Owens Corning

NYSE:OC

Earnings Call Transcript 2018-Q4

[Operator]

Good morning and welcome to the Owens Corning Fourth Quarter 2018 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Thierry Denis, Vice President of Investor Relations. Mr. Denis, please go ahead.

[Thierry Denis, VP of IR]

Thank you and good morning everyone. Thank you for taking the time to join us for today's conference call in review of our business results for the fourth quarter and full year 2018. Joining us today are Mike Thaman, Owens Corning's Chairman and CEO; Brian Chambers, Chief Operating Officer; and Michael McMurray, Chief Financial Officer.

Following our presentation this morning, we will open this one hour call to your questions. In order to accommodate as many call participants as possible, please limit yourselves to one question only.

Earlier this morning, we issued a news release and filed a 10-K that detailed our financial results for the fourth quarter and full year 2018. For the purposes of our discussion today, we have prepared presentation slides that summarize our performance and results and will refer to these slides during this call. You can access the earnings press release, Form 10-K, and the presentation slides at our website owenscorning.com. Refer to the Investors link under the Corporate section of our homepage. A transcript and recording of this call and the supporting slides will be available on our website for future reference.

Please reference Slide 2 before we begin where we offer a couple of reminders. First, today's remarks will include forward-looking statements based on our current forecasts and estimates of future events. These statements are subject to risks, uncertainties and other factors that could cause our actual results to differ materially.

We undertake no obligation to update these statements beyond what is required under applicable securities laws. Please refer to the cautionary statements and the risk factors identified in our SEC filings for a more detailed explanation of the inherent risks and uncertainties affecting such forward-looking statements.

Second, the presentation slides and today's remarks contain non-GAAP financial measures. Explanations and reconciliations of non-GAAP to GAAP measures may be found in the text and financial tables of our earnings press release available on owenscorning.com. Adjusted EBIT is our primary measure of period over period comparisons and we believe it is a meaningful measure for investors to compare our results from period to period. Consistent with our historical practice, we have excluded certain items that we believe are not representative of our ongoing operations when calculating adjusted EBIT and adjusted earnings.

We adjust our effective tax rate to remove the effect of quarter-to-quarter fluctuations, which have the potential to be significant in arriving at adjusted earnings and adjusted earnings per share. We also use free cash flow and free cash flow conversion of adjusted earnings as measures helpful to investors to evaluate the Company's ability to generate cash and utilize that cash to pursue opportunities that enhance shareholder value. For those of you following along with our slide presentation, we will begin on Slide 4.

And now opening remarks from our Chairman and CEO, Mike Thaman will be followed by CFO, Michael McMurray and our Q&A session. Mike?

[Michael Thaman, Chairman and CEO]

Thank you. Good morning, everyone.

As Thierry mentioned, I'm here today with Michael McMurray, our CFO and Brian Chambers, currently our President and COO. As we announced last month, after 26 years with Owens Corning and almost 20 years in executive leadership, I believe this is the right time for me to retire as CEO, effective April 18th.

I will continue as Chairman of the Board and I'm committed to ensuring a smooth and successful transition. I couldn't be more excited that the Board has elected Brian, a strong proven leader with a 15-year career at Owens Corning to be our next CEO, the eighth in the Company's 80-year history. You'll hear more from Brian during the Q&A portion of the call.

Overall, 2018 was a record year with revenues of $7.1 billion and adjusted EBIT of $861 million, up 11% and 1% respectively over 2017. All three of our businesses produced double-digit EBIT margins.

This is the first time in Owens Corning's history that we've had this margin performance across the entire portfolio and all three businesses generated EBITDA margins close to 20%.

We faced about $240 million of inflation and higher transportation costs. We're able to more than cover this with $255 million of price improvement. Before I talk about our financial results, I'd like to give you an update on safety. Our recordable incident rate for 2018 was 0.52, similar to 2017. This is particularly noteworthy given the successful integration of about 4,700 employees from our recent acquisitions.

Also, going into 2019, we established a new record for hours worked between injuries, over 3.3 million hours compared with our previous record of about 2.6 million hours in 2013. This represents nearly a full month injury-free as a company.

Now I'd like to briefly review our financials and our views on 2019. Michael will follow with more detail. In Insulation, revenue in 2018 grew $2.7 billion, up 36%, while EBIT increased to $290 million, up $113 million and 64%, in line with our previous expectations.

Revenue growth was generated mainly by our Paroc acquisition and $128 million in price improvement, primarily in the North American residential fiberglass insulation business.

In Composites, we said that we expected EBIT to be approximately $260 million. For the year, we fell slightly short of this goal with EBIT of $251 million on lower volumes in several core markets. EBIT margins for the year were 12%, reflecting manufacturing productivity and lower operating expenses.

In Roofing, we delivered $2.5 billion of revenue, down 2% with EBIT margins of 17%. Roofing performance for the year was negatively impacted by the reduction in the U.S. market for asphalt shingles as growth in the remodeling and new construction markets were more than offset by lower storm demand.

Despite the decline in the market, I'm pleased to report that Roofing delivered significant price gains of $127 million, exceeding asphalt and transportation inflation. While the business lagged inflation in the early part of the year, we were pleased with our inflation recovery in the second half.

On today's call, you will hear that we are taking a bit of a different approach to our forward guidance. First, you will note that we've moved this call to 9:00 AM so that investors can benefit from our commentary and presentation from this call before the market opens. We are hopeful that this approach will enhance our earnings release.

Second, we intend to provide less guidance related to full year EBIT at the business segment level. We will provide an assessment of our expectations for our markets for the year with more emphasis on near-term expectations to help investors understand the current business performance.

All changes are being made in response to investor feedback and our own analysis on how best to support investor communications. Michael will provide forward guidance in his comments and then he and Brian will lead the Q&A session.

I'm going to end my remarks where I began. We transformed this Company over the last decade with thoughtful and disciplined actions that have built a strong company with three market-leading businesses with an unconditional commitment to safety, working every day to demonstrate our caring for our colleagues.

In Insulation, we've built a strong global business with significant through-the-cycle earnings power. In Composites, we built a business with market-leading platforms in glass non-wovens and glass reinforcements to capitalize on favorable industry trends and market growth.

In Roofing, we've driven durable commercial and operational performance and built a components business that generates above market growth and supports sustainable earnings over time.

And, as an enterprise, we've made significant and steady progress from the end of the last downturn and have produced four consecutive years of record performance. Over the last three years, revenue grew 10% annually. Adjusted EBIT and adjusted EBITDA improved by about $300 million and $440 million respectively, which represents growth of about 15% annually for both these key financial metrics.

Adjusted earnings per share grew at a 24% rate over the same period. Importantly, free cash flow conversion exceeded 100%. All of these indicators demonstrate the strength of our Company. In short, we're a company with an improved competitive profile and strong earnings potential.

With that, I'll turn it over to Michael to further review the details of our performance. Michael?

[Michael McMurray, CFO]

Thank you, Mike, and good morning everyone.

In 2018, we set new records for revenue, adjusted EBIT and adjusted EPS. For the full year, we grew revenue by 11% to over $7 billion and delivered adjusted EBITDA of $1.3 billion. In 2018, all three businesses returned EBITDA margins close to 20%. Revenue and EBIT results finished in line with expectations for the fourth quarter although free cash flow trailed expectations. I will comment more on this later in my prepared remarks.

We delivered strong operational, commercial execution in the fourth quarter despite the challenging market conditions we highlighted on the third quarter call. During the quarter, we continued to make substantial progress on price. The actions taken in 2018 have delivered over $250 million of price improvement for the year, offsetting inflation and higher transportation cost for the Company.

Now, let's start on Slide 5, which summarizes our key financial data for the fourth quarter. You'll find more detailed financial information in the tables of today's news release and the Form 10-K. Today, we reported fourth quarter 2018 consolidated net sales of $1.7 billion, up 7% and over $100 million compared to sales reported for the same period in 2017, primarily driven by our Insulation business.

Adjusted EBIT for the fourth quarter of 2018 was $228 million, up 6% compared to $215 million in the same period one year ago. Adjusted EBIT for the quarter improved to a record level, despite more challenging market conditions and persistent inflation. Our quarterly adjusted EBIT margin of 13% was in line with last year.

Net earnings attributable to Owens Corning for the fourth quarter were $171 million, compared to a $4 million loss in the same period last year. Adjusted earnings for the fourth quarter of 2018 were $152 million or $1.38 per diluted share compared to $125 million or $1.11 per diluted share in 2017.

Depreciation and amortization expense for the quarter was $110 million, up $8 million as compared to the fourth quarter of 2017. The year-over-year incremental depreciation and amortization from our Insulation acquisition was partially offset by lower accelerated depreciation associated with the prior year's Composite restructuring actions. For the year, depreciation and amortization expense was $433 million.

Our capital additions for the year were $542 million, up $140 million versus last year, primarily driven by growth in productivity projects. In the fourth quarter, we took advantage of downtime to accelerate our 2019 capital program.

In addition, we closed on a small non-wovens acquisition that was treated as CapEx in the fourth quarter. As a result, capital additions tracked a bit higher versus our previous expectations. Free cash flow declined just over $400 million and was below our expectations. The main drivers of the year-over-year decrease were higher inventories and higher capital spend.

Higher inventories were driven by inflation, the deceleration of demand we experienced in the second half, and a purposeful build in synthetic roofing underlayments in advance of potential tariffs. Although free cash flow was below our expectation, conversion exceeded 100% for the last three years.

On Slide 6, you'll see the detail of our full year 2018 adjusting items, reconciling our 2018 reported EBIT of $821 million to our adjusted EBIT of $861 million. For the full year, our adjusting items totaled $40 million, $19 million were primarily related to restructuring charges resulting from actions announced last year to strengthen the Composites' low delivered cost position and $21 million were acquisition related costs in our Insulation business.

I'd like to highlight a couple more items related to adjusted EPS. We've adjusted out a $32 million non-cash income tax benefit from a fourth quarter tax litigation settlement in Europe. This was related to the Paroc acquisition and represents a significant win. Also, we finalized our accounting for U.S. tax reform legislation that was enacted in 2017, which resulted in a minor update in 2018 to our original estimates. These adjustments are described in more detail in the notes of our 10-K.

Now please turn to Slide 7 where we provide a high-level review of our adjusted EBIT performance, comparing 2018 to 2017. Adjusted EBIT increased by $6 million. Insulation EBIT increased by $113 million as compared to the prior year.

Composites EBIT decreased by $40 million and Roofing EBIT decreased by $101 million. General corporate expenses were $114 million, a $34 million improvement versus the prior year, primarily due to lower performance-based compensation.

With that review of key financial highlights, I ask you to turn to Slide 8 where we provide a more detailed review of our business results, beginning with our Insulation business. Sales in Insulation for the fourth quarter were $732 million, up 23% from the same period a year ago, primarily on strong price realization and the contribution of the Paroc acquisition, partially offset by lower sales volumes.

EBIT for the quarter was $115 million, up $36 million compared to the same period in 2017. The EBIT improvement was driven primarily by strong price execution and the contribution of Paroc. These benefits were partially offset by persistent materials and transportation inflation and lower sales volumes. Insulation delivered strong quarterly EBIT and EBITDA margins of 16% and 22% respectively.

For the full year, insulation sales were $2.7 billion, up 36% compared to 2017 on the contribution from our acquisitions and higher selling prices. EBIT for the full year of $290 million was $113 million higher as compared to 2017. The benefits from higher selling prices and our acquisitions were partially offset by materials and transportation inflation and higher furnace rebuild costs.

For the full year, we delivered EBIT and EBITDA margins of 11% and 18% respectively. Although we continued to face challenging market conditions in the fourth quarter, commercial execution was strong across the Insulation segment, with particular strength in our U.S. residential business. We delivered significant price progress in 2018 with further price progress in the fourth quarter.

For the full year, we delivered almost $130 million of price improvement, including $41 million in the fourth quarter. Also, we implemented an additional pricing action in January in our U.S. residential business.

Earlier this month, we celebrated the one-year anniversary of our Paroc acquisition. I'm pleased to report that the integration is progressing per plan. Paroc delivered solid results in the fourth quarter with EBITDA margins of 18%.

In 2019, we expect a flat macro outlook for the North American residential fiberglass insulation business. In this business, we expect price carryover from 2018, progress from our early 2019 announcement, and any additional pricing actions to be offset by the financial impact of lower volumes and production curtailments.

Given this outlook and our expected lower share of the market in the first half, we made significant moves to adjust our North American fiberglass insulation capacity to meet the current demand environment.

Most notably, we recently took the decision to take one of our production lines in Santa Clara, California cold in the first quarter. The actions we have taken in regards to capacity reductions have been decisive and are consistent with running this business for long-term profitability. The financial impact of the curtailments will be particularly heavy in the first quarter.

In the technical and other building insulation businesses, we expect revenue and earnings growth, driven by improved operating performance and global growth in construction and industrial insulation markets. We expect improved operational performance in our U.S. business and strong organic growth in Europe with the start-up of our new mineral wool facility in Poland. We also expect to get good organic growth across the globe in most products.

In the near-term, our progress in our technical and other building insulation businesses will not overcome the financial impact of lower volumes and curtailment actions in our North American residential fiberglass insulation business. As a result, we expect first quarter 2019 EBIT in Insulation to be positive, but significantly lag last year.

Now, I'll ask you to turn your attention to Slide 9 for a review of our Composites business. Sales in Composites for the fourth quarter were $481 million, down 5% compared to the same period in 2017. The decrease was driven by negative foreign currency translation and slightly lower sales volumes.

EBIT for the quarter was $56 million, down compared to $74 million in the same period last year. The decrease was primarily driven by higher inflation and to a lesser extent, lower sales volumes.

Full year sales were $2.0 billion, down 1% compared to the same period in 2017, on lower sales volumes and stable pricing. Sales volumes were down 2% as broad overall market growth was offset by weakness in a few core markets, particularly the U.S. roofing market. The business delivered full year EBIT of $251 million, which was down $40 million from the prior year as higher inflation, higher rebuild and start-up cost, and lower sales volumes more than offset improved manufacturing and lower operating expenses.

Composites maintained double-digit margins for the full year delivering EBIT and EBITDA margins of 12% and 20% respectively. From a cost perspective, we expect that our recently completed low-cost India facility expansion, strategic supply alliances in Asia, and our previously announced high-cost melter restructuring actions will drive manufacturing productivity and improve our cost position in 2019 and beyond.

In 2019, we expect growth in the glass fiber market, consistent with global industrial production growth with a more uncertain global economic environment. We expect volume growth in line with the broader market and improved operating performance will be offset by inflation.

One additional item of note in Composites, we are seeing good volumes at the start of 2019, but we expect first quarter 2019 EBIT will lag last year primarily due to continued inflationary pressures and a planned furnace rebuild in South Korea.

Slide 10 provides an overview of our Roofing business. Roofing sales for the quarter were $546 million, down 3% compared with the same period a year ago. Lower sales volumes, partially offset by higher selling prices, primarily drove the decline.

In the fourth quarter, our sales volumes trailed market shipments, which we believe was primarily as a result of distributor year-end buying activity with other manufacturers. We believe this late season activity was driven by the desire to achieve rebate gains and is not totally reflective of underlying end market demand.

Sales for the full year were $2.5 billion, a 2% decrease versus the prior year. The U.S. asphalt shingle market declined by 5% as growth in remodeling and new construction markets was more than offset by lower storm demand. Higher selling prices partially offset the lower sales volumes. Full year EBIT was $434 million, a $101 million decrease from the prior year primarily due to lower sales volumes.

For the full year, Roofing delivered pricing improvements that exceeded asphalt and transportation inflation. Our contribution margin dollars per unit consistently improved since the beginning of 2018 as we successfully implemented multiple pricing actions despite a weaker demand environment. For the full year, Roofing delivered strong EBIT and EBITDA margins of 17% and 19% respectively.

Contribution margins entering 2019 are healthy, despite asphalt and transportation inflation that was persistent for much of 2018. Asphalt prices moderated at the end of 2018, but moved higher in February, despite the weakness in the price of oil. In addition, we are anticipating further asphalt inflation in the first half. As a result, we've announced a price increase that will be effective in April.

The Roofing business is positioned to deliver another strong year in 2019. We expect relatively flat U.S. asphalt shingle end market demand with industry shipments slightly below last year, assuming average storm demand. We expect an above-market volume opportunity for Owens Corning resulting from favorable geographic mix and a higher share of industry shipments in 2019.

I wanted to highlight the expectations for first quarter volumes. If you recall last year, there was significant storm volume carryover into the first quarter and an outlook for a significant asphalt and transportation inflation.

In addition, manufacturers had announced multiple price actions during the first quarter of the year. The market environment is different this year and as a result, we anticipate our volumes will track lower than last year.

Now let me turn your attention to Slide 11, which provides an overview of significant financial matters. We repurchased 2.9 million shares of the Company's stock in 2018, leaving 4.6 million shares available for repurchase as of the end of 2018 under our current authorization.

During 2018, we returned $203 million of cash directly to shareholders through share repurchases and $92 million through dividends. The Company's Board of Directors declared a cash dividend of $0.22 per share payable on April 2nd, 2019 to shareholders of record as of March, 8th, 2019. The dividend has grown an average of 7% per year since its inception.

Now please turn to Slide 12, where I provide more context on our business outlook for 2019. For 2019, the Company expects an environment consistent with consensus expectations for global industrial production growth, U.S. housing starts and global commercial and industrial construction growth.

In Insulation, the Company expects a flat macro outlook for the North American residential fiberglass insulation business with positive pricing momentum, offset by lower volumes and production curtailments. In the technical and other building insulation businesses, the Company expects earnings growth driven by improved operating performance and growth in global construction and industrial insulation markets.

In Composites, the Company expects growth in glass fiber markets consistent with global industrial production growth. With a more uncertain global economic environment, the Company expects volume growth and improved operating performance to be offset by inflation.

In Roofing, the Company expects relatively flat end market demand with industry shipments slightly below last year, assuming average storm demand. For Owens Corning, the Company anticipates a favorable geographic mix comparison and a higher share of industry shipments in 2019. Contribution margins entering 2019 position the business for continued strong performance.

Now, please turn to Slide 13 where I provide more guidance on other financial items for the year. As discussed in previous earning calls, improved earnings, better working capital performance and our advantaged tax position has translated into a strong conversion ratio of adjusted earnings to free cash flow over the past four years. In 2018, our results trailed our expectations.

Looking forward, we have confidence in returning to another year of strong free cash flow generation in 2019. At this time, the Company plans to prioritize free cash flow to ongoing dividends and making progress in paying down our term loan.

Additional free cash flow could be available for share repurchases under the Company's current authorization. We expect corporate expenses of $140 million to $150 million with the year-over-year growth primarily due to the reset of performance-based compensations.

Capital additions are expected to total approximately $500 million and includes capital for the completion of Paroc's capacity in Poland, the relocation of our Shanghai insulation plant, and investments in productivity. Depreciation and amortization expense is expected to be about $460 million. Interest expense is expected to be about $130 million.

As a result of our tax NOL, foreign tax credits and other planning initiatives, we expect our 2019 cash tax rate to be 10% to 12% of adjusted pre-tax earnings. Our 2019 effective tax rate is expected to be 26% to 28% of adjusted pre-tax earnings.

With that, I'll turn the call over to Thierry to lead us in the question-and-answer session. Thierry?

[Thierry Denis, VP of IR]

Thank you, Michael. And we are now ready to begin the Q&A session.

[Operator]

[Operator Instructions] The first question today comes from Stephen Kim with Evercore ISI. Please go ahead.

[Stephen Kim, Evercore ISI]

I guess my first question relates to your comments about the Santa Clara line going cold or moving to cold in 1Q. I was wondering if you could give us a little bit more background around that and also dimensionalize what the costs might look like. So, for example, what does this plant make? How permanent is this curtailment? If you could give us a sense for what those costs associated with that curtailment we can expect will be? And if you eventually start this thing up, will there be associated start-up costs as well on the other side?

[Brain Chambers]

This is Brian. Thanks for that question. A lot to unpack there, so let me kind of set the stage a little bit. When we talk about our first quarter performance and around the curtailment, we have our technical insulation business; we have our res insulation business. This is all around our res insulation business and really tied to volumes and the outlook we see there.

So, we continue to operate our residential insulation business believing that we're not at the top of the Roofing cycle or of the - I'm sorry, the housing cycle and, but we do expect we're going to see some less volume coming through in the first part of the year, primarily due to some softness we're seeing in the overall housing market that's translating through to a demand for our products.

We also are maintaining our price position and strategy and we believe that that's going to cost us little bit of discretionary share here in the first part of the year. And then we are facing some tough comps versus prior year where another manufacturer had some production issues and we picked up some discretionary volume last year that we're not seeing flow through this year.

So, on a year-over-year basis, when we look at our volume outlook through the first part of the year, we've decided to take some proactive steps to curtail some production across our manufacturing lines and then remove some high cost capacity with the facility and with the line in Santa Clara. So we think that curtailments impacts we're taking, if I had to dimensionalize the impact there, I think we said in the past that an average line is about 2% of industry capacity.

So I think that should give you a characterization of kind of the capacity that the Santa Clara line would represent. And overall, we think curtailment that would represent about a third of our total curtailments we're planning for the business in that space.

So I think in terms of the length of time in that, clearly we've seen a reduction in the housing market outlook. We've seen estimates come down to a pretty flat year this year and into next year.

So I think we want to - we're optimistic that we could see some housing growth through the year in '19 and into '20, but we want to be realistic in terms of rightsizing our business to make sure that we're delivering on our working capital, our cash flow goals in the space.

So these are actions that we believe are right for us given where we're at in the cycle. They are going to have an impact to our 2019 earnings, especially in the first quarter, but certainly gives us maximum flexibility to respond to the different demand scenarios as they progress this year and into 2020.

[Operator]

The next question comes from Matthew Bouley with Barclays. Please go ahead.

[Matthew Bouley, Barclays]

Thank you for taking the questions and I just want to extend my congratulations to Mike on his retirement. So I guess just following up on that point with Insulation specifically. So when you mentioned that a lot of these puts and takes in Insulation effectively offset this year and please clarify that, if that's not correct, but in that comment, are you assuming future price increases in Insulation? And really more broadly, how are you thinking about future price increases to the extent that they can be realized in 2019 given everything you're saying about the new residential environment? Thank you.

[Brain Chambers]

Yes, I mean, I think we demonstrated some great success in 2018 around capturing price in the Insulation business overall, particularly in our res business. So we've got some carryover pricing that's coming into the year. We announced our January increase that we are implementing in the space. So while we expect to capture some additional price from these actions, certainly these increases we think are going to offset the curtailment costs and some of the lower volumes out there.

We continue to believe in our pricing strategy, which is that price is critical to us returning this business to historical profitability levels. So we're going to look and see how the year plays out, but again, we don't believe we're at the top of the cycle and at this point, as housing starts progress, if we see the growth that is forecast in the back half of the year, we think that we get the option of, in terms of maintaining price that we have in place and capturing some incremental volume coming back. So we think it sets us up well given the variability in the market outlook.

[Operator]

The next question comes from Susan Maklari with Credit Suisse. Please go ahead.

[Christopher Kalata, Credit Suisse]

This is actually Chris on for Susan. Thanks for taking our questions. Just want to drill in a little deeper into the Insulation pricing. Could you just give us some color on what you've seen so far in your January price increases and - as well as how do you expect industry participants to react to the reduced capacity at Santa Clara now?

[Michael McMurray, CFO]

Chris. So I think I'd characterize the environment, certainly we saw a softness in demand coming through in the fourth quarter that we've seen continue kind of into the first part of the year and we think there's a bit of an air pocket that's been created by housing starts coming down.

When we look at the impact interest rates had on the back half of the year, I think we believe that had some impact on that, but going forward, when you look at the overall macro economy, we believe that with household formations, with employment growth, pricing - income growth, we think it's a constructive market to see growth in new construction.

So we want to make sure we're positioning the business to take advantage of that as that comes back to us, but certainly, we're in an air pocket now that's created a little bit of slack in demand and that's put some pressure on pricing in the near-term, but again, back to our pricing strategy, business has been - we think it's a key part to return the business to profitability.

We think holding price at this point certainly gives us the best option to get both price and volume in the second half if the new construction market strengthens.

[Operator]

Next question comes from Michael Eisen with RBC Capital Markets.

[Michael Eisen, RBC Capital Markets]

Wanted to transition to the Roofing segment and talk about the price-cost dynamics that are at play. You talked about an April price increase and the ability to overcome some of the inflation you saw in '18. So thinking out to next year, how should we inflation [indiscernible].

[Michael Thaman, Chairman and CEO]

Yes, you kind of broke up a little bit. I think your question - I'll take, I think the question more around the outlook on pricing and how we see that playing out in 2019 and margins and performance in our Roofing business.

Clearly, I think we've got a great track record in our Roofing business to be able to offset asphalt inflation with price. I think we demonstrated that through 2018 where even in a weaker volume environment and a lot of inflation coming through to us in terms of asphalt and transportation, we were able to get pricing into the market to recover that. As Michael said in his comments, we finished the year with very strong cash contribution margins in the business.

So I think it demonstrated the value of our product and certainly demonstrated our ability to go get price when we faced inflationary pressures in our Roofing business. So, as we spin that forward into 2019, we've announced a price increase, as we are expecting some continued asphalt and transportation inflation in the business, albeit at a more kind of moderate pace than last year.

But we think where we finished the year in cash contribution margins, we were in a - we're in a very good position. So, our pricing philosophy is to go out and recover that upcoming asphalt and transportation inflation to keep those contribution margins strong. So I think that gives us a good base.

From a market volume outlook, we believe we're in an environment where, if we get some - just average storm demand, we think we're going to have another constructive demand year in the market.

So that should give us some opportunity to get a little bit of volume growth, as we talked about earlier in the prepared comments with strong margin. So we do see a path where we can continue to generate revenue growth and good earnings in our Roofing business in 2019.

[Operator]

The next question comes from John Lovallo with Bank of America. Please go ahead.

[John Lovallo, Bank of America]

I guess in terms of the Composites, you were talking about volume and improved operating performance offset by inflation. How should we think about pricing in that business in 2019?

[Michael McMurray, CFO]

So, here is what I'd say to kind of think about pricing for the Composites business this year. I mean, I think first and foremost, I'd let you know that overall utilization rates remain quite high. So, that's a good thing. Also, based on kind of current expectations from a macro perspective, we're going to - we expect to see decent global growth although there is heightened uncertainty.

So overall, we're probably expecting another year of price stability. As you know, the current performance of our business from a financial perspective is pretty strong. We do a fair amount of competitor analysis as well and we think that the industry leaders are earning strong financial returns as well, probably return on capital before tax in the mid-teens. So we probably don't expect any meaningful price in the near-term. Now, we do have a desire to offset inflation with price and so that's no doubt a desire,

If you look at the long-term history for Owens Corning, that hasn't been the fact, and actually, as a company, we've driven a fair amount of productivity and cost takeout over the last couple of decades to offset inflation.

As we look at 2019 specifically and look forward, we've gotten a lot done over the last couple of years around our subscale melter restructuring, also our low-cost India expansion which came online last year, and then the strategic supply alliances that we put in place in Asia Pacific.

So, kind of thinking about - thinking about this year, again expecting decent global growth although heightened uncertainty, we're confident that we're going to improve our operating performance and putting those two together, we think that that should largely offset inflation kind of based on kind of current consensus estimates for global industrial production growth.

Now, what I would tell you from a longer-term perspective, two of the larger Chinese participants, CTG and Jushi, their parent companies merged and they've a stated expectation that they're going to merge the glass companies at some point in time, date to be determined.

[Operator]

Your next question comes from Truman Patterson with Wells Fargo. Please go ahead.

[Truman Patterson, Wells Fargo]

Just wanted to touch on your Roofing segment, it looks like you had a lot of pricing in the fourth quarter, it more than offset the asphalt and transportation cost, but it seemed like the other inflationary pressures really hit your margins, even accounting for some of the loss leverage. I guess how should we really think about this other inflationary pressure throughout 2019 and will this continue to kind of eat into margins?

[Michael Thaman, Chairman and CEO]

Just to kind of characterize a little bit the margin performance in Q4 and then I'll talk about some of the other inflation drivers. I think when you look through the performance in the fourth quarter, this is really primarily a volume issue in the fourth quarter in terms of impacting margins on a year-over-year basis.

We just lost a fair amount of operating leverage across our manufacturing facilities in recovering our OpEx leverage. So price was offsetting inflation which is what we expected, but we just lost a lot of leverage on the operations side carrying in.

But I think how to think about that as we go into this year, we believe pricing will offset inflation. Our cash contribution margins are strong. I think part of the other impact there, a little bit is, when you look at the inflation recovery, it's kind of a dollar for dollar.

So we got prices up, but $1 price kind of cover a $1 of inflation. So while our cash contribution margins have stayed strong at historic levels, I think we've lost a little bit of EBIT margin leverage with just that translation between price and inflation.

So as we come into this year, we feel our contribution margins are good. We think that the pricing action we've announced would allow us to stay on top of asphalt and transportation and some of that other inflation that we see coming through. We also have a pretty robust productivity program inside all of our businesses to help offset that other material inflation. So, we feel the margin performance of the business is good and will stay strong in 2019.

[Operator]

The next question comes from Keith Hughes with SunTrust. Please go ahead.

[Keith Hughes, SunTrust]

My question is in Insulation. Your comments about 2019 of EBIT, I believe, being positive, but being, I assume the comment is down pretty substantially in the year. Is that about residential insulation or about the segment as a whole?

[Brain Chambers]

This is Brian. So, again, going back to our Insulation business, we really have our res business and then our technical insulation and other building materials business. So when we're talking about kind of the earnings outlook, primarily when we look at our res business, I think we've talked about where we're seeing some positive price momentum, but that's really going to be offsetting what we believe to be our curtailment costs and some lower volumes as the year plays out.

Where we're expecting some continued revenue growth really is inside our technical insulation business and this has been a core part of our strategy as we've looked to really invest to grow this part of the Insulation business, it gives us access to some new markets, different product applications.

It's a segment or it's a business that's much less price sensitive to some of the volume changes and we feel like that the investments we've made there are going to generate growth in terms of revenue and earnings moving forward so - and we're pretty excited. I think our Paroc and our FOAMGLAS business integrations have gone very, very well.

Those businesses are delivering financial performance in line with our expectations. We are going to be completing out our Paroc investment, as Michael talked about, that gives us additional stone wool capacity.

In Europe, we're seeing some positive regulation changes that we think are going to open up additional opportunity for stone wool into building applications there, which gives us a growth avenue.

In North America, we're continuing to see growth in our North American mineral wool business in new applications, our glass, pipe and mechanical businesses. So, really inside of our technical building insulation business, we do expect to see positive growth going forward in 2019.

So I think it's really a combination of, in our res business, we think we're going to be a little challenged based on the volume outlook and housing starts outlook, but in our technical insulation business, we feel like we've got good revenue and earnings growth in sight for us in 2019.

[Operator]

The next question comes from Garik Shmois with Longbow Research. Please go ahead.

[Garik Shmois, Longbow Research]

Just wanted to ask about Roofing, can you talk about what you're seeing on core roofing demand excluding storms? And it also sounds like there were some channel fill in the fourth quarter on the part of competitors. So just wondering if you can speak to inventory levels and how that might impact the ability to get price to offset inflation this year?

[Michael Thaman, Chairman and CEO]

Yes, thanks Garik. So just, let me talk a little bit on fourth quarter maybe put some context around that. I think we came into the quarter thinking that we were going to see a drop in volumes. In the third quarter, we saw manufacturing shipments down about 20% and we thought that that could continue into the fourth quarter.

In fact, we saw a little bit of storm demand, particularly in Colorado, Carolinas, but then, as you say, a pretty significant impact that we think some distributors that brought in some inventory tied to some incentive gate. So we don't think this is any kind of widespread change in behavior, but certainly that impacted some of the fourth quarter volumes with inventory coming in that we would normally, I think, expect to see in 2019.

So when I look at that impact as it carries into 2019, if I step back and just look at broad demand drivers, we continue to see, the reroof, remodeling business pretty strong. We've got good contractor visibility and we think that there's good backlog and optimism that there's going to be continued growth there in 2019.

I think new construction demand could be a little flat given our outlook on housing starts, but I think still when you look at the overall market opportunity assuming a pretty average storm, we think we're going to be in a very constructive market environment.

We think there is opportunities for growth in our business relative to outperforming a little bit of the manufacturing shipments because we weren't shipping into the fourth quarter, similar to a few other manufacturers.

And then, in 2018, we had some geographic headwinds, a lot of demand up on the East Coast that we think that balances out for us. So, we think inside an average kind of storm year, we would expect to see end market demand pretty flat. Manufacturing shipments might trail a little bit because of the inventory pull through, but our volume outlook would be pretty strong and we'd see some opportunities for a little bit of growth relative to the opportunity in the market.

[Operator]

The next question comes from Justin Speer with Zelman & Associates. Please go ahead.

[Justin Speer, Zelman & Associates]

I just wanted to unpack if you could - I know you've mentioned it earlier, but the free cash conversion in the year, particularly relative to what you were thinking even a couple of quarters ago was disappointing. So I was wondering if you can unpack that for us and then talk to what you think you're going to be able to achieve in 2019.

[Michael McMurray, CFO]

A couple of things, so let me kind of set it up and then I'll take you through kind of what transpired throughout the year, but you know, I think first and foremost, if you look back over the last four years, the free cash flow performance for the Company has actually been a big bright spot and then the improvements that we've made in working capital had been very, very significant in the years '15, '16 and 17.

Talking specifically about our 2018 results, you would have heard us on the third quarter call highlight that we were going to track below kind of our 100% conversion goal for the year. Actual results actually tracked lower than that. Again, kind of thinking about it year-on-year, primarily working capital related and then some higher CapEx; about half each.

Now, if you think about the goal that we laid out some years ago around generating average conversion of a 100% over a three-year period looking specifically to last year, we were probably about $200 million of free cash flow better than that goal and then, looking specifically at this year or '18, we were about $300 million worse than our goal.

Specifically looking at 2017, we hung up a fair amount of payables on the balance sheet related to CapEx and so that was a tailwind for '17 and a headwind for '18 to the tune of about $60 million. Still, if you look over the last three years or you look over the last four years, we've generated free cash flow conversion slightly in excess of 100%.

Now for the year 2019, we expect another strong year of cash flow and free cash flow conversion. Now, thinking about some of the headwinds that we faced in '18 to talk - maybe give you a little bit more color around working capital specifically, the primary driver was related to inventories.

The biggest build in that space would have been within our Roofing business and really in two key areas. Half of it would have been roughly related to asphalt inflation and then the other half would have been related to purposeful or conscious build of coated wovens inventory here in the U.S. that's coming from China and we were getting that inventory here on the ground in advance of potential tariffs.

And then lastly, due to the kind of underlying market slowing down late Q3 and into Q4, we did see some inventory build in our two businesses that melt glass. Those assets are hard to turn on a dime.

And then within Composites specifically, we had a bit of a purposeful build related to some of the asset moves that we've made around small melters and the new asset that we were building or bringing up in India.

So again, looking to '19, so I think we have confidence that we're going to return to another year of strong free cash flow generation. Clearly, we're not going to face the same headwinds that we did in 2018 and I think that working capital inventories in particular are going to be a source of free cash flow. You heard us talk in our prepared remarks, you heard us talk in Q&A that we're taking some pretty significant curtailment actions in our Insulation business.

[Operator]

The next question comes from Michael Wood with Nomura Instinet.

[Mason Marion, Nomura Instinet]

This is Mason Marion on for Mike. In Composites, what are your rebuilding expense assumptions in 2019 relative to 2018? And then any update on trends within the Indian wind market? Thank you.

[Michael Thaman, Chairman and CEO]

Yes, from a rebuild perspective, I'll help you out thinking about it this way. So last year, essentially we had two rebuilds. This year we're expected to have two rebuilds. The difference last year is that we're also bringing up our new facility in India, so that would have been a little bit of a headwind. So when you think about kind of manufacturing costs year-on-year that should be a bit of a tailwind.

And then regards to the India wind market, while it was a disappointment most of last year and came back slower than what we had anticipated, we made progress in the third quarter of last year, we've made progress in the fourth quarter of last year, and we're anticipating progress this year as well. So momentum is building. It's headed in the right direction.

[Operator]

The next question comes from Michael Rehaut with JPMorgan. Please go ahead.

[Elad Hillman, JPMorgan]

This is Elad on for Mike. I just wanted to dig in a little bit deeper on the Roofing volumes at the - in 4Q and then going forward. Was there something in particular driving the year-end rebates from other manufacturers or is this something that you've seen in the past? And then, what have you seen so far this year with distributor buying trends and how much of an impact from the inventory pull through do you expect? Thanks.

[Brain Chambers]

This is Brian. You know, volume incentives are not uncommon practices inside the Roofing business. I think - so that's not unusual to kind of see some of those incentive structures put in place for distributors. I think it's a little unusual to see what we believe is pretty significant inventory buy-in as a result of that.

And again, I think that was a combination of these incentives being set at the beginning of the year against specific volume gates and as the year progressed, it was a little slower than the prior year.

And so I think that caused some distributors to make an economic decision to weigh bringing in inventory against an incentive or kind of letting it go and pushing it into 2019 and clearly there was enough of incentive for some distributors to want to do that, but again, I think it was a handful that participated and certainly not widespread in that space.

So I think as we roll that into our outlook for 2019, again overall, I don't think that any of those moves impacted out-the-door sales or our contractor share positions in the market. I just think it pulled forward some of the manufacturing shipment demand that we'll see in 2019. So in 2019, we expect end markets to stay pretty strong, but manufacturing shipments to trail on a full year basis as a result of this.

I think as I - as I think about how that's going to play out in Q1, I do think that inventory pull will have an impact on Q1 purchases. So I think as we look at the shape of the year versus last year, we're expecting a little softer Q1 where we would see significantly less storm demand on a year-over-year basis. Again, '17 was pretty strong in a storm year and we had a fair amount of carryover into the first quarter of '18. We're not seeing that kind of carryover. We think there is going to be some impact on some of this pre-buy activity for some of the distributors.

And also I think the third component that's going to shape the year a little differently is, you know, last year we were in a very high inflationary environment. We had a couple of spring increases announced. So that gave distributors a lot of incentive to buy earlier in the year ahead of the season, much more than this year.

So we think this year we're going to see some more volume drift into the second quarter, just as normal kind of buying pattern out of distributors that they buy ahead of the season on that space.

So I think that's going to shape the first quarter and first half a little differently in terms of distributor buying, but I think, again, on a full year basis in end market, we think it's still going to be pretty strong for us.

[Operator]

Next question comes from Scott Schrier with Citi. Please go ahead.

[Scott Schrier, Citi]

I just wanted to ask you about Insulation, taking into account all the comments that you made. Yes, we're going to have a weaker 1Q, which is seasonably light anyway, you're making the curtailments. With a little volume environment and with good pricing, how should we think about your incremental margins maybe with respect to some of the numbers you've communicated in the past as being a mid-cycle average and then, more broadly speaking, long-term, do you still think after some of these actions that that's still the correct way to think about the business from an incremental margin perspective?

[Brain Chambers]

Yes, let me frame it a little bit. Maybe I'll ask Mike to jump in on some of the historical piece. I mean, I think that the outlook in terms of volumes that we see growing through the year, we do expect we're going to need a little bit of positive market momentum to maintain our volume space and allows us to then look at additional pricing, but I think overall the margin carry that we have today is solid, but we're not at historical levels.

So, we continue to want to push the performance of the res side of the business up even further. So I guess Mike, maybe I'll ask you to make a few comments on that historic point.

[Michael McMurray, CFO]

Yes, thanks, Brian, I'd be happy to try to add something there. Scott, I think it's a good question. I mean, we talked about the business, historically, as being an operating leverage story and I think during the period of time where we began that narrative, probably in the 2013, 2014 time frame, it really was a res improvement story. I mean res at that time was losing money.

We had visibility to improved housing starts that are going to drive our utilization, give us a leverage in our economics, give us a leverage maybe to get a little bit better pricing environment. So those two things combined caused us to see the top line and bottom line in Insulation was going to be largely driven by a significant improvement in res.

In the environment we're in today, we've obviously dramatically built out the technical insulation side of the business. We've diversified the business to Europe. We've diversified the business across multiple technologies.

On the technical side, that's a much more stable pricing environment, which is, in today's environment, not giving us a tremendous amount of leverage, but it is a very good news. In a downturn, we like those businesses because they tend to be much more stable in the ups and much more stable in the down.

So I think with the mix of business today, it's probably hard to see an overall operating leverage story for the entire Insulation business that would be at the kind of levels we had talked about previously. Now for res, I think we would still think that's a business that can produce that kind of leverage.

Specifically to 2019, we're talking about a year where there is an offset, price on the positive, volume and curtailment on the negative, those offsetting as we go through the year depending on how the second half comes out.

So, I don't think res is today a big part of the story of how we would see improvement in Insulation in 2019, but I do think, as we look through the cycle, we'd continue to expect with some volume growth back in res that we'd get back to operating leverage on the res side of the ledger.

[Thierry Denis, VP of IR]

Yes Anita, it's Thierry. It looks like we're probably at the end of the Q&A session, right? Anita?

[Operator]

We have the next question comes from Ken Zener with KeyBanc.

[Ken Zener, KeyBanc]

Good morning, gentlemen. Hello?

[Operator]

And do you have a question?

[Thierry Denis, VP of IR]

Ken, we can hear you.

[Ken Zener, KeyBanc]

I couldn't hear you. Sorry about that Thierry, last question yet again. Appreciate that color and the new approach gentlemen. For Insulation, the - I understand the annual comments that you gave, I think it's good that you're talking about the first quarter pressure. My single question is, can you talk about the first half expectations for housing activity versus your expectations for the second half. So if consensus is flat, I'm just trying to see how much downside you're seeing in the first half versus a potential recovery in the second half? Thank you very much.

[Brain Chambers]

Thanks, Ken. I mean, look, we think right now if we look at expectations for housing starts, it's kind of a mirror effect to what we saw in '18. So we think that that decline was in the back half of last year, sloping down and we believe this year we would start to see progression and positive movement of the housing starts as we move into Q2 and through the rest of the year. So that's the progression of housing starts from a market opportunity that we're planning for.

The biggest uncertainty around our res is going to be a little bit of that macro timing on when those housing starts actually materialize and when that - then flows through to demand for us. So that's something that - we're not expecting a lot of volume growth in the first half of this year as a result of that and we think that carries through and creates a stronger second half for us if that materializes.

[Thierry Denis, VP of IR]

Thank you, Brian and I think this concludes the Q&A session. And with that I'd like to thank everybody for joining today's call and I'd like to hand it over back to Mike for some closing comments.

[Michael Thaman, Chairman and CEO]

Thank you, Thierry. To summarize, 2018 was another record year for the Company. Notably, for the first time in our Company's history, all three of our businesses achieved double-digit margins at the same time. As I think about the past decade, we've built a resilient company. We've accomplished this through sustainable productivity improvements, organic investments and acquisitions. Today, we have a more diversified portfolio that's better able to generate strong cash flow, deliver consistent performance and generate attractive returns for our investors across the cycle.

I'm proud for Brian to have the opportunity to lead Owens Corning. He has been instrumental in driving value in our Roofing business and at the enterprise level. He is dedicated to our customers, our businesses and our employees. He understands teamwork and how to get teams to perform at the highest level. I've worked closely with Brian throughout much of my time as CEO and have full confidence in him to lead this great Company forward.

It's been my distinct pleasure to call Owens Corning home for the last 26 years and lead our talented associates as CEO for the last 11. This is a special company, one that understands the requirements to perform, while maintaining a set of values and can-do spirit that carries the Company through opportunities and challenges alike.

It's been my honor to represent this Company to our investors. Our markets can be challenging and very competitive, but our businesses are market leading and have enjoyed the opportunity to share my passion for Owens Corning with you, and to have enjoyed your support over the past decade.

Thank you everyone for your time today.

[Operator]

This conference is now concluded. Thank you for attending today's presentation. You may now disconnect.