James Hardie Industries' (JHX) CEO Louis Gries on Q2 2017 Results - Earnings Call Transcript

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James Hardie Industries SE (NYSE:JHX)

Q2 2017 Earnings Conference Call

November 16, 2016, 18:00 ET


Louis Gries - CEO

Matt Marsh - CFO, EVP Corporate


Emily Smith - Deutsche Bank

Peter Steyn - Macquarie Group

Keith Chau - JPMorgan

Simon Thackray - Citigroup Inc.

James Rutledge - Morgan Stanley

Andrew Peros - Credit Suisse

Louis Gries

Good morning everybody. Walk you through the result as we usually do. I'll give you a really quick overview and then Matt will walk through the financials and we've got a Q&A. So we've got our disclosure pages and some on page eight. So as you can see as you would expect most of the euros are pointing up. We talk a little bit about the EBIT margin on the next slide. Basically the markets pretty good and the market side of our business has been doing all right we've struggled a bit on the operations side as we've talked about a couple of times now. So we will talk through that some more.

Just looking at the bullet points there. We did get higher volume so we’re positive no a market index. Even margins at 25.5 which is above the range but quite honestly it shouldn't be about that based on where we're at with the market. So we will talk about that and then you get your cash flow of Summerville capacity. So we are in free and non-capacity mode again in the U.S. or so we will no doubt cover that either on one of the slides or certainly in more detail before we get into Q&A and get the dividend comment there. So if you go to North America you see 12% up on the quarter and 14% on a half year and the problem is we could ship everything we had orders for in the second quarter. So our manufacturing continues to restrict supply. It restricted somewhat in the first quarter but we had some inventory we could use to work-off of time, by the time we get to second quarter we don't have much inventory to work off. So you're basically saying we shipped what we can make. We had orders for more so the backlog higher than normal going into the third quarter.

Average price has been doing what it's been doing, we thought it would be flat slightly down and it's been slightly down most of the year and EBITDA obviously the percent increase has been under underwhelming partly due to the manufacturing issues and partly due to the investments we've made in the business on the SG&A side mainly from market demand. We do have that last comment in there about free costs and input those are starting to level off so they were better in the first quarter than they were in the second quarter.

Going to our EBIT margin slide you can see the last couple of years we've been at the top of the range, but like I say this year if we had performed better on the operations side. We'd be more like last year rather than just right at the top of ranges where we're winning right now. Sales price we talked about we’ve been between fiscal year '15 and '17 we have been pretty flat little bit down on last year. We can talk about that some more when we get to Q&A and top line growth. we are we are in front of our market index even though we’re restricted on capacity but it's disappointing obviously that we are restricted on capacity because that kind of mask where we are really on our market demand.

In the International business, you can see performance have been really good on the EBIT line some of that’s FX while most of it's business performance. The half year number still has [indiscernible] so that kind of skews the volume a little bit. We'll go through business by business but a short summary is Australia is doing all right we can do better on market side so we need to work on that. New Zealand is good even though you’re going to see it has a little bit of a negative EBITDA comp, we should worry about that it's no big deal it's just something that you kind of work through naturally it's more designed than a stage and in the Philippines we do have we have hit a bump in the road in the Philippines. So here's all your arrows up for the business as you can see Australia flat on volume in the second quarter.

Like I said I think we can do better than that. So our guys would be working to do better than that, [indiscernible] has been okay and EBIT has been good. Now we got a favorable comp on the EBIT because we had a plant start-up in Australia last year so we're comping against a higher cost of startups so that's part of the reason the unit is up as much as it is. New Zealand like I said there's your air going down on the EBIT but I wouldn't worry about that, that business looks pretty good both from a market demand and pricing standpoint. Unit cost is fine it's up a little bit but no issue.

The Philippines we definitely hit a bump in a road so all the down arrows in the Philippines are given by lower value. Basically we've got a more competitive situation that we've had in the Philippines for a long time from an importer and we getting some market position because it had so we guys are working on a game plan that kind of restablish our market position where it had been In Europe if you remember we had a bad year in Europe last year, we are having okay year in Europe so is comping well but it's really comping against a bad year. And then over to Matt.

Matt Marsh

Good morning. I will take everyone through the financials similar set sort of charges to what we normally do. So for the second quarter we had sales of almost $96 million of about 10% volumes are up and most of the businesses average net sales price in the international fiber cement segment was up a reported 10 for the quarter but there are some FX in there so the underlying price was up more like five, some of that was mix and some of that was price increases in Australia and then just quarter normal pricing in New Zealand the Philippines. Gross profit increased 10% so in line with net sales most of that lack of leverage if you will is what mentioned earlier with respect to the production inefficiencies in the U.S.

SG&A expenses increased about 10, so they were up again in the second quarter not as much as they were in the first quarter I think we said in August that the first quarter was probably the toughest comp from an SG&A perspectives and had the biggest year-over-year increase and you can see that starting to come down as we go through the year we'd expect that to start to level off of it or continue to invest in the business. So they won't go flat but it just won't be as quite of a steep incline. So those investments are mainly in sales and marketing I say in almost all the businesses and not just the U.S. but also in Australia and New Zealand it's hoping business as well as continuing to add organizational capability at a corporate level to support the growth initiatives.

Operating profit on a reported basis $57 million down 56% but that's obviously got a number of adjustments in it like a stress test primarily. So the adjusted EBIT for the quarter was up 11 and adjusted and operating profit of 74.7 million was up 14%. So for the half year I'd say the dynamics are pretty similar numbers are slightly different but more or less a repeat story for the half much like I just went through for the second quarter so net sales of $973 up 11 very similar dynamics and drivers, gross profits up 11, gross margin percent up slightly 20 basis points it should have been up a lot more than that had the plants been running better.

We've also got some startup costs in the U.S. as we're trying to ramp up capacity. There's an inherent efficiencies that come with trying to do that quicker than doing kind of at the pace that you'd normally want to do it. So a combo of those two things are compressing margins and in the quarter and we will probably continue to compress them for the year. SG&A expenses are up 14 for the half again in the second quarter up 10 and they're up more than that—up more than the 14% in the first quarter and then net operating profit up 10% percent on an adjusted basis on a reported basis obviously down 24% but again that’s there's got to [indiscernible].

Nothing really going on below the line kind of tax, other income and expense and interest or more or less moving where you'd expect them to move to really nothing much to talk about there. You can see the trend chart on the Aussie dollar and U.S. dollar, for the most part for the half foreign exchange isn't really a feature in the results. We talk a little bit about it in this quarter, we talked a little bit about it in the first quarter. They offset each other for the half, it doesn't have a huge impact you can kind of see that in the bottom right hand translation impact box on a dollar basis pretty immaterial on a percentage basis it doesn't show up.

On input costs, so the price of pulp is up about 4% compared to the same period a year ago. We're performing better than that but pulp is starting to move back up. Cement prices are up about five we're in the market, we're performing better than that with our sourcing strategies but nonetheless cement is still got an inflationary feature on it for us probably the biggest change is gas prices continue to trend down but we're starting to see those change in the marketplace. So we're not expecting that that necessarily to continue for the rest of the year and into next year but for the first half result they were down in the market about 20%.

Freight in the marketplace is down, our freight costs aren't quite down that much with some inefficiencies built-in is we’re trying to maximize throughput out of the plants and ship out of various locations so there's an inherent inefficiencies when you do that. Our freight costs are still down year-over-year which is not to the same extent that market prices are down and then you see electricity prices are down about 9% in the U.S. So I'm going to go through the segments. North America second quarter and first EBIT for about seven and five, again that compression versus the top line growth and the gross profit growth is a combination of startups the plant production in efficiencies that we're experiencing at the moment and then we're continuing to invest in SG&A to get ahead of the growth that we see.

The international segment their numbers are good for the first half in the quarter of '16 and '18 , if you don't mind we had close to $10 million of Carole Park startup costs in the prior fiscal year and a lot of that was from first half kind of loaded cost. So that was $5 million, $6 million, $7 million in the first half and the remaining balance to $2 million, $3 million plus dollars in the second half. So they're benefiting for sure from a favorable comp. I've talked a little bit earlier on average net selling price the underlying core is up 2%, 3%. We're benefiting in Australia from some favorable mix from product mix in particular and then kind of pricing strategies in general and New Zealand where we want them to be and we're getting a little bit in this quarter some foreign exchange that's helping us I guess reported on price so for the way we think about price in international is more like 3% to 5% and that's a combination of list price increases and mix and capital pricing and we're happy with where we are on that front.

Lower production costs on Australian dollars obviously the plants a year plus in now almost 18 months into running in Carole Park with the new line so that's going to give us a better unit cost compared to year over year. The other businesses you know we are continuing to cut our losses in the other segment that's primarily Windows, we will continue to execute pretty well with the wind Windows business so as that business performance improves the EBIT losses will continue to narrow.

No real change in R&D more or less still on strategy kind of in the lower band, lower end of that 2% to 3% band. No strategic change in any other projects or whatnot it's just reflects the normal timing. General corporate costs are basically about flat, there's three major pieces of corporate cost so there's labor and capability, there is stock compensation and then there's foreign exchange. So what you're seeing is flat is a little bit up on labor and capability offset a little bit in the first half with the stock comp and foreign exchange in general not material enough to kind of worry about but we are adding capability to some of the corporate functions as well as we see growth. On a tax basis so we're now estimating an adjusted income tax estimate for the year income tax rate sorry for the year of 26% that's down from what we talked about in August of 27, that primarily comes on the backs of the U.S. result we're forecasting to be a bit different for the year and that's a high income tax jurisdiction. Adjusted income tax expense for the quarter and half year increase increased primarily due to the adjusted operating profit partially offset by lower ETR as our earnings forecast changed for the year. No real change in where we pay taxes, we pay taxes I think a lot of you that know us well we pay in Ireland and the U.S., Canada and New Zealand and the Philippines and then not in Australia due to the asbestos deduction that we have in the country.

Almost $131 million of cash flow from operations for the half is up 50%, 53%. It's a good cash flow generation that continues to be a strong feature. Favorable change in working capital obviously a combination of inventory levels coming down and no real different dynamic than normal on receivables and payables those are continuing to perform well. Obviously the increase in net income once you adjusted for noncash items and then that's partially offset by higher payment that we need this year to the asbestos trust. Our CapEx is down a bit, you can see 17% is down $7 million, $8 million in the first half the year compared to a year ago.

Keep in mind a year ago we were starting out earlier constructing both the Plant City line which is now running and the Cleburne line which we're in the process of starting up in the current third quarter. So that's the reason for the adjustment. We talked more about kind of CapEx in the Q&A. And then you can see on the dividends paid slightly lower this year, keep in mind that the 206 had a special dividend from FY ‘15 in it but you can see that we executed on the share buyback during the second quarter. So we've got a CapEx as I said you know half year CapEx is about $36 million down 16%, 17% from the prior year. We are announcing that we’re restarting the Summerville facility so that's a Summerville, South Carolina. It's a facility we mothballed during the financial crisis. We're in the process of getting that facility started back up. It'll be relatively inexpensive Brownfield capacity you can see about $18 million. We hope to get that started back up in the early part of fiscal year '18 first half of fiscal year '18.

We're in the process of commissioning the Cleburne flat sheets line that we put in place so the construction project is now complete and the teen in November started that line up. So we've got that capacity coming on line and then we'll continue to look at additional capacity, projects. We bought a piece of land in Tacoma last year. So we've got a team that's now working on starting to put engineering construction plans in place to build out lines on that piece of land and then we're looking for additional land in the northeast and then down the road. I think last year we talked a little bit lot about having a plant some point in time in the mid-south and we're going to continue to look for a piece of land for the mid-south. So CapEx well down now will be a feature -- there will be an increase if you will in future quarters. The Philippines Capacity project is on track despite kind of the temporary pick up in the business. We're going obviously continue to build out the capacity in that facility and that's going more or less on track.

In terms of capital allocation no real change, the financials and the overall health of the company continues to be very good. Strong margins and as you saw good operating cash flows, the ratings haven't changed since I think we last talked. The capital allocation priorities haven't changed either so our top priority continues to be investing in organic growth. So whether that's getting capacity in place for the plants infrastructure of existing facilities, sales and marketing resources or SG&A in the form of supporting PTG initiatives but that continues to be the number one priority you know followed by the ordinary dividends, we say $0.10 first half dividend in line with our payout ratio and then number three is kind of flexibility for sort of everything after that. So we always want to have flexibility to be strategic, if an opportunity presents itself sufficient cushion with the way we manage the balance sheet in the event that the market cycle changes quickly and then additional returns as we see appropriate liquidity and funding is really good, I will take everybody through that on the next page.

So no real change on the corporate debt structure, we still have $500 million of unsecured revolving credit facility. We've got a $400 million senior and secured note now maturity in 2023, $85 million of cash. Net debt still well within our range. So we're at 1.17 so 1.12 if you will well within that one to two range that we continue to try to manage the balance sheet and we did complete the $100 million share buyback in the six months ending in September. So we are pleased with that result.

Guidance for the year you know obviously we're changed guidance down to $250 million to $270 million, that's primarily driven by a combination of the startup cost that we're experiencing by trying to get a combination of Plant City line number four up and running now that the new Cleburne line up and running, Summerville constructed and going. At the same time that we're trying to also look at additional capacity for the future combined with not being able to ship everything that we had orders for. So a combination of those two is really the driver of the adjustment down at $250 million to $270 million is what we're now providing for guidance for the year. No real change in kind of underlying macro-economic or macro-indicators U.S. housing still is kind of in this 1-2 to 1-3 new construction starts for the year. Our overall market index hasn't changed on that front and no real underlying change in some of the evaluation based items like foreign exchange or our view on commodity prices things like that. So that the guidance adjustment that was really driven on a combination of startups and production. So now we will go to questions.

Question-and-Answer Session


Q - Emily Smith

It's Emily Smith from Deutsche Bank, so just a couple of questions around the capacity ramp up in the costs associated with that. I know you mentioned that the main reason for the change but so what you kind of had that some increase in capacity sort of in your plans. So what's changed between now and say even a month or two ago in the U.S. Secondly, I think Matt, when you were talking about the startup costs you didn't mention Plant City Three which I thought was also coming on line in Q4, is that still the case?

Okay, and just finally I guess when you look at that profile around additional capacity that’s been added that’s really only capacity coming on line in Q1 I think according to your timeline. So is it fair to say that FY ‘17 is going to be the worst in terms of cost risk and I guess overlying that potentially with a price increase in March 2017 is that still on the cards? Thanks.

Matt Marsh

I will shift the question a little bit because the question was on startup cost. I think most it -- most of the questions are probably about our EBIT margin which I think we talked about this a bit in September but we clearly had our equation for capacity wrong for a category that's so much -- with was a big share. So we didn't have enough insurance in our capacity utilization equation. What happened is then we did start growing a little bit more in the market but the plant started to perform below expectations and what that's triggered is four things really, we’re growing up startup cost forward, we’re having higher freight cost because we’re throughput optimizing so we're going with a plan, with the machines to determine where products are made rather than closest to the market.

We have a higher unit cost because we are trying to throughout optimized so we have when you think of unit cost it has an numerator which is what you spend and the denominator which is how much you make and our focus is to spend more on the numerator to get the incremental board out of the plant which doesn't result in more unit cost but it does result in higher throughput and a better situation for our customers.

And the other thing is we're restricting shipments. So we got some volume that we didn’t ship that we could have and should have shipped. So that's kind of a story of the EBIT margin is set for part equation and it all started with the planning by the supply chain and where our capacity utilization need to be and how quickly bring up capacity and then it was made much worse by the fact that our current network of plants just basically started to run not as well as it had, few of the plants kind of maintained throughputs in few plants kind of fell off a cliff and the rest of the plants were just a little bit less than they should have been.

Now we are starting to see that -- we’re starting to work out a way through that as far as the existing mines and we are seeing the right kind of trend lines that the plants that have fallen off the cliff if kind of responded that was somewhat related to some major equipment failures in a few of the plants and just starting to chase through tail trying to catch up. So we've seen a positive trend line there. We're not back to where we think we should be but we're approaching that, and then the startup PC, PC start up is now made some trim which was a big hurdle so we started to get line up and planks ramped it up to a certain efficiency and switch to products which -- switch the product line at trim which is another learning curve. So we took a dip there but we are producing trim off the line and we expect to go up that kind of improvement curve over the next six months, pretty steep probably for the first three or four months and then starting to flat out.

We had some Board off Cleburne, a number three, so we're very early in that ramp up and the funny thing on ramp up if they go well they actually cost you more so whenever you stand up a line and Board you're producing is more expensive than the average cost you have for your board in your system. So we actually think Cleburne is going startup pretty well, so far it looks good. If it starts really well it will actually be a little bit more of a drag on EBIT between now and at the end of the year and it kind of starts up average but we would you see how that goes and we asked about PC-4 and we are doing work in PC-4 to have them available next year. We're doing work in Summerville to have that ready they are starting up next year. So we do think fiscal year '17 we should have had the capacity so it was a mistake which I have recovered that is where we would see is the shortage we had this year we don't expect next year. We don't have as much kind of insurance in the equation as we would like and that’s why we're celebrating all the start-ups. Price increase was the other part of the question for those of you that the follow the company we normally review price at the end of the calendar year and if we’re going to take an increase we announce it early in the year and I knew that goes into effect March 1st through April 1st. So we're in a process it's quite certain that we will take price this year but we haven't been through the whole calculation to determine exactly what level but we will take price issue.

Emily Smith

Can I just follow up why you're restricting shipments?

Matt Marsh

We are shipping what we're making, it's just being restricted by the [indiscernible] production.

Peter Steyn

Peter Steyn from Macquarie. Louis could you comment on how you are seeing the markets, Matt made some comments in his closing remarks around the market but are you comfortable now having gone into the election and then out of the election on the other side, how are you reading the market? Is there any signs that particularly worry you going into calendar '17 and beyond that makes you uncomfortable that the market may have changed?

Louis Gries

The short answer is no, the market has been good for us. It's been kind of slow steady recovery for several years now which since we're a company that tries to grow market share that's the ideal situation of the market share. So we like where the market is at. I would have a clue and I don't think anyone else would have a clue as far as if there's going to be an election impact on housing market. We're not planning for one. So if we get a positive bump I've to be ready to take care of that and if we get a little bit of a negative drag on housing market we will adjust to that but we're not expecting any real significant change in what we are seeing in the market which is slow steady improvement.

Peter Steyn

And then maybe just changing back on working capital, could you comment on how you see the progression in inventory trends over the next number of quarters? You're obviously short right now. You were planning to rent that up into the next quarter, how do you see over that coming out fee from a cash flow point of view?

Louis Gries

It's a good question. I guess the thing we want to clarify is the reduction in the inventory was not a plan it was out of necessity to service as much demand as we could so we pulled our inventories down. So we will bring them back up. We always bring them up in winter, but this time next year you will see higher inventories that we have currently just because we don't expect to be sure about capacity at that point.

Peter Steyn

And you don't see [indiscernible] side, two questions following on net market question though, your numbers tracking well above market sort of [indiscernible] orders which have also been well above market, their lives result are only -- the order growth was only 3%. Is that significant and why you're looking at the market or is that just you think that's been discussed?

Louis Gries

I mean when your data gets smaller and smaller and now you’re on one build for the quarter, your variance just gets bigger. So I think Horton's you know kind of doing well in the market and if they had a kind of soft comp I think that just reflects where they are at that particular quarter versus the previous I don't think it reflects anything on our housing market. I think if you put all the big billings together you see they're taking a little bit more share as we go through the recovery and their growth looks pretty good. Remember we just want an increase in market we don't we don't actually want to strongly increasing market. So we've been living with whatever spend 5 to 10 or 11 for three, four years. It's a perfect market I would think it's a perfect market to grow market share and looking back we probably should have grown also we’re focused on making sure we get another two, three years of steady increases. We're going to work hard to grow more share than we have.

Peter Steyn

You [indiscernible] 10% market depending where it is and clearly a sign you could have actually shipped more had you had more to ship. So you know might be the question but I'm just thinking who's taking the stuff that you're not shipping?

Louis Gries

Obviously some of this can be in deferred they're waiting for us. We got the seasonal downturn happening. So we're now for the first time in the last several weeks we're actually producing more than we’re getting orders for so we are starting a play little catch up now. So a good amount of our shortage hopefully we can get back in the slower months. The rest of it people that had to go on and build their house and couldn't our material, I would say that would be some conversions from mine or they deferred conversion. They made a commitment to go to [indiscernible] and because product availability was tight. You know they pushed it back and as you guys know our most closest alternatives are CFC and LP. CFC I don't think has a lot of capacity to deal with so if anyone picked up directly from us it would have been [indiscernible], their close alternative that has capacity.

Peter Steyn

Just on the Philippines, the imported product is that a [indiscernible] or?

Louis Gries

It is [indiscernible].

Keith Chau

Keith Chau from JPMorgan. Just a quick question relating to couple of comments from September to around your recruitment drive. I think you mentioned that is a few heads to the allocated or acquitted to the Global Management Team including HR International and sales. How far processed are you in that process? And do you think allocation or appointment of the Head of HR will actually help you just configure the operation of the way where we have some of these issues or it will help you plan the bit of the [indiscernible] of 35-90?

Louis Gries

So the quick update is we're at the very end of HR search. We make announcements there shortly. I don't know if we will announce it publicly but we will internally and then with Head of Sales and Marketing and Head of International we're at the very beginning of the searches. So in that respect three to six months for those searches and then whenever we bring on someone senior we have a pretty long onboarding. So even if the HR -- Head of HR will join in January and they wouldn’t be fully in the job till May or June. So to go through and learn the business period that’s fairly long. We've have bridge organizations in place to kind of your question why you’re doing this, are you doing it for 35-90, the answer is absolutely.

On the org side, on the HR side you guys admit, a lot of guys admit, we got really good people but our depth isn't what it needs to be. So you also know part of the reason the depth isn't what it used to be or it needs to be is because we're kind of reluctant in the past to recruit externally at a very senior level and all, we prefer people really in their career when we recruit them and then our turnover is running above our targets. So put those two things together we’re short of depth that gets in the way of running initiatives, slows down things whether it be on the operation side or the margin side.

So there's just a bit of shifting with our organizational strategy that enables our 35-90 that needs to happen and we've gone for a Chair Executive and that we think can provide the leadership we need in that area. Head of Sales and Head of International is really just build a more depth on the GMT. So once you guys know Fisher, he takes care of international and international as you've seen from our results runs pretty well. The Head of International is more about what's the growth potential for Hardie outside of the U.S. in fiber cement, then it is about running the Asia-PAC business. We got a got organization in Australia that runs Asia-PAC business and now continue to have that responsibility so the Head of International is more of a longer term strategic position similar to none we have seen which Fisher as he gives up international non-CFC [ph] growth which we think is important five to seven years out and probably the fiber cement outside of US is important more like maybe seven or 12 years out. We do think there's an opportunity to think about fiber cement and some of the geographies and when we start doing work.

Unidentified Analyst

It's [indiscernible] from UBS. Just can you get a bit more color on PDG and I guess the regional mix and how you did in the various regions?

Louis Gries

I think what's been disappointing to us is our overall growth especially [indiscernible] is fine if we would add up capacity you're probably looking at PDG very close to our target if not right on our target. We're not running our full game up in the final markets. So we get LP in some of those markets and obviously most of the vinyl's mid-Atlantic North East, Midwest and Canada, Eastern Canada mainly and we've done all right in the markets but we're just not as laser focused on vinyl's we need to be so that's one of the things we're trying to change in the business.

On the other hand you know kind of the more fiber cement markets or the kind of hardboard wood type markets in the mountains. We've done well and we've done well when our growth initiatives and knows they are a little bit simpler, simpler game plans to run, but we run them well. We haven't run the vinyl game plan as well as we should.

Unidentified Analyst

And just follow up on Andrew's question around the deferred shipments. Are you able to maybe quantify what those were in the second quarter up?

Louis Gries

I'm sure we have an exact number in the company but basically what I try to indicate is we’re 14.5 in 12, maybe 15 for the year instead of 14 and probably 14 for the quarter. So second quarter demand looks very similar to first quarter demand like I said in the first quarter we able to ship down and use some inventory and ship extra board that we didn’t produce, second quarter we're kind at the point where we had no excess inventory to ship so we are just shipping what we're producing. And I think everyone who knows the business knows the exteriors run at a higher rate than the interiors. So those will be higher numbers for exterior.


The first phone question comes from Simon Thackray from Citi. Please go ahead.

Simon Thackray

I just get to understanding the guidance, I took your point about what's been implied in terms of capacity additions and taking those cost to double line etcetera but I'm just trying to understand it, based on the guidance you told me about the split between 53% first half or 58% first half what you're talking to into second half? Historically your revenues reasonably balanced half on half, call it 51 or 52 and your profitability for this first half at 15% impact on sales is the highest it has ever been but just can you get me through where -- what's the total impact that you’re expecting in that guidance of 250 to 270 from a $1 perspective and exactly where it comes from?

Louis Gries

I think the purpose of the range is not to provide an exact number. So I mean I will try to give you some sense though Simon help -- why do we guide down. So I think in the earlier part of the year we obviously weren't anticipating that there would be some incremental cost to the normal run rate in the business related to startup, few things that sort of changed in the last few months. So one is we're going to startup more so we’re pulling some of the startup forward and then two we’re trying to go quicker with the startups and that is inherently more inefficient. So I think we may made a comment in the August call that startup costs were kind of mid-single digits and they will be above call it $10 million, $11 million now for the year just in the U.S.

So with Summerville, Cleburne-3, Plant City 3, Plant City 4 and getting both lines in Fontana up and running. We've got five startups now kind of running and we're trying to do that concurrently and it's a bit of a double edged sword in the sense that if it doesn't run well obviously there's waste and that costs us and when it does run well you get higher unit cost per board that you end up shipping so you know the startup kind of adds incremental cost both ways in that regard. There was one factor in the way we thought about guidance this time versus what we thought about in August. The second is in August we weren’t anticipating that we weren’t going be able to fulfill all the orders to the extent that's played out over the last couple of months and so when you leave orders unshipped obviously that changes the volume forecast for the year and then obviously that has an impact on the earnings we’re going to play out for the year. So a combination of those two factors is really what drove the adjustment from where we were on guidance in August to the guidance that we’re providing today.

Simon Thackray

So I would like to assume that that’s going to be the second half will have a much weaker EBIT margin performance on that basis?

Matt Marsh

Compared to a year ago I think that’s probably pretty safe assumption.

Simon Thackray

I'm just trying to understand that the acceleration, the five plant launch when we were in Charleston in September the discussion was around having allocated the A-team [ph] to the startups and leading the existing manufacturing businesses to their own devices and net of cost in terms of operational performance and that strategy was going to be reversed I think from memory you were bringing your A-team back on to the line to make sure the existing network would be operating effectively, but we were anticipating that the might go down [indiscernible]. So had some in terms between September and now or that’s completely misinterpreted that.

Simon Thackray

I think we need to go back to the headline. Manufacturing has been more of a problem and a longer problem than we're anticipating in the summer. I guess the best way to describe it is in the summer we thought we were getting kind of lot of normal variance and then some things we got to fix in those two plants. The reality is we had few issues across the network pretty much across the network, I would say in a couple plants that need to be addressed and we backed up and addressed that. So we got behind on some things we shouldn't have got behind on. It's resulted in some excessive downtime in several plants in the U.S. As far as the startups probably the biggest change between when we talked at length in September and now is we live with the problem we have this year long enough to say we just got to push through this thing make sure everything's exactly like it needs to be going in the next year and we're more aggressively bringing the startups forward.

And as Matt said and I alluded to earlier, the way the Cleburne startup which has been set up like we had talked in September they're doing very well, firewalling the startup from the existing lines. We started to make board on the new line and the efficiencies and existing lines had not fallen off like they did at Plant City and Carole Park. So that little part of the thing initially thing has worked well, but bringing all these startups forward and like we commented if the startups go really well you just put more board in the system at higher cost, if the startups go poorly which we don't anticipate or don't have any indicators that they will you know you have a lot of waste. So it's just—we're just being really aggressive internally to get all of our available capacity started up and producing board and that’s pulling cost forward.

If you look at two years, clearly our EBIT margins would be better this year if we weren’t fighting this problem but last year we shouldn't have deferred startups if we had to write equation we went to deferred startups and we weren’t paid for some of those startups last year. So it's just -- there's some areas in our planning there but it's more timing and it is absolute dollars there or even double [ph].

Simon Thackray

And you said it's two to three quarters before you get back to your expected manufacturing guidance or operational targets presumably for fiscal '18 because you need -- how fast can you grow and not get caught by the market?

Louis Gries

I think we can grow 20% and not have supply problems and we don't anticipate the market being more on an index say about 6 to 8 so 20 is a plenty headroom. And as far as a two or three quarters to get where we want to be in manufacturing. Obviously when you’re run into a problem like this you do a lot of work to understand what drove it. We found some drivers we didn't like so like I said we backed up kind of changed our approach in a few important areas. So I do think you know there's a bit of a real learning going on at Hardie, it takes two or three quarters to get there but I like where organizational thinking is going and I'm starting to like to see the trend lines as well. So I think we’re good but it probably does take two, three quarters before we're happy.


The next question comes from James Rutledge from Morgan Stanley. Please go ahead.

James Rutledge

Just following on I guess from Simon's question in terms of how we’re thinking about fiscal '18. I guess you've talked about some of those one off costs embedded in your guidance for fiscal '17 coming out and then getting the manufacturing efficiencies. I guess that combined with price and a reasonably strong volume environment would take you well above the 25% margin top end of the range. How should we think if you’re thinking about that kind of investment, does that restart SG&A investment or is it something else that I'm missing there?

Louis Gries

As you know we don't guide forward into the next year but if you listen to my story you got all the points, right. I think we hit the bottom in manufacturing this year so we will have better numbers next year. We'll have a market price increase, I think our capital pricing will be the same or little better. We're not anticipating a bigger than normal meaning our trend line and SG&A build and we expect to grow above the market index and it's supposed to be a market that might be up index wise around 6% or 7%. So yes if you read all those comments we should be looking for a nice financial kick up next year which we didn't get this year. Obviously we're going on the wrong way on our bottom line leverage this year. So it's pretty disappointing result for us. I mean obviously they are Hardie financials so they are good financials but financial improvement is not good. So we see that as a temporary situation.

James Rutledge

I guess the story around SG&A there is that it's just incremental growth there is no need for further step change or I guess returns you get from further investment in SG&A. You still saying the returns from the prior investment so there is no need to have another big step up.

Louis Gries

Yes as far as the market programs we don't have any major launches or anything that we think is going to take a lot of dollars. As far as our field sales we made a lot of additions there, we had some incrementals but it won't be a step change which we had like a year ago. Building up the debt at the senior level that cost you a bit but I think that will get lost, you know it's not big enough to really see it drive the EBIT number but you will see SG&A increases at that level but I don't think they're going to be big enough to worry about.


The next question comes from Andrew Peros from Credit Suisse. Please go ahead.

Andrew Peros

You kind of answered my question around inventory but perhaps I can ask a question why you -- you’ve obviously talked about the inventory rolled over -- [indiscernible] running a plant bit harder, just wondering to what degree will that have a positive impact on your EBIT margins over that period and is that potential for that to more than offset those startup costs that you’re talking about throughout the remainder of this fiscal year?

Louis Gries

I think the number to look for this year is our guidance number, so we guide you down and we guide you down because the U.S. forecast has been reduced and U.S. forecast has been reduced because the operating center of business is costing us more than we originally had planned for. So I mean I think our guidance is you know what it should be and it does reflect -- we're not out of the woods on the unit cost and freight cost increases and that's somewhat related to startups. I do feel way better about our trend line and existing equipment. I think we've addressed a few of those issues and we put those behind us pretty quickly but yes so as far as anything else on EBIT margin for this year, Matt indicated their guidance change because of the U.S. EBIT. So I think you can figure out where our EBIT margin expectation is. We expect to be at the top of the range just like we always say, but I'm analyzing [ph] as you already know with the kind of market demand we had we should be above the range of this year and we stub their toe in manufacturing, that's why we're just right on top of the range.


Thank you. At this time we are showing no further questions from the phone.

Louis Gries

All right, thank you. Appreciate everybody. Thanks.

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