USG Corp. Q2 2009 Earnings Call Transcript

Executives

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

William C. Foote – Chairman and Chief Executive Officer

James S. Metcalf – President and Chief Operating Officer

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

Rick Lowes – Senior Vice President and Controller

Analysts

Daniel Oppenheim – Credit Suisse

Kenneth Zener – Macquarie Capital Securities

Michael Rehaut – JPMorgan

Ivy Zelman – Zelman & Associates

Garik Shmois – Longbow Research

Trey Grooms – Stephens, Inc.

David Wells – Thompson Research Group

Jim Barrett – CL King & Associates

Todd Vencil – Davenport & Company

Fred Taylor – MJ Asset Management

Joseph Weiss – JRW Associates

USG Corp. (USG) Q2 2009 Earnings Call July 22, 2009 11:00 AM ET

Operator

Good morning ladies and gentlemen and welcome to the USG Corporation's second quarter 2009 earnings conference call. (Operator Instructions). I will now turn the call over to Mr. James Bencomo, Director, Investor Relations and Pension Investments. Mr. Bencomo, you may begin.

James R. Bencomo

Thank you, Christine, and good morning, and welcome to USG Corporation's second 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 at www.usg.com and clicking on the link to the webcast.

Also 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, Jim Metcalf, President and COO, and Rick Fleming, Executive Vice President and CFO. First, Bill will comment on market conditions and the outlook for our businesses. Jim will follow with comments on how our operating units are performing. 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. Also present for the Q&A portion of the call will be Rick Lowes, Senior Vice President and Controller. We'd 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 question.

With that, Bill?

William C. Foote

Thank you, Jim, and good morning to all of you. We appreciate your taking the time to join the call this morning. And as always, we appreciate your continuing interest and support of our company.

Market conditions in the second quarter of this year were very similar to the conditions that we have faced over the last several months. Housing starts remain very low, repair and remodeling activity declined further, non-residential construction continued to worsen, and most international markets were in recession.

The global economic recession continued and not surprisingly, the demand for our products and services was sharply lower. Total sales in the quarter fell by more than $400 million compared to the second quarter of 2008. That's a 34% decline. We reported $40 million operating loss for the quarter and I'm proud to say that this is virtually unchanged from the second quarter a year ago. All of our businesses are being affected by the global economic contraction.

We continue to operate in what is obviously a very difficult environment against this backdrop of what are frankly breathtakingly low buy-ins. I am very pleased that our operating performance benefitted significantly from the aggressive actions that we have taken to resize the company and cut costs.

We have worked hard to reduce costs and improve product pricing. Indeed, we improved unit margins for many of our key products. We have also reduced SG&A expenses in the second quarter compared to last year by more than $20 million, which substantially mitigated volume declines year-over-year.

As a result, the operating loss of $40 million is virtually the same as the $39 million reported in the second quarter a year ago, with sales being $400 million lower. In addition to taking aggressive action to control our costs, we have heightened our focus on liquidity. Here, too, I am pleased to report that our efforts have been successful.

Our cash and total liquidity position, cash plus unused borrowing capacity, were both better at the end of 2Q than at the end of the previous quarter, the first quarter of this year. Specifically, our cash increased from $223 million at the end of March to $302 million at the end of June, and total liquidity increased from $429 million to $495 million over that same timeframe.

We are managing working capital even more aggressively throughout the company. And we are consistently pursuing new avenues to add liquidity. On the asset side of our balance sheet, we have reduced capital expenditures, improved our working capital's position and are working to squeeze cash out of all surplus and other assets.

On the liability side of the balance sheet, we've taken a number of additional steps to improve our financial profile. For example, during the second quarter, we finalized a credit agreement at our Canadian subsidiary that adds approximately 25 to our total borrowing base and we drew down the second $25 million tranche under our ship mortgage facility.

We have sustained a consistent strategy throughout this global downturn, which for us started a little more than three years ago. Specifically, we are focused on manage the fundamentals; the safety of operations, the quality of our products, the service we provide our customers, continuing innovation, cost reductions being very important, both in terms of scaling our operations to the market and to manage our overhead people and programs and lastly, financial flexibility.

By anticipating changes in the market, we are succeeding in each of those areas. We are running our plants and distribution centers safely and efficiently. Customer satisfaction performance remains very high. We have optimized our operations to market conditions by closing or curtailing wallboard lines, paper mills and distribution centers. Overhead expenses are significantly lower. And we have a solid and improving liquidity position.

Looking ahead at the remainder of 2009 and into next year, we are not expecting much improvement in our markets. More specifically, we are planning for low levels of residential construction, though some stabilization seems on the horizon, a continuing slowdown in repair and remodel and a fairly significant drop in new non-residential construction.

The new residential construction market has fallen so far that there's really not much more room for further declines. The market appears to be stabilizing and the June starts figure of 582,000 is somewhat encouraging, but there's no evidence yet of a meaningful rebound.

Looking down 2009, stability in the new residential and repair and remodel markets will be a welcome relief. The major area of concern right now is non-residential construction. It declined on the second quarter and is likely to continue declining for the next several quarters.

While the future direction of our markets remains uncertain, we are confident that our efforts to resize the company during this severe contraction are taking us in the right direction. Our second quarter results demonstrate that our strategies are working.

We have already done a great deal to cut costs, resize the company and bolster our liquidity. Those efforts have clearly mitigated the impact of this lengthy and severe downturn, and I am very confident of our ability to continue to stay ahead of changes in the market.

Now I'd like to turn to Jim Metcalf, our President, for a more detailed discussion of each of our businesses.

James S. Metcalf

Thank you, Bill. All of our business units are feeling the effects of the global recession. As Bill mentioned, sales have declined substantially for the quarter, down more than $400 million, and for the first six months down more than $700 million.

In this environment we have and we will continue to be proactive with aggressive actions to adapt to this market. Throughout the company we've closed operations, reduced cost, sized our workforce and aggressively managed working capital. By doing so, we are mitigating much of the impact of this steep drop in demand.

Compared to last year, North American Gypsum has reduced its operating loss by more than half in the quarter despite a 29% drop in sales. Worldwide Ceilings had a very good quarter, reporting an operating profit of $18 million. Our distribution business, L&W Supply, was the hardest hit in the second quarter posting an operating loss of $26 million on sharply lower volume across the board.

Our cost reduction efforts are ongoing and we will continue to have contingency plans. We took action in late 2008 to reduce cost in anticipation of the fallout from last fall's financial meltdown. The positive impact of our actions is flowing through our operations this year. We haven't stopped. We continue to squeeze costs out of our business.

In the second quarter, we made further adjustments in our spending that will reduce costs by an additional $50 million annually. And as I said, we will continue to look at new opportunities to reduce our costs and, most importantly, position USG for the future.

Now, I'd like to discuss our operations starting with our number one priority, safety. As we explained last quarter, our U.S. manufacturing operations set an all-time company record for safety performance. We operated the entire first quarter without a single lost time or restricted duty accident. We nearly equaled that record during the second quarter, with perfect safety performances in both April and June. This is a remarkable achievement and another proof point that demonstrates our focus on the controllable factors in our operations.

Now, I'd like to talk about the performance of each one of our business units, starting with U.S. Gypsum Company. Wallboard volume at U.S. Gypsum declined 38% during the quarter. U.S. Gypsum shipped 1.2 billion feet of wallboard compared to 1.3 billion in the first quarter and 1.9 billion feet in the second quarter of 2008.

Those declines were consistent with the dramatic drop in residential construction which remained in record low territories during the second quarter. Despite the lower volume, our average wallboard price in the quarter was approximately $121.00, an improvement of last year's average price of $109.81 and virtually flat from the first quarter of 2009.

By significantly reducing costs and resizing our operations, U.S. Gypsum was able to reduce its operating loss by $39 million compared to the second quarter of last year. This was done with substantially lower demand across virtually every product category. The fundamentals in the business, safety, customer satisfaction, operating efficiency and quality, all remained at near record levels during the quarter.

Other product lines within our Gypsum business felt the impact of the recession but did perform better than the market. Total sales for performance surfaces, which includes our industry-leading joint treatment products, were down approximately 19%, but outperformed the market. The gross profit for our surfaces business increased during the quarter reflecting the impact of operational efficiencies, price and market share improvement.

Sales for our performance substrates business which includes Durock and Fiberock also fell 19% during the quarter. Margins were under significant pressure earlier this year, but our cost control actions, efficiencies at our plants and new product introductions have reversed that trend. Unit margins for these two product lines have improved but it did not entirely offset the impact of the very low demand that we are experiencing.

Now, I'd like to discuss our distribution business, L&W Supply. The decline in commercial construction which began late last year had an impact on results at L&W Supply. Sales in the second quarter declined almost 38%. This sharp drop in sales reflects lower demand in all major product categories in both the residential and commercial segments.

This drop in market demand has caused L&W to swing from an $8 million operating profit in the second quarter of last year, to a $26 million operating loss in this year's second quarter. Aggressive cost reductions and wallboard price improvement at L&W have mitigated the impact of lower demand.

In addition to the 54 centers that were closed last year, L&W closed nine locations this year, as well as reduced personnel, spending and equipment. As we've done on the manufacturing side at USG, we will continue to right-size L&W to match market demand. Other than safety, L&W's return to profitability is the number one objective.

Now, I'd like to discuss our ceilings business. As I mentioned earlier, the performance of our ceilings business was relatively strong in the face of a commercial slowdown and a global recession. USG interiors posted an operating profit of $17 million in the second quarter. Sales reflected the decline in the non-residential construction, falling about 20% from $141 million last year to approximately $113 million in 2Q '09. Operating profit only declined slightly due to cost reductions, manufacturing efficiencies and price improvement across all product lines in our ceilings business.

So the same trends we've seen in other businesses are evident in ceilings as well. Demand and sales are off, but aggressive cost reduction efforts, efficient operations and a keen focus on our customers have mitigated the impact of this market decline.

Now I'd like to turn to our international business. The global slowdown has affected our international business in each market we participate in. Our international business experienced slowdown in market demand negatively affecting sales in all of our regions.

Operating profit for our total international business was $6 million compared to $15 million in the second quarter of 2008. Our international operations have adapted the same strategy of cost reductions, while keeping a focus on the USG fundamentals of safety, customer satisfaction and quality.

Our second quarter results demonstrate our ongoing efforts to resize the company and our focus on cost reductions and USG fundamentals are making an impact. As we stated before, we will continue to have contingency plans to mirror market demand.

Market conditions in the first half of 2009 were considerably worse than last year. Sales in almost every business and product line declined, yet in almost every business, our results are trending the right way. Obviously, we have not yet achieved our goal of returning to profitability; that goal is our number one focus. The cost control initiatives throughout the company have been very effective and we are carefully balancing price and volume in each one of our businesses to improve operating results.

As Bill mentioned, customer satisfaction metrics remain high, our operational efficiencies at our plants are excellent and, most importantly, our safety performance is outstanding. The end result is our controllables are headed in the right direction. Those controllables are the USG foundation. We remain focused on getting to the other side of this unprecedented market, but we need to get there much stronger.

Now, I'd like to turn the call over to Rick Fleming, for a more detailed discussion of our financial performance and our progress on improving liquidity through this downturn. Rick?

Richard H. Fleming

Thanks, Jim, and good morning to all of you. As Jim mentioned, I'll recap our second quarter and year-to-date financial results, and provide some additional details on overhead, interest expense, taxes, capital expenditures, debt and liquidity.

Second quarter 2009 net sales were $829 million, down 34% from the second quarter of 2008 net sales level of $1.251 billion. Our second quarter operating loss is $40 million, including $19 million of restructuring charges. In last year's second quarter, we reported an operating loss of $39 million which included $21 million of restructuring charges. So as Bill mentioned, our operating loss was virtually unchanged despite a 34% sales decline.

Second quarter 2009 net sales after tax was $53 million or $0.53 per share based on average diluted shares outstanding of 99.2 million. This compared to a net loss of $37 million or $0.37 per share in last year's second quarter.

As noted, second quarter 2009 results included restructuring and asset impairment charges of $19 million before tax or $0.12 per share after tax. These restructuring charges are related to severance due to salaried workforce reductions, lease termination costs associated with facility closures and asset impairments related to idled and closed facilities.

The breakdown of the $19 million of pretax restructuring and asset impairment charges by core business is as follows, North American Gypsum, $11 million; building products distribution, $5 million; worldwide ceilings, $1 million and corporate $2 million. For the first six months of 2009 net sales were $1.7 billion compared with $2.4 billion in the first half of last year, a 30% decline. Despite this decline in net sales, our operating loss improved to a net loss of $82 million in this year's first half from a loss of $99 million for the first six months of last year. These amounts include pre-tax restructuring and asset impairment charges of $29 million in 2009 and $25 million in 2008.

Our net after-tax loss for the first six months of 2009 was $95 million or $0.95 per diluted share. This compares to a net loss of $78 million or $0.79 per diluted share for last year's first half. The increase in the 2009 net loss is due primarily to this year's higher level of interest expense.

Now I'll add some details in the rest of the P&L and discuss what we've done to manage capital spending, our balance sheet and our liquidity. I'll start with overhead. Selling and administrative expenses or SG&A declined by $22 million or 23% in the second quarter of 2009 compared with the same period last year. In total, SG&A expenses were $72 million in the second quarter and $152 million for the first six months of 2009. On an annualized basis, SG&A spending is now at 2002 levels.

Interest expense is $36 million for the second quarter and $78 million for the first six months. We currently anticipate that our annual interest expense will be about $147 million for all of 2009 on a P&L basis and about $138 million on a cash basis. The effective tax benefit rate was 30% for the second quarter of 2009 resulting in a six-month rate of 36.7%.

This compares to rates of 36.9% and 40.9% in last year's second quarter and first six months respectively. Looking ahead to the full year, we anticipate an annual tax benefit rate of approximately 37% depending on the mix of worldwide income. It should be noted that our federal tax laws carry-forward is not about $1 billion and as such our cash taxes will be very low in the early years of the recovery.

Turning to capital spending, capital expenditures totaled $12 million in the second quarter of 2009 compared to $67 million in the same quarter of last year. For the first six months CapEx totaled $28 million and we are currently forecasting about $50 million of capital spending for the full year. Since we have made substantial investments in our operations over the past several years we are comfortable with this level of spending, and we believe that it can be maintained into 2010 as well.

Regarding our cash and debt situation, our June 30 cash balance, excluding $1 million of restricted cash, was $302 million compared with $223 million at the end of the first quarter and $471 million at the end of 2008. The decrease since year end primarily reflects the use of $190 million to repay all of the borrowings under our old unsecured revolving credit facility which is amended and restated in January of this year.

Especially notable is the $79 million increase in cash since March 31 which resulted from surplus property sales, tight working capital management and phase two of our ship financing which provided $25 million. Total debt was $1.67 billion as of June 30 compared to $1.836 billion at the end of last year. As noted, most of the reduction in debt reflected the payoff of borrowings on the old credit facility. We currently have nothing borrowed on the new secured revolving credit facility.

This new facility is subject to a borrowing base and $167 million was effectively available to us at the end of June after taking into account outstanding letters of credit and the minimum availability requirement of $75 million. This amount combined with our cash on hand and the new undrawn CGC credit facility resulted in $495 million of liquidity at the end of the second quarter. This represents a substantial increase from the March 31 level of $429 million.

In addition, we expect to add further liquidity through our continued focus on working capital and surplus asset sales. We presently have over $20 million of asset sales under contract and we still anticipate that our surplus asset sale program could total $50 million to $100 million over two years.

Now let me sum up our cash flow performance for the first 2009 and report some really good news. As you will note from our press release, our net cash provided by operating activities after interest expense for the first six months of this year, exceeded our cash use for capital spending and other investing activities by several million dollars. This is great news and evidence that our plans are bearing fruit.

So in conclusion we continue to focus on the basics, superb customer service, quality, cost and liquidity. As you heard from Bill and Jim, considerable progress has been made in terms of scaling the company to match reduced market conditions and we are prepared to take more action if necessary and we are unwavering in our goal of returning USG to profitability and to have EBITDA exceed cash interest and CapEx. Here, although progress has been made, we still have more work to do but we will continue to be relentless in our efforts to achieve these goals.

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

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from Dan Oppenheim – Credit Suisse.

Daniel Oppenheim – Credit Suisse

Thanks very much. I was wondering if you can talk about the pricing environment and you've done a great job in terms of controlling costs, but with some of the cost escalation out there and thinking about the gross cost increase for August, how much of an increase do you think you need just to offset the impact of the higher production costs and transportation right now?

James S. Metcalf

Well, we, I appreciate your comments on our price improvement from the beginning of the year. It's been a very tough market to get price improvement. We've had some great track record really for the last 18 months on it, and we have a price increase in the market for August of 10%. We are going to aggressively attempt to get price improvement in August. We have – we've been talking to all of our customers because it's a very, very difficult pricing environment because the supply chain is getting pressed down the channel on pricing, but we're going to continue to aggressively go after it.

Daniel Oppenheim – Credit Suisse

Thanks very much, and then in thinking about the cash flow during the quarter you commented in terms of the cash flow for the first half of '09, if we think about the second quarter how much of a benefit did you have in terms of just working capital and should we expect to see more of that coming through in the second half of this year or is there any reversal of that?

Richard H. Fleming

Well, for the first half of the year there was a significant benefit from both reducing receivables and inventory and right now we think a good portion of that was due to lower volume but there's also a substantial component that's due to structural changes we've made. Clearly the good news in the second half we hope is that business picks up a little bit and we build some receivables but right now as I say the focus is on making sure we're as effective and efficient as we can be on working capital

management.

Operator

Your next question comes from Ken Zener – Macquarie Capital.

Kenneth Zener – Macquarie Capital Securities

Good morning. I'm wondering, could you kind of talk about, you mentioned an additional $50 million in cost reductions. First, can you break that up into kind of between a variable and a fixed component and then how much farther do you think you guys are able to take down the fixed portion of your wallboard business?

James S. Metcalf

Well, the $50 million as I said is an annual number. The majority of that is positions that we've taken out. We made some changes on our retiree benefits and some reductions we made in our distribution business so probably half of it is SG&A. The rest of it is between benefits and L&W distribution reductions. We have taken out, if you look at the last two years, approximately $400 million out of our cost structures in four different tranches and one of the things we're keen on is keeping the value proposition. We're very focused on some of our projects that we do.

We can't do everything but we're going to – we have a contingency plan if the market gets worse and we'd be prepared to pull the trigger but also we have a contingency plan if the market gets better as well so from a plant standpoint, again, we have, if demand decreases we have plants that would come out of the network. We know where they are. We know which ones they are, so we're prepared for the market to go down as well as to go up. So we – these have been tough decisions we've made for the last two years but we're prepared if need be to make further decisions.

Kenneth Zener – Macquarie Capital Securities

Okay. And I guess I'm just trying to get a sense for specifically in the wallboard business that recognizing you have other plans, but at the current stability that we see in housing starts unfold, being unstable, when would that kind of imply given your current fixed cost reductions and the current pricing that you'd be getting to kind of profitability specifically in the wallboard business not the other products within wallboard?

James S. Metcalf

The key, at 550 housing starts, it's pretty difficult to get there. We are focused on returning the gypsum business to profitability. We feel that with a little bit of lift in the markets, we can get there probably around a 650,000 to a 700,000 mark. That really gives us a little breathing room.

We also will continue to take costs out. They key is that we have positive spreads in our business. We're keeping our costs in line, we're getting some price improvement but we're seeing positive spreads in our wallboard business that we didn't have a year ago. And I think that's the key is reducing cost and having positive spreads in this terrible market. But I'll tell you a little bit of demand lift would really help us.

Kenneth Zener – Macquarie Capital Securities

Yes, I imagine. And I guess let's see, the pricing that we saw in the quarter, I realize you guys just reported on an average quarterly basis. But was there much impact from regional mix in there in terms of pricing that we're seeing for the company as opposed to like for like within specific regions?

James S. Metcalf

It's very regional obviously some of the harder hit markets like the Floridas have a different price. We report an average price. It is a regional business and we're starting to see some signs of regions stabilizing and some regions feeling a little better. But you're quite right, it is a regional business and the pricing can be different from one coast to the other.

Operator

Your next question comes from Michael Rehaut – JP Morgan.