USG (USG) James S. Metcalf on Q4 2015 Results - Earnings Call Transcript

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Q4 2015 Earnings Call

February 05, 2016 9:00 am ET


Ryan Flanagan - Senior Director-Investor Relations

James S. Metcalf - Chairman, President & Chief Executive Officer

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


Robert Wetenhall - RBC Capital Markets LLC

Stephen S. Kim - Barclays Capital, Inc.

Mike Wood - Macquarie Capital (NYSE:USA), Inc.

Michael Jason Rehaut - JPMorgan Securities LLC

Garik S. Shmois - Longbow Research LLC

Kathryn Ingram Thompson - Thompson Research Group LLC

Philip Ng - Jefferies LLC


Good morning and welcome to the Fourth Quarter 2015 USG Corporation Earnings Call. My name is Brandon, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note this conference is being recorded.

And I will now turn it over to Ryan Flanagan. You may begin, sir.

Ryan Flanagan - Senior Director-Investor Relations

Thank you. Good morning and welcome to USG Corporation's fourth quarter and full year 2015 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,, 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 assumption of our business, market and other conditions, and management undertakes no obligation to update these statements.

These 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. In addition, please refer to our earnings press release and presentation slides for disclosures and reconciliations on non-GAAP measures used when discussing our results and outlook.

With me today to discuss the fourth quarter 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 year and quarter, plus additional insight into our businesses. Matt will review the financial results for the Corporation and the business segments.

We'll then open the call for questions and conclude with a few comments from Jim. We'd like to ensure everyone has an opportunity to ask questions, so as always, when we get to the Q&A session, callers are asked to limit themselves to just one question. Jim?

James S. Metcalf - Chairman, President & Chief Executive Officer

Thank you, Ryan, and good morning. Before I get into the details of the fourth quarter, I'd like to take a minute and talk about what we have accomplished in 2015. We had great progress in many areas, and I want to highlight a few of these areas that we put across the goal line in 2015. First of all, most importantly, adjusted net earnings improved by more than 75%. Operating margins increased in all of our core businesses. We generated over $600 million of adjusted EBITDA which is the best since 2006, and that's a year in 2006 where there were 1.8 million housing starts. I think that's a remarkable achievement for the Corporation.

We delivered on our commitment to control costs. We talked about costs throughout the year. This has been a relentless focus that we've had at USG, and we delivered that. SG&A in 2015 was below 2014 and also 2013. USG Boral, which we've talked about during the year, is a key part of our growth initiative. It generated $48 million in income and delivered $38 million in cash dividends. And as the industry leader in innovation, we introduced 25 new products during the year. But finally, and not taking our eye off our most important priority, safety. We were named one of America's safest employers, which we're extremely proud of.

We advanced our plan to win in 2015 by strengthening our core businesses, diversifying our earnings, and differentiating USG through innovation. I'm really proud of the progress we made in 2015, but what it does, it positions for a successful 2016 and beyond.

Now I'd like to touch on the fourth quarter, and then I'm going to turn it over to Matt, and he'll provide some additional details of the fourth quarter and as well as 2015 and beyond.

In our Gypsum segment, wallboard, the surfaces and substrates businesses all drove margin expansion during the quarter. In the surfaces and substrates division, we continued to expand our reach in other parts of the commercial building. This is a new business for us. It's been growing over the last four years. Our roofing products, floor solutions, exterior sheathing, our tile backerboard, all have helped us diversify our earnings. For the quarter, these products contributed $5 million of improved profit, and this is not a onetime deal. This is the fifth consecutive quarter that we had this level of improved profitability. So, we have a wonderful trend in this division.

In our U.S. wallboard business, we had a really good fourth quarter. As we talked about with you and we projected that volumes were going to be down on the fourth quarter, absent some pre-buy that occurred in 2014, but the key is, we outperformed the industry, with our volume only being down around 3.5%. In fact, we started 2016 very strong. Demand in January exceeded our forecast of about 5% to 6% growth despite some tough weather that we all know we had on the East Coast.

Our price in the fourth quarter for wallboard held steady and was up about 2% for the year. The important point is, we want to continue to expand our margins in wallboard, and it's vital to our success, and that's our plan for 2016, which is no different than it's been the last four years.

Turning to our operations in our plants. We continue to operate our wallboard plants at high efficiencies, and our cost for the quarter improved due to the wonderful efforts throughout the entire organization. We had safe operations, as I mentioned, but we had top recovery speed and delay (5:48) at our plants, and this helped us with our Lean-Six Sigma efforts, which continued to have success of lowering our breakeven. Even with the favorable natural gas costs that assisted on our efforts, our plants are operating extremely well, and I'm very proud of this performance.

Now, I'd like to make one final note on our Gypsum segment. As always, an important question you ask is on wallboard price. Our pricing policy for 2016 hasn't changed from last year; just the timing. We have not increased our price at this point, but it is our plan to do so. And as we've done in the past, we will provide 30 days' advance notice to our customers.

Now I'd like to turn to our Ceilings business. Our U.S. Ceilings business had a record fourth quarter for operating margins. That is a unbelievable accomplishment, a record fourth quarter. Now, the main driver of this margin expansion was improved pricing in both tile and grid products. And as we've talked about in earlier calls, we continue to focus on moving our mix to high-performing products. But really, the headline for the fourth quarter on Ceilings is that pricing was up in all product categories.

Now let's move to distribution. L&W Supply comp store sales and wallboard volume were both up 3%. We were successful at driving out working capital in the quarter, and our wallboard spread increased about 8% year-on-year. Increasing the performance of L&W, as you know, continues to be a key priority. We took some great steps in the fourth quarter, and as you can see by the results, we made wonderful progress with L&W's bottom line during 2015. We have work to do, but we're starting to see some good progress.

At USG Boral, the operating margins expanded despite the strong headwinds that we're all seeing from foreign exchange. And Matt's going to talk a little bit in more detail about FX and what it's done to the business.

With Boral, we saw continued move from our standard board to Sheetrock, NextGen sales, with conversion rates increasing from 13% to almost 20%. We also saw increased sales at USG Boral of joint treatment and ceilings. Now, we believe we've achieved about half of the $50 million synergy target that we've talked to you over the past year about. And this pace of realization of the $50 million is really ahead of our internal expectations. So we're very pleased with the progress at USG Boral, and this emphasizes our – part of our plan to diversify our earnings.

So, with that, I'm going to turn it over to Matt. He's going to get into the details, and then I will come back and talk a little bit about what we see in 2016 for demand. Matt?

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

Thanks, Jim, and good morning, everyone. Before I get into the details, I'd just like to start by simply saying how pleased I am with 2015 and how we finished really strong in the fourth quarter and I think you saw that in the release that went out this morning. And I'm equally excited about 2016, which I'll lay out some of the details on that in a few minutes as well.

As I've done in the past, I've included a bridge of our GAAP to adjusted results in the detail of our press release and the earnings slides. But to clarify, there are four principal income adjustments for the quarter that are included in our GAAP results, but excluded from our adjusted results, which collectively amounted to $750 million of income.

So, first and most prevalent is the $731 million favorable non-cash income tax adjustment related to the reversal of our longstanding tax valuation allowance which I'll discuss in a little bit more detail in a few minutes. Second is $6 million of income related to the recovery of the GTL receivable that we wrote off a year ago. Third is a $7 million net gain related to the sale of surplus property down in Mexico during the quarter, which we sold for $15 million in U.S., and then lastly, a net gain of $6 million related to the sale of our Knauf-USG joint venture that we announced in the third quarter, with final cash proceeds of $52 million, again, in U.S.

Since Jim already covered the highlights for full year 2015, I'll focus my remarks really around the fourth quarter in 2016, but I'd characterize our fourth quarter in 2015 as just – as excellent. We improved operating margins in Gypsum, Ceiling and USG Boral, volumes in Wallboard were better than expected and we held both share and price. We saw price improvement in all of our ceiling tile categories. We substantially lowered our SG&A from a year ago and we ended the year with $670 million of cash, which puts us in a really good position to delever the balance sheet. And I'll spend a little bit more time talking about that. But all in all, I'd say we had a really strong finish to the year and I couldn't be more pleased.

Now I get into the numbers in a little bit more detail. For the fourth quarter, adjusted net sales were essentially flat at $925 million, with adjusted net income doubling to $62 million. And our results were even stronger when you consider the negative impact of foreign currency embedded in our fourth quarter and full year results. We've included a new page in our slide deck, page eight. So I'd like to steer you to page eight in our slide deck where we've outlined the impact of foreign exchange. So, I'll give you the summary. For the fourth quarter, the strength in the U.S. dollar unfavorably impacted revenues by $18 million and lowered our net income by $8 million, and that's partly why we see a flat revenue line in the fourth quarter. And for the full year, foreign currency was a drag of $65 million on revenue and about $28 million – that was a hit to net income as well. So, clearly, you'd need to think about foreign exchange when you're doing 2015 to 2014 comparisons.

Also we made a lot of progress in lowering our break even in 2015. SG&A for the full year came in at $317 million, which was favorable to our guidance where we said it was going to be under $325 million, and as Jim said, it's below 2014 and 2013 levels. And what's terrific is that I expect SG&A to come in below 2015 levels in 2016, which I'll cover in a few minutes. So, with that kind of overview, let me get into some of the details around the segments.

In the Gypsum segment, adjusted net sales for the fourth quarter were $593 million compared to $605 million last year, with foreign exchange amounting to a $15 million headwind for the quarter. Adjusted operating profit increased 180 basis points from 11.2% to 13%, and that came through both price and cost improvement. And again, if you factor in foreign exchange, we did even better than 180 basis points.

Specifically, if you break it down, wallboard contributed $1 million of improved profit. Jim talked about surfaces and substrates, which contributed $5 million, lower SG&A spending in the fourth quarter, with $6 million of improvement. And then we also improved performance in Canada, Mexico, which was really offset by $6 million of unfavorable foreign exchange. Jim touched on volumes already which were down about 3.5% year-over-year for the quarter, but a bit better than what we were actually thinking.

Wallboard price was up 2% and flat sequentially. I know there's been questions in the market about that, but good performance around price. We did see some inflation in certain input costs including synthetic Gypsum paper, labor, some other things. But we really more than offset this inflation with continued manufacturing efficiencies through Lean-Six Sigma, and we did have a tailwind of natural gas, which was about $2 million for the quarter.

Our surfaces and substrate division, which represents almost half of the sales of the Gypsum segment, had another really strong quarter with 5% revenue growth and $5 million of additional profit, and that was really led by roofing products and joint treatment and there were a host of other products that helped this as well. Surface and substrates now represents about 30% of U.S. Gypsum's EBITDA and it's grown to over $800 million in annual sales. I mean, I think that's pretty remarkable. And just to put that revenue in perspective, that's approaching twice the size of our U.S. Ceiling business.

And what's really great as a CFO is I get to – I can expect to see the margin continue to expand and I expect to see volumes continue to move in a positive direction, particularly as we think about architectural and contractor preferences. They continue to love our products and we continue to put new products out in the marketplace which helps us as well. So, I'd have to say, as the CFO, again, I'm really pleased with how this business is doing.

Now on to Ceilings, net sales were $115 million in the fourth quarter, which were down slightly from $121 million last year, with foreign exchange accounting for $2 million of that lower revenue. We saw adjusted operating margins expand 160 basis points from a year ago from 14.9% to 16.5%, which was really driven by three elements: pricing, mix and costs.

So, pricing on ceiling tiles was the primary driver, with prices up in every tile category. Again, I know there are questions out there. But I couldn't be more pleased that we saw pricing improvement in every category. We saw continued mix shift to higher-end tiles that we've seen for the last few years, and costs were lower due to tailwinds from natural gas which offset some of the labor inflation that we saw in ceilings as well.

Just moving to Distribution, we made $5 million in adjusted operating profit, down from $7 million in the prior year. L&W's profit from wallboard and adjacent products was really – I mean, it was up nicely during the quarter, which reflected really improvements in the strengthening of the business. And look, while our operating profit was down, it was down primarily due to a slight uptick in delivery costs.

I want to turn to USG Boral, our JV, and I want to reference pages 14 and 15 in the slide deck, you may – look – 14 is a new slide, so I hope you like it. And I want to start with the broader size, scope and profitability of the JV. Just to remind everybody, the JV operates in 14 different countries around Asia and Australasia. And if you take out China, which is a relatively small part of the business, we have an average market share of roughly 40% across the rest of the countries. And 2015 was a really strong year. You heard Jim talk about it, and we really accomplished what we set out to do. I mean, if you go by the numbers, USG's portion of adjusted net income for 2015 was $48 million, up from $35 million in 2014.

And if you factor in the negative foreign currency impact, USG's portion of adjusted net income on a constant currency basis, let me repeat that, on a constant currency basis, increased to $56 million. That's roughly a 33% increase on an annualized basis, pretty strong performance. The JV is also cash-positive. It paid USG $38 million in cash dividends last year, with $20 million coming in the fourth quarter.

USG also finished the year with a strong fourth quarter. Again, if you strip out foreign exchange and view its fourth quarters on a constant currency basis, revenues increased 7% to $290 million and total adjusted net income for the JV was around $34 million on a constant currency basis.

Our 50% portion of adjusted net income was $15 million. That's a $1 million increase over the prior year. But I'd like to point out, if you take a look at the $1 million of improved performance, it was really driven by $6 million of real business performance, real operating performance. And that $6 million was offset by $2 million of unfavorable currency and the absence of a $3 million insurance recovery recorded in the fourth quarter of 2014.

So, look, I know that's a lot of data to throw at you. But as you can see, I mean, I think there's – you can see a lot of organic performance through the JV last year, and I'm really encouraged about what we see as real growth opportunity in front of us. In fact, Jim and I were recently over in Asia and I'll tell you, we both feel very strong and positive about the business prospects over there. Very good investment for us.

You may recall that when we entered the JV two years ago, there were three principal areas of focus. First was the conversion of markets to NextGen, which is essentially UltraLight products, second was growing our adjacent products and third was reducing our JV production costs, and I would add on to that, improving the quality of our products as well. So, if you look back in retrospect, I'm very pleased to say that we made tremendous progress on all three.

The conversion to NextGen board has improved from 13% in the fourth quarter to roughly 20%, I think Jim referenced that, in the fourth quarter of 2015. And just like UltraLight board across North America, NextGen board commands a price premium in the JV markets as well.

Second, as I said, we continue to grow our adjacent products like plasters and joint compounds. Ceiling tiles and grids are picking up steam. And we're still in the early innings of introducing our full adjacent – our product portfolio into the JV regions, with plasters and compounds seeing more saturation at this point than products like Fiberock and Durock in Ceilings, but we're picking up steam, as I said. With that said, adjacent products already represent 25% of the USG Boral business, so it's more than just the plasterboard business.

The third thing I had mentioned was lowering costs in the USG Boral business, which is a huge strategic priority just like it is in North America for us. And the implementation of USG's manufacturing technology, listen, I need to call out the manufacturing team in the JV, they've just done a tremendous job. They put in our technology. They've lowered per-unit costs in 2015, increased quality. And we've had a little bit of improvement, too, in some lower input costs such as natural gas and transportation costs for the quarter as well. But, look, the team over there is doing a great job, and I expect that with some additional rollouts of technology in – which are scheduled for plants in India, Malaysia and South Korea, that we can expect some continued cost improvements in 2016 as well.

So, I kind of covered 2015. I'd like to move to 2016 now, and let me first set the table. We expect to get operating margin improvement in each segment through both price increases and cost improvement in 2016. And Jim has already addressed pricing, so I'll start with input costs for wallboard. We expect our total net input costs to be up about 1% to 2%. Specifically, we expect some mild inflation in labor, synthetic gypsum, paper and transportation costs in 2016, and that will be partially offset by some of the deflation that we're seeing in natural gas, which represents about 15% of our wallboard costs.

So, as a reminder, for natural gas, we're about 80% hedged in 2016, and I'll give you a few numbers here on that. Our average hedge rate for 2016 will be around $3.60 per dekatherm. That compares to $4 – not $14, $4.15 in 2015, and then we'll float with the market spot rate on the remaining 20%. So overall, the way I think about this is, the overall gas rate should be about – should be down about 10% to 15% in 2016.

On the SG&A front, we continue to focus on ensuring that we're getting value for every dollar that we spend, and again, I couldn't be more pleased to tell all our shareholders that SG&A expense will come in below 2015 levels in 2016. It's going to be below $317 million, and we've really taken a hard look at expenses this year, and we continue to take work out. We're streamlining processes. We're reducing discretionary spending. But just to be clear, we're still making investments in the business to drive top line and improve operating profit, and that's really, really important, so we're being very surgical in the way that we're thinking about SG&A.

Regarding taxes, now I know everybody is at the edge of their seat waiting to hear me talk about taxes. So, let me start around some commentary around our fourth quarter and specifically the reversal of a significant portion of our tax valuation allowance in December. As I mentioned in the past, this tax adjustment is, I mean it's really positive if you think about it because it's – we're reversing it because of the strong earnings power and the strong earnings that we've had over the last four years. So, this really puts us back in kind of the normal category. But we don't pay cash taxes, and I'll get into that the second.

The release of the valuation allowance amounted to a single non-cash income statement benefit of $731 million, which was posted on the tax line with an offsetting increase to deferred tax assets on the balance sheet, and that's about as far as I'm going to go explaining tax accounting here in my prepared remarks. You can save those questions for after I get done. But with the release of our valuation allowance in the fourth quarter, we will now begin to record book tax expense in the first quarter of 2016 at a consolidated rate of between 30% and 33%, and that includes the JV, the Boral JV income. As I mentioned just a few seconds ago, I think it's very important that everyone understands that we will not, I repeat, not be a cash taxpayer for income taxes in the U.S. until we fully utilize our $1.9 billion of net operating losses and some of the other carry-forward benefits that we have.

So, while we'll record book tax income expense in 2016, we won't cut a check – cash check in the U.S. for a while. Similar – with respect to cash taxes in 2016, similar to 2015, our cash tax payment should be around and hover around $2 million per quarter, primarily related to foreign taxes.

On a related note, given that our book tax expense will distort the comparison of our 2016 net earnings relative to 2015, I'm including a new metric, an additional metric in our disclosures, namely, and I quote, adjusted EBITDA per fully diluted share. And I think this'll help provide an apples-to-apples comparison of our performance from 2016 to 2015. And to help you, I've put that calculation in the appendix of the current earnings slide presentation that you have in front of you.

Just a few more comments and then I'll turn it back to Jim. But I just – I want to talk a little bit about foreign exchange. It's hard to not be impacted by foreign exchange in 2016, and I believe our 2016 results, unfortunately, would be unfavorably impacted by foreign exchange by almost $25 million. And that's assuming that rates stay flat in 2016 as compared to the rates at the end of December. The $25 million is roughly split between – half goes to Gypsum and the remaining portion is equally attributable to Ceilings and USG Boral. And at this point, I expect the majority of the foreign exchange will be felt in the first half of the year. But again, with foreign exchange, obviously, it's very difficult to predict, but that's our best view right now.

A few comments around our balance sheet and capital spending. Turning to our capital budget for 2016, I expect total capital spend to be around $100 million. And of this, roughly half will be for maintenance of business and the other half will fund various investments across the businesses.

Moving to debt and pension liabilities, for 2016, we expect our total interest expense to be about $155 million, which compares to $163 million in 2015. And that's before we consider any kind of potential refinancing or early debt retirement. Additionally, I expect to make cash contributions to our pension plans of around $65 million in 2016, which is about the same amount that we contributed in 2015.

I'd like to really – I think this is an important point. I'd like to point out that our total cash position improved in 2015. We moved from $380 million of cash to $670 million. And I expect more improvement on the cash line in 2016. In addition to all of the operating improvements that Jim's talked about and I've laid out here, we also have several working capital initiatives in place that we think are going to drive stronger free cash flows, and I think you saw some of that in our 2015 results, with free cash flow improving from around $40 million to just under $240 million in 2015.

As of December 31, 2015, our total all-in debt, which includes unfunded pension, OPEB liabilities, lease obligations, amounted to $2.3 billion, down $300 million from the end of 2014. And based on our 2015 EBITDA of – adjusted EBITDA of $609 million, our debt-to-EBITDA ratio now stands at roughly 3.7 times, down significantly from almost five times a year ago. I got to tell you we're making real progress on this, folks. As you've heard me say on previous calls, our goal is for this ratio to settle between 1.5 times to 2 times on a net basis at the mid-cycle. And most importantly here is that the $500 million bullet loan that is due in November of this year is clearly within our sights. And that will just be another significant step towards delevering the company.

So let me just finish with saying, overall, I feel really good about what we accomplished in 2015, and I'm proud of the team that we finished really strong in the fourth quarter and I'm confident that we'll even bring in a better 2016.

So, with that, I'll turn it back to you, Jim.

James S. Metcalf - Chairman, President & Chief Executive Officer

Thanks, Matt. Think that's a nice review and digging into the details of the business. Before we get into the Q&A and we really want to get your thoughts for the remaining time that we have, I'd like to give you some additional color on 2016. I think Matt framed it up really well from a numbers perspective, and I want to just really touch on the market and how we're seeing the market and our customer activity, particularly in North America. 2015 I think you would all agree was a very strong year for us, but I agree with Matt: I'm very excited about what we expect in 2016. So let me just give you a little color about how we're set up as we start out the year.

Really, in my three decades of being in this business, this is probably the best position I've seen the company in a long time. Matt talked about what we've done about lowering our break even, about growing our business, and this is something that we're really excelling in of doing both. I like to say we like to be ambidextrous of really focusing on cost, but reinvesting in new products and reinvesting in growth markets. What we do on our markets -- we see in 2016 growth in every end-use market. North America is going to be growing this year, we expect it, and also, in Asia and Australasia. So we are in the right position from a marketplace standpoint. As you know, we exited Europe and we're really focused on key growth markets for construction.

We also plan, as Matt said, margin improvement in every major product category, and we can do this in two ways: our value proposition that we have in the market, putting new products, better quality, being the innovation leader in the industry; but also lowering our breakeven through Lean Six Sigma, which I'd like to call out the entire Lean Six Sigma team that has grown organically within USG, but has really helped us offset some of this inflation as well as some of the Lean manufacturing initiatives that we've just started.

Along with that, in 2016 we're going to continue our innovation pipeline. We have some very exciting things we're going to be introducing throughout the year and into 2017, including we just introduced a few months ago some very high-end performance ceilings products that we think have a unique performance in the market that none of our competition has. And next month we're going to be starting up our Plaster City, California plant. The line there that will be making high-end glass mat panels, which continues to grow our high-performance portfolio. We want to continue to move our portfolio, both on ceilings but also on wallboard to more of a high-performance portfolio. And that's exactly what the architects and our contractors, as Matt said, are requesting and as building science and building standards change as we move forward.

Along with that, in 2016, we're going to continue our relentless cost control program. This continues to help us lower our breakeven, helps us on the balance sheet, as Matt said, focus on that $500 million bullet we have in November, but also continuing to offset inflation and continuing to have efficient manufacturing facilities throughout the network.

Along with that, as a shareholder, you really focus on that $500 million. We want to continue to strengthen the balance sheet. Matt said we want to get to that 1.5 times to 2 times. But I don't want you to forget, as we said, we have tax-free earnings in the United States as we're going to utilize that NOL. And so that really puts us in position that we feel really excited and confident about 2016. We're going to continue to execute our plan. As we've talked about it, it's three legs: it's strengthening our core, it's diversifying our earnings, and it's differentiating through innovation, and we're going to continue to put initiatives under those three categories. And as I mentioned, this will allow us to simultaneously grow our business and lower our breakeven. So we're going to do both.

So let me touch on our view of market demand in 2016 and just some of our thoughts. A lot of these numbers are probably aligned with what you see, but just wanted to give you a little additional color on the market. We're projecting overall demand will improve about 5% in most of our key markets. But let me break it down for you; residential, commercial, and repair and remodel.

As you know, in residential, 2015 we ended with housing about 1.1 million housing starts, and that kind of lined up with the projections that I think we had most of the year. That was about a 10% increase, and we're projecting similar growth in 2016 of about 1.2 million housing starts. So this will be another year of growth in housing in the United States. But what is kind of interesting, this still only represents about 80% of the historical mid-cycle opportunity. So we still believe that we have some ways to go to get to mid-cycle, but the good news is we're seeing some nice growth. There's positive trends with the drivers that we see; household formation, consumer confidence, existing home sales are just a few of those trends that we look at to support the view that we believe housing is going to continue to grow in 2016.

Moving to new commercial, we expect construction starts within the areas that use our products which, as you know, office, education, retail, healthcare, those are kind of the big areas for us. We feel that we're going to see about 2% to 3% growth in 2016. And as you know, when these projects break ground, the contractors don't put our products in for about nine to 18 months. So we have about a nine- to 18-month lag from anything you're seeing from a McGraw-Hill and some of the economists that are looking at constructions.

Some of the construction starts that we're seeing from outside firms, their numbers are little more robust than ours, but we're taking a more conservative view on commercial. But we still are starting to see some positive growth in that business, specifically for demand for ceiling products which, as you know, they are highly levered to the commercial space where we expect to see the opportunity for ceilings to increase around 2% to 3% as well in 2016.

Turning to repair and remodel, which is a key market for us, we're encouraged by comp store sales that some of our large customers that serve that market are seeing, and we're expecting about a 3% growth in repair and remodel opportunity for us as well. And I'd just like to finally touch on, and Matt gave a great overview of USG Boral, and hopefully the additional information we're giving you will give you a real perspective of the unbelievable opportunity we have with Boral, of a growth engine for us and how it diversifies our earnings. And we're expecting to see demand in those 14 regions, and this is kind of a blended demand over the regions to be up about 5%.

But in addition to that, we're seeing the GDP levels are higher than they are in the United States. We're encouraged by the adoption rate of western construction practices. And as Matt said, this is not just a wallboard or as they refer to in that part of the world plasterboard business. We're really integrating our ceiling products, our joint treatment products and we're very pleased with the early success we've had there.

We expect wallboard shipments in Asia and Australasia to be up around 5% to 6% and net income for USG Boral this year to increase at least 10%. So, hopefully, that gives you kind of an overview of how we're seeing the market, also how we plan to execute in 2016.

So with that, I'd like to open it up – call for your questions and then we'll wrap up here in a few minutes.

Question-and-Answer Session


Thank you. And we will now begin the question-and-answer session. And from RBC Capital Markets, we have Bob Wetenhall. Please go ahead.

Robert Wetenhall - RBC Capital Markets LLC

Hey. Good morning, everyone.

James S. Metcalf - Chairman, President & Chief Executive Officer

Hey, Bob.

Robert Wetenhall - RBC Capital Markets LLC

Congrats on a very strong finish to the year with some encouraging trends. And my hat's off to you. I think you've done a really great job of really managing the things you can control, like margin growth and cost control and the balance sheet is in great shape. I was thinking about Jim's comments about the outlook for commercial construction, and he kind of cited the 5% number as being what you're anticipating for volume growth or perhaps that's dollar spend. Then you were touching on ceilings and wallboard and your expectations for R&R was more like 2% to 3%. We also saw U.S. construction put in place was pretty robust when the number came out earlier this week. So I was hoping, Jim, you've been in the business for a long time. Where are we in this cycle? And can you step us through how to think about the discrepancy between your modest volume growth low-single digit versus some of the other end markets like housing growing at 10% and 5% overall number you cited? Thanks very much and good luck.

James S. Metcalf - Chairman, President & Chief Executive Officer

Thanks, Bob. I appreciate your comments. On the commercial opportunity, as you know, we do have our lag. So we're working from demand off of nine to 12 months of the numbers last year, which weren't up as much. We've also looked at some of the trends of the outside agencies and firms that have done projections, and they've been overoptimistic in our point of view. We would rather take a more conservative route. We feel that if we miss it on the low end, it really doesn't have a major impact to our business.

We're still very early in the cycle. You asked about where we are in the cycle on commercial. We're very early on recovery. It's the last market that's recovering. And most of the high rises, for example, in Chicago there's about 30 high-rise cranes to 35 high-rise cranes here and most of those are residential. Those are not commercial projects. We talked about that last quarter. So they don't use ceilings as much. Mostly it's all plasterboard. The units are smaller. So that falls in the residential. So when you look at the housing being up 10%, that high-rise commercial falls into that number of multifamily. So I think that's why some of the numbers are off.

If you look at – just to kind of put it in perspective, though, why we're feeling better about commercial or high-rise construction. Of the 34 high-rises that are in Chicago, in 2014 there were only 14 or 15 high-rises. So you can see that there is growth there, but it's coming from a very, very low base. And a lot of the numbers get skewed because of the multifamily high-rise falls into the housing numbers versus in the commercial opportunity numbers.

Robert Wetenhall - RBC Capital Markets LLC

Just to clarify, Jim, are you saying because of the lag then, there's potentially a sizable bit of demand that could manifest itself in 2016, i.e., construction was started in 2015 and you're going to see potentially volume growth in 2016?

James S. Metcalf - Chairman, President & Chief Executive Officer

Yes. 2016, early 2017, yes.

Robert Wetenhall - RBC Capital Markets LLC

Okay, great. Thanks. Great quarter and good luck.

James S. Metcalf - Chairman, President & Chief Executive Officer

All right, Bob. Thank you.


From Barclays, we have Stephen Kim online. Please go ahead.

Stephen S. Kim - Barclays Capital, Inc.

Yes. Thanks very much, guys. A lot of questions we could ask. But let me just take the question of your CapEx. I think you had mentioned, Matt, about $100 million in CapEx, half maintenance. Looking further out, should we be expecting that CapEx rate to increase meaningfully? Can you just sort of describe in general what your philosophy has been towards investment in your plants? Our sense is that maybe that you've been able to invest a little less than what you would normally expect to do as kind of normal run rate. Whether that's true and sort of what do you think may need to be done as you look little further out past 2016?

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

Yes. Stephen, it's Matt. Hey, I'm disappointed you didn't ask about taxes.

Stephen S. Kim - Barclays Capital, Inc.

That was the next (44:27).

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

With that being said, I'll answer your CapEx question. So I think the last couple of years we've spent around $100 million. We typically will spend somewhere between, I would say, $100 million and $150 million. It's generally split 50%, 50% between maintenance of business and growth. So I would put the maintenance of business typically in a run rate of $50 million to $75 million, and then you can put growth on top of that.

Look, we're being very thoughtful about where we're putting our CapEx. And I think we've got some things in front of us that are exciting. And I don't want to get too far over my skis and I've got Jim looking at me here, so I'll be careful. But there's a lot of things that we can do in the plants to improve productivity. If you look at advanced manufacturing out in the manufacturing world, there are some very cool things that can be done, and so that drive real benefits to the bottom line much like we've done in Lean Six Sigma.

So I think it's too early to get into what investments might look like for advanced manufacturing. But clearly, I think, as cash flow builds, we will look at perhaps accelerating some things around advanced manufacturing. And I would tell you on the advanced manufacturing, the payback on that stuff is really very good. I mean, they're tremendous investments. So I would kind of put it in that organic growth bucket. So I think for 2016, $100 million is fine. We start to make some investments in advanced manufacturing now, and we'll be in a better position sometime later this year to get into what 2017 might look like and some other investments.

Stephen S. Kim - Barclays Capital, Inc.

Okay, great. Thanks very much, guys.

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

Yes. You're welcome.


From Macquarie Group, we have Mike Wood online. Please go ahead.

Mike Wood - Macquarie Capital (USA), Inc.

Hi. Excellent job in the quarter. A question just on the wallboard shipments. That down 3.5% doesn't seem like that much of a destock. Curious to get your thoughts on where inventories were coming into the quarter, if you feel now that third quarter might have included some destocking in advance, and where you see inventories at distribution and maybe even L&W at this point?

James S. Metcalf - Chairman, President & Chief Executive Officer

Yes, Mike, the inventories are very low at this point. There's parts of the country right now -- as I said, we started out January extremely busy. We knew January would come back from a order count. And as I said, we were thinking 5%, 6%, and then January was stronger than that. Texas is very busy. There has been, obviously, a lot of discussion about oil and fracking and what impact that's going to have. And Texas is busy. Houston has slowed up a little bit but from very high levels. California is extremely busy, particularly on the residential side. I think it just came out that of the 20 top residential markets in the United States, more than half of them are in California. So California showed -- in the fourth quarter it was the only region in the country that had positive shipments. So I believe the industry shipments in California in the fourth quarter were up 4% or 5% even with what we talked about, the absence of any surge buying.

So to answer your question, inventories throughout the network are fairly low. People are busy, and we think demand this quarter, absent any big-time weather that we will have the rest of the quarter, we think it's going to be a nice quarter. In Texas I will say distribution inventories are extremely low and lead times have started to expand. So we're starting to see some nice bright spots for the year.

Mike Wood - Macquarie Capital (USA), Inc.

Thank you.


From JPMorgan, we have Michael Rehaut on line. Please go ahead.

Michael Jason Rehaut - JPMorgan Securities LLC

Thanks. Good morning and congrats on the quarter.

James S. Metcalf - Chairman, President & Chief Executive Officer

Thank you, Michael.

Michael Jason Rehaut - JPMorgan Securities LLC

The first – the question I had was kind of centered around, I guess, both the gypsum and the ceilings segments. From the gypsum side, the pricing has been consistent, and I think you said flat sequentially, up 2% year-over-year. You haven't announced a price increase yet, but you plan to do so in 2016. But I recall, Jim, last year at our conference actually, you talking to the idea that from here on in gypsum price increases would be more just to combat inflation, which would suggest kind of the same type of a rate, low, perhaps mid-single digits type increases, versus in prior years where you would kind of put out 10%, 15%, 20% price increases. And certainly the end market growth continues to be moderate given where we are in the cycle. So I just wanted to get your sense on the gypsum side in terms of pricing, and I know you don't comment on specific pricing, but just from a broader, bigger picture perspective, if that's still the case in terms of more Gypsum pricing more just kind of covering inflation

And on the Ceilings side, the margins, and you got some good pricing there as well, the overall consolidated margins in Ceilings has been in that 17% to 18%, or a little above 18% range. Can it break out of that any time soon, and is that part of your expectations over the next couple years? Thanks.

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

Thank you, Michael. And I would assume that's one question, one two-part question. So, we have quite a few people in line. But I'm going to get to both of those questions, Michael.

On wallboard price, we have a value proposition that is unmatched in the market. What we've done with putting new products in the market, our customers are really excited about what they've been seeing over the last two years. UltraLight, we've talked a lot about. Our Glass-Mat, we're going to continue to grow that portfolio. And we feel that price improvement is part of that, and it isn't offsetting inflation. I want to be perfectly clear. Price improvement -- we want to continue to expand our margins. And we're looking at margin expansion in every part of the business, and the wallboard business is no different.

So, these are conversations we're having directly with our customers, but our customers will pay for our value, and we're going to get as much as we can and what our customers will pay. So, we want to exceed inflation. So it's not offsetting inflation. We want to continue to have margin expansion. And we are not at historic highs in our wallboard business. So we want to continue to march down the path of increasing our margins in wallboard. What is a really important component of that is we look at demand, and we're seeing some positive signs of demand and capacity utilization. So we watch those as well.

Turning to Ceilings, as you know, we had a great fourth quarter. We got price improvement, but we are moving that mix. So, to answer your question, yes, we want to continue margin expansion in Ceilings at 17%, 18%. It's a nice business, but we feel the market is changing to high-end, high-margin business, more of the commodity tile business that you see, typically you see in people's basements, and the market is moving away from that high NRC, high CAC. And we have [audio skip] (52:50) capacity – one of the previous questions was about our CapEx plan. A couple years ago, we added capacity at our Cloquet plant to position us for this high-end, high-margin portfolio.

So, I would expect the rising tides lifts all boats. So, going to that high-margin products should and we expect will improve the margins of the Ceilings business.

Michael Jason Rehaut - JPMorgan Securities LLC

Great. Thanks so much.

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

You're welcome.


From Longbow, we have Garik Shmois online. Please go ahead.

Garik S. Shmois - Longbow Research LLC

Hi. Thank you. Congratulations. Just wanted to pick a little bit on distribution. The wallboard margin and volume spread was positive $1 million in the quarter. I think that was down from a run rate earlier in the year of closer to $5 million to $6 million. So, I'm just wondering if you could provide a little bit more context on what's driving the deceleration in spread. Is it tougher passing through wallboard pricing, how much was some other factors impacting the spread and what can we expect from that as we look out to 2016?

James S. Metcalf - Chairman, President & Chief Executive Officer

Sure. If you look at L&W for the year, we were pleased with the bottom-line movement. I mean, we almost doubled our bottom line. Now, obviously, the numbers can move because you're dealing with some small numbers. If you look at wallboard spread, for the quarter, it was up about I think 8%. Comp-store sales were up.

I think what you look at for the quarter, we had some additional delivery expenses that Matt talked about. We're repositioning our fleet. We've talked about in previous calls, we're downsizing some areas. We're taking some fleets out of the system. We're repositioning some fleet.

So, that really hit us in the quarter when you look at that delivery cost. So, that's kind of a quarter anomaly. We're really – we're pleased with the progress at L&W. We think we're going to continue to march down the path in 2016 with better results on the bottom line. And really, it's focused on not only wallboard spread that's important, but one really key component of L&W is non-wallboard. 50% of L&W's business is steel studs. We talked about ceiling tile. They are the largest ceiling tile distributor in the United States. We talked about positive trends there and really it gets down to velocity because L&W is really tied to the commercial market, so we're starting to see, as I said with some earlier questions, some positive trends commercially which will continue to help L&W from a velocity standpoint.

So, this is a velocity business. It's come from really the ashes, and I'm really proud of the team. We have some very specific initiatives on our fleet, as I mentioned, on how we do truck turnaround and really two or three hard operational initiatives that are starting to take root. So, I wouldn't get hung up on some of the sequential quarter-to-quarter. If you step back and look at the progress that we've made and, hey, I'll admit, we have some work to do and we aren't where we want to be from a margin basis. But I think we're getting some tailwind we haven't had in the last couple years.


From Thompson Research Group, we have Kathryn Thompson online. Please go ahead.

Kathryn Ingram Thompson - Thompson Research Group LLC

Hi. Thank you for taking my questions today. On wallboard and your outlook, if you could just remind us where your current plant structure is in terms of effective capacity utilization. What would it take to get to that optimal utilization off of current levels given your housing and non-res outlook that you currently have for the 2016 market? And then just a quick follow-up on those end markets, it seems a little bit more conservative. Is this driven by what your customers are telling you or just being generally prudent? Thank you very much.

James S. Metcalf - Chairman, President & Chief Executive Officer

Yes, Kathryn. On our outlook, we've taken a conservative approach really the last four years and because let's be frank, there's been a lot of outlooks that have been too rosy. So, maybe we've been a little gun shy about overshooting our targets here on where we think the market is going to be and think it's going to be a hockey stick in the third quarter or fourth quarter. But really a lot of that we talk to our customers as well. You see a lot of the analyst reports on where commercial is going to be, and then we take that information and we talk – we have relationships with larger architectural firms. We see what their backlog is and large commercial contractors. In every major city, we know what – as I mentioned the factoid in Chicago on the high rises. So, it's really – there's some science, but there's a lot of art and the customers can tell us if their backlog is up or down, and it is a little uneven. As I mentioned, some areas that are very busy, but there is also some areas that are still not showing us positive numbers.

Your question on capacity utilization, if you look at our effective capacity utilization right now, it's around 80%. If you look at – nameplate capacity overall is probably approaching 65%, 67% as an industry. So, we really look at effective capacity what we have staffed and Matt had talked a little bit about advanced manufacturing that's why that's so important for us because staffing up is becoming more and more difficult even in this environment of getting quality production workers and we want to make sure that the demand is durable before we start adding shifts. But our effective capacity right now is at a really good spot. And we think as I said earlier, looking at the business for a few years like I have, we are running the plants very well. And we're running at some efficiencies that I think are in a nice sweet spot. And we have time for one other question.

Kathryn Ingram Thompson - Thompson Research Group LLC

Thank you.


From Jefferies, we have Phil Ng online. Please go ahead.

Philip Ng - Jefferies LLC

Hey. Good morning, guys. It looks like you're seeing some restocking in the first quarter in wallboard and a competitor mentioned they're seeing some pre-buying in 1Q. Can you provide some color on what you're seeing in the marketplace? And how does that stack up versus years past? Thanks.

James S. Metcalf - Chairman, President & Chief Executive Officer

Yes. I said inventories are pretty low. We haven't really seen that much pre-buy. Really, what we're seeing in our customers, we have some very large customers that do not participate in pre-buy. But also we're seeing just durable demand. So, in which we find that encouraging. So, as I said earlier, there's some parts of the country where inventories are very low and the capacity utilization is very high. So, for example, in Texas, we have customers that probably we would have a tough time having any type of surge because we're busy.


Did we want to take one more question?

James S. Metcalf - Chairman, President & Chief Executive Officer

No. No more questions. Thank you.


Okay. I'll close. At this point, I'll turn over back to you for closing remarks.

James S. Metcalf - Chairman, President & Chief Executive Officer

Thank you. And I'll be very brief because we're just really past everyone's time. I appreciate you spending the hour plus with us kind of going over 2015 and outlook in 2016. And just to reiterate, we had a great finish in 2015, we're very happy with it. But more importantly, we're off to a very strong start in 2016. And we'll look forward to updating you next quarter. Thank you for your time.

Ryan Flanagan - Senior Director-Investor Relations

Thanks, Jim. A taped replay of this call will be available until Friday, February 19. Information is available on This concludes our conference call. Thank you.


Thank you. Ladies and gentlemen, you may now disconnect.

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