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USG (NYSE:USG)

Q4 2013 Earnings Call

February 06, 2014 11:00 am ET

Executives

Ken Banas

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

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

Analysts

Stephen S. Kim - Barclays Capital, Research Division

Jason Aaron Marcus - JP Morgan Chase & Co, Research Division

Michael Dahl - Crédit Suisse AG, Research Division

Joshua K. Chan - Robert W. Baird & Co. Incorporated, Research Division

Wenjun Xu - Thompson Research Group, LLC

Dennis McGill - Zelman & Associates, LLC

Mike Wood - Macquarie Research

Garik S. Shmois - Longbow Research LLC

Philip Ng - Jefferies LLC, Research Division

Trey Grooms - Stephens Inc., Research Division

Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

Mark A. Weintraub - The Buckingham Research Group Incorporated

Desi DiPierro - RBC Capital Markets, LLC, Research Division

Albert Leo Kaschalk - Wedbush Securities Inc., Research Division

Operator

Welcome to the Fourth Quarter and 2013 USG Year-End Results Conference Call. My name is Vanessa, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. And I will now turn the call over to Mr. Ken Banas, Treasurer. You may begin, sir.

Ken Banas

Thank you. Good morning, and welcome to USG Corporation's fourth quarter and full year 2013 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, market and other conditions, and management undertakes no obligation to update these statements. The statements are also subject to a number of factors, including those listed at the end of the press release, and actual results may be different from our current expectations.

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 and year, 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 will then open the call for questions and conclude with a few comments from Jim.

As always, we would like to ensure that everyone has an opportunity to ask questions. [Operator Instructions] Jim?

James S. Metcalf

Thank you, Ken, and good morning. We appreciate you joining us this morning. And over the next few minutes, I'd like to give you a brief update of our fourth quarter and full year 2013, and then turn to our outlook for 2014.

2013 was truly a foundational year for USG. I'm extremely proud to report that the company was profitable for the year, generating net income for the first time since 2007. To put it in perspective, this was a time when industry demand was 31 billion feet in 2007 compared to 21 billion feet last year.

As we've talked before, we've created our own recovery by changing the leverage in our business and our results are evident that our Plan to Win is getting traction. I believe that our business is well-positioned for growth, as we continue to see demand strengthening in each of our markets.

During the fourth quarter, all of our businesses generated operating profit with improved results from a year ago. We also took important steps towards delevering our balance sheet and forming a very important joint venture, and with that, we had approximately $24 million of costs on these transactions. While these actions did have an adverse impact on the quarter, they better position our company over the long-term.

Now I'd like to review our business segments. In our North American business, North American Gypsum business, we had a very strong quarter. We generated $58 million more in operating profit compared to last year. The primary drivers continue to be wallboard price, volume, and with price increasing 17% and volume improving by 13% year-on-year.

In fact, our quarterly wallboard volume was the highest it's been since the fourth quarter of 2008. North American Gypsum also saw strong growth in our substrates businesses led by Durock, with sales increasing 18% and improved profits of 35% compared to the fourth quarter of 2012.

In our worldwide Ceilings business, we had a record fourth quarter. Our performance was driven by improved margins in both pile and grid, as well as strong volume with our grid products. Our Ceilings business continues to perform well, despite the choppiness that we've talked about the last few quarters in the commercial market. And while I'm very pleased with the fourth quarter performance, some of that improvement is related to timing of some certain large jobs that shipped during the quarter. We believe that this may have an impact on the first quarter, but our Ceilings business continues to remain very strong.

In Building Products Distribution segment, L&W continues to make progress, recording $4 million in operating profit during the fourth quarter, an improvement of $14 million versus last year. Improved margins in volume and wallboard were the key drivers, but we're also seeing improvements in other core products that led to a 12% comp store improvement. Additionally, at L&W, we had a reduction in our bad debt reserve due to better collections and an improvement in the credit quality of our commercial customers.

Executing our Plan to Win continues to drive our results, and I'm confident that we have the right strategy to realize our long-term initiatives. Our strategy, as reviewed with you in the past, is comprehensive, but I'd like to say it's very concise: Strengthen the core, which is improving our results in our North American manufacturing and distribution businesses; diversifying our earnings through geographic extensions and product adjacencies; and differentiating through innovation. Strengthen, diversify and differentiate is our strategy.

Our commitment to strengthening the core is evident in our North American Gypsum and L&W performances. In 2013, our full year North American Gypsum revenues were comparable to 2008, but our operating profit improved by $500 million. Through these changes to our wallboard pricing policies, effective cost controls, growth in our surfaces and substrates businesses and innovative products, we have substantially improved the operating leverage of our North American manufacturing business. We are very well-positioned now to capitalize on the growing demand in all segments, Commercial, Residential and Repair and Remodel, throughout North America.

L&W generated a full year of positive operating profit for the first time in 6 years and did so with $1 billion less in revenue and 100 fewer branches than we had in 2007. Let me repeat that. We did it with $1 billion less in revenue and 100 fewer branches. We have fundamentally changed L&W. While maintaining our position as the nation's largest specialty dealer, we refocused our energy on the commercial channel, as we've talked about in the past, where we feel adds more value and we have fewer competitors. We've optimized our branch network, and we have been committed to the relentless pursuit of profitable business at L&W. L&W remains a strategic part of our portfolio because of its nationwide footprint for new product launches, supporting the USG growth in price strategies. And because of their product adjacencies, it allows us to really diversify our earnings, with approximately half of L&W sales coming from non USG-manufactured products.

Another critical component of strengthening the core is deleveraging our balance sheet. We took important steps in 2013, including calling $325 million of our convertible securities and improving the funding of our pension plan. Deleveraging our balance sheet continues to be a top priority, and we will evaluate every opportunity to organically pay down debt in 2014.

The second pillar of our plan is to diversify earnings. And we took a big step forward in 2013 with the announcement of our joint venture with Boral Limited in Asia, Australasia and the Middle East. By bringing together Boral's leading market share and footprint with our world-leading technology, we have truly created critical mass for our business outside of North America. We're very excited about the USG-Boral joint venture, not only because it is immediately accretive, but it also should soften some of the cyclicality in our business. To put it in perspective, the trading areas of Boral to 12 countries, the opportunity right now is 24 billion feet of wallboard demand, which is equivalent to what we're seeing in the United States. So think of it as a United States market has just attached to our portfolio.

However, let me assure you that we are not taking our eye off the ball in the recovering North American market as we execute this joint venture. And while this joint venture has been slightly delayed due to one New Zealand final regulatory approval, the USG-Boral teams are working well together in some areas and I'm very pleased with the early technology exchange.

Differentiating through innovation is our third pillar of our strategy. We've had a long legacy of leading the industry in product innovation and operational excellence. And our product innovations create competitive advantages and truly differentiate us in the marketplace, and most importantly, help our customers win. We continue to focus on developing high-performance systems that drive energy efficiency, sustainability and speed of construction to the benefit of our customers. At USG, we're proud of our culture and our track record of innovation. And differentiating through innovation remains a core component of our Plan to Win.

Now I'd like to provide and turn it over to Matt who's going to talk about our financial results from the quarter and from 2013. Matt?

Matthew F. Hilzinger

Thanks, Jim, and good morning, everyone. As Jim said, I'll recap our full year and fourth quarter results, as well as provide some detail into each of our businesses and some of what we're expecting in 2014.

For our full year 2013, our revenue was $3.6 billion, an increase of 11% compared to 2012, and we generated full year GAAP net income of $47 million compared with a GAAP net loss of $126 million in 2012. Our full year fiscal 2013 adjusted net income was $73 million, about a $200 million improvement over last year, and the first time since 2007 that we had net income for a full year.

Looking at the fourth quarter, total revenue was $915 million, an increase of 12% compared to a year ago, and while we generated a GAAP net loss of $3 million during the fourth quarter, adjusted net income was $22 million, with the largest adjustment of $16 million for a special noncash pension settlement charge related to early payouts of certain vested retirees. In addition to improving our adjusted net income by $74 million over the prior fourth quarter, we also took actions to further delever our balance sheet, which I'll discuss in a few minutes.

Turning to our segment results. Net sales for North American Gypsum increased by 16% to $590 million during the fourth quarter, and operating profit was $75 million compared to $17 million during the fourth quarter of 2012. Our fourth quarter U.S. wallboard shipments of 1.38 billion square feet were up 13% from the fourth quarter of 2012. Our average sales price during the fourth quarter of 2013 was $155 per 1,000 square feet, compared to $132 during the fourth quarter of 2012.

The biggest contributors to our year-over-year segment improvement in the fourth quarter were: wallboard margin at $30 million; Wallboard volume at $7 million, our shipping business, GTL, at $5 million; and mining, for which we had a $9 million asset impairment charge last year.

For 2014, we anticipate that total contributions from GTL will be about $20 million, similar to its earnings in 2013. We also expect that at least 60% of its earnings will be recognized in the second half of the year, and the majority of that recognized in the fourth quarter due to how we account for the shipping revenue. We also anticipate that the results from our mining operations will be flat year-over-year.

In our Worldwide Ceilings segment, we had a strong fourth quarter generating $154 million in revenue, a 9% increase over last year, and $19 million in operating profit compared to $14 million in 2012. Ceiling tile and grid margins contributed $6 million, and volume contributed $2 million on a year-over-year basis. While we are very pleased with the results, we do not see as much of the normal seasonal drop during the fourth quarter due to the timing of certain job-related shipments. As a result of the strong fourth quarter and the cold and snowy weather in January, we expect a smaller seasonal pickup than we would normally see in our first quarter. We do, however, expect that the combined results for the fourth and first quarters will be about the same as what we saw last year.

At L&W supply, we recorded our third consecutive quarter of positive operating profit, earning $4 million on $314 million in revenues, an increase of $14 million in operating profit on $32 million in incremental sales compared to 2012. Wallboard was the biggest driver, contributing $7 million to our year-over-year improvement, but we also saw gains in ceilings, insulation and other products that improved results by $4 million. Additionally, about $5 million of the year-over-year improvement was due to a reduction in our bad debt reserve, which is a result of improved customer balance sheets and better collections.

Now I'd like to shift to SG&A spending. For all of 2013, SG&A was $320 million compared to $304 million last year. In the fourth quarter of 2013, SG&A expenses were $91 million, which includes about $5 million of the special pension settlement charge mentioned earlier. This compares to $80 million in the fourth quarter of 2012. As I discussed last year, we expected SG&A to be higher in the fourth quarter as we made some customer-focused investments in IT and product packaging enhancements to comply with new regulations, coupled with an investment in our new brand and Olympic sponsorship to raise our international visibility.

For 2014, we expect SG&A to be in the $330 million to $340 million range, with 1/3 of the year-over-year increase due to inflation. The remaining spend is related to our ongoing investments around our customers, focused on IT, product branding, R&D and targeted growth initiatives. Even with this year-over-year increase, our SG&A expense to revenue ratio will remain below our 20-year average.

Turning to taxes. For all of 2013, our tax expense was $11 million compared to $12 million in 2012. For 2014, we expect our total tax expense and cash taxes to fall in the range of $14 million to $20 million. This includes a potential special onetime tax payment of $8 million to $10 million in the first quarter related to the value of our technology license to the USG-Boral joint venture. I expect the balance of our taxes, which are primarily attributed to foreign earnings, to be spread evenly throughout the year.

As a reminder, we do not expect to pay any U.S. federal income taxes in 2014, as we continue to utilize our $2.1 billion net operating loss carryforward. Also, I do not expect that our valuation allowance of almost $1 billion to reverse in 2014, so I do not anticipate recognizing the deferred tax asset on our balance sheet this year.

Turning to product input costs for 2014. We anticipate inflation in the low single-digit range across all of our products, with the principal drivers being paper, gas and wages. With respect to natural gas, we're about 70% hedged at this point, and we may increase this up to 90% based on how the forward curve moves after the recent cold spell across the country. We are primarily hedged using collars, with the mid-range of those collars about 5% above our 2013 average cost of $3.70 per decatherm.

To give perspective, natural gas represents about 15% of our input cost to manufacture wallboard, and every change of $1 per decatherm represents about $2.25 change in our wallboard costs.

Looking at capital expenditures. In 2013, we had $124 million of normal CapEx, plus $22 million of funding for Oman, India and our joint ventures. This came in slightly below our projection, but we expect that some of this CapEx will carry over into 2014. So for 2014, we anticipate total CapEx to be around $145 million. Of that, $135 million is expected to be spent as part of the normal course of our business, and $10 million is related to finalizing our wallboard facility in Oman.

With respect to our new USG-Boral joint venture, I want to remind you that, as I said in October, we expect net earnings to be between $35 million and $45 million on an annual basis in 2014, before adjusting for foreign exchange. Please note that my projection was for a full 12 months and actual results for 2014 will be lower due to the projected closing on February 28. Also, given the 50-50 structure of the joint venture, it will be reported as an equity method investment but we intend to provide additional details about revenues, operating profits and depreciation and amortization when we announce our future results. As I have previously stated, I firmly expect that all future capital expenditures related to our joint venture will be self-funded by the joint venture.

Shifting to liquidity. As of December 31, 2013, we had total liquidity of $1.27 billion compared with total liquidity of $874 million as of December 31, 2012. Our 2013 number includes the $350 million in debt that we raised for our joint venture with Boral, and we expect our liquidity to drop by over $500 million due to the expected February 28 funding of our cash payment to Boral.

Based on where we are in the cycle, I believe that we have adequate liquidity in an improving demand environment. As we look at 2014, I expect that, consistent with prior years, we'll use more cash in the first half of the year compared to the second half due to rebate and incentive payments and normal business requirements, as well as the closing of our USG-Boral joint venture this year.

Lastly, I want to talk about our debt levels and our absolute commitment to organically delevering the balance sheet. As of yearend 2013, our total debt plus pension and other post-retirement benefits was $2.6 billion, which compares to $2.9 billion at the end of 2012. We took 2 very important steps towards delevering our balance sheet and optimizing our capital structure in 2013. First, in December, we called $325 million of our $400 million convertible securities, which were quickly converted into equity, reducing our interest burden by approximately $34 million per year. Second, we made considerable progress in improving the funding of our pension plan, which I consider debt. Our unfunded pension liability was reduced from about $400 million a year ago to roughly $115 million at December 2013, a $285 million improvement in the funding of our pension. We did this in part through continued contributions, strong investment performance and rising interest rates. We contributed approximately $60 million in 2013, and we are now funded at about 92% on a PBO basis.

In the fourth quarter, we also took steps to reduce the overall pension liability by offering a special onetime lump sum payment to vested retirees. In doing this, we reduced the overall pension obligation by $80 million, which will help dampen its overall volatility and reduce annual pension costs by $2 million to $3 million per year going forward. We also issued $350 million in senior notes during the year that we will use to fund a portion of our cash payment to Boral. However, in doing so, we will acquire an accretive asset that we believe will ultimately help us delever the company and reach investment-grade metrics more rapidly with the inclusion of another source of earnings.

As we look into 2014, we'll continue to take steps to delever the balance sheet. First is the maturation of the $59 million bullet debt due in August of this year, which we plan to retire with cash on the balance sheet. This will contribute to reduced future interest costs and it is our expectation that our 2014 interest payments will total approximately $183 million, $12 million better than last year. Second, we expect to contribute another $60 million to the pension plan with cash from operations to improve its funded status. We expect our pension expense to be around $40 million to $45 million this year. And as we are getting more funded, we are also taking steps to implement a liability-driven investment plan, or LDI for short, to reduce volatility and better immunize our plan against interest rates. I expect that the gap in our unfunded liability will continue to close as we make our annual contribution and as interest rates continue to rise.

And lastly, we will continue to evaluate opportunities to reduce our leverage by calling our remaining $75 million of convertible securities as soon as we prudently can. As we look to 2014, I want to stress that we remain focused and committed to further delevering our balance sheet and taking additional steps towards reaching our target leverage ratio of 1.5 to 2x debt-to-EBITDA. Delevering is a top strategic priority and we will continue to evaluate every opportunity to organically pay down debt.

On one very final note, we intend to file our 10-K by its due date of March 3, in conjunction with the closing of our joint venture with Boral. As a result, our filing will be a few weeks later than we normally file.

With that, I'd like to the turn it back to Jim.

James S. Metcalf

Thank you, Matt. What I'd like to do over the next couple of minutes is share our thoughts about the market in 2013, but more importantly, our outlook for 2014. As everyone probably knows, in 2013, housing starts came in around 920,000, which was slightly better than what we projected. This does represent the fourth consecutive year of positive growth in residential. But housing still remains well below the long-term average of 1.4 million to 1.5 million starts.

For this year, in 2014, Blue Chip consensus calls for about 1.1 million starts, but we continue to be more conservative and are forecasting slightly below that number. We do believe, though, that housing recovery is underway and many of the major metropolitan markets, for example, Florida and California, that were really depressed, are improving and we're going to continue to see that improvement throughout 2014.

In the Commercial business, we saw low single-digit growth last year, and as we move into 2014, there are some positive signs but we're still seeing mixed reviews. The architectural billing index has been positive 14 of the past 17 months, but we have recently seen some softening. We are hearing from our customers that backlogs are generally getting stronger, but there is still inconsistency from market to market.

While we believe the commercial recovery has started, but due to the timing of when our product shipped, we expect we will continue to see fluctuations in our commercial businesses throughout this year and with a more robust recovery in 2015. Thus, for 2014, our forecast calls for commercial growth still in the mid-single digit range, primarily picking up in the back half of this year.

In 2013, our repair and remodel business represented about half of our total sales and we saw an improvement of about 7% in that business. Looking to 2014, we expect repair and remodel to continue to be a major driver in our business and is going to grow in the mid-single digit range, similar to what it did in 2013.

We have the right channel customer partners and the macroeconomic factors indicate favorable demand environment with unemployment declining, consumer confidence strengthening, the rising of home prices, and on the commercial side, we're seeing office vacancy rates improving.

We are very optimistic about 2014, and we believe our business is poised to capitalize on the growth in each one of our end-use markets. We believe that the improving conditions are very durable, and that we have built upon the foundation over the last few years, and we are positioned to grow the USG of the future.

So what I'd like to do now is turn it over to you and we'd be happy to answer any questions you may have over the next 30 minutes.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Stephen Kim with Barclays.

Stephen S. Kim - Barclays Capital, Research Division

I wanted to just follow up, though, on your comments about the Ceilings business, if you didn't mind. I think you had said that there were some shipments that sort of benefited the fourth quarter and you thought that there may be a little bit of an adjustment as a result in the first quarter in the negative direction. I just wanted to see if you could quantify that a little bit? And also, maybe put a little bit more color around your comment about how you thought, I think, fourth and first quarter together would be about the same and I just wanted to make sure I got that right?

James S. Metcalf

Sure, Stephen. And thank you for comments. Our fourth quarter was better than we expected. We had some jobs that shipped early. We also -- we have some price increases in our Ceilings business positioned for early February. So there was -- some customers did pull some shipments into December for that as well. I think, the best metric is really looking, as Matt indicated, the fourth and first quarter of last year. If you look at our Ceilings business, we typically have a pretty big seasonal drop in the fourth quarter. We didn't see as much of that this year versus last fourth quarter, and the first quarter of last year, it bounced back. So I think, the best -- it's not going to be dramatic in the first quarter. It's just -- we're just trying to manage expectations. Along with that, the weather is not helping us in any of our businesses. So I would just -- if you look at the seasonality that we had last year, we were a little stronger in the fourth quarter, which means we think we'll be a little weaker in the first quarter of this year.

Operator

And our next question comes from Michael Rehaut with JPMorgan.

Jason Aaron Marcus - JP Morgan Chase & Co, Research Division

This is actually Jason Marcus in for Mike. My question is around L&W. So the margin in L&W showed some really nice improvement during the quarter. And I was hoping you could maybe go into a little detail to discuss some of the drivers there and how you're thinking about that business going into 2014, and if the current level of profitability is sustainable going into 2014, or if you think there's room for continued margin expansion from here?

James S. Metcalf

Yes, if you look at L&W's business, it was really -- it was driven by the Wallboard business. Comp store sales were up, as I said, about 12% total, but Wallboard margins, they had margin expansion in the quarter, which was very, very positive. They also grew their business in the quarter as well. But the complementary products really were a big driver. Each one of the areas of complementary products, that would be steel, insulation, ceiling tile, grid fasteners, all had nice growth in the quarter, which is starting to get some traction on our focus on the Commercial segment. So we're very pleased with having a profitable year. We still have work to do. The ROIC is still below what we have set for the business. But we do expect continued progress at L&W. We've taken out, as I indicated, 100 branches. We've optimized the network and right now, it's continuing to grow the business. From a margin standpoint, a profitable business. We're very focused on the commercial contractor. One of the things you need to keep in mind is that my comments on the Commercial segment, L&W, about 2/3 of their business is focused on commercial. So until you start seeing some really good traction in commercial, that will really help the velocity of L&W, which we indicated is probably the back half of the year. So we're pleased where we are now. We made money. We have a lot of work to do, and I think, 2014 will be better than what you saw last year.

Operator

And our next question comes from Michael Dahl with Crédit Suisse.

Michael Dahl - Crédit Suisse AG, Research Division

I wanted to ask about your comments on leverage. And if you look at the balance sheet here, it seems like 1.5 to 2x is still a couple of years out. So hoping you can speak to, first, is it your expectation that, that will take several years? And second, really, if you see opportunities to remain aggressive on offense here, how willing are you to extend those target levels?

Matthew F. Hilzinger

Yes, Michael, this is Matt Hilzinger. Yes, I think, it is going to take several years. I mean, you guys all go do your projections. But if you think about where we are at $2.6 billion of debt and 1.5x leverage, that means we probably have to take somewhere around $1.5 billion of debt off. And clearly, that's going to take more than just a year or 2, so -- but it -- as I said and as Jim said, it is a strategic priority for us and we think about it every day. I can tell you, I do, and Ken Banas thinks about how we can deleverage this balance sheet every day. And I pointed out some things that we're going to do around just paying down some debt maturities this year. We're going to be very focused on improving the fundability and the leverage around the pension plan. We're going to look at every opportunity to call the rest of the convertible securities. There are -- we have some debt that's due in 2018 that's callable at the end of next year and early 2015. I think, it's way too early to get into whether we would do that, but clearly, those are some levers out there that we could take a look at, I think, largely depends upon the performance of the business and we'd like to see the macros continue to improve in the economy. And I think that will give us an opportunity to continue to deleverage the balance sheet.

Operator

And our next question comes from Josh Chan with Baird & Co.

Joshua K. Chan - Robert W. Baird & Co. Incorporated, Research Division

I just want to get your thoughts about the L&W footprint. You mentioned that being down 100 locations from the peak. And just wondering, as you see this recovery ahead of you, how do you expect to manage the location count and do you think you have sufficient coverage?

James S. Metcalf

Yes, thank you, Josh. As I said, we're down about 100 branches. One of the key things, when we looked at this recovery, we wanted to make sure we didn't exit any markets. And that was very, very important for us because we were looking ahead. So right now, with our current network, which is about 150 locations, we can take care of all the metropolitan markets that we were in before the recession. And we still have quite a bit of room on additional volume without adding branches. We added a couple of branches last year in a couple of key areas, which were very minor but we do not see any branch expansion in 2014. You may see 1 or 2 small ones, but we feel that we have enough, we've really optimized the overall network and we can get more out of our current footprint at this point, and handle the additional volume that we're looking at from a demand standpoint. We think the overall wallboard demand is going to be about 24 billion feet in 2014, up from about 21 billion. And we still -- we'll be able to do it with our current footprint.

Operator

And our next question comes from Kathryn Thompson with Thompson Research.

Wenjun Xu - Thompson Research Group, LLC

This is Wenjun sitting in for Kathryn. My question is on the current commercial trends. You talked a little bit about that in your prepared remarks. In Q4, our industry contact saw some meaningful improvement in non-res activities. But could you clarify regional trends that you see and how this has changed from early 2013? And separately, if you could provide some color on what you're seeing in L&W in terms of types and sizes of projects, commercial projects?

James S. Metcalf

We're seeing the -- as I said in my prepared comments, the Commercial business is still very choppy and a lot of that has to do with regionality. We're seeing that the Northeast is very, very strong in Commercial business. The Northern California, Silicon Valley is extremely strong, and the Dallas-Fort Worth Metropolitan area. So those are really 3 areas from a commercial geographic segment that we're seeing. If you look at the overall commercial starts, it is very segment-oriented. We're seeing retail and health care being the leaders in those segments as we go forward. Office is also -- office remodel is also something that we're seeing some positive trends. The size of jobs, your question on L&W, the jobs, you still aren't seeing the large commercial jobs, but we're seeing more of the medium-sized, higher-profit jobs, which is really good in our wheelhouses as well. So we still think, to really get some traction in the Commercial business, we're 6 to 12 months away from some real velocity here, but we're much better than we were a year ago. The last 3 years have been low to single-digit increases, but at least the trends are going the right way but still fairly choppy, both geographically and from a segment standpoint.

Operator

And your next question is from Dennis McGill with Zelman & Associates.

Dennis McGill - Zelman & Associates, LLC

I guess, my question would be, on 2014, if your outlook and kind of a general macroeconomic outlook plays out for both res and non-res construction and knowing what you know about your internal pricing strategies and internal costs, do you think that leverage, expense leverage, in margins across the portfolio would actually be on par with what you generated in '13, better than or worse than?

James S. Metcalf

Well, Dennis, I wouldn't be doing a good job if it was on par or worse. So we're very focused on margin expansion. I talked about L&W, we have a lot of room to go there from a margin standpoint. We're very pleased. Our margins are very strong in the Ceilings business. So maintaining and slightly growing our margins there are very, very important. And as -- on the Gypsum business, obviously, it's wallboard cost and price, we feel that there's price improvement in the market, but most importantly, we have some headwinds on the cost side. So we have some very specific cost initiatives through our manufacturing facilities, Matt had talked about some of the inflation that we have. But we have Lean Six Sigma groups all through our manufacturing operations to manage those costs. So without giving a projection, obviously, we want -- we're looking at margin expansion in each category, as well as growing the business.

Dennis McGill - Zelman & Associates, LLC

Sorry, Jim, I didn't mean in absolute terms on margin but more the incremental margin, whether that would accelerate or hold steady?

James S. Metcalf

We've averaged the last 3 recessions between $0.35 and $0.55 on operating margins. And as we spoke last year, I mean, we came out pretty strong on quarter-by-quarter. So we -- if you look at the margins, the leverage we've had on each quarter, it does vary quite a bit. But to have $0.80 margins going forward, I think is unrealistic. So I would look at our historic leverage, which has been $0.35 to $0.55, put in your numbers about how much cost you think we've taken out and I think that gives you an idea of what the average margins will be going forward.

Operator

And our next question is from Mike Wood with Macquarie.

Mike Wood - Macquarie Research

From the margin bridge that you provided for North American Gypsum, it seems as if the incrementals on the price realized in Wallboard was pretty close to 100% throughout the year and it didn't deteriorate as we got into the back half of the year. I would've thought that given you had one price increase at the beginning of the year, that debt inflation, that may have slowed down. And so was there productivity offsetting that? Or was there inflation subsiding? And can you just give us some color in terms of how we would expect that incrementals on the price that you get to get reflected throughout the year?

James S. Metcalf

As you look at quarterly price throughout the year, it would -- it varied slightly. And each quarter, we would say it's where we ship and we ship into different parts of the country and there's different customer segments. But the key is it was pretty flat. If you look at it quarter-by-quarter, it would go up or down a few cents. And that is really important for our customers. It gives them certainty on one of their raw materials. So that is one of the advantages of one price through the year. They don't have to guess where the price is going. What you saw this year, we ran our plants extremely well, I'm so proud of our manufacturing organization, as I mentioned in the previous question about Lean Six Sigma, but we had probably the best efficiencies we've had in years. We had some records. We looked at recovery speed and delay. We have a very aggressive strategic sourcing group that does a phenomenal job of -- Matt talked about our natural gas and how we hedge our natural gas. But there's also a lot of commodity input costs that we really manage well. So what you saw this year is one price for the year, basically, as we said, is around $155, and we really manage that cost line. That's something that is a core competency for USG. It's focused on manufacturing costs. In fact, this past year, we had the best quality year for our customers in the history of the company. So we not only ran the plants very efficiently, we put a product out, the best our customers have ever seen. And that's the challenge going forward is getting our price improvement, and with some of the inflation that we're talking about, is how do we continue to offset the inflation. And most importantly, all the hard work we've done the last 5 years is keeping our breakeven at the appropriate levels so that leverage stays strong going forward.

Operator

And our next question comes from Garik Shmois with Longbow Research.

Garik S. Shmois - Longbow Research LLC

Just had a question on the debt reserve in L&W in the fourth quarter. It was a pretty meaningful benefit for you. How should we think about that in 2014? Is there going to be a continued benefit as we move through the balance of the year, as your customers' balance sheets improve? And if so, is it possible to quantify it at all for us just given that the $5 million improvement in 4Q was actually a pretty big number relative to the overall growth of the business?

Matthew F. Hilzinger

Yes, hey, Garik, this is Matt Hilzinger. So the adjustment really is a reflection of kind of 2 years of very hard work by the L&W team in improving collections and looking at credit of our customers and extending credit where we absolutely can, but really driving improvement in collections. I think, clearly, the environment has gotten better, right? So our customers' balance sheets have gotten a little bit stronger. So the whole environment has just improved to the point that we felt that we should reflect kind of a lower bad debt expense. It's kind of episodic. It's not something that happens every quarter. You kind of go through and you take a look at it on a periodic basis, we take a look at it annually. I think, we're in a very good spot. If you take a look at our actual bad debt write-offs at L&W, they are extraordinarily low, very, very low. So there's not a lot of room more for improvement, but we continue to work on our collections. So I would look at this as more of a onetime and not really roll it into any kind of expectations for '14.

Operator

And we have our next question from Philip Ng with Jefferies.

Philip Ng - Jefferies LLC, Research Division

Had a quick question, you guys flagged bad weather being a headwind. Obviously, you're seeing an uptick on the nat gas side, but can you quantify what the impact is going to be from a demand perspective? And are you guys having any operational issues running your facilities with bad weather?

James S. Metcalf

We think, this year, we still have not come off our demand forecast, even with the basically 6 weeks of some pretty bad weather throughout most of the United States. So if you look at the overall demand, we feel the opportunity is going to be about 24 billion feet this year from 21 billion of last year. So along with that, we still are running -- capacity utilization has room to go up. So you may -- if the industry or we were running at 90%, 95% capacity utilization, that could really impact the demand for the year. So we feel comfortable with that forecast, even sitting here in early February with the cold weather. On operations, we have had some spotty shortages of nat gas in some areas, nothing critical. The key is we just can't ship to a lot of jobs, and with the expressways and freeways covered in snow and ice, a lot of things are backed up. So operationally, a few issues, nothing to speak of. We have, as I said in the earlier question, we have a very professional strategic sourcing group that makes sure that we get supply. We have our natural gas hedged, 70% is hedged so we know what our costs are going to be, even with the increase in nat gas. And the key is we need the snow to go away so we can ship it to our customers. So we feel that the demand will be there and they'll probably, looking forward, I wouldn't be surprised if we come to early spring that there could be some spot shortages, some tightness in some areas because some regionalities, we're busier in some regions, as I said earlier. So it's going to -- we still think it's going to be a good year.

Philip Ng - Jefferies LLC, Research Division

And just on the spot shortages, are you talking about any products specifically, or is it wallboard, ceilings?

James S. Metcalf

I was talking about 2 things. I was talking about some natural gas shortages earlier, which we have handled. But the spot shortages could be on supply, yes.

Operator

And our next question is from Trey Grooms with Stephens.

Trey Grooms - Stephens Inc., Research Division

Just a real quick one on looking at the North American Gypsum segment, I mean, obviously, there's several buckets there. And I think, it looks like that SHEETROCK sales, I guess, overall, are 1/3 of that business or so. But there's a lot of other moving parts and you guys talked about substrates, you talked about with DUROCK and having some success there. Is there any way that we should be thinking about, as we're looking forward and trying to think about those ancillary businesses, any way for us to think about how to quantify, where and how much and what the size is of these different businesses, like joint compound, like DUROCK, things like that? Is there any more color you can give us on that specifically?

James S. Metcalf

Yes, if you look at the rest of the U.S. Gypsum or the North American Gypsum business, second largest category, and you hit the nail of the head, Trey, is joint treatment. And we have a -- our market share in joint treatment is 2x what it is in wallboard, so we're covering a lot more wallboard than we ship. The joint treatment is growing probably relative to what you see in wallboard growth, with pretty durable pricing in joint treatment. Durock, Fiberock and substrates probably make up 25% of that. So the big category, if you look at the wallboard, the next largest category would be in North American Gypsum would be the, we call it, surfaces, which is not only joint treatment but also plaster, which we have a leading market share. There are still some areas in the country that conventional lathe and plaster are our key products. So we don't break those out numerically, but if you just look at the growth of Gypsum, put in a large percentage of the next would be joint treatment and we're covering competitive products as well.

Operator

And our next question is from Keith Hughes with SunTrust.

Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

Question is on wallboard [indiscernible] pre-buy heading into potential price increases here in 2014. And any kind of commentary you would be willing to make on prices in wallboard in 2014 would be helpful as well.

James S. Metcalf

If you look at the industry shipments for the quarter, there was obviously some pre-buy. But if you look at our shipments and really compared to last year as well, the industry was up greater than our shipments. We basically have some policies on pre-buying. We feel that we want to make sure that if a customer is buying 10 loads a week, they will get their 10 loads. But we really try to manage that process and we've done a pretty good job the last couple of years. So the industry did do some pull forward, shipments were up greater than what we ship. So those numbers are very public and you'll be able to see those. Along with that, as we said earlier, we're talking about weather. So you had some pre-buy and some weather. We don't comment forward-looking on pricing. We have a price increase in the market for 2014. Our pricing strategy remains the same, as it has been the last 3 years. We will give one price for the year, and that will be our price for our customers. Those prices, we're a national player, they vary by geography, by customer segment, and that is why we sit down and have individual conversations with our customers. So we'll be able to report the pricing after the first quarter, but our price is up in 2014.

Operator

Our next question comes from Mark Weintraub with Buckingham Research.

Mark A. Weintraub - The Buckingham Research Group Incorporated

The question is you mentioned the potential for some spot shortages on the wallboard side, very different experience than what we've had in the last several years. Are you beginning to think about any adjustments to your production schedules given what looks to be, at least in certain markets, potentially a real change in the supply-demand dynamic?

James S. Metcalf

Well, we will not be bringing back any capacity. What we are looking at, there possibly could be a shift to the plant here and there, a shift is about 20 people. If you look at what our costs would be to add a shift is about $1.5 million. So you really have to think long and hard about adding $1.5 million, it has to be a very durable demand. It can't be just demand has jumped up for 6 weeks and you add a shift and it goes back down the normal levels. So we would rather run a plant tight and run overtime. And we want to be doggone sure that the demand is durable and is just not a pent-up demand from the weather that we're seeing right now. So we are being very diligent on that. We worked extremely hard over the last 5 years of taking costs out and we want to make sure that we're running our network very efficiently but more -- most importantly, we need to take care of our customers. We've learned in this recession to run our plants 2 or 3 days a week. And as I said earlier, we have some top efficiencies that were on output. So long answer to your question. There may be a shift added here or there but we to make sure that the demand in that market is durable.

Operator

And our next question comes from Robert Wetenhall with RBC Capital Markets.

Desi DiPierro - RBC Capital Markets, LLC, Research Division

This is actually Desi filling in for Bob. On the Ceilings business, you highlighted that you benefited from a richer product mix. Is that a trend you expect to continue in the future? And can you give us an idea of what's driving the mix shift?

James S. Metcalf

Yes, our richer product mix or our high-end products, really, it's demand-driven. You see more offices that are LEED 4 offices, very big on energy, on noise, on light, people working on their computers. And those are all high-end ceiling tiles. A lot of the open office spaces that you're seeing throughout the country, sound and noise are very, very important. So it's a high NRC, noise reduction coefficient products. We have been very busy on those products. We like them because they're high-margins, but our Cloquet plant has been sold out. We made a capital investment 1.5 years ago to expand our capacity at our high-end plants. And we do foresee that trend continuing. So we feel that's very positive for the business.

Operator

We now have a question from Al Kaschalk with Wedbush Securities.

Albert Leo Kaschalk - Wedbush Securities Inc., Research Division

Jim, on the UltraLight products, I think, you have said that it's 59% of shipments for U.S., for the Wallboard. What are you hearing from customers and how can that be further basket [ph] going forward to the pricing and revenue story in that segment? In other words, do you think that's a 60%, 70% -- sorry, 75% of wallboard shipped will be UltraLight? What do you think here going forward?

James S. Metcalf

Well, we're very pleased with UltraLight. It is -- our customers continue to demand UltraLight. And really, it's all about the performance. There's been a lot of talk about how light it is, it's 1/3 lighter. But it's really about the performance. It doesn't sag, the cutability is better and it's the best-performing product in the market. That actually was one of the products in our USG-Boral joint venture that's very attractive to them because it is in high humidity areas in that part of the world. If you look at our half-inch UltraLight, the percentage is even higher. Percentage in our half-inch UltraLight is probably around 80% of shipments. We're expanding our portfolio. We've expanded it to UltraLight 30, which continues to grow, which is -- goes in the commercial market. So as I said earlier, the commercial business is starting to return. So we anticipate that growing. And then, our UltraLight Firecode, which is a one-hour rated product, which is the only one in the market, we only are shipping that in half the United States, and we will be expanding that throughout the United States, so we anticipate that to grow as well. So the number won't be 100% because SHEETROCK Classic is still a great product for us. Actually, SHEETROCK Classic is lighter than most of our competitors' products. But we probably anticipate that 69%, that will -- you'll see that growing each quarter as the portfolio expands throughout, actually, North America as well.

So what I'd like to do is just wrap up. I really appreciate all the questions and comments about the year. This is a very exciting time at USG. We are making progress, as I think you see by the numbers on our Plan to Win, and we are very pleased to have generated net income and positive EPS for 2013. But I want to assure you, we still have work to do.

We are positioned to capture the recovery in the United States with our leading customers. We're going to grow end markets with our new manufacturing footprint with USG-Boral, and we're staying extremely focused, very focused on our costs and keeping our breakeven at appropriate levels. But as Matt said, and I reiterated, we are simultaneously deleveraging our balance sheet. We're very optimistic about the year ahead, and we truly appreciate all the support from our wonderful customers, our shareholders, and really, our dedicated employees throughout the world who have worked extremely hard over the last 5 years to position USG to grow.

Thank you for your interest in our company, and we will talk to you next quarter.

Ken Banas

Thanks, Jim. A taped replay of this call will be available until Thursday, February 13. Information is available on usg.com. This concludes our conference call. Thank you.

Operator

And thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.

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