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USG (NYSE:USG)

Q4 2012 Earnings Call

February 06, 2013 11:00 am ET

Executives

Ken Banas

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

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

Analysts

Mike Wood - Macquarie Research

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

Mark A. Weintraub - The Buckingham Research Group Incorporated

Garik S. Shmois - Longbow Research LLC

Neil Frohnapple - Northcoast Research

Trey Grooms - Stephens Inc., Research Division

Dennis McGill - Zelman & Associates, LLC

Kathryn I. Thompson - Thompson Research Group, LLC.

Seth B. Yeager - Jefferies & Company, Inc., Research Division

John F. Kasprzak - BB&T Capital Markets, Research Division

L. Todd Vencil - Sterne Agee & Leach Inc., Research Division

Operator

Welcome to the USG Corporation Fourth Quarter 2012 Earnings Conference Call. My name is John, and I'll be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Mr. Ken Banas. Mr. Banas, you may begin.

Ken Banas

Thank you. Good morning, and welcome to USG Corporation's fourth quarter 2012 earnings conference call and live webcast. We'll be using a slide presentation in conjunction with our call today. It is available by going to the investor information section of our website, 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 assumptions of our business, markets 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.

With me today to discuss our results and our outlook are Jim Metcalf, Chairman, President and Chief Executive Officer; and Matt Hilzinger, Executive Vice President and Chief Financial Officer. Jim will provide a general overview of the quarter, plus additional insight into some of our businesses. Matt will review the financial results for the quarter and the year for the corporation and the business segments. We'll then open the call for questions and conclude with a few comments from Jim. [Operator Instructions] Jim?

James S. Metcalf

Thank you, Ken. Good morning. I appreciate everyone joining us and your interest in USG. I'm looking forward to giving you a quick update on the quarter as well as what we're currently seeing in the market and into 2013. In Q4, we had the best quarter for our Wallboard business in a few years, with volume we haven't seen since 2009 and pricing at 2007 levels. This is evidence that our plan is working, and we continue to see a recovery in our core markets. We had positive adjusted operating profit for the fourth quarter in a row, only missing positive EBIT due to restructuring and asset impairment charges brought on by our continued cost reduction activities. Despite demand in the U.S. that's well below historical levels, we're making strides towards our primary objective of positive net income.

There are 3 reasons our earnings were lower in Q4 than the previous 3 quarters. First and most significantly was seasonality. Second was a continued drop in commercial activity, which primarily impact our Ceilings business at USG Interiors and L&W Supply. And finally, as we planned, we increased our infrastructure spending at our manufacturing plant. Regardless of demand, we remain committed to lowering our breakeven. We're not waiting for the market to fully recover, and as I've said before, we will continue to create our own recovery.

We've taken out over $0.5 billion in costs, including $38 million in additional cost reductions in 2012 by closing L&W branches, consolidating our back office and implementing a recent management workforce reduction. These actions are allowing us to make targeted investments in growth areas, offset some inflationary pressures and continue to focus on lowering our breakeven.

Now I'd like to turn to our business units. In our North American Gypsum segment, wallboard results continue to be the primary driver of improved performance. Wallboard volume increased 12% year-on-year in the fourth quarter. The wallboard price was up slightly from the third quarter. With a full year under our belt, the results of our new pricing strategy are very positive and our customers are pleased as well. We've enabled our customers to reduce their back-office costs with a policy that's easier to manage and now, we can focus on other ways that we can improve our customer sales and profitability with high levels of service, quality and product innovation. As we said in the past, we have implemented the same pricing strategy in 2013 and I'm happy to say we're pleased on what we received so far in the results, and we'll give you more details on pricing in the first quarter in our call in April.

Moving on to other core products in North American Gypsum. Our focus continues to produce solid results. Joint Treatment had a great fourth quarter with improvements in all categories: volume, price and cost. We also made positive contributions from our shipping business, which we talked about last quarter, Gypsum Transportation Limited. GTL profitability improved by $11 million in Q4 compared to last year as we redeployed our ships to transport iron ore.

Worldwide Ceilings had solid performance despite the seasonality I mentioned earlier. Ceilings had a record year in operating profit in the United States despite continued flat demand. Worldwide Ceilings profitability was down approximately $3 million compared to the fourth quarter of last year, although this drop is consistent with historical fourth quarter performance. This historical seasonality will point typically to a stronger first quarter, and despite choppy demand in the commercial market, we are confident the Ceilings business will continue its track record of improved profitability in 2013.

Turning to our distribution business. L&W Supply improved their operating results in this very difficult commercial market and remains on the path to profitability. L&W's wallboard spread and volume increased 10% and 8%, respectively, from last year, and core products, beyond wallboard, saw a $1 million improvement in profitability compared to last year. L&W has shifted its strategic focus to partner with commercial contractors, while still taking advantage of profitable residential opportunities. With nearly 2/3 of L&W sales coming from commercial construction, results will continue to be choppy until more velocity returns to the business. The L&W team is very focused on delivering value to our customers and returning to profitability as quickly as possible. And I'm confident we have the right plan to achieve that objective in the near future.

We made excellent progress in our businesses in 2012, and we did so by executing our Plan to Win. Each of our 3 areas of strategic focus produced results for both the quarter, and most importantly, for the entire year. Our commitment to strengthening our core can be seen in the positive operating profit for the year, which is our first year of operating profit since 2007. There are a number of factors that are contributing to our improved performance, including our new wallboard pricing strategy, lowering product costs across our entire portfolio due to Lean Six Sigma, strategic decisions at USG Interiors to modify both the product mix and procurement strategies in a weak demand environment and finally, the L&W strategic realignment. We will continue these actions with an intense focus on satisfying our customers, lowering our breakeven and product margin improvement and support our value proposition.

Our second pillar of our strategy is diversify our earnings. Our joint ventures, to serve the growing markets in India, are well underway. Finding new growth markets to offset some of the cyclicality that's inherent in our North American businesses is important as we look to grow in the future. We're very excited to have launched this opportunity and to be a leader in a key growth market. Our land and assets, critical mass and our local sales team are working together with our globally recognized brands and our technology expertise. These will serve the needs of our current customers and our future customers in these growth markets.

And finally, growing our business through innovation, which continues to be one of our strategic priorities with the most visible example, as you've seen over the last year or so, the success of our SHEETROCK Brand UltraLight platform. This product now comprises 49% of our total wallboard shipments in the United States in the fourth quarter. We continue to convert new customers, and this platform allows us to strengthen our relationships with existing customers. Our customers are attracted by the lighter weight but keep coming back for the improved performance on-the-job of this reengineered product. But this isn't a single product, this is a new technology platform.

We've just launched the latest product in this lightweight portfolio. SHEETROCK Brand UltraLight Mold Tough. These mold-resistant panels are being well-received by our customers, including the Home Depot on the East Coast. And we will be rolling out Mold Tough across our network during 2013.

Our strategy is comprehensive: strengthen the core, diversify our earnings and differentiate innovation. This is to grow USG.

And now, Matt will give you some greater detail on the quarter and on the full year results. Matt?

Matthew F. Hilzinger

Thanks, Jim, and good morning to all of you. As Jim mentioned, I'll recap our fourth quarter and full year results and provide some additional details on each of our business segments. Before I begin, I want to mention that at the end of the fourth quarter, we finalized the sale of our European operations with net cash proceeds of $73 million and a gain on sale net of tax of $55 million. The results from these operations are reported in discontinued operations and past results have been recast to show prior period results without these operations. As a reminder, the results from our European operations have been reported previously and entirely within USG International and our Worldwide Ceilings segment.

Moving on to total corporation results from continuing operations for the fourth quarter of 2012. Net sales were $815 million, up 12% from the fourth quarter last year. Our fourth quarter operating loss was $8 million, which compares to an operating loss of $43 million in the fourth quarter of 2011. This quarter's operating loss included $13 million in restructuring and long-lived asset impairment charges. The remaining year-on-year improvement was driven primarily by improved wallboard gross profits, which benefited from higher wallboard prices, lower unit cost and higher values.

Using adjusted operating profit to remove the effects of restructuring, we had a $43 million improvement in adjusted operating profit on an $89 million increase in sales in the fourth quarter, resulting in an incremental operating profit margin of 48%. This is lower than the incremental margins for the first 3 quarters of the year due to the 3 factors that Jim had noted earlier: Seasonality, decreased commercial opportunity and planned infrastructure spending as is not uncommon in previous fourth quarters.

Briefly recapping full year 2012 results from continuing operations, the total corporation saw an 11% increase in the top line to $3.2 billion and a total year operating profit of $73 million compared to an operating loss last year of $206 million. Our 2012 total year incremental adjusted operating profit margin was 71%, demonstrating the strong operating leverage of USG.

We continue to take steps to lower our breakeven and focus on managing our SG&A expenses. In the fourth quarter of 2012, SG&A was $80 million versus $76 million last year, with the full year SG&A being up about 5% to $304 million. As we look to 2013, we expect SG&A to have a slight increase as we work to offset inflation with further cost reduction initiatives.

I'll now provide a little more detail on fourth quarter segment results. Net sales for our North American Gypsum segment increased over 20% to $508 million for the quarter and operating profit was $17 million versus an operating loss last year of $21 million. These results were driven by improvement in many of our products and businesses. A few of the key contributors are noted here. Higher U.S. wallboard price contributed $24 million; the reduction in U.S. wallboard manufacturing cost of $7 million due to lower natural gas and lower fixed costs; and $11 million in incremental profit due to our GTL shipping business. In 2013, we anticipate the operating profit for GTL to be recognized in a manner similar to 2012 with a loss in Q1 turning into a net gain for the year of approximately $11 million.

Our U.S. Wallboard business shipped 1.22 billion square feet in the quarter, an increase of 12% compared to the fourth quarter last year and up 2% from the third quarter. We believe the increase in volumes in the fourth quarter, when we would typically see seasonality and lower volumes, is evidence of the continued recovery in underlying demand for our products. We had an average realized price for 2012 fourth quarter of $132.26. As we have mentioned in the past, quarterly average wallboard pricing will experience fluctuations throughout the year due to variations in the channel and regional mix of sales, along with freight charges.

Turning to Worldwide Ceilings. Our Ceilings business delivered a typical fourth quarter of positive operating profit for 2012. Fourth quarter net sales for Worldwide Ceilings increased year-on-year by $1 million to $141 million although fourth quarter segment operating profit from continuing operations was $14 million, down $3 million from the prior year.

As we discussed in the past, our commercial opportunity remains choppy, and we also saw some seasonality that is typical in this business. In the fourth quarters of 2009 and 2010, the operating profit for USG Interiors dropped, on average, over 50%, which is what we saw again this year. We believe we will continue to experience a return to a more typical seasonal cycle in this business, which would include a solid first quarter, as Jim had mentioned earlier.

In our building products distribution segment, net sales increased 7% year-on-year for the fourth quarter, with same-store sales up nearly 13%, a sign that our branch rationalization efforts are delivering results. The operating loss in this year's fourth quarter decreased $10 million from $15 million a year ago. L&W increased wallboard spread and volume and saw a gross profit improvement in other core products as well.

Now I'll add some details on corporate spending and what we have been doing to manage capital spending in our balance sheet, including liquidity. We had $70 million of capital spending for the full year of 2012, plus $34 million of funding into Oman, India and our joint ventures. In 2013, we will complete the $60 million spend in Oman that we previously disclosed. Including this spend, we plan to show total cash outflows of $175 million on capital spending and investments for joint ventures in the investing section of our cash flow statement. We consider $110 million of that total to be capital expenditures in the normal course of our business, as compared to $70 million we spent in 2012. The other $65 million in 2013 is capital spending for Oman and other joint ventures. We expect a portion of this $65 million to be offset by a loan from our Oman partner in the financing section of our cash flow statement as they will provide funding for their ownership share of the capital outflows for Oman.

Finally, as of December 31, 2012, we had total liquidity of $874 million, an increase of $93 million from the end of the third quarter, and an increase of $40 million from a year ago. As we head into 2013, we continue to benefit from low natural gas prices. Through a combination of options and swaps, we are now almost 90% hedged for this year. The legacy hedges from when gas was above $9 per decatherm have completely rolled off. Based on the forward curve and our current hedge position, we would anticipate our total 2013 natural gas spend to be slightly above our total 2012 expenditure of $3.57 per decatherm.

In 2013, we are planning to contribute about $70 million to our pension plans worldwide, which is slightly higher than our 2012 contributions. Regarding taxes, we are anticipating a tax expense for all of USG of $8 million to $12 million with cash taxes being the same. This represents taxes paid on foreign earnings as we will pay no U.S. federal income tax in 2013.

Let me conclude by saying that while we are pleased to have delivered positive operating profit in 2012, we remain focused on achieving positive cash flow and net income as quickly as possible. We will continue to manage our costs and endeavor to lower the breakeven of each business, while investing in those businesses that will generate an appropriate return on invested capital.

At this time, I'd like to turn it back to you, Jim.

James S. Metcalf

Thanks, Matt. I'd like to take a few minutes before Q&A and just share a few thoughts on 2012 but most importantly, what we are seeing as we move into 2013. 2012's residential opportunity did exceed our expectations with housing starts at 780,000 which was an increase of over 28%. This was off a very low base and still well below historical trough levels. As I said a year ago, we'd rather be conservative on our housing projections. Blue chip consensus for starts in 2013 is 950,000 and we've already seen 954,000 in the numbers in December. For our planning purposes, we are forecasting around 900,000 starts. With current USG capacity utilization rates in the mid-50s for 2012, we are well-positioned to take any part of the share of an upside.

This conservative estimate, and it's really important that we want to be conservative because we want to continue to keep focused on our efficiencies, our cost reductions that require us to lower our breakeven as Matt and I had been mentioning in our comments.

With our wallboard effective capacity utilization in the mid-80s, we do have some plants that are running near a point where they're at full capacity with current shifts. While our current forecast does not required any tiring at a facility, it wouldn't be a surprise to have a shift or 2 added some time in 2013, depending, of course, on the regional shape of the recovery.

With capacity utilization in the low 60% range for the fourth quarter as an industry, we have plenty of excess capacity available with these additional resources. With 50% of our business serving new commercial and commercial repair and remodel markets, we are encouraged to see some signs of a recovery, albeit it's lagging residential.

Looking at McGraw-Hill Construction starts, they were only up slightly in 2012, with some segments showing some improvements, while others remain relatively weak. Forecasts are for mid-single-digit increases in 2013, with even a larger uptick the following year in 2014.

We believe we still have a few quarters of some choppy commercial opportunity ahead of us as the macroeconomic factors such as weak job growth and the debt ceiling and international growth weigh on investments in this sector.

Our repair and remodel activity should also begin to see some improvement in 2013, with current projections around 4% improvement in opportunity. We're also pleased with our partnerships in the segment. We believe we're with the strongest partners and we plan to grow with each one of these customers.

We believe the soft volumes we saw for some of our products in the fourth quarter were due to typical seasonality and this is really an evidence of an improving market, not a faltering one. I'm very excited about our opportunity ahead in 2013, and I will say I feel much better today than I did this time last year. I believe that 2013 will be a great transition year for USG, one where we are moving from creating our recovery to building of a recovery.

I'd like now to open it up to questions. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Mike Wood from Macquarie.

Mike Wood - Macquarie Research

I noticed your year-on-year wallboard cost improvement moved to $7 million in the fourth quarter from $10 million in the prior 2. Could you give us some color in terms of what that change was or whether you anniversaried earlier cost takeout?

James S. Metcalf

We have done a phenomenal job on cost reduction out of wallboard plants. As I mentioned earlier, we've put in Lean Six Sigma efficiencies. We did have -- natural gas, did help us from a raw material standpoint. But we have been running our very low-cost plants very efficiently and in those plants have been quite busy. So I think some of that regionality that I talked about in the past really fell into some of our plants that are very low-cost and we ran them very well. We're continuing to focus on wallboard cost efficiencies. We can -- raw materials go up and down but we feel that as we can leverage technology, leverage our innovation, utilize less water, we really have a focus on our manufacturing facilities of sustainability, which is very, very important. So this was just continued improvement in wallboard cost efficiencies, and that's something that we're extremely focused on.

Mike Wood - Macquarie Research

Okay. And can you also provide -- you've provided the color for natural gas, can you talk about any expected changes next year for OCC paper cost or other materials?

James S. Metcalf

Yes, thank you. Go ahead, Matt. [indiscernible] talk about...

Matthew F. Hilzinger

Hi, Mike, this is Matt Hilzinger. So as Jim said, what we've done for 2011 and 2012 has been fantastic. We are starting to see a little bit of inflation in the marketplace and some inflation in some of our materials. As I said, natural gas is going to be up slightly from 2012. We see paper going up a little bit from 2012. We see wages going up a little bit into '13 from 2012. So we're starting to see some inflationary pressures but as Jim said, all the things we're doing around lowering our breakeven, particularly around the manufacturing side with Lean Six Sigma, we're going to do everything we can to offset those inflationary pressures. So as I had -- I think we've said before, just to reiterate to everybody, energy is about 10% of the input cost, paper is about 25%, rock is about 20%, other raw materials, another 10%. So that's about 30% on kind of rock and other materials. Labor is about 15% and fixed is about 20%. So that will give you a sense of how to kind of think about if you want to model those.

Operator

Our next question comes from Michael Rehaut from JPMorgan.

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

First question I had was on the USG Interiors margins. You noted that the sequential decline was kind of in line with '09 and 2010 but if you go back even further, I think some years, it was more stable or down just a little bit and in other years, had a similar type of drop off. So with that said, I mean, do you attribute most of the decline to just your negative effects from lower revenues or were there some other costs that were creeping in that had a negative effect than -- would that then effect a year-over-year comparison as well to -- for the first quarter?

James S. Metcalf

Yes, Michael. Your assessment is very accurate. The main driver of the fourth quarter was volume. And if you look at the quarter-on-quarter comparison, it was volume -- it was actually in all areas, particularly our high-end, which focuses on office construction, which is tied into job growth. There was, as Matt said, a little bit of inflation. Quite frankly, that had to do with running less products through our manufacturing plants. So a little bit of slight manufacturing increase is because of the volume drop, but the seasonality and the top line volume was really the key. The unit volume was really the key to the results. We're very optimistic. The Ceilings business is extremely profitable. They just came off a record year. They beat the year prior, which was, I think, the second best year ever. And if you look at the unit or the revenue the last 4 or 5 years, it's really been flat. So any type of wind in our back on commercial will help us. We still think we have a few choppy quarters ahead of us. But from a profitability standpoint, we're still very optimistic about the Ceilings business and it contributed to the corporate profitability into 2013.

Michael Jason Rehaut - JP Morgan Chase & Co, Research Division

So then just to...

James S. Metcalf

Michael, we have quite a few in queue here and what I'd like to do is take your follow-up, if we have time, please. Just look at the list here and I'd like to get everyone on board, if you wouldn't mind.

Operator

Our next question comes from Bob Wetenhall from RBC.

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

Just had one question and I just want a little bit of clarification because the disclosure is terrific. So I'm on board with what you're saying about incremental margin performance in U.S. Gypsum. The reason it went down is really seasonal, plus some infrastructure cost that you took and we would be looking for better incremental margin performance more consistent with 1Q '12 when incrementals were in the 90s. Am I getting that right?

James S. Metcalf

You're hitting the 3 categories. I mean you have restructure impairment, our planned infrastructure, which actually was -- we did back-end load that. We were -- early in the year, Bob, we really were focused on operating profit and we held off a lot of projects. So it's not that we spent anymore on infrastructure. We just put a lot of it into the fourth quarter. We took some of our plants. We had a logistics plan for the last 4 months, we talked about it last quarter and it allowed us to do some routine maintenance. So we took the position. We knew we're going in the fourth quarter and we said we want to take some maintenance because we do feel the next couple of years, things are going to start getting better and we want to make sure that our plants are ready to ramp up where needed. So yes, those are the categories. If you would put those big categories into the incremental for the quarter, I think your 40-some percent would go up about 20 points and be in the mid-60s for the fourth quarter.

Robert C. Wetenhall - RBC Capital Markets, LLC, Research Division

Okay, that's great. So the full year incremental of 78% that you realized in 2012 is kind of in the ballpark for 2013.

James S. Metcalf

Well, Bob, I'm not going to give you a projection but I wouldn't dispute of what -- your math, but it's your math.

Operator

Our next question comes from Mark Weintraub from Buckingham Research.

Mark A. Weintraub - The Buckingham Research Group Incorporated

I was going to ask one question but, boy, that last one made me think of a different one. So I'm going to go with that one. So basically...

James S. Metcalf

Mark, that's great as long as it's one, okay?

Mark A. Weintraub - The Buckingham Research Group Incorporated

It will be one. Can you remind us what type of pricing initiatives you have in place? And if we're expecting a similar type of incremental margins on revenues, can one deduce that the pricing improvement for this year will probably be fairly close to a type of pricing improvement you had last year?

James S. Metcalf

Can you tell me what product you're talking about?

Mark A. Weintraub - The Buckingham Research Group Incorporated

For gypsum.

James S. Metcalf

Okay, all right, yes. For wallboard, as we've said, we had a pricing strategy that we implemented last year that we were quite successful with the results. Our customers were pleased with it. It took a lot of uncertainty for our customers out of the market. It allowed them to focus on growing their business and profitability for our customers. We have announced a similar strategy for 2013. We've sat down with each one of our independent customers over the last 45 days, and we are having one price for the year with our customers. So we're in a regional business, we're in different segments. We're also looking at -- Matt had talked about inflation, so we'll be able to report on the first quarter, how our pricing looks for the first quarter and right now, we're pleased with the early results.

Mark A. Weintraub - The Buckingham Research Group Incorporated

Great. So the first quarter should show most of the improvement or would it potentially -- some of it show up first quarter and some could show up later?

James S. Metcalf

We'll be able to give you more color as we'll be a little smarter at the end of the first quarter and be able to give you that color.

Operator

Our next question comes from Garik Shmois from Longbow Research.

Garik S. Shmois - Longbow Research LLC

Just wondering if you could provide a little more color just on your CapEx. You're bumping it up by about $40 million in 2013 on the core part of your business. Is this mostly maintenance-driven, anticipating higher volumes, so you'll be performing more maintenance CapEx to your facilities. You did talk about anticipating to bring on a line or 2 in some of your tighter markets potentially in 2013? Just how much of the CapEx is maintenance versus expansion driven? And then maybe if you could provide a little bit more of a long-term outlook, how we should be thinking about the CapEx needs as volumes return?

Matthew F. Hilzinger

Garik, this is Matt Hilzinger. So the maintenance that we expect to spend in 2013 is very similar to what we spent in 2012. So we don't expect a significant increase there and, in fact, if you look back over the last 4 or 5 years, that's been an area where the company has just -- they put in the right amount of capital. So we haven't starved the plants at all. So when we think about maintenance capital, it's really what we've been putting into the plants. We don't expect to have any kind of spike up in maintenance. Most of the increase -- so if you think about kind of normal CapEx, we spent $70 million last year. We're going to spend about $110 million in 2013. That increase is primarily, in fact, substantially, all growth. I mean, it's to drive revenues and we're very disciplined here about how we think about capital and putting capital to work. But this is all around growing the business. And these are things about adding some capacity into our Ceilings business, it's growing some capacity around fiberglass, we're investing a little bit in IT, we think of IT now as a strategic weapon, we're putting in sales force automation. So there's a lot of things that we're doing to really try and drive the top end of the business and continue to do things that we need to do to lower our breakeven. So that's where our capital is going. As we think about Oman, I had mentioned before in Oman, that we're going to complete the $60 million spending. And so we had a little bit of a shift from 2012 into 2013. But that CapEx is on plan and anticipated to get those... I think the core is up and running sometime at the end of this year and then the wallboard plan is the first part of 2014. As we think about CapEx over the long term, if you look back over the cycle in terms of depreciation, that can give you kind of a view of where CapEx could be. But I will tell you what we're really focused on now is making sure that the CapEx that we're spending is going to drive a return to the shareholder. And it's going to support our sales growth. So it's harder to give you kind of an outlook over the next 2, 3, 4, 5 years but as we continue to see demand come back, we'll spend money if it's going to drive return to the shareholder.

Garik S. Shmois - Longbow Research LLC

Just some summary just real quick. The 2013 increase is more broad-based than just assuming it's targeting North American Gypsum?

James S. Metcalf

Yes.

Operator

Our next question comes from Neil Frohnapple from Northcoast Research.

Neil Frohnapple - Northcoast Research

Did you guys close any L&W branches during the quarter? And how many more locations could you look to reduce in 2013? I'm just trying to get a sense of how you're trying to balance branch closures to drive near-term profitability higher versus maintaining L&W's footprint given its leverage to the commercial construction market, which typically, like the housing recovery, could be the real nice next layer of growth here?

James S. Metcalf

As we've been talking about realigning the strategy for L&W, and we really have a laser-focus on servicing the commercial contractor with our products. We have 7 core product categories. Wallboard, just to remind everyone at L&W, is only about 1/3 of the sales for the total company. Commercial steel installation, the big focus -- commercial installation is the big focus, commercial ceiling tile and grid, exterior ease [ph]. We have 7 core product categories. We aren't into lumber, we're focused on where we can win. When we look at the network, we do not want to exit any market. So for example, we closed 13 locations this year and we closed a few in the fourth quarter, not anything to speak of, but 13 for the year. We really look at how we can service those commercial contractors. So the market did contract and some markets where we would have, at one time, maybe 15 locations, we have 8. But the key is servicing those commercial contractors. Growth is very important at L&W. We've been talking a lot about getting to profitability, but this is a velocity business and profitably growing our business with our value to that commercial contractor is very important. So when we look at restructuring and the things we've been doing at L&W, the first thing we say is can we profitably service that market? And we're very keen on not exiting any strategic market. So as you go into 2013, there may be some branch closures but that's not going to be the big focus. It's really going to be being efficient on our deliveries, our value proposition, getting paid for what we do and most importantly, we think with the return of the commercial opportunity, we're going to get some wind at our back.

Operator

Our next question comes from Trey Grooms from Stephens.

Trey Grooms - Stephens Inc., Research Division

Just one question on the continued cost reduction activities that you guys have put through in 2012, $38 million. Can you -- I mean, are we pretty much at a point where you've realized about everything you can on that front? I mean, as we kind of look out into '13 with continued improvement into your end markets here, and you kind of look at putting more money into the businesses again I guess or could we expect to see additional kind of cost reductions in '13?

James S. Metcalf

Trey, that's a great question and the key is when -- as business starts returning, which we think 2013 it is, we have to be very cognizant of where we add, as Matt said, on CapEx. These are projects that are great return projects. These are businesses [indiscernible] example, the Ceilings business that's earned their way to getting resources and we are extremely diligent of where we're spending money. We're still in a soft market. I mean, we're talking about the gypsum opportunity in 2013 to be 20 billion feet. And you look at -- we're still at some very historically low levels. Even though we're optimistic about we're starting to get some wind at our back, we are very focused on continuing to keep an eye on our breakeven and some previous questions on our leverage. We want to make sure that we have as much leverage in the business for each incremental dollar. So we are never done, is a long answer to your question, we're going to continue. We think there's great opportunities to take Lean Six Sigma out of the plants and look at other areas, how we can be more efficient on strategic sourcing. We're doing things at L&W through inventory stratification, being more efficient there. So our cost and focus will never be done here. It's a core competency but what I like to say, we can -- I'd like to lower the breakeven. You can cut costs but also, you want to lower the breakeven so you can grow the company. So it's going to be a little bit of weeding and feeding and we are not going to take our eye off the ball.

Operator

Our next question comes from Dennis McGill from Zelman & Associates.

Dennis McGill - Zelman & Associates, LLC

I guess I just needed a little bit more help with the leverage. Thinking about year-over-year, seeing the incrementals come down, I guess I don't quite understand why seasonality should play into that. If anything, it would seem that seasonality would be a benefit because the sequential trend in revenue this quarter was better than normal and better than last year. So I was hoping you can maybe help me with that? And then on the infrastructure spending that similarly is impacting that, can you just give us an example of what that would be, that would be expensed versus capitalized?

Matthew F. Hilzinger

Yes, this is Matt Hilzinger. So Dennis, I think we gave the quarter-to-quarter view on operating leverage but I think the way that we really think about it, and the way to think about it is on an annualized basis. I mean, 71% on an annualized operating leverage basis is just terrific and when you look at the improvement that's been made year-over-year as we think about 2013 and as Jim said, it'd be great for us to be able to give -- I'd love to be able to give you a forecast for next year but I can't. But I think you heard what Jim was saying in terms of kind of the numbers. I think we would expect to see continued leverage into '13. We may need to add a shift here or there. But I think we have line of sight to net income and I think that will pose real positive to the operating leverage.

Dennis McGill - Zelman & Associates, LLC

I guess, excluding that, I guess what you're saying is there's some timing of items that impacted the fourth quarter year-over-year. So seasonality is not really the driver and it sounded like the timing was on some of the maintenance or infrastructure spend as you called it?

Matthew F. Hilzinger

Yes, there was a little bit. As Jim said, look, we backloaded the second half with infrastructure spending and we've got some infrastructure spending to do, obviously, in 2013 and we'll probably pace that out a little bit more evenly than we did in 2012. But I think it's difficult when you start breaking the operating leverage down by quarter, by month, even by week. So I think you got to take a look at it in totality in terms of kind of the annualized operating leverage. And as I said, as you think about 2013, we have line of sight to real improvement on the profits here and we would expect to see good things continue on the operating leverage side.

Dennis McGill - Zelman & Associates, LLC

Just to clarify now, and I'll hop off. So the infrastructure spending, can you just give us some examples of what that is that's being expensed versus the maintenance that you're talking about being capitalized?

Matthew F. Hilzinger

Yes, infrastructure stuff would be, it's going through and it's painting, it's other such things. I mean, it's taking care of ceilings and holes in the ceilings and that kind of stuff. Maintenance CapEx could be repairing floors and putting up new walls and some other things. So there's some very strict rules between what you can capitalize and what you can expense. But I will say this, that the infrastructure spending, going back to one of the previous questions, between maintenance CapEx capital and infrastructure spending, it's going to be roughly the same in '12 as it is for '13. The pattern might be a little bit different but we don't see a big change and a big increase in infrastructure spending in '13.

Operator

Our next question comes from Kathryn Thompson from Thomson Research Group.

Kathryn I. Thompson - Thompson Research Group, LLC.

I wanted to focus a little bit on your L&W division margin, which were maybe a touch softer than we would have anticipated given the improvement in the top line. My question is how much of this is driven by your greater non-res focus that you've been working on versus driven by pricing negotiations being moved to the distributor and away from wallboard manufacturers with the elimination of job quotes in the Wallboard segment?

James S. Metcalf

Kathryn, this is Jim. Really, the big driver at L&W has been velocity. If you look at historic sales and just units, they're still some very, very low levels. We have walked away from some unprofitable residential business, which typically would put some velocity through the system but it wasn't a good margin business and we didn't have a value proposition. As I said earlier, we aren't in lumber, we aren't really in residential roofing and we really wanted to refocus on where L&W is. L&W's wallboard margins improved in the quarter and the L&W pricing in the market has been very, very solid and so it's really -- if you look at L&W, we're going to start seeing some improvement to the bottom line, it's truly the return to commercial. As I said, next couple of quarters, they're still going to be choppy but L&W has lowered their breakeven. We've taken the branches out as I've talked earlier. But really, it's been in other ways of how they go-to-market and having a value proposition. And I think one indication is their wallboard margins improved in a very soft commercial market. So if you look at their results, I really just -- really points to that top line and the profitable top line. We just don't want to go get volume to go get volume.

Kathryn I. Thompson - Thompson Research Group, LLC.

So the margins are larger than -- it sounds like it's more of a softer non-res? I guess I'm just trying to get a little bit more clarity on the little bit softer margin that we have expected for L&W but it sounds like what you're saying is even though you had a 6.5% increase or 6.5% to 7% increase in the top line, it's still a relatively soft market and just haven't -- and much of this is driven more by non-res than anything else?

James S. Metcalf

Right. It's a throughput. I mean, It's really focused on the throughput and also, it's consciously not chasing low-end residential business where that's been the growth in the market. L&W doesn't plan the repair and remodel, the do-it-yourself and it's really positioning them where we can provide value. And we're looking ahead. As I said earlier, 2013 non-res is going to be mid-single digits so there's a lag but we're in steel studs in L&W and it's not as much of a lag as it is with the Ceilings business and in 2014, the McGraw-Hill projections are a little more optimistic. So we think we're very well-positioned from a cost standpoint. I think we're very well positioned from a value proposition of how we get paid for what we do. And, quite frankly, we want to get a bigger share of wallet from our commercial contractors and provide value to them. It's still a very difficult market to service so we don't have as many competitors because putting product in a high-rise takes some skills and we do know how to do it. So that's another area that's very important and the question that we get is why would L&W just focus on commercial? If you look at the amount of competitors that we have in distribution, it's exponentially lower than the amount of competitors that can service a homebuilder. So strategically, we think it will make sense but we just need some velocity, Kathryn.

Operator

Our next question comes from Seth Yeager from Jefferies.

Seth B. Yeager - Jefferies & Company, Inc., Research Division

With the sizable joint venture investments that you guys have been going into at this point, can you provide some -- maybe some updated timing metrics or hurdle rate so we can think about these opportunities going forward and how that will float through your P&L? And then just going forward, how do you weigh allocating dollars towards additional emerging market opportunities against say, in taking advantage of lower rates, reducing or refinancing parts of your balance sheet versus additional investments on new products?

James S. Metcalf

That's a great question. Let me take the first part and I'd like Matt to then talk about our strategy on ROIC and how we're going to be allocating capital into all of our businesses, including the emerging markets. As Matt went through the numbers, we've made an investment in Oman, which basically is going to be servicing the Indian market. I had a chance to be in India last month and I will say that the USG brand is very recognized. The customers are very anxious about us being there. We have boots on the street now. We've started to set up a distribution channel. But it's going to take some time and this is -- the market is growing but we are new in the market. We're seeding the market as we speak from other wallboard locations that we have in our network. But long-term, we need to have landed assets in that market. So I just want to caution everyone that this is going to be a -- this is a strategic move for us, but it will take some time. And saying that, we're going to continue to keep our eyes open on other options that people would look at our brands and our technology. And there, when you're in a worldwide market, our brand is very recognized. So on one side of it, this is going to be a very good part of diversifying out of our cyclical North American business. But this is a -- it's going to be a glide up versus a hockey stick and that's why we have to keep our other options open. How we allocate capital is very important. You have to look at the risks, we look at the country risks. We look at what product we're going to be manufacturing. Is it going to be wallboard or DUROCK or ceiling tile? And the good news is what we found in India. Our customers want the full product line. They're very interested in our ceiling tile, very interested in our FIBEROCK product, as well as the plasterboard products as they referred to it in that market. Now how we allocate capital, I'm going to turn that over to Matt because that's a very important question because the good news is we have a lot of opportunities throughout the company here to grow the business. The other news is we just have to be diligent of where we allocate that capital and making sure it has the best returns for our shareholders.

Matthew F. Hilzinger

I was just going to say this: last year, we did a very comprehensive top-down review of all of businesses. And as Jim said, we looked at the risk and we looked at the expected returns. And we've done a lot of analytics to come up with return on invested capital targets by each business. And obviously, they're going to be different whether we're in the gypsum business here in the U.S. or we're doing something overseas and we've got the Ceilings business. So we don't give out individual hurdle rates but I will tell you, we've been very comprehensive and analytical in how we come up with what we see those returns, expected returns and what they ought to be. And we do use this model, our return on invested capital model to take a look at how we allocate capital between the businesses now. And we find and see the international businesses [indiscernible] is a very attractive opportunity for us. And we clearly wouldn't be investing in it if we didn't believe that we can get to the right return on invested capital. So it's a big, big process in terms of kind of our capital planning, as well as our strategic planning of how we think about where capital needs to go, how we deploy it and having different hurdle rates within our businesses in terms of what they're expected to meet and make over the years. So I'm really pleased with where we are on that and I think we're going to see the fruits of that analytics bear over the next few years.

Operator

The next question comes from Jack Kasprzak from BB&T.

John F. Kasprzak - BB&T Capital Markets, Research Division

The restructuring and long-lived asset impairment charge of $13 million, can you tell us what segment or segments that's attributed to? And I assume there's no associated tax effect from that?

Matthew F. Hilzinger

There is -- those are -- the numbers we gave you are effectively after-tax. So majority -- if you look at the 3 areas or the impairment, about $12 million of that is in North American Gypsum. And I'd say about 2/3, about $8 million of that has to do with asset impairments related to a couple of facilities that we have up in Canada, closed facilities and the other 4 or 5 is restructuring due to the management reduction that we had that Jim had talked about earlier.

Operator

Our final question comes from Todd Vencil from Sterne Agee.

L. Todd Vencil - Sterne Agee & Leach Inc., Research Division

You mentioned the possibility even though you're not planning it, of adding a shift or 2 later in the year. And just around that issue, are you seeing any competitors doing that? And when you do it, how should we think about that impacting your margins? And any sort of competitive approach that you might take?

James S. Metcalf

Well, when we look at our opportunities, I said we're kind of on -- we're cautious on planning purposes and optimistic that we have some wind at our back. And we have to be very diligent and I said we may be adding a shift or 2. And here's the issue that we have, it takes time, most of our plants are in outlying areas. So to bring people in, we have a very rigorous preemployment screening, which also takes time. And the last thing we want to do is hire a shift and then 3 months later, lay it off. That's unfair to our employees and really doesn't help our shareholders. We have to be very confident that any type of regional recovery is sustainable. It isn't just about seasonality. We talked a lot about seasonality earlier. It isn't about a customer did a block buy and it was -- so we have to be very, very cognizant. We can -- we have about 51% [ph] volume increase that we can do without even adding shifts, if you look at systemwide. Now there'll be some regional areas. We have the opportunity to ship product in from out of area, if we think it's just going to be a monthly phenomena. So I just wanted to alert anyone that may happen but I just want to stress with everyone it has to be a very diligent, well thought out forecast that we know that, that opportunity is going to be there long-term. There's a lot of leverage in this business and when you add a shift, you're adding cost and when you add a shift, it has to have the appropriate return on investment just like it would if we're putting capital in. So that is how we plan our business. We work very closely with our customers, and get their projections [indiscernible]. One of the beauties of having a part of our company like L&W Supply, they have a customer base of 30,000 customers out there, so we get projections from them. We put that all into our black box and say are we going to do this or not? But we have to [ph] sure it's going to be right long-term.

L. Todd Vencil - Sterne Agee & Leach Inc., Research Division

I totally understand and that definitely seems like an appropriate level of consideration to give it. I mean, when and if you decide to do that and presumably you'll have to at some point, if volumes keep growing, how should we think about how that's going to impact margins and maybe even the way you approach competition in a region or will it?

James S. Metcalf

Well, if volumes are strong and we need to add a shift is -- in all the points I said earlier, it should positively contribute to volumes and be great to the bottom line. I'd like to say it will add to the pile of money. So we're not going to do this for the practice.

L. Todd Vencil - Sterne Agee & Leach Inc., Research Division

I like that. And have you seen anybody else -- any of your competitors adding shifts yet?

James S. Metcalf

I cannot comment on what they do. Probably the best thing is to ask them.

I appreciate everyone's questions. I know there were some people that we didn't get to, but it's good to see that we have a lot of interest in our company. And I just -- would just like to close. I thank everyone for your questions and your interest. And when we look back at 2012 and this will be the last time we'll be talking about it on a call, I think we can say we've seen the beginning of the recovery. After 5 years or I'd like to say, after half a decade, demand is starting to return to our business and our markets are healing. The near-term macroeconomic factors that drive our business, if you look at the credit availability and GDP growth and overall demographics, even though it's slow, it is improving. We're starting to see improvement in household formation and some of the underliers that we've all talked about really are -- I'd like to say we have a breeze at our back, maybe not a wind at our back. I look forward to the opportunities that we have in 2013. I'm very excited about 2013. We continue -- we'll continue to take care of our wonderful customers and I like to say working alongside, I believe the best team in the industry that we have at USG. We've taken some strong steps forward but clearly, there's more work to be done. We'll continue to execute our Plan to Win as we build on this recovery and we will continue to see the results from our efforts and you will continue to see those results over the next quarters and years as we move to our main focus now is our path to positive net earnings. And that's really front and center focus for us.

So as always, I appreciate your time and I appreciate your interest in USG and we look forward to updating you next quarter on the first quarter results. Thank you.

Ken Banas

A taped replay of this call will be available until Friday, February 15th. Information is available on usg.com. This concludes our 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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