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Executives

James Bencomo - Director of IR and Pension Investment

Bill Foote - Chairman and CEO

Jim Metcalf - President and COO

Rick Fleming - Executive Vice President and CFO

Rick Lowes - SVP and Controller

Analysts

Dan Oppenheim - Credit Suisse

Kathryn Thompson - Thompson Research

Will Green - Stephens

Ivy Zelman - Zelman and Associates

Michael Rehaut - JP Morgan

Ken Zener - Macquarie

Todd Vencil - Davenport & Company

John Baugh - Stifel Nicolaus

Jim Barrett - CL King & Associates

Garik Shmois - Longbow Research

Mark Weintraub - Buckingham

Tom Kaplan - East Shore Partners

USG Corp. (USG) F4Q09 Earnings Call January 27, 2010 11:00 AM ET

Operator

Good morning, ladies and gentlemen. And welcome to the USG Corporation Fourth Quarter 2009 Earnings Conference Call. At this time, all participants are in 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 of Investor Relations and Pension Investment. Mr. Bencomo, you may begin.

James Bencomo

Thank you. Well, good morning everyone and welcome to USG Corporations fourth 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; 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. And Rick Fleming will conclude with some additional comments on our results and a discussion of 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 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. Bill?

Bill Foote

Thank you, Jim. Good morning to all of you. Thanks for taking the time to join us. As always we sincerely appreciate your interest in the company. Looking back at 2009, we expected market conditions to be bad indeed it was an exceptionally challenging year. Due to weak markets our sales fell 30% or $1.4 billion.

We took significant steps throughout the entire company to adapt to the very sharp declines in our markets. The actions we took were effective, despite the drastic decline in sales, our operating performance improved and we enhanced our liquidity.

2010 is likely to be another challenging year, but we entered the year well prepared and we are confident the company is well positioned for the eventual market recovery.

The global economic recession in 2009 affected all of our businesses and all of our key end markets. Housing starts were invisible at about 550,000 starts for the year, thus by far the lowest level since the federal government began reporting that statistic.

Well about shipments to the industry were about 18.4 billion feet in 2009, that's a 27% decline, compared to 2008 and 2009 was a tough year as well revenue being down 18%.

Other segments of the construction market were soft too. The commercial market declined sharply and the repair and remodel markets experienced double-digit decline the fourth year of declines. By almost any measure it was a challenging year in construction, as well as, broader economy.

Recognizing that it would be a challenging year we are active on many fronts attempting stay ahead of the declines. We knew we would need to resize the business according to the anticipated opportunity, cut costs and enhance liquidity.

Let me give you the highlights of steps we took. We continue to close and curtail manufacturing capacity and we closed 37 of our L&W facilities. We implemented further budget and workforce reductions the fifth time since we've been so -- done so in this down cycle.

We significantly reduced our investments in working capital. We reduced our capital spending to less than $50 million down from 238 million in the prior year. We raised about 300 million in senior note offering in third quarter and we reached $105 million settlement in a six-year old patent infringement and trade markets lawsuit against Lafarge.

The positive impact of our efforts to proactively cope with recession can be seen in our full year results. Our total sales, as I said earlier, our total sales fell from $4.6 to $3.2 billion, a decline -- a staggering decline of $1.4 billion. Against this back drop of a 30% decline in sales our operating performance improved in 2009 compared to the prior year. Rick Fleming will walk you through the numbers in detail later in this call.

In addition, we were highly successful in adding to liquidity. We finished the year with almost $700 million in cash, that figure includes the proceeds of the lawsuit, I mentioned earlier, as well as, $300 million from the senior note offering.

Total liquidity including available borrowing was more than 800 million at year end. It's clear that our efforts to resize our operations according to the market cut costs and both the liquidity were successful. Cash flow from operating activities exceeded cash used for CapEx and other investing by $30 million last year not including the proceeds from the lawsuit.

This positive cash flow is directly attributable to our aggressive cost cutting and resizing the business. We are a much leaner company today than we were at the start of this recession and our liquidity has substantially improved.

We expect to benefit again in 2010 from these restructuring actions taken last year and prior years. Some segments of the market such as residential housing appear to have stabilized. Market forecast for 2010 for housing ranged from 600 to 900,000 starts. That's not great by historical standards but we're delighted that there seems to be some lift in our markets but we're not expecting the upward in that range but it will be a far improvement over last years 550,000 starts.

We're not expecting much change in the R&R segment but stability there is a welcome change from the four years of decline. Analysts are expecting growth in R&R to resume in the second quarter 2010, commercial construction forecast is continue to decline this year. As I said a moment ago we're well prepared for these market conditions both in terms of our cost structure and liquidity.

Looking beyond 2010, we're optimistic about the long-term prospects for our businesses. We are very well positioned for the inevitable recovery in our markets. The actions we have taken during this recession have made us a linear and more efficient company.

We have maintained excellent customer relationships. We preserved our broad footprint in North America and found ways to expand internationally. We've continued to innovate with new products and our brand names are among the best in the business. All of these will be important elements when the market rebounds.

With that, I'd like to turn the meeting over to Jim to discuss our operations in more detail. Jim?

Jim Metcalf

Thank you, Bill. Good morning. As we've discussed in previous calls, we operate in a cyclical industry and we've dealt with recessions before. Of course, we're always quick to add that this recession is unlike any other downturn. During this downturn, the key strategy, our management team focuses on is managing the fundamentals, very simply, controlling the controllables.

I'd like to talk about the goals we set for ourselves and more importantly, how we performed against those targets. You heard me review these areas over the last 18 months but it's important to mention that this focus has improved our operations with absolutely no help from demand or the market.

As Bill just mentioned but it's important to reiterate, sales were down caused by demand by $1.4 billion but our operating profit improved. This was done by a sharp focus on three key targets, operational excellence, cost reductions and balancing -- strengthening our balance sheet.

First, let me review operational excellence. When you look at operational excellence, safety is always job number one at USG. We're very proud to report that the company achieved an all-time safety performance record in 2009. We had 11 lost time injuries in our entire operations worldwide, but we are not satisfied until that number is absolutely zero.

We continue to pursue the coveted OSHA Star Award for outstanding safety performance with 11 of our manufacturing facilities already achieved at proud distinction and more in progress.

Operational excellence also means superior customer service. USG strives to set industry standard for service, product quality and innovation. In a market like this, our customers have choices and we want to make sure that they choose USG.

We are diligent about measuring the performance factors that are most important to our customers. Our ratings on these services remained at or near record levels throughout 2009 delivering the industries best service.

Having contingency plans in place in this turbulent market has allowed us to proactively size our operations. With the decline in industry demand which began in mid 2006, we rationalized our manufacturing network, distribution and our corporate staff functions.

Over the last three and a half years as Bill just mentioned, we've closed wallboard and paper manufacturing facilities, we have curtailed ceilings manufacturing that closed a significant number of L&W locations.

Our approach has been the same throughout the world with our international operations, scaling back as necessary in anticipation of any reduced demand. In doing so, we've been very careful to manage our unique ability to service our customers. We have preserved our overall market presence and we will be poised to participate in the market recovery. Our company is now much leaner and in many ways more efficient.

Our second target is a keen focus on cost reduction. We have reexamined every part of our organization for manufacturing to marketing, distribution, our staff units and even international, everything has been under the microscope.

Our corporate overhead declined by more than $75 million in 2009, since 2006, we have reduced overhead by $115 million in overall spending by over $400 million. We have significantly reduced working capital in 2009 by managing our inventories, extending payables and working with our customers to ensure we are paid according to our terms.

Our working capital was reduced by approximately $200 million with one-third of that improvement attributable to structural changes that we made. For example, we have set specific inventory targets at each manufacturing plant to match demand with our best-in-class on time delivery. This was done by utilizing the investment we made over the last few years in IT and with our corporate logistics team working with our field units.

We reduced CapEx substantially in 2009 to under $50 million down from approximately $240 million. We were able to do this because of the significant investments we made to upgrade and modernize our manufacturing assets. These investments have allowed us to operate our plant network at all times best efficiency and now more than half of our wallboard capacity is less than 10 years old. If necessary we can continue to run the business at this $50 million CapEx range through these low demand levels.

Finally, a key target has been strengthening our balance sheet, in necessity and vital in any recession is having sufficient liquidity. With approximately $800 million in cash and unused borrowing capacity it gives us ample liquidity to run the business and manage through this cycle.

We are also better positioned for opportunities that may present themselves as we navigate through this recession. Rick Fleming will elaborate more on liquidity in a few minutes.

Our intense focus on the controllables is one has enabled us to achieve the improvement in our operating performance in 2009, while we are operating in the worst market in the history of our industry.

Let me reiterate we are not satisfied with our results in 2009 and realize 2010 will be another challenging year. The key is maintaining the same focus in 2010 to position the company for a market recovery and accelerated growth.

Now, I'd like to give you a brief overview of our individual business units starting with U.S. building systems. Wallboard shipments were relatively stable for the last three quarters of 2009. We balance wallboard price and volume throughout the year to optimize our financial performance.

The average price declined to 10,986 in the fourth quarter compared to 115 per thousand in the third quarter. This was attributed to weak demand, low industry utilization and lower energy costs. Our strategy continues to be a balance between price and volume, focusing on profitability while keeping our national footprint to service all of our customers.

On our surfaces and substrates businesses, they have solid performances in 2009. New products were introduced such as secure rock sheeting which we’ll now see buildings wrapped in green and Durock Next Generation, which is the lightest product in its category and it installs 20% faster.

Margins were strong in all major product categories such as joint treatment, Durock and FIBEROCK, all these product lines benefited from cost reductions and manufacturing efficiencies at our plants.

Turning to our ceilings business, it experienced a very successful year relative to the ongoing challenges in the commercial market. Ceiling margins in 2009 were stable, compared to 2008 based on successful price and cost management, volumes tracked with industry opportunity. Ceilings results also benefited from our corporate-wide focus on overhead reduction and working capital management.

For the year, these substantial successes could not offset the impact of the significant reduction in market opportunity. The office and retail sectors were hit particularly hard in vacancy rates in both sectors continue to rise. Despite the challenges presented by the drop in the market opportunity, the ceilings business continues to generate strong returns. We will remain focused on delivering exceptional value to our customers and improving our margin performance, in fact, we were announcing the ceilings price increase this month.

The business is also currently impacted by -- the business that is most currently impacted by the commercial construction is L&W Supply. Financial results in 2009 reflect the accelerating decline in commercial construction. We took action throughout the year to reduce costs and adapt to the declines in the market.

As recently as the fourth quarter of 2009, we closed an additional 23 locations to prepare for the full impact of last years decline in commercial. Returning L&W to profitability is one of our top priorities in 2010 and we will continue to size the operation to reflect market conditions.

Our international businesses maintain the same strategic focus as our domestic units. International and Canadian Gypsum Company had strong operating performances in 2009. In China, we completed construction and start up of a new ceiling tile plant and we established a strategic alliance in Columbia to manufacture and market wallboard in Latin America.

As we look ahead into 2010, we expect our key domestic market segments to be mixed with modest, some modest growth. Outside of the United States, we are focusing our efforts on emerging markets utilizing our strong brand and world respected technology.

In the U.S., as Bill reiterated, market forecasts for housing in 2010 vary widely but most of the blue chip forecast are anticipating an improvement in residential from the weak levels, which will obviously help our wallboard, surfaces, substrates and distribution businesses.

We are anticipating some improvement over 2009 but don't think the market will reach the most optimistic estimates, which are above 900,000 starts. What is important to note that it does appear that the residential market has achieved stability and is poised for modest growth in 2010.

The repair and remodel market also appears to have stabilized particularly residential with analysts projecting growth in the second quarter. We have an excellent market position with our big box retailers and would expect to benefit from any improvement in the R&R segment. Repair and remodel now represents the largest demand driver in wallboard with over 50% of the total demand.

As I mentioned earlier, new commercial construction dropped off dramatically in 20 -- 2009. L&W and ceilings will feel the lag impact of that decline this year with over 50% of L&W's business coming from new commercial and about 24% of our ceilings business dedicated to new commercial. We've taken action to size those businesses as I mentioned and have contingency plans to do more if necessary.

As we enter in 2010, customer satisfaction remains high. Our operational efficiencies throughout the entire company are excellent and our overall safety performance is outstanding. We introduce new products, expanded operations in China, started a distribution and manufacturing alliance in Columbia and our distribution business remains the only one of its kind with a national footprint.

We will continue to focus on the fundamentals as we navigate through this market. We will control the controllables but most importantly position USG for growth. We are not counting on a market rebound, although obviously any improvement will certainly help, regardless we intend to focus on the fundamentals as we strengthen our competitive and financial position.

We intend to capitalize on our strengths to get through this cycle, see strategic opportunities if any present themselves and remain poised to return to a growth agenda.

Now I'd like to turn the call over to Rick Fleming for a more detailed discussion of our financial performance. Rick?

Rick Fleming

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

Fourth quarter 2009 net sales were $720 million, down 27% from the fourth quarter of last year. Our fourth quarter operating loss was $11 million including the benefit of $97 million in income net of fees from the settlement of our patent and trade secrets lawsuit against Lafarge.

The operating loss also included $31 million in restructuring, goodwill and asset impairment charges, a majority of the restructuring charges relate to severance, lease termination and other costs associated with the closure of L&W distribution centers.

We believe that these restructuring actions especially those at L&W will continue to move us toward profitability. All of our businesses in L&W in particular have faced dramatic declines in demand so scaling our operations to market conditions remains a key priority and we will take additional actions if necessary.

To break it down by business unit of the $31 million of restructuring long lived asset impairment and goodwill and other intangible asset impairment charges, as well as, $97 million of Lafarge settlement income is detailed in the press release.

The fourth quarter 2009 net loss after-tax was $598 million or a $6.02 loss per share, as I previously mentioned this net loss included restructuring and goodwill and impairment charges, as well as, the income from the Lafarge settlement. But by far the largest single component of our net loss for the quarter was a $548 million deferred tax valuation allowance on a per share basis, this was $5.51. That's big number, so I'd like to take a moment to explain the deferred tax valuation allowance.

Accounting rules require that the carrying value of deferred tax assets be reduced by a valuation allowance is based upon various considerations is more likely than not that the assets will not be realized. One important factor considered is the cumulative size and duration of the losses.

We have a policy as required by the accounting rules that a cumulative net loss for prescribed period is a mandatory trigger for evaluation allowance. Consistent with practice in the homebuilding and related industries, we have a four year cumulative loss policy and at the end of 2009, we met that threshold.

As a result, we recorded the non-cash valuation allowance against all of our federal net operating loss carryforwards and a portion of our state NOLs. I want to emphasize three things regarding the valuation allowance.

It is non-cash, recording the allowance in no way limits our ability to utilize our $1.2 billion of U.S. federal net operating loss carryforwards and we continue to believe that we will only, will have sufficient profitability to realize the economic value of our NOLs before they expire for federal tax purposes, the net operating losses begin to expire in 2026.

Now, I’ll briefly recap the full year results. Net sales were $3.2 billion, a 30% decline from last year. Operating loss for the full year of 2009 was $185 million compared to an operating loss of $512 million for the full year of 2008.

Our net loss for the full year of 2009 was $787 million or $7.93 per share, this compares a net loss of $463 million or $4.67 per share for last year.

The results in both periods include restructuring impairment and other charges, as well as, the deferred tax valuation allowances. The 2009 results also include the Lafarge litigation settlement. The pre-tax and after-tax amounts are detailed in the press release.

Now I'll have details on the P&L and discuss what we've done to manage capital spending and our balance sheet including liquidity.

Let me start with interest expense. Interest expense was $45 million for the fourth quarter and $165 million for the full year. We currently anticipate that our annual interest expense will be about $178 million for 2010 on a P&L basis and about $170 million on a cash basis.

Regarding taxes, due to the deferred tax valuation allowance issue, going forward, there will essentially be no tax benefit on any future losses or any tax expense on future income as the tax effects from both will flow through the valuation allowance until the valuation allowance can be reversed.

In future periods the valuation allowance can be reversed if the corporation has sufficient cumulative net profits. During 2010 we will be paying some foreign and State taxes, so overall you should expect an effective book tax rate of 1% to 2%.

Turning to capital spending. Capital expenditures totaled $44 million in 2009 and we are forecasting about $50 million of capital spending for 2010. We continue to benefit from the substantial investments in our operations that we have made over the past several years and this has allowed us to keep expenditures at this $50 million level.

Regarding our cash and debt situation, our December 31st cash balance, excluding $2 million of restricted cash was $690 million, compared with $621 million at the end of the third quarter and $471 million at the end of 2008.

As Bill mentioned our year-end cash position benefited from Lafarge settlement and the proceeds from last summer's senior note offering but we also benefited from strong working capital management, in fact we were cash positive before the Lafarge settlement, specifically our net cash from operating activities exceeded the net cash used for capital expenditures and other investing activities by $29 million before taking into account the $74 million of cash from the Lafarge settlement that we received in 2009.

We currently have nothing borrowed on our revolving credit facility. This facility is subject to a borrowing base and $90 million was effectively available to us at the end of December. This amount combined with our cash on hand and the undrawn CDC credit facility resulted in $808 million of liquidity at the end of the fourth quarter. This compares to the September 30th level of $796 million.

Total debt as of December 31st was $1.962 billion essentially the same as the balance at the end of the third quarter.

In 2010, we’ll continue to focus on working capital and further surplus asset sales. Jim has discussed our working capital initiatives already, so I'll briefly recap our surplus sale activity.

We realized $16 million in the sale of surplus assets in 2009. We presently have over $18 million of surplus asset sales under contract and these sales are scheduled to close during the first half of this year. Overall we still anticipate that our surplus asset sale program could total $50 to $100 million over the next several years, including the 2009 sales activity.

Let me conclude by emphasizing some points made by Bill and Jim. Market conditions in 2009 were challenging and we have very modest expectations for any improvement in 2010. We have successfully responded this downturn by controlling the controllables with an intense focus on operating fundamentals, regaining profitability through cost reductions and scaling our operations to market conditions. As well as enhancing financial flexibility and liquidity, and this will be our game plan in 2010, just as it was in 2009.

So in summary we are weathering the storm and we are well positioned to take advantage of the recovery whenever it comes. Now, we'll be happy to answer any questions you may have, as mentioned earlier, please limit your questions to one question and one follow-up. Thank you.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Dan Oppenheim from Credit Suisse. Please go ahead.

Dan Oppenheim - Credit Suisse

Thanks very much. I was wondering if you could talk briefly, talk about what you've done on the operational side and reducing the expenses and such anymore this year. How when you take a step back and you think about the industry how -- and I think some of the liquidity issues that are aided by the assets. How do you think of it in terms of just what will be needed for the industry as a whole to get back to better levels in terms of having better trends in terms of some price stability at least and what role do you see USG playing?

Jim Metcalf

Well let me just. This is Jim Metcalf. What we started to look at in 2006, we had a contingency plan for the demand decrease and we focused in three areas. We looked at programs, we looked at our portfolio and we looked at our products. And we really lens our portfolio to see if we had any businesses in there that we should get rid of and we really took a long hard look at, what was really necessary to get through this tough market.

Since 2006, as I said in my comments, we've taken out $400 million in costs, that's a miscellaneous cost, that's in overhead and unfortuntely, it was a lot of people positions as well. We've taken capacity out. We've gone through and taken out approximately 3.1 billion feet of capacity both on the wallboard side and then we've taken out another 17 billion feet in paper capacity.

But the industry is running at 50% and until we get the industry at some healthier levels, it is going to be a tough market. If you look at historic measures as we said in our comments, we haven't been operating at this rate in a long, long time if ever. What the industry, if you take out, we have contingency plans if the market gets worse, but it's not going to move the capacity utilization that much.

Operator

Our next question comes from Kathryn Thompson from Thompson Research. Please go ahead.

Kathryn Thompson - Thompson Research

Hi. Thank you. Can you please give an update on your current hedges?

Rick Fleming

Sure, I'd be happy to. This is Richard Fleming. Just to give you a little bit of background, you might recall that last year, we had a hedge ratio on our natural gas purchases of about 80%. This was effectively a combination of hedges that have been put in place before the economic downturn and then combined with lower operating levels the ratio had moved up to the 80% level.

You might recall we also shared with everybody that the legacy hedges as I called them rolled off in great part in 2010 and so legacy hedges now represent about 22% of a hedge ratio at this juncture.

Relative to what we're doing at this point in time, we have start to lay in some at the money swaps and also out of the money options, the combination of the two have effectively given us a 50% hedge ratio and over time we'll probably dollar cost average that up to about a 72% hedge ratio.

Kathryn Thompson - Thompson Research

And what price are you hedged?

Rick Fleming

Well, it's a work in process as mentioned but current spot prices right now are about $5.72 and legacy hedges are over $9, recent purchases have been as low as $5.35.

Kathryn Thompson - Thompson Research

And just to clarify that 22% is in 2010 or is it a current number?

Rick Fleming

The 22% is the legacy hedges that represent a hedge ratio in 2010 and then -- since then as mentioned we've added current market priced options and swaps which bring it up to about 50%.

Kathryn Thompson - Thompson Research

Okay. Finally, what is your current capacity utilization and any other addition? I know you previously commented on manufacturing capacity, I thought it was intriguing you said, you could take capacity out but it really wouldn't move the needle in the market in terms of pricing. Could you expand on that?

Rick Fleming

Well, what I just reiterate, I said it wouldn't move the needle a lot on moving capacity utilization up.

Kathryn Thompson - Thompson Research

Okay.

Rick Fleming

We have -- as I said earlier, 50% of our network is 10 years or less so we're running our newest network, we're running our low cost lines, any higher cost plants that we are currently running, we're really running for a few reasons. One is to service our specialty products, as I mentioned, we have a new product called SECUROCK.

The second reason we run some of our higher cost plants is we need to service our customers and its miles to market, and what we do when we look at our network we look at lowest delivered cost. So we are running, the industry is running approximately 48% to 50% capacity utilization. Historically, a healthy industry, is somewhere in the ‘80s, so we have a ways to go.

Kathryn Thompson - Thompson Research

And are you operating at or below industry capacity utilization?

Rick Fleming

We've been operating a couple points below.

Kathryn Thompson - Thompson Research

Okay. All right. Thank you very much.

Operator

Our next question comes from Trey Grooms from Stephens. Please go ahead.

Will Green - Stephens

Good morning. This is actually Will Green on for Trey. I wondered if you could talk about kind of how your, I guess with the hedges, kind of rolling off in 2010 to some degree anyway. I wondered if you could talk about how that's affected your pricing mentality going forward?

Rick Fleming

Well, we as I said we balance price and volume in the market. We look at every market to maximize profitability. We always, look at margins, obviously what we pay for natural gas is part of our, its a big component of our wallboard costs. It has had some impact I think how some competitive reaction has been but we really maximize profitability and we do it by balancing our price and volumes. So the hedges -- the hedge cost is part of our spread but we try not to change your behavior to market because of what we're paying for gas.

Will Green – Stephens

All right. I guess, what I was getting at is basically, if you can potentially, pay less to produce the wallboard and you're already operating profitably, I mean could you potentially give up some more price in effect going forward?

Rick Fleming

Well, we like to maximize profitability and we have a value proposition, we have in the market with our customers. As I said we have a full line of products and at this point, we like to get paid for the value that we have for our customers.

Will Green - Stephens

Okay. Thanks. That's all I had.

Rick Fleming

Thank you.

Operator

Our next question comes from Ivy Zelman from Zelman and Associates. Please go ahead.

Ivy Zelman - Zelman and Associates

Hi. Good morning, everybody. Recognizing I think you've indicated very clearly that demand needs to come back and obviously there's only so much that you can do about it but you've done what you can to reduce your overall cost structure.

If you can just comment maybe with respect to away from your own footprint, is there any possibilities that others in the industry given either problems on the financial front that others might have to capitulate here and that you're maybe optimistic that there could be industry consolidation, and then recognizing that there's the non-resi market is as challenging as it is, is there strategic plans for further cost reductions in other areas that we've yet to identify or that you have yet to identify?

Bill Foote

Ivy, this is Bill. You know, there have been, we've taken out a lot of capacity, one of our competitors took out some capacity in December and they know their numbers and more might come. We, in terms of participation there, we’ll continue to adjust our network, we don't have anything on the horizon but that could change based on volume and in terms of opportunities to acquire something we're always interested improving our cost position and serving the marketplace more effectively, so we'll keep our ears close to that.

I think Jim alluded to contingency plans. There's a lot going on in L&W right now. They are really tighter by the tail with a drop in new commercial and we'll get that right. So there's a lot going on and we have plans there, and corporately we're continuing to look at ways to reduce structural costs.

Ivy Zelman - Zelman and Associates

That's helpful, Bill. So just to add on that with respect to pricing, there was, you know, at least we understand one of the manufacturers announced a price increase in January and I believe you followed and then you delayed that or deferred it.

What would it take for you to come back out to market with a price increase given the weakness in the end markets? Is there something on the horizon or is it really just too difficult with the organization so low?

Jim Metcalf

Well, Ivy, this is Jim, and as you know we don't comment on future pricing, so I think we're pretty consistent on that. But we're going to take every opportunity that we can in this market to improve pricing. If you look back in 2008, utilization rates went that, we were still in some anemic utilization rates and up until two quarters ago, we had consistent price improvements. So we're going to continue to ask our customers to pay us for our value and they’ll tell us in this market.

I'd also like to come back to your comment on non-res and just, I think it's important to highlight the non-res market which we all agree is in terrible shape but if you look at the wallboard demand for the non-res market it's only 14% of our demand.

So the big drivers I said in my prepared comments in demand is R&R and that's where we're best positioned. We have our higher market share in that side of the business and we think that market is going to be coming back first, so the non-res is going to have a big impact on L&W as we indicated. It has a less of an impact on ceilings but on the wallboard side it's not as much as people may think.

Ivy Zelman - Zelman and Associates

Is that non-res meaning new construction versus repair and remodel, which is refurbishment on commercial and res and you look at that split because the repair and remodel on non-res as we think about commercial properties has also been scaled back to the bare minimum with companies not refurbishing and correct me if I'm wrong, please?

Jim Metcalf

No. You are right. The numbers I stated were new commercial.

Ivy Zelman - Zelman and Associates

Okay. Thank you.

Jim Metcalf

You're welcome.

Bill Foote

Thanks Ivy.

Operator

Our next question comes from Michael Rehaut from JP Morgan. Please go ahead.

Michael Rehaut - JP Morgan

Thanks. Good morning, everyone. First question just if you could kind of recap what you believe has happened over the last couple of quarters and particularly in the last quarter with regards to average selling prices for gypsum and as, relative to the stability that you had or in the first half of the year, was it more just driven by the lower shipment volume or how shipments go throughout the year or could you kind of witness some more competitive dynamics as demand continued to be relatively weak?

Bill Foote

Well, I think a few things happened. First, if you look at the overall, the industry demand, it got pretty anemic particularly in the third and fourth quarters. What did happen though when we get back from natural gas, natural gas came down.

We were hedged some of our competitors were playing the spot market so they could ship further. They could be more competitive and maintain some spread that they couldn't do in the first half and it puts some pressure on pricing. We do get a premium with our customers and that premium got pretty wide and we felt it was important that we kept our good customers competitive.

Michael Rehaut - JP Morgan

Okay. And just going forward, I know you don't comment on pricing going forward, but if you could just remind us, in terms of any type of price related announcements by yourselves or any competitors in the last two or three months?

Bill Foote

There was an announcement as in the previous caller had mentioned, there was a price increase announcement for this month, which we have not cancelled, we have deferred.

Michael Rehaut - JP Morgan

Okay. And just lastly, looking at the different restructuring activities and cost saving activities that you've taken in 2009 including in the fourth quarter. Could you just review what the incremental benefit you expect that to represent in 2010 across gypsum and ceilings and, particularly as it relates to the North American, sorry, the U.S. gypsum margin which kind of fell back to excluding the one-time items a negative 12% type number, everything else equal, how do you -- how should we think about that in the upcoming year?

Rick Lowes

Yeah. It's Rick Lowes speaking. You know, we've been very aggressive on restructuring costs since 2007 and as Jim mentioned we've had five programs. We had another program in 2009 of about $50 million, half of which went into last year and the other half will flow through in 2010.

We also been very -- and most of that we split between North American Gypsum and worldwide ceilings and some at corporate. Also L&W has been very aggressive in restructuring their operations and that's another $25 to $30 million and we've not yet to realize until next year.

Michael Rehaut - JP Morgan

Great. Thank you.

Bill Foote

2010.

Rick Lowes

So, 2010, sorry.

Michael Rehaut - JP Morgan

So $25 to $35 million from L&W in 2010.

Operator

Our next question comes from Ken Zener from Macquarie. Please go ahead. Ken, your line is now open. If your phone is on mute, please unmute it.

Bill Foote

Let's just move on.

Operator

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

Todd Vencil - Davenport & Company

Hi, guys. Thanks. That January price increase that you mentioned it was deferred. Can you tell us how much that was or what magnitude?

Rick Fleming

We were trying to get approximately $10 per thousand square feet.

Todd Vencil - Davenport & Company

Got it. And has anything really changed competitively in the market, it has been a very long and deep downturn obviously. I mean, do you feel like there's been a change in the sort of competitive dynamic that would allow you to start getting margin incremental price increases at some point as volume returns before maybe the sort of historically typical 85%, I mean, is there something that makes you feel as though your competitors would be that hungry for margin or is it going to be balanced volumetrically?

Bill Foote

Well, I can't speak for our competitors and I don't quote forward-looking pricing but what I will do is if you look back last year capacity utilizations were way below 80% and we realized price improvement. And I think what we have learned in this last three years is really how to operate our plants very efficiently. If you think about the industry and we're running our plants at 50% capacity utilization. And year-on-year we've lowered our costs, we've run our plants 97%, 98% recovery and what we have learned is how to operate these big plants in a very, very low demand market.

When we start really the key of this whole thing is getting a little bit of wind at our back on demand and you get some wind at your back, we can run these plants and they can start really lowering some costs. So we've learned how to operate our plants. We know that we at USG will continue to attempt to get price improvement but we have to provide value to our customers and our customers will tell us if we're worth it.

Todd Vencil - Davenport & Company

Yeah. And let me just say, I mean, you guys have obviously done a fantastic job of working through a very tough environment. I guess the way I'm thinking about it is, as I recall the price increases last year were mostly related to input costs and not sort of things that were providing you guys with higher margins.

And I'm wondering, I mean, obviously I would tend to expect that prices would go up this year again if input costs went up. But in terms of price increases, are you going to carry margins across you guys, I mean, is that still a couple years away when you get back to the mid ‘80s of capacity utilization or might it be closer than that?

Bill Foote

Well, we just again we don't comment on future pricing, we just don't want to go there.

Rick Fleming

It might be helpful just given what you said to point out that this natural gas prices have risen recently, we're up about a dollar decotherm from the November lows.

Todd Vencil - Davenport & Company

Fair enough. Okay. Thanks a lot.

Operator

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

John Baugh - Stifel Nicolaus

Good afternoon. I have two quick questions. One, just if you comment on the magnitude of ceilings price increase? And then secondly, I'm curious what you're thinking if not forecast is for say three years out for the four key end markets, new res, commercial new and commercial R&R, and how you think about where we'll be in those four segments say three years out?

Jim Metcalf

Sure, on the ceilings increase we're trying to get somewhere around 7% of an increase. If you look at the opportunity, let me just give you a top of the pile number, on gypsum wallboard opportunity our projections this year are 19 billion feet.

We think there's going to be some, the next few years we're going to get some positive movement. The R&R is probably lead by R&R, which is about 55% of the opportunity. If you look at the segment that is the weakest, obviously it's the commercial, the new commercial.

So what we're looking at this year is wallboard opportunity being up about 3.3%, non-res and again this is a non-lag number down 3%, that's followed by a 42% drop last year and R&R growth at 3%. So if you kind of put that all in there the industry was at 18.4 billion feet in 2009, and we are projecting around a 19 billion-foot market for 2010. We feel that going forward that there will be continue to be some lift in demand but it's going to be kind of a slow rode up.

John Baugh - Stifel Nicolaus

So, I mean, in your thoughts three years out where maybe housing starts might be in terms of just how you're thinking about managing your capacity currently?

Jim Metcalf

Well, we sure are anticipating they're going to be at 550, but if you look at the [Howard] numbers and you look at the overall demographics, you just run those numbers and you're looking that housing starts North of 1 million, 1.2 million, you're not going to be jumping up into the 1.5 million, 1.6 million range until further out.

So we're looking at this very modestly. We would rather prepare for the worst and hope for the best, but we aren't putting any big numbers out there. We want to make sure we're going at this in a very conservative manner.

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.

Bill Foote

Good morning, Jim.

Jim Barrett - CL King & Associates

Bill, could you talk about ceasing strategic opportunities, considering the amount of cash on the balance sheet, how much of that given the outlook, Jim, just articulated for the markets would you be comfortable investing in a new acquisition?

Bill Foote

Jim, as I said earlier, within our core businesses, there are opportunities to improve our cost position, or serve customers more effectively, we'll look at it. We are going to be very selective and very disciplined.

Jim Barrett - CL King & Associates

I understand.

Bill Foote

You know, things are selling or should be selling for cents on the dollar and…

Jim Barrett - CL King & Associates

Right.

Bill Foote

… with our liquidity, we're able to do some things but we're going to be very judicious in doing that. And that would be within the core gypsum business, possibly in distribution although there's probably more fall out there to come before we fund the bottom and on a highly selected basis, there maybe some opportunities internationally, we've had this opportunity with Columbia in the last six months. So we're out and trying to stay in touch with things but we're going to be as I say judicious in what we do.

Jim Barrett - CL King & Associates

I Understand. And then just one follow-up, Rick. If your volumes do stay flat or up very slightly in 2010. What will be the delta in terms of the amount of money or -- that you would spend on natural gas and wastepaper in 2010 relative to 2009?

Rick Fleming

Sure, I'd be happy to take a crack at that. Wastepaper has been really flat, Jim, so I don't think there's much of a delta there so far at least. Natural gas as you know last year the legacy hedges versus had we just bought its spot cost the company about $68 million. And so obviously, on a go forward basis since the legacy hedges have largely rolled off we'll capture substantial portion of that if you just talk about the wallboard business, it's probably in the zip code of $25 to $30 million for that business I will quote, probably closer to $40 to $50 million.

Jim Barrett - CL King & Associates

Thank you very much.

Bill Foote

Thanks, Jim.

Our next question comes from Garik Shmois from Longbow Research. Please go ahead.

Garik Shmois - Longbow Research

Thank you. First question, should you secure the ceilings price increase that you're out with now. Would it fully offset what appears to be rise in steel price environment for you or do you have to go back into the market for another ceilings price increase to fully offset?

Jim Metcalf

Well, we -- our strategic sourcing group really follows steel pricing, and we're, obviously, that's a big component of any type of any type of grid price increases. When you talk about ceiling tile, obviously steel is unrelated to that.

But what we secure steel for and how that relates to price is very closely correlated and we have a very, very professional group and if you really want to look at the ceilings operating performance, it's on how well we stay ahead of raw steel costs.

Garik Shmois - Longbow Research

Okay. Thanks. And just secondly, you've mentioned in the past, could you provide another update, if you have it on what you think industry average wallboard cash costs are right now?

Jim Metcalf

We think it's around $128 to $130.

Garik Shmois - Longbow Research

Great. Thank you very much.

Operator

Our next question comes from Mark Weintraub from Buckingham. Please go ahead.

Mark Weintraub - Buckingham

Two quick follow-ups. One on wastepaper, I guess, a little puzzled there. I think OCC prices have actually skyrocketed in the last month or so, that they're up $50 to $60 per tonne. What is the impact? How does that flow through to you guys?

Jim Metcalf

Well, if you look at our total raw materials wastepaper is included there, it's about 35% of our total wallboard cost, energy is about 25% of that. So OCC, the fluctuation of OCC has a direct impact of our costs on paper. But also, most importantly, we have our own paper mills. We just built a state-of-the-art paper mill in Otsego, Michigan. It is a paper mill that basically supplies the east coast United States, and we can offset a lot of that by efficiencies at our mills.

Mark Weintraub - Buckingham

Okay. So how much wastepaper would you say you were buying last year either directly or via the purchase of paper?

Rick Fleming

Well, I can give you more of a dollar feel for rather anticipating, our total wastepaper expense for wallboard is around $20 to $30 million…

Mark Weintraub - Buckingham

Okay.

Rick Fleming

… in a period.

Mark Weintraub - Buckingham

Okay. And bigger picture question. Well, on that cash cost actually, just coming back to that again, did I hear what you said 128 to 130 or something like that?

Jim Metcalf

Yes.

Mark Weintraub - Buckingham

And what is the and you gave the price right now as about 109?

Jim Metcalf

Yes. Just under 110.

Mark Weintraub - Buckingham

And that was a cash cost you were saying, 128 to 130?

Jim Metcalf

Yeah. That's for the industry.

Mark Weintraub - Buckingham

I mean, on the surface, it's just obvious, because it just seems incredibly surprising that we would be going this length of a time with the industry, with the average industry guys operating under cash cost, I mean,. what's your thoughts there?

Does that make you question the accuracy of that industry cash cost number or obviously it's not sustainable for a tremendously extended time. It's hard to get a lot of visibility on the numbers because a lot of the companies don't provide the information. It just seems a surprising number for you to put out there?

Jim Metcalf

Well, there are some competitors there that don't have the broad range of products that we do that I'm sure are having some interesting meetings. We don't want to -- we can't comment on those, but we are -- but that's an estimate we have, we make, 125 to 130, we scrubbed those numbers pretty well. As you indicated a lot of our competitors are private and don't disclose numbers. So we're just making some estimate as well but we think we're pretty close in the range.

Mark Weintraub - Buckingham

Okay. Thank you.

Rick Fleming

And I would mention on the paper side and right now I'm looking at our view for 2010, and even Jim did a good job of summarizing the dynamics here, the efficiencies we're getting from the Otsego mill have basically allowed us to have a very modest increase in paper cost in our 2010 plant, less than 6%.

Mark Weintraub - Buckingham

Okay. Thank you.

James Bencomo

Operator, we'll take one more call.

Operator

Our final question comes from Tom Kaplan from East Shore Partners. Please go ahead.

Tom Kaplan - East Shore Partners

Thanks for taking the call. One quick question. Just, can you just give me the number again that you gave out on the borrowing base?

Rick Fleming

Sure, the borrowing base effectively would be deduction for letters of credit $84 million and the available minimum requirement of $75 million results in $90 million of availability.

Tom Kaplan - East Shore Partners

Above and beyond the 75?

Rick Fleming

That's correct.

Tom Kaplan - East Shore Partners

Let me just ask you a conceptual question on the balance sheet, given the cash balance, et cetera and the job you've done in working capital. I mean, clearly, if you're not drawing on the revolver and you're going to be tight with working capital going forward and you're in default in a single covenant anyway. What's the point of even paying for the privilege of having that around?

Rick Fleming

Well, keep in mind as the business recovers, we'll be investing in receivables and inventory and the borrowing base will naturally expand and the borrowing availability will expand. So really that facility will be highly useful in particular when we are rebuilding working capital. In the last year we've had over $200 million reduction in working capital…

Tom Kaplan - East Shore Partners

Yeah.

Rick Fleming

… and thus the decrease in the borrowing base.

Tom Kaplan - East Shore Partners

Right. But you don't envision any scenario in which working capital declines to the point where that $75 million level gets breeched, correct?

Rick Fleming

No. I don't; in fact, we're probably at the seasonal low point for the year right now.

Tom Kaplan - East Shore Partners

Okay. Fair enough. Thanks for taking the question. I appreciate it.

James Bencomo

Thanks for your questions. Bill, you want to conclude?

Bill Foote

Yeah. Thank you all for your questions and interest. There remains considerable uncertainty about exactly what the market will look like in 2010, but like most observers, we anticipate another challenging year. Jim, Rick and I have described how we've focused on things within our control, sizing our market operations to market controlling costs and enhancing liquidity. We can see the benefit of those strategies paying off for us this year in 2010.

Market rebound will certainly come and we remain very confident that our strategies represent the correct balance between navigating through the current recession and positioning the company to capture the upside. Thanks for joining us this morning.

James Bencomo

Thank you, Bill. I'd just like to mention that there is a taped replay of the call that will be available until Friday, February 5th, and the information for that is available on our website. That concludes our call. Thank you very much.

Operator

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

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Source: USG Corp. F4Q09 Earnings Conference Call
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