Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

USG (NYSE:USG)

Q2 2012 Earnings Call

July 25, 2012 11:00 am ET

Executives

Ken Banas

James S. Metcalf - Chairman of the Board, Chief Executive Officer and President

Matthew F. Hilzinger - Chief Financial Officer and Executive Vice President

Analysts

Rodny Nacier - KeyBanc Capital Markets Inc., Research Division

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

Kathryn I. Thompson - Thompson Research Group, LLC.

James Barrett - CL King & Associates, Inc.

Trey Grooms - Stephens Inc., Research Division

Garik S. Shmois - Longbow Research LLC

Neil Frohnapple - Northcoast Research

Joshua Pollard - Goldman Sachs Group Inc., Research Division

Mike Wood - Macquarie Research

Michael Rehaut - JP Morgan Chase & Co, Research Division

Dennis McGill - Zelman & Associates, Research Division

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

L. Todd Vencil - Sterne Agee & Leach Inc., Research Division

Daniel Oppenheim - Crédit Suisse AG, Research Division

Ken Copley

Operator

Welcome to the USG Corporation's Second Quarter 2012 Earnings Conference Call. My name is John, and I'll be your operator for today's call. [Operator Instructions], Please note that this conference is being recorded. I will now turn the call over to Mr. Ken Banas. Mr. Banas, you may begin.

Ken Banas

Good morning, and welcome to USG Corporation's Second Quarter 2012 Earnings Conference Call and live webcast. We'll be using a slide presentation in conjunction with our call today. It is available by going to the Investor Information section of our website, www.usg.com and clicking on the link to the webcast.

Before we proceed, let me remind you that certain statements in this conference call may be forward-looking statements under securities laws. These statements are made on the basis of management’s current views and assumptions of our 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 the press release, and actual results may be different from our current expectations.

With me today to discuss our results and our outlook are Jim Metcalf, Chairman, President and Chief Executive Officer; and Matt Hilzinger, Executive Vice President and Chief Financial Officer. Jim will provide a general overview of the quarter plus additional insight into some of our businesses. Matt will review the financial results for the quarter for the Corporation and the business segments. We'll then open the call for questions and conclude with a few comments from Jim. [Operator Instructions] Jim?

James S. Metcalf

Thank you, Ken, and good morning. I appreciate everyone joining us today. We appreciate your interest in USG, and I'm looking forward with sharing our results with you this morning. After reaching the important milestone of operating profit in the first quarter, we've continued that positive trend with operating profit in the second quarter of 2012. In fact, our sales of $825 million in the second quarter were the highest since 2009. That's an important comparison. The key difference is in 2009, we lost $40 million in that quarter. We believe now that we've turned the corner, and we're focused on achieving net earnings. This is a testament to the innovation and commitment of all of our employees despite the market demand well below historical averages.

Today, I'm going to focus my comments on 2 areas. First, I want to review the highlights of the second quarter, and Matt is going to go into some more details of the numbers. Then I want to discuss a key strategic component in our strategy, and I like to say our plan to win, is our new wallboard partnership to support the India market.

So now, let's take a look at the quarter. For U.S. Gypsum, overall wallboard volume, price and cost significantly improved compared to the second quarter of 2011. Compared to the first quarter, our volume was down slightly, but our margin increased with both price and cost improvement. Our new pricing strategy, which we instituted earlier this year, which gives our customers certainty on price levels, continues to be very effective. In our Substrates business, we had strong results with our next-generation DUROCK, with margins up over 16% year-on-year, and DUROCK volume was the strongest since 2008.

Now turning to our Ceilings business. Profitability in the quarter remained strong due to the growth of our high-end ceiling tile and solid grid margins. Sales were down slightly versus the first quarter, but we do expect a pickup as we are currently in the school construction season and the seasonality of our big-box business, which will happen in the fall.

The next area is our Distribution business, L&W Supply. L&W's wallboard volume and price increased in the second quarter, and we had strong performance in steel and ceilings compared to the first quarter of 2012. Our comp store sales increased 11% year-on-year as we continue to focus on the commercial contractor, where L&W provides value. In fact, sales and margins at L&W improved in all 7 core product categories year-on-year.

Our international units continued to weather various storms in their market. For example, Canadian Gypsum Company's second quarter year-on-year sales are ahead of last year, while operating profit was down. USG Mexico sales also improved year-on-year despite a very challenging market. In order to strengthen our product portfolio in Mexico, we've successfully launched both UltraLight and Mold Tough during the second quarter.

Our results from the first half of this year give us reason to be cautiously optimistic with both top and bottom line improvement. Despite a continued weak market in the United States, we made slow recovery. We continue to focus on our plan to win.

Our strategy has 3 key components: strengthening the core, which is our North American manufacturing and distribution; differentiating our portfolio through innovation with introductions like UltraLight; and diversifying our earnings to select emerging markets.

In previous calls, we've talked about strengthening our core and differentiating through innovation. So today, I'd like to expand on diversifying our earnings. We compete in a business that has been dependent on the North American construction market. Because of this, we carefully evaluate new and existing markets that meet some important criteria for us. To provide geographic diversity to our earnings, we look at the growth potential where we can achieve a #1 or #2 market position, a market where there's Western construction practices, particularly in commercial construction, and the USG brand is strong. One key emerging market for us is India. In order to serve the high-growth Indian market, we have launched a new wallboard manufacturing partnership with a very highly regarded company, the Zawawi Group. The Zawawi Group has partnered with multinational organizations such as Avis and DHL and has the local strength, resources and management expertise. The first important factors to succeed in India, we needed to secure a reliable gypsum rock source. We've done this by the way of a gypsum mining joint venture and we also plan to build a wallboard plant that we can cost-effectively shift to India. We plan to begin the mining operations in Oman in the third quarter of next year, and the wallboard plant is slated to come online by the end of 2013.

The India market exhibits very attractive growth opportunities where we have strong brand awareness, Western commercial construction practices and an architectural preference of USG systems. Wallboard market demand in India is expected to grow at a pace of 15% year-on-year to approximately a 2-billion-foot market by 2020. And our goal is to participate in that growth. As we look at our competitive position in the market, we are also exploring strategic alternatives for our European operations. We are currently in discussions with the respect of a possible sale and we'll communicate more about this when our plans firm up.

As we look at the current market, we still need to create our own recovery. We will continue to take care of our customers with innovative systems and absolutely continue to lower our breakeven.

As we look to the remainder of 2012, we believe that the recovery in North America is slowly improving but the pace is still uncertain. So we need to continue to focus on the areas that we have control. We expect that our wallboard and ceilings pricing strategy will continue to improve margins and give our customers clarity of their cost. We project that industry wallboard demand has bottomed with improvements over 2011, and our volume will also increase, particularly with the continued growth of our lightweight portfolio.

We've had success with our cost-reduction efforts over the last several years, and we've shared those with you over the last few quarters. We've taken out over $450 million of permanent costs. We remain committed to cost reductions, and we have additional initiatives underway, which we expect to continue to lower our breakeven.

We are moving ahead with our international strategy but we're doing it with caution as we continue to explore additional ways to diversify our earnings. Overall, we expect the positive momentum from the first half of the year will carry through the remainder of 2012 with a keen focus on positive net earnings as soon as possible.

Now I'd like to turn it over to Matt, who is going to give you greater details on our results from the quarter. Matt?

Matthew F. Hilzinger

Thanks, Jim, and good morning to all of you. This is my first earnings call as USG's new CFO and I'm very pleased to be here. As Jim mentioned, I'll recap our second quarter results and provide some additional details on each of our business segments.

Second quarter 2012 net sales were $825 million, up 8% from the second quarter of last year. Our second quarter operating profit was $31 million, which compares to an operating loss of $21 million in the second quarter of 2011. This $52 million improvement year-over-year is due in large part to improved wallboard gross profits, which benefited from higher wallboard prices, lower unit costs and higher value. Given all of the above, our incremental operating profit in the second quarter of 2012 versus 2011 was $52 million and $64 million of increased sales, resulting in an incremental operating profit margin of 81%. This demonstrates the strong operating leverage of USG.

The second quarter 2012 net loss was $57 million or $0.53 loss per share. This compares to a second quarter loss last year of $70 million or $0.69 per share. The net loss this year included a $41 million charge related to the extinguishment of debt associated with the refinancing of our 2014 maturity bonds. Excluding this charge, the adjusted net loss was $16 million or $0.15 per share.

In the second quarter of 2012, SG&A was $78 million versus $72 million last year. We continue to take steps to lower our breakeven and focus on managing our SG&A expenses. We have several cost-reduction programs in progress across the enterprise. And despite this increase in the second quarter, SG&A in 2012 should only slightly be higher than 2011.

I will now provide a little more detail on our second quarter segment results. Net sales for our North American Gypsum segment increased 13%, $473 million for the quarter, and operating profit was $31 million versus an operating loss last year of $16 million. These results were driven by improvement in many of our products and businesses. A few of the key contributions are noted here: higher U.S. wallboard price contributed $24 million; the reduction in U.S. wallboard manufacturing cost, $10 million due to lower natural gas and lower fixed costs; and $2 million in incremental profit due to wallboard volume improvement. Our U.S. Wallboard business shipped 1.15 billion square feet in the quarter, an increase of 16% compared to the second quarter of last year and basically flat from Q1 of this year. We attribute this increase to overall market improvement and to the continued customer demand of our SHEETROCK Brand UltraLight Panels as our shipments of these panels continue to grow. Average wallboard selling prices were up with an average realized price for 2012 second quarter of approximately $132 per million square feet compared to approximately $112 per million square feet in the second quarter of 2011. For the balance of the year, the roll off of job quotes from 2011 should have a de minimis impact on our pricing. As you can see, our new pricing strategy has been highly effective. We have not seen deterioration of wallboard pricing this year, and we remain committed to this new pricing methodology.

Turning to Worldwide Ceilings. Our Ceilings business continues to deliver consistent and solid results, continuing its track record throughout this downturn of a positive operating profit every quarter. Second quarter net sales for Worldwide Ceilings increased by $4 million to $177 million and second quarter segment operating profit was $22 million. These results were driven by strong grid and tile margins due to both a shift in mix to higher-end products and strategic pricing actions that offset input cost increases and slightly lower volume.

In our Building Products Distribution segment, net sales increased 9% year-on-year for the second quarter. The operating loss in this year's first quarter decreased to $7 million from $14 million a year ago. As L&W continues to expand and grow its product portfolio outside of wallboard, we believe this will help our customers and strengthen our results.

L&W wallboard volume and price was up in the quarter, contributing $4 million in incremental operating profit versus the second quarter of 2011, even while competition among distributors remains a factor. L&W continues to lower its overhead cost on its path to operating profit with a $1 million year-on-year reduction contributing to its results in the second quarter.

Now, I add some details on corporate spending and what we have been doing to manage our capital spending and our balance sheet including liquidity. Capital expenditures totaled $14 million in the second quarter and we are forecasting about $75 million of capital spending for the full year of 2012. This is higher than last year in order to fund a number of projects that will generate both top line growth and incremental cost savings. These projects are underway and should begin to show results later this year and in 2013.

As part of our strategy to diversify earnings by growing in select international markets, we plan to make approximately $60 million of loans to and investments in foreign joint ventures in 2012, which includes our investment in Oman, of which we expect approximately $45 million to be spent this year and $15 million in 2013.

Finally, as of June 30, 2012, we had total liquidity of $745 million.

Let me conclude by saying that while we are pleased to have continued our positive operating profit in the second quarter of 2012, we remain focused on achieving positive cash flow and net earnings as quickly as possible. We will continue to manage our costs and lower the breakeven of each business, while investing in those businesses that will generate an appropriate return on invested capital.

At this time, we'll be happy to answer your questions, and I'll turn it back to you, Ken.

Ken Banas

We are ready for questions, operator.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Rodny Nacier from KeyBanc Capital Markets.

Rodny Nacier - KeyBanc Capital Markets Inc., Research Division

I was interested in the Wallboard pricing. It was up 1% sequentially and appears to be in stable territory. So I was wondering, could you give me the mix of UltraLight shipments this quarter versus the second quarter? And secondly, how much of pricing on an apples-to-apples basis was it up, excluding any legacy projects carried over from '11?

James S. Metcalf

Thanks, Rodny. As Matt said, sequentially, we're up about $2 from the first quarter. UltraLight shipments are about 44% of our total, which is up from first quarter as well. I think we were 40%, 41%. We are continuing to get great acceptance on UltraLight and actually, the portfolio is expanding. We now have UltraLight 5/8" 30 throughout the United States and all of our locations. And that has grown in the second quarter as well. In fact, we shipped as much in the second quarter, I believe, as much as we shipped all of last year. We've also expanded UltraLight 5/8" X. We have that primarily in the Northeast and have expanded that to 4 plants, and we're getting some really good customer acceptance there. We are getting a premium on those products. And on the price side, we're very pleased with the results. I think getting rid of job quotes has given much clarity to our customers, as I said in my prepared comments, but also it allows our salespeople to go out and promote our products. So everything is nice and firm on our price side, and we're quite pleased.

Rodny Nacier - KeyBanc Capital Markets Inc., Research Division

And can I have a follow-up?

James S. Metcalf

We'll try to have one question. So if you wouldn't mind hanging on, Rodny, and if we have some time, we'll grab that as we get through the queue.

Operator

Our next question comes from Bob Wetenhall from RBC.

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

Could you just touch on incremental margin performance in the L&W segment and what your thoughts are in terms of margin performance, given your cost-saving initiatives in the business?

James S. Metcalf

Sure. As you know, Bob, we're very focused on getting L&W profitable. And from a sequential standpoint, we kind of went sideways. From an operating standpoint, all key 7 categories, that's steel, joint treatment, ceiling tile, quarter-on-quarter we had gross margin improvement. Volume was up slightly. Really where -- the impact in the second quarter was wallboard spread. L&W took their price up, but some of the legacy quotes from the manufacturing side took hold and there was a little backward motion on spread. But if you look at top line, the top line is strong, our comp store sales were up over 10%, 11%, and those 7 category margins were all, quarter-on-quarter, up. So we aren't where we need to be from an operating profit. We do have a line of sight to get there. If you look at overall expenses at L&W, delivery, overall branch expenses were down both year-on-year and quarter-on-quarter. So I'm not pleased where we are. We're very focused, but I do have the confidence we're going to get there very shortly.

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

In terms of wallboard spread that you just referenced, does that roll off those manufacturers' quotes through now and year end to improve the spread?

James S. Metcalf

Well, what we need to do, and we are continuing to L&W, is since we had some spread compaction, is continue to get price improvement on the L&W side in the market. So really, that's the key. As those quotes roll off, L&W's costs do go up and those need to be passed along in the market. So as I said in previous calls, we have a very focused approach on wallboard pricing at L&W. It's done centrally and if you -- the distribution market is very fragmented, but we still feel confident of getting price improvement with L&W in the market.

Operator

Our next question comes from Kathryn Thompson from Thompson Research Group.

Kathryn I. Thompson - Thompson Research Group, LLC.

A question just on the wallboard division. Our industry conducts are showing that volume trends into July are still as robust. One, I wanted to get your commentary on volume trends in July? And also, it looks like from a market share standpoint, while you're up year-over-year, maybe it was down sequentially. In your opinion, do you think your market share in the wallboard segment has settled out?

James S. Metcalf

Thanks, Kathryn. We think we're getting into seasonality, which is kind of interesting, it's really the first year. The second quarter typically, our business will pause a little bit from a volume perspective because our market share in the big-box area. Now they go into lawn and garden and go into seasonal where we start getting into the fall, our business typically gets stronger, October typically is a very strong month for us. And we haven't seen that in the last 4 years. So we think with the market, we have a little wind at our back on demand. We still are balancing price and volume. This is not a market share gain for us. We are getting great traction with UltraLight and we have customers that want the UltraLight portfolio. They are -- we do get a premium price for UltraLight. So that's really been the driver behind our volume increases. So we're cautiously optimistic in the second half and we think that with UltraLight, that gives us something different to talk about with our customers and gives them something to go in the market with. So the volume is hanging in there. But we're focused more on profitability and our line of sight on net earnings. So this is not about market share, this is about margin improvement.

Kathryn I. Thompson - Thompson Research Group, LLC.

The volumes have maintained and continue to kind of...

James S. Metcalf

Yes, they have. We saw some seasonal fall-off. Sequentially, we were down slightly from the first quarter but that's not surprising to us.

Operator

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

James Barrett - CL King & Associates, Inc.

Matt, the profits in Q1 were on a GAAP basis, $27 million. Because of the refinancing, I know the company reported possibly an unaudited $6 million in Jan, Feb. Can you tell us what happened in Q2 to cause overall profitability to be up only a few million dollars in spite of what looked like a very strong March with profits up over $20 million?

Matthew F. Hilzinger

Yes. March, as you know, if you go do the math, March was a very, very strong month for us. And I don't want to dissect the quarter by month but as we look at the second quarter, as Jim said, we've had strong volumes, improved margins. And one of the things that I think did creep up on us a little bit in the second quarter was just SG&A. And we're committed, I mean, we are absolutely committed to lowering the breakeven of this company. And when we look at SG&A through the balance of the year, I think it's going to be up just slightly above what it was a year ago. But I think in the second quarter, there were some timing issues and some other things that came up and hit us. And I think that put a little bit of pinch when you kind of look at the math for March versus the second quarter. So I feel very good about the profitability of where the second quarter ended.

Operator

Our next question comes from Trey Grooms from Stephens Inc.

Trey Grooms - Stephens Inc., Research Division

So in the past, you've said that -- I think in the last quarter, you said that all of the legacy price contracts, I think you said they roll off by the end of third quarter. Could you give us an update on that? Is that still the case? And then also, can you kind of give us an idea how to think about what kind of impact this is going to have on both the Wallboard business and L&W?

James S. Metcalf

Thanks, Trey. As Matt said in his comments, the back half of the year is going to be small. Most of the job quotes do expire midyear into the third quarter. So I wouldn't look for a big bump as you look in the back half of the year. What we're pleased about is we got $2 from the first quarter and price is very firm and we are making no price action. Actually, we're looking ahead to 2013, so that's rolling off. If you look at L&W, as I said, with the earlier question, L&W is very focused on margin improvement in all product categories including Wallboard. They're very focused on the commercial contractor and providing value there. So getting price improvement and spread improvement with L&W is going to be key, particularly as those legacy quotes roll off from L&W's manufacturers, obviously we are the largest one they buy from, roll off. So the key is price improvement, not only on the Gypsum side, U.S. Gypsum, but also L&W continuing to get pricing improvement and they're going to do that, quite frankly, because they are providing value to their customers. So that's really our focus there, and we have some great checks and balances to make sure we don't go backwards on the distribution side as well.

Operator

Our next question comes from Garik Shmois from Longbow Research.

Garik S. Shmois - Longbow Research LLC

I have a question on the Ceilings division. Just wondering if you could provide a little bit more color on the incremental margin. I'm looking at it more quarter-over-quarter, think the incremental margins were down about 100% decremental. Just wondering if there's anything going on in the costs. I noticed on the slide deck you had about $6 million year-over-year in all other changes negative. I was just wondering if maybe you could provide a little bit more color as to what that line entails?

James S. Metcalf

Sure. The Ceilings business, as we said, we're continuing to be very pleased with the results in Ceilings. Really, if you look at last year, there was a sequential move on operating profit quarter-on-quarter. We're basically 2 things: volumes came off, we had some volume decreases with overall opportunity, the opportunity came down in commercial so the opportunity came down; also, as I said earlier on the Wallboard side, we have a pretty big presence in big-boxes so it was a seasonality and we're right now into the summer school construction season, and then we'll be working into the fall where our large customers will start focusing more on building materials. But if you look at costs, there were some -- grid, we hung in there, where were some steel increases that basically, we offset. So really, if you look at -- really it was -- really at the volume impact, which affected some manufacturing [indiscernible] primarily on the tile side. Our high-end ceiling tile, the margins were very strong quarter-on-quarter. Really, the big impact to what you saw was lower volumes in our commodity tile and with some cost increase there. So we're still optimistic in the back half of the year on Ceilings and I think we're continuing on a record pace on operating profit.

Garik S. Shmois - Longbow Research LLC

And some of these projects that you highlighted, with respect to seasonality and the school construction, are you seeing the mix benefit continue into the third quarter there?

James S. Metcalf

Yes. I mean, we are seeing a big mix change and really, that's a big contributor to our operating profit over the last couple of quarters is really specifying and selling that higher-end, that higher-performance ceiling tile, which is a higher-margin product. So commodity tile is the volume but our higher-end margin for both grid and of the high-end ceiling tile is part of our strategy. So yes.

Operator

Our next question comes from Neil Frohnapple from Northcoast Research.

Neil Frohnapple - Northcoast Research

Jim, you mentioned you're looking forward to price in 2013. Do you still anticipate wallboard prices to be significantly higher next year? And sort of when are you thinking to formally send out price letters or have those discussions with distributors?

James S. Metcalf

Well, it's still early. I mean, there's a lot of uncertainties in unit cost. We look at a lot of things. We look at demand, we look at unit cost. There's a lot of questions once we get past the November election. So right now, we are formulating our plans. One thing I will say, on 2013, we are going to continue our policy of no job quotes. That policy has worked and it has worked for our customers. And as I said earlier, our sales organization has more time to promote, sell and service our customers. So we're formulating all that now and we're going to have those individual conversations later this year when we have a better idea what '13 looks like. But I will say that the plan is that the pricing -- we're going to improve pricing as we continue to do over the last couple of years.

Operator

Our next question comes from Joshua Pollard from Goldman Sachs.

Joshua Pollard - Goldman Sachs Group Inc., Research Division

First, I want to congratulate you guys on keeping analysts to one question. I think you're doing a better job than Apple in that standpoint. My question is actually on profitability. How long do you guys expect to keep these 80% to 100% incremental margins in the Wallboard business? And how much of that is actually coming from your natural gas benefits you're seeing both the hedge and spot, maybe if you could just give an overall update on where you guys are for nat gas?

James S. Metcalf

I'll turn in the natural gas over to Matt but on the profitability, we are very focused on net earnings. And that is just not getting it from one product category or the other. We need to get L&W profitable, we have a line of sight of getting L&W profitable, we're going to continue to grow the profitability of our Ceilings business. And our Wallboard business, we talk about wallboard a lot, but Joint Treatment and DUROCK and the entire portfolio, we have everyone focused on satisfying our customers, growing our business, growing our margins and I'm really pleased with 2 quarters of operating profit. But as we said earlier, we need to have positive cash flow, which we're very focused on and positive net earnings. So until we get in that spot, we are going to continue to lower our breakeven and things like natural gas have helped, but I will say, at our plants, our plants are running 50% plus or minus capacity utilization, and they have done a remarkable job of efficiencies. Recovery, speed and delay have been at historic highs. Our safety record has been wonderful and natural gas has helped. And again, Matt will give you some comments on that but I just want to assure everyone on the call that we are extremely focused on getting this wonderful company to net earnings.

Joshua Pollard - Goldman Sachs Group Inc., Research Division

When do you expect that if I could just ask that question?

James S. Metcalf

My expectation is as soon as possible and my job is to be very impatient about that. And it is as soon as possible. I'm not giving a projection, but my team around me knows that there is a tremendous amount of focus that, that has to happen ASAP. So I can't give you a date or a time, but stay tuned. Matt, do you want to...

Matthew F. Hilzinger

So kind of the blended cost for gas for us for this year on an MMBtu basis is about $3.50. And that's down substantially from a year ago, up somewhere around call it $5.50. And when we look out to next year, we continue to hedge for 2013. We'd like to be about 50% hedged when we go into 2013 and leave a little bit open as we continue to kind of watch what happens with spot prices so we can take advantage of that. But you look out next year and the forward for gas has been around $3.50 to $3.70. I think it creeped up just a little bit today. But it's not too far off from where we are now. So we watch it very carefully and as Jim said, it's an important component of costs, but we're going to continue to do things around all of our other cost line items to bring the breakeven of this company down. So does that answer your question, Joshua?

Joshua Pollard - Goldman Sachs Group Inc., Research Division

I would love to understand at what level your hedging at just so we get a sense of where you are and I know you want to be 50% by year end, but are you at a quarter at $3.50 or you're at a quarter at $3? That will be helpful.

Matthew F. Hilzinger

Joshua, you were commending us on our one question. So we'll be more than happy to answer that. So if you can hang on.

Joshua Pollard - Goldman Sachs Group Inc., Research Division

That's fine. He asked me if it answered my question. I'll be good. I'll hop back in queue.

James S. Metcalf

That's fair. We'll get that answer to you.

Operator

Our next question comes from Mike Wood from Macquarie.

Mike Wood - Macquarie Research

It looks like the non-wallboard North American Gypsum sales were relatively flattish or just up slightly year-over-year. Can you sort of give color in terms of why that growth would be so different from the wallboard volume levels year-on-year?

James S. Metcalf

Sure. It's really -- one of the biggest categories is our Joint Treatment and Surfaces business. We had a pause from the first quarter. We had a couple large customers with some very substantial first quarter block buys of Joint Treatment and when you look at quarter-on-quarter, that's really the biggest variance on the non-wallboard products. Also, if you look at -- in the Canadian Gypsum, our CGC results sometimes get blended and that was Ceilings -- Ceiling results up in Canada as well but the primary area was our Surfaces business.

Operator

The next question comes from Michael Rehaut from JPMorgan.

Michael Rehaut - JP Morgan Chase & Co, Research Division

First question on the -- I just want to go back to the Ceilings business for a moment. I believe you said that some of it was some seasonality, also lower volume in tile with cost increases but if you look at the margins of USG Interiors going back the last few quarters, you had a 19-plus percent margin in the first quarter. Before that, you were running anywhere from 13% to 16%, and now you're back at roughly 16% x charges. So how should we think about this? It seems like first quarter '12 at plus 19%, again this is just the USG Interiors business, was a little bit of an outlier. Should we think about a 15%, 16%, 14% to 16% margin going forward? Is that reasonable? And maybe what drove that bump in 1Q?

James S. Metcalf

I mean, your numbers are right. If you look at last year, we probably, you said 14% to 16%. You see the 1Q versus second Q last year, we went from 16% to 13%. So just as a comparison, 2011 first Q, we were 16 and change. Second Q, we were 13 and change. We had a very good first quarter. There were some -- in the first quarter of 2012, let me be specific, there were some sales that were brought into the first quarter because of grid price increases. So we had a bump in our grid business in the first quarter, which really gave us some great results. So looking forward and not giving any guidance, I am very comfortable and as I said, we're on pace to have a record year in Ceilings. So I think there isn't really anything that should concern you. Really, the key and what I tell people about the Ceilings business on the results is really focus on can we stay ahead of any type of steel increases. That's really the big area in Ceilings. If there's a steel increase and we can pass that along and get improved margins in our grid business ahead of that, really, you're going to see some positive quarterly results. Last year, we were behind one quarter. We had grid increases and we didn't pass that along in the market and we felt that. So when you look at the business, really the key is how are we doing on steel procurement and can we pass that along in the market. And quite frankly, if you look at grid margins quarter-on-quarter, they were basically flat. And the impact, as I said earlier, was really volume-related on the commodity. So I think your models are pretty good and we're very confident on the rest of the year.

Operator

Our next question from Dennis McGill from Zelman and Associates.

Dennis McGill - Zelman & Associates, Research Division

Just interested in your opinion of price realization relative to the industry and if I could ask across both manufacturing and distribution. So if you look at year-to-date price realization, I'm specifically focused on wallboard, do you believe that you are above industry, equal to industry or below industry? And then same question as it relates to L&W and their pricing to market?

James S. Metcalf

Let me comment on our pricing. I really can't comment on the industry pricing. We always believe that to get value with our products, we should be able to get a price premium. And our customers will tell us if our value proposition is worth the price premium. So -- and you can always ask yourself, is the price premium last look on a large job or is the price premium a dollar amount? So we continue to introduce new products across our portfolio, and it's just not UltraLight, we have some other new products that we plan to introduce that's providing value to our customers. So we have value-added selling, and that's why eliminating job quotes and giving clarity to our customers this year on one price for the year, it allows our people and our salespeople to promote our entire portfolio. So at the end of the day, I'm quite pleased with where we've gone on price improvement. And we're very focused to continue to provide value and hopefully, our customers will continue to pay us for it. On distribution, let me just go to distribution. We have taken a very different approach over the last 12 months on distribution. As I said earlier, we have a very focused price policy at L&W Supply. Price authority is very centralized. It is now out of the field, it's monitored and watched every day. Price improvement realization on L&W is absolutely key, and that's why our strategy at L&W, focusing on the commercial contractors, we provide value. If you look at our 7 core product categories, steel studs, commercial insulation, ceiling tile and grid, exterior systems, that's really in line with our commercial contractor. The residential homebuilder customer is an important part of the L&W portfolio. But quite frankly, we don't provide as much value to that customer. Thus, that customer is not willing to pay for it. So our focus at L&W is providing value and to be able to provide value, hopefully the customer sees that the prices that we charge, they're willing to do it. So it's very similar to our U.S. Gypsum strategy with the exception that there is a keen focus on the commercial contractor, which quite frankly, is new. It's a focus we've had for about the last [indiscernible] quarters.

Dennis McGill - Zelman & Associates, Research Division

I think Jim, you're making me read between the lines. But if I had to summarize that, I'm hearing you say that your pricing realization would be better. Both of those things would imply that's better than industry, is that a fair assessment?

James S. Metcalf

Again, I'm not going to comment on the industry, Dennis. But I think your assessment's -- I don't want to comment on it. I think you may be on the right track.

Operator

Our next question comes from John Baugh from Stifel, Nicolaus.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

My question is relating to Gypsum segment and looking at it Q2 year-over-year, you commented on non-wallboard and you talked about the Joint Treatment I think, being down from first quarter. Could you comment on the quarter year-over-year both on volume and pricing in joint compound? And then any other non-wallboard categories and how they played out year-over-year in Q2?

James S. Metcalf

I appreciate the question on non-wallboard products because they're very important segments. We break the non-wallboard grouping into Surfaces, which is our Joint Treatment Texture and Plaster business and Substrates, which is our performance Substrates, DUROCK, FIBEROCK, SECUROCK. And let me start with Substrates. Volumes year-on-year, as I said in DUROCK, are up 16%. Margins are up year-on-year. FIBEROCK business has improved slightly. We took a step backwards a few years ago on some customers that -- customer shifts. So the year-on-year volume are very, very strong but we're very focused, it's no different. We're very focused on margin improvement in those categories. If you look at the other non-wallboard products, which would be Joint Treatment, our Joint Treatment business, we have been very aggressive on price improvement in Joint Treatment and we lost some volume and we balanced. We have a very high market share in Joint Treatment. We have to really balance our price and volume and our margin improvement in Joint Treatment very carefully. Our Plaster business, we don't talk a lot about and that business is a slow growth business but, again, we have a big market share there. So year-on-year, I think each one of those categories from a volume perspective is low-single digits and more up. Margin improvement is also key, but those are areas that we have very specific general managers that run the business and that we want to focus on growing those businesses. We just introduced a new Joint Treatment, our lightweight Joint Treatment business, which is just getting into the big-box retailers and we're getting into the market and the rollout has been, quite frankly, a little slow for us. And so that's something we are focused on and we think the back half of the year, we'll see some improvement. So if you look at the Joint Treatment business, you equate to industry growth, we do grow our Joint Treatment higher than the industry because of our large market share. But it's very -- Joint Treatment is very contractor-focused. It's a pool strategy and we have people in the field that are doing trials every day. So I think that side of the business, we're very pleased with and even with our large market share, we are going to continue to introduce new products.

Operator

Your next question comes from Todd Vencil from Sterne Agee.

L. Todd Vencil - Sterne Agee & Leach Inc., Research Division

On the wallboard price this year, I mean, do you feel at this point like we've fully realized the increase in the beginning of the year? And can you talk about what the drag was from freight on the net there in relation to what it was in the first quarter?

James S. Metcalf

As we said, we don't give any projections, as you know, in the back half of the year but you're going to see the job quotes roll off. It's going to be very small percentages as we get into the second half of the year. If you look at freight, it did have some drag in the second quarter, particularly early in the second quarter. It has come down slightly, but that was -- it wasn't any huge impact to the net price. That is something that when you look at the net realized price freight, freight increases do impact that. So if you look at diesel costs or if you look into any of the factors that go into the freight category when you are doing your models, that does have an impact plus or minus on the net price, but it's not of significance. So we're very pleased where we are. I think the most important part or the fact on us being pleased is we talk to all of our customers. And it has given our customers some unbelievable clarity. It's one less thing they have to worry about. They know what their price is for the year. They can quote their jobs. They can focus on bigger things like labor and growing their business. So this -- it's been very different for us. We're extremely excited about the way it's worked for our customers, and they've told us, "Continue this." And the reason we're saying there's no job quotes into 2013 is because our customers say this really works for them and it gives them clarity. So I just wanted to clarify why we're pleased, because this is what our customers are telling us.

Operator

Our next question comes from Dan Oppenheim from Credit Suisse.

Daniel Oppenheim - Crédit Suisse AG, Research Division

I was wondering if you can talk a little bit about the non-res side. I think overall it seemed very positive in terms of comments on wallboard in general. But as you think about what's happening in the non-res side, what's your view and outlook there?

James S. Metcalf

On the commercial side, as I said earlier, it's taken a pause a little bit and it's had a bigger impact on our Ceilings business and, quite frankly, on the L&W business. We were looking at the beginning of the year, low-single digits and when you look at the -- if you look at McGraw-Hill or any of the forecasts out there, our products, particularly ceiling tile, have about an 18-month lag. So we're still working through, if you look back, our non-res was down double digits 18 months ago. We're still working through that 18-month lag for ceilings. So we're probably in the single-digit increase on non-res. We're really -- a lot of it has to do with job creation and office construction. And job creation has a big impact on the non-res business. So it did affect -- it does affect L&W from a volume perspective. As I said with one of the previous callers, our focus is on the commercial contractor. So if you look at the segments, everyone -- we know where housing has gone year-on-year. The repair and remodel business has been solid. But in the second quarter, it did take a pause because of seasonality and maybe also the economy. But the third area, the non-res business is really -- it's limping along. So as you look forward, we aren't expecting any big bumps in commercial construction in our cycle.

Operator

Our next question comes from Ken Copley from Capital Executive.

Ken Copley

I'm not looking for any month-by-month dissection, just general color from an aggregate perspective. But I'm trying to get a feel for if there were any business downturn in the month of June. So how was your month of June from an aggregate perspective [indiscernible] quarter itself?

James S. Metcalf

We don't break it out month-by-month but I will say the quarter, and this is the first time in probably 4 years, Ken, that we've seen seasonality. If you look historically, if you go back and throw out the last 3 or 4 years, because it was just like catching a falling knife. I mean, every quarter top line was on opportunity, was going down. But typically, in our business, the second quarter, your first and fourth quarters are typically strong quarters, the second quarter is your weakest quarter. But it didn't fall off that much. You can see our wallboard shipments were down slightly. And so, we were pleased but there wasn't any big outlier.

Operator

Our next question comes from Rodny Nacier from KeyBanc Capital Markets.

Rodny Nacier - KeyBanc Capital Markets Inc., Research Division

My follow-up question is actually on the gypsum supply. So I'm trying to get a better understanding of the synthetic gypsum supply dynamics and when I'm looking at coal consumption, it was down about 40% year-over-year in the first quarter. And I assume it's down again pretty sharply in the second quarter. So at what point do these declines start to affect the synthetic gypsum supply for the industry? And are we already seeing the impact and perhaps, the industry starting to view the remaining supply as a more valuable diminishing asset?

James S. Metcalf

That's an excellent question and absolutely, we have seen the impact of gypsum supply really over the last 3 or 4 months. Supply has gotten tight. We have seen some shortages in some areas. We have not really had those shortages. But the good news is we have very firm contracts with the utilities. We've been in the synthetic gypsum business for 25 years so this isn't new for us. And it is becoming a more valuable part of the raw materials. So you hit the nail right on the head. Everyone knows what's happening with coal consumption and that has had an impact. So it's something that I view -- we're very comfortable with our supply. It has -- overall supply has gotten tighter. And it's something that is something you got to keep your eye on. So the answer is yes.

Rodny Nacier - KeyBanc Capital Markets Inc., Research Division

And while we're on the industry, what was the utilization rate for the industry in wallboard and/or industry shipments?

James S. Metcalf

Utilization was mid-50s. Still on a punky area. But as I talked in some previous quarters, that's assuming everyone would be running their plants full out. We like to look at effective capacity utilization. It's going to take -- to add a shift at a plant, it could take anywhere from 3 to 5 months. So if you look at the effective capacity, it is much higher than that 50%. It could be anywhere from 15 to 20 points higher of plants that are staffed at the current rate and not being able to add any additional manpower.

Operator

Our final question comes from Yoma Abibi [ph] from JPMorgan.

Unknown Analyst

My question is on free cash flow. Can you give us a sense for, even if you don't want to give specific guidance, perhaps you can give us a little bit more color how we should be thinking about free cash flow for the balance of the year with respect to perhaps, some line item expenditures we should expect going forward perhaps in the context of seasonal free cash flow?

Matthew F. Hilzinger

This is Matt. So if -- in the slide deck, on the cash flow statement, which we included in our press release, I think everybody can take a look at it, but free cash flow for the first 6 months is a negative $78 million compared to a year ago for the first 6 months of a negative $180 million. So clearly, the trend to get to positive free cash flow is there. That's what we want to do. We've got, as we look at 2013, that's clearly a goal as Jim had said, is to get to positive net earnings, to get to positive net cash flow. When we look at capital expenditures, we are going to spend somewhere around $74 million, $75 million this year. Those are solid projects and things that we truly believe are important to either growing the top line for us or reducing our expenses. And we have not figured out what our CapEx is going to be next year. But clearly, we're going to go through and figure that out as we approach the second half of the year and approach year end. And as Jim has talked about, that's -- we clearly have a line of sight to positive free cash flow and net earnings next year. So I feel good about where we are from a cash flow statement on a year-to-date basis. I don't have any worries about the second half of the year. And from a liquidity standpoint, we've got about $750 million of liquidity, over $500 million of cash in the balance sheet. So clearly, we can afford the CapEx and we feel very good about it.

Unknown Analyst

If the seasonal historical patterns work, what does free cash flow look like quarter-to-quarter?

James S. Metcalf

Can we -- we're just -- we're about at the end and what we'd like to do is as we said, trying to keep this to one question. We still have some other people in queue but we do have to wrap up. So we'll be more than happy to follow up on any questions that you or the other callers that are in queue. And I apologize if we didn't get to all of the callers, that's why. And I really appreciate everyone trying to keep it to one question and giving everyone a shot to ask us. So let's have -- we'll have that as a follow-up.

I really appreciate everyone's interest in our company, and we are pleased, as I said, that we've achieved an operating profit in the first half of 2012. As Matt just said, we have an absolute keen focus on net earnings, positive cash flow and we still have some work ahead of us. Our strategy, as we've talked about, strengthening our core, that's really absolutely critical. We want to diversify our earnings, and we want to continue to differentiate through innovation. We think each one of those legs of that strategic plan are starting to take hold. I want to assure everyone that we're extremely focused and we know what needs to be done really to execute our plan. Our customers, and I appreciate any customers that are listening, you are our #1 priority, and we're going to continue with our new product innovation, which will provide the value that we want to give you and help you grow your business as we get into 2013. I want to also assure you that our efforts to reduce the breakeven, we have additional initiatives that we talked about, diversifying our earnings have laid the foundation, really, to profitably grow this fine enterprise. So I appreciate everyone's interest this morning and you taking the time and we look forward to updating you next quarter and on our results and our path to profitability. Thank you.

Ken Banas

Thank you, Jim. A taped replay of this call will be available until Friday August 3. Information is available on usg.com. This concludes our conference call. Thank you.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: USG Management Discusses Q2 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts