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Executives

James R. Bencomo - Director of IR and Pension Investments

William C. Foote - Chairman and CEO

James S. Metcalf - President and COO

Richard H. Fleming - EVP and CFO

D. Rick Lowes - Sr. VP and Controller

Analysts

Michael Rehaut - JPMorgan

David MacGregor - Longbow Research

Michael Wood - Banc of America Securities

Jim Barrett - CL King & Associates

Kenneth Zener - Merrill Lynch

Mark Weintraub - Buckingham Research

Al Kabili - Goldman Sachs

USG Corporation (USG) Q4 FY07 Earnings Call January 29, 2007 11:00 AM ET

Operator

Good morning, ladies and gentlemen, and welcome to the USG Corporation Fourth Quarter 2007 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.

I'll now turn the call over to Mr. James Bencomo, Director of Investor Relations and Pension Investments. Mr. Bencomo, you may begin.

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

Thank you, and good morning, everyone. Welcome to USG Corporation's fourth quarter and year-end 2007 earnings conference call and live webcast. We will be using a slide presentation in conjunction with our call today. It is available by going to the Investor Information section of our website, www.usg.com, and clicking on the link to the webcast.

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

Earlier today, USG reported fourth quarter 2007 net sales of $1.2 billion, and a net loss of $28 million or $0.28 per share on a diluted basis. These results reflect the difficult market conditions caused by the ongoing sharp contraction in the U.S. housing market.

With me today to discuss these 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.

Bill will begin with some thoughts on the current business cycle and the actions we are taking to manage through it and USG’s positioning for the eventual recovery. Jim will discuss the operating results in our core businesses, and then Rick Fleming will conclude our prepared remarks by covering consolidated financial results including capital spending, cash, and debt management. We will then open up the call for questions and conclude with a few comments from Bill.

Also present for the Q&A portion of the call will be Rick Lowes, Senior Vice President and Controller. Our goal is to be completed within the hour, so let us begin. Bill?

William C. Foote - Chairman and Chief Executive Officer

Thank you, Jim, and good morning to all of you. We appreciate you taking time to be with us this morning. Your interest in the company is important to us, and we value to these opportunities to discuss the company's performance and strategic direction with all of you.

My senior management team and I are an experienced group. We average more than 20 years in the building materials business. We've all seen and managed through cycles before. In this case, we've been saying for sometime that this is going to be a multi-year downturn in the housing market. Unfortunately, we were right. The market started showing the first signs of weakness in the middle of 2006 and the trend has been downward for the last 18 months. Inventories of unsold homes remain high, the turmoil in the credit markets has continued, and consumer confidence is falling. You can see the impact in our financial results for the quarter and for the year. Sales are down, and we reported a net loss in the fourth quarter of 2007. Clearly, this is a very difficult market.

But there are three things that I would like to focus on with you. The first is that this is a wallboard price issue driven by terrible housing market. All of our other segments performed well, given the challenging state of the U.S. housing market. Jim Metcalf will give you more detail in a few minutes, but suffice it to say that we are pleased with the performance of our distribution, our substrates, our ceilings, and our surfaces businesses. Our operating efficiencies at our wallboard plants have been great. As a matter of fact, we set a new company-wide safety record last year, and our customer satisfaction ratings have been excellent.

The second thing I'd like to emphasis is that we've been very nimble and proactive in managing through this downturn. We've proactively scaled our capacity to meet market needs, significantly reduced overhead spending, and reduced both management and hourly staffing levels. We continue to close high cost manufacturing lines and optimize our plant and distribution networks to ensure the lowest average delivery cost. Our supply chain management capabilities are world class and we are using them to continuously optimize our manufacturing network to maximize profitability.

And the third point I'd like to focus on is our balance sheet, which remained strong. We expect to have the resources to manage through this downturn and still invest in the long-term growth of the company. At the end of the year, we had almost $300 million of cash and no debt maturities until 2016.

So the question in everyone's mind is this, have we reached the bottom yet? The candid answer is we don't know. The signals are mixed. On the one hand housing starts are very weak and inventory of unsold homes remains at very high levels. On the other hand, the depth of the decline in the housing market is now reaching levels similar to those reached in the last two major downturns in the early ‘90s and in the early ‘80s. Also worthy of note is the housing affordability index has begun to improve for the first time in several years.

Manufacturing capacity has been removed from the market, but more needs to come out. In past cycles, economic realities prevailed. That is to say, when the marginal cash cost of manufacturing seized the market price, the high cost capacity was removed from the market. We believe the industry has reached that point in the current cycle. Let's turn now to pricing.

Prices have been down over $70 for the full year of 2007. It is important to note though that the rate of decline slowed in the fourth quarter. It is possible that the trend in pricing is suggesting that we are approaching the lower threshold for this cycle, but that really isn't clear yet.

Before I return the call over to Jim, I'd like to summarize by saying we are managing the things that are within our control. We are controlling our costs, we are scaling our operations, we are maintaining strong relationships in the marketplace, and we are setting records for employee safety. It's a difficult market, but we are managing the company well in these challenging circumstances.

With that, let me turn it over to Jim Metcalf.

James S. Metcalf - President and Chief Operating Officer

Thank you, Bill. Good morning. Before I comment on our business and the market, I'd like to take a minute to add to some of Bill's thoughts. This is a very difficult market. There is no question about that. We are feeling it as well as our customers and other companies that are serving the housing market. When wallboard prices fall over $70 a thousand in a year, which is exactly what happened in 2007, you are in a very sharp market decline. We at USG have experienced previous downturns and we know what to do. It is the intense focus on operational excellence that sets us apart. Downturns are opportunities to upgrade our manufacturing network, build our distribution business, strengthen our customer relationships, and extend our nationwide low delivered cost advantage. We are doing all of these things. Our focus on operational excellence is benefiting us in this very challenging market. And that same focus will position USG for strong growth when the market rebounds.

This morning, I would like to review with you some of the 2007 market dynamics, the strategic actions we took last year and are continuing to take in 2008. I will start with some comments about the wallboard business and then move on to our other product lines of surfaces, substrates, and ceilings. I’ll also talk about our distribution and international businesses before I turn the call over to Rick Fleming for a review of our financials.

As wallboard prices and volume trended downward through 2007, we were proactively scaling back our network, reducing our costs, adjusting our workforce, and focusing our operations to maintain the low delivered costs nationwide. We have curtailed or closed more than 3 billion feet of capacity since the market began to decline. In the fourth quarter, we closed our New Orleans wallboard line and our Jacksonville paper mill. We have just announced that we will also be closing our Boston wallboard line, which is almost 80 years old. This announcement is representative of our strategy to remove high-cost capacity and replace it with new state-of-the-art production.

We will serve the important northeast market through our current network, with the addition of our new Washingtonville, Pennsylvania plants and our alliance with Atlantic Wallboard, a J.D. Irving company. As we balance our manufacturing network to lower production levels, we are very careful to maintain our focus on customer service and operational efficiencies. This is a very challenging task for any manufacturing company when you're making dramatic changes to your operating levels. We have successfully managed our network down from full capacity 18 months ago to current levels. In fact, we are now running our plants at better operating efficiency rates and improved service. In the fourth quarter, we ran our network five points higher than the industry with a delivered cost advantage. We are now striving to grow our cost and service advantage. We have superior customer service, the broadest network of plants, and leading supply chain and technology capabilities.

Next, I'd like to discuss our surfaces products, which include our industry-leading joint treatment, plaster, and SHEETROCK tools. These products are influenced strongly by the conditions that we all know in the housing market, much like our wallboard business. But I am pleased to say, in spite of the soft wallboard demand these products have outperformed the market. With the dramatic reduction in market opportunity in residential and the important repair and remodel segment, these products have increased market share.

Turning to our Substrates products, which include leading brands like DUROCK, FIBEROCK, and LEVELROCK, which is used in both residential and commercial markets, DUROCK and FIBEROCK achieved significant improvement in profitability due to a number of initiatives on market share, cost reductions, and supply chain improvements. LEVELROCK which is a liquid poured flooring underlayment used in commercial applications continued to grow up at a strong pace with sales increases of 28% and improved profit margins. These product lines contributed to an increase of sales and margin of 2% and 24% respectively as we grew our share in the big-box, residential, and commercial segments.

Now, I'd like to comment on our distribution business, L&W Supply. L&W has the largest market share in its business and is the only specialty distribution company with a national footprint. This allows L&W to service residential and commercial contractors in major markets throughout the United States. We grew L&W in 2007 as a result of two very significant acquisitions, CALPLY in the Western United States and All Interiors in the southeast. These acquisitions brought talented people, expanded product breadth, and geographic coverage to L&W supply. Also, CALPLY and All Interiors contributed to L&W’s sales and profitability, contributing over a $130 million of sales in the fourth quarter.

Wallboard shipments for L&W declined in the fourth quarter versus last year, but were softened by the positive contributions of these acquisitions. Non-wallboard sales, which represent 60% of L&W's revenue, performed very well, growing 18% in the quarter. As in our other businesses, L&W maintained a sharp focus on costs and operational excellence, resizing the business to current demand by reducing locations, staffing, and equipment. Despite the soft market conditions, operating profit was $23 million in the fourth quarter, a solid performance in a very tough market.

Now, turning to a bright spot in the fourth quarter for USG, our ceilings business. Worldwide ceilings sales and operating profit were both fourth-quarter records. Sales reached $199 million and operating profit was $23 million for the quarter. Many factors contributed to these results, but the key was intense focus on our customers and influencers in the ceilings business. The efficiency programs that we implemented at our plants over the last few years as well as focusing on product quality, service, and innovation provided a foundation for our growth. In fact in 2007, we released a comprehensive online specification tool that uses leading-edge technology. USG Design Studio is targeted to architects and designers to assist them in building design in USG system selection. This is one example of USG’s ceilings providing leadership in the industry and setting itself apart from our competition.

As I wrap up our operations, I want to mention our international business performance in the fourth quarter. We are all aware that the international market continues to grow at a steady pace. This is especially true in emerging markets, since China, India, and Russia account for one half of the global growth last year. China is the fastest growing construction market in the world, although it is now being challenged by the Middle East with about $1 trillion of construction projects throughout the Gulf region. We are participating in these opportunities through new plants, joint ventures, and exports. We have recently build a new joint treatment plant in St Petersburg, Russia; entered into a ceilings joint venture in China; and are shipping wallboard products to Dubai servicing the tallest building in the world. USG International’s fourth-quarter sales of $67 million increased $9 million and profit was $2 million for the quarter. This is due to the improved performance in Europe and reduced expenses, as well as a focus on growth.

In summary, I'd like to highlight two vitally important areas for USG, customer satisfaction and employee safety. Our work is never done in each of these areas, but our progress continues to display industry leadership.

We are continuing to make significant improvements in customer satisfaction. Key customer services areas such as on-time performance, transactional accuracy, and overall customer service levels have all improved. A recent customer survey rates our service levels the best in the industry as well as a top performer for B2B companies. The positive results from that customer survey were no fluke. We worked very hard to achieve them. This is a very tough market, our customers have choices, and we continue to work hard to earn their business everyday. Our focus on operational excellence has undoubtedly contributed to these high customer satisfaction levels.

The accomplishment I most personally proud of is our safety performance, in fact it was outstanding. We set an all-time company record for safety at our manufacturing facilities in 2007. And I would like to share with a couple of safety facts. 91% of our locations operated without a single loss time injury all year, 91%. 40 locations have operated more than 1000 days without a single loss time injury and 30 thirty location have operated more than 1 million man hours without a single loss time injury. Four of our plants earned the prestigious OSHA Star award for safety, and we will be adding to that total in 2008. We at USG have a very rigorous approach to safety. We take it very seriously and we are very proud of our employees for this outstanding performance.

To summarize, we are in the midst of a multi-year downturn in our core market. Obviously, we can't influence the macro economic factors that are affecting demand, but we can run our business with the relentless pursuit of operational excellence. We will optimize our manufacturing network, extend our customer satisfaction leadership, operate our plants at industry leading efficiencies, and most importantly operate them safely. This is our focus, the focus that will get us through this downturn and position USG for growth.

Now, I would like to turn to Rick Fleming who will review the numbers. Rick?

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

Thanks, Jim. As mentioned, I will provide some details on our fourth-quarter financial results, including capital spending, cash, and debt management. Fourth quarter 2007 net sales were $1.2 billion, down 7% from the fourth quarter of 2006 net sales level of $1.29 billion. We had a net loss of $28 million, including $5 million in after-tax, $8 million of pretax, restructuring charges related to workforce reductions, shutdown costs for the closures of the wallboard lines in New Orleans and the paper mill at Jacksonville, Florida, and an asset impairment charge taken on our wallboard line in Boston, all in response to current market conditions. For the same period a year ago, net earnings were a $100 million.

On an EPS basis, the fourth quarter loss was $0.28 per share based on average diluted share as outstanding of 99 million. Fourth quarter 2006 EPS was $1.11. The decline in earnings largely reflects the downturn in new housing construction and the resulting lower levels of pricing and demand for SHEETROCK brand gypsum wallboard.

On a full-year basis, USG had net sales of $5.2 billion compared to $5.8 billion for all of 2006. Net earnings in 2007 were $76 million or $0.78 per share on an EPS basis compared to $288 million or $4.33 per share in 2006. The 2007 results include a pretax restructuring and impairment charge of $26 million, which were allocated as follows; $15 million to United States Gypsum Company; $5 million for Corporate; $3 million for CGC; and $3 million for USG Interiors, USG International, and L&W Supply combined. USG's 2006 results include a charge of $528 million, $325 million after-tax, for post-petition interest and fees paid under USG's plan for reorganization, and $44 million, $27 million after-tax, for a reversal of the reserve for asbestos-related liabilities.

Now, I will turn to some additional highlights of our consolidated fourth quarter 2007 financial results. Selling, general, and administrative expense or SG&A totaled $102 million in the fourth quarter of 2007, a decrease of $12 million or 11% from the fourth quarter of 2006. This year-over-year decline is primarily due to our recent cost reduction efforts, salaried workforce reductions, and a lower level of accruals for incentive compensation. As a percentage of net sales, SG&A was 8.5% compared with 8.8% for the fourth quarter of 2006. As Joe indicated, we continue to believe that the wallboard industry will face very challenging market conditions for the next few years. As such, we are currently implementing plans to further reduce overhead expenses.

Interest expense for the fourth quarter of 2007 was $20 million compared to $16 million in last year's fourth quarter. At our current levels of debt, our annual P&L interest expense in 2008 would be about $84 million, net of capitalized interest of $12 million.

The effective tax benefit rate was 51.8% for the fourth quarter of 2007. The effective tax benefit rate reflects a higher proportion of income and lower tax in non-U.S. areas of the world compared to 2006 and a reversal of valuation allowances for certain NOL carry-forwards. We anticipate the tax rate for 2008 to be closer to about 40% depending on the mix of worldwide income and our ongoing assessment of a valuation allowances.

Regarding our cash and debt situation, our cash balance as of year-end was $297 million compared with $353 million on September 30. Cash declined $56 million during the quarter, primarily due to capital spending activity associated with the completion of the Norfolk, Virginia plant and the final stages of spending on the Washingtonville and Otsego facilities. I'll discuss capital spending in more detail in a few minutes.

Total debt was $1.2 million as of December 31, unchanged from the end of the third quarter, but down substantially compared with $2.5 million on December 31, 2006. As you may recall, we paid off our $1.065 billion tax bridge in last March and clearly paid off our bank term loan borrowing in September. As a result, today we have a solid capital structure built around longer dated fixed rate debt with no funded maturities until 2016. Our debt includes two $500 million 10-year senior note issues with a blended rate of about 7% and maturities in 2016 and 2018, as well as $239 million of adjusted revenue bonds at a blended rate of about 6% and an average maturity of 23 years. As of September 31, 2007, the borrowing capacity net of letters of credit under our undrawn revolving credit facility totaled $572 million, the same as last quarter, and as mentioned cash on hand was $297 million. We expect that this liquidity will drive us with considerable flexibility to deal with the current challenging market conditions. Further, we're presently working on an accounts receivable securitization, working capital initiatives, and other projects to add to our liquidity and flexibility during the recession.

Regarding capital spending, capital expenditures totaled $119 million in the fourth quarter of 2007 compared to $156 million in the fourth quarter of 2006. The recent level of spending on CapEx reflects the funding for a number of large strategic investments including the rebuild of our Northfolk, Virginia wallboard plant; a new wallboard plant in Washingtonville, Pennsylvania; and a new paper mill in Otsego, Michigan. Northfolk has now been completed and the other two projects will be completed in 2008.

As such, CapEx for 2008 excluding acquisitions is expected to be down significantly from the 2007 level of $460 million, excluding acquisitions. We are currently projecting that CapEx will decline about 50% in 2008 to the low to mid $200 million level depending on acquisitions and the pace of spending on other projects. We are currently doing all approved but unspent projects and adjusting spending as appropriate, given the current market conditions.

So in conclusion, I'd like to echo Bill's and Jim's comments that USG is intensely focused on operational excellence and selective strategic growth. Jim shared with you some of our operational excellence [inaudible] and metrics. Suffice it to say, we are striving each day to optimize our performance in those areas we can control. At the same, time we are implementing our selective, strategic investments in low cost manufacturing and distribution capacity, and this will uniquely position us to capture the next upturn in business whenever they come.

Regarding the business cycle, as Bill said, it is too early to call a bottom, but if bad news is good news we must be getting closer because each day the newspapers are full of our daily dose of bad news. As the Japanese say, the night is always its darkest at the base of the lighthouse. Signs that we are getting close to the bottom include the declining rate of descent in housing starts, rising housing affordability as prices have declined and interest rates have fallen, and on the wallboard side the declining rate of price erosion. So although a few more chapters of this story still need to be written, it’ll continue to unfold as we have anticipated.

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

Question and Answer

Operator

Thank you. [Operator Instructions]. Our first question comes from Michael Rehaut from JPMorgan. Please go ahead.

Michael Rehaut - JPMorgan

Hi. Thanks. Good morning, everyone.

William C. Foote - Chairman and Chief Executive Officer

Good morning, Mike.

Michael Rehaut - JPMorgan

First question is just on pricing, and I guess how it's flowing through the margins, so I guess a couple of questions here. With some of the shutdowns, still the capacity utilization rate fell pretty sharply and I guess that's the difference between more of a… I guess on some level a more temporary shutdown versus a permanent shutdown. And I was wondering if you could kind of just confirm that and also if you are planning more permanent shutdowns that might favorably impact that capacity utilization number in 1H08?

William C. Foote - Chairman and Chief Executive Officer

Mike, I think the issue in capitalization is demand is falling faster than the industry's withdrawing capacity. We've been withdrawing it, but demand is a thing that's been the main factor in this. The units we've been withdrawing are at capacities of 200 million feet to 400 million feet, and the next one to be closed is Boston and that's 250 million feet.

Michael Rehaut - JPMorgan

I mean… and that's come out of the denominator?

William C. Foote - Chairman and Chief Executive Officer

We represent about a third of the industry, and we can't offset the demand decline. We are doing… we are optimizing our system and cost structure, but it's not sufficient to overcome a broader issue.

James S. Metcalf - President and Chief Operating Officer

Michael, this is Jim Metcalf. What we are doing, as Bill indicated, is we are running our network to match up to current demands. As I indicated, we've either closed or idled 3 billion feet in the last 18 months. We are running our low cost lines at approximately 90% in the high 80s. We're running our medium lines around 70% and our high-cost lines, which we still have in the network because we're looking at the lowest delivered cost because freight is such a key component, we're running those around 40%. But each month we look at the demand forecast coming from our field, run that in our network optimization looking at the lowest delivered cost of our total network and then we decide what plans will come down. We have made shift changes on current plans and we do have plans that we haven't closed, but we just aren’t running as full out as we did 18 months ago. So that is an ongoing process we do. We have the technology to react very quickly to market demands, and we're running the network we feel most efficient for the demand and most importantly taking care of our customers on customer service.

Michael Rehaut - JPMorgan

Just so I understand, I mean the 3.3 billion of square feet that has been taken out, I mean how much of that is still included in the denominator when you think of denominator being still overall capacity in that? Isn't there a distinction between something that's closed on a temporary basis, which is... I know what a lot of this is versus a permanent basis?

James S. Metcalf - President and Chief Operating Officer

Yes, it is. That $3 billion has shift changes, it has plants that we've idled, and plants that we've closed. For example, Boston, we are closing that plant. We will not be running... starting that plant up again. The other plants are idled, they are mothballed, but considering the other end of the demand cycle in the next... when the market turns around, we would be able to put those plants back in service. But again, you have to hire people, you have to get the equipment up and running. So it’s... they are in the formula, but they are mothballed right now.

Michael Rehaut - JPMorgan

Right. And so how much of the $3.3 billion, Jim, would you estimate is being closed permanently in like Boston?

James S. Metcalf - President and Chief Operating Officer

About 1.5 billion.

Michael Rehaut - JPMorgan

1.5. Okay. Lastly, you had mentioned the price declines and you thought that they were... that the pace was slowing throughout the quarter. I was wondering if you can give us an idea of where price ended at... where price was at quarter-end and why you think people are... that certainly the quarter-end I would think would be less than the average and why people are maybe this time more running at below the high cost manufacturing versus last time?

William C. Foote - Chairman and Chief Executive Officer

Mike, we can't give you the December number, but let me just review for you the quarter-to-quarter trends in '07. In the first quarter, prices were down $17, second quarter $23, third quarter of $19, and in the fourth quarter only $12. And so we went from adjustments of $6 to $8 a quarter down to $3 to $4 at the end of the year.

Michael Rehaut - JPMorgan

Okay. And about the price being below the high cost level, any comments on that?

William C. Foote - Chairman and Chief Executive Officer

Well, there is a spread and we've been taking down capacity that’s longer economic, and we suspect that our competitors are facing very similar issues. And we don't forecast our actions, but if history… as I said in my comments, if history repeats itself, we would expect that they would be making... they are in the midst of making significant adjustments as we speak.

Michael Rehaut - JPMorgan

Okay. All right, thank you.

William C. Foote - Chairman and Chief Executive Officer

Yes. Thank you, Mike.

Operator

Our next question comes from David MacGregor from Longbow Research. Please go ahead.

David MacGregor - Longbow Research

Yes. Good morning, everyone.

William C. Foote - Chairman and Chief Executive Officer

Good morning, David.

David MacGregor - Longbow Research

I wonder if you could just talk a little bit about the potential for further industry consolidation? I know we’ve got a fairly good downsizing since 2000, 2001, but what do you see as being where we could get to over the course of the next couple of years? And also, you made the observation about cash costs and selling prices. What percentage of the industry capacity do you think is selling today below cash cost?

William C. Foote - Chairman and Chief Executive Officer

The last answer I gave to Michael's... the answer I gave to Michael's last question I think speaks to the expectations on capacity reductions versus that point where we would expect it. But competitors will take their own action. Our sense is that the high-cost capacity probably represents on the order of 15% to 20% of industry capacity. And it remains to be seen how much of that comes out, but that's the estimate that we have made at analysts meetings in the past and I just reiterate.

David MacGregor - Longbow Research

And so I just want to be sure we are talking about the same thing. You are saying that 15% to 20% of capacity is currently selling... has cash cost above selling prices?

William C. Foote - Chairman and Chief Executive Officer

No, that would be the highest cost. I would say at least that might just sell in below cash cost.

David MacGregor - Longbow Research

Okay.

William C. Foote - Chairman and Chief Executive Officer

It could be higher than that.

David MacGregor - Longbow Research

It could be higher than that. And then, on the question of consolidation, maybe I didn't ask the question very well, but I am just trying to get a sense of not so much how much more capacity you can get shut down, but do we see some of the smaller players in this business selling, or are you hearing any talk at all in the Street about other players expressing an interest in getting out or just thoughts about foreign players coming in? I am just trying to get a sense of overall consolidation.

William C. Foote - Chairman and Chief Executive Officer

If you look at the history of the industry over the last ten years, there has been quite a bit of consolidation, and we see no reason for that to change in this current cycle. It is an industry that has gone through consolidation and there is still seven or eight major players in the business and those trends we would see continuing, but as to specific individuals, we have no comment.

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

But scale is important in this industry.

David MacGregor - Longbow Research

I am sorry.

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

Scale is important.

David MacGregor - Longbow Research

Yes… no, I understand that. I just... I know you guys have been through a number of cycles before. I am just trying to get a sense of are we getting close to people's threshold of pain on this.

William C. Foote - Chairman and Chief Executive Officer

Yes. Well, we think our cost position is the best in the industry and we are hurting. So I suspect it's hurting a lot more in other places.

David MacGregor - Longbow Research

Yes, sure. Last question, just on L&W you did awfully well on the non-wallboard business. And I am just wondering if you could elaborate a little bit more on that business, remind us what are the largest categories in non-wallboard and also what percentage of non-wallboard is sealing products?

James S. Metcalf - President and Chief Operating Officer

This is Jim Metcalf. As I indicated in my prepared comments, about 60% is non-wallboard and those key products are construction steel, that's the steel framing… light-steel framing that you see in commercial construction, commercial installation, ceiling tile and grid are really the big three. Along with that, you have roofing, commercial doors, tools, and ancillary products. Ceiling tile is a very significant part of that 60% and we do keep that as proprietary information.

David MacGregor - Longbow Research

Great. Thanks very much, and good luck.

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

Thank you.

William C. Foote - Chairman and Chief Executive Officer

Thank you.

Operator

Our next question comes from Dan Oppenheim from Banc of America Securities. Please go ahead.

Michael Wood - Banc of America Securities

Hi, this is Mike Wood.

William C. Foote - Chairman and Chief Executive Officer

Hi, Mike. How are you?

Michael Wood - Banc of America Securities

Good. When you speak of the declining rate of prices… price declines, is that being driven primarily… if some plans are reaching cash costs, that portion is actually seeing some stabilization and the price declines in the other plants are continuing, or are you seeing a broad base that the general rate of decline is slowing?

William C. Foote - Chairman and Chief Executive Officer

Will, the observation that the rate of price decline is slowing. The reasons for that, we suspect that your… what you said as the premise is right that people are below cash cost. And I would remind you that we've had significant factor cost inflation energy and wastepaper. So it's not been a static situation. So I think people putting red ink and saying enough is enough.

Michael Wood - Banc of America Securities

Okay, and what was the annual capacity of the Boston plant? I'm not sure if you've mentioned that.

James S. Metcalf - President and Chief Operating Officer

The annual capacity of Boston is approximately 250 million feet.

Michael Wood - Banc of America Securities

Okay, thank you very much.

William C. Foote - Chairman and Chief Executive Officer

Yes.

Operator

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

Jim Barrett - CL King & Associates

Good morning, everyone.

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

Good morning.

William C. Foote - Chairman and Chief Executive Officer

Hi, Mr. Barrett. How are you, sir?

Jim Barrett - CL King & Associates

I'm doing really well, thanks. Bill, I have a question for you. The... when you consider what the consensus numbers are for housing starts in 2008, can you as gypsum specifically run close to cash flow neutral? Are there enough costs to reduce their… given what seems to be your valid interest in maintaining customer service and maintaining your market share?

William C. Foote - Chairman and Chief Executive Officer

You always ask very good questions, Jim. I should tell you one thing that our forecast for housing is a little below consensus, blue chip I think is at one-one filling our budget around 1 million, and the toughest times of the year are where we are right now and you see what the fourth quarter was, but we are very comfortable with our liquidity given the maturity structure, the cash on hand, and the revolver, and we think we will be fine as the year unfolds, but it’s tough [inaudible] right now.

Jim Barrett - CL King & Associates

Right, and a somewhat related point. When you do open up Washingtonville, I mean is it reasonable for shareholders to expect that at the very least Washingtonville will displace as much capacity as it adds? In other word, are you trying to exit this cycle with less capacity than you entered it with, excluding the mothballed plants that obviously can be restarted?

William C. Foote - Chairman and Chief Executive Officer

Certainly at this point, we will offset whatever we added Washingtonville with other closures. From the peak of the cycle to where we are now, we are down 3.3 billion and we will depending upon the strength of demand slowly ramp that back up, but at the moment I would not expect any net increases in capacity. Washingtonville will be just be at the low end of the cost curve replacing higher costs plants like Boston. So there is more to come. We just can't tell you that until we need to notify employees and customers first, but we have a very dynamic model that allows us to bring these new plants up and adjust at older plants.

Jim Barrett - CL King & Associates

Okay, Bill. Thanks a lot.

William C. Foote - Chairman and Chief Executive Officer

Yes.

Operator

Our next question comes from Ken Zener from Merrill Lynch. Please go ahead.

Kenneth Zener - Merrill Lynch

Good morning.

William C. Foote - Chairman and Chief Executive Officer

Good morning, Ken.

Kenneth Zener - Merrill Lynch

I wonder if you could outline the 9% increase in wallboard costs that you guys had year-over-year? If you could kind of qualify between the higher cost absorption wastepaper and some of the other material inflation in those three categories, is it equally split at 3% each?

William C. Foote - Chairman and Chief Executive Officer

Yes. I'll let Metcalf to cover that.

James S. Metcalf - President and Chief Operating Officer

If you look at year-on-year, wastepaper was the biggest component, that was just short of 40% increase in cost along with… there were other raw materials. A lot of the raw materials were ethanol based raw materials and everyone knows what is happening there and that was double digit. And then there is a volume impact on fixed cost of just… of 17% of capacity going out of the network. But the big area is wastepaper and general raw material inflation.

Kenneth Zener - Merrill Lynch

Okay. So when I think about wastepaper, if it's up 40% year-over-year and it is about 20% of the cost structure, that itself would imply roughly an 8% increase in your cost?

James S. Metcalf - President and Chief Operating Officer

No, actually that equates to about just short of 3%.

Kenneth Zener - Merrill Lynch

Okay. And I'm wondering kind of related to the… last quarter I asked you how much your production cost declined excluding these types of inflationary items relative to your plant mix, so more low cost plants versus high cost plants and you said that was 3%. Can you update us what it was this quarter, A, and B, where you think you could take that cost structure just based upon a mix change of your plant utilization?

James S. Metcalf - President and Chief Operating Officer

Yes. We think it is about 4% now, and one thing is really critical is we are running our current network, and this is very important to note, at better efficiencies and we were running our networking in full allocation. And that is looking at speed, recovery, and delay, and those are very important internal metric. So we are continuing to have great efficiencies. Of course that goes hand in hand with our strategy of running our low cost state-of-the-art network at 88%.

Kenneth Zener - Merrill Lynch

Okay. And I guess, when I look at... so if you’re at 4% decline right now, when I look back to 2001 the way we modeled your business, as we looked… saw an MSF cost fall about 10% from kind of the end of the 2000 through plant closers at the end of '01, early '02. Is that kind of the peak-to-trough decline in your cost excluding the inflationary items that you would expect this time as well?

James S. Metcalf - President and Chief Operating Officer

Well, the big... I know you want to exclude inflation, but the big one from 2000, 2001 to now has been energy. The last year, we've done a pretty good job on hedging energy, but that has been the biggest increase of cost in all of our production plants, wallboard and all production plants from 2001, energy has basically doubled.

Kenneth Zener - Merrill Lynch

Okay. And then the last question related to the cost is, I’d asked you guys about this last quarter is just the high absolute stated cost of MSF… per MSF that is coming out of your... out of the gypsum business, if we were exclude Canada, Mexico, and assign some margin to the other business. Can you… I mean, it’s well in excess of $100 million, $150 million, and I know you had outlined ERP gas hedges, R&D. Could you give us a sense for how much those costs… which really I did not see in 2005, how much of those costs could be in 2008 above your cash cost that people talk about, because there is a big gap there, and I just wonder if you could give people some better comfort about how much those extra expenses are that you’re expecting in '08 relative to '07? Thank you.

D. Rick Lowes - Senior Vice President and Controller

It is Rick Lowes speaking. We actually expect that those drops will… drop dramatically almost 50% year-over-year in those categories you talked about, Ken. So you will see a dramatic drop in that number.

Kenneth Zener - Merrill Lynch

Okay. Thank you very much.

Operator

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

Mark Weintraub - Buckingham Research

Thank you. Just trying to understand your... the assertion that you have got the lowest cost system, and I am sure by certain metrics that you look at that that's valid. At the same time you lost $74 million in your U.S. gypsum business and that seems to be at a higher level, and the third quarter is true as well. It seems to be as higher or higher level than those situations where we can kind of glean what some of the other folks are doing. So I am just trying to understand what can be done to why that difference between the public numbers, those that we can get our hands on, which again are limited, and the continued assertions that you've got the lowest cost system? I am sure you've got a lot better information to be able to make that judgment than I do from the outside. So I am just trying to get a little bit more color. Can you help me understand that and what you can do to make that assertion show up on the bottom-line more?

William C. Foote - Chairman and Chief Executive Officer

Well, this is Bill Foote. The issue has been largely price and volume, which is a function of demand levels, which have dropped 18% year-over-year in the industry. From a cost standpoint, you are right, there is a real shortage of data. The next two largest competitors we face are both private and the one after that is part of a large European group. But we model our economics plant by plant and have a very good sense of the cost structure and feel quite confident. I know it is in an assertion on our part, but we feel quite confident of our cost position and how we are operating relative to others. So I don't know that I can give you any more comfort with it, but I would remind you what I started with, which is the biggest issue here is the drop in demand and the impact on marginal pricing.

Mark Weintraub - Buckingham Research

And of course, I guess I am not trying to be petty here with the question, but it seems to be rather critical in strategically thinking about how you stay the course that you--.

William C. Foote - Chairman and Chief Executive Officer

Well, I think you can look at the difference on our plant operating rate. We are operating at about five points more capacity utilization. We've gained... slowly gained some share over the course of the year. A year ago, we were, at the onset of the recession, reluctant to cut prices and other started cutting quite dramatically. We wanted to maintain our relationship with customers, so we very slowly built back our share position and have maintained operating rates in excess of our competitors. And I think that all speaks to how we are doing. You also would note that the two comps that are out there are Eagle and Lafarge, and you can look at their segment results to get an indication of how they are performing.

Mark Weintraub - Buckingham Research

Right. Well, and on that... okay, I'll leave it there.

William C. Foote - Chairman and Chief Executive Officer

Okay.

Operator

Our next question comes from [inaudible]. Please go ahead.

Unidentified Analyst

Yes, I want to discuss a little bit more, you made a comment about looking at accounts receivable securitizations and another ways of increasing your liquidity, which seems somewhat ample. Obviously, the management has been pretty [inaudible] in terms of understanding where the market was going to go and some of the declines and too much capacity, etcetera. Are you signaling that you think that this may continue further than just an '08 phenomenon or beyond into '09?

William C. Foote - Chairman and Chief Executive Officer

As I said, probably we've been through a lot of cycles, and we're ones that would rather have more liquidity and more flexible than not. It is not signaling anything except that we're conservative and we think of ourselves as an investment grade… having an investment grade profile and so we are tapping liquidly wherever we can. But it is less about riding a cycle, more about having the firepower to make investments that we want to as we reach the bottom of the cycle.

Unidentified Analyst

And I guess as I listen to the call and listen to various parties ask the question, it seems like everyone is looking for and I am sure they are looking for the same types of criteria, but anyone is looking for the signals or the signs that we have reached this bottom that more capacity will be coming out. Basically, are we looking for announcements, that is what we on this side of the fence should be focused on, watching for announcements of further product closings because it doesn't sound like the [inaudible] is getting better anytime soon?

William C. Foote - Chairman and Chief Executive Officer

I think two things, one is having a keen ear and see what other actions that would be very… telling us to how people are doing. But as I said in my prepared remarks, the news on... I mean this is a question on everyone's mind and I think the nature of people who invest in this sector is... money is made when you call the turn right. The signs on the demand side are mixed. We have… the bad news is record levels of inventory of unsold homes and housing starts should continue to deteriorate. On the other hand, the decline in starts is now about... to give you the specifics, about 39%, and in the down term of the ‘80s it was about 42% if I'm... 43%, and in the ‘80s 48%. So we're approaching... that is on a monthly basis.

If you look on a sequential basis, we're approaching those lows, and the housing affordability mix bottomed at about 108 and it is back up to about 120, and that data stream goes back to the early ‘70s. So there is… and with home prices coming down and accommodation from the Fed that that affordability index should improve, we have… I want to be very clear, we've not called the turns, but we're seeing early signs and there are some prerequisites to finding the bottom, which is the kinds of adjustment that we see. So we think we are getting closer, but we are not calling it yet.

Unidentified Analyst

And the final question is, you talked about your high cost capacity operating I think you said in the 40s from a capacity utilization perspective. Any sense for how much of your actual capacity is high cost at this stage?

James S. Metcalf - President and Chief Operating Officer

Of our total capacity that we run, we probably have about… we are down to… probably 10% to 12% of total capacity is high cost. And when we say high cost, I want to reiterate, that's ex-factory. We have still run this distribution model and transportation costs are very important. We look at the delivered cost to the major markets and also these plants make some of our specialty products that we provide a broad breadth of products for the commercial market and some specialty areas in residential. We just aren’t... you could run our plants and just make half inch and five-eighths [ph] wallboard, but we are the leader in the industry and we have… we provide the full breath of products. So we use those higher cost plants to provide some of our specialty products for the industry.

William C. Foote - Chairman and Chief Executive Officer

We are about three minutes from 11, and that was the time we had intended to complete the call. Why don't we take two more questions. We may spill over a couple of minutes, which we apologize for. And those who we don't get to on the call can call back in.

Operator

Our next question comes from Albert Kabili from Goldman Sachs. Please go ahead.

Al Kabili - Goldman Sachs

Yes. Good afternoon, guys.

William C. Foote - Chairman and Chief Executive Officer

Good morning, Albert.

Al Kabili - Goldman Sachs

Question first on the cost reduction, on the previous question, the 50% reduction in costs such as R&D, ERP hedges, etcetera, can you just quantify the dollar amount that that equals to?

D. Rick Lowes - Senior Vice President and Controller

We always give full dollar amounts, so we have finished our ERP system, we are taking out costs related to corporation, you can see it in our overhead. We're really focused on prioritizing any special projects that we are doing. We’re still maintaining R&D’s key to future, so the cuts that we're making are appropriate for this current market environment, but we are going to see it all roll. It is pretty a substantial... [inaudible] ERPs have been a tremendous success for us. It will take a tremendous amount of cost out of our system year-over-year.

Al Kabili - Goldman Sachs

Okay. And then, can you give us a sense as to what percentage of your wallboard plants today are running below average cost? And I know, 10%, 12% is high cost capacity, but it sounds as if for me the medium cost capacity may even be bumping there now?

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

We really can't disclose that.

Al Kabili - Goldman Sachs

Okay. And then, final question on the curtailed capacity, it looks like you have 2 billion of curtailed capacity. Any plans to permanently closed some of that? And then a clarification on the Washington, Pennsylvania startup, which will be... will that be all permanent closures, when you say it will replace existing capacity or will that also entail additional curtailments when you say it's going to replace capacity?

James S. Metcalf - President and Chief Operating Officer

Washingtonville is going to be replacing Boston for sure. So Boston is coming out of the mix as we indicated earlier, and we will put Washingtonville into our network and that will have an effect on some of the medium and higher cost plants that we talked about earlier. We don't want to announce of talk about any type of closures on idles before it is public with our employees, but Washingtonville is approximately 1 billion foot plant, it is going to be coming on the third quarter of this year, and it will have a very positive impact to the network, but it will have an effect on some of they medium and high cost plants.

Al Kabili - Goldman Sachs

Okay, and then last question on the curtailed capacity, why not… given the prospects of a turnaround in housing, why not cut into that curtailed capacity with permanent closures at this point?

James S. Metcalf - President and Chief Operating Officer

Well, the long- term demographics that we've been looking at and we've been seeing to a lot of industry sources still show that the overall gypsum industry is going to be growing at 3% over a ten-year window. So we're keeping our powder dry. One thing we look at is our capacity utilization, how that matches up with our market share, and we still have… our capacity utilization is below our market share number. So we want to be able to keep our powder dry on the other side of this because we feel that the industry is going to continue to grow and we don't want to be cut short as we've been in the last two cycles.

Al Kabili - Goldman Sachs

Okay. Thank you.

William C. Foote - Chairman and Chief Executive Officer

Last question please.

Operator

Your last question comes from Bob Thompson with [inaudible] Capital. Please go ahead.

Unidentified Analyst

Hi, guys.

William C. Foote - Chairman and Chief Executive Officer

Hi, Bob.

Unidentified Analyst

I just want to… a couple more questions on… what again was the current liquidity?

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

The... undrawn revolving credit facility is about $572 million, net of letters of credit, and the cash is about $297 million.

Unidentified Analyst

$297 million, okay. And in terms of like the new the plant like Washingtonville, what is that cash break-even on a plant like that. On the new ones coming online?

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

That will be a very low cost plant. And we have talked in the past about low cost plants being half the cost of high cost plants. But Washingtonville will be one of our most superb low cost plants.

Unidentified Analyst

Okay. So you mean, if my… I think the overall range is about 115 to 125 is break... cash break-even?

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

. That's a higher costs plan type of number, that's correct.

Unidentified Analyst

That's a higher cost. So current overall cost for the company is lower than 115?

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

Well, we can't… we don't disclose our actual cost for definitive reasons, but I think you're doing the math, yes.

Unidentified Analyst

In terms of... would you call this the… is this the worst market for gypsum that you've seen in… even though… even through the '90, '91 cycle and the '01 cycle or not?

William C. Foote - Chairman and Chief Executive Officer

Yes. This is comparable with the early ‘90s, but every cycle is different and we've lived through those… my team and I have lived through those two cycles. So we feel… as tough as it is, we feel quite confident on what we're doing and how we're going to navigate through this and position ourselves on the other side.

Unidentified Analyst

Okay. And do you see any… or what are the... any covenants that you... like if you see an acquisition that looks good, a smaller acquisition or something, do you have any covenant issues that you would need to worry about to tap into that?

William C. Foote - Chairman and Chief Executive Officer

As I talked earlier in response to the question about the receivable financing, we think that more liquidity is better than not, and we talk with our bankers all the time and feel comfortable with the position we are in right now.

Unidentified Analyst

Okay. And my last question is regarding the housing starts number. If that number were to come down substantially down under say the 800 range, would that... what... how much additional pain would that add to the industry?

William C. Foote - Chairman and Chief Executive Officer

As I said earlier, the consensus right now there are 1.1. Our budget is built around $1 million, and when we seasonalize that we could see a quarter to this year below that. So we're actually expecting that. So everyone can calibrate their own forecast, but that's our take on things.

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

But the real sum is the 100,000 housing starts equals about $850 million fee for the industry.

Unidentified Analyst

Okay.

William C. Foote - Chairman and Chief Executive Officer

Thanks very much.

Unidentified Analyst

Thank you very much.

William C. Foote - Chairman and Chief Executive Officer

Let me say a few things to wrap up. We know from experience that downturns represent opportunities for companies with clear strategies, sound management, and are financially sound. We know how to take advantage of cycles to improve our position in the business. Accordingly, we are removing old high-cost capacity from our network and at the same time investing in new very low-cost capacity such as Washingtonville. We are using this downturn to protect and extend our low-cost delivered position. We are very confident of that strategy.

We are also very focused on customers. As Jim said, they have choices and that's what we hear from customers everyday, it counts. We have recently done a survey that supports the strength of our relationships, we never take them for granted.

We are also poised to seize opportunities to grow our distribution and another businesses. As always, we are very discipline buyers, but if a contractive opportunity rises we expect to have the wherewithal to take advance of it.

In short, we are controlling the things that we can control. Past experience has taught us that doing so will benefit us in the short term and position the company for growth when the market rebounds.

Thanks for joining us today. We look forward to our continuing dialogue.

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

Thank you, Bill. And let me just mention that we will have a taped replay of this call available later today. You may reach that by dialing 1-800-315-2944. The pass code is 20365008. The replay will be available until Tuesday, February 5. And I do know that there were a few people left on hold for the question and answers. My phone number is on our press release. If you would like to call me… if you have questions you still like to ask. And thanks again for participating on the call today.

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

Thank you.

Operator

Thank you, ladies and gentlemen. This concludes the USG Corporation fourth quarter 2007 earnings conference call. Thank you for participating. You may all disconnect.

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