USG Corporation Q2 2010 Earnings Conference Call Transcript

 |  About: USG Corporation (USG)
by: SA Transcripts


Welcome to the USG Corporation's second quarter 2010 earnings conference call. My name is [John] and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session.

Please note that this conference is being recorded. I will now turn the call over to Mr. Brian Moore. Mr. Moore, you may begin.

Brian Moore

Good morning and welcome to USG Corporation's second quarter 2010 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,, 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, they will comment on market conditions and the outlook for our businesses. Jim will follow with comments on how our operating units are performing. Rick Fleming will conclude with some additional comments on our results and discuss how we're 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 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. Bill?

Bill Foote

Thank you, Brian, and good morning to all of you. Thanks for joining us on this call. As always, we appreciate your interest in USG. I'd like to start with a brief review of market conditions in the second quarter and then discuss our operating performance which was significantly better than the first quarter of the year.

The improvement is evident in the operating loss which declined to $25 million from $82 million in the prior quarter due to our continued focus on margin improvement and operating efficiency.

Turning to the market conditions, we've always expected that the recovery in the US and abroad would be uneven with improvements followed by retractions in some regions rebounding more rapidly than others.

Most of the second quarter economic indicators that are relevant to our business support that viewpoint of the unevenness of the recovery. For example, annualized housing [construction] the second quarter ranged from a high of $660,000 in April to a low of $549,000 in June. The average for the quarter was a little over $600,000. The second number quarters were certainly affected by the expiration of the government homeowner's tax credit.

Regardless, by historical standards those are all very weak demand numbers but on average they're better than the numbers we experienced last year. Year-to-date we're a little over $600,000 compared to last year's levels in the mid $500,000s.

The outlook for the residential repair and remodel segment, which is our biggest segment for wallboard, remains positive. We are projecting the segment to grow about 3%, which is a little less than other forecasters but we agree that the outlook for residential R&R is positive.

The consensus on the non-res market suggests it has not found a bottom yet but that the rate of decline has slowed. A recovery isn't expected until next year.

In general, our international markets are in recovery. While much of Europe is struggling with the credit crisis other emerging markets are the key markets like [China recovery]. Most notably for USG Mexico is steady and Canada has been improving nicely this year.

So as you can see, it's a mixed bag. Domestically new residential construction is weak but better than last year. Repair and remodel activity is expected to grow. Non-res construction is declining but at a slow rate. Some of our international markets are rebounding more quickly than others.

Turning to results, overall we didn't get any help in the form of stronger demand for our products during the quarter but our operating loss was substantially less in the quarter than the first. It's still a loss and any loss is unacceptable to us but our strategies are producing improved results.

We succeeded in cutting operating loss to $25 million in the second quarter from $82 million in the first. After adjusting for restructuring and impairment charges and income from a litigation settlement in the fourth quarter last year, our adjustment operating loss improved $18 million from $70 million in the first and $77 million in the fourth quarter of last year.

The financial schedule for the company to our press release today included reconciliation of adjusted operating loss to the reported GAAP numbers.

On previous calls you've heard us describe the many actions we've taken to scale the company and reduce costs to align the company to the recession and thus improve margins and operating results while maintaining our dedication to safe operations and excellent customer service.

The second quarter results are a clear indication that our efforts are succeeding. More broadly we were able to achieve significant improvement in our operating results in a market demand environment that is still very weak. As the economy recovers and demand for our products improve we can capitalize on the operating leverage in our businesses by moving more volume through that network.

Aside from margin improvement cost reduction, another key objective during the recession has been maintaining financial flexibility. On that score we remain in very solid position. Cash and cash equivalents total $555 million as of June 30. Added to the volume availability under our credit lines, our total liquidity was over $700 million at June 30.

As we look ahead to the remainder of 2010 and into 2011 we are encouraged by the positive impact of our many restructuring initiatives. It is clear that those initiatives contributed to our improved operating performance in the second quarter. We expect to continue to benefit from those actions in coming quarters, especially when market demand grows, allowing us to achieve better operating leverage throughout the manufacturing distribution network.

The recession in the residential and commercial construction markets has been both lengthy and severe. Our actions over the last several years have been designed to enable us to endure the downturn and most importantly preserve our ability to capture the upside. I am confident that our inherent strengths are intact, safety, quality, satisfied customers, strong brands, operational efficiency and innovation.

Those leadership attributes, combined with a much leaner organization, put us in a strong position to capitalize on the economic recovery as it unfolds. With that, I'd now like to turn it over to Jim Metcalf for discussion of operations.

Jim Metcalf

Thank you, Bill, and good morning. As Bill stated, we had improvement in our operating results in all business units during the second quarter. We are continuing to benefit from the initiatives we implemented to improve operating margins and return to profitability.

More importantly, we have improved these operating trends in spite of continued very weak demand. As demand improves we will be able to drive the additional volume through our manufacturing distribution networks which provides substantial operating leverage.

This will allow us to take further advantage of the substantial cost reductions and operating efficiencies that Bill mentioned that we've been implementing for the last few years.

In addition to operating efficiently in this very weak environment we continue to do it safely. This is our number one priority. In fact, we're on pace to set an all time company safety record, which is our most important focus in any market that we deal with.

Our manufacturing operations throughout the world have not had one single loss time injury this year. In fact, 66% of those locations have operated more than 1000 days without a loss time injury.

L&W Supply also is having an excellent year in safety with 89% of all locations operating over 1000 days without a loss time injury. This achievement highlights our discipline of our operating distribution teams as we continue to demonstrate this through weak market conditions.

Now I'd like to review each one of our businesses starting with our domestic wallboard business, US Gypsum.

Wallboard shipments in the second quarter were approximately 1.1 billion square feet, which is slightly lower than the first quarter of 1.15 billion square feet. We believe that wallboard demand has bottomed and we anticipate improvement in demand over the next few quarters led by R&R as Bill mentioned earlier.

Wallboard price improved in the quarter despite very weak demand. The average price for the quarter was $114.17, an improvement over $106.58 in the first quarter. We've also just announced an August 30 price increase in wallboard as we focus on improving our margins.

Our strategy continues to balance price and volume as we navigate through weak demand while improving our wallboard price. In spite of low demand, wallboard cost in the quarter improved compared to last year and the first quarter.

Higher per unit fixed costs were offset with manufacturing efficiencies, fixed cost reduction programs and our supply chain initiatives.

In addition to an outstanding safety performance, our manufacturing team has driven cost out of our network. As I mentioned on our call last quarter, we closed two plants, one in southern Oklahoma in April and in Stoney Point, New York this past June. We continue to be very selective about capacity closures to assure that we provide the industry best customer service as well as the lowest delivered network costs.

In spite of these terrible market conditions we are still focused on key customer initiatives. The first initiative I'd like to talk about is innovation. Earlier this month we started to roll out what we believe is a revolutionary new product, sheetrock brands ultra light panels.

Compared to our competitor's standard half inch panels, sheetrock ultra light panels are up to 30% lighter, stronger pound for pound, easier to carry and install. This product also reduces transportation costs for our dealers and obviously complies with all industry building code requirements.

Our customers have told us the product weight and performance are top product features. So sheetrock ultra light panels are a milestone in wallboard product innovation. This exciting new product will provide USG customers with a value added product to compete in this very challenging market.

Ultra light panels will begin rolling out throughout the United States over time and continues to prove our innovation leadership in the industry.

An important part of our business is our industry leading sub straights and surfaces business. These business units have had a solid second quarter both benefiting from a leaner and more efficient cost structure led by DUROCK and FIBEROCK, which improved in volume and margins.

Now turning to our ceilings business, ceilings had a solid first quarter with another strong performance in the second quarter. Sales in the quarter improved 8% led by price improvement in spite of lower volumes.

The strong performance is also attributable to product mix improvement, our focus on commercial repair and remodel and the retail big box customers. These segments have not experienced the same decline as new commercial construction.

We've also announced a (inaudible) increase for August 16 for 15% in the Southeast and 5% in the rest of the United States. We continue to be committed to offset cost pressure with price increase and our continued focus on ceiling's operational efficiencies.

Now moving to our distribution business, L&W Supply; L&W is operating our most difficult market segment and they've taken actions to restructure, reduce costs and improve pricing. These actions to improve margins and a focus on key customers contributed to a reduced operating loss in the second quarter.

Operating losses were reduced compared to the first quarter by 44% or 33% if you exclude restructuring charges. Wallboard price increase and margins improved in complementary product lines compared to the first quarter of this year.

L&W also had aggressive balance sheet management, which decreased working capital by over $120 million over the last 18 months. L&W has also reduced delivery and center overhead costs by over $170 million since the peak of the cycle.

L&W Supply will continue to take steps to return to profitability and adapt to these challenging market conditions. As I mentioned last quarter, we will continue to increase L&W wallboard pricing in the market in conjunction with manufacturing increases.

Now let's turn to our international business. International operations are having a strong year. Sales outside of North America were up 6% in the first half compared to the first half of last year and operating profit was $5 million versus $2 million in the prior year.

In North America our Canadian operations are benefitting from successful initiatives to reduce costs and the business is capturing the upswing of the Canadian housing market. Sales in Canada were up 20% in the first half and operating profit was $19 million compared to $3 million in the same period.

In Mexico our first half results were impressive given the soft market conditions. Operating profit in the first two quarters totaled $7 million on a 6% increase in revenue. The operating profit margin improvement is attributable to our ability to manage volume, price and cost. The Mexican economy is expected to improve in the second half of this year.

In conclusion, let me be clear. We are aggressively focused on returning to profitability. The improvements that we achieved in the second quarter does demonstrate that our strategies are working but there is still work to be done.

Our cost reduction programs and our pricing strategies have been effective. We are operating efficiently and most importantly we are operating safely. We continue to partner with our customers providing them with industry-leading service and new innovative products.

Generally speaking, the main issue we have right now is demand. We've sized the operations and most importantly we've lowered our break even to position our manufacturing and distribution networks for growth.

We fully expect to achieve improvements in all areas of our operations as we leverage our low-cost manufacturing assets, our national distribution network, our very strong brand names, customer satisfaction leadership and our outstanding product quality.

Now I'd like to turn the call over to Rick Fleming and he'll give you a further review of our financials.

Rick Fleming

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

Second quarter 2010 net sales were $769 million, down 7% from the second quarter of 2009 net sales levels of $829 million. Our second quarter operating loss was $25 million compared to a loss of $40 million in last year's second quarter. These results included $7 million of restructuring and other charges this year and $19 million last year.

Therefore, excluding restructuring charges, our second quarter adjusted operating loss improved $18 million this year versus $21 million last year despite lower sales. In addition, our sequential improvement, as Bill mentioned, was notable a the $18 million adjusted operating loss this quarter compares with $70 million adjusted operating loss in the first quarter of 2010.

Please see the schedule attached to our press release for the reconciliation of adjusted operating loss to GAAP operating loss for the fourth quarter of last year and the first two quarters of this year.

The second quarter 2010 net loss after tax was $74 million or $0.74 per share based on average diluted shares outstanding of $99.5 million. This compared to a net loss of $53 million or $0.53 per share in last year's second quarter.

For the first six months of 2010 net sales were $1.485 billion compared with $1.693 billion in the first half of last year, a 12% decline. Operating loss was $107 million in this year's first half versus a loss of $82 million for the first six months of last year. These amounts include pre-tax restructuring and asset impairment charges of $19 million in 2010 and $29 million in 2009.

Our net loss after tax for the first six months of 2010 was $184 million or $1.85 per diluted share. This compared to a net loss of $95 million or $0.95 per diluted share for last year's first half.

As mentioned in our first quarter call, a major contributor to our higher after-tax loss this year versus last year is the fact that in the fourth quarter of 2009 we recorded a deferred tax valuation allowance against all federal and most state deferred tax assets due to our four-year [committed] loss position.

As such, in 2010 we are currently not recognizing any federal tax benefits against losses for accounting purposes and our tax provision for the year will relate primarily to our foreign operations in some states. It is important to note that this accounting treatment is separate from management's economic view as we [expect] we have sufficient profitability in future periods to realize the economic value of our federal income tax benefits before they expire.

Now I'll add some detail to the rest of the P&L and discuss what we've done to manage capital spending and our balance sheet, including liquidity. I will start with overhead.

Selling and administrative expenses or SG&A was $73 million in the second quarter of 2010, up $1 million from the same period last year. For the first six months of 2010, total SG&A was $157 million compared to $152 million for the first six months of 2009. On an annualized basis, SG&A spending continues to be held at 2002 levels.

Interest expense was $44 million for the second quarter and $89 million for the first six months. We currently anticipate that our annual interest expense will be about $178 million for all 2010 on a P&L basis and about $170 million on a cash basis.

The effective tax provision rate was 9.9% for the second quarter of 2010 resulting in a six-month tax benefit rate of 5.4%. This compared to tax benefit rates of 30% and 36.7% in last year's second quarter and first six months respectively.

Looking ahead to the full year we anticipate an annual tax benefit rate of approximately 3% depending on the mix of worldwide income.

Trade and capital spending; capital expenditures totaled $5 million in the second quarter of 2010 compared to $12 million in the same quarter of last year. For the first six months CapEx total $11 million and we are currently forecasting about $50 million for capital spending for the full year.

We continue to benefit from the substantial investments in our operations that we've made over the past several years and this has allowed us to keep annual capital expenditures at the $50 million level.

Regarding our cash and debt situation, our June 30 cash, cash equivalents and marketable securities balance was as expected at $555 million and this level compares to $585 million at the end of the first quarter and $690 million at the end of 2009.

We currently have nothing borrowed on our revolving credit facility. This facility is subject to a borrowing base and $123 million of equity available to us at the end of June. This amount combined with our cash on hand and the undrawn CGC credit facility resulted in $706 million of liquidity at the end of the second quarter. This compares to the March 31 level of $734 million.

Total debt as of June 30 was $1.96 billion, essentially the same as the balance at the end of the first quarter as well as year-end 2009.

In addition, we expect to add to our liquidity through our continued focus on working capital and further surplus asset sales. We closed a $3 million surplus asset sale during the quarter and we currently have about $28 million of sales under contract.

Let me conclude by emphasizing that we continue to have an intense focus on improving our profitability, reducing costs and managing our balance sheet and liquidity. We are encouraged that our restructuring efforts are bearing fruit as evidenced by our substantially reduced adjusted operating loss in the second quarter.

But despite this progress we have more work to do, so our intense focus on profit margin, cost and cash continues. Now we will be happy to answer your questions you may have.

Question-and-Answer Session


(Operator Instructions) Your first question come from the line of Dan Oppenheim - Credit Suisse.

Dan Oppenheim - Credit Suisse

I was wondering if you could just elaborate in terms of the comments in terms of the overall coverage in terms of demand bottoming. Can you talk about the monthly trends as the quarter progressed and sort of how you're looking at the outlook for demand following into the tax credit here in the States.

Jim Metcalf

This is Jim Metcalf. Thank you, Dan. We're looking at the overall wallboard demand for 2010 as basically flat or up slightly from last year. As you know, we don't give projections. We're looking at our different models that are out there, housing numbers somewhere in the mid 600s. As Bill indicated, R&R we think is going to be up about 3% and we're still suffering the 12-month lag on commercial which was down over 40% last year.

So if you look at overall wallboard demand it's probably -- you're looking somewhere in the mid 18 range, which is equal to or up slightly from last year.

Dan Oppenheim - Credit Suisse

I guess I was just wondering in terms of the August 30 increase and sort of in the context of what appears to be decreased demand at this time and just how you're looking at getting it through given some concerns about May or we heard of weakness in June or giving off some of that May increase at that time.

Jim Metcalf

As you probably saw, we mentioned -- we announced this past Monday for an August increase and when we announce an increase we do it with a full anticipation of getting price improvement. If you look back earlier this year, discussions with our customers have changed from the price moving down to the discussion now is how much of the increase is going to be realized.

So I think there has been a sea change just with our discussions with the customers and we've announced the increase for August and right now we're optimistic.


Your next question comes from the line of Michael Rehaut - JPMorgan.

Michael Rehaut - JPMorgan

First question I was hoping just to circle back to the price increases. There was one announced in March, another in May. I think each was 20%. The average sales price for the quarter came in a little bit less than we were expecting and I would think that I was a little more conservative maybe than others.

I was wondering if maybe you could just kind of walk through each one of those price increases, estimated what was realized and what the actual price increase percentage-wise was announced for August.

Jim Metcalf

Let me answer your last question first. The increase for August is 20% as well. If we just go back historically we looked at some numbers back to 2004, 2005 and average price improvement in those markets where capacity utilization was very, very high averaged about $6.25 historically.

We're quite pleased with the $8. The trend is going the right way. We're still on capacity utilization of a very sloppy market of around 50%. So stepping through each one of those increases, the trend is it was increasing up.

We're pleased with the price improvement that we receive quarter-on-quarter and we're optimistic for the next quarter. Demand is very weak but if you go back historically in previous cycles, even with higher demand, this is kind of in the zip code of average price improvement.

Michael Rehaut - JPMorgan

In terms of the margin improvement that you say in the US Gypsum Company I was wondering if you could give a little bit more granularity in terms of -- amid the improvement in, let's say, basis points or percent margin -- if you can give us a sense, what came from the better margins of the complementary products versus what you think flowed through from the improved manufacturing efficiencies.

Jim Metcalf

Well, you had -- a big chunk of that was wallboard spread improvement. There was a positive margin improvement quarter-on-quarter. Our complementary products had a significant -- had a component of that, also continued cost reductions. So it was kind of three components on the margin improvement probably close to equal value, so a margin improvement on wallboard, good improvement on non-wallboard products and cost controls.

Michael Rehaut - JPMorgan

One last question, just the capacity utilization rate estimated for the quarter for USG and the industry?

Jim Metcalf

We're estimating 45 to 47 respectively. It's still very, very sloppy. The industry right now is about the -- we're looking at -- we estimate about 34 billion foot industry of capacity.


Your next question comes from the line of Joshua Pollard - Goldman Sachs.

Joshua Pollard - Goldman Sachs

Can you tell us what your 3% R&R forecast implies for second half 2010 growth and also talk about what the indicators are for you all right now in your expectations of a bottom from here?

Jim Metcalf

If you look at the three -- as Bill mentioned in his prepared comments, we're probably on the lower end of that 3%. There's been some numbers at 4% or 5%. Most recently Harvard came out with some forward-looking information on expenditures on repair and remodel and they're at 5% and actually they're really a little more aggressive as you get into the first quarter of 2011. Again, that's Harvard. That's not our numbers and that's a published report of two weeks ago.

We feel that with residential R&R, which is broken up basically half and half between commercial R&R, we do feel that, as I said in prepared comments, that the industry demand has bottomed and we hope in the next few quarters we're going to see a little bit of lift led by R&R.

Joshua Pollard - Goldman Sachs

Then just to circle back on the pricing front, was there more -- did you get more out of your March price increase than you did out of your May price increase? Then I have one last quick one on CapEx.

Jim Metcalf

Well, we don't comment on increase in May because that's during the quarter. We'll be able to comment a little more as we get further down in the year. But both increases had impacts and, as you can see, it's, again, the numbers speak for themselves. It's $8 quarter-on-quarter on basically an industry that's running 45% capacity utilization. So we're pleased with the pricing trend up.

Joshua Pollard - Goldman Sachs

Last quick question on CapEx, it's come again well below so far what you guys would say was $50 million in guidance. Should we expect a step up in second half alongside what you feel is a bottom in demand or should we expect you guys to run pretty low on CapEx? One last one is what are your cash costs or what do you think industry cash costs are today?

Jim Metcalf

Well, you were pretty good. You fit about four questions in there. CapEx, as we've said our CapEx budget is $50 million for the year, which is similar to what we had last year. As always, we have contingency plans. We do not expect or will not be spending more than $50 million and we are monitoring the markets and being very cautious as we look forward. But if you want to -- I would continue to have $50 million in your model but we look at that every month.

Next question.


Your next question comes from the line of Jim Barrett - CL King & Associates.

Jim Barrett - CL King & Associates

Jim or Bill, can you talk about the ceiling business. Having only a 1% drop in revenues appears to be a great performance and I understand that the industry took price in ceilings but I’m trying to understand what that says about non-residential remodeling trends especially given the 40% drop in non-res [start flash] gear and what that might say about your market share in that space.

Jim Metcalf

Thank you, Jim. We're very pleased with our ceilings results. As you recall, the last part of the last year we've been talking about commercial construction and being very cautious about the impact on ceilings.

We have -- our strategy has been to focus on commercial R&R and that, I think, has proved well in this environment. We all know what's happening with new commercial and there is just no action there, so focus on commercial R&R, focus on a lot of the government buildings that are being constructed.

Really we've had great success in the retail big box. There has been some nice improvements there. We're very pleased with some of the comp store sales that we're seeing with some of our large customers there.

We have focused on manufacturing efficiencies and, quite frankly, a lot of the operating profit improvement is our strategic sourcing group staying ahead of the very volatile steel market and making sure that when we see steel increases we pass those along or we stay ahead of those.

So it's been a combination of two or three. We've been balancing price and volume, as you indicated. We have been getting price improvement and this has not been a market share grab. This has been a fine balance of profitability and higher-end products where we're focused on some of our higher-end products. So we're really pleased that the strategy is being executed and in a very, very tough market.

Now saying that, looking ahead, if you look at new commercial we aren't -- the projections aren't as bad, 42% last year with a lag that we have in this business. Any type of lift we may have there in the next 24 months will help the ceilings business.

We do look at some leading indicators on commercial one as the AIA index, which everyone can look at, and the index just came out at 47 which means the commercial market is still contracting. Put that in perspective, June of 2007 it was probably mid-60s, 65, 68. So we have a loose correlation of about a six-month lag on our revenue on that index. So new commercial is still a ways away but we're focused on some of the segments that we think are showing some signs of life.

Jim Barrett - CL King & Associates

Jim, as a follow-up, considering the pricing especially on grid, should I assume that the underlying volume declines in ceilings may be mid to somewhat higher in terms of volume declines, mid single digits or somewhat higher?

Jim Metcalf

Yes, you're in -- that's the zip code.


Your next question comes from the line of Trey Grooms - Stephens.

Trey Grooms - Stephens

A quick question on the wallboard as far as big boxes and how much of your wallboard volume actually goes to big box retails currently?

Jim Metcalf

If you look at our total wallboard demand, we have about 45% is going to repair and remodel, which a lot of that is big box, a lot of that is commercial repair and remodel. You figure about half of that is probably, as a rough estimate, probably half of the 48%, so mid 20s.

Trey Grooms - Stephens

Then looking at the pricing and how it differs from big box as opposed to other distribution channels, is there a significant difference there and whenever you're putting out price increases, etcetera, just helping us kind of think about -- reconcile the 750 or so that you put up in price increases versus kind of what was the now. So I'm just trying to get a feel for how much of that was mixed versus what really stuck, etcetera.

Jim Metcalf

Well, I think one of the things we should look at or discuss is we're a nationwide supplier product. There are markets that are stronger in the United States than others, so when we go to a market with a nationwide price increase some of the nuances would be depending on the regionality. The Southeast is much weaker than the Midwest.

So a lot of it has to do with the geographics versus the segment and the segments do have some nuances as well. When we go at the price increase, we go at the price increase with all customers 20% and we then sit down and have our individual negotiations. So there's not an overall policy that big box versus specialties of certain level. We get price improvements across the channel and we want to do it in a way that we continue to improve our margins.

Trey Grooms - Stephens

Then you said that pricing was trending in the right direction through the quarter. Can you tell us where you ended the quarter on wallboard pricing?

Jim Metcalf

What I'll do, I'll tell you in about three months at our next call. Trey, we just give the average quarterly price. So we have to …

Trey Grooms - Stephens

I thought it was worth a try. Also on the ceilings business, just one other thing on that, it looks like the margins were pretty strong. Do you think that that level of margin is sustainable as we kind of look into the back half of the year?

Jim Metcalf

Well, we don't give projections, so that's another good try, Trey, but we're very focused on our ceilings business, as I said in the previous call about ceilings. We're focused on balancing price and volume and it's all about profitability.

We're still in a very tough commercial environment, be it as we're in the repair and remodel in big box. But it's still a very tough commercial environment. So we're focused on -- product mix is very important in ceilings and this is not a share grab. This is maximizing profitability. So I would hope that the performance continues but we aren't going to project that at this point.


Your next question comes from the line of Dennis McGill - Zelman & Associates.

Dennis McGill - Zelman & Associates

Just first question, I wanted to maybe tease out a little of what you've talked about on the repair and remodel side. It sounds like the 3% growth is across both residential and non-residential but you're seeing good trends in both.

Can you maybe separate that out a little bit as far as your expectations for the year, either based on your exposure to the big boxes or conversations with customers? Can non-residential repair grow through the year or is that 3% [compicent] across the two end channels?

Jim Metcalf

Well, that 3% we gave you is total commercial and R&R and the non-residential R&R is probably going to be the weaker of the two. We don't break those numbers out but we do track our comp store sales with some of our big box customers and we're starting to see some positive results there. So we think of the two segments, if you looked at residential R&R, that would be a more positive number in that 3%.

Dennis McGill - Zelman & Associates

Would you think non-res would be sort of modestly down and residential would be up in a little bit more of that 3%? Is that how to think about it?

Jim Metcalf

Yes, I think that would be a good way to think about it.

Dennis McGill - Zelman & Associates

Second question, just on cash flows, working capital there are some estimates here, but through the first half of the year it looks like this year is going to be a usage of $50 million, $60 million. Last year it was a positive $30 million. How should we think about working capital needs for the year?

Rick Fleming

Yes, this is Rick Fleming. In terms of cash usage during the year, in the second quarter we did have cash usage of about $25 million; in the first quarter, probably about $108 million between CapEx and cash flow from operations.

We should be pretty steady state on a go-forward basis. We do expect actually some improvement in liquidity and a reduction in [working capital] in the fourth quarter just do to seasonal factors. So I would just state that I think for the year-to-date we've pretty much seen the cash usage component of our balance sheet.

Dennis McGill - Zelman & Associates

When you say steady state you're implying the second half of the year is basically sort of neutral on cash standpoint?

Rick Fleming

That's correct.


Your next question comes from the line of Garik Shmois - Longbow Research.

Garik Shmois - Longbow Research

I just want to circle around volumes. Your volumes were down I believe 9% on the quarter and industry I think was down about 1%. I was just wondering if you could maybe offer some color on the disconnect. Was it geographic or did you benefit maybe a little bit more from -- maybe some pre-buying in the first quarter, ahead of the first price increase. If you could just help us out with that, that would be great.

Jim Metcalf

Yes, you hit two areas that -- correct, it was geographic. There was some pre-buying. If you looked at the -- the March volume numbers were quite robust, which pulled some volume from early in the quarter. As I said in my prepared comments that we will continue to balance price and volume and there will be some areas that we raise price and passed on orders. So it's really the three, geographic, some pre-buying and balancing price and volume.

Garik Shmois - Longbow Research

Could you offer maybe a little bit of color which geographies are doing better or worse right now?

Jim Metcalf

Well, the southeast continues to be challenging, particularly Florida. I'm sure that's not a surprise to anyone. California did weaken during the quarter. We also saw some weakening in the upper Midwest. But really if you look at the two coasts it's the Southeast and the far West are still pretty anemic from a demand level.

Garik Shmois - Longbow Research

My last question is on L&W with the wallboard sales declines. Can you tell us what is was like on a, I guess, same store basis given that you've closed some capacity over the last year, what those trends look like?

Jim Metcalf

On the same store basis this is the first quarter we saw some positive trends. If you look from a year-on-year basis, L&W's volumes down about 20% and that's with the exposure. As we said before, they're higher exposure in the commercial and new commercial business. But this was the -- sequentially we saw some positive comp store sales this quarter.


Your next question comes from the line of Jack Kasprzak - BB&T Capital.

Jack Kasprzak - BB&T Capital

Regarding the August price increase, to your knowledge, have any other wallboard producers announced a price increase as well [piled on]?

Jim Metcalf

Yes, Jack. I believe all competitors have announced. We announced this past Monday but all competition's up -- there are different dates all around the last part of August, mid to last part of August timeframe.

Jack Kasprzak - BB&T Capital

Secondly, you guys mentioned break even levels, lowering your break even levels during some of your prepared remarks. Is there any way to give us an idea of either what level of quarterly wallboard volume or housing starts on an annualized pace you guys think we might need to see to get to that break even level?

Jim Metcalf

That's a great question and let me give you a little historic perspective versus a forecast. If you look back at our business in 2001 and 2002 our revenue, our sales went up year-on-year $200 million.

The operating profit -- and this is for North American Gypsum. Our operating profit went up $180 million. So when you think about break even it just shows -- and I said in my comments -- the leverage that we have in this business by the cost reductions, the efficiencies, our low-cost capacity. So just as a straw man you can look, $200 million increased revenue North American Gypsum year-on-year, $180 million improvement in operating profit.


Your next question comes from the line of Kathryn Thompson - Thompson Research.

Kathryn Thompson - Thompson Research

Yes, I got 7% sequential pricing for wallboard and it would imply there could be additional pricing going into the third quarter. When could you conform that and also could you clarify how receptive the big box retailers have been to the price increase?

I'm just saying their acceptance and the magnitude is different than traditional distributors. What would be the overall timing and potential acceptance of the wallboard price increases that we've seen this year?

Jim Metcalf

Well, as I said earlier, I don't know if any customer's really accepting price increases with open arms in this environment but we go to each one of our customers, including our big box customers and get price improvement.

We have negotiations with each one of our customers regardless of what segment. So we go to the market very consistently. The timing would be, as I said, it's August 30 increase. I'm not sure if, Kathryn, if you could clarify your question. You were wondering the timing of that increase.

Kathryn Thompson - Thompson Research

My understanding from our primary research shows that the big box negotiation is a little bit longer process than from your traditional distributors and maybe not all the price increase goes through as quickly for big box retailers. So I'm really just trying to get an understanding of that dynamic and how that's played through with your March and May price increase.

Jim Metcalf

I see. Thank you. There are negotiations with the big box and specialty dealers. For example, there are job commitments that have been made prior to an increase that we will go to a customer and we have quoted a job. It's a commitment we made as a company and that price is held for a certain amount of time. So that happens on the specialty dealer side. So that's why sometimes you will see not the entire realization of a price increase go through.

You also have programs with builders that go in six-month periods. So there may be -- at the end of June 30 pricing may move up or down considering the contract with the builder as well as big box where you may have a commitment of time that you've agreed upon prior to the increase that this will be the price for a month or for a quarter.

So each one of the segments have different dynamics; it's just not focused on the big boxes. But that's why you see increases of a certain percentage don't fall straight through because there are commitments made.

I bring your attention back to previous cycles where capacity utilization has been very, very high, 85%, 90%, and we've averaged on a quarter anywhere between $6 and $8 on a quarterly increase. So this increase, considering where we are in capacity utilization, we're quite pleased with.

Kathryn Thompson - Thompson Research

Is it a correct assumption though that you could see continued momentum from the price increase and your March and May carry into the third quarter above and beyond the August price increase you announced?

Jim Metcalf

Well, we don't give a projection on the price but we would -- again, it isn't sometimes a firm date. So we'll have to report back to you next quarter and we can talk about it.

Kathryn Thompson - Thompson Research

Talking a little bit about volume, I know that obviously there has been some pull on the impact in volumes from the housing tax credit ruling off. But could you give us a better sense of the [patent] trajectory of all your trends towards the quarter-end and how that -- if there are any different [roads] in certain segments where you're seeing some [involvement] improvements.

Jim Metcalf

Yes, sure, the Gypsum industry, the entire industry had an extremely, extremely weak June. In fact, the total industry in June shipped equivalent to what was shipped in December of last year. So there was a pull back from demand. There might have been -- we look at it as kind of a smoothing effect.

March, shipments were quite high, so those were probably higher than what they should have been. But we did see some pull back in the quarter from overall industry demand.

Kathryn Thompson - Thompson Research

But going into July have you seen a recovery relative to June in terms of your volume trends?

Jim Metcalf

Again, that would be giving a projection, so I can't comment on that right now but we will next quarter. Kathryn, I'm going to ask that we move on to the next caller. You can always give us a call. We'll have some follow-up questions with you.


Your next question comes from the line of Mark Weintraub - Buckingham Research.

Mark Weintraub - Buckingham Research

First, just want to understand, you were operating, I think you said, 45% or so across the system as a whole. Do you -- can you give us a sense as to what the range? Do you have some facilities which are operating in the 80s and others which are much lower or is it fairly consistent through the system?

Jim Metcalf

No, you're exactly right. We do have a range. We tend to operate our low-cost, high-efficient plants at a higher capacity utilization. Those are the plants that can reach further distances. You look at probably -- that's a big percentage. The next group would be our medium cost lines, which makes specialty products and are closer to the major metropolitan areas.

So you're exactly right. It is a -- we have a network optimization model that we look at lowest delivered cost in every major market and we feed our low-cost plants as much volume as possible but, again, it's miles to market and it's the deliver costs into the market.

Mark Weintraub - Buckingham Research

I asked the question in trying to help figure out what hopefully will become -- at some point when demand does pick up and there is incremental volume, what type of incremental costs will there be with that incremental volume? In other words, presumably you'll have a lot lower than your average costs as the new volume comes into play. Can you help us in that analysis?

Jim Metcalf

Well, I kind of bring you back to what we were talking about 10 years or so ago where revenue went up $200 million year-on-year and this was in the Gypsum business and operating profit improved $180 million. So it flowed straight through.

Mark Weintraub - Buckingham Research

But was there any price involved in that though? I mean, obviously price is going to go straight through.

Jim Metcalf

Actually, no, there was only -- in that environment there was only $2 in realized selling price improvement.

Mark Weintraub - Buckingham Research

Although I guess I'd be scared to model 90% margins on incremental volume.

Jim Metcalf

I'm sorry?

Mark Weintraub - Buckingham Research

I probably would be scared to model 90% margins on incremental volume.

Jim Metcalf

Well, that was a historic number that shows you the leverage in this business. So you're going to have to use your own discretion on your model. But it is very powerful.


Your next question comes from the line of [John Shane - Shane & Company].

[John Shane - Shane & Company]

I am wondering how you guys are thinking about the overhand in supply and the residential and non-residential structures. Obviously the shape of the recovery for the wallboard industry will have to do with waiting until the excess supply sort of gets whittled down over time and you guys probably watch that more intelligently than the vast majority of people.

Of course, it's ultimately unknowable. But how do you guys think about the over supply in residential and non-residential? How many years do you think it'll take to whittle that down?

Rick Fleming

This is Rick Fleming. You're absolutely correct that it's a bit of an unknowable but we do look at foreclosures, we look at vacancies, we look at the future foreclosure estimates. From a lot of that work we have a view that it's going to take several years to clear the inventory on the residential side.

I think we're probably not too different than many of the forecasters in that they look for the inventory to be much better by the time you get to 2012 with some improvement in 2011 but it's a multiyear process and I think that's been evident in the last few weeks as we get the economic data that this is a slow and rather muted recovery in housing but, nonetheless, recovery is unfolding.

Relative to the non-residential side, as Bill mentioned, we really don't expect that segment to drop until next year. We take some encouragement from the fact that this is primarily a financing issue as opposed to a supply issue. In fact, as we look at some of the data that we're getting right now on the existing stock, good properties that are cash flow positive, we're actually starting to see some increase in the appraised value of these properties, ever so modest but, nonetheless, up this year versus the declines we saw last year.

So it tells us the existing stock is fairly healthy and with no real overhand of new stock coming into the marketplace obviously the name of the game right now is repairing model in the existing stock and then overtime as the financing markets become more liquid and the usage of the existing stock gets higher we'll undoubtedly see some new projects come to market. But it's going to take a while and, as Bill mentioned and as I emphasized, it won't even drop until next year.

[John Shane - Shane & Company]

One very quick follow-up; can you summarize in wallboard business just some rough numbers? In normal times, I guess, thinking back over history -- we're certainly not in normal times now -- what's the split between the wallboard sold into the residential markets for both new construction and repair and remodel versus wallboard sold into the new construction repair and remodel for non-residential?

Jim Metcalf

Yes, the R&R market has been -- in normal times is still 45% to 48% of the overall demand and that's broken out, as we said, half and half between res R&R and commercial R&R. The two segments, of course, that have come down tremendously have been new housing and commercial.

But commercial typically on wallboard is only -- new commercial is only 10% to 12% of overall demand.

We'll have one more caller please.


Your next question comes from the line of Todd Vencil - Davenport.

Todd Vencil - Davenport

Circling back around on the incremental margin conversation that we've had, that period 10 years ago when revenues went up by $200 million and profit went up by $180 million, what did capacity utilization look like around that period?

Jim Metcalf

You had -- it was about 11 -- we were shipping about 11 billion square feet. Right now we're about half of that. So you're capacity utilization was pretty high. It's probably 87% to 90% capacity utilization.

But I think the important metric on that comparison is there was only $2 of price improvement throughout the year, so there wasn't a big price improvement to skew that operating profit number. It was just showing that incremental volume coming through a very low-cost system.

In fact, the system was not as low cost. Our network wasn't as new then. 50% of our capacity now is eight years or younger. So we have a very efficient, a very low-cost network of ready to go here. So, as I said in my prepared comments, this is a demand issue.

We've taken $450 million of costs out of this network. We plan to keep this network very tight and with any type of demand uptick, which we -- everyone has their time of when that's going to happen -- the leverage in this business is very, very, very strong.

So capacity utilization was much greater than it is now but there wasn't a lot of price leverage up in that period. That's really why we picked it as a good comparison for you.

Todd Vencil - Davenport

Sure, that makes a lot of sense. I guess my question would just be -- I don't think anybody knows necessarily but you guys are certainly in the best position to know. Do you think given comparative factors that sort of kick in at 50% capacity utilization or below 85% or what have you, do you think that the industry will allow itself to realize all that incremental margin that kicks in when volume begins to grow again or do you think that some or a lot of that may be eaten up by sort of competition for volume?

Jim Metcalf

I think -- I'm not speaking for the industry. I know with any type of demand it's going to be very positive for us. We are always the price leader of getting price improvement. We feel we have a value proposition to do that and what we need is -- if you go back and just look at a 20-year period from 1985 to 2004 on demand -- and we did 2004.

We wanted to take out the '05 and '06 numbers because those were off the chart high. A 20-year demand is about a 25 billion foot market. That's a very, very healthy market. Regardless of where you are if you say, "Well, 20 years is too far. Let's take a 10 year look," '95 to 2004 with a 10-year demand and you have a little -- we need a little more capacity reduction, maybe another 2 billion or 3 billion feet that comes out. It takes the industry to 29 billion feet.

So it's not going to take a lot from a demand standpoint but I think the industry has gone through four years of a depression here and I know from our standpoint we are very anxious and we're very focused on returning to profitability as soon as possible and maximizing return to our shareholders.

Thank you. That concludes our questions. Bill, I think you have some concluding comments.

Bill Foote

Thank you all for your questions and interest in the company. Let me just sum up the second quarter with three thoughts: first, market demand clearly remains weak. Secondly, we had a strong improvement in operating results. Thirdly, that leads you to the operating leverage we see going forward. It's significant. When demand moves we will certainly benefit from it.

We continue to be vigilant on factors under our control. Safety has been terrific, quality, customer satisfaction and our costs and margins. Let me add one of the hallmarks of this company is its innovation. We've become more focused given limited resources but we are in the midst of introduction sheetrock brand ultra light panels which we think is a breakthrough in this business and we're very excited to be rolling that out over the next several months.

Our financial performance this quarter demonstrates we're making progress during what's become a very severe and prolonged recession. We're well-positioned for recovery and expect to fully capitalize on that when the pendulum swings.

Thanks very much and let us know if you have any continuing questions after the meeting. Thanks.

Jim Metcalf

Thanks, Bill. A taped replay of this call will be available until Friday, July 30. Information is available on our website at That concludes our conference call. Thank you.


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

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