak - BB&T Capital Markets

Hi, do you guys have an estimate for how much of the industry's capacity is made up of the high cost plants-to-plants with the cost in the $130 range that Rick mentioned earlier?

Richard Fleming

Jack, its Rick. We have tended to say that number at time ramping around 20% to 25% of the industry but I have stated right now because there are a number of closures in the last 90 days, so that probably needs to be updated.

Jack Kasprzak - BB&T Capital Markets

So, okay. So, have there been some closures so far to this point in '09, I know in '08 we had quite a few?

Richard Fleming

No, it was the latter part of '08 that we had a number of plants to shut down.

Jack Kasprzak - BB&T Capital Markets

And I mean were transportation costs down I know when they were high that was a concern with what the producer looking at may be closing a plant because you have to ship it from farther away to keep the customer, but was transportation cost down, I mean why wouldn't you or anyone close the high cost plant and shift from one of these modern low cost synthetic plants, if the goal is to optimize cash flow?

Richard Fleming

It's Rick again. I'll give two reasons and each I think has its individual elements but in same cases, there may be a competitor has one plant in a market so they would exit the market if the shut down. That's something that they can consider doing but they obviously have to think about it.

Jack Kasprzak - BB&T Capital Markets

Yeah.

Richard Fleming

Always service that market. In other cases, it might be a plant that's dedicated to more special products, thicker boards and in that context it's appropriate for the network even though it's higher cost. So, these things have to be looked at plant-by-plant.

Jack Kasprzak - BB&T Capital Markets

Got it. Has anybody to your knowledge, any of the closures we know about so far, been along the variety of somebody exiting the market, has that happened?

Richard Fleming

Yes, it did has happened selectively.

Jack Kasprzak - BB&T Capital Markets

Selectively. Okay great thanks very much.

William Foote

Thanks Jack.

Operator

Our next question comes from Trey Grooms from Stephens Inc.

Trey Grooms - Stephens, Inc.

Good morning. The price increase -- forgive me if you're already answered this I got -- picked up the call for just a second, but the price increase sequentially that you saw in the quarter, was that all a result of the January price increase that was put in place?

Richard Fleming

Yes, there was just it was only one price increase put in -- announced in and put in place in the first quarter.

Trey Grooms - Stephens, Inc.

Okay. And how much was that price increase and - I guess how much of that did you get and was it across most of your markets or was it kind of regionally stronger than others?

Richard Fleming

The price increase was around, it was at 10% it was across all our market. We obviously we obtained 2% and now it would be more in some markets and less in some markets. That was the total amount we achieved.

Trey Grooms - Stephens, Inc.

Any color on which markets were stronger than others?

Richard Fleming

We don't comment on individual markets for pricing.

Trey Grooms - Stephens, Inc.

Okay. That's all I had, thanks.

Richard Fleming

Thanks Trey.

James Bencomo

I think, that concludes our questions. Bill, I think you have some concluding comments?

William Foote

Yes. Let me just step back and say that in our recently calls with you, we described the aggressive actions we've taken from the company of debt to exceptionally difficult market conditions we have been facing. Now we don't do much of that today, rather we focused on the positive impact that those actions we're having on our financials by focusing things that are within our control; our customer relationships, cost efficiencies, safety and financial flexibility.

Everyone of our businesses was able to mitigate the affects of the severe contraction of markets. As I said this is the first time in any quarters that we're operating with better results on a comparable basis. That said, we're not satisfied with our results. We still reported loss and we remain resolute to get this company back to profitability. We remain very cautious and concerned about the external environment. There's no hard data that suggest the turnarounds occurred. There are some anecdotal signs.

We'll keep a watchful eye and see if there are precursor. Meanwhile, the hard work remains of getting this company back to profitability. We make good progress in the quarter. And we'll continue to work at that. We thank you for your continued support and interest in the company. And appreciate your time today.

Thank you very much.

Richard Fleming

Thank you, Bill. Let me mention that there is a tape replay of this call available. If you dial 1888-843-8996 and enter the passcode 24297438, the replay is available until Friday, May 1st. The call is also archived on our Investor Relations website.

That concludes our conference call. Thank you all for joining us.

Operator

Thank you ladies and gentlemen. This concludes today's conference. Thank you for participating. You may all disconnect.

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Source: USG Corp. Q1 2009 Earnings Call Transcript
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