USG Corporation's (USG) CEO James Metcalf On Q1 2016 Results - Earnings Call Transcript

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USG Corporation (NYSE:USG) Q1 2016 Earnings Conference Call April 21, 2016 9:00 AM ET


Ryan Flanagan - Senior Director of Investor Relations

Jim Metcalf - Chairman of the Board, President, Chief Executive Officer

Matt Hilzinger - Chief Financial Officer, Executive Vice President


Kevin Hocevar - Northcoast Research

Jason Marcus - JPMorgan

Stephen Kim - Barclays

Bob Wetenhall - RBC Capital Markets

Garik Shmois - Longbow

Keith Hughes - SunTrust

Todd Vencil - Sterne

Philip Ng - Jefferies

Kathryn Thompson - Thompson Reuters

Tim Wojs - Baird


Welcome to the Q1 2016 USG Corporation earnings call. My name is John. I will be your operator for today's call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.

I will now turn it over to Ryan Flanagan.

Ryan Flanagan

Thank you. Good morning and welcome to USG Corporation's first quarter 2016 earnings conference call and live webcast. We will be using a slide presentation in conjunction with our call today. It's 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 first 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 quarter plus additional insight into our businesses. Matt will review the financial results for the corporation and the business segments.

We will then open the call for questions and conclude with a few comments from Jim. We would 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 one question. Jim?

Jim Metcalf

Thank you, Ryan and good morning. I would like to start out by saying how pleased I am with our first quarter results. I am going to go into the specifics in a moment, but first I want to highlight some of our terrific accomplishments from the quarter. Over the past 12 months, you have heard me talk about the importance of expanding operating margins.

In the first quarter, we significantly expanded margins in gypsum, ceilings, and L&W. U.S. gypsum margins expanded to 19%. This was the best in a decade. Margins for U.S. ceilings rose to almost 23%, the best quarter ever for this business. And L&W margins of 3.1% were the strongest since 2007 and more than doubling from last year.

As a company, we generated $181 million of adjusted EBITDA. This is the highest of any quarter in nine years. We have talked about costs over the last year or so. Our focus has been relentless. We drove SG&A to the lowest first quarter level in 15 years and with that we used free cash flow to pay off $110 million of our $500 million note that we have due in November. I could probably stop here and to some Q&A, but you are probably going to want to hear a little more. So let me go on.

Obviously we are off to a strong start in 2016. We are seeing demand improve in all of our markets; residential, commercial, and repair and remodel. You have heard me talk about our plan to win, strengthening the core, diversifying our earnings, and differentiating USG through innovation and this is delivering results in the short term as you can see, but what's important is building a strong foundation for profitable growth in the long-term. Now let's get into some of the specifics in the first quarter and then I will turn it over to Matt and he is going to give you some more detail.

Turning to our gypsum segment. We expanded margins from 12% to 17%, driven by contributions from both wallboard, but also from our surfaces and substrates businesses. Surfaces and substrates, this business has had a record quarter with $12 million of increased profit over the prior quarter. This is a significant accomplishment. Think about $12 million of incremental profit in our non-wallboard businesses. This performance was led by joint treatment, Durock, Fiberock, and our roofing products.

Our substrates products which I want to talk more about continued to gain traction in the commercial market as we obtain more specifications with our architects. We are growing our share business in the commercial building through roofing, flooring, sheathing, and building envelope products. This is a great example of how we are diversifying our earnings as we grow our business.

Our U.S. wallboard business also turned in a very impressive quarter. The strong January volumes we mentioned in the last call, continued with volume up 20% for the quarter. The increase in volume was also driven by improved demand, including an uptick in our commercial work. Roughly half of the increased volume was due to a combination of a few factors. Obviously, we had a mild winter and we had some surge buying ahead of our March wallboard price increase. Now, we don't project volume continuing to grow at this rate for the full year, but demand in all of our markets is going to be stronger than we had originally planned. I am encouraged that roughly three weeks into April, wallboard volumes have continued to outpace the prior-year.

The operational performance at our plants continues to be best in class. I am so proud of our manufacturing team. We are running our plants safely. Our quality is excellent and plant efficiencies are at an all-time high. Our manufacturing team is using techniques like Lean Six Sigma and lean manufacturing to increase productivity, which is really important during these busy times in reducing costs and lowering our breakeven throughout our network.

Our U.S. wallboard price was down slightly compared to the first quarter of 2015, but relatively flat compared to the fourth quarter. A number of variables, including sales and geographic mix as well as the timing of our March price increase influenced the first quarter pricing. We did implement a wallboard price increase during the quarter, which was effective on March 28. Our increase has been in the market for roughly four weeks and volumes have remained at solid levels.

Now, I would like to turn to ceilings. What a remarkable quarter. On the heels of a record fourth quarter, our U.S. ceilings team delivered the best margins in the history of the company. The best margin ceilings has ever delivered. Operating margins I mentioned of almost 23% were driven by improved volume, lower manufacturing costs, and higher pricing on ceiling tile. As we mentioned in the last few quarters, we continue to see the sales mix of our ceilings business shifting towards higher-end products which is higher-end margins.

Now moving to our distribution business L&W. Operating margins improved to 3.1%, as I mentioned, which were double from last year. Stronger volumes at L&W and a continued focus on operational improvement initiatives that we have talked about the last couple of quarters that we launched last year did contribute to this performance at L&W. Comp store sales were up 9%, wallboard volume was up 12%, and incremental contribution from our steel stud business was up $3 million. Now this is a great indicator the steel stud growth of improving commercial demand and we like to look at our steel stud business of what is coming up in the commercial market. I am pleased with the improvement at L&W. The results are coming through and we are going to continue to drive improved performance throughout the year at L&W.

Next, I would like to go to USG Boral. We turned in a quarter that was very similar to last year despite some regional macroeconomic headwinds. Profitability was up slightly year-on-year after taking foreign currency into account. Australian and Korea, all outperformed the prior-year while China and Indonesia, these markets were softer in the quarter. But across all territories at USG Boral, the adoption of Sheetrock, NextGen, what we call in the United States. UltraLight, the adoption continued with conversion rates increasing from 19% to 24%. In fact, in Australia the NextGen adoption rate has been over 45% with a price premium in the market.

Plasterboard throughout the region was up in the majority of geographies and volume was up 3% in the first quarter. At USG Boral, we are also seeing increases in our adjacent products sales like joint compound, steel studs, and mineral fiber ceiling tile. We are going to continue to drive improvement in manufacturing facilities with the successful rollout of the USG manufacturing systems into USG Boral.

So with that, I would like to turn it over to Matt and he is going to dig into the details little more and then we will come back for Q&A in a few minutes. Matt?

Matt Hilzinger

Thanks, Jim and good morning, everyone. Before I get into the details for the quarter, I would like to echo Jim's enthusiasm on how we started the year. Just fantastic. I just want to thank the USG team for their terrific execution during the quarter. It's also really nice to see how our growing momentum can really drive cash flows with a little bit of added volume and a lot of hard work. So thanks to everybody.

A few administrative items before I get into the details of the business. I just like to remind everyone that this is the first quarter in seven years that we have actually recorded a tax provision on our U.S. earnings. So we are not paying cash taxes, I want to repeat that, we are paying cash taxes on U.S. earnings. Our net income and EPS looks like apples--oranges on a comparative basis this year to last year. And as I said in the last quarter to help everybody, we are now disclosing adjusted EBITDA per diluted share to put the comparison on an apples-to-apples basis with last year, which I am happy to say was up almost 40% in the first quarter to $1.23 from $0.89 a year ago.

Second on my administrative list is our bridge from our GAAP to adjusted results, which is listed in the detail of our press release and earnings slides. There are two non-routine adjustments during the quarter. The first relates to our old shipping business, GTL, where we collected $5 million, net of tax, which puts GTL behind us. That's the final settlement. And the second item is a $1 million charge associated with our early debt retirement which I will talk about in a few minutes, but I am really happy that we have been able to do take a bite out of the balance sheet.

Now let's get into the numbers for the quarter. Adjusted net sales were up 8% to $970 million, with adjusted net income up over 40% to $63 million despite the impact of recording a $29 million U.S. tax provision. Another way to see this is to consider that if we hadn't had to record the $29 million tax provision, our adjusted income for the quarter would have been $92 million versus $44 million. So more than double over last year. We also had some foreign currency headwinds again this quarter, not surprising, to the tune of $12 million unfavorable impact to sales and a $6 million hit to net income.

So with that let's move into some more detail around the segments. In the gypsum segment, adjusted net sales for the first quarter were up 12% from last year to $635 million, with foreign exchange headwinds of $10 million to first quarter revenues. Adjusted operating profit increased 500 basis points to 17% from 12% through improved volumes, lower cost and really a banner quarter for our surfaces and substrates business. And our performance was even better when you factor in $4 million of unfavorable foreign exchange.

Breaking gypsum down a little bit further, our wallboard division contributed $24 million of improved profit. The surfaces and substrates business contributed a record $12 million, which Jim talked about. Canada and Mexico saw $4 million of combined operational improvements, which offset basically the foreign currency impact. Canada also had a $3 million favorable reserve adjustment.

Jim already covered wallboard pricing. So I will focus really my comments around volumes and costs. Volumes in the U.S. were up 20% and that drove $19 million of improved profit in wallboard. As Jim mentioned, we had about half of this was driven by organic demand and it's hard to get exact measurements on this. It's a little bit of an art. There is a little bit of the science too. But it's our best view that pre-buy, favorable weather and an extra shipping day, all contributed but all-in-all, we believe that organic demand was strong and continues to be strong. And it's supported by the fact that L&W's wallboard volumes were up 12%, our joint treatment volumes were very healthy and very important to notice, Jim had mentioned, is that we have seen volumes hold up in the first three weeks of April, which is really a very positive sign.

We did well on the cost side too this quarter, at least I hope you noticed. Wallboard costs were a $10 million tailwind to the quarter and it was really driven by three things, lower natural gas prices, greater volumes against fixed costs and all of our Lean Six Sigma efforts out in the plants and across the corporate centers. And we certainly saw a benefit of lower natural gas during the quarter, which amounted to about $4 million of the $10 million in our cost savings. And you may recall that our unhedged position for the year is about 25%. So what really helped us during the quarter was that spot prices were running I just under $2 per decatherm. So that helped quite a bit.

With that said, we are still seeing some inflation in our input cost, specifically labor, paper and some of our special ingredients. And we are also seeing for the first time some tightening in the availability of synthetic gypsum, particularly across the Eastern Seaboard, which is inflating it's delivered cost a bit. The great news is, is that we offset all of this inflation and as I look through the balance of the year, it's very possible that our all-in manufacturing cost could trend slightly favorable for the remainder of 2016, probably to the tune of a few million bucks each quarter, largely depending upon volumes and where spot price of natural gas lands.

I would like to move everybody to surfaces and substrates now, which just continues to grow and improve profitability. The incremental $12 million of profit in the first quarter is a record, I think we have said that three times already and was generated on 10% sales improvement. So many of the products that we have introduced over the last few years are really just starting to take hold and I expect these products to continue to grow, show improvement and outperform last year as you think about the balance of the year.

All of us at USG continue to be very encouraged about surfaces and substrates but I believe that some of these products are still underappreciated and perhaps not fully understood by the street and our investors. So I have added some additional color in our earnings material this quarter to help you become a little bit more familiar with these products and how they are used.

So if you would just turn to slide 11 in the deck, I think you will see a pretty flashy slide there that shows our product categories. But surfaces and substrates products are just, they are less visible because they are usually behind something like tile, brick, carpet, paint. So even though you don't necessarily see them, they are very much an integral part of residential and commercial buildings. These products are growing in the market because they are very much focused on solutions for our customers, solutions that improve energy efficiency, sustainability and increase the speed of construction, which is really important. In fact, all of these things are gaining importance in the eyes of our customers. So while I won't walk through each specific product category on slide 11, I will say that each product is filling a really important need for our customers.

Moving to ceilings on slide 12. Net sales were $125 million in the quarter, up slightly from $123 million last year with about a $2 million drag on revenues from unfavorable foreign exchange. Similar to gypsum, we saw operating margin expansions with margins up 610 basis points to 23.2%, a new all-time record. Pricing was up in our tile products on both mix and better pricing on our high-performance products. Pricing on grid was down modestly and was driven primarily by lower steel costs. Additionally, volumes improved in both tile and grid categories and costs were favorable on a combination of natural gas, lower steel and operational efficiencies. And even though steel provided a modest benefit in the first quarter, I don't expect steel cost to be a tailwind for the rest of the year. In fact, I expect to see steel prices move up through the balance of the year and we have already seen a sizable uptick in April.

On to distribution. L&W's net sales were up 7% over last year to $357 million. Adjusted operating profit more than doubled to $11 million and margins expanded 190 basis points to 3.1% in the first quarter. L&W's profit from wallboard and adjacent products, both grew $5 million, reflecting the improving strengthen in the business, particularly in commercial and the high-rise residential area which, as Jim said, saw a really nice growth in the first quarter. And despite demand being stronger, inventory levels in L&W are actually down around 15% year-over-year as we continue to make really strong progress on working capital efficiencies across the USG network just as we did in the fourth quarter.

Turning to USG Boral, the JV. Financial results for the first quarter, as Jim said, are on par with the first quarter of 2015. Net sales were essentially flat at $229 million and the total JV adjusted net income for the first quarter was $15 million, down $1 million from last year due to unfavorable foreign exchange. And one way to really look at this is, if you strip out foreign exchange and view the results for the first quarter on a constant currency basis, the underlying business is really doing well. Revenues increased 7% to $244 million and the total JV adjusted net income increased 6% to $17 million. And just remember that USG's portion of adjusted net income is 50% of that.

You may also recall, as we have talked in the past, that the first quarter is really the seasonally slowest out of the year in the USG Boral region. As Jim will discuss in a few minutes, but we both continue to feel confident about the trajectory of Boral through the remainder of this year in there ability to create operating margin expansion and meeting our 10% earnings expectations despite some of the macro headwinds that we are seeing over in the Asian economies.

I would like to shift to our SG&A spending. We had a great quarter. I just can't say that enough. We had a great quarter. At the last earnings call, I said that our 2016 SG&A cost would come in under our 2015 spend. We are under $317 million. Again, we got off to a great start with SG&A of $71 million, down $6 million from a year ago and to a level that we haven't seen in 15 years and that's on a nominal basis. That's not inflation adjusted. So thanks to everybody at USG for helping.

We have been and we will continue to be absolutely committed to have our 2016 SG&A come in lower than 2015, but I wouldn't necessarily extend the first quarter run rate to the balance of the year. What's really important is that we have permanently taken out costs from SG&A and we continue to streamline processes and control, just a wide berth of cost. But in the first quarter, we frankly took a very conservative approach and there is some cost like labor that we deferred in the first quarter, that will very likely show up through the balance of the year.

Just a quick update on foreign exchange. Based on currency movements in the first quarter with the U.S. dollar, it's actually depreciated a fair amount against our counter currencies and I now expect that for the balance of 2016 that the results will be unfavorably impacted by only about $1 million of foreign exchange and that's assuming constant rates as of the end of March. So we will probably see a little bit stabilization on FX, at least I hope so.

Moving to the balance sheet. I am really pleased to say that we early retired about $110 million of the $500 million bonds that mature in November. And we did it via open market purchases, $65 million during the first quarter and the rest of it in April. And I can't tell you, as a CFO how long I have been waiting to do that. It's awesome. And at this point, I would tell you, I am very confident that we will organically pay off the rest of the notes later this year. And it will be another huge step towards hitting our 1.5 to two times debt-to-EBITDA leverage target, which remembers on a net basis, net of cash at the midcycle.

So one last item before I wrap up. As I mentioned on our fourth quarter call, the USG team really believes that there are some great investments around advanced manufacturing that will deliver high returns for our investors and we are really excited about advanced manufacturing technologies and what they can do to our cost position profitability and return on invested capital. And we have already started to make some very modest investments in that program, but it's still a little bit too early to get into the details. I am sorry. But I do promise that we will have more as we go through the balance of the year. So stay tuned. More to come on that.

But to summarize, really I feel we got off to a great start in 2016 and I am really encouraged about the year and the opportunity to continue to delever the balance sheet, put money back in and reinvest in the business and grow our return on invested capital.

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

Jim Metcalf

Thanks, Matt. It's always great to have your CFO excited about the numbers. So hopefully you are as well. Before I open it up for questions, what we would like to do is just briefly discuss what we are seeing in our end-use markets and summarize our thoughts for 2016. As we have said numerous times and you probably may be getting tired of hearing about it, it's been a long time since we have been able to really hammer the results that you are seeing here. It's a great start on all factions of our business and the team is really excited about the prospects for 2016 and really beyond.

As you know, our plan to win, we have been very focused on that. We aren't taking our eye off the ball of our core businesses. But we want to diversify our earnings, but also focus on innovation as well. We believe the underlying demand that drove the performance is going to continue. And we think that this year in the States, we are going to be ahead of our 5% growth target that we talked about last quarter. We also expect growth in our end-markets and not only North America, but in Asia and Australasia. So as Matt said, for USG Boral, first quarter is usually the softest quarter and we are still very enthusiastic about our joint venture with USG Boral.

In residential, you all see the numbers and we are still with housing starts about 1.2 million for the year. We are all seeing increases in existing home sales. The numbers came out yesterday very strong. Prices are strong. Rental rates, wages. So we see all positive trends for residential activity in 2016. We think the market will continue to grow.

In commercial, we are starting to see improvement in wallboard shipments and that was a contributing factor to the improvement in our overall volume. And one of the things that we look at in commercial high-rise, a lot of that is residential commercial high-rise, but steel studs, commercial distribution goes into that business. So a lot of you may be looking at residential multifamily. But a lot of that is high-rise construction that we "at USG" view that as commercial. While we expect new commercial starts to increase 2$ to 3%, as you know, we have a lag of 12 to 18 months for our products and we still continue to see strong activity in the United States and as I call it the golden horseshoe, which is the Southwest, the South and Southeast which are very, very strong as we speak.

Turning to repair and remodel. We continue to see steady improvement and continued growth with volumes in the low to mid single digits. Our big-box retailers, their comp store sales are very, very strong. Had a strong fourth quarter and actually continued into April and we expect this segment of our business to outperform year-to-date from our original plan. So very, very strong. And as you recall, repair and remodel for USG is about 50% of our sales both residential and commercial repair and remodel.

Finally, at USG Boral, as I mentioned, we expect demand growth for the 14 regions and net income to increase at least 10% and as Matt just indicated, we don't expect to come off those projections at this point. We do see some headwinds. Lot of you read about in the paper, but it's not enough to take us off our forecast and like our U.S. operations, we expect both margin expansion and stronger cash flows at USG Boral.

So before turn it over to you, I just want to set and remind you of our priorities that we have set for the USG team for 2016. And these are very important priorities for us and I believe we are hitting on each one of them and there are four.

Number one and Matt just talked about it, is organically retire our 2016 debt obligations. We are very focused on that. We have knocked down $110 million to-date and we have a laser focus on that $500 million coming in November.

The second is expand margins in all of our businesses. As you saw, we did that in the United States in the first quarter. We are going to continue to focus on margin expansion, the top and bottom line. And that is very, very critical for us.

Number three is keep our costs, as Matt said, at or below 2015 levels. We have the processes to do that, Lean Six Sigma, advanced manufacturing. These are proven procedures to not only take costs out permanently but also have growth initiatives that you can expand your business without adding a lot of capital.

And finally and fourth is selectively invest in projects that are growth initiatives. High-performance ceilings is one area. As we talked about the high margin growth in ceilings and that's an emerging trends. And also growing our specialty and glass mat business on the West Coast with our expansion of our Plaster City plant, which is up and operational and has had a wonderful start-up.

So we believe these are the right priorities to make 2016 a very, very successful year and we are very determined to deliver on each of those four priorities that we will continue to discuss with you as the year unfolds. So with that, as Matt said, we are both very excited about the start of the year, but more importantly we are very excited about the rest of the year and into 2017.

So with that, I would like to now open it up for your questions.

Question-and-Answer Session


[Operator Instructions]. We have a question from Kevin Hocevar from Northcoast Research.

Kevin Hocevar

Hi. Good morning, everybody. Congrats on a nice quarter.

Jim Metcalf

Thanks Kevin.

Kevin Hocevar

I wondered if you could comment on, in terms of your outlook for wallboard, I believe you mentioned you expect the growth to be above 5% for the full year and you mentioned that half of the growth in the first quarter, you believe, was organic growth. So is that kind of the growth rate we should think about going forward? And how should we think of the second quarter, the impact from the pre-buy? It sounds like things are positive at this point, but do you think given the impact of the pre-buy, can you ultimately grow volumes in the second quarter?

Jim Metcalf

As we mentioned in April, volumes are outpacing last year. So we are hanging in there on volumes. Just as Matt said, there is a lot of art and science on this. We think the pre-buy was about 7% to 8% of the 20% and demand was about 7% to 8%, the true demand. Weather did help and you had an extra day in the quarter. Typically the second quarter, if you look, is not the strongest quarter of the year. It really goes into the third quarter, it is our strong quarter, but as we start out early in April, we are outpacing last year. So you aren't going to see 20% in the second quarter. I wish we would. But our projections now are north of that 5%, and we think this year’s -- the underlying economics are there. Repair and remodel is strong and this high-rise commercial residential is really starting to take root and we are grabbing some share there. So I would put something north of 5% and maybe in that 7% to 8^ for the year.

Kevin Hocevar

Okay. Great. Thank you very much.


Our next question is from Michael Rehaut from JPMorgan.

Jason Marcus

Good morning. It's Jason Marcus, in for Mike. My question is on the ceiling and the incremental margin that you have been getting there. So you have discussed the improvement and next steps that occurred over the last several quarters in terms of mix shift towards the higher-end ceiling business. So I wanted to get a sense of what the incremental margin is on the higher-end ceiling business versus the basic business? And as you continue to expand in that segment, how are you thinking about incremental margins from where we are today and throughout the rest of the year?

Jim Metcalf

If you look at the margin difference between the high-end and as we call the entry-level ceilings, it could be anywhere from two to three times from a margin expansion, two to three times more. If you go into the high-end specialty, it could be 3.5 times more. And that's a smaller market. That's the high-end clouds, wood, metal ceilings, but the high NRC, the 80 to 90 NRC is about 2.5 times greater from a margin expansion. You are seeing trends going that way. It's not growing at 20% a year. But this has been just a steady growth away from some of the entry-level ceilings.


The next question is from Stephen Kim from Barclays.

Stephen Kim

Thanks very much, guys. Congratulations on a very good and strong quarter.

Jim Metcalf

Thank you, Stephen.

Stephen Kim

Well, actually I guess I only get one question. So I will ask about the cost. Clearly you had, I think you said $10 million in the gypsum segment and $5 million of benefit in ceilings. You talked about, in the gypsum side, nat gas helping you by about $4 million. I am trying to figure out, if you could give us a little bit more clarity on maybe what the other $6 million was? In particular, if you could focus on some of the Six Sigma and other productivity related issues, things you were working on in the quarter? And kind of as a backdrop to that, I just want to make sure that your commentary later seemed to suggest that most of what we could expect for the rest of the year was going to be dependent upon nat gas spot pricing and volume. And so, I just wanted, I didn’t hear you mention anything about what I would consider sort of hard productivity, so I think if you can just give us some color on what we saw in the quarter and can expect from the back part of the year? Thanks.

Matt Hilzinger

Yes. Hi Stephen, it's Matt. So if you look at the $10 million for wallboard, I would break it into three buckets. So nat gas was about $4 million, volume was about $4 million and then I would put $2 million as net operational stuff. Remember, we still have some level of inflation in the business and we were seeing some inflation in synthetic gypsum. We are seeing some inflation around labor, around paper costs, and so we more than offset the inflation through a lot of the productivity efforts that we have been doing through Lean Six Sigma.

So when I think about wallboard costs going out, as much as I would like to be able to take the $10 million and multiply it by four and say that's going to be the cost of the year, just I don't think that's realistic. I do think there is a trend that we are going to get a tailwind through the year. But if you just take nat gas as an example, a big part of that was the spot price being under $2. So nat gas is probably this year versus last year, for the full year, we are probably going to get about 15% benefit. It's going to be 15% lower. And part of that is being driven by where the spot price is. So if spot price stays low, I think we are going to see a bigger tailwind that you might otherwise see in nat gas. But I wouldn't count on the full $4 million.

And volumes, quite frankly, look, if I could count on 20% volumes each quarter, that would be awesome, right. But I don't think we can do that. And so, I think part of that $4 million that we saw came through volume. So Jim talked about our expectations around growth, and so I would expect to see some tailwind in the remaining quarters as growth continues to stay in that mid-to-high single-digit range. And then the productivity effort is, in some cases it gets lumpy, but I would expect that we are going to continue to do the things that we need to do to keep our costs low, and we are going to try and offset the inflation and we did that effectively in the first quarter. So again on wallboard, the way I would think about it is, I said a few million bucks kind of a tailwind in the second, third, and fourth quarters. And I think that's probably the right way to see it and you can see where the levers are going to be around that.

On ceilings, there was $5 million of cost savings in ceilings. And I would break that into three bucket. So I would put natural gas and operational efficiencies probably gave us $1 million. And then steel, the tailwind that we saw on steel was about $2 million for the quarter. I don't think that that's going to stay. And I have put those in my prepared comments. And in fact, we have started to see steel move back up back. In fact, there was a sizable increase in April and we think that steel, quite frankly, is going to end the year in an all-in blended cost that's higher than the cost we had last year. So even though we got a tailwind in the first quarter on grid and I think there will be pricing adjustments and some other things to kind of deal with movement in steel cost. And then there was a $2 million reserve adjustment in ceilings a year ago that is showing up through cost. So I would look at costs in the ceilings area of that $1 million to $2 million depending upon nat gas and volume.

And then I would just address SG&A. Again, I don't want everybody that those models out there to take the $7 million bucks and multiply it by four, right. As much as I would love that to go through do that, we were pretty conservative in the first quarter to go around labor and we hope some open positions key things that that and some k, particularly around labor. We hope some open positions and key positions that just need to be filled as we were watching volumes and watching what was going on with price, I think it was the prudent thing to do. So we are absolutely committed to delivering lower SG&A to the balance of the year. But as much as I like to be able to say to you, I can deliver the same that we delivered in the first, I think it will be a little bit less than that.

So Stephen, I hope that was hopeful and provides some clarity.

Stephen Kim

Yes. Okay. Thank you very much.

Matt Hilzinger



Our next question is from Bob Wetenhall from RBC Capital Markets.

Bob Wetenhall

Hi. Good morning and congratulations on a terrific quarter. I think it's the most profitable quarter I have seen since I started coverage of the company.

Jim Metcalf

Thanks Bob.

Bob Wetenhall

So Jim, I just wanted to ask and Matt's excited on the cost side today and that came out very tangibly and you are working on the balance sheet and the stuff you can control. You have done a great job. On the bigger step, the macro picture, you hit on, each are doing well and kind of strong organic demand on the wallboard business and you are getting good pull through as well on substrates. Am I correct in sensing there is a distinct shift in your tone or a favorable bias this quarter versus your last conference call? And if you could just give me a little bit more kind of a granular thing, what's the source of your optimism, if I am correct in thinking there is a shift? Just because the majority of your comments you do sound pretty favorable. Thanks very much and good luck.

Jim Metcalf

Thanks Bob. When you start the year off as strong as we have and we have some wind at our back, but there has been a lot of hard work, As you know, the last couple of years, we been focused on the cost side, lowering our breakeven. We are very focused on new products coming to market. We talked about innovation and as you can see, it's pulling through on surfaces and substrates products that a lot of you probably don't realize we even made and that's all market share growth. We are getting margin expansion in each one of our businesses and actually each one of our end-use markets are showing underlying positive demand.

And as I said earlier, everyone looks at the commercial business a little differently. We look at commercial high-rise residential as a big opportunity. In fact in Chicago, I think we have 38 cranes and 34 of them are commercial residential, which you know helps L&W. It pulls through steel studs. On the advanced manufacturing, we have an amazing program that we are starting to introduce that will not only lower our breakeven but it will also provide additional productivity without adding staff. And what we are doing in Asia and Australasia, I think is amazing. We put the USG manufacturing systems in there. Our technical team just did a bang up job. Our engineers level set all of the plants that we have in that region.

We are now putting NextGen or UltraLight throughout the system and getting price improvement and adoption rate in some countries that people didn't think would happen. We are doing extremely well in countries like Vietnam, which are very new to us that are growing at double-digit digit rates. So it's one of those things, I don't want to jinx it, but we are kind of hitting on all cylinders. And we have gone through some dark days here and we are very excited not only about 2016, but we think the next few years are going to be really gangbusters for USG.

We are going to continue to grow the business, come out with new products, lower our breakeven and really take care of our customers. So I am pleased with the numbers. I am very excited about our team here. We have extreme alignment on what we want to do, as I mentioned, our four priorities. One thing is really, really important for me as we get this balance sheet bulletproof and we are making progress there.

As Matt said, we definitely plan to knock that $500 million off in November, actually it's November 15. So I have that date circled on my calendar and I want to make sure that this company has a balance sheet for the future that will be prepared for any type of macroeconomic cycle, but also be prepared to maybe make some investments that we hadn't been able to make in the past. So it gets me excited and I am just really enthusiastic about the initiatives that we have put in front of you that we are checking the box on each one of those.

Bob Wetenhall

Cool. That's very helpful. Good luck.

Jim Metcalf

Thank you.


Our next question is from Garik Shmois from Longbow.

Garik Shmois

Hi. Thank you. Congratulations, of course. Just wondered if you could talk about the demand trends in wallboard. You have talked about your end market outlook. But I am just wondering, as we look back, if we step back and look to the back half of 2015, you talked about it, I think, in the third quarter, there is an air pocket. So demand didn't materialize then. So wondering if you are seeing any potential catch-up and maybe some of the volume gains in the first quarter and into April as just the natural catch-up of projects that you thought were going to materialize in the second half of 2015 and now they are getting completed? And then I guess, just to expand on that, as we are starting to see an improved construction market, are you seeing any easing with respect to labor availability and in turn the lag between when project breaks ground and when wallboard and ceilings is ultimately installed?

Jim Metcalf

We talked about that air pocket six months ago and I think there is still a little bit of a mystery to us at that point, but I think you hit the nail on the head. I think some jobs are delayed. Labor did have a factor there. There is an extreme labor shortage, particularly in commercial construction, getting in fact in Chicago, some commercial contractors are having to pay $4 and $5 an hour over the union labor rate just to attract carpenters and apprentices.

So that air pocket could very well be, you could tie labor into that and yes, there was some catch-up in the first quarter. Labor is going to continue to be tight. We see it in the manufacturing side and that's why in the first quarter, we are very diligent about adding any type of hourly labor to our plants. We would rather run our plants full out pay overtime and actually our volumes in March, we were sold out in March. And we want to keep a cap on things from a labor standpoint. Because it takes you a long time to get production workers, but we don't want to hire and then layoff.

So we want to make sure that things are durable. But the air pocket you talk about, there was some catch-up. Labor is a big issue. CDL drivers from L&W standpoint, they are very hard to find. It's really, you have to keep your eye on keeping them because they can get recruited for another type of truck driving. So this is one area that I think all of construction talks about and it's something that why advanced manufacturing for us is so important because labor right now, there are 10,000 baby boomers retiring every day and if you look at all manufacturing in the next 10 years, there is going to be two million jobs that are not going to be filled because of lack of production workers.

So as Matt talked about advanced manufacturing, this is really looking into the future. It will lower our breakeven but it's also taking jobs that are monotonous and maybe dull jobs and having more high technical jobs, so we can recruit people into manufacturing. So we knew there is talk about advanced manufacturing. This ties into lowering our breakeven, being more productive, but also this growing trend that you are talking about of labor shortages is not going to go away.

So it is a big issue for manufacturing and also for construction. But we are getting our arms around at USG on advanced manufacturing. So we are going to be opening that discussion up with you here when we have a little more detail that we share with you. But these are some investments that are nice return investments that are under the roof of our manufacturing plants. There is so much out there on automation and robotics and this is getting people, I like to say, behind the glass for jobs that are more technical that they want to come work for us. And our customers are looking at the same type of the initiatives.

That's why when we look at our products we introduce, having products that are lighter, that are easier to install, our commercial contractors like it because their labor productivity increases, which means they don't need to have as many people. So when you hear us talking about our new product introductions, we are really tying that into some of the labor shortages our contractors have in the market. So it's a full circle of our product innovation as well of tying it into labor. I hope that helps.


Our next question is from Keith Hughes from SunTrust.

Keith Hughes

Thank you. You had make some commentary on sequential price improvement in wallboard here in April. I know it's early still a little bit on price increase. What does that look like on a year-over-year basis? Are you making some gains there?

Jim Metcalf

What we do is, we were pleased through the first, we went in March 28. So we are about four weeks into it. Our volumes are hanging in there. So it's really tied into our volumes as well. And what we will do is, into the second quarter, we will be able to give you a better look at that. But it's still early and as you know, our pricing is regional. We do business in 50 states. So it's so far so good and we will be able to give you that sequential or that year-on-year number when we talk to you in three months.

Keith Hughes

Okay. Thank you.


Our next question is from Mike Wood from Macquarie Capital.

Mike Wood

Hi. Excellent job leveraging the recovery. I wanted to ask you, in addition to the manufacturing improvement you called out, how are you working to improve the L&W distribution margins? Can you just tell us what you are working there with logistics or anything else? And on that same topic, would L&W benefit from the price increase in late March in wallboard spread?

Jim Metcalf

So L&W, we talked about some operational initiatives. We put those in effect about a year ago. A couple areas and you touched on one is a dispatch system. Utilizing your trucks in a more efficient manner. Truck utilization. Using technology to have more efficient deliveries. Really, we looked at our working capital as well. How much inventory we were going to have at L&W.

We also looked at working L&W as a network versus individual locations. So there is about three or four operational initiatives that have to do with delivery and how you turn your trucks. Basically it's productivity and efficiency that now we track it and we have better automation on that. And really, it's starting to take some grips on the results. If you look at L&W spreads, they also have a value proposition. They are very focused on commercial construction and residential high-rise.

So any type of price increase to L&W regardless if its wallboard or steel studs, they need to get a value proposition in the field and get a price improvement so their spreads improve. So price increases to L&W, regardless what product it is. They need to go out and get a price improvement in the market. And what they have been doing, which we are very proud of, they have been getting margin expansion by doing that with their value proposition.

We still have some work to do there. We aren't claiming success. But as you can see, each quarter we are getting sequential improvement both on comp store sales. The early indication on steel studs, we think, is a nice indicator of the commercial market, but it's also better utilization of the equipment, which really can make or break a month.


Our next question is from Todd Vencil from Sterne.

Todd Vencil

Hi guys. Good morning.

Jim Metcalf

Good morning.

Todd Vencil

Probably too early to think about category, I am going to ask this question. It's good to hear that moving the price increase back into the stronger selling season around March worked out. Back before shift in 2012, a lot of times we would see multiple rounds of price increases, the first coming in March or April and then another one in maybe May or June, probably to lock in the first one. So is there any thought of maybe going after another round of price increases this year? Or is there anything in the terms of the March increase that would keep you from trying at another one later?

Jim Metcalf

I like your first comment, it's too early to tell.

Todd Vencil

Can you tell me whether there is anything in the March 28 increase in the terms that it would restrict you from having another one over the next few months?

Jim Metcalf

What we are doing, we are very focused, Todd on this increase. And as I have talked in the past, margin expansion in wallboard is really key. And a lot of it has to do with the demand, how strong the demand is. It is a regional business. So actually we aren't thinking ahead on that next round. We want to be focused on getting price improvement with our value proposition on our March 28 increase. So back to your first statement, I agree with that, it is still too early to tell.

Todd Vencil

Fair enough. Thanks very much.

Jim Metcalf



Our next question is from Phil Ng from Jefferies.

Philip Ng

Hi. Good morning guys. L&W saw a pretty impressive operating leverage. Can you talk about what's driving that? But I did notice that we saw a nice lift on the other core products segment. Can you talk about what's providing that lift there? Is more tied to the commercial side of your business? Thanks.

Matt Hilzinger

Hi Phil, it's Matt. L&W is probably 70%, 75% commercial or as Jim talks about, the high-rise residential, right, which is like a commercial building. And so their comps were up around 9%. I think wallboard was up around 12%. The other products were up around 6% and steel studs was a big piece of that, right. I think Jim referenced steel studs were up around three million box, almost I think around 20% in terms of volume. So some really good things in the other products side of it. And I think the steel stud is really a great indicator of what we might see here in the next call it 12 to 18 months.

Remember most of this product goes in, other than steel studs, 12 to 18 months afterward. So it's a great leading indicator for us. We have talked about that in the past. So overall I think L&W on their other products, they are starting to hit some of the sales targets that they want to do on that. But overall we are really pleased with the top line coming through L&W. And I got a put a plug-in for what that team has done around working capital as well and all the other initiatives. Things are starting to progress there in a nice trajectory.


Our next question is from Kathryn Thompson from Thompson Reuters.

Kathryn Thompson

Thompson Research Group, actually. Thanks for taking my questions today.

Jim Metcalf

Hi Kathryn.

Kathryn Thompson

You had mentioned in your prepared comments earlier about a synthetic gypsum shortage in a particular region in your particularly out East. How much of this is a function of just increasing demand from the wallboard industry versus capacity reductions at coal fired plants? Thank you.

Jim Metcalf

Kathryn, this is Jim. Majority of that is the production of a coal fired plants. The individual plants that were shut down. The power plants have shut down more their high cost plants. As Matt indicated earlier, with natural gas being at historically low levels, a lot of conversion over to nat gas and it has caused actually in the first quarter a tremendous amount of stress in the system. Then there were some increased volume. As you saw, we were up 20%, it had something to do with it, but majority of it is, capacity has come up.

What's great with our network, we have a strategic sourcing group and you could have an individual power plant and we had some that did not have any synthetic gypsum, but we can move it around. And so at USG, there is not a risk of us not having SynGyp. We are 60% rock versus synthetic gypsum. Majority of our plants can run both ways, which a lot of people don't realize that gives us flexibility. We know that there is some synthetic gypsum shortages with competition in the market because we have got phone calls that we wanted to sell synthetic gypsum. We really have a great leverage point here, if it even gets tighter.

Now what Matt said, there is increased costs. Even though synthetic gypsum will get short in an area, we have to transport it in. So that's where some of that inflation that Matt was talking about in the first quarter that we offset, but we are going to continue to see that throughout the year because we have to bring it, for example up the Ohio river on barges, transport it in,. So we aren't going to run out of it, but it does fall into the transportation cost of bringing it in.

So a long answer to your question, majority of the synthetic gypsum shortages is a coal-fired plants as you indicated taking capacity out. As you know, from a political standpoint, that hasn't been very popular. Coal-fired power plants have been under fire as well. And also then you had the demand being a slight factor in the first quarter. So it was something that we can drive on.

Matt Hilzinger

And Jim, I would just add, just to quantify, just so people get a sense. It was probably $1.5 million to $2 million headwind for us in terms of transportation cost for the quarter. So you know it's an irritant that you have got a deal with it. But it's not anything that's going to break the bank and we did offset that with a lot of other productivity cost. So I just want to frame it up, that people don't blow this out of proportion. It's out there.

Kathryn Thompson

Yes. And you guys also have the largest reserve of naturally occurring gypsum at the manufacturers, if I recall correctly.

Jim Metcalf

Correct. It gives us tremendous flexibility. We have time for one more question.


We have Tim Wojs from Baird.

Tim Wojs

Close enough. Hi guys. Good job. I just wanted to go back to the early debt pay down, Matt. I know you feel like you are going to organically be able to do that over the course, by the end of this year. Should we think about, I guess one, maybe repurchasing more of that debt as the year goes on? And then two, maybe looking forward a little bit, I know you had some maturities in 2018, would you guys look to potentially repurchase some of that in 2017 ahead of that expiration?

Matt Hilzinger

Yes. It's a great question. Clearly we would look to buy some more in the open market, if we can get it at the right price, right. I mean it's pretty easy to go through and say you want to buy below the make whole and we will continue to watch and if there is opportunities to do that, we will do that. And we did have that advantage in the first quarter. We will continue to look at it. And look, I am really confident that given our outlook and given everything that we are doing that we are going to be able to knockoff the rest of that $500 million.

We probably need to pay somewhere off $1 billion to $1.2 billion in debt. We have talked about that in order to get down to our target ratio and we do have $500 million out there in 2018. I am confident that we will be able address that without a problem. And if there is opportunities to the look at buying some of that in the marketplace, I think we will do that. I don't think we want to get ahead of ourselves. I want to cleanup the first $500 million first and then we will look at some of our other debt.

So we are in a really good position to be able to manage our capital structure and manage it in a right way. Drive some interest costs out but strengthen the balance sheet. So I think we are in a good spot. And just stay tuned as we continue to manage the capital structure here. So thanks.

Jim Metcalf

Okay. We really appreciate all the questions and hopefully our enthusiasm has come through during the call. Improved demand and solid pricing and we believe there is significant opportunities as Matt and I have been talking about over the last hour with you for 2016 and beyond. We are going to continue to provide our customers with superior service and as I mentioned innovative new products. We have some really cool products that are in the pipeline that we will start talking you about that you will see that will start hitting the bottom line. Our focus on cost control and the strong cash flow are really important. And we are well positioned to take advantage of these opportunities that we have been talking about. So we really appreciate your interest and we look forward to talking to you about our progress next quarter. Thank you.

Ryan Flanagan

Thanks, Jim. A taped replay of this call will be available until Friday, May 6. Information is available on This concludes our conference call. Thanks.


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

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