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Owens Corning (NYSE:OC)

Q2 2014 Earnings Conference Call

July 23, 2014 11:00 AM ET

Executives

Thierry Denis – Director, IR

Michael Thaman – Chairman, President and CEO

Michael McMurray – SVP and CFO

Analysts

Stephen Kim – Barclays Capital

Phillip Ng – Jefferies

Michael Rehaut – JP Morgan

Ken Zener – KeyBanc Capital Markets

Dennis McGill – Zelman & Associates

George Staphos – Bank of America/Merrill Lynch

Keith Hughes – SunTrust Robinson Humphrey

Operator

Good morning, and welcome to the Owens Corning Second Quarter Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded.

I would now like to turn the conference over to Thierry Denis, Director, Investor Relations. Please go ahead.

Thierry Denis

Thank you, Emily, and good morning, everyone. We appreciate you taking the time to join us for today’s conference call in a review of our business results for the second quarter of 2014. Joining us today are Mike Thaman, Owens Corning’s Chairman and CEO; and Michael McMurray, Chief Financial Officer. Following our presentation this morning, we will open this one-hour call to your questions. Please limit yourself to one question and one follow up. Earlier this morning, we issued a news release and filed a Form 10-Q that detailed our financial results for our second quarter. For the purposes of our discussion today, we’ve prepared presentation slides that summarize our performance and results for the quarter. We will refer to these slides during this call. You can access the slides on our website, owenscorning.com. We have a link on the homepage and a link on the Investor section of our website. This call and the supporting slides will be recorded and available on our website for future reference.

Please reference to slide two before we begin, where we offer a couple of reminders. First, today’s presentation and remarks include forward-looking statements based on our current forecasts and estimates of future events. These statements are subject to risks, uncertainties and other factors that could cause to differ materially and we undertake no obligation to update these statements beyond what is required under applicable securities laws. Please refer to the cautionary statements and the risk factors identified in our SEC filings for a more detailed explanation of the inherent risks and uncertainties affecting such forward-looking statements.

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

We adjust our effective tax rate to remove the effect of quarter-to-quarter fluctuations, which have the potential to be significant in arriving at adjusted earnings and adjusted earnings per share. In the second quarter, we have utilized an effective tax rate of 29%, in line with our anticipated annual effective tax rate on adjusted earnings for 2014. For those of you following along with our slide presentation, we would begin on slide four.

And now, opening remarks from our Chairman and CEO, Mike Thaman, who would be followed by Michael McMurray. Mike will then provide comments on our outlook prior to the Q&A session. Mike?

Michael Thaman

Thank you, Thierry, and good morning everyone. We appreciate you joining us today to discuss our second quarter results. Today, Owens Corning reported consolidated revenue in the quarter of 1.36 billion, flat with the same period a year ago. The company 96 million in adjusted EBIT for the quarter, down from 124 million last year. Adjusted earnings were 45 million, down from 68 million one year ago. The company’s financial performance for the quarter, reflect continued year-over-year improvement in both insulation and composites. The improvement in these two businesses was in line with our expectations for the first half of the year. Roofing volumes underperformed the market in the second quarter, and the volume weakness through the first half of the year resulted in updated full year guidance that we issued in June.

At the outset of the year, we discussed a number of expectations for sustained or improved performance across our businesses over 2013. Now, I will review our performance against those expectations starting with safety. As is the case each year, we said that we would continue to make progress toward the goal of creating an injury free workplace. We continue to perform at a very high level of safety with recordable incentive rate of 0.5 for the six months ending in June. This is consistent with our rate in the same period a year ago. Year-to-date, we have greatly reduced the severity of our injuries, and our goal to achieve and maintain injury free workplaces across our global network. At insulation, we said we should continue to realize the benefit from the growth in U.S. residential new construction, improved pricing and operating leverage. Insulation delivered 14 million more in EBIT in the second quarter versus the last year, driven primarily by better pricing and volume growth. The insulation business also improved EBIT, for the 12th consecutive quarter. In the first half, the business delivered operating leverage of 63%. This is consistent with our guidance of 50% operating leverage through the recovery.

In composites, we said we expect improving market conditions and pricing to drive EBIT growth, with improved manufacturing performance and higher volumes expected to offset higher rebuild cost and cost inflation. Second quarter composite EBIT was 37 million, an increase of 5 million over the same period of last year. I’m pleased with the progress in composites. Our operating performance has been very good, and market conditions have been supportive of both volume growth and improved pricing. We realized $10 million price improvement compared with the second quarter 2013. In addition, we’re seeing stronger volumes in glass reinforcements in the second quarter, with second quarter growth outpacing first quarter.

In roofing, we ended the year with expectations well above our current outlook. In our June guidance update, we said that first half volumes could be as much as 20% lower than the same period in 2013. Roofing volumes in the first half were down slightly less than 20%. Our share of the market improved in the second quarter versus the first quarter, but was below our share in the second quarter of 2013. As a result, our volumes underperformed in the market for the second consecutive quarter. Revenue in this business dropped 14% year-over-year and EBIT margins were 14% for the quarter on lower volume leverage, lower prices and higher asphalt costs.

Before I move to our outlook for the business, we have one other achievement in the quarter that I’d like to note. We released our 2013 sustainability report, demonstrating good progress toward achieving our 2020 environmental footprint goals. Highlights of the report included, commissioning the largest onsite solar energy system in the state of New York in our Delmar Insulation plant, recycling 1 million tons or 10% of all the asphalt shingles in North America, and doubling the freight miles that were driven our natural gas in Owens Corning. These sustainability initiatives provide economic benefit, in addition to environmental benefits.

Now let me review our expectations for the remainder of 2014. We expect that the insulation business to continue to benefit from growth in U.S. residential new construction, improved pricing, including our price increase and operating leverage. We continue to focus on improving insulation prices as we return the business to historical levels of profitability. The composites business is benefitting from stable global economic growth, improved operating performance and pricing. We expect pricing to be the primary driver of either growth in 2013. Based on year-to-date performance, we expect that the full year price improvement for the business will likely be at the top-end of the previously communicated range of 20 million to 30 million.

The roofing market was down for the first two quarters of the year. For the full year, we now believe that the market will be flat to slightly down. Our goal for the second half will be to restore our share of the market to historical levels, so they more closely track the market. We are obviously disappointed with our first half performance in roofing. Given the market conditions, mid-teen margins appear to be the near-term reality. We believe that we have the right action plan to improve our second half volume performance, and continue to demonstrate price and margin discipline. In the near-term, the business will likely perform at margin levels below those we enjoyed over the past five years. The continued momentum in our insulation and composites businesses is expected to more than offset, the weaker financial performance in the roofing business, and we will generate earnings growth for full year 2014.

With that, I’ll now turn it over to Michael who will review further details of our business and corporate performance. I’ll then return to recap and open the call up for questions. Michael?

Michael McMurray

Thank you, Mike and good morning everyone. As Mike mentioned earlier, in the second quarter our insulation and composites businesses continue to demonstrate year-over-year improvement. The momentum and earnings growth in these two businesses is expected to more than offset the weaker financial performance in our roofing business. Now, let’s start on slide five which summarizes our key financial data for the quarter. You will find more detailed financial information in the tables of today’s press release and the Form 10-Q. We reported second quarter 2014 consolidated net sales of 1.36 billion, which were largely flat with sales reported for the same period in 2013. In our roofing business, net sales were down 14%, primarily on lower sales volumes. Net sales for insulation business were up 8%, primarily on increased selling prices. Lastly, net sales in our composites business were up 7%, due primarily to higher sales volumes and increased selling prices.

In a moment, I’ll review our reconciliation of items to get to adjusted EBIT, our primary measure to look at period to period comparisons. Adjusted EBIT for the second quarter of 2014 was 96 million, compared to 124 million in the same period one year ago. Adjusted earnings for the second quarter of 2014 were $45 million or $0.38 per diluted share compared to $68 million or $$0.56 per diluted share in 2013. Depreciation and amortization expense for the quarter was 78 million, and in line with our prior year. Our capital expenditures for the quarter were 77 million, including the net effect of alloy purchases and sales.

Now on slide six, let me reconcile our 2014 second quarter adjusted EBIT of 96 million to our reported EBIT of 73 million. In the second quarter, we entered into an agreement to sell our European Masonry products business, which resulted in $19 million impairment charge that we have adjusted out of earnings. We expect this transaction to close in the third quarter of 2014. We have also adjusted (inaudible) cost New Jersey roofing facility that was damaged as a result of super storm Sandy as discussed in previous calls. We do not expect any further charges related to this project. Also within the quarter, we received the final payment of 44 million related to the sale of our U.S. Masonry products business to industries, which closed in the fourth quarter of 2010. This payment had no impact on earnings. Now, please turn to slide seven, and I will provide a high level review of our adjusted EBIT performance compared to second quarter of 2014 with the same period one year ago.

Adjusted EBIT decreased 28 million. The 14 million improvement in our insulation business and 5 million improvement in our composites business were more than offset by 54 million decline in our roofing business. General corporate expenses, were 7 million lower versus the prior year primarily due to a reduction on a performance based compensation expense, and strong cost controls. With that review of key financial highlights, I ask you to turn to slide eight where we provide a more detailed review of our businesses starting with building materials. For the second quarter, building materials net sales were 884 million, a 4% decrease compared to the prior year. Building materials delivered 80 million in EBIT, down from 120 million for the same period in 2013.

Slide nine provides an overview of our roofing business. Roofing net sales for the quarter were 437 million, a 14% decrease compared with the same period a year ago. EBIT in the quarter was 62 million, down 54 million compared to the same period in 2013. The declines in revenue and EBIT were primarily driven by lower sales volumes, along with slightly lower selling prices. EBIT margins for the quarter and we were disappointed with the performance of our roofing business for the first half of 2014.

We estimate that industry shipments were down low to mid single digits year-over-year. The roofing channel that generally replenished on a sell through basis and where we have higher exposure continue to extract below the market during the quarter. In addition, our share replacement within distribution channels had impacted early in the second quarter from late first quarter buy activity that shipped in the second quarter. As indicated on the first quarter call, we did not participate in late first quarter discounting. We previously expected the U.S. asphalt shingle market to grow in 2014, primarily driven by growth in new construction activity and possibly some growth in re-roof. Given the market performance on a year-to-date basis, we now expect the full year market in 2014 will be flat, to slightly down. This should result in second half market being slightly up to flat compared to the prior year. We are working through to improve our share appointment, and it is our goal to see our volumes more closely tracked to market in the second half of the year.

Now slide 10 provides a summary of our installation business. Sales for the quarter in insulation are 447 million, were up 8% over the same period a year ago, and higher selling prices and the acquisition of thermal fiber. Slightly higher sales volumes were offset by unfavorable mix. The business delivered EBIT of 80 million in the second quarter, compared to 4 million in the same period one year ago, primarily on higher selling prices partially offset by inflation. This was our 12th consecutive quarter of EBIT improvement in our insulation group.

And we have experienced in previous quarters, our operating leverage results will be subject to volatility, growth was limited to challenging weather conditions in the first four months of the year, and its impact on construction activity. 2014 U.S. housing starts just above 1 million units. We continue to be very focused on improving pricing in our insulation business. Even though market conditions earlier in the year were less supportive of price actions. The U.S. residential business took further action midyear, and I’m pleased to report that we have made good progress. Looking forward, the insulation business should continue to benefit from growth in U.S. residential new construction, improved pricing and strong operating leverage. Now, I ask you to turn your attention to slide 11, for a review of our composites business.

Net sales in our composites business for the quarter, were 505 million, a 7% increase compared to the same period in 2013. The increase in revenue were driven by higher sales volume, increased selling prices, favorable customer mix, and the impact of foreign exchange translation. Prices continued the sequential improvement that started in the third quarter of 2013, and we are seeing a healthy volume environment, as second quarter demand growth outpaced the first quarter. EBIT for the quarter was 37 million compared to 32 million in the same period last year, and primarily to improve selling prices that were partially offset by higher expenses associated with plant rebuilts. In composites, this was our fourth consecutive quarter of year-on-year EBIT improvement, driven primarily by improved operating performance and pricing.

For the year, we continue to expect moderate global industrial production growth. Based on our year-to-date performance, we expect pricing to be at the high end of the previously communicated 20 million to 30 million range. As discussed on previous call, improved manufacturing performance and volume growth are expected to be offset their higher expenses associated with plant rebuilds and inflation. Now, I thought it might be helpful to provide a bit more visibility into plant rebuild expense for 2014. As a reminder, we’ll complete rebuild on melters that represent roughly 20% of our global capacity in 2014. This represents about two times typical rebuild activity.

We expect that plant rebuild expense will be roughly 30 million higher in 2014 versus the previous year. Rebuild expenses for the first half were about 10 million higher for the same period in 2013 and we were able to grow our year-to-date adjusted EBIT in the business by 23 million. Plant rebuild expense in the second half are expected to be about 20 million higher than in the same period one year ago with the majority of the expense taking place in the third quarter. We expect the momentum we have established in the first half, were more than offset these headwinds in the second half. Now let me turn your attention to slide 12.

In June, our Board of Directors approved our second quarterly dividend payment to be made on July 29, 2014. The dividend represents added value to our shareholders, and demonstrates confidence in our earnings and free cash flow outlook. In the second quarter, we also repurchased 300,000 shares of the company’s stock for 12 million under a previously announced share repurchase program, and as of June 30, 2014, 7.7 million shares remained available for purchase under the company’s current authorization. As we balance our priorities, for the future deployment of free cash flow, both dividends and stock repurchases will be important mechanisms to return capital to shareholders.

With that review of our second quarter results, I now should turn to slide 13 where I’ll review our guidance for 2014. We continue to expect that our full year adjusted EBIT will be greater than the previous year, even though our results for the first half of 2014 failed the previous year by 23 million. The continued momentum in insulation and composites and the actions that we are taking in roofing to drive better volume performance gives us confidence in delivering this expectation.

Now please turn to slide 14, where I’ll provide other financial guidance for the year. We expect corporate expenses to be in the range of 100 million to 110 million. This represents a 20 million cost reduction versus our previous guidance due to strong cost controls and lower performance based compensation for the remainder of 2014. Capital spending guidance for 2014 has been reduced 30 million, and is now expected to be about 370 million including approximately 65 million of spending, associated with the construction of our new non-weldings facility in Gastonia, North Carolina.

Depreciation amortization expense is expected to be about 315 million. Our 2.1 billion U.S. tax NOL will significantly offset cash taxes for some time to come. As a result of our tax NOL, and other tax planning initiatives, we expect our 2014 cash tax rate to be approximately 10% to 12% of adjusted pre-tax earnings. Our 2014 adjusted effective tax rate is expected to be approximately 28% to 30% of adjusted pretax earnings.

Thank you. I’ll now hand the call back to Mike. Mike?

Michael Thaman

Thank you, Michael. As I noted at the outset of today’s call, the company’s financial performance for the quarter reflect continued year-over-year improvement in insulation and composites. Roofing volumes were down for the first half of the year. We believe we have the right action plan to improve our second half volume performance in this business and continue to demonstrate price and margin discipline. The continued momentum in our insulation and composites business is expected to more than offset the weaker financial performance in our roofing business, and generate earnings growth for the full year 2014.

With that, I’d like to turn the call over to Thierry who’ll liaison the question-and-answer session. Thierry?

Thierry Denis

Thank you, Mike. Emily, we are ready to begin the Q&A session.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Our first question is from Stephen Kim of Barclays. Please go ahead.

Stephen Kim – Barclays Capital

Thanks very much guys. I just wanted to touch on the roofing business a little bit. You talked about the fact that you lost this much market share in 2Q as you had in 1Q. It seems to me that, that from what we are hearing out in the marketplace, that the pricing discipline in the industry that the industry enjoyed let’s say a couple of year ago, seems to have been kind of breaking down not just in terms of manufacturers having to discount, but also distributors, getting more competitive with one another. And I’m just curious if you could give us some color/commentary on what you’re seeing in that regard in terms – do you believe that the discipline in the industry is going to a period here where there is a bit of breakdown in discipline of the distributor channel retail as well as the manufacturers?

Michael Thaman

Yeah, Stephen, it’s Mike. It’s a very good question, and there is no doubt that what we’re seeing in our reported results and what we’re seeing in our business that it’s a more competitive environment out there today. If you look at kind of how we played through the first half of the year, Michael, talked in his prepared remarks about some of the buy activities at the end of the first quarter that we decided not to participate in. We were looking at end of the first quarter going into the earlier part of the second quarter there was an April price increase out there. I think we were very focused on price discipline and trying to affect margin improvement from the first quarter, second quarter based on pricing. Obviously that strategy hasn’t played out for us and it impacted first quarter volumes and then some of the deals that were done at the end of the first quarter continued to ship in the second quarter. So that also impacted second quarter volumes.

If you look at our second quarter margins they’re not what we’re grow accustomed to, but we still our margins in the mid teens. So still there is a fair amount of profitability in the industry for shingle manufacturers, and I think of that, that both as good news bad news story. It’s good news because we are still quite profitable but also gives some competitors and also some of the manufacturers the ability to work with pricing as a way to attempting a market share. I think as we look at it today, we had historically given our guidance for the business as being mid teens or better when we arrived at that guidance it was based on some historical analysis with the performance of our business and the things that we’ve done to try to improve the structural cost position and product lines. It is also based on some competitive analysis, kind of the marginal economics of the different players in the industry, and how their economics work in terms of trying to gain share and take volume at the expense of price.

And both of those analyses kind of brought us to the conclusion that when our business is operating in the mid teens, it doesn’t make a lot of sense based on marginal economics in the industry for some of our competitors to be chasing more market share. So, we don’t necessarily see that it should a lot more impact on margins in our business as we roll forward, but I think that’s something that remains to be seen. I think this price environment, and we hear from a number of our distribution customers, is not working well for distribution. I think the market worked much better for distribution when there was some winter buy activity, in the winter they could load in some low cost inventory and then we were in a rising price environment through the year. That tended to give them support they needed to be able to manage pricing in the marketplace.

I think some of the manufacturer pricing actions and some of the distribution pricing actions have broken that down as well for the distributors. So, it’s a bit more difficult market right now, and I think it’s going to need to sort itself out which is why, I said in my comments I think in the near term as we look into the second half of the year, we don’t see the catalyst that kind of moves us out of the mid teens margins environment. We do see some nice underlying trends in the market and some things that we think we can do with our business, that help us get back to our historical market share levels without disrupting the market unnecessarily. We think that’s really more related to not participating in the buys in the first half, but really being more competitive in pricing at market prices in the second half should get us back to our market position which is what we’ve enjoyed historically. So, we’re working our way through this. But we think we’re at margin level today that at least based on our current understanding of the market, we should be able to sustain.

Stephen Kim – Barclays Capital

Yeah, that’s very helpful. I appreciate that. And I’m sure there would be a lot of questions on roofing, so let me just shift over to insulation for a minute. You saw even improvement about 18 million and you made a comment – I think there was commentary about pricing adding about $22 million. So I was curious so first of all do I have those numbers right? And then, could you give a bit color about the operating leverage and carrying the business and may be why we didn’t see as much as we might have thought outside of the price that’s operational?

Michael Thaman

Well the actual improvement in the business for the quarter was about 14 million, and we’ve improved even line and we have improved 36 million year-to-date. And I think what we’ve said is the primary driver of that even improvement year-to-date has been pricing. So it’s pricing that’s coming through in the business today that’s driving the EBIT improvement. If you look at the second quarter, we didn’t have a lot of volume growth in the second quarter. We work off of lag housing starts and in fact, if you go back and look at actual starts in the first quarter 2013 and then actual starts in the first quarter 2014, lag those into the second quarter which is when we’ve seen them, the actual number of units built in the first quarter 2013 is about flat with 2014.

So even in a 10% up housing environment which is what consensus is today and what we’re working off of, that was going to play out it would our view much more as growth in the first quarter for our not much growth in the second, and growth in the third and the fourth. So this was going to be the soft spot quarter in terms of the volume based on the shape of housing starts. And that’s why I think what you’re seeing in top-line for the second quarter is a little bit more correlated to where the timing of starts are going to be in 2014.

Stephen Kim – Barclays Capital

Got it. Great. Thanks very much, Mike.

Michael Thaman

Thanks, Stephen.

Operator

Our next question is from Phillip Ng with Jefferies. Please go ahead.

Phillip Ng – Jefferies

Hey guys. You mentioned that you saw some pushback on insulation pricing but you see better traction. Can you give us a sense of the magnitude we should expect in 3Q or the back half in general and the timing of that?

Michael Thaman

Well, we continue to make progress obviously in the first half of the year as evidenced by the answer I just gave to Stephen regarding insulation pricing. We did have a late 2013 price increase that we were hoping would give us increased momentum to the first half of the year. That price increase wasn’t as successful. There was some price improvement in the market, but I think weaker volumes the tough winter, slower housing starts just didn’t create a market environment where our customers felt confident that they can pass their pricing through. Seasonally now, we are heading into the second half of the year where there is a lot more units to be insulated. We’ve also seen a little bit of pick up in housing starts over the last three months where housing starts to average about 1 million units in the March-April-May timeframe.

We have this number for June that I think everyone is trying to digest, I’m not sure if any of us is really sure when June housing starts because meet the client in the Southeast. But if you look at May, April and March, we averaged about a 1 million. So, we think there is decent volume out there in the second half of the year that gives our contractors the opportunity to be busy that has the builders with decent volumes, and we should be the environment we’re more successful in pricing. In Michael’s comments and we don’t comment on individual price increases in terms of realization, but we did have a price increase late second quarter that was a double digit price increase in the 12%-ish range and we feel that we had good success with that price increase. So that should help us in the second half.

Phillip Ng – Jefferies

Got it. That’s very helpful. And on roofing, if I understand your guidance correctly, you are expecting volumes to be flat to down modestly, insulation as a whole as well was pretty weak in the first half that would imply pretty big bounce back in the back half? Is that how we should be understanding it? And can you give us some color on how volumes are tracking in June and July?

Michael Thaman

Sure. So let’s just kind of do the math on overall guidance for the industry. Michael said that the industry through the first half we think is down to low mid single digits. So for the industry in total that would be flat in the second half it has to be up about the same amount in the second half. So, down low-to-mid single digits in the first half. We typically ship or did more in the first half, so we probably need to be up mid single digits in the second half to get a flat full year. What we said today in our guidance is, we’re expecting the overall industry to be flat to slightly down, that probably puts the second half in our view somewhere between flat to up mid single digits it’s going to be somewhere in that range. So I don’t think we need a gigantic bounce back, but we are going to need to see better volumes in the second half than we saw in the first second half relative to last year versus what we saw in the first half of the year.

I think we need to step way back and say we have a year here where in many parts of the country winter lasted five weeks longer than it lasted in 2013. And you said, where would you expect volumes to be at the midpoint of the year? You’d expect them to be behind (inaudible). So I think with all of the buys and timing issues and market share issues and everything else, at a very macro level of you just sit back and say, given that half the country was under snow for five extra weeks this year, is it unreasonable or unnatural that the market be a little bit behind last year and yet you could still expect the overall market to be flat to last year that seems like a reasonable conclusion. Now obviously, if we print a couple of additional consecutive quarters of negative growth for the overall market that’s not going to be good theory, and would say that we is falling yet further because storm demand seems to be comping above flat to last year, new construction should be flat to slightly up.

So for the overall market to be down, appreciably, it would be another year of a leg down in re-roof. And it seems like there is an up activity out there today that that just doesn’t feel like the right kind of base case for the industry. In terms of our business, we have seen improvement as we come through the year, part of that has been the evolution of channels which Michael talked about, some of the channels that work on replenishment obviously gets stronger during the seasonally strong price of the year. We get more shipments there that helped us move our market share. We also had a bit more shipments in other channels in June. So June we did composite positively to last year we saw some pick up as we went through the second quarter and buys worked their way out of everyone’s book of business, or went out of inventory. So we have some signs of optimism, but I would tell you it continues to be a tough volume market and a difficult price market for us. And I think our team is doing a very, very good job of trying to get the best possible profitability out of the markets.

Phillip Ng – Jefferies

Got you. That’s very helpful. Good luck in the quarter.

Michael Thaman

Thank you.

Operator

Our next question is from Michael Rehaut of JP Morgan. Please go ahead.

Michael Rehaut – JP Morgan

Thanks. Good morning everyone.

Michael Thaman

Good morning, Mike.

Michael Rehaut – JP Morgan

Just going back to roofing for a second sorry to return the focus there, but obviously a key mover for the quarter. What gives you the confidence in terms of to the extent that volumes can come back a little for you in the back half of the year and regaining a little bit of share? I mean is it completely some of the channel replenishment and the June coming back little bit naturally for your business, or are there any other kind of company specific actions on top of that that you’re looking at and would that in turn, further put any pressure on these mid teens margins which you appear to be expecting for the back half?

Michael Thaman

Obviously I think we’ve had a lot of internal dialog and internal reviews, market by market, customer by customer, region by region wherever the business stands. So our team is all over the business in terms of volume and market conditions. I think that analysis has given us some confidence that where we were not volume effective in the first quarter, it was really fundamentally a product of us not meeting market price conditions. And that simply – we are a market price competitive company.

I mean our goal is obviously to make a lot of money to shareholders, but if market conditions are establishing prices that require us to meet market pricing, that’s the way Owen Corning operates. And I think with the exception of late first quarter when there was some of these buys, for the most part, the rest of our activity in the first half of the year, would be a market price type behavior, and we know that that’s what resulted in us to be able to sustain our normal position in the market.

So really the second half is just getting some of the noise out, and the noise of these buys out and us just competing in market prices in us believing we have enough contract or loyalty, we have enough distributor royalty. We have enough value in terms of our service programs, our product offerings some of our product differentiation that will go back to kind of a normal spot in terms of what our customers are selling out their door. As long as they are selling the appropriate percentage of Owens Corning product out their door, they’re going to buy the appropriate percentage of Owens Corning product on the buy side. So that – easy said hard done I guess would be how I would describe that, which is there is no magic to this except for kind of market by market, customer by customer making sure that we’re very much in tune with marketing conditions and then they are selling enough of our product to want to buy a share product that’s acceptable to them and acceptable to us.

Michael Rehaut – JP Morgan

And as you do that, I guess the key question is and perhaps you’ve even seen some of this in your profitability levels in 2Q, I mean that’s what I’m missing. And as you continue to retake some of that share or meet the market so to speak, that is incorporated in your outlook for mid teens or to kind of operating margin that you saw in the second quarter or going forward for the back half of the year?

Michael Thaman

Yeah, I mean based on our current market conditions, we didn’t really see a lot of in fact market deterioration in the second quarter if you look at it on a margin dollar – variable margin dollar per unit basis. Variable margin dollar per unit in the second quarter were pretty much in line with the first quarter, and typically we make progress and they are better in the second quarter because there is historically been good pricing actions in the spring that has lot of widened margins out a little bit in the second quarter. We didn’t see that this year. What you’re seeing in our numbers for the second quarter is a bit of compression on the operating margins due to the fixed cost absorption because of weaker volumes. So the fundamental selling equation on shingles, we still have decent margin dollars variable margin dollars per square on the shingles that we sell, that the current marketing conditions sustain themselves we think that we can deliver good operating margins at decent volumes.

Michael Rehaut – JP Morgan

I appreciate that, Mike. And just on the composites, I appreciate the additional comments on the rebuilt cost, the incremental rebuilt cost of 30 million. So that equates rough math I think so about 0.5 of margin for this year that’s 30 million incremental. So I mean just to dot the, I and cross the T here, as you would expect 2015 to go back to a normal rebuild type year. Is that correct number one that would return to that and so they have 30 million of incremental costs, you wouldn’t see expect that to recur in 2015?

Michael Thaman

Yeah, so I want to make sure all the investors on the call understand the dialog, because this is built off of on prior calls as well. But we had come into the year saying that we had to re-built about 20% of our global capacity this year our melters typically last about 10 years, corrosion and just the impact of melting glass over 10 year period of time requires you to put the melter in the turnaround, and reline it with new re block and other things. That has capital associated with it and also has expense dollar associated with it, because a lot of the activity is both down time and then also expenses associated with doing the work which aren’t able to be capitalized. Because we were rebuilding 20% of our melters in the average life our 20% of our capacity and the average life is about 10 years, in a typical year, we rebuild about 10% of our capacity that’s where the two extra numbers come from.

On an incremental basis, that produced about 30 million of cost headwind versus 2013. Now 2013 was not a super large rebuild year, so we were comping against the year that was down a bit. And when we look ahead to 2015 we’re still working on our capital plans in terms of looking at melter life, and which melters are going to need to be addressed in 2015 which ones are going to be extended to 2016. I think it’s fair to conclude, we’ll be able to call back some substantial portion of the 30 million. I don’t know at this point, that we’ve given you enough information for you to be able to conclude whether it will be some or all of that, but your point which is directionally on a comparable basis has turned to a tailwind for us next year, we would expect it would be. And we expect that it would be at a material level in terms of operating margin, I just don’t want you to come to the conclusion where we’ll have to get all of it back until we finalize the next year’s rebuilt schedule.

Operator

Our next question is from Ken Zener of KeyBanc Capital Markets. Please go ahead.

Ken Zener – KeyBanc Capital Markets

Good morning gentlemen.

Michael Thaman

Hey, Ken.

Michael McMurray

Good morning.

Ken Zener – KeyBanc Capital Markets

So, the volumes on roofing were where I think people initially expected, but I’m struggling with the broader question about how to think about your company and how you guys are thinking about guidance? I know that over the years there’s been several iterations, given out the segment level which you’re doing this year in composites and they are kind of leaving it a little more generalized between the two other segments. Could you help us think about as you struggle through this process as well you can’t control the weather, housings is going to do what it does.

But could you guys help us think how we can the challenges you face in communicating to us around the guidance of your company because roofing you can’t figure it out but the insulation perhaps around some said variables that we might have sensitivity to would be helpful, because it seems that while your businesses could be very good it’s hard to synchronize them. So I realize it’s a more broader question Mike 1 or Mike 2 but if you could help us through because it seems to be one of the issues that your stock has in particular.?Thank you.

Michael Thaman

Yeah thanks, Kevin. And it’s a great question and hopefully my answer is up to the challenge. You started your question by saying how should we think about the company and at a very high level, I have to think about the company the way we’ve always asked you to think about the company which is three great businesses in three great industries all of which are capable of delivering double-digit operating margins. In recent history, while we believe that that’s been true, our financial performance has largely been driven by one business, which has been our roofing business. As we work composites through a difficult global competitive environment and as we break insulation through an excruciating housing downturn.

Now if you look at those two businesses composites now in four quarters in a row of improvement insulation now 12 quarters in a row of improvement, both of them demonstrating operating leverage of around 50% during that improvement period and with those businesses improving 50 million just in the first half of this year, I think we’re getting much closer to financial performance that looks like three great businesses in three great industries. Now unfortunately and I think frustratingly to the leadership team here, roofing which has been our business that was volatile difficult to guide and was difficult to forecast, happens to be overwhelming that message right now because of some of the challenges in roofing.

But if you look at our overall portfolio and we have a roofing business that is a mid teens or a better business through some recovery in the roofing cycle which is consistent to what we’ve been saying. And then you have composites and insulation business we continue on the path to recovery that we’ve begun to demonstrate over the course of last three years in the case of insulation of course the last in last year in composite, you actually get much closer to an overall company where they have very strong portfolio of businesses that at least relative to historic standards is actually operating at high levels of performance in a synchronized way. Now that high level of performance of roofing as it relates to the last 20 years is not high levels of performance necessarily right now always to the last 16 quarters.

We haven’t given up on roofing one day again being a 20% operating margin business we are, five points away from that reality. So there is not a lot that’s needed to see the roofing business perform better, but we’re seeing roofing performance today that we think it’s sustainable and it’s consistent the way we’ve guided that business historically even though we are disappointed but not as good as we expected to be. But we’d ask you continue to think about our company as being three great businesses two of which are establishing a very nice track record of improvement that we believe is sustainable, one of which has been a more of a challenge but even in its tough days it’s producing mid teens operating margin and great cash flow.

Ken Zener – KeyBanc Capital Markets

So it’s tough. Complexity tends a great discounting I’m not an activist type perspective but it certainly helped. Can you on insulation, the amount of price that you got was that pretty much 100% from the residential side implying commercial what’s going on domestically commercial or international insulation obviously Canada, but that price came largely in, in the residential commercial side. Thank you very much.

Michael Thaman

Thanks, Ken. The pricing is I would say largely residential, but if you look at the product line that goes into residential, we tend to call those products light density which are kind of fluffy fiber glass insulation products which would be where you would be accustomed to seeing a standard stick residential construction. Those similar product lines which are built off of similar assets tend to move pricing kind of in tandem with couple of the commercial markets. So, some of the insulation products that would go into standard commercial construction, some of the insulation products that go into metal buildings, some of insulation products that go into some duct insulation and HVAC type insulation, are made on similar assets. And as a result, when we see residential pricing improving, we tend to see also some improvement in some of those a little bit more engineered density products. It’s a bit more broad-based than residential, but I think for purposes of how to think about the business for purposes of your analysis, the driver of price improvement in insulation would be the residential business.

Operator

Our next question is from Dennis McGill from Zelman & Associates. Please go ahead.

Dennis McGill – Zelman & Associates

Hi. Thank you, guys. First question just on pricing I guess, I think the disclosure on roofing was up, prices for the quarter were down 3% and I think you said, June volumes were up year-over-year positive in June. Can you just talk about pricing trend through the quarter? Did you have to get more or less aggressive on price to gain that volume?

Michael Thaman

We don’t disclose anything on kind of monthly pricing or have any public disclosure on that. I would say, there is not – I don’t think there is a bit story to be told there or a big news there. I think from our perspective, margin rates, we tend to manage often variable margin dollars per square. Our margin rates in pricing I would say were fairly stable through the quarter.

Dennis McGill – Zelman & Associates

Okay. And then, on the insulation side, you just went through it on the price, but can you also may be talk generally what you’re seeing volume-wise across the various pieces I think talked enough about the new construction site, but may be re-insulation, commercial, international what you guys are seeing there in volumes?

Michael Thaman

Yeah, I mean so going back to the new construction piece. It’s always just a good reminder that when we look at starts, we look at lag starts. And if you do the math on that, the first quarter lags starts this year, well not really much improvement over what was last year, but kind of already what’s baked in the cake in the third quarter. We should see an improvement in lags starts for the third quarter as a result, our expectation is we’ll see a little bit better volume on the residential side in the second half. I would say, some of the other key markets, the commercial market, some of the OEM markets have looked more like kind of economic growth, we’re seeing some positives growth in those markets but probably tend to track GDP or industry production type growth more than they would track residential new construction – has continued on the international side that would be a good market for us.

Canada has been a little bit weaker, that’s been true for I guess the last couple of years. We’ve seen housing starts to come off a little bit there. We’ve seen couple weather patterns and things, so Canada has been a little harder to forecast to maybe not as well what we saw a couple of years ago. We are very well positioned in Canada competitively because we have production assets in Canada so as the Canadian dollar weakens, our cost positioning in Canada does not deteriorate. We do have some competitors who ship some product in from the U.S., so we would believe that, that would make them less competitive going into Canada.

Conversely, we are profitable in Canada so the weakening of the dollar, we also see what profits in terms of translation and the (inaudible) we make in Canada. But that market at least for us, is well hedged and that our production – we sell and make in Canadian dollars. So if the dollar goes up we don’t have any impact there. If anything, a weaker dollar may be extends our competitive advantage a bit, relative to U.S. manufacturer trying to sell in Canada.

Dennis McGill – Zelman & Associates

So I guess, Canada is down, Asia is up and non-residential is up a little bit, any color on retail?

Michael Thaman

Retail, it’s been a little bit of tale of two cities there. On the routing side, retail has been one of the challenge that’s been a little bit weaker for us, we talk about that as one of the markets that buys on a replenishment basis I mean obviously the big retailers don’t take long positions on inventory. They bring inventory in when they need it. And same store sales growth and things in heavy building materials, like roofing have been for the most part, earlier in the year and through the second quarter, trailing behind last year. Insulation sales in retail has actually been fine. So that’s been more of the roofing theme for us at insulation, we’ve been happy with retail sales on insulation.

Dennis McGill – Zelman & Associates

Okay. Appreciate it. Thank you.

Operator

Our next question is from George Staphos with Bank of America/Merrill Lynch.

George Staphos – Bank of America/Merrill Lynch

Hi everyone. Good morning. Thanks for taking my questions and for the details. I guess I had a couple of questions again on roofing. So, as we think about the rest of the year, and what your revenue trajectory could look like, you noted that June comps were positive I think you said Mike and you expect to track in line with industry more or less or I think you’re guiding to flat to may be mid single digits for the industry. Now as I recall, third quarter last year, you lost a fair amount of market share for what you deemed to be somewhat aberrational effects, based on the regions the Midwest versus the Coast.

So if that’s true, what are the puts and takes why couldn’t you do a bit better than the industry from a revenue growth standpoint within roofing in the third quarter, and for the whole of the second half? The second question I had on roofing is, you talked about variable margin dollars and the like and your analysis of your peer set. Do you think that if you looked at it on a cost of capital basis that most of our competitors right now are basically out of breakeven levels, versus cost of capital if not, why would you expect to get any kind of pricing, any kind of margin until you see much larger pick up in re-roof? Thank you, guys. Good luck in the quarter.

Michael Thaman

Thanks, George. In response to your first question, you are in fact right. If you go back to last year, our third quarter share in roofing was not in fact our fourth quarter share on roofing was very, very good. So our second half performance last year in roofing from a market share point of view was very much in line with our historical average numbers. They were just timing in terms of what came in the third and what came in the fourth. So in terms of goals that we kept for ourselves, flat to slightly up market, trending back towards our historical market share, little bit easier comp in the third quarter so may be a little bit easier to catch up to last year’s volumes in the third. If that is what we stood at the end of third, then we may be able to go on the fourth because our market share was pretty high on the fourth. But we’re cognizant of that in the guidance we’re giving that, we’re going to have make progress in each of the two quarters in terms of market share and try to get back to volumes, that are acceptable to us.

In terms of your question on cost of capital, it is a way of looking at the industry I think at this point in time our estimate of our competitors would be most of our competitors are surely making money today and our earnings positive returns on capital. There is a not a lot of investment opportunity though, because you don’t see a lot of growth in demands. So the ability to apply capital to the roofing market would be applied really based on the theory of you can get a bigger share of a fairly static pie, and that would be the purpose of putting capital in. Second it goes to the comment I made earlier about, the marginal economics, I’ll try to take additional volume at lower prices. Today, when we look at marginal economics of ourselves, when we look at the marginal economics of most of our competitors, we don’t see anyone who has cost position or a market position, where their marginal economics try to go through price that they have that kind of advantage that winning strategy for them. Obviously for us, over the last four, five years, we’ve made a lot of money in the business, and we’ve tried very hard to earn market share, but we’ve never seen a point in time to even given the level of profitability that we’ve had over the last four years, that it made sense for us to somehow try to take additional volume at lower prices, just based on how the marginal economics of our business would work, if we went and did that. We don’t think we’re unusual in that regard, we think that’s the same position, most of our competitors find themselves in. So, while cost of capital – return on capitals are acceptable, the marginal economics are cutting price to gain volume, just don’t seem to be there for anybody in the industry because it’s a fairly consolidated industry today. So most everyone has a reasonable amount of market share and doesn’t have the economics to do that.

George Staphos – Bank of America/Merrill Lynch

I mean what you’re saying is to gain the share you cut the price efficiently, whatever spread you have from your analysis would dissipate and so therefore the desire to do that in the first place?

Michael Thaman

I think that’s one factor and the second factor is historically, any market share gains based on cutting prices is sustained.

George Staphos – Bank of America/Merrill Lynch

Fair enough. Thanks, guys. Good luck in the quarter.

Thierry Denis

Emily, this is Thierry we probably have time for one more round of questions.

Operator

Okay. Our last question will come from Keith Hughes with SunTrust. Please go ahead.

Keith Hughes – SunTrust Robinson Humphrey

Thank you. This is respect to in terms of production volumes for the second half based on your demand outlook, discussed several times would you expect manufacturing volumes to be up or down versus manufacturing production rates to be up or down versus prior year?

Michael Thaman

I would expect the manufacturing would be about in line with prior year, but that’s going to be very dependent on the timing of the volumes independent on costs. So a lot of our decision on how much to produce in the second half of the year, is driven by a, what we’re shipping but b, as we get later in the year everything asphalt is inexpensive and it’s going to inflate in the first part of the following year, we’ll go ahead and buy some asphalt and convert it into finished goods in order to position ourselves as low cost inventory. If we think asphalt costs are relatively high and we are not going to see that inflation, we’ll deplete our inventories. And since the business doesn’t have a lot of manufacturing fixed costs absorption most of our fixed costs absorption problems in the business or fixed cost leverage tend to be more fixed overheads and headcount related. That’s not a big driver of our margin economics in terms to whether we curtail production or whether we push production ahead.

Keith Hughes – SunTrust Robinson Humphrey

Okay. Final question, what is your sense of where roofing channel inventories right now? Just discussions with distributors or competitors as we end the second quarter.

Michael Thaman

Our sense is that our first of all our distributors as they continue to kind of consolidate and grow and become more sophisticated I think they are becoming increasingly efficient in the amount of inventory they need to carry to support their business. So they are very returns focused. So in flat markets, I don’t know if it’s a good assumption anymore than any flat markets end each year with same amount of inventory they had in the prior year. If their volumes are flat I would expect that they would expect to see some inventory productivity and probably find ways to reduce inventories.

That said, some of the big distributors have also been opening some new branches and expanding the geographic footprint which tends to be added to the inventory. So, the macro sense of inventory we think flattish inventory is probably a reasonable assumption a year over year. Our sense is that outdoor sales for distribution out to door sales for most of the channels have been copying mildly positives which is causing them to work their way through inventories they brought earlier in the year. They had given that manufacturing shipments comp negatively through the first half of the year and in markets that now is probably counting positively out the door. That’s a dynamic that would say we are going to see some reorders in the third quarter and fourth quarter in the support of the outlook given for the overall industry. So that would be the theory of how can our guidance holds together of when people are going to need to order and why they are going to need to order.

Keith Hughes – SunTrust Robinson Humphrey

Okay. Thank you.

Operator

And this concludes our question-and-answer session. I’d like to turn it back to Thierry Denis for any closing remarks.

Thierry Denis

Thank you, Emily, and thank you everyone for joining us for today’s call. In fact, I’d like to turn it back to Mike Thaman for a few closing remarks.

Michael Thaman

Well, thank you everyone. We thank you obviously for your interest in our company and your ongoing support on the company. I think we have covered all the basis in today’s call in terms of talking about Owens Corning and talking about the businesses. There is a lot of really good things that we’re reporting today that I don’t want to get lost in the roofing volume headlines. For the first half of the year, our insulation business and our composites business are $60 million are even more profitable than they were in the first half of last year. That is the continuation of the trend that we have seen now for multiple years in insulation. It is consistent with and we believe at the beginning of a trend of what we would expect to see in composites as we see more disciplined capacity environment, disciplined global utilization and a more constructive pricing environment.

So we believe that there are two big fixed costs intensive businesses that can produce, big time operating leverage on growth that bolsters businesses at the same time and are now positioned to continue on a path volume growth associated with global industrial production and volume growth associated with residential new construction. And we can drive that way through improved operating performance, improved volumes, improved pricing and great operating leverage. Unfortunately, right now we’re doing that in an environment where the roofing business and the roofing market has disappointed us a bit in the first half. I don’t want that disappointment to be so pronounced that we lose sight of the fact that the business is still a significant business with healthy margins, producing significant EBIT and significant cash flow.

We are obviously working very, very hard to get it back to the levels that we have enjoyed over the four years. Having said that, we always believed that Owens Corning was a company that had three great business and that the real strength of our company is one of three of our business is performing at very high levels. And as you look through with the report that we have put out today, I think if you go through that report and see we are getting closer to that reality of three very strong businesses performing at high levels. We’ve got some more to do to finish off the year and make sure we produce a strong year financially. I think we’ve done a lot of good momentum into the businesses it will help us get there. And then we got the challenges ahead of us that we believe we’re up to in terms to getting the roofing business with performance that we’d be proud of in the second half. We look forward to talking to you on our third quarter call to give you update and appreciate your continued support. Thank you.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.

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Source: Owens Corning's (OC) CEO Michael Thaman on Q2 2014 Results - Earnings Call Transcript
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