USG (USG) Q4 2016 Results - Earnings Call Transcript

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USG Corp. (NYSE:USG) Q4 2016 Earnings Call February 1, 2017 9:00 AM ET

Executives

Ryan Flanagan - USG Corp.

Jennifer F. Scanlon - USG Corp.

Matthew F. Hilzinger - USG Corp.

Analysts

Kevin Hocevar - Northcoast Research Partners LLC

Robert Wetenhall - RBC Capital Markets LLC

Ivy Lynne Zelman - Zelman Partners LLC

Stephen Kim - Evercore Group LLC

Michael Jason Rehaut - JPMorgan Securities LLC

John Lovallo - Bank of America Merrill Lynch

Garik S. Shmois - Longbow Research LLC

Keith Hughes - SunTrust Robinson Humphrey, Inc.

Philip Ng - Jefferies LLC

Timothy Ronald Wojs - Robert W. Baird & Co., Inc.

Scott Schrier - Citigroup Global Markets, Inc.

Jim Barrett - C.L. King & Associates, Inc.

Operator

Welcome to the Q4 2016 USG Corporation's Earnings Conference Call. My name is Sylvia, and I'll be your operator for today's call. Please note that this conference is being recorded.

I will now turn the call over to Ryan Flanagan. Ryan, you may begin.

Ryan Flanagan - USG Corp.

Thank you. Good morning, and welcome to USG Corporation's fourth quarter and full year 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, www.usg.com, and clicking on the link to the webcast.

Before we proceed, let me remind you that certain statements in this conference call may be forward-looking statements under securities laws. These statements are made on the basis of management's current views and assumption of our business, market and other conditions and management undertakes no obligation to update these statements.

The statements are also subject to a number of factors including those listed at the end of the press release and actual results may be different from our current expectations. 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 Jenny Scanlon, President and Chief Executive Officer; and Matt Hilzinger, Executive Vice President and Chief Financial Officer. Jenny will lead out the call with commentary on the full year and our strategic priorities. Matt will then review the fourth quarter financial results for the corporation, the business segments and then provide commentary on our 2017 financial outlook. Jenny will close with discussion on our 2017 end-market outlook, and then we'll open the call for questions.

Based on the number of participants already on the call this morning, I do anticipate having more focus in the queue to ask questions than we're going to have time for. So we're going to strictly abide by the one-question per participant guideline to give as many people as possible an opportunity to ask a question.

So, with that, I'll now turn the call over to Jenny Scanlon.

Jennifer F. Scanlon - USG Corp.

Thanks, Ryan, and good morning. It's a pleasure to speak with everyone about our fourth quarter, a solid quarter that topped off a transformative year for USG Corporation. We carried out our operational initiatives and strategic priorities and have entered the New Year well positioned to capitalize on the growth we expect in all of our end markets.

We begin 2017 in a stronger financial position than we have been in for many years. We have a focused portfolio as the leading manufacturer of building products and innovative solutions around the world. We have a leaner cost structure with opportunities for further margin expansion over time. It's an exciting time at USG.

2016 was a year of strategic repositioning. On our last call, I laid out four strategic priorities. Let me take a minute to update you on each of these. The first priority is ensuring a smooth transition of our legacy L&W Supply business to ABC Supply. We finalized the sale of L&W at the end of October and while we are still in early days, I'm pleased to report a successful first three months of this new relationship. The overall transition of the L&W business to ABC is exceeding our expectations. Our conversations with other customers are highlighting meaningful and tangible opportunities to grow our business now that we have eliminated channel conflict in wallboard. Ensuring stability by executing an orderly transition of L&W continues to be a top priority. Early indicators are certainly positive.

The second priority is our continued focus on cost containment. SG&A as a percentage of revenue declined as our sales were up 4% in 2016 and our adjusted SG&A was $12 million less than 2015. I expect our focus on the smart deployment of SG&A along with emphasis on operational efficiencies that lower our breakeven to continue.

The third priority was strengthening our balance sheet and we did just that. We used the proceeds from the L&W sale along with our strong free cash flow generation to retire $1 billion of adjusted debt in the fourth quarter, $1 billion.

We are now within our desired leverage range of 1.5 times to 2 times net debt to EBITDA. Our strengthened balance sheet and our targeted leverage ratio allow us to focus on the fourth priority, the effective deployment of capital.

Last fall, we announced an investment program in Advanced Manufacturing that we expect to be high return, low risk. Today, I'm pleased to announce that our board has authorized a $250 million share repurchase plan which we expect to execute over the next 12 months to 18 months. We'll fund the repurchases which represent roughly 6% of our market cap at current prices from free cash flow. This is a great milestone for the company.

These strategic initiatives position us well for 2017. Our uses of cash flow and capital allocation should look much different. One, we're not planning any further debt paydown this year. Two, our interest bill has essentially been cut in half from $145 million last year to about $75 million this year. Three, we've been lean with capital expenditures over the past few years, and now it's time to reinvest back into our manufacturing business, increasing CapEx from $83 million in 2016 to around $200 million this year. This strategic use of capital is an addition to the $250 million we've authorized for share repurchases.

Now, let me offer some brief commentary on our full year financial results that were bolstered by these strategic moves. In 2016, we expanded adjusted operating margins in all of our businesses. 130 basis points of improvement to 17.4% in U.S. Gypsum, 490 basis points of improvement to 22.1% in U.S. Ceilings, an annual record, and 270 basis points of improvement to 15.3% in USG Boral.

Additionally, we generated about $675 million of adjusted EBITDA, over $100 million of improvement compared to 2015 and USG Boral outperformed our expectations with our portion of adjusted net income increasing almost 20% in 2016.

Finally, I'd like to thank all of our employees for their tireless efforts in generating these results. And I'd also like to highlight recognition we all received for our long-term dedication to safety. In the fourth quarter, USG was honored to be the 2016 recipient of the National Safety Council's Robert W. Campbell Award, which is one of the most prestigious awards a manufacturing company can receive. This award recognizes organizations that achieve business excellence by integrating environmental, health and safety best practices into business operations. We were also recognized as one of Canada's safest companies. I'm grateful for and proud of our employees. Overall, we had a successful year in 2016 and expect to build off of this positive momentum in 2017.

Now, I'll turn it over to Matt to go through our financial details.

Matthew F. Hilzinger - USG Corp.

Thanks, Jenny, and good morning, everyone. Let me just tell everybody that I've got a raspy voice this morning, so you might want to turn your headsets up so you can hear everything that I'm going to say. But I'd just like to start this morning off reiterating Jenny's excitement for what our team did in 2016. The balance sheet is strong, our operating cost structure is the lowest it's been in decades and we've repositioned the portfolio strategically. I mean, honestly, we're in a great position to continue to grow our return on invested capital. So, I'm very excited.

Before getting into the fourth quarter results, I'll start with a reminder. L&W results continue to be recorded through discontinued operations and all prior period financial information has been recast to exclude L&W. So, our financial statements and earnings materials are all on an apples-to-apples basis.

On our bridge from GAAP to adjusted results, I want to acknowledge that we have more adjustments than usual this quarter, but that is almost entirely due to the fact that we sold L&W. The gain on sale, debt retirements, pension settlement and lease exit costs are all related to the L&W transaction. So, let me take a minute and I'll explain kind of each component.

First, we excluded the gain from the sale of L&W and the operating results for L&W in the month of October, which nets to $275 million. Second, we excluded a pension charge of $17 million as a result of lump sum settlements taken by employees. Third, we excluded $4 million of cost to exit lease space associated with L&W. Fourth, we excluded a $32 million charge associated with our $600 million of early debt retirements from calling our 2020 and 2021 notes. And lastly, through our USG Boral joint venture, we excluded $4 million of a non-cash asset impairment charge related to our portion of certain assets, operating assets, in Oman.

For a more detailed reconciliation of our GAAP to adjusted earnings, just go take a look at slide 20 in the appendix of today's slide presentation. It's all laid out there for everybody.

Now, let's dive into the numbers for the quarter, starting with consolidated results. Net sales were up 2% to $734 million. Adjusted operating profit increased $3 million to $96 million and adjusted EBITDA was up 7% to $148 million. We generated $65 million in adjusted net income and $0.44 of adjusted diluted earnings per share in the fourth quarter. We also had a $21 million tax benefit run through our tax expense line, a result of certain tax planning strategies executed during the quarter, which I'll discuss more in a few minutes. We've included this benefit in adjusted results because it drives cash savings to the corporation. It's a real benefit.

So, with that, let's go to the segments. In the Gypsum segment, net sales for the fourth quarter were up 3% from last year to $627 million. Adjusted operating margin was up slightly to 13.9%, and that includes a $3 million unfavorable foreign exchange charge. The headline for you really is in Gypsum. It's really the wallboard, surfaces and substrates areas that drove $7 million in profit improvement in the fourth quarter.

Total wallboard volumes in the U.S. were up 2% year-over-year, but they were up over 7%, if you exclude export sales primarily to Canada. The reduction in our export volumes is due to an anti-dumping tariff in Western Canada initiated in September of 2016. As a result, we served our Canadian customers with more wallboard manufactured in Eastern Canada and exported less wallboard from Western United States. From a North American perspective, this dynamic didn't have a material impact on our total shipments, but it does skew our U.S. wallboard volumes relative to industry data which captures export volumes in the total U.S. wallboard volume figure.

These lower export volumes, coupled with lower volumes in the South Atlantic region in the U.S., represented roughly 80% of our volume shortfall relative to the industry. The South Atlantic area just continues to be a highly competitive area and one where we really manage our price and volume relationship.

It's very important to note that our year-on-year volumes were not, let me repeat, not impacted by our transition with L&W. As Jenny mentioned, our wallboard business with ABC Supply through the first three months post transaction has been in line with our expectations. We're very pleased.

Regarding wallboard price, our all-in price was effectively flat year-over-year and down 1% domestically on a sequential basis and that was primarily as a result of our transition of the L&W business to ABC Supply. Again, we are balancing price and volume across a competitive environment and we really look at the fourth quarter results as having held our price.

In mid December, we announced a price increase on wallboard products for January 23. So, while there was likely some pre-buy in December, we believe that the majority of the pre-buy will be contained in the month of January.

Cost for the fourth quarter were nominally lower year-over-year, which was consistent with my expectations. The net $1 million tailwind was driven by lower natural gas pricing and manufacturing efficiencies and partially offset by inflation and labor, paper and synthetic gypsum.

Moving to surfaces and substrates products, we had a good finish to the year and generated $3 million of incremental profit in the fourth quarter. The improvement was driven by 6% revenue growth across the whole portfolio, led by joint treatment and Durock.

Our Canadian and Mexican Gypsum operation showed nice improvement during the quarter, driven by higher pricing in wallboard in Canada, and stronger joint treatment volumes and lower SG&A in both countries. The price improvement we saw in Canada is due the general price increase that was effective September 2016, plus the impact of higher prices in Western Canada due to the recent anti-dumping tariff. Given the wallboard tariff situation I spoke about earlier, we will likely shift more production to Eastern Canada, where our Canadian board plants are located and import less board from the United States.

And lastly, I want to remind everybody that for both Gypsum and Ceiling segments, we have recasted adjusted operating results for prior periods as the sales and profits of Gypsums and Ceilings to L&W are only recorded to the extent L&W sold through their USG purchases to end customers during the period. So there's no change to profits over time but there's some small timing differences between quarters relative to what we presented before. For the fourth quarter of 2015 that resulted in a $6 million increase to adjusted operating profit in last year's recast fourth quarter results, which is why we're calling it separately in our operating profit bridge.

You'll also see this phenomenon in our upcoming first and second quarters but to a much smaller extent. I'll refer you to slide 14 to see the recast numbers by segment so you can get a sense of the magnitude of a similar adjustment that you'll see in the first and second quarters of 2017.

Moving to Ceilings, I'd characterize the quarter as a solid finish to a record year. Fourth quarter net sales were down 3% to $109 million this quarter but adjusted operating margins for the segment were up 40 basis points to 16.5% on cost efficiencies in the U.S. Ceilings business. Pricing was essentially flat in the U.S. on our tile and grid products, although we did see a slight mix shift towards premium ceiling tiles which we've been seeing over the past few years. Costs, as I mentioned, were down slightly on lower natural gas pricing and manufacturing efficiencies partially offset by higher steel cost.

U.S. Ceiling volumes decreased low-single digits across tile and grid products primarily due to lower exported tile volumes to Mexico and Latin America but domestically, volumes were essentially flat. For the full year, our total Ceilings volumes were up low-single digits consistent with our original guidance, and that's what we also expect in 2017.

Moving to USG Boral, this segment continues to make really good progress with adjusted margins in the fourth quarter up 110 basis points to 15.3% due primarily the strong plasterboard volumes and continued Sheetrock next-gen board conversion.

The JV's total net sales were $274 million, up $13 million from the prior year. Adjusted net income of $32 million was up $2 million from the prior year with USG's portion of the JV's adjusted net income increasing by $1 million to $16 million, which excludes our share of the asset impairment charge for Oman.

Plasterboard volumes across the entire JV were up 6% and plasterboard price improved across most regions. Market conversion from standard plasterboard to Sheetrock next-gen board increased sequentially by 500 basis points to 32%. Adjacent products continue to grow with steel stud volumes up 22% and ceiling volumes improving over 40%.

Now, let me touch on a few corporate items and balance sheet matters for the fourth quarter before getting into our 2017 financial outlook. Starting with SG&A, our fourth quarter adjusted SG&A of $77 million was flat with the prior year. Please note that our adjusted SG&A for the quarter and year excludes a $14 million charge related to pension settlements cost and also cost to exit office space associated with the sale of L&W and I mentioned these in my opening remarks. We ended the year with adjusted SG&A at $290 million, which was $12 million below 2015. So kudos to the whole USG team for making that happen.

Moving to the balance sheet, as of December 31, 2016, our total all-in debt, which includes pension and OPEB liabilities and lease obligations amounted to $1.1 billion, a $1.2 billion reduction from the end of 2015. Based on our 2016 adjusted EBITDA of $674 million, our net debt to EBITDA ratio now stands at roughly 1.7 times, which is within our target leverage range of 1.5 times to 2 times.

Regarding income taxes, our effective tax rate for the fourth quarter was favorably impacted by $21 million tax benefit, which I noted in my opening remarks. We were able to generate these benefits through some tax planning strategies and the sale of L&W and our growing profitability were also critical to unlocking the value of certain foreign tax credits that we could not have used previously. So, kudos to Dan Ryan, our Chief Tax Officer, and his team.

Now, let's shift gears and move to our financial outlook for 2017. Jenny will cover out market outlook in a few minutes, so I'll keep my comments focused on costs and the balance sheet side of things.

With respect to input costs in the Gypsum business, we expect our total net input cost to be up about 1% to 2% driven by continuation of mild inflation that we saw throughout 2016 but without the strong tailwind of natural gas. In 2017, we expect our all-in natural gas cost to essentially be flat with last year.

It's a similar story in our Ceilings business as we expect 1% to 2% inflation in our Ceilings manufacturing costs with rising steel cost being offset by manufacturing efficiencies. And while we expect inflation in both of our businesses in 2017, we will continue to find ways to offset inflation with Lean Six Sigma and other manufacturing efficiencies.

Moving to SG&A, I expect annual SG&A to come in around $300 million in 2017, which is a slight increase over our adjusted SG&A of $290 million in 2016. This increase is driven by some modest inflation in our labor costs and investments in both growth initiatives and advance manufacturing. With that said, we are really finding ways to continue to reduce costs through greater efficiencies and, again, we're going to be really focused on every dollar we spend.

Moving to foreign exchange, based on where currency rates were as of the end of December, we expect foreign exchange to be about $14 million headwind to operating profit in 2017. The majority of this impact should land in the Gypsum business. With the peso's significant weakening against the U.S. dollar, our Mexican business is expected to face the stiffest FX headwind. And while we're on the topic of Mexico, I would point out that our U.S. imports and exports of finished goods to and from Mexico are just not that significant. So, from a regulatory and political standpoint, we don't have a lot of underlying Mexican exposure, just foreign currency exposure.

Regarding interest expense for next year, given our $1.1 billion of debt retirement in 2016, net interest expense should come down sharply in 2017 to under $75 million. That's a $70 million benefit compared to our total interest expense of about $145 million in 2016.

We also intend to refinance our last high interest rate debt this year. Specifically, we have $500 million note due in January of 2018 at a current rate of 8.25%. We also intend to refinance our credit facility in 2018 as well.

Regarding income taxes, given our tax shields, our cash, tax payments and cash tax payment should continue to hover around $2 million a quarter primarily for foreign taxes. That said, in 2017, we'll record consolidated book tax expense at an estimated rate of between 31% and 34%.

The tax planning strategy that I mentioned earlier has also shifted the composition of our overall tax shields and this is good news. As of December 31, 2016, we had roughly $1.5 billion of tax shields for U.S. income. About $1 billion of that shield is comprised of federal NOL, and the remaining $500 million consist of various tax credits. So, as you think about the cash flow power of USG, just take note that we'll pay no income tax in the U.S. on the next $1.5 billion of U.S. earnings. Pretty amazing.

Moving to capital spending, excluding our Advanced Manufacturing investments, I expect our capital budget to be in the ballpark of $120 million in 2017. As I said before, we expect to make around $80 million of Advanced Manufacturing investments in 2017. So, all-in, we anticipate investing around $200 million of capital in 2017.

As a reminder, our Advanced Manufacturing program is a $300 million total investment over four years that will improve the quality, lower our manufacturing cost and increase our operating margins. And at the conclusion of the program, we expect Advanced Manufacturing to drive an additional $100 million in an incremental annual EBITDA.

We're making investments now to ramp up Advanced Manufacturing, and I expect a $5 million to $10 million headwind to operating profit in 2017 as we make those investments. While this will dampen operating margin expansion in the near term, these investments are expected to flip to a net operating profit benefit by 2018. I mean, I'm very excited about this program, and all of us at USG look forward to delivering on our commitment to you.

Before I hand it back to Jenny, let me briefly touch on our upcoming first quarter. As you recall, industry volumes, industry wallboard volumes particularly, in the first quarter last year were up north of 25% on a year-over-year basis. This was primarily due to the shift in pre-buy activity from the fourth quarter in 2015 to the first quarter of 2016. In addition, we had significant cost tailwinds in the first quarter of 2016 due in large part to natural gas. So, these items drove very strong results in our Gypsum business and a record quarter in our Ceilings business. I mention this only to help ensure that your models are thoughtfully prepared and that expectations for the first quarter of 2017 consider this dynamic.

So with that, let me turn the call back to Jenny and let her walk through thoughts around our end markets in 2017.

Jennifer F. Scanlon - USG Corp.

Thanks, Matt. I'm optimistic about the opportunity in front of us this year. All of our businesses should benefit from the growth that we expect in each of our end markets. I expect our earnings per share to grow as we drive our segment profits, benefit from lower interest and execute our share repurchase program. In the U.S. end markets, we expect continued strength in household formations, personal wage growth and consumer confidence, all of which should support increased new residential starts from the $1.17 million we saw in 2016 to around $1.25 million in 2017.

The commercial markets we serve, primarily office, retail, education, hotel and healthcare, these markets continued to show signs of modest acceleration. For these sectors, we expect starts to be up in the low to mid single-digit range in 2017.

We also expect growth in the commercial and residential repair and remodel markets with office vacancy rates and existing home sales both trending in positive directions. We expect our R&R markets to be up mid single-digits.

Specifically in our Gypsum business, we'll be focused on continuing a smooth L&W transition. We will focus on profitably growing surfaces and substrates products. Given the backdrop of improving end markets, both residential and commercial, we expect industry wallboard shipments to increase in the mid single-digit range this year. As Matt said, we announced a wallboard price increase effective January 23.

On the flipside, we anticipate some mild inflation in our manufacturing costs and our year one investments in Advanced Manufacturing should drive some incremental costs which are not expected to be offset until 2018. I expect our surfaces and substrates products will outperform 2016.

In Ceilings, we expect to see the product mix continue to shift toward more premium products, and we will continue to work hard to keep our cost structure low and offset inflation. We expect a low single-digit level of improvement in our overall Ceilings volumes and like our wallboard business, we announced a Q1 price increase.

In USG Boral, I expect that we'll deliver mid single-digit earnings growth as we see plasterboard demand growth in the mid to high single-digits in 2017. The construction markets in Australia and South Korea may be a bit overheated at the moment, but USG Boral is well-diversified geographically and we expect any contraction in those particular markets to be offset with growth across other Southeast Asian countries.

So with that, operator, at this time, let's open the call for questions. And please, as Ryan said, I'm reminding everyone of one question per participant.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. And our first question comes from Kevin from Northcoast Research.

Kevin Hocevar - Northcoast Research Partners LLC

Hey. Good morning, everybody. Wondering if you could comment on – on slide 7, you show that U.S. wallboard price was a positive $2 million contributor to the segment EBIT during the quarter. And it seemed like there was a lot of moving pieces there. I think you called out domestic price was down 1% sequentially, and L&W was a factor there. So, wondering if you could comment on how that was up $2 million with pricing down a little bit sequentially domestically and how the impact of the mix in exports impacted that as well as your outlook for 2017 for pricing, given these factors as well as the price increase you have outstanding.

Jennifer F. Scanlon - USG Corp.

All right. Thanks, Kevin, for that compound question, but we will try to tick them off in order here. The first thing, just on wallboard price and the way that exports affected share and price as well as the transition to L&W, I mean, our headline is always that we run the math and we focus on the economic equation of balancing price and volume. And so, without exports, as we said, we were up 7% versus 11% in the industry, and we balance this by keeping price relatively flat.

What we believe on price is that the industry is going to continue to trend in a direction where premium product matters and we intend to continue to get paid for the value that we deliver. That said, there is some noise and complexity around the share and the effect on exports.

The Gypsum Association is the external independent association that reports on share and what they report on reflects U.S. production and that defines it to include exports. We've been in the Canadian market for 100 years. We've got five manufacturing plants and 700 employees there, and so we're a national player across both U.S. and Canada, and we make decisions about the markets in Canada separately from the markets in the U.S.

But every day, we do make decisions about the best facility to manufacture and deliver each customer order, and in recent years, because of the proximity of our Rainier plant to Western Canada, as well as the FX position, we shifted more production to the Western United States for delivery into Western Canada. But in the fourth quarter, because of the tariff, we shifted more production away from Western U.S., and we shifted that over to our Eastern Canadian plants. And so, what has happened is that across U.S and Canada, across North America, volumes stayed the same as far as what ultimately got shipped to each country. And that there's certainly no impact on our decisions about price and volume in the United States based on what's happening in Canada.

So, in summary, think about our price the way that we always think about it, which is, we want to get paid for value. And we believe that a percentage of price is more valuable to us than a percentage of volume.

Matthew F. Hilzinger - USG Corp.

Yeah. So, Kevin, I'll add onto that. Since you asked a long question, you get a long answer, I guess. But let me just add in three dimensions, talk a little bit about the volume, the impact on price on slide 7, and then just think about how this tariff flows through the P&L in both the fourth quarter, and how to think about it in 2017. So, our exports typically are about 10% of our production here in the U.S. That dropped to about 5% in the fourth quarter. And as Jenny said, we would expect to see that drop and see that production shift over to Canada. I guess, the overall takeaway, and Jenny said this, it's not really meaningful, and it virtually has no impact on the U.S. business. So, you'll see a shift from some exports into Canadian production, and that's okay. We're good with that.

In terms of price, there is a small impact to the all-in price because we were selling product before the tariff. We were selling product at basically cost plus 10%. And since that volume went down, we're selling less product at a lower price, right? And so, that effectively makes the all-in price go up. So, that's kind of the mechanics of why we saw the all-in price go up, but if you think about where we are in the U.S., it's effectively flat, then it was down 1% sequentially. So, that's how I would think about price.

And then in terms of how to think about this in terms of the P&L, on slide 7, there's a line in there that says Canada and Mexico, a positive $7 million, and just bear with me for a moment. Part of that is Mexico, about $1 million of that is Mexico, about $1 million is efficiency, $1 million is surfaces, which leaves about $4 million of price that we saw in Canada. About half of that, or $2 million, is really the general price increase that we got. So, next year, you could probably see somewhere between $5 million and $8 million of incremental profit in Canada because of just the general price improvement that we got back in September.

The second piece is about $2 million as a result of the tariff, right? And that is because we're selling product that was produced in Canada at higher prices in Western Canada. Again, that was about $2 million. So, I hate to extrapolate that. I mean, it's possible that next year, based on the tariff, that Canada could have anywhere from zero to maybe $6 million or $7 million of additional profit, but it's not done yet, right? The proceedings are not yet done. I mean, we're still waiting for the Canadian Ministry of Finance to go through and give a final ruling on this. We're just not sure where that's going to be. But that's how I would think about kind of Canada and volumes and price as a result of the tariff.

Operator

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

Robert Wetenhall - RBC Capital Markets LLC

Hey, good morning and thanks for the detail. I kind of wanted to go big picture because you guys drilled down so deeply. Sounds like lot of momentum going into 2017. I was going to ask Jen, you had a really good year. You're six months into the job now as CEO, the business is in great shape, especially the balance sheet after paying down debt. You've gotten militant on cost management on the SG&A side. I think that goes to math. And now, you've also announced some pretty big plans to double CapEx spend and this large $250 million buyback. So, that's like an incredible amount of stuff to do in someone's first six months in a role. What's next on the agenda and how do you see this unfolding in your new leadership position? Thanks.

Jennifer F. Scanlon - USG Corp.

Thanks, Bob. I appreciate it, and you know I love talking big picture. What's next on the agenda is flawless execution. We've got to make sure that we continue to execute the L&W transition in an orderly process. It's going very well, particularly when you think about the complexities not just of shifting L&W to an independent customer, but also taking 140 branches and 2,200 people transferring out of being part of USG and into a new organization. So, we're very, very focused on ensuring that that L&W transition continues to go as smoothly as it's gone since November 1.

The second flawless execution piece is around our uses of capital and investing in our business. And so, as Matt commented, and we both commented on Advanced Manufacturing, those projects are still in early days, but really getting that flywheel turning and getting the ones that are in progress repeated across similar plants and making sure that the significant step change that we have going on in our manufacturing organization continues to exceed our expectations. We've also got some other capital planned, as Matt said, where we're investing both where we've historically in recent years have not invested as heavily in some of our maintenance projects. But also we've got a lot of growth capital that we're focused on and contemplating, and certainly addressing the high-growth regions of the country for that.

And then we'll also be, from a big picture perspective, looking opportunistically if there are tuck-in acquisition opportunities for particularly our substrates, surfaces and Ceilings businesses. It's number four on our list of priorities on how we use capital, and we've got to continue to flawlessly execute on both investing in our business and doing buyback appropriately, but there's a lot of options out there for the future. And I'm really optimistic that we're going to do it well.

Operator

Next question comes from Ivy Zelman, from Zelman & Associates.

Ivy Lynne Zelman - Zelman Partners LLC

Good morning, and thanks for taking my questions. Congratulations, guys. It's interesting to hear all the initiatives and all of the things that you're doing that are going to bring you guys to a level of profitability that we're excited about. A lot of people on the call, it might be helpful on the Advanced Manufacturing over a four-year timeframe with the total CapEx for that today only being $80 million in 2017, recognizing you expect to generate over $100 million. What would maybe helpful, Jenny, is to kind of give us why this is such a critical investment. And why can't you do it faster? And $100 million, how are you going to measure the success of this? How are you going to let us know it's going well? What are some of the things that we're going to be able to hear quarter to quarter that we know that it's being executed flawlessly and it's working and why not faster and sooner? Thanks, guys.

Jennifer F. Scanlon - USG Corp.

Thanks, Ivy. I appreciate that. And I do like the idea of faster and sooner, but we have to acknowledge the fact that these are a series of projects that we consider low risk because this is in our wheelhouse. Our technical services, engineering and manufacturing teams along with our CIC, they're really good at finding ways to continuously improve our business. This is larger scale, and what makes it so important is that we do see it fundamentally improving our cost structure for the long term. This is all about dropping cost improvements to the bottom line. And so we want to make sure that each investment, each one of these series of projects, we've completed four, we've got 19 in progress today and 27 additional planned for this year. We need to make sure that each of those stand alone as being very good returns on investment and also have that opportunity for being repeatable across similar plans.

So, it's a lot of moving parts. It's a lot of project management, and it's a lot of just rolling up our sleeves and getting things done. And I think that you should expect to hear from me and from Matt on a regular basis how much we're spending and what types of results that we're seeing on those projects. And the challenge on why not faster is we just need everybody mobilized and moving in the right direction and the right amount of project management. We've got that. And so it's a pace issue and a throughput issue. But it's an exciting opportunity and we're pushing it as fast as we can.

Operator

Our next question comes from Stephen Kim from Evercore ISI.

Stephen Kim - Evercore Group LLC

Yeah. Thanks very much and let me add my congratulations. You guys certainly sound like you are very busy. I guess I wanted to drill in a little bit more, again, on the Advanced Manufacturing focus. I guess, what I had in my mind is, since obviously this is a multi-year and long-term focus, I was curious as to what kind of level of production are you optimizing your manufacturing process to? And what kind of flexibility is built into your spend program in order to be responsive to, let's say, any changes in the economic environment. So, just basically a little bit more detail about this manufacturing program that you're implementing. What kind of assumptions essentially are you making about where volumes can go in order to be most optimized to that level and what kind of flexibility do you have baked in?

Jennifer F. Scanlon - USG Corp.

Yeah. Great question, Stephen. Thank you. And what I would say is, again, Advanced Manufacturing is a series of coordinated projects that we can ramp up and ramp down to reflect what we believe are the economic realities of the amount of capital that we have available each year over the time that this is prescribed. So, the approval mechanism is each project has to stand on its own. And our teams have identified each of those projects with the benefits, and we've been very clear on calculating when and how we believe those benefits are available. And so, that is how we ended up prioritizing what projects we focus on first, and then which ones are farther out.

The assumptions with regard to volume that you ask, I think I would think about that a different way. Our real focus is a continuation on lowering our breakeven. And that's what Advanced Manufacturing does for us permanently. And so, it helps us mitigate the risks of the cyclicality of our industry and the rise and the fall of volume levels into the future.

And at the same time, we can take a balanced perspective each year on how hard we want to push and how quickly we can get each of these projects done, given the economic conditions that we're forecasting.

Operator

Our next question comes from Michael Rehaut from JPMorgan.

Michael Jason Rehaut - JPMorgan Securities LLC

Thanks. Good morning, everyone. Question I had was around the Ceilings margins. It's been a huge success for you guys over the last couple of years. In the U.S., in particular, getting almost 600 basis points of expansion in a fairly low growth type of backdrop. Obviously steel being a nice tailwind for you there, but I'm sure a lot of other positive price and other tailwinds helping that margin, how should we think about that going forward? For the full year in 2016, U.S. Ceilings 21.6%. You mentioned that you expect a little bit of input cost inflation, and also some investments going on. So, is there a little bit further upside potential there or could that normalize a little bit to the downside? How should we think about that margin?

Jennifer F. Scanlon - USG Corp.

Yeah. Thanks, Mike. All right, I'm not going to guide on specific margins because we don't do that. But what I do want to continue to emphasize as we talk about Ceilings is that it is a product mix game. And the trends that we're seeing in the architectural community, in the builder community, and even in the owners of buildings is a shift toward the higher-performing premium products. And so right now, our current mix is about 50% what we would consider value-oriented tile and 20% to 25% mid-range and 25% to 30% premium.

So, as they move up the food chain toward the mid-range and the more premium product, margin improvement occurs. And that's what we're positioned to take advantage of. That's where we're investing a lot of our research and new product enhancements in Ceilings is to address these changing preferences.

So indeed, Matt mentioned that we expect to see some inflation this year and we're going to work hard to offset that both through just normal continuous improvement projects, use of our supply chain, but also addressing a portion of our Advanced Manufacturing investment long term into Ceilings.

So, it'll continue to be a higher-margin business for us, albeit overall, mineral fiber ceiling tile is a lower growth element of the market.

Matthew F. Hilzinger - USG Corp.

Yeah. And I would add on to Jenny's comments. We've been talking about this move to premium product and we've seen it virtually every quarter for the last three years, and that's really kind of a structural change in the industry. But we've also continued to get pretty good cost improvement. We improved costs in that business every quarter in 2016 and we are expecting to see some inflation. I would expect that we're going to do everything we can to offset as much of that as we possibly can. But I think when you think about margins, I would put cost improvement as a way to continue to drive margins up in that business.

And then the third area is price. We continue to be able to get one or two price increases a year in both grid and ceiling tiles. We've got price increase coming up this quarter in both tile and grid. So, I can tell you that Jenny and my expectations as well as the whole team running Ceilings is to drive operating profit improvement. So that's the view that we have and we think we can continue to improve that business.

Operator

Our next question comes from John Lovallo from Bank of America Merrill Lynch.

John Lovallo - Bank of America Merrill Lynch

Hey, guys. Thanks for taking my call. I guess my question will be on just nameplate capacity utilization. Where do you guys see that trending in 2017 on an industry basis and then at USG?

Matthew F. Hilzinger - USG Corp.

Hey, John. It's Matt Hilzinger. I'll grab this one real quick. So, in the fourth quarter, the industry was around 77%. The competitors were around 82% and we were running at 62%. So, our sense is, and Jenny talked a little bit about our outlook for next year, I mean, we see mid single-digit growth in the wallboard business and I think we're going to continue to see capacity utilization get absorbed.

As we move into 2017, 2018, and 2019, we're very bullish about the next few years. So, we think that that capacity is going to get absorbed.

Operator

Our next question comes from Garik Shmois from Longbow Research.

Garik S. Shmois - Longbow Research LLC

Hi. Thank you. Congratulations. My question is on surfaces and substrates. You talked a little bit about some of the seasonality in the comps related to the wallboard volume in the first quarter and how we should think about that perhaps for the full year. How should we think about surfaces and substrates in conjunction with the comps and the progression this year? Would it look like it usually does and it matches wallboard volumes, or could there be a divergence just given the timing of the pre-buy? Thank you.

Jennifer F. Scanlon - USG Corp.

Yeah. Thanks, Garik. I think the best way to think about surfaces and substrate, surfaces really does mirror wallboard demand. It's the joint compound that holds the wallboard together. So I think the same trends that you see in wallboard tend to be reflected in surfaces.

Substrates, it's a little different mix. There's still some cyclicality and seasonality, but a lot of our substrates products, they're either water management systems that are going in in multi-unit residential or commercial hotels, the durock under the showers, or our new structural panels which are flooring for low-rise commercial and our roofing products which are for low-slope commercial buildings. So, on some of the substrates, it would really reflect more of the commercial trends than the residential trends.

Operator

Our next question comes from Keith Hughes from SunTrust.

Keith Hughes - SunTrust Robinson Humphrey, Inc.

Thank you. In the prepared text, you talked about the benefits of not being vertical in wallboard but you're seeing some intangible benefits from new customers or increasing share with customers. I guess, my question is moving forward, how quickly does that become tangible? Will you be able to get some wins during the season or will it take another off season for customers to change their mix of where they're buying products?

Jennifer F. Scanlon - USG Corp.

Thanks, Keith. I think it's an ongoing trend. What we're already seeing is a number of customers who have expressed desire to do more business with USG, both small customers and large customers. And I think if you look at our year-on-year volumes of our top five customers, we were up 7% year-on-year. And so that indicates to us that it'll be a orderly dynamic as we continue to shift product to a broader set of customers beyond L&W but that we anticipate not only our top five customers but customers across the board who we've already been selling substrates and surfaces to, to continue to grow with us. And so we're not expecting any dramatic shift. We're expecting an orderly transition.

Keith Hughes - SunTrust Robinson Humphrey, Inc.

Thank you.

Operator

Our next question comes from Philip Ng from Jefferies.

Philip Ng - Jefferies LLC

Hey, guys. I guess, with the favorable mix shift that you've seen in Ceilings certainly has helped on the margin side of things but volumes just seem to have large lag, the underlying trends, whether it's on commercial or residential. Should we expect that demand profile for Ceilings to try closer to underlying trends this year? Thanks.

Jennifer F. Scanlon - USG Corp.

Yeah. I think on volume, I would look at it that way. There's a long tail, 12 months to 18 months from commercial starts to the ceilings going in. But I do want to emphasize that as we're focused on moving our architects and owners to the higher end, higher performing Ceilings products and improving that mix, there is also an element of what we're having our CIC, our research organization focused on, which is expect to see us piloting some other Ceilings products later this year that help address those trends that are broader than just mineral fiber ceiling tile.

Operator

Our following question comes from Tim from Baird.

Timothy Ronald Wojs - Robert W. Baird & Co., Inc.

Hey, everybody. Good morning. I guess, going back to Gypsum a little bit. I know you don't want to give any sort of kind of point estimates or anything like that on margins but just given a lot of moving parts with inflation and pricing and some of the investments in Advanced Manufacturing, is there a way to think directionally how Gypsum margins should trend in 2017? And then, just secondarily, Matt you alluded to the tougher compare in Q1. Is there a way to maybe put a little finer point on what volumes could look like?

Matthew F. Hilzinger - USG Corp.

Thanks, Tim. I appreciate that. Without giving guidance it's a hard two questions to answer. But, look, we have a price increase in the market. We are not yet prepared to talk about what size that is. I mean, you guys can go do your channel checks and if you do please do it in a reputable way and go to a reputable folks. Some of the data out there just gets to be a little bit sloppy. But we've got a price increase out there. And as I said, we would expect kind of the cost side of the equation to go up 1% to 2% depending upon what your assumption is on wallboard price. If it's above that 1%, 2%, you would expect to see some margin expansion.

With that being said, we've also said that there's going to be some headwinds as we go through the transition with L&W. And all those three things need to kind of wash through. But I can tell you this, that Jenny and myself and the rest of the team here at USG are very, very focused on making sure that we serve our customers and we're also very focused on making sure that we grow the profitability of the company.

And so, I know that's kind of a weak answer to a question that you wanted a more specified number to, but we are doing everything we think is appropriate to drive our margin structure up here. There's just a couple of moving parts here, and we'll see how they settle out in the balance of the year. So, I feel good about where we are. I feel good about where we're positioned. And you heard Jenny's excitement. So, overall, I think we're positioned really well on the Gypsum side, surfaces and substrates, as well as Ceilings and Boral. So, I think we're in a good spot.

Operator

Our following question comes from Scott Schrier from Citi.

Scott Schrier - Citigroup Global Markets, Inc.

Hi. Good morning. Thanks for taking my question. I wanted to ask you about how you're thinking about the cadence of free cash flow generation and possibly how that relates to the buyback program. Specifically, it looks like you're calling out some headwinds whether it's some cost inflation going forward. And by the time we might see some of the ceilings and wallboard pricing take hold, are there some near-term headwinds from free cash flow until you can start deploying that into buybacks? I know that you have the big tailwind from a lower interest expense being offset by putting that capital towards the Advanced Manufacturing. Thank you.

Matthew F. Hilzinger - USG Corp.

It's a great question and one that I would answer with – look, we wouldn't have announced the $250 million buyback if we weren't committed to executing on that buyback. And I know there's many buybacks out in various industries that get announced and people don't follow through. Look, we were very thoughtful in putting together this number, the timeframe. And absent a cataclysmic drop in the world or U.S. economy, we intend to go through and carry through with this buyback.

So, we're going to see some variability from quarter-to-quarter. But, again, we're very very optimistic about 2017 and even into 2018 and 2019. And so, we're going to go and execute the program and not worry about what might be minor fluctuations in profitability.

Ryan Flanagan - USG Corp.

And we have time for one other question.

Operator

Our next question comes from Jim Barrett from C.L. King & Associates.

Jim Barrett - C.L. King & Associates, Inc.

Good morning, everyone. Jenny, you commented that you were allocating growth capital for high-growth regions of the U.S. Aside from piloting new ceiling products, could you elaborate on that comment in terms of what you see over the next several years?

Jennifer F. Scanlon - USG Corp.

Yeah. I think there's a couple of things to focus on here. One, within Advanced Manufacturing, as we prioritized which plants we're focused on first. We are focused on the regions of the country where you see the high growth and a lot of that is in the South and the Southeast and South Atlantic. But we're also looking at not just from an Advanced Manufacturing perspective but ways in which to improve just some of our older plants in general and focusing on how we can invest capital in those plants to take advantage of the market growth rates. And so, again, we're very specifically focused on some of our plants that are in the East-South Central and South Atlantic regions.

Matthew F. Hilzinger - USG Corp.

And let me just add on to that. We are very focused on return on invested capital. So, these additional investments that we're making, we don't take lightly. We're very focused on making sure that they're going to add to our return on invested capital and bring shareholder wealth to those that are in our stock.

Jennifer F. Scanlon - USG Corp.

All right. We appreciate your interest in USG this morning. And I think as you heard, 2016 was a transformative year for us and much was accomplished. We've turned the page. We've hit the ground running in 2017. We'll continue to execute the L&W transition in an orderly fashion. We'll begin implementing those high-return investments in Advanced Manufacturing, and we're going to invest in select areas of growth for the future. I expect that 2017 will generate even more value for all USG stakeholders, and I thank you for your time today.

Ryan Flanagan - USG Corp.

Thanks, Jenny. A tape replay of this call will be available until Friday, March 3. Information is available on usg.com. This concludes are conference call. Thank you.

Operator

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

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