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USG Corporation. (NYSE:USG)

Q2 FY08 Earnings Call

July 22, 2008, 11:00 AM ET

Executives

James 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

Dennis McGill - Zelman

Jim Barrett - C.L. King and Associates

Jack Kasprzak - BB&T Capital Markets

John Emrich - Ironworks Capital

Angela Uttaro - Oppenheimer Funds

Mark Weintraub - Buckingham Research

Operator

Good morning, ladies and gentlemen, and welcome to the USG Corporation Second Quarter 2008 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 will now turn the call over to Mr. James Bencomo, Director of Investor Relations and Pension Investments. Mr. Bencomo, you may begin

James Bencomo - Director of Investor Relations and Pension Investments

Thank you, Jamie and good morning. And welcome to USG Corporation’s second quarter 2008 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 at 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 assumptions about business, market and other conditions and management undertakes no obligation to update these statements. The statements are also subject to a number of factors including those listed at the end of today’s press release and actual results may differ from our current expectations. I would also like to point out that we do have reconciliation as a non-GAAP adjusted operating profit figure that we maybe discussing today. That will be at the end of our slide presentation.

With me today to discuss our results and our outlook are Bill Foote, USG’s Chairman and CEO, Jim Metcalf, President and COO and Rick Fleming, Executive Vice President and CFO. Bill will begin by commenting on current market conditions, USG’s performance this past quarter and some of the initiatives that we have taken to deal with the difficult business environment that we are in.

Jim will then discuss the operating results in our core businesses and Rick Fleming will conclude our prepared remarks by covering consolidated financial results, capital spending, cash and debt management. We will then open up the call to 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 an hour. So, let’s begin. Bill?

William C. Foote - Chairman and Chief Executive Officer

Thank you, Jim. Good morning to all of you. As always we appreciate your interest in the company. It has been roughly two years, the summer of 2006, that the market for wallboard started showing signs of deterioration. At the time, I am sure most housing market participants like you and we were hoping for and maybe even expecting, a housing downturn similar the one we experienced in 2000-2001. When the decline in housing starts was in the mid-single digits and the repair and remodel markets paused for only about a year.

The current recession is indeed far worse than the previous downturn. Housing starts are now down more than 50% from the peak and inventory of unsold homes at an unprecedented a 11-month supply. These two statistics alone will certainly qualify this downturn as a very severe decline. But, as you all know, that’s only part of the story.

In the past 12 months we have witnessed home builders filing for bankruptcy, record foreclosures, bank failures, and numerous other credit-related problems throughout the economy. If we are talking about hurricanes and I guess this is the hurricane season, this would definitely be a Category 5 storm.

The turmoil in the credit markets in the broader economic uncertainty, have all affected our businesses, particularly our core wallboard business. We reported a net loss in this quarter and last quarter and we are not happy about it. I can assure you, that we are working exceptionally hard to offset the effects of the weak housing market and raw material cost increases. These efforts are succeeding.

In addition to cost reductions, positive contributions from our non-wallboard businesses are also helping to soften the impact of the housing market decline. Our Ceilings business and our distribution businesses were both profitable in the second quarter as were most of our non-US operations. It’s a difficult market. It is having the greatest impact on the wallboard business. But we are taking decisive action throughout the company to manage through this downturn, serve our customers, and position the company to succeed and grow when the market rebounds.

Jim will discuss our operating performance in market conditions in few minutes. Before he does, I would like to talk about some of the initiatives we were taking to deal with the current recession, while positioning the company for the upside. Specifically there are four things I would like to mention.

The first is cost control, since the beginning of this downturn we have been keenly focused on managing our costs. In the second quarter, we announced and implemented further staff reductions. We are clearly benefiting from those initiatives. You can see it in our overhead cost which is down $20 million in the first six months of this year, compared to the first half of last year.

Our consolidated second quarter results definitely reflect the benefits removing costs from the business. The housing market did not improve in the second quarter compared to the first, in fact in some respects it deteriorates further. But USG’s financial performance did improve. After adjusting for restructuring charges operating profit improved $38 million in the second quarter, compared to the first quarter, much of that improvement is attributable to our cost reduction efforts.

The second topic that I would like to mention is the improvement in our manufacturing network. During this market decline we have closed or curtailed 3.5 billion feet of our highest cost capacity and are replacing some of that high cost capacity with new low cost assets in places like Norfolk, Virginia and Washingtonville, Pennsylvania.

We also have significantly upgraded our paper manufacturing capabilities by closing or curtailing two mills and replacing them with a new state-of-the-art mill in Otsego, Michigan. I’m very confident that the quality of our manufacturing network is improved significantly since the start of the recession. We are in an excellent position to excel, when the market eventually rebounds.

Third, I would like to comment on the solid performance our non-wallboard businesses. Our distribution business L&W Supply returned to profitability in the second quarter, posting an operating profit of $7 million. The residential side of L&W business was very soft.

But cost control and strong results from the commercial side of the business enabled L&W to return -- to turn profit in the quarter. And our ceilings business achieved another record quarter, a record quarter, reflecting better pricing for ceiling tile and lower grid manufacturing cost.

Lastly, I would like to talk or comment briefly on our financial flexibility. Since emerging from bankruptcy a little more than two years ago, we have taken several steps to maintain the company’s financial flexibility. Over the past few years, we have raised equity on two occasions and refinanced our debt portfolio, such that we have no term debt maturities until the year 2016.

And as we speak, we are exploring additional financing alternatives that could provide about $300 million in additional liquidity. Rick, will describe those initiatives in more detail for you in a few minutes.

Let me wrap up. As I said earlier, despite the severity of the downturn in our core market, we are not at all satisfied reporting losses in the first and second quarters of this year. Actually it’s been three quarters now. We are working hard to change that and our efforts are producing positive results. Recessions can bring us the best in a company and its people, and I believe that’s what is happening right now at USG.

We are taking decisive action to address the worse housing downturn in decades. We’re cutting costs. We are managing our liquidity. We are focused on serving customers, and we continue to invest in the future of this company. I’m confident that our vigilance during these challenging times is making USG a better company and a stronger competitor, both now, and for when the market returns.

With that, let me turn it over to Jim, who’ll comment more specifically about market dynamics in each of our businesses, Jim?

James S. Metcalf - President and Chief Operating Officer

Thank you Bill, good morning. I’m glad to have this opportunity to discuss our business with you today. I know many of our shareholders and analysts who are on the call today follow the performance of other companies in the broader housing market.

You must be tired of hearing bad news, and quite frankly, we’re tired of reporting it. But as Bill mentioned, we are very focused on working through this very, very challenging market. We have reason to be encouraged despite the severe recession we are currently in. Before I discuss our business in detail, let me mention some key points.

First, wallboard margins, wallboard prices have improved since they hit bottom in January of this year. Those price improvements are partially offsetting the cost pressures we are experiencing. Wallboard is obviously our largest business, and it’s where we are facing the biggest pressure. But I’d like to share some highlights from our other businesses.

Worldwide Ceilings, as Bill mentioned, our ceilings business posted another record quarter. Ceiling, tile and grid performed well due to our increased selling prices and improved manufacturing efficiencies.

L&W Supply, our distribution business reported a $7 million operating profit, benefiting from a diverse product offering and aggressive cost reductions.

International, our international operations all reported solid results with operating profit improving significantly from the first quarter. And our most important area safety, we had another great performance in the quarter. There is a strong correlation between safety and operating efficiency. So, it comes as no surprise that our operating efficiencies are at or near record levels in the quarter.

So we definitely have some positive trends that are taking place in this long shadow of our wallboard business. But the sheer size of wallboard relative to our other businesses means that it will dominate our consolidated results. I think it’s fair to say that this is currently a one-product one-market issue.

Now I would like to spend a few minutes talking in more detail about our operations, starting with North American Gypsum. In the US wallboard business, there were three market dynamics that are influencing our results: soft demand, rising raw material costs, and modest price improvement.

Demand for wallboard continues to be very weak. US Gypsum shipped 1.9 billion feet of wallboard in the quarter, down approximately 11% from the first quarter. We ran our network at approximately 69% of capacity utilization, outperforming the industry. Regardless, our operating rate is still down from an already low rate of 76% in the first quarter of 2008.

Rising raw material and freight costs are also impacting our results in wallboard. While all of our competitors are affected by raw material inflation, we do have an advantage on freight costs, because of our broadest manufacturing network with fewest miles to market.

Turning to price, our average price for the quarter was approximately $110 per thousand, which is well below the $142 in the second quarter of 2007. But the good news is that after bottoming out in January of this year, prices have increased almost every month in 2008. The price increases have been modest, but the trend is in the right direction. We will continue to seek price increases throughout the remainder of this year, but the main focus is to improve wallboard margins, with the anticipated energy and raw material inflation that is occurring.

Next I would like to discuss our surfaces and substrate business units, which includes products like joint treatment, textures, plaster, specialty product such DUROCK and FIBEROCK. Volume for joint treatment was down in the second quarter, but to a lesser degree than wallboard. Prices improved modestly, but raw material cost pressures continue to be a challenge.

Performance substrates were affected by difficult market conditions, but still achieve solid results in the quarter. The highlight in the substrate’s business was a performance of our FIBEROCK product line, where profitability increased despite the challenging conditions that we are in. FIBEROCK was rolled out to all Home Depot stores across the country, which will continue to boast our sales and profitability in this business unit.

Now I would like to turn to our worldwide Ceilings business. As Bill mentioned, we followed up a record first quarter with another very strong quarter in our Ceilings business. We achieved excellent results in both ceiling tile and grid due to higher selling prices and improved manufacturing efficiencies.

Overall margins increased about 2% compared to the first quarter and operating profit was up 27%. Our Stockton California Grid Plant achieved OSHA Star Status in the second quarter. This recognition reflects superior safety and quality performance at the operations. All of our domestic ceiling tile and grid plants have now achieved this prestigious OSHA Award.

For the first half of 2008 has been very solid for our Ceilings business. We do expect the US commercial construction market to soften, as this year progresses and into 2009. But we will remain focused on improve profitability for our Ceilings business.

Our Distribution business, L&W supply recorded an operating profit of $7 million in the quarter, compared to a $1 million loss in the first quarter. That’s a clear indication that cost control initiatives are impacting our business. We have closed or consolidated 20 centers since the beginning of the year.

Our focus at L&W is on cost, but there are opportunities to grow L&W even in a market like this. L&W is benefiting from a diverse customer base. It serves both the residential and the commercial market. Diversification helps in markets like this, where the commercial market is considerably stronger. Not surprisingly wallboard shipments have weakened at L&W, is a sharp contrast they are sales of non-wallboard products like ceiling tile and metal, which are event to last year second quarter results.

I would like to turn now to our international operations. Canada, Mexico and Europe all achieve strong results in the quarter. USG Mexico achieved solid increases in both sales and operating profit. Sales increased approximately 15% over the previous quarter and operating profit improved to $7 million from $4 million in the first quarter of 2008. The Canadian housing market remained solid in the quarter. Canadian Gypsum Company did experienced pressure on wallboard price, due to the excess supply of wallboard in the US and the strength of the Canadian dollar.

As I wrap up my comments, I like to reinforce a few thoughts. First, USG is more than just wallboard. We served the residential, commercial and repair and remodel markets. All of our businesses are affected to some degree by the severe downturn in the housing market. But our non-wallboard businesses and product lines had a solid quarter relative to the market.

Clearly, they aren’t decisive scale to offset the challenges we have in wallboard, but they have softened the impact. Second, the actions we are taking to control costs and managing our network are succeeding. We have removed substantial overhead costs from all areas of the company. We are seeing the impact of those efforts in our results, and we will continue to see the benefit as 2008 unfolds.

Of course, we’re never done. We’re going to continue to explore new ways to reduce structural costs throughout our entire enterprise. We’re making tough decisions to get the most out of this very difficult market. When the market rebounds and it will, USG will be well positioned with an excellent customer base, a broad product portfolio, a streamlined cost structure, and what we consider to be the best manufacturing network in the industry.

Now, I’d like to turn the call over to Rick Fleming who will discuss our financials.

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

Thanks Jim, and good morning. As indicated, I’ll update you on our second quarter financial results and provide some details on performance of our core businesses, capital spending, and cash and debt management. Both Bill and Jim have commented on the challenging market conditions we currently face.

In the midst of this downturn, we are not only focused on our operations, but also our finances, update you on the reviewing demands cash flow, and as well fully during these challenging time.

But first, I’ll recap our second quarter financial results. Second quarter 2008 net sales $1.251 billion, down 11% from net sales level in the second quarter of 2007. We reported an operating loss of $44 million compared to last years second quarter operating profit of $88 million.

Second quarter 2008 net after-tax loss was $40 million versus net earnings of $56 million from last years second quarter. This loss largely reflects lower wallboard prices, combined with higher raw material and energy costs, and lower profitability in our distribution business. These factors more than offset increased profits in our Worldwide Ceiling business.

Our net loss for the quarter included restructuring charges of $21 million pretax or $30 million after-tax, which is $0.13 per share, primarily associated with our salaried workforce reduction program, the closure of L&W location, and the shutdown of several manufacturing lines. We’re also plant startup costs during the quarter for our Otsego, Washingtonville and several other projects that totaled $4 million pretax or $0.02 a share after-tax.

I should note that there will be additional startup costs incurred in the third and fourth quarter of this year, totaling approximately $10 million pretax. The breakdown of pretax restructuring and plant startup costs by core business is as follows, North American Gypsum $13 million; building products distribution $5 million; Worldwide Ceilings $2 million; corporate $5 million.

Turning to earnings per share. Our loss per diluted share was $0.40 this second quarter based on average diluted shares outstanding of $99.1 million. This loss includes restructuring and plant startup costs of $0.15 per share. Last year second quarters EPS was a profit of $0.56 per share. Jim gave you a pretty good recap of what was behind the performance of our three quarters is, North American Gypsum, L&W Supply, and Worldwide Ceilings.

Let me turn to some additional financial highlights of our consolidated results. Selling, general administrative expense or SG&A, totaled $94 million in the second quarter, a decrease of $5 million or 5% from a year ago, due to cost control measures, including a workforce reduction program, we eliminated approximately 500 positions. And for the first six months SG&A is down $20 million versus last year.

Cost savings in SG&A and cost of sales, from actions taken to-date as well the completion of plant startup costs are expected to generate approximately $150 million in total annual savings. It will be fully in place by end of this year for calendar 2009.

Interest expense is $21 million for the second quarter and $38 million for the first six months of the year. We are currently anticipating interest expense for the full year to total about $84 million. The effective tax benefit rate for the second quarter of 2008 was 37%, based on the current mix of worldwide income we expected our full year tax rates will be about 41% similar to the six-month year-to-date rate.

Regarding capital spending, capital expenditures totaled $67 million in the second quarter, compared to a $130 million in the same quarter last year. For the year, we now expect CapEx to be approximately $240 million versus $460 million last year. This decreased level of capital spending reflects the completion of a number of strategic investments that have been underway over the past two years.

Going in to 2009, all of our major CapEx projects will be behind Stockton, which is currently scheduled for 2012. So, we will have a lot of flexibility regarding 2009 CapEx. Regarding our cash and debt situation, our cash balance as on June 30th was a $181 million, compared with a $190 million at the end of the first quarter.

Total debt was $1.385 billion as of June 30th, compared with $1.283 billion on March 31st. As of June 30, 2008, the unused borrowing under our revolving credit facility totaled $425 million and when combined with cash on hand, total liquidity was $606 million. This compares to requirement in our credit agreement that we keep on hand cash and unused committed borrowing capacity of at least $300 million.

We believe that we have substantial financial flexibility to deal with this challenge in times. We proactively manage our capital structure in the last 18 months, positioned USG to write-off this severe business cycle by issuing $422 million of new equity in March 2007, refinancing our floating rate bank debt were $1 billion of ten-year notes and as a result we have no term debt maturities until 2016.

In addition we have extended maturity of our revolving credit facility by one-year to 2012 and we have revised its financial comments provide flexibility during this downturn. And we continue to be proactive. We are working to finalize new borrowing capacity against our fleet of ships that haul gypsum rock, a new line of credit for our Canadian subsidiary, the new accounts receivable bad credit facility, until all we have approximately $300 million an additional liquidity in the work.

In summary, although we find ourselves facing a severe recession with weak demand and pricing for wallboard combined with significant costs pressures and vital capital markets. We have made meaningful progress toward our goal of returning to profitability, further adding to our liquidity and being well position for the future.

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

Question and Answer

Operator

Thank you. [Operator Instructions]. Our first question comes from [inaudible] from Longbow Research. Please go ahead.

Unidentified Analyst

Hi, good morning

William C. Foote - Chairman and Chief Executive Officer

Hi, Gary.

Unidentified Analyst

Hi, just a first question, I know one of your competitors have announced a series of wallboard price increases here in the summer, and into the fall. Can you just talk about your view on future price increases this year and perhaps help us understand the percentage of wallboard demand that it was the aspect just given the nature of these price increases coming so hot and heavy here in the third quarter. And what percent perhaps is little bit more discretionary?

James S. Metcalf - President and Chief Operating Officer

This is Jim Metcalf. We have a price increase announced in the market for 12% on August 11th and we put in our price increase sweater that there could be some possible future price increases, but at this point, we have a price increase, we have a 30-day policy and we have just also had a price increased in the last month of 10%. So, with the raw materials and inflation we’re seeing in the industry, this is something as critical and it’s really on our path to profitability and we are focused on price improvement as we look forward.

Unidentified Analyst

Sure, are you seeing L&W’s ability to pass through the wallboard price increases get any easier or customers understanding a little bit more with the raw material increase and you need to absorb the wallboard price increases or is that just a challenging as ever?

James S. Metcalf - President and Chief Operating Officer

Well, in the first six months of the year the dealer network had some troubles passing along the contractor. That’s where some of the issues were, but with raw material increases coming through really in all product categories, I don’t think there’s a building product out there that isn’t passing through raw material increases. L&W has been very proactive to get the price up in the market, dealing with their contractors. As I mentioned, they have a diverse customer base both the commercial and the residential market and have been very, very proactive to announce price increases, where it’s applicable.

Unidentified Analyst

Okay. And maybe a last question for Rick. Can you just talk a little bit about, where you stand in relation to your debt covenants right now?

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

[indiscernible]

Unidentified Analyst

Okay. And they haven’t been amended since the 10-K filings, is that correct?

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

That’s correct. Okay. Thanks a lot and good luck.

William C. Foote - Chairman and Chief Executive Officer

Thank you.

Operator

Our next 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

Hi, Mike.

Michael Rehaut - JPMorgan

First question. Just don’t want to spend too much time as you just had a couple of questions on, but with the price increases in the face of further softness in demand and the past utilization coming down. What really drives, I mean I guess two questions related to this: One, have you seen in prior cycles, because it is seems unusual and impressive that you’ve been able to get pricing given how low capacity utilization is, and in fact weakened throughout the quarter.

Have you seen that occur in prior cycles, and what gives you the confidence in terms of the announced price increases ticking.

William C. Foote - Chairman and Chief Executive Officer

Well first of all, going back to our previous increases, as I mentioned in my prepared comments. We have had price improvements from -- really January till today. So we have had price improvement through the first half of the year. What is different in this market is the capacity utilizations are low. But we have unprecedented energy and raw material costs that we have never seen over the previous cycles, when you have energy going up in the last 10 years double, and that is touching every product category.

It is an unprecedented inflation with very low demand. So the formula has been that we 85% or 90% capacity utilization in our industry, we are on uncharted grounds now. And price improvement is essential for profitability. We want to service our customers. But it is all predicated on the energy in raw material inflation that the industry is seeing.

Michael Rehaut - JPMorgan

Okay. And in terms of the cost improvements that you announced I think you said $115 million that would flow through from I guess a combination of some of the plant actions and headcount. I was wondering if you could just give us a little further detail in terms of what actions add up, how the different actions add up to the 150 and also what portion of that you expect to realize or have realized so far and expect to realize in ‘08 and the incremental for ‘09?

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

Yeah, this is Rick Fleming and my colleague Rick Lowes, he jumped in. But let me mention that the 150 is the combination of activities that you can appreciate, Mike, we’re not letting any rock not get turned over right now, to fund again and from programs to people to also recognize in at the begun in 2009, we’ll have costs that have simply stop being incurred, such as plant startup costs, costs associated with our wind systems. When you go through the whole gamete of the people to program, the lack of cost going forward in area like fine startups, it just totals up to about a 150, now the people can call it roughly about two thirds of that.

Michael Rehaut - JPMorgan

Okay. And just an idea of the -- how much in ‘08 and how much in ‘09 and how much you’ve already got in ‘08 and what you expect to get through the rest of the year?

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

Well, you’re seeing so far this year the first program was actually announced last year. So it’s pretty much in place, and it’s a $50 million program. Mike, if you got another question so, I think we got time for one more and we will move on the next.

Michael Rehaut - JPMorgan

No thanks, Rick. Just trying to get a sense of the $150 million is something that you fully expect this year or how much incremental of that number haven’t you realized or you don’t expect to realize in ‘08 that would be an incremental benefit to ‘09?

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

Well recognizing that we have restructuring costs, this year. I would say it once again the best way I can describe is we’ll fully in place at year-end, the program one which is $50 million is now in place.

Michael Rehaut - JPMorgan

Okay. Thank you.

William C. Foote - Chairman and Chief Executive Officer

Thanks Mike.

Operator

Our next question comes from Nitin Dia [ph] from Lehman Brothers. Please go ahead.

Unidentified Analyst

Good morning.

William C. Foote - Chairman and Chief Executive Officer

Morning.

Unidentified Analyst

One of your competitors reported numbers yesterday and their wallboard pricing was down sequentially and obviously yours is up. So could you just comment on what market dynamics you are seeing out there?

William C. Foote - Chairman and Chief Executive Officer

We are a nationwide player, and some of our competitors are just compete in certain parts of the country, and as the leader in the business, we like to get paid for what we do this. So we’ve been, Jim said a minute ago, had price increases in the market since early this year, and a lot of that’s driven by the cost pressure we face. But as a leader, we try to get paid for what we do, and so we’ve been somewhat successful in getting prices up. And we’ll continue to seize opportunities as they come.

Unidentified Analyst

And are the competitors following your price increases or are you seeing some of them try and gain shares?

James S. Metcalf - President and Chief Operating Officer

The competitor reaction is really independent to them. We are pricing our product as Bill said, because of raw material and inflation, but also the price improvement you’ve seen in the first six months, we have a broad array of products. We are not only a residential player, we have a market in the commercial market we have a big position in the R&R and the Big Box. And also everyone, if you look at the entire industry, everyone is facing a kind of cost pressures that we’re seeing. So we have been very, very proactive and with our customers to let them know about inflation and cost and we plan to continue to do that.

Unidentified Analyst

And how much, I don’t know if you can share this. But how much of the average price increase -- sequential price increase of 5%, how much of that was pricing versus a mix?

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

We don’t disclose those numbers.

Unidentified Analyst

Well fair enough. And lastly...

James S. Metcalf - President and Chief Operating Officer

Well let’s just do one or two questions and then as we get through everybody, let’s come back to follow up.

Unidentified Analyst

All right. Thank you very much.

James S. Metcalf - President and Chief Operating Officer

You bet.

Operator

Our next question comes from Dennis McGill from Zelman. Please go ahead.

Dennis McGill - Zelman

Morning, guys. Thank you.

William C. Foote - Chairman and Chief Executive Officer

Morning, Dennis.

Dennis McGill - Zelman

My first question just have to deal with the comments you had made about the Ceilings business potentially weaken, but as we move forward, as the commercial market started to soften, and I think we are familiar with the weak orders that have been coming out of that sector so far this year. How long would it typically take for new projects that are flowing to roll through to the Ceilings and wallboard component of your business?

William C. Foote - Chairman and Chief Executive Officer

We have approximately an 18-month lag on the Ceilings business.

Dennis McGill - Zelman

How about on the wallboard side?

James S. Metcalf - President and Chief Operating Officer

Wallboards about six months.

Dennis McGill - Zelman

Okay. And then just thinking about how that may roll forward when that business does come through. Can you just put your expectations as far as margin in perspective to what we saw back in 2001-2002? Is it seems like on the volume side at least it could shape up to the similar to that downturn?

William C. Foote - Chairman and Chief Executive Officer

Well, I think what we’re looking at next year is the overall commercial market we’re estimating to be down about 5% with the lag, but what you have to do the components in that market, are there’s going to be some relative strength. - There’s going to be strength in education, healthcare and the public works. And really the margin improvement is very definite in each one of those segments.

So it’s really ticking your position of where you want to grow your business and as I said in my prepared comments, we’re going to continue to focus on profitability. The Ceilings business is a business that there can be nice profit gains, we’re taking costs out. We’re growing with customers with higher-end products and we feel even in a down market, we can continue to improve our margins.

Dennis McGill - Zelman

Okay and then just my last question. Could you detail a little bit more the capacity movements that you made in the quarter as far as the wallboard? I think you mentioned you curtailed some more capacity, but maybe some specific ground location and magnitude?

William C. Foote - Chairman and Chief Executive Officer

The capacity for the quarter was basically two areas on wallboard, which was Boston and Fort Dodge and those closures were approximately combined about 450 million feet.

Dennis McGill - Zelman

Okay great. Thanks again guys.

James Bencomo - Director of Investor Relations and Pension Investments

Thank you.

Operator

Our next question comes from Jim Barrett from C.L. King and Associates. Please go ahead.

William C. Foote - Chairman and Chief Executive Officer

Hi, Jim.

Jim Barrett - C.L. King and Associates

Good morning everyone. Hi, Jim question on the Washingtonville plant. What it will be the market area of that plant when I look east, west, north, south?

James S. Metcalf - President and Chief Operating Officer

Washingtonville, primarily Jim will be New York City, the New York market. Obviously we have a low cost plant now will equip us, so that will push our corporate to the West. We have been shipping right now, I will quite the board too far east the freight does. We all know what’s happened with freight cost.

So, really New York City, upper New York and start touching into the lower Massachusetts area. It’s a large plant it has far reaching capabilities, but we are in a new situation, where freight costs are coming into the picture.

Jim Barrett - C.L. King and Associates

Are you saying that freight has reduced what you may have originally believe was the market area for that plant.

James S. Metcalf - President and Chief Operating Officer

Freight has had an impact on that, yes.

Jim Barrett - C.L. King and Associates

And Rick one question for you and is, you mentioned the CapEx in ‘09, you have a lot of flexibility. How flexible can you be? One fact is your crew maintenance CapEx if you put your growth initiatives on hold.

D. Rick Lowes - Senior Vice President and Controller

Jim, we are still formulating our plans for ‘09, so I’d like to be more directional in my answer, but let me mention that number one, we are going into the year with virtually no major projects outside of Stockton, which will have no more spendings now equated for 2012. So, we have a tremendous amount of flexibility and that we don’t have the carry forwards doing a great degree as we have had last couple of years.

The secondly we have always use a rule found that tough year, we can easily spend one of our depreciation, which is $580 million and I would just say that we are working through that, but it could be well below that number.

Jim Barrett - C.L. King and Associates

Thank you very much.

William C. Foote - Chairman and Chief Executive Officer

Thanks, Jim.

Operator

Our next question comes from Jack Kasprzak from BB&T Capital Markets. Please go ahead.

Jack Kasprzak - BB&T Capital Markets

Thanks, good morning everyone.

William C. Foote - Chairman and Chief Executive Officer

Hey Jack.

Jack Kasprzak - BB&T Capital Markets

Hi. I wanted to ask about natural gas. The price of gas is fluctuating around the $11, $12 range. And I think you guys have been hedged on 75% or so of your gas at eight bucks if memory reserves. If the price stays in the $11 or $12 range for 2009, would you necessarily be facing $3 or $4 increase on your gas purchases in that scenario for 2009 or is that some other factors that we should consider?

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

It’s Rick Fleming. You are directionally correct, that we have obviously a situation, where we hedged this year and you are accurate in your memory. We are done at about $8 deck of therm for about 75% of our overall need. As you can appreciate, we do a rolling 12 months hedge and so we also buy on dips [ph].

And so the reason I can’t give you precise number right now for ‘09, is we are still lane in hedges. But what I’d tell you is that we are now up to a 50% hedge ratio for ‘09. The recent dips that reported to us [Inaudible] and more hedges and we are today below the market. But I’d slightly complete the program before I get more precise and what we have laid in terms of debt and the cost. But right now it look stable even to today’s market haven’t fall back.

Jack Kasprzak - BB&T Capital Markets

Okay. Thanks, great. And with regard to the June price increase 10%, did it all hold, if not how much held can you tell us and what was your wallboard price at the end of June?

William C. Foote - Chairman and Chief Executive Officer

We don’t give you any forward information until the quarter is over. We’re into the second quarter at 110, and that we’ll be pleased to report that next quarter to you.

Jack Kasprzak - BB&T Capital Markets

And finally, had there been any recent capacity closures in the industry that say, even in the last few weeks that are new?

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

No.

Jack Kasprzak - BB&T Capital Markets

Okay, great. Thanks very much.

Operator

Our next question comes from John Emrich from Ironworks Capital. Please go ahead

John Emrich - Ironworks Capital

Thanks. What is the percentage of the total company revenue that’s tied to non-residential construction, and what’s the mix of that between ceilings and wallboard?

D. Rick Lowes - Senior Vice President and Controller

Yes, it’s Ricks Lowes. If you look at our total sales, about -- I guess, one third really is non-residential construction, corporation overall, and the third is new residential construction and then you have last average – it’s prime remodel and that’s pretty well spread equally between non-res and new residential construction.

John Emrich - Ironworks Capital

Great. And in the mix of that non-res portion, that is ceilings and wallboard, I’m guessing, it’s part of each?

D. Rick Lowes - Senior Vice President and Controller

Well if you look at it its part of each. Wallboard is less dependent on non-res than ceilings, higher proposition of that being in the ceiling business.

John Emrich - Ironworks Capital

Great. Thank you

Operator

Our next question comes from Angela Uttaro from Oppenheimer Funds. Please go ahead.

Angela Uttaro - Oppenheimer Funds

Hi. You said that you were expecting to have commercial demand falling off through 2009. I was wondering if you could give us an overview as to your expectations for the housing market in general, mostly residential, obviously, because that’s where most of your sales are.

D. Rick Lowes - Senior Vice President and Controller

Yeah, it’s Rick Lowes again. We expect based on what we’re hearing in the market and forecast of other people who are looking at market that ‘09 will be a very similar year in the housing market, to what we’re seeing in ‘08.

Angela Uttaro - Oppenheimer Funds

When do you see it turnaround?

D. Rick Lowes - Senior Vice President and Controller

Certainly, we hope.

Angela Uttaro - Oppenheimer Funds

Well, there’s hope and then there’s…

James S. Metcalf - President and Chief Operating Officer

Angela, if you knew the answer to that you can get really rich.

D. Rick Lowes - Senior Vice President and Controller

We can’t say we don’t expect a meaningful recovery, so there really is $0.20.

Angela Uttaro - Oppenheimer Funds

Well, and you expect your liquidity to hold out until then, I mean it’s kind of a chicken and then egg.

James S. Metcalf - President and Chief Operating Officer

The answer is yes. And as mentioned, I’m also adding to our liquidity right now, we speak from an additional $300 million.

Angela Uttaro - Oppenheimer Funds

Great. But after that $300 million?

James S. Metcalf - President and Chief Operating Office

I think we’re in fine shape to weather the storm.

Angela Uttaro - Oppenheimer Funds

Do you expect anymore capacity reductions?

D. Rick Lowes - Senior Vice President and Controller

Well, we can’t anticipate what our competition is going to do. But depending on the market condition and demand, we have a contingency plan to take capacity out if necessary.

Angela Uttaro - Oppenheimer Funds

Okay. That’s what I wanted to hear.

James S. Metcalf - President and Chief Operating Officer

Thanks, Angela.

Angela Uttaro - Oppenheimer Funds

Thanks.

Operator

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

Mark Weintraub - Buckingham Research

Thank you. You’d mentioned additional or expected restructuring costs in the second half of this year. Might that potentially encompass some further capacity reductions or if there were to be further capacity reductions that would be all supplemental to what you’ve outlined?

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

This is Rick Fleming. I think you are referring to the remark I made in my script that, we anticipate additional plant startup costs and that we have of approximately $10 million, forecast restructuring costs.

Mark Weintraub - Buckingham Research

I apologize. Thank you for the clarification. And second, on the energy side, can you give us a sense roughly how much natural gas you are buying a year?

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

At today’s level of utilization will be approximately $26 billion cubic feet.

Mark Weintraub - Buckingham Research

Okay, great and then lastly. As you look at transportation costs where they are versus where they were in the second quarter. Are they meaningfully different or is it -- it is not necessarily going to be a big delta, if would assume they stay where they are now versus the second quarter?

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

Transportation costs in the first half did go up it did affect our business, our results. And an easy metric is look at diesel fuel and depending on what happens with crude oil and diesel fuel, that’s going to have impact on our freight costs.

Mark Weintraub - Buckingham Research

Okay. Thanks very much.

William C. Foote - Chairman and Chief Executive Officer

Thank you.

Operator

Our next question comes from Justin [indiscernible]. Please go ahead.

Unidentified Analyst

Hi, thanks, I was just wondering if you could give us an update on the charges you’ve periodically put out or you look at the net additions in terms of closures and expansions in wallboard for 2008 ad 2009, what total capacity expansion you expect in this year industry wide?

William C. Foote - Chairman and Chief Executive Officer

Well the capacity this year that will be coming online, we will be starting up on Washingtonville, Pennsylvania plant later this year and that’s approximately into this year about 150 million feet. Other than that we announced our Norfolk Virginia plant which was replacing Old Norfolk. There was new capacity that came in Mountville, South Carolina, Savannah, Georgia and Silver Grove, Kentucky, as well as, Mount Holly, North Carolina and those were all competitive plants.

Unidentified Analyst

Have any change, any plans change as far as 2009 with your expectations of new capacity?

William C. Foote - Chairman and Chief Executive Officer

No, nothing has changed to our notes. Some of been pushed back that we see and as Rick mentioned in his prepared comments that Stockton is tentatively plant for 2012.

Unidentified Analyst

And then lastly do you have any update on your expectation of demand for wallboard in US through the 2008 year. I think you guys have previously talked about 10% to 15% decline, that’s though you are expecting?

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

Right now, we are looking a total, total gypsum board opportunity for 2008 to be down about 14%.

William C. Foote - Chairman and Chief Executive Officer

For the industry?

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

For the industry.

Unidentified Analyst

Thanks.

William C. Foote - Chairman and Chief Executive Officer

Thank you.

Operator

Our next question comes from [Tripp Rogers], Carlson Capital. Please go ahead.

Unidentified Analyst

Hi, good morning. Congratulations on the improvement at L&W sequentially.

William C. Foote - Chairman and Chief Executive Officer

Thank you.

Unidentified Analyst

Can you talk about, quantify or maybe just talk a bit more about the impact of fuel you saw there and maybe also talk about how much the freight is reducing your met … non-met [ph] premium prices?

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

Tripp, we don’t give that level of detail. But as Jim just commented fuels had an impact in the first quarter, also the Gypsum Company and the distribution side of our business and with that we have offset and as I say quarter-to-quarter, we had a 30 million improvement in operating performance. And they were really delighted with that given the cost control and the performance of these units. So, we are trying to stand in front of these increases whether its natural gas or diesel and having some success in doing so.

Unidentified Analyst

But the net impact has been at large, I mean, the price lets say per square foot obviously, has impacted that given that process?

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

Absolutely, absolutely yes. I mean market prices were up and we have had net against that some freight increases. So, yeah, it’s moderated the realization for us.

Unidentified Analyst

Great, thanks a lot.

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

Yes.

Operator

[Operator instructions]. Our next question comes from Jack Kasprzak from BB&T Capital.

William C. Foote - Chairman and Chief Executive Officer

Welcome back, Jack.

Jack Kasprzak - BB&T Capital Markets

It’s good to be back.

William C. Foote - Chairman and Chief Executive Officer

I appreciate today.

Jack Kasprzak - BB&T Capital Markets

I think I forgot my question. How long does it take you guys to realize a wallboard price increase.

William C. Foote - Chairman and Chief Executive Officer

They’re announcing they’re realized over the next two to four weeks, so its…

Jack Kasprzak - BB&T Capital Markets

Pretty fast.

William C. Foote - Chairman and Chief Executive Officer

In a market as sloppy as this, I mean its, our customers, who are the first to know and we work with them and realize as much as we can, and it’s our expectation that they will be getting some price improvement, but each mind their own business, so.

Jack Kasprzak - BB&T Capital Markets

Okay, great. Thank you.

William C. Foote - Chairman and Chief Executive Officer

Okay, thanks.

James Bencomo - Director of Investor Relations and Pension Investments

We’ll take one more call, if there any others.

Operator

I am showing no further question.

James Bencomo - Director of Investor Relations and Pension Investments

Great. Well then, thank you and Bill?

William C. Foote - Chairman and Chief Executive Officer

Yes. Thanks again for all those you listened in and those who have asked questions. We really appreciate your active interest and support of the company. We certainly are in one of the worst housing markets, we have all seen in our professional careers. It’s a really tough environment, but let me assure you that, we are doing everything we can to control those things are within our control.

We have had good success from moving structure cost from the business and you can see in the numbers this quarter. We are operating very efficiently. We are operating safely and add our near peaked efficiency levels and importantly, we are managing our financial flexibility. We know that the key to the future is having the flexibility to deal with this downturn and to grab opportunities as they emerge and they will emerge.

We have got our eye on both the current market and on the horizon, we are building for the company. We have some terrific new low cost capacity and that’s in combination with our customer relationships and the strength of other businesses, gives us hope and promise for the future. So thanks again for joining in, and we’ll talk to you next quarter.

James Bencomo - Director of Investor Relations and Pension Investments

Thank you, Bill. Let me mention that there is a taped replay of our call. It will be available within a few hours. You may dial 1-888-843-8996 and use a pass code of 22078033 to access that replay. Thanks again for joining us this morning. Goodbye.

Operator

Thank you ladies and gentlemen. This concludes the USG Corporation’s second quarter 2008 earnings conference. Thank you for participating. You may all disconnect.

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