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USG (NYSE:USG)

Q3 2012 Earnings Call

October 18, 2012 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

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

Daniel Oppenheim - Crédit Suisse AG, Research Division

Trey Grooms - Stephens Inc., Research Division

Mark A. Weintraub - The Buckingham Research Group Incorporated

Mike Wood - Macquarie Research

Garik S. Shmois - Longbow Research LLC

Neil Frohnapple - Northcoast Research

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

Kathryn I. Thompson - Thompson Research Group, LLC.

Dennis McGill - Zelman & Associates, Research Division

James Barrett - CL King & Associates, Inc., Research Division

Peter Lisnic - Robert W. Baird & Co. Incorporated, Research Division

Desi DiPierro - RBC Capital Markets, LLC, Research Division

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

Operator

Welcome to the USG Corporation Third Quarter 2012 Earnings Conference Call. My name is Tricia, and I will be your operator for today's call. [Operator Instructions] Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I would now like to turn the call over to Ken Banas. Please go ahead.

Ken Banas

Thank you. Good morning, and welcome to USG Corporation's third quarter 2012 earnings conference call and live webcast. We will 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, plus additional insight into some of our businesses. Matt will review the financial results for the quarter and the business segments. We will then open the call for questions and conclude with a few comments from Jim. [Operator Instructions] Jim?

James S. Metcalf

Thank you, Ken, and good morning. Thank you for joining us, and we appreciate your interest in USG. I'm looking forward to sharing our observations on the quarter with you today, as well as some initial thoughts that we have on 2013. In the third quarter, we continued our positive results from the first half of the year with yet another quarter of positive operating profit. We achieved the highest operating profit since 2007, our best quarter in the last 5 years. We achieved high levels of customer satisfaction and delivered industry-leading products in a safe manner. Despite demand in the U.S. well below historical levels, we are making strides toward our primary objective of positive net income.

We do believe we are in the early stages of a recovery in our core markets. With that said, the path back to our historical norms is likely to be choppy. We are pleased with the progress in our business, and I'm optimistic about the future. Demand for new residential is getting stronger as you saw in the numbers yesterday, but we continue to experience some weakness in our commercial markets, in fact -- in principally our Worldwide Ceilings business and L&W Supply.

We are committed to continue to lower USG's breakeven. We are not waiting for the markets to fully recover. As you've heard us say before, we are creating our own recovery. We've taken out nearly $0.5 billion in cost, and we will continue to weed the business so we can feed our growth. These actions are allowing us to make targeted investments in growth areas and lower our breakeven. We are implementing break-even initiatives to accomplish this objective, and we are currently making some small investments there. This will occur over the next few quarters to complete the implementation of an expanded shared services organization for HR, information technology, finance and supply chain and outsource some of our back office functions. And these actions will further reduce our cost as the market recovers.

Now I'd like to turn to our business units. In our North America Gypsum segment, our U.S. pricing strategy that eliminated job quotes and established a single wallboard price for the year continues to be very successful. Wallboard volume increased 14% year-on-year in the third quarter, and price was flat in the quarter. The 1.2 billion square feet of wallboard we shipped in the quarter was the highest since the same quarter in 2009. We plan to continue this pricing policy in 2013. We will have a price increase on January 1, and we'll begin communicating that increase to our customers later this quarter.

We did experience some wallboard cost pressures in the quarter due to slight raw material inflation and some planned infrastructure spending. We were aware of this possibility. When we implemented our policy of a single price for the year, we're satisfied that the incremental profitability from our price improvement has more than offset this inflation.

Our focus on our other core products continues to produce solid results. Joint Treatment profit was up over $3 million from the third quarter of 2011 and showed improvement from last quarter as well. We also had positive contributions from our shipping business, Gypsum Transportation Limited, or GTL. GTL's profitability improved by $8 million compared to last year as we redeployed our ships to transport iron ore.

Worldwide Ceilings continued its solid performance despite some headwinds. USG Interiors profit was up approximately $3 million compared to both last quarter and the third quarter of last year. We also saw a slight increase during the quarter in volume due to the seasonality that we mentioned to you last quarter. Demand in commercial construction remained soft. And based on historical McGraw-Hill commercial starts, it's likely to remain weak for the near future. But I'm proud of our team, particularly our Ceilings team, and their ability to offset this market weakness with innovative high-performance Ceilings products, margin improvement and a strong distribution network.

Now turning to our distribution company. We believe L&W Supply continues to make progress on its path to profitability. Again, we are creating our own recovery, pursuing profitable contractor business, leveraging shared services such as our new procurement system and reducing our branch footprint to drive towards operating profit. L&W saw wallboard spread and volume improvement from both last year and last quarter. Core products beyond wallboard at L&W saw a $4 million improvement in profitability compared to last year.

We will grow this business by focusing on value with an emphasis on systems selling. Let me be clear. Despite the fact that distribution is a business that requires velocity to maximize profitability, the L&W team is working to achieve profitability now, and we have a line of sight to this objective.

I would now like to touch on what we're doing today on our Plan to Win, our strategic priorities; strengthening our core business, diversifying our earnings and differentiating through innovation. In the third quarter, we made progress on each of these fronts, and let me touch on them briefly. Our focus on strengthening the core can be seen in the results, our new wallboard price policy, the positive results from our other core businesses. USG Interiors' strategy in a very soft demand environment and L&W's year-on-year improvement are all evidence we are creating our own recovery. We will continue these actions with an intense focus on satisfying our customers, lowering our breakeven, a margin improvement that supports our value proposition.

To continue to strengthen our core, we must also organically delever our balance sheet. We are not satisfied with our debt level. And now that the recovery has begun, we will look to allocate our cash generated over the next few years towards lowering our debt and investing in the business to drive shareholder value. Our intention is to move towards investment-grade metrics for our balance sheet, although the shape of the recovery will dictate the timing of achieving that objective.

The second layer of our strategy is to diversify our earnings. Last quarter, we announced our investment that will enable us to serve the growing market in India. Staffing and engineering work are underway towards commencing quarry operations in a new wallboard plant late next year or first quarter of 2014. We believe this investment will position USG to capitalize on high-growth emerging markets, but will also help offset some of the cyclicality that's inherent in our core businesses.

We continue to grow our business through innovation with the success of our SHEETROCK Brand UltraLight platform. This product now represents almost 50% of the total wallboard shipments in the United States during the quarter. Customer demand has been outstanding, which is converting across all channels. Our customers are attracted by the lighter weight, but keep coming back because of the improved performance of this reengineered, innovated -- innovative product platform. We're continuing the rollout of more products, such as our new SHEETROCK Brand UltraLight Joint Treatment. Each pail is nearly 40% lighter than conventional Joint Treatment, and we are seeing traction in both the large retailers and specialty dealer channels.

We are also extending the platform across more of our Gypsum Wallboard products with another new release scheduled for next quarter. Our strategy is simple; strengthen, diversify and differentiate to grow USG.

So now, I'd like to turn it over to Matt Hilzinger, and he will give you a greater detail on the quarter.

Matthew F. Hilzinger

Thanks, Jim, and good morning to all of you. As Jim mentioned, I'll recap third quarter results and provide some additional details in each on our business segments. Before I begin, I want to point out that results from our European operations have been reported in discontinued operations in the third quarter. In addition, our prior results for 2011 and 2012 have been recast to show these prior periods without our European operations.

During the third quarter, we announced that we entered into a definitive agreement to sell our European operations. Although that sale has not yet been consummated, net sales of $27 million and operating profit of $1 million from European operations in the third quarter have been reported as discontinued operations. My comments today and our disclosures going forward will reflect these updates. Results from our European operations had been reported previously, entirely within USG International and in our Worldwide Ceilings segment.

Moving on to total corporation results from continuing operations, third quarter 2012 net sales were $828 million, up 9% from the third quarter last year. The third quarter operating profit was $29 million, which compares to an operating loss of $79 million in the third quarter of 2011. This quarter's operating profit included $3 million in restructuring and long-lived asset impairment charges. As you recall, the loss last year included restructuring and asset impairment charges of $59 million, of which $51 million related to the closure of our Windsor Quarry. The remaining year-on-year improvement was primarily driven by improved Wallboard gross profits, which benefited from higher wallboard prices, lower unit costs and higher volume.

Using adjusted operating profit to remove the effects of the Windsor charges last year and restructuring this year, we had a $52 million improvement in adjusted operating profit on a $65 million increase in sales, resulting in an incremental operating profit margin of 80%. This continues to build upon the 83% and the 74% incremental margins we saw in Q1 and Q2 of this year and demonstrates the strong operating leverage of USG.

We continued to take steps to lower our breakeven and focus on managing our SG&A expenses. In the third quarter of 2012, SG&A was $74 million versus $66 million last year. Our business has performed better in 2012, and our incentive compensation has increased accordingly. We now expect SG&A to increase approximately 5% for the full year in 2012 versus 2011 after adjusting for Europe, which is now in discontinued operations.

I will now provide a little more detail on our third quarter segment results. Net sales for our North American Gypsum segment increased 14% to $496 million for the quarter, and operating profit was $35 million versus an operating loss last year of $70 million. These results were driven by improvement in many of our products and businesses.

A few of the key contributions are noted here: Higher U.S. wallboard price contributed $24 million; the reduction in U.S. wallboard manufacturing cost of $10 million due to lower natural gas and lower fixed cost; and $2 million in incremental profit due to wallboard volume improvement. Our U.S. Wallboard business shipped 1.2 billion square feet in the quarter, an increase of 14% compared to the third quarter of last year and up 4% from the second quarter. We attribute these increases to overall market improvement and to the continued customer demand for our SHEETROCK Brand UltraLight Panels as our shipments of these panels continue to grow.

Average wallboard selling prices were up over 18% year-on-year, with an average realized price for 2012 third quarter of $131.97 per 1,000 square feet compared to $111.66 in the third quarter of 2011 and $132.90 for the second quarter this year. This was -- there was very little impact this quarter from residual 2011 job quotes as well. As we mentioned in the past, quarterly average wallboard pricing will experience fluctuations throughout the year due to variations in the channel and additional [indiscernible] sales along with freight charges.

As Jim mentioned, we will have a price increase on January 1, and we are currently evaluating the appropriate increase. We are reviewing our forecast on raw material cost, notably natural gas and wastepaper, and regional demand profiles in setting the price for next year. And we'll begin to having individual conversations with our customers later in the fourth quarter.

Turning to Worldwide Ceilings, our Ceilings business continues to deliver consistent and solid results, continuing its track record throughout this downturn of positive operating profit every quarter. Third quarter net sales of Worldwide Ceilings increased year-over-year by $1 million to $155 million and third quarter segment operating profit from continuing operations was $24 million, which was up $5 million from the second quarter. These results were driven by strong grit and tile margins due to focused shift in the mix to higher-end products and strategic pricing actions that offset input cost increases and slightly lower volume. Tile and grit volume decreased in the low-single digits year-on-year, but did see an increase from Q2 2012 as we had the benefit of some seasonality.

In our Building Products Distribution segment, net sales increased 6% year-on-year for the third quarter, with the same-store sales up nearly 10%, a sign that our branch rationalization efforts are delivering results. The operating loss in this year's third quarter decreased to $10 million from $17 million a year ago. As L&W continues to expand and grow its product portfolio outside of wallboard, we believe that this will help our customers strengthen our results.

L&W wallboard price and volume were up in the quarter, contributing $3 million in incremental gross profit versus the third quarter of 2011, even while competition among distributors remains a factor. All 4 products had sales improvements from last year with wallboard having a 5% increase in volume and a 10% increase in spread. L&W also closed 12 branches this quarter, further evidence of our commitment to returning to profitability.

Now I'll add some details on corporate spending and what we've been doing to manage capital spending in our balance sheet, including liquidity. We are forecasting about $75 million of capital spending for the year of 2012, plus $60 million in investments in, and loans to joint ventures this year, which includes Oman. We have spent $34 million of those investments at the end -- as of the end of the third quarter. And as we look at liquidity, as of September 30, 2012, we had total liquidity of $781 million, an increase of $36 million from the end of the second quarter.

Let me conclude by saying that while we are pleased to have continued our positive operating profit in every quarter of 2012 with our highest operating profit for the year in the third quarter, we remain focused on achieving positive cash flow and net earnings as quickly as possible. We will continue to manage our cost and endeavor to lower the breakeven of each business, while investing in those businesses that will general -- generate an appropriate return on invested capital.

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

James S. Metcalf

Thank you, Matt. I'd like to, before we go into Q&A, just give you some of our early thoughts on 2013. As I said earlier, we believe that we have finally turned the corner, and we're seeing the early stages of a recovery in our market. The increase in housing starts, same-store sales increases at both retail and specialty dealer partner and commercial construction starts are beginning a gradual improvement in 2013, all are evidence of this trend. We believe that housing will continue to improve, but we do and we could experience some headwinds because of some industry staffing that affects truck drivers for distribution, hourly plant employees and general construction labor that have left the market.

While our wallboard capacity utilization remains in the mid-50% range, our effective capacity utilization is closer to 80%. We believe the recovery is going to be very regional and lead times may be extended due to challenges of staffing up as we see regional increases in demand. We want to be confident of a sustained recovery before we start the hiring process, which can take anywhere between 3 and 6 months.

Also availability of credit may also dampen the recovery, lower availability of working capital for our customers, challenges with contractor receivables and the ability for homeowners to qualify for mortgages may impact the rate of growth next year. We believe the commercial recovery will lag residential. McGraw-Hill Construction starts overall have been relatively flat in 2012, with some segments showing improvement, while others still remain relatively weak.

The office segment has improved throughout the year, and we will benefit our commercial business in 2013 as we ship products approximately 12 to 18 months after a commercial start. Other segments like retail are stabilizing, but have not yet begun to grow.

As we look to 2013, we believe we'll see growth in new residential construction, although commercial and repair and remodel are likely to remain soft. New household formation will drive this increase in demand and even if moderated by the factors that I've just covered. I'm pleased with our progress this year and feel positive as we look into 2013, but I want to assure you we still have work to do.

Now I'd like to open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Michael Rehaut from JPMorgan.

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

I did want to though focus on a couple of moving pieces within the North American Gypsum segment, specifically the declining margins in the U.S. Gypsum company for 2 quarters now. Sequentially, if you could kind of review -- you're at -- excluding charges, you're at 8.1% in the first quarter, then 7.3% last quarter and now 6.0% this quarter. So if you could review the drivers of that, and if you expect that to continue further into 4Q. And also, if the GTL profit -- is that something that's sustainable that we should margin -- model in each quart -- now going forward, or is it more of a one-time, 1 quarter type of event?

James S. Metcalf

Thanks, Michael. Let me just touch on the GTL briefly. We -- that GTL profitability is -- will be solid as we go forward. We have a greater arrangement transporting iron ore. It is under contract. And you will see GTL profitability throughout the business here. On the margins, a couple of things have happened throughout the year. In the first quarter, we delayed some plant infrastructure because we weren't sure how the first quarter was going to play out. We had a new pricing strategy in. We weren't sure how weather was going to be. If you recall, a year prior, we had a terrible winter. We were very fortunate with a very mild winter. But we held off some planned infrastructure spending that we knew we would have to do particularly in the back half of the year. So that's really one big segment you -- charge you saw that impacted margins in the third quarter. Also, we have a little bit of raw material inflation from 3Q versus 2Q. So we feel that, that has moderated, the infrastructure spending that was planned. And our strategy and our plan is, Michael, as we said both with Matt's comments and mine, we're very focused on net earnings for the corporation. So we need to continue to grow our margins in the Gypsum segment as well as the other segments. So not to give you a projection, but our focus is net earnings as soon as possible and you can't get the net earnings if your margins are going the wrong way.

Matthew F. Hilzinger

Michael, it's Matt Hilzinger. I just want to add on GTL. So last year, we had about an $8 million loss. And this year, we're expecting to have income of around $11 million, so a $19 million turnaround. And the way to think about it as we go into next year is that it's going to generate somewhere around $11 million of operating profit. The timing of that could vary by quarter, but I don't want you to take the $8 million delta right now and view that as that's what's going to come through each quarter going forward. So think about it as $11 million of operating profit, kind of, on a going forward basis.

Operator

Our next question comes from Dan Oppenheim from Crédit Suisse.

Daniel Oppenheim - Crédit Suisse AG, Research Division

I was just thinking about the cost if we look at that in terms of natural gas. How much -- if you think about what could be achieved next year for pricing, how much is that being based on -- you touched now about the margins, so if you think about the cost situation. How much do you think that will drive on pricing versus -- offsetting it versus getting a lot more in terms of margin area?

James S. Metcalf

We -- as Matt said in his prepared comments, we're looking at a few factors. Natural gas and any raw material input are very, very important. As we get closer to the end of the year, we're going to be a heck of a lot smarter. We look at wastepaper cost, natural gas cost. And as everyone knows, natural gas is at historically low levels. We do lock in some of these low factor costs, so we have a pretty good grasp of where natural gas will be. We also look at the regional demand. As I said in my prepared comments, we think the market is going to come back, kind of, in an uneven format. So we're looking at regionality. So all of those factors go into our pricing. And natural gas probably is one of the raw materials that we have the best insight on as we get into 2013, and we still think it's going to be at some fairly low levels.

Operator

Our next question comes from Trey Grooms from Stephens Inc.

Trey Grooms - Stephens Inc., Research Division

With price increases coming early next year, do you guys think that you're seeing any prebuying with the distributors at this point?

James S. Metcalf

What we did -- we're a lot smarter this year going through it. We started about 30 days ago, Trey, and we put in a controlled distribution policy for our customers. So we would not see a lot of surge-buying in the fourth quarter. So we pretty much have our operating network lined out for the next 1.5 months, which helps us from an efficiency standpoint. So we think we're going to see some very nice efficiencies at our plants. We're in constant contact with our customers with what their needs are going to be in the fourth quarter, and they know what they can expect from us. So we don't see any surge-buying from our customers because they know there's a ceiling on what they can purchase.

Trey Grooms - Stephens Inc., Research Division

Great, that's very helpful. And then just one follow-up, could you talk a little bit about -- as much detail as you can anyway about kind of how the volume progressed through the quarter on the wallboard business?

James S. Metcalf

Well, we -- as I mentioned, we were up 14%, and we had a pretty -- it was a pretty smooth -- we had more shipping days, obviously, in September but -- or, excuse me, in August. But it wasn't real choppy. As I said, 1st of September, we put our customers on controlled distribution. We kind of knew what the daily rate would be. So it -- I'd have to tell you, we look at the daily rate every day, and we have a very extensive supply chain organization that looks at the forecasting from our salespeople, all the way through to really -- so we can run our network efficiently. But more importantly, we want to have on-time delivery with our customers. So a long answer to your question, it was -- our daily rate was pretty steady throughout the quarter.

Operator

Our next question comes from Mark Weintraub from Buckingham Research.

Mark A. Weintraub - The Buckingham Research Group Incorporated

The -- as you mentioned, your volume of shipments were up 15% or so, but the distribution volumes for Gypsum were only up 5%. Can you explain the variance there?

James S. Metcalf

Yes. If you look at L&W Supply, and we've talked about it in previous calls, we have really moved the L&W on a really, very focused approach. Their value -- L&W's value is really, as I like to say, is where we can win, and where we can in L&W is in the commercial space. We don't have lumber. We don't have residential roofing, steel studs, commercial insulation. Our value of L&W Supply is stocking material into very difficult commercial jobs. That's where our value, and that's where our customers pay us. If you look at the commercial opportunity numbers that I was referring to earlier, the opportunity in the commercial segment lags residential. So that is one of the drivers. The second driver is L&W has shed some business. The focus of getting L&W to profitability as soon as possible. We have segmented a lot of customers that where we can provide value and they pay us for the value, we are going to do business with them. So there was some market shedding of unprofitable business. And as I indicated, we had price improvement at L&W quarter-on-quarter. So it's market opportunity where we're positioned as a value player and also getting margin improvement on Wallboard.

Mark A. Weintraub - The Buckingham Research Group Incorporated

Okay. So you do not think that there was any inventory build either by distributors or any of your customers to the mills?

James S. Metcalf

No, as I said in the previous -- with the previous caller, we've had our customers on controlled distribution since early September. So they physically cannot do that.

Mark A. Weintraub - The Buckingham Research Group Incorporated

Okay. And just really quick, the tax rate, can you explain what we -- what the tax rate in the fourth quarter is going to look? And then also, once you start making money, what will the book tax rate be and then presumably the cash tax rate is a whole lot lower?

James S. Metcalf

Now before we answer that, and I think you're on the fourth question so this is okay, we have a lot of people in queue, or maybe that was a 1 question with 3 parts. So I'm going to assume that's 1 question with 3 parts.

Matthew F. Hilzinger

Trey, this is Matt Hilzinger. So I would start with saying, look, I -- our view for the full year in terms of tax expense is going to be somewhere between $8 million and $12 million, and that's primarily tax on our International business. We pay virtually no tax in the U.S. side. The tax rate, specifically in the third quarter, gets very complicated with some rules around how you allocate a loss when you’ve got a loss and a couple of periods of losses. So I won't get into that. I think the main thing to think about is $8 million to $12 million for the balance of the year. Now when we think about the future, when we start making net income, we have about a 2.2 -- we'll have about a $2.2 billion net income at the federal level, and we also have NOLs at the state level. So as we start to make net income, we will continue to be a taxpayer on international operations like we are now, but we won't pay taxes up until the point that we chew through about $2.1 billion, $2.2 billion of net income. I mean that generates and shields a large amount of cash. And so that's how I would think about it going forward.

Mark A. Weintraub - The Buckingham Research Group Incorporated

Right. And that -- is that also booked, or is that just for cash taxes?

Matthew F. Hilzinger

That's for book as well.

Operator

Our next question comes from Mike Wood from Macquarie.

Mike Wood - Macquarie Research

This GTL profit that you discussed, it's a pretty large portion of operating profit. So I just wanted to get more color in terms of whether this was just temporary until demand normalizes in wallboard or is this a permanent part of the segment as the seasonal slowing in wallboard and a seasonal pickup in iron ore stocking is part of the year?

James S. Metcalf

Well, this is -- we have redeployed our ships, and these ships were typically part of our vertically integrated system taking rock from Nova Scotia to our Eastern plants. As you've seen the market has changed to synthetic gypsum. And with the market demand being down, we could not use those ships and it was -- as Matt said earlier, it was a big negative to our profit. Our team was very creative to look at different uses. They are very specialized ships. And we have entered into a contract on iron ore for specific footage -- or excuse me, tonnage over the next few years. So it will be a fairly steady stream of profits. It's similar to a synthetic gypsum contract, but the other way around. And we have a contract to transport a certain amount of tonnage. We know that, that tonnage is each year going forward at a profit. So it won't be the bulge that you saw because we were just getting started, but it will be a fairly steady profit for GTL, which will -- that's part of the North American Gypsum segment.

Operator

Our next question comes from Garik Shmois from Longbow Research.

Garik S. Shmois - Longbow Research LLC

I have a question on L&W margins. You had about 12% incrementals this quarter, a little bit lighter than what we saw over the last couple of quarters, a little bit lighter than what we tend to see in a recovery. I'm just wondering if you could maybe provide a little bit more color on incremental margins in the third quarter at L&W and how we should think about that going forward?

James S. Metcalf

Sure. If you kind of -- if you saw on the slides we have, there -- L&W had about a $5 million in the quarter of -- I'd like to refer to it as non-operational impact. So we had some administrative costs. We also had some additional overhead costs because of the corporation's improved performance. So if you back that $5 million out, the -- incrementally, quarter-on-quarter, instead of a $10 million, you had a $5 million lost. So there was improvement as we went sequentially quarter-to-quarter. Wallboard spread went up quarter-to-quarter. Comp store sales were up. Steel and complementary products margins were up. So L&W -- the key is getting margin improvement in wallboard in the market regardless of what their -- we have -- if you have a price increase of any of the product lines that's getting margin improvement there and getting paid for value. So our plan, as I said earlier, we have a line of sight on L&W on operating profit. And that -- I'm very impatient, quite frankly, that we aren't there yet, but I'm very confident that the team has a very focused approach to get there. We have taken out almost half of the branches. If you go back the last 4 years, we have a smaller footprint but the good news is we have a much more efficient footprint, and we have a value proposition in the market that we haven't had in the last few years. So I am confident we're going to continue to improve margins. And if you back out those one-time charges, I think it may clarify some of your concerns.

Garik S. Shmois - Longbow Research LLC

That's helpful. So just to clarify, those -- that $5 million is not going to be repeated in the fourth quarter going forward?

James S. Metcalf

That's not the plan, correct.

Operator

Our next question comes from Neil Frohnapple from Northcoast Research.

Neil Frohnapple - Northcoast Research

Pertaining to wallboard, have you seen volumes pick up thus far in October? Particularly in the big-box area, are you still not seeing that seasonal pop here that you historically experienced prior to the downturn?

James S. Metcalf

Well, it's interesting. We have seen some seasonality this year, in general, in the business. But it's kind of -- it's going to be kind of masked because we were on controlled distribution as I said earlier. We do follow our big retail customers' comp store sales, and it's still pretty soft. It's still pretty soft. This typically is a big season when getting out of lawn and garden and coming inside. And our big-box customers has some very focused plans here. But as I said earlier, they don't play a lot in the new residential. So the repair and remodel still, to use your term, we haven't seen the pop. It can be masked -- it could be masked because, again, we are trying to eliminate any type of inventory surges from -- in the channel. So we think we're looking at very low-single digit R&R growth as we get into 2013. It's really any type of demand increases. Right now, it's going to be led by what we're seeing with housing.

Operator

Our next question comes from Jack Kasprzak with BB&T.

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

Jim, you mentioned effective capacity utilization in the industry is over 80% as companies have shuttered lines of existing plants. But with the surge in housing starts we saw yesterday, the industry is likely going to have to start to bring on some capacity along, I think, next year. You mentioned the lag time. But how do you manage that process of bringing on step function increases in capacity without jeopardizing the pricing environment?

James S. Metcalf

That's a great question. Let me just clarify, when I was talking about effective capacity of 80%, that is USG's effective capacity. We know our staffing levels. So I just want to make sure that I'm clear that was not an industry number. If you look at the housing start numbers yesterday, they were very positive. And we've had a nice trend here. And I think 850,000 to 900,000 starts is a very solid number. But housing starts is only part of the story. If you look at the gypsum opportunity for demand into 2013, we're still at some very, very low levels. If you're looking at opportunity anywhere between 19.5 billion and 20 billion feet, those are historically low levels. We know our network, and we have, as I said earlier, a very well run strategic sourcing and planning network of how we run our network -- how we run our plants, and we can run our plants with some overtime. We can run our plants if we do have to add a shift. It isn't adding capacity. And we are going to be extremely, extremely careful and, quite frankly, as the CEO, I need to be convinced that any type of recovery is sustainable. We have a long lag of bringing people back. They have -- we're in outlying areas and people have left the jobs. So as I said, it's anywhere, 3, 4 to 6 months to bring people back. So we have to be extremely confident that this isn't a false-positive. And as I said in my comments, there still are some signs, we're being very, very conservative. So adding plants back is not in the plan for us in 2013, do not see it happening. In adding a shift or staff, we have to be extremely confident in that region that it's sustainable because it is very expensive to hire people and, quite frankly, I -- the last thing I hate to do is get rid of people. So this is something -- we're going to run our network very, very tight. That's why it's important we stay in touch with our customers on their demand. And quite frankly, with our organization, we have the widest sales organization and, I believe, the best sales organization in the field that calls on the customers every day. So we are in touch with individual demand ups and downs. So we're still cautiously optimistic. The housing start number was good, but that's only part of the story. R&R is still weak, commercial still weak and the overall demand is going to be up, but not at any historical levels.

Operator

Our next question comes from Kathryn Thompson from Thomson Research.

Kathryn I. Thompson - Thompson Research Group, LLC.

On the core manufacturing side, but focusing on L&W -- I know that this has been a division that's been a little bit of a nag, to say the least, over the past several years. My question to you, why would you keep this division, particularly in light -- and at the peak of the market, it generated roughly 1/3 of the margins of your core manufacturing, wallboard manufacturing group? Why keep such a meaningfully lower margin business even if we do have a meaningful recovery in the overall construction industry?

James S. Metcalf

Well, let me be clear on the L&W. We view L&W as a strategic part of the corporation. And they have had -- and L&W has had 70% of their business, their demand that was hit in the last 4 years. They are not really in the retail business. And as I said earlier, the focus is really commercial construction. We think, through the cycle, L&W makes the portfolio stronger. L&W has, as I like to say, it lends to the contractor, provides margin on products we don't manufacture. We used to be in the steel stud business, where we made about 5% gross, and L&W is one of the largest distributors of steel studs. It makes the corporation smarter. We are on the ground everyday talking to contractors. We aren't hearing it second and third hand through other distribution. And L&W, I believe, is industry-leading in safety. So L&W is a key part. And, Kathryn, we -- actually, in the last 4 years, we looked at every business we have and looked at the strategic value throughout the cycle as a part of our portfolio, and we did a lot of due diligence with the management team, as well as our Board. And we feel, through the cycle, at the top of that cycle, L&W made $150 million to $200 million of operating profit. And we feel that they are a key part of our business. They make us a better company for our other customers because we sit in their seat. We know how important working capital is, safety, workmen's comp, all of the things that our other customers have to deal with. So we've had a tough row. We've made some very difficult decisions here, and L&W just made some decisions this quarter of taking some additional branches out. So be patient, the results are going to speak for themselves. And I think through the cycle, it makes USG a much better play.

Kathryn I. Thompson - Thompson Research Group, LLC.

Yes. I guess, just as a follow-up, I was speaking in terms of targeting optimal returns. So as you said, in the peak, it generated an EBIT of $150 million to $200 million. I think peak EBIT was 8%. But peak EBIT for your manufacturing operations were north of 20%. So...

James S. Metcalf

Right.

Kathryn I. Thompson - Thompson Research Group, LLC.

I was thinking in terms of when you're looking out in terms of ROIC, if that was in the cards, and if you will consider it just from a returns basis?

James S. Metcalf

Well, actually -- no, that's a great question. And we are definitely looking in each business from an ROIC perspective, particularly where we invest. We probably -- in the past, we had kind of a 1 ROIC number for the corporation. And the investments in distribution will be quite different from a hurdle rate than it would be manufacturing. If you look at the gross margin percentage, the margin percentage of L&W compared to like customers in that segment, distribution is a high-single digit business. But again, throughout the entire portfolio, we do believe it provides value.

Operator

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

Dennis McGill - Zelman & Associates, Research Division

This is more of maybe a historical question. But I think at the end of last year or early part of this year, when you tried to help investors understand the incremental leverage in the business, you kind of pointed back to the '02 timeframe where incremental margins across the whole portfolio were plus 80% and that seems to be where you're coming out today as well. But when we think forward as far as what the next lag or recovery looks like, in '03 revenues were up, utilization rates were strong, pricing was flattish, but you saw a 20%-type decline in operating profit. So I'm just curious if you could go back and maybe use that as an example of what happened then that we won't see happen now? And then just as we think about those incrementals in the second or third leg of the recovery, how should we think about that relative to what we're seeing today?

James S. Metcalf

If you go back, you talked about 2002, 2003, actually, I think we went back 1 prior cycle of that was the early '90s, and the leverage was a low of 35% to a high of 50%, 55%. And that's kind of -- from a historical standpoint, we were using that as kind of a foundation of -- as we look forward. We were pleasantly surprised actually in the last 3 quarters that it's been, as Matt indicated, in the 80s, 80%. And the reason it's different is those last 2 cycles, and yours truly was in the middle of those 2 cycles, is when we took cost out, we took cost out of primarily U.S. Gypsum and only the manufacturing side. This cycle, as I've just indicated in the previous caller, Kathryn, is we've taken out a tremendous amount of cost and lowered our breakeven with L&W Supply as well. So not to give you a projection going forward, we like to say, historically, anywhere from $0.35 to $0.50 of the last 2 recessions, and we've taken out over $0.5 billion in cost this time. And as I said earlier, we're continuing to take some additional cost out. So I truly hope the leverage is even more than what you see.

Dennis McGill - Zelman & Associates, Research Division

What -- do you remember what it was specifically in '03, where even within the American Gypsum segment, you saw a 20% decline in profit even though revenue was up high-single digits?

James S. Metcalf

I don't have that in front of me. But if you want to follow up with Ken, we can take you all the way back there. Just off the top of my head, we also -- I know wallboard pricing and that -- it may not hit the exact year, but there was a -- wallboard pricing was fluctuating. But we can give you all those historical numbers. I just -- I can't go back that far. I have a good memory, but not that good.

Operator

Our next question comes from Jim Barrett from CL King & Associates.

James Barrett - CL King & Associates, Inc., Research Division

The one question I had, some of our industry contacts are claiming that the price premium for UltraLight has disappeared. Is that accurate in your view as you're seeing your price realization on that product?

James S. Metcalf

Well, we still -- we're still getting our value for UltraLight. We do have -- one of the things we've looked at, Jim, is we were still adamant on our 2-skew strategy. We have our regular SHEETROCK wallboard, which, quite frankly, our regular SHEETROCK, not UltraLight, a regular SHEETROCK is as light or lighter than some of our competitors' lightweight, which is kind of interesting. The second thing is where a customer does not want to pay the premium for UltraLight, we give them a choice that they can buy "the Classic." So we are still getting the premium in the market. And there may be some confusion between SHEETROCK Regular and SHEETROCK UltraLight. We're also expanding the portfolio. We're -- our 5/8 commercial business for UltraLight is really growing. We talked about almost 50% of our overall wallboard is UltraLight, but we're seeing some great traction and our UltraLight 30-minute is now nationwide. Our 5/8 X is growing in the Eastern United States, and we will soon be expanding that nationwide. And we're going to be announcing some additional wallboard products with the UltraLight portfolio coming up in the next quarter. So we're investing in our customers and innovation, and we're going to continue to get price -- a price premium.

Operator

Our next question is from Peter Lisnic from Robert W. Baird.

Peter Lisnic - Robert W. Baird & Co. Incorporated, Research Division

First question, just in terms of investment cost that you've alluded to a little bit earlier in the call, it sounds like with increased confidence in end market improvement that you've maybe opened the door a little bit for some spending. Can you give us a feel for -- as you look to 2013, is there anything there on that front that could be material that could dampen incremental operating leverage next year?

James S. Metcalf

I'm going to turn it over to Matt in a second, but let me -- I want to stress something, lowering our breakeven. Even seeing a recovery, we said we're starting to begin seeing signs is absolutely critical. We're looking at, as I said earlier, we're- - we've moved a lot of personnel out of the field from a -- and have a shared services model. It is less -- it's less staff. So we're going to continue to push that down. We are very diligent on, if we have a good investment, where is it going to come. I'd like to use that term, weed and feed. Some of the incremental, as Matt said, we're looking at maybe 5% increase in overhead this year. That, quite frankly, is because most of it is that of our improved performance. We did not pay an incentive to the management team last year because we did not make any money, and I put -- I really focus on the organization that we had to have operating profit in 2012. That's something on this call last year, we talked about I'm very focused on 2012. So we are very, very stingy on SG&A. And it's not just SG&A, but the overall cost, a fixed cost. But let me have Matt just give you a few metrics.

Matthew F. Hilzinger

Yes. So as we think about where we are now and where we are in 2013, yes, we are making some investments and some additional cost investments in shared services. I think Jim has talked about bringing in some of the field folks into a shared services organization. There is some additional costs to get that implemented, so we're incurring some of those now and we’ll incur some of those in 2013. But on a net-net basis, there ought to be and will be cost savings there. There will be some additional investments in Oman and India as we continue to grow those businesses. And again, we would expect to see benefits coming out of that. And we're going to look at some strategic investments in IT. We think IT is a strategic weapon. It’s something that is important that we continue to take a look at. So the investments that we're making are focused on either generating revenue growth or bringing our cost down. And as Jim said, we are focused on bringing the breakeven of this company down, and that's what we're going to do, but it will require a little bit of investment.

Operator

Our next question comes from Desi DiPierro from RBC Capital Markets.

Desi DiPierro - RBC Capital Markets, LLC, Research Division

I'm just calling in for Bob. In the Energy segment, you used -- in the slide it says there's $10 million of wallboard cost benefit, are there -- other than natural -- lower natural gas prices, was there anything else that contributed to that?

Matthew F. Hilzinger

Desi, it's Matt Hilzinger. The other thing that we've seen is fixed cost continued to be a benefit to us. So as we've continued to drive down cost, again it kind of flows into the last answer to the last question. We will continue to drive down to lower our breakeven, and our fixed costs are going down. So you're seeing -- we're seeing a benefit there. So when we look at where a lot of the benefit came from, it's from around natural gas prices and [indiscernible] cost.

Operator

Our next question comes from Seth Yeager from Jefferies & Company.

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

In your prepared commentary, you mentioned the goal of returning back to investment-grade. Just following up on that and looking at your cash usage going forward, can you just give us a sense as to what CapEx and cash going towards your investments in India and Oman we can think about for next year? And any additional asset sales you're looking at?

Matthew F. Hilzinger

Yes. So first, we aren't looking at right now any additional asset sales. So when we -- and we aren't prepared right now to give CapEx for next year. But we said there will be about a $60 million spend, at least our portion, for opening up Oman, that's both the quarry and the plant. We're going to spend about $45 million of that this year, and we'll have about $15 million moved in to next year, and those will be up and running in the second half of next year. So Jim did outline the -- our goal to be investment-grade, and I would put it in really kind of 2 goals from our perspective -- from my perspective. One is to delever the company. We've got about $3 billion of debt, all in, all funded debt and about $100 million of equity and that's clearly too much. So we want to delever to investment-grade metrics. We want to do that organically through cash flow from operations, and we want to simplify the capital structure. Those are really our 3 objectives, and that's going to be dependent partly on the recovery Jim had talked about, but that's clearly our goal.

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

Okay. If I could sneak in a follow-up just from a cost of capital standpoint, would the -- beyond the 9.75% of '14, would the converts be the next logical target when those are callable?

Matthew F. Hilzinger

Yes, we are looking at those. We have not made a decision, but they're callable in December of '13. If we call them, then the bond holders have a choice to either take cash or stock. The stock is clearly in the money. That would be another step for us to delever the balance sheet, and it's something that we're considering right now. But we haven't made a final decision on that but clearly, that's a way for us to take another step to delever right now.

James S. Metcalf

I appreciate everyone's question. And as I wrap our hour with you, as we've achieved our best quarter of operating profits since 2007, we do believe we've turned the corner. The recovery, though, is going to be choppy, and I indicated that earlier. But I wanted to assure you, we do have contingency plans if the market goes the wrong way. As I said, I feel better this year and even more positive of what 2013 will deliver to our shareholders. I'm very pleased, though, on our entire organization. We've been through a half a decade of a recession, and we remained focused on our customers during this slowdown. And to our customers that are listening or on the line, I just would like to say, thank you, and we appreciate your business. But I think we all know, particularly the USG people, we still have work that needs to be done.

We will continue executing our Plan to Win. And as I've said earlier, we are going to continue to create our own recovery. Hopefully, you'll see from the results that in last few years as we moved forward that we're very focused on positive net earnings. We've had 3 quarters of operating profit, that's only our first step. And this management team is very, very focused on getting net earnings to USG corporation as soon as possible.

As always, I really appreciate your time, your interest in USG, and we'll look forward to catching up with you next quarter. Thank you.

Ken Banas

A taped replay of this call will be available until Friday, October 26. 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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