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Executives

James Bencomo - Director of Pension Investments and Administration

Bill Foote - Chairman and CEO

Jim Metcalf - President and COO

Rick Fleming - EVP and CFO

Rick Lowes - SVP, Finance

Analysts

Jim Barrett - CL King & Associates

Trey Grooms - Stephens Incorporated

Michael Rehaut - JPMorgan

Dan Oppenheim - Credit Suisse

Kenneth Zener - Macquarie

Garik Shmois - Longbow Research

Joshua Pollard - Goldman Sachs

Kathryn Thompson - Thompson Research Group, LLC

Mark Weintraub - Buckingham Research Group

John Baugh - Stifel Nicolaus

Todd Vencil - Davenport & Company

John Emrich - Ironworks Capital

USG Corporation (USG) Q1 2010 Earnings Call April 20, 2010 11:00 PM ET

Operator

Welcome to the USG Corporation's first quarter 2010 Earnings Call. My name is Christine and I will be your operator for today’s conference. 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 James Bencomo, Director, Pension Investments and Administration. You may begin.

James Bencomo

Good morning, everyone, and welcome to USG Corporation’s first quarter 2010 earnings conference call and live webcast. We will be using a slide presentation today in conjunction with our call and 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 today is Rick Lowes, Senior Vice President, Finance.

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 question. Bill?

Bill Foote

Thank you, Jim, and good morning to all of you. Thanks for joining us on this call. As always, we sincerely appreciate your investment and interest in the company.

During our last call on January, we said that 2010 would be another difficult year. We still believe that to be the case, given our power of the residential and commercial construction markets have declined from their peaks. Most segments have a long way to go to get back to healthy demand levels in markets here and abroad. The good news though is that overall the construction markets appear to be stabilizing.

During the fourth quarter of last year, we felt that most segments of the residential and some segments in commercial market in the US and abroad had started to stabilize. That's the broad characterization of conditions in various segments in different parts of the world. Generally speaking, we thought that declines in the construction markets slowed or stopped late last year. We expect this stability to continue in the first quarter of 2010 and indeed that was the case.

For example, our domestic wallboard shipments in the first quarter of this year were slightly better than last year's fourth quarter at about 1,150 million feet, that's four consecutive quarters that we've shipped around 1.1 to 1.2 billion feet.

Some key market indicators have begun to move in a positive direction. Housing starts for example have improved steadily in each of the last three months of this year from 609,000 in January to 616 in February and 626,000 in March. That's not great by historical standards, but it's a definite improvement over the levels from 2009, which were in the mid-to-high 500 range all year.

Existing home sales have been trending positively as well. Existing home sales in February were fine. We made 20,000 marking the eight consecutive month in which existing home sales were higher than the same period one year earlier and just yesterday it was reported that mortgage delinquencies declined for the second consecutive month. Best three separate indicators were related to the residential markets that are moving in the right direction. The improvements are modest but our positive trend for our wallboard business.

Turning to our Ceilings business, sales of our ceiling products here and abroad were relatively strong in the first quarter and higher than the levels achieved in the fourth quarter of last year. Jim Metcalf will provide additional detail in a few minutes but our Ceilings business has performed well in this downturn and it continue to do so in the first quarter.

Looking outsides the United States economic growth around the world appears to be rebounding. The OECD reported last week that economic indicators of 29 of the 30 member country grows in February compared to January and indicates that those economies are expanding in excess to United and Japan reported the large gains.

We have been very focused on reducing and containing cost throughout this recession. We maintained that focus in the first quarter and in fact took additional steps in both, the wallboard business and the distribution business to cut cost and size the business appropriately for market conditions. Jim will give you those details but the point is that we are a much leaner company now and as the economy improves we expect to benefit from our aggressive cost control initiatives.

Another of our key objectives over the last few years has been to maintain sufficient liquidity. As we anticipated, our businesses were net users of cash in the first quarter. That’s a typical first quarter seasonal impact. Regardless, we ended the first quarter with cash and cash equivalents of $585 million combined with unused borrowing capacity on our credit agreements we have in excess of $725 million of liquidity.

As we look ahead to the remainder of the year, we expect to benefit from our efforts to streamline the business and our strong liquidity position. In addition, many of our key markets have stabilized and some market indicators are showing the initial signs of improvement. A combination of these factors, stability in our markets, cost control and liquidity are reasons that causes optimism. Looking beyond 2010, we remain confident in the company's inherent strengths and our ability to capture the upside in the inevitable recovering in our markets.

With that, I would like to turn the call over to Jim Metcalf for a discussion of our efforts. So, Jim?

Jim Metcalf

Thank you, Bill and good morning. The operating results in the first quarter were consistent with our expectations as Bill just mentioned. Domestic wallboard volume continued to be weak but has stabilized over the last several quarters. The ceiling business continues to perform well and our international markets started to show some signs of recovery, as well as our overall cost performance was good for the quarter.

The results at our Distribution Business, L&W Supply continued to reflect a depressed market conditions, primarily in new commercial. In response to those conditions, we took further action to reduce our cost at L&W and position the business for a continued weak commercial market.

To summarize the situation, the domestic wallboard business has stabilized and is beginning to show some signs of modest improvement. Our Ceilings business remained solid. The international business is rebounding and distribution results are weak but with some promising trends.

Before I review each one of our businesses, I would like to start what I always do, with our most important goal, safety. The topic of safety has recently been in the news because of some very unfortunate accidents in West Virginia in the auto industry. It's extremely difficult to operate safely everyday but we strive to do just that.

In fact, at USG, that is our expectation. Our goal is perfection, and even though we have not achieved that, I'm very proud to report that our safety performance continues to be excellent. Our manufacturing operations have not had one single lost-time injury this year, which includes all US and international plants.

Our distribution company operated 99% of our centers, reporting no lost-time injuries this year. The entire company had a great safety performance in 2009, and we hope and plan to exceed that this year.

Now I'd like to give you a brief overview of the business units starting with our US wallboard and Ceilings businesses. Wallboard shipments, as Bill just mentioned, in the first quarter were 1.15 billion square feet, which is a slight improvement over the fourth quarter. Volume has stabilized over the last several quarters and has seemed to have bottomed out.

Wallboard volume should be improving, given the recent reported housing starts and projected R&R improvement. Wallboard price for the first quarter was $106.58 per thousand. That was down about $3 from the fourth quarter, but it does not reflect the full impact of the price increase we implemented on March 15. We have since followed the March increase with a second quarter increase for May.

On the cost front, we continue to operate our plants at top efficiencies in spite of the low volume. This is a testament of our past investments of low cost, state-of-the-art facilities as well as our very dedicated manufacturing team. We announced the closure of wallboards lines at two plants during the quarter, one in Oklahoma, which will be idle this month and one in Stony Point, New York that will close in June.

Our strategy continues to be a balance of price and volume focusing on profitability but keeping a national footprint to service our fine customers. Our business units of surfaces and substrates had mixed results in the quarter. First quarter sales of substrates were down compared to the fourth quarter. Not particularly surprising since sales of many of these products can be significantly affected by adverse weather.

Despite the sales decline in this category, gross margins improved reflecting the success of our continued cost control efforts. In the surfaces business which includes our industry leading joint treatment and plaster products, our sales and gross profit improved from the fourth quarter.

Turning to our Ceilings business, results continued to be very solid and has performed extremely well throughout this recession. Our pricing cost management strategies have been effective and that continued in the first quarter of this year. We implemented price increases in tile and grid during the quarter and have announced a grid increase of 10% for May.

Sales of ceiling products increased in the first quarter compared to the fourth quarter and most product lines continued to generate strong returns both domestically and internationally. The main reason for our continued strong performance in ceilings is our focus on the commercial R&R segment and big box retailers which had not experienced the same declines as new commercial construction. We will remain committed to delivering exceptional value to our ceilings customers in improving our margin performance.

Turning to L&W, the decline in new commercial construction continued to affect our distribution business. More than 50% of L&W's business comes from new commercial construction. So the on-going weakness will continue to put pressure on this business. To stay ahead of the projected weak demand, actions were taken in the first quarter to help mitigate this impact. We reduced our cost by closing three additional locations and reduce the size of our workforce.

L&W also implemented a nationwide price increase for wallboard during the quarter to help mitigate the operating losses. This increase was paramount to L&W's returning to profitability. A balance of price and volume will continue to be our key L&W strategy. We navigate through this difficult commercial market.

Now, I would like to wrap up operations with our international business. Many of our markets appear to have been in early stages of recovery and we are starting to see the positive impact in our international business. We are pleased with our progress in results and our results are promising. For example, our Canadian business had a very good first quarter. CGC recorded a 7% increase in sales in the first quarter compared to the fourth quarter and operating profit improved by $3 million.

Our new Beijing ceiling power plant began operations in the quarter which will position us to capture growth in China and other emerging markets in the Far East. Elsewhere, internationally, we continue to explore emerging markets for expansion opportunities leveraging our industry leading technology.

In conclusion, wrapping up operations, in many regards, the first quarter of 2010 was similar to the fourth quarter. Obviously the fourth quarter was not a great quarter but the encouraging news is that things seem to have stabilized. The US wallboard business is stable and poised to capture any growth in our new residential construction which many market observers project will happen this year.

The Ceilings business continues to produce strong results. We have taken corrective action at L&W, both on the cost side and the price improvement side and the benefits of those actions will help improve the trends at L&W during the year.

Outside of the United States, key markets are recovering and growing, which will benefit our international operations. We will continue to focus on the fundamentals at USG as we navigate through this very difficult market. Safety first, our customer relations are vital and our dedicated employees will all position USG as the industry leader.

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 you. As Jim mentioned, I'll recap our first quarter result and provide some additional details on interest expense taxes, capital expenditures, debt and liquidity.

First quarter 2010 net sales were $760 million, down 17% from the first quarter of last year. Our first quarter operating loss was $82 million, which included $12 million in restructuring charges. So excluding the restructuring charges, we had an adjusted operating loss in the first quarter of $70 million. This compares to an adjusted operating loss of $77 million in the fourth quarter of 2009 as detailed in the schedule attached to our press release.

The $70 million improvement in our adjusted operating loss occurred despite slightly lower net sales, primarily because of improved operating efficiencies, our cost controls and restructuring activities.

Now let me discuss our first quarter 2010 restructuring actions, which continue to focus on scaling our operations to the marketplace. Due to decline in commercial construction, L&W closed three distribution centers, consolidated sales force and restructured many of its leases. Due to successful start-up of its low cost Washingtonville Pennsylvania plant, US Gypsum was able to idle its high cost Stony Point, New York plant.

In the first quarter US Gypsum also scheduled the closure of a high cost wallboard production line at its Southard, Oklahoma plant. We believe that these restructuring actions will continue to move us toward profitability. Wallboard business and L&W in particular that faced dramatic declines in demand, so scaling our operations to market conditions remains a number one priority and we’ll take additional action if necessary.

The first quarter 2010 net loss after tax is $110 million or a $1.10 loss per share. The effective tax benefit rate for the first quarter of 2010 was 13.4% compared to 43.6% for the same period a year ago. The effective tax benefit rate was lower in the first quarter of 2010 because the corporation recorded a valuation allowance against all its federal and most state deferred tax assets in the fourth quarter of last year due to its cumulative loss position over the past four years.

As such, no federal tax benefits are currently being recognized for accounting purposes against the corporations' losses and the tax provision for this year will relate primarily to our foreign operations in some states, but I want to emphasize that this accounting treatment is separate from management’s economic view. As discussed in our 10-K, we still expect to have sufficient profitability in future periods to realize the economic value of our federal income tax benefits before they expire.

Finally, another factor, the effect of the first quarter tax provision was recording of a discreet income tax benefit of approximately $90 million as detailed in our press release.

Now add some details in the P&L and discuss what we have been doing during the quarter to manage capital spending and our balance sheet including liquidity. Let me start with interest expense. Interest expense was $45 million for the first quarter 2010 compared to $42 million in the first quarter of last year and about the same as the fourth quarter of 2009. We 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.

As noted, our first quarter cash expense rate was 13.4% which includes the previously mentioned $19 million discrete tax benefit adjustment. For the full year of 2010, the tax benefit rate is expect to average 3% and as mentioned, our income has provisions for the balance of this year will be largely related to foreign and some state income taxes.

Turning to capital spending, capital expenditures totaled $6 million in the first quarter and we are forecasting about $50 million of capital spending for 2010. The continued benefits 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 the $50 million level.

Regarding our cash liquidity and debt situation, our cash, cash equivalents and marketable security balance as of March 31 was $585 million compared with $690 million at the end of the 2009. This change was primarily the result of seasonal changes in working capital, including incentive rebates realized by our customers.

We currently have nothing borrowed on our US revolving credit facility. This facility is subject to a volume base on a $190 million which is effectively available to us at the end of March. This amount combined with our cash, cash equivalents and marketable securities plus the undrawn CGC credit facility resulted in $734 million of liquidity at the end of the first quarter. This compares to December 31'st level of $808 million. Total debt, as of March 31, was $1.961 billion, essentially the same as the balance at the end of the fourth quarter.

I would like to give you a brief update on our surplus asset sale activity. While we do not finalize any sales during the first quarter of 2010, we presently have over $28 million of surplus asset sales under contract or close to contract and we expect that these sales will close during the next six months.

Overall, we continue to anticipate that our surplus asset sale program to total $50 million to $100 million over the next several years, including the $60 million in asset sales completed in 2009.

Let me conclude by emphasizing that we continue to respond to this downturn with an intense focus on operating fundamentals, regaining profitability through cost reductions as well as scaling our operations to market conditions and maximizing financial flexibility and liquidity during these uncertain times.

Now, we'll be happy to answer any questions you may have. As Jim mentioned, we would like you to limit your questions to one question plus one follow-up, so that everyone has a chance to discuss the results with management. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions). The first question comes from Jim Barrett from CL King & Associates.

Jim Barrett - CL King & Associates

Bill or Jim, could you discuss your US Gypsum regionally is the pricing and demand in markets like Florida, Southern Cal, the Southeast trending any differently than the Northeast and Midwest?

Jim Metcalf

Yes, Jim. This is Jim Metcalf. There are some regional differences. The Midwest, the mid part of the United States seems to be in pretty good shape compared to some of the, we call them ground zero areas. Florida is still weak. We are starting to see a little bit of signs of improvement, but still found some very low fables, and I'm talking about demand.

The Northeast, if you take out February which as everyone knows weather came into affect there, is fairly stable and in the mountain areas of the West seem to be solid areas. Now you get into Arizona, Southern California still relatively weak from a demand standpoint. The Pacific North West, from a demand standpoint, is another area that is showing some stability in our markets and really if you look at pricing it goes the same way.

As you know we implemented a March 15 price increase nation-wide and other areas took effect in greater numbers than maybe some other geographic areas but we did realize price improvement nation-wide but it's still a very regional business. There is a lot of inventory in Arizona, California and Florida.

Jim Barrett - CL King & Associates

Then as a follow-up, Jim can you give us order of magnitude how much of that 20% March 15 increase stuck on average?

Jim Metcalf

I will be more and happy to do that next quarter, Jim. We are two weeks into the March increase. So it was a 20% increase we were extremely firm and as you know we don’t report mid-quarter increases pricing but we did get some price improvement.

Operator

Your next question comes from Trey Grooms from Stephens Incorporated.

Trey Grooms - Stephens Incorporated

It sounds like some distributors were buying ahead of this March increase. Are you seeing a similar up tick ahead of this May increase coming from distributors?

Rick Fleming

We did see a little bit of surge buying. Some of that also had to do with the weather because inventories were extremely low particularly in the east, so there was a little rebuild of inventories from some of the, for example L&W lost four shipping days because of inclement weather.

We think there is a little bit of surge buying prior to the increase as you said and right now we haven’t seen at this point but we are close enough to demand increase yet. We will probably start seeing something in the next week or so but we haven’t seen anything at this point.

Trey Grooms - Stephens Incorporated

Then just from your perspective, how do your distributor inventory look like now coming out of that first increase?

Rick Fleming

Inventories were up slightly, nothing alarming but there was a little bit of surge buying. There were some protected committee protected work out there but you don’t see a lot of inventory barging at that seams. There was a little bit surge but what we did is we put in some controlled distributions so we didn’t have a big up-tick in volume. That was artificial. So we did not add any ships. We did not add any inventory. We just ran our typical network and really limited too much surge buying from our customers.

Operator

Your next question comes from Michael Rehaut from JPMorgan.

Michael Rehaut - JPMorgan

First question, I was hoping just to use it as getting some key numbers and then add a second question on ceilings. For the wallboard business, I was wondering if you could give USG and industry capacity utilization rates and also the wallboard price at the quarter end.

Jim Metcalf

Sure. The industry and really USG and the industry have been running in the mid-to-high 40s. Capacity utilization for the first quarter did tick up a little bit from the fourth quarter. So we've been probably lagging industry nearly a point or so, because we've been balancing our price and volume. If you look at our end of the quarter price, end of the fourth quarter price was around 109; end of the first quarter price was around 106.

Michael Rehaut - JPMorgan

Just before I got to my second question, the quarter end was similar to the average, so not much further downward pressure?

Jim Metcalf

Let me just clarify that was an average. When I said end of the quarter, that's what our average for the quarter, that was the average for the fourth quarter and average for the first quarter. That was not the price at the end of the quarter.

Michael Rehaut - JPMorgan

Right, so can you give out what it was at the end of the quarter or?

Jim Metcalf

No, we don't disclose that.

Michael Rehaut - JPMorgan

Second question just revolves around profitability on the ceilings and for that matter, I know I'm kind of sneaking one in here on the L&W supply as well. The ceilings has held up better than we had looked for given the decline in revenue. I was wondering if you could discuss that and if you are comfortable with and feel that you can sustain those margins going forward.

Conversely, on the L&W supply continues to come in little worst than we were looking for. I know you guys continue to right size their business. Should we be looking for similar margin like a low-double digit margin going forward or with what you've done, do you think that the margins or the losses can start to moderate?

Jim Metcalf

Let me first comment on your question on ceilings. The Ceilings business and this is a fact that I think is really important. If you look at USG ceilings only 24% of their sales goes to new commercial. We have a big focus on the repairing and remodel and also on the big-box. So I think that has helped mitigate that, we have had a big focus on - we do a good job with the big-box. Retailers have had some nice conversions there and that’s helped mitigate the new commercial losses. Obviously, year-on-year volumes are down from a ceiling standpoint because new commercial, still is a in a 24% of the business.

We have also done a nice job on strategic sourcing of our steel. It's very important that you are buying steel at the right price worldwide and staying ahead with price increases in the market as steel prices fluctuate up and down. So our grid performance has really helped the Ceilings business from a profitability standpoint and in our return on investment.

Still it has a lot of wind in our face because the commercial business has lagged, the overall new commercial business was down, big time double-digits last year and we are kind of end of the phase of that now. So, the Ceilings business even though the results are solid, we are going to have a choppy market ahead of us.

Turning to L&W supply, the reason for the proactive downsizing again in the first quarter is, more of L&Ws business. If you look at L&Ws business over 50% of their business is new commercial, so very much a different format. They are very focused on steel studs, commercial installation, our commercial products that’s really in the sweet soft for L&W and the problem they have is lack of demand.

The cost reductions we have taken out. We feel it's going to help mitigate the losses. The key is return to profitability, that’s going to be difficult this year quite frankly. The cost reductions we have, we feel we should take about $15 million out of cost. Along with that we are taking a very proactive approach of getting wallboard price improvement with our distribution business and having L&W sacrificing volumes for price improvement is a strategy we are implementing. So its kind of a twofold approach, its taking cost out of L&W but also being able to parking trucks in lieu of getting price improvement, its something that we are very focused on.

Michael Rehaut - JPMorgan

Then the $15 million is that annualized that you have yet to see benefits from, in terms of the actions you took in 1Q and in prior quarters?

Jim Metcalf

Yes. That will start rolling out as we go through the rest of the year. That’s an annualized number, yes.

Operator

The next question comes from Dan Oppenheim from Credit Suisse.

Dan Oppenheim - Credit Suisse

I was wondering you talked about the 2010 level of CapEx at $50 million. What do you see as the normalized level of CapEx, given what you have done over the past couple of years and when do you think you will need to get close to that normalized level?

Rick Fleming

Sure. This is Rick Fleming. We generally tell investors that on balance, when we are in more normal times, we would like to spend our depreciation to basically keep our plants running well and in a very good cost reduction mode. We have been able to benefit as mentioned from the heavy investment we did prior to the downturn. So we have been able to hold the capital spending for this year and last year to $50 million and if necessary we think we can do that even in 2011 but on the long run we would like to spend our depreciation and that is in addition to any activities the corporation would have for strategic growth, which would be added to our depreciation level of spending.

Dan Oppenheim - Credit Suisse

Then secondly, wondering on the L&W side, closing the three distribution centers and get to a total of a little bit over 100 right now. In total here, they've shutdown. Do you think you are at the right level there, and is there enough volume that you think have in events of [parking the trucks], does the business work if you give up share in that business now.

Jim Metcalf

At this point, we're at around 160 centers. We still have a national footprint, we've been very cautious about exiting markets; we've taken locations out of markets. The big cost reduction in the quarter was really from a personnel standpoint of just reducing the overall, the overhead that supports the 160. So if you take out centers, you lose volume for both sides of the business, so it's something that we have a contingency plan. If we have to have another plan, we're prepared to do that, and it'll really be from an overhead an d cost perspective versus a location perspective.

Along with that, when I say parking trucks that's something that I think is very important that we're balancing price and volume on our distribution businesses, just like we've done on the wallboard business. We are prepared to park trucks, to get price and margin improvements because with the heavy concentration on commercial, we don't see the velocity coming back for distribution this year, so the return to profitability is to improve our wallboard and other complimentary products spreads and we're going to be extremely aggressive of getting the price up.

Operator

The next question comes from Kenneth Zener from Macquarie.

Kenneth Zener - Macquarie

With the price increase that you guys have captured some of and obviously your expectations of future pricing, it seems like the effective utilization rate, taken out mothballed lines probably closer to 80%. You are still carrying the fixed cost of those mothballed. Can you talk about your ability to trim to the fixed cost structure further perhaps on the wallboard part of the business, not the other part of the wallboard?

Jim Metcalf

Well, Ken as you know we have been very proactive on taking cost out in all areas. We have taken out approximately 5000 positions from a personal basis. We have taken out over $450 million in cost. We have reduced our programs, the marketing and some R&D initiatives. So, we are really focused on reducing our fixed cost. We are also looking in the middle of a program of where we can verbalize some of our fixed costs so some of the areas that we have currently staffed; we are looking at leveraging our technology investment we made few years ago. So, the key is really taking some of those fixed cost we currently have in verbalizing those and that’s an initiative we currently have underway.

Kenneth Zener - Macquarie

Then the other part of the business, I know you said the gross margin has gone up, I assume perhaps the operating margins were kind of flat because of higher SG&A absorption, but could you just go into detail little bit there about perhaps the operating margins and the other part of that wallboard business as well in ceiling the concern you might have about rising steel cost.

Jim Metcalf

The operating margin with our surfaces and substrate business has been very solid. Obviously we are losing a little top-line growth just because of demand, but the sales reductions are not equivalent to what the overall demand has been reduced. We are very pleased with both surfaces and substrates because we have taken a lot of cost out. We have become more efficient. For example, our closure of our Southard, Oklahoma plant will help reduce some of the overall cost for our substrates businesses because they were carrying some of the wallboard cost.

We are very pleased with our margin performance in all of our other businesses, including ceilings and we have a really focused approach with our organization, we have a general manager running each one of these businesses. So that’s been one of the advantages through this recession is focusing on the other non-wallboard businesses to make sure we don’t have any margin compression in those.

On ceilings and you hit the nail right on the head, grid is key. As I mentioned earlier is that we buy globally our steel, we are very large steel purchaser and we keep our eye on the futures of steel and making sure our pricing is ahead of raw steel increases. That is the reason why we have a May grid increase of 10% in the market because of what's happening with global steel prices. So if you look at the Ceilings business, the spread on our grid business is really the key to increased profitability in our Ceilings business.

Kenneth Zener - Macquarie

Right, and do you guys do [features] at all for the express feature in your steel contracts?

Jim Metcalf

No.

Operator

The next question comes from Garik Shmois from Longbow Research.

Garik Shmois - Longbow Research

I have a question on wallboard pricing. Certainly, it looks like the March increase is gaining traction better than we had anticipated, the industry is jumped onboard with a May 1, but we also saw pricing go up in 2008 and only this year pullback over the last year. Do you get the sense that there might be a change in the competitive dynamics, so that perhaps these increases would be more sustainable?

Jim Metcalf

Well, I can't speak for competitors. I just know that we're very focused on spread improvement on wallboard. As you said the spread got started out last year very strong and as the year progressed and capacity utilization was going down, market prices got very aggressive.

I think what is the big change in this dynamics is our customers; our specialty dealer customers are now very proactive of getting price improvement to their customers. As I said in my comments a minute ago about L&W supply, we are very proactive of getting price improvement in the distribution channel, and I think that's the big sea change in this last go-round of increases.

Operator

The next question comes from Joshua Pollard of Goldman Sachs.

Joshua Pollard - Goldman Sachs

You often quote that last year new orders on commercial were down and they call it 40% range. Could you discuss what internal thoughts on growth or decline in the repair and remodel side of commercial for 2010?

Jim Metcalf

Yes. We are looking at repair and remodel in 2010 up about 3%.

Joshua Pollard - Goldman Sachs

Then the driver there?

Jim Metcalf

The driver there is really led by public works and education.

Joshua Pollard - Goldman Sachs

The other question is around the price increase as well. Could you talk about whether or not you are seeing aggressive starts by your competitors to take share within these price increases or is it a goal of USG in 2010 to increase market share.

Jim Metcalf

Our strategy is as we have been working through this recession is to balance our price and our market share with an eye on profitability. We have given up some market share over the last 24 months in lieu of price improvement and we have about fine balance with that. We track our market share by region. We know exactly where it is by MSF and in this environment a point of market share is not as valuable as getting price improvement because there is not that much demand there. I think pricing in general is still a very, very tender area because of capacity utilization is very low and there is a lot of pressure in the channel and that’s why I think it's imperative with L&W's proactive approach of getting price improvement along with the US Gypsum price improvement. It shows that our distribution company is willing to get price improvement in lieu of share.

Joshua Pollard - Goldman Sachs

So in markets where, are you seeing very big market dynamic differences such that there is well under capacity in places like Florida, potentially under capacity in places like the Mountain West and your are able to raise prices or even gain market share, actually do both in certain regions?

Jim Metcalf

There are some regional dynamics that may fall along with that but again we have it as an industry a demand issue and there is not that much market share to go grab and it's very, very tender and customers are very, they partnered up with their supplier. So, there are some regional differences but not a great extent of a change.

Joshua Pollard - Goldman Sachs

So if I understand, you are right, the market share shift around the industry is at least from a USG perspective is not nearly as important as pricing and hopefully that’s what's going on across the industry.

Jim Metcalf

That, speaking for USG, actually our strategy.

Operator

Your next question comes from Kathryn Thompson from Thompson Research.

Kathryn Thompson - Thompson Research Group, LLC

Hi, thank you so much. First question is on volume. Will you talk about the pace and trajectory of towards this quarter end and what's driving volume? In other words, repair and remodel on your construction and also any further capacity reduction plans?

Jim Metcalf

Well, just Kathryn, what is driving volume? Is that what you are asking?

Kathryn Thompson - Thompson Research Group, LLC

Yes, exactly. Is it more repair and remodel? Or is it new construction and what does that play into any further capacity adjustments you may or may not have?

Jim Metcalf

Well, the biggest part of US Gypsum's wallboard demand is repair and remodel. It's over 50%. So the projections that we are working on. In other words, its industry experts hearing and some other industry experts, repair and remodel, this year is going to be up about 3%. So if you look at 1% change in repair and remodel, it is about 100 million feet of wallboard demand. The next area would be new res.

We are working on projections anywhere between low 600s to low 700s. As Bill mentioned in his comments, that’s up from the 550 range. So every 100,000 housing start is about 800 million feet overall demand. So that gives you a metric to wherever your housing start number is, its about 800 million. If you look at commercial, which for US Gypsum, is only 14% of the overall demand, that’s new commercial.

So for every, if you look at overall footage, commercial footage, every, say 10% change in commercial footage is about 1% improvement or change in commercial footage is about 1% improvement or change in wallboard demand with a one year lag. So a new commercial we are working off a pretty dramatic decrease last year, right now but again, that's only 14% of the overall wallboard demand.

Your second question is on capacity reductions. As we mentioned in our prepared comments, we have idled or closed two facilities just announced, which account for about 500 million feet of total capacity, and one of our competitors announced last quarter for first quarter announcement, which was about another 500. So there has been a billion feet of capacity in the first quarter that's either been announced or has been taken out of the industry. So you are looking at industry capacity now around 30, on an annualized basis around 34 billion feet.

Kathryn Thompson - Thompson Research Group, LLC

Then moving on to the second part of my question, which is on pricing. If you could just remind us again, and for the wallboard segment, what your cash cost of production is on a unit basis, and then also could you comment on how much of the March pricing fees captures rising OCC pricing?

Jim Metcalf

The industry cash cost at the factory, for the industry is probably $117.Sso that would be for the industry. We don't disclose what our cash cost would be. The OCC has not had a huge impact. If you look at OCC prices have gone up. They've gone up probably 80%, 85%. So if you look at wastepaper as a component of our cost, wastepaper costs are only about 5% of our cost.

So it's not as big as an input cost as for example, if natural gas went up to $10 a deck of therm. So OCC is a key part of our wallboard cost but there is paper distribution, paper energy that goes in there but just the OCC cost increase has been offset by our efficiencies that are at our paper mills and taking fixed cost out.

Kathryn Thompson - Thompson Research Group, LLC

In other words your cost saves and also the price increase pretty much captures all the waste paper price appreciation since the start of this year.

Jim Metcalf

Yes.

Kathryn Thompson - Thompson Research Group, LLC

Also I have noted and this is the same case in Q4, you had a little bit higher SG&A than our expectations. Could you talk a little bit more about the increase and what we can reasonably expect going forward for fiscal ’10?

Rick Lowes

This Rick Lowes speaking. I will take you back to 2007 by the way and our first quarter spend was $117 million and we are down to $84 million. The increase in the first quarter versus the fourth quarter is really two items, one item was calculation of long-term incentive compensation plan which hits mainly in the first quarter and that’s about a $10 million to $15 million swing quarter-to-quarter. So if you take that out of the fourth quarter or the first quarter actually much lower than we were in the first quarter and then we hadn’t a non-cash charge for increasing our pension expense. So you can anticipate that our overhead spend will go back in to the last years type levels and we will actually spend lower than 2009 overhead.

Kathryn Thompson - Thompson Research Group, LLC

Okay that’s great and I guess final question. If you any updates on your hedges?

James Bencomo

Yes, well let’s come back to that question if we can so that we can take another call.

Operator

The next question comes from Mark Weintraub from Buckingham Research Group.

Mark Weintraub - Buckingham Research Group

Just trying to understand you talked about L&W raising prices, improving margins etcetera. Were the price increase initiatives to L&W before the announced gypsum price increase or in conjunction last after?

Jim Metcalf

The L&W price increase was done a few days after US Gypsum put their price increase in the market. So it was primarily together with it.

Mark Weintraub - Buckingham Research Group

Then presumably it was of a similar magnitude as the USG price increase?

Jim Metcalf

Yes, it was. In fact, the nationwide letter was up to 20%.

Mark Weintraub - Buckingham Research Group

Then when you said that you were very firm on the 20% increase, would it be fair to interpret that to mean that you expect to achieve the great majority of the 20% increase?

Jim Metcalf

Again, we don’t project our price and I would report that to you next quarter.

Mark Weintraub - Buckingham Research Group

Then lastly, the May increase, is that also a 20% increase?

Jim Metcalf

Yes, it is.

Mark Weintraub - Buckingham Research Group

I realize we are getting in to semantics and all that but to be going over the 20%, presumably that means that you have finished putting in whatever you would be putting in from the first price increase so that you can put a percent on what the next increase is. Is that?

Jim Metcalf

Yes. That’s correct.

Mark Weintraub - Buckingham Research Group

Then, just one last unrelated question. Under you [carry] model, which you said is greater than 50%, how would you break that down between residential and commercial?

Jim Metcalf

It's about half. It's about residential and commercial R&R is about half, 49-51. It varies but it's just as an easy number for you, it's 50-50.

Operator

Your next question comes from John Baugh from Stifel Nicolaus.

John Baugh - Stifel Nicolaus

Well, thank you. Just quickly, so if I do the math right, your new residential and wallboard is about 35% of the mix currently. Is that correct?

Jim Metcalf

New? Yeah. It's about 30%.

John Baugh - Stifel Nicolaus

30%. Then if you could go back to your peak, this is USG-only. I'm curious on wallboard in the capacity changes of the net number, what that change has been from peak to current, and then I am curious about the closed capacity, the gross closed capacity. How much has been permanent versus mothball. Thank you.

Jim Metcalf

The capacity USG, we have taken out 3.6 billion feet of capacity. That started back in January of 2007. Most of that capacity is idled, some capacity is closed. For example our plant in Santa Fe Springs, California is closed, and we'd be more than happy to follow-up with you on the specific idled versus closed, because it's quite a long list.

Again, anything that's idled, does take some capital and some time to bring back into the markets, so our philosophy is, as you look at it globally, idle capacity, you're going to have a very, very strong demand market and have the confidence that that demand is sustainable for any idled capacity to come back in.

If you look at the industry and I said again, the number for our capacity, our closures in idled is 3.6 billion. The competition has taken out approximately 5.2 billion of additional capacity bringing the total capacity reductions just short of 9 billion feet, and that leaves as I mentioned earlier with the current capacity in the industry around 34 billion feet in a market that is around $19 billion.

I know one of the questions always is when other capacities are going to come out. We look at our network. The key is that we need to service all of our customers nation-wide. We have a full product line, so we are going to continue to look at balancing our network with how our delivered cost is as well as how does demand look in the market.

John Baugh - Stifel Nicolaus

The industry is closed $9 billion since the peak, and I guess opened about what $5 billion to offset sort of $4 billion net change?

Rick Lowes

Yeah. That's pretty close.

Operator

The next question comes from Todd Vencil from Davenport & Company.

Todd Vencil - Davenport & Company

Thanks for letting me ask the question. On the ceilings, you mentioned grid and tile increased in the first quarter. Can you talk about what the magnitude of those were?

Rick Lowes

They were 5%.

Todd Vencil - Davenport & Company

At this point that together with the grid increase is that keeping you in line with ahead of what you expect cost to do, how is it relative to cost of the steel?

Rick Lowes

The key is to stay ahead of it, so we are pleased with the results.

Todd Vencil - Davenport & Company

Then final question just a quick last one. Can you tell us where we stand on natural gas relative to hedging and how much is hedged and where you are relative to spot in last quarter?

Rick Fleming

Sure. I will be happy to. This is Rick Fleming. The program this year consists of three components. We have the old legacy hedges that were left from several years ago. That’s about a 23% hedge ratio for the corporation. You might recall those hedges were done at about $9 in a quarter, but we did lay in new swaps at about 15% net ratio at $5.35, and then the balance of the program, we did with options, which really protect against the spiking gas prices, but you get the benefit of any decline in prices.

That's around 26% of program, yet basically the un-hedged would be option piece and we have a floating benefit here if gas prices go down 62% of our purchase for the year, so we feel pretty about the program. Our current spot right now is about roughly $4, little bit less than that and the forward curve is about $4.37. We just calculate this year's gas by basing these numbers with the current spot and the forward curve versus last year. We have about $44 million benefit this year, 30 of that at the Gypsum Company, and the balance to the rest of the corporation.

Operator

The next question comes from John Emrich from Ironworks Capital.

James Bencomo

Christine, We'll make this our last question. Then we will go to concluding remarks.

John Emrich - Ironworks Capital

Someone asked the question about whether the price increase was covering all or some part of your cost increases. I was going to ask you in a different way, so I understand it better. If you get all the price increases that you are looking for, is that basically to just cover all that cost increase i.e. hold margin steady?

Rick Lowes

What are you talking about? The Ceilings business or the wallboard business or that’s our universal?

John Emrich - Ironworks Capital

The wallboard business.

Rick Lowes

Actually, the price improvement was predicated on margin improvement. The prices came down last year. Wallboard actually, wallboard cost have been relatively flat.

John Emrich - Ironworks Capital

Okay, so the cost increases you are experiencing are in the ceiling business?

Rick Lowes

Correct.

John Emrich - Ironworks Capital

I got it. My confusion. Thank you.

Jim Metcalf

Thank you, and we'll conclude with some remarks from Bill.

Bill Foote

Thank you, Jim. We're pleased that the first quarter provides further evidence that the construction markets are stabilizing. Obviously it wasn't a great quarter, but it was stable compared to the prior quarter and some key indicators are now improving.

There's solid evidence that international economies are rebounding and the US economy is sure to follow. We remain confident that our strategy will allow us to navigate through the current recession and position the company to capture the benefits of rebound. Thank you all for joining us this morning.

James Bencomo

Thank you, Bill. Let me just mention that there will be a taped replay of this call that will be available until next Friday 30th, and the information is available on our website. I thank you all for joining us this morning.

Operator

Thank you for participating in the USG Corporation's first quarter 2010 earnings conference call. This concludes the conference for today. You may all disconnect at this time.

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