James Hardie Industries - Q2 2019

Transcript

Louis Gries (CEO)

Okay, good morning, everybody. We'll go through this the same way we always have. Matt and I will take care of it. Everyone, everyone knows that Jack and I are in a transition period. Jack's working with the team on initial assessment of North American business and early stages of the three-year strategic plan. So, but as far as the results go in the Q&A, Matt and I will take care of those. But, if you catch up with Jack later, he's right up to speed on everything that's going on in the company, so, you get his perspective. All right, so, slide number eight, I guess. You see a lot of green arrows, but our problem is our top line's better than our bottom line.

We'll go through the reasons for that. Of course, EBIT margin ends up being red because of that, meaning declining EBIT margin, both in the U.S. and in the company overall. The most unusual thing in this result is we have done a strategic review of non-fiber cement U.S., and have decided to close both the windows business and a product line, which we call MCT internally. But that's a resin type technology we invested in five, six years ago as a potential trim for the Northeast. In order to prove out the technology, we made shapes that we sold along with our current trim lines.

The shapes are fine, but it's not a big enough market to stay in the technology. The technology itself, like the things we compete against, urethane, fiberglass, all those technologies just have a higher cost point than including our technology than we think is. You know, you can really sustain margins with long term. We're getting out of both of those, which this next slide covers that a bit. This also has ColorPlus. Those of you that were there in September know that one of the key initiatives for accelerating growth is what we're calling Win With Color initiative inside North American business.

Basically, we're at the point now with both scale and capability and color, we thought we could reposition the product line, and we're kinda going, trying to kind of divide the product line and point it specifically at certain customers. We got a premium color line, which has some capacity that you would see in the result associated with it, which it'll give you the whole rainbow of colors. And then we're gonna get more core with our existing color line for targeting most of the market that's looking for a more affordable color. The affordability comes some through manufacturing. It doesn't come through anything through paint, so the paint's exactly the same, film thickness, weatherability, fade, everything's the same.

But it comes through manufacturing, through longer runs and higher bigger unit sizes, lower freight. But it's really most of the gains are a more efficient supply chain. So we had a small write-off that we're anticipating for obsolete inventory, colors that we're not going to make in our core offering anymore, or SKUs. The Window business, non-FC. So the next thing two items are non-FC, and I'll kinda summarize it at the end, but one of them was always reported in U.S. business, and that's MCT. Already commented on that. The Windows had always been kinda reported. I think recently we reported in the other category, so it's pretty easy to see where we've been with that business.

Basically, we had certain criteria for that business, and over the five years we've been in the business, the first three years were a pretty rough start. Last two years, we actually did, you know, have pretty good progress in the business. But with a good review of it, we just decided it wasn't gonna end up being what we were aiming for in the beginning, and that was mainly around potential scale of the business, not so much profitability. So the price cost was kind of tracking in line with what we thought it had to, and, but we didn't think we'd get to the scale where it would be an important business for Hardie. So we decided to close down.

Like I said, you know, with Jack and I in the transition period, this was done, both of us are aligned on the decision. It's not one or the other making the decision. The timing's not so much around the transition. It's not the new CEO clearing the decks. It was scheduled for a review in October, and that's when we did it. So here we are in North America. Yeah, the 8%, which I think most people would be happy with, we were aiming a little bit higher, okay? So we came in a little short of what we wanted. Some of that seems to be external, and some of it's internal. And on the internal stuff, and it's a fairly small percent, say 2% or 3%.

So, it's really kinda hard to tell at this point how much is which. But we're still working hard in the business to get all the momentum we want in the market. It's not like there's anyone clearly winning against us. You guys see the vinyl numbers, you see the LP numbers, and those are the two we play against the most. But we did just come in a little bit short. Also on EBIT margin, and the EBIT margin is more about input costs that have run stronger than we were forecasting. Our CapEx is up, and the volume increase isn't quite kinda covering it for us. So when we plan the business, we were funding initiatives based on a certain volume increase.

Now that we're coming in a little short on that volume increase, we're seeing your costs being higher than ideally we'd like them to be from an EBIT margin perspective. But the stuff we're doing is good stuff, so obviously Jack and the team are looking at things, but we're not, like, just pulling back because the volume doesn't divide out the way we planned it. There may be some trimming there, but it'll be more about, you know, how valuable the work is that we're doing. Interiors, it's a quarterly variance, so don't get hung up on the six. We still think that's a flat minus one or two for the year. We get a volume chart next. I'll comment more on it there. Price is tracking as planned.

EBIT, obviously, even when you adjust for the one-offs, it's still, it's still flat. And you know, again, that's, that's kind of a series of things. So it's the input, it's the SG&A, volume be a little bit short based on the SG&A, and we have started up Tacoma. So there's this first quarter, you're seeing some startup costs out of Tacoma that is affecting the number to any degree at all. Startup's going well, though. It's not, it's not an issue with the startup. The startup's going well. It's just a matter that it's going on, so. When you look at the volume, you can see the red line's exteriors. Like I said, we would have rather been at 10 or 11.

That's what we were forecasting we could get to, especially on this quarterly comp. We didn't quite get there, and we're not sure if it's, you know, more external or internal, but like I said, we got some internal things we still haven't gotten to where we want them to be. So it doesn't matter that much to us, to be honest with you. The market's still good. It's not like we're dealing in a bad market, or things are pulling back, or anything like that. It's just a bit of a dead market for a variety of reasons, which you've probably seen in other results. And then the interiors, like I said, the six is more of a quarterly variance.

The first part of that chart is when we were pulling out of stuff we didn't wanna be in, in interiors, and that was the gypsum channel and the four-by-eight board. And then, you know, we kinda feel like we're in a slightly declining opportunity market because of the change in flooring preference. But having said that, you know, from September, really, nothing's changed. That quarterly result doesn't bother us in any real way. The EBIT margin, you can see four quarters were right at the top of the range and, a hair above it a couple times. Now we're right back, not quite the middle of the range, but, further down in the range that we would, than we would've been thinking we would be. And like I said, it's the stuff I covered.

It's, you know, input costs, startup going on, org cost, and volume coming in a little short. So, you would've seen in the write-up, I guess, we're still talking the top half of the range, and but there is pressure on the EBIT margin right now. So we're gonna have to work through that during this, you know, winter quarters to make sure we end up where we think we're gonna end up. This slide's kind of a nothing new slide. Price is going as we expect. You see that big slope, and you think, well, you're taking too much price, but relative to the industry, that price is in line with the industry. So it's not like we're taking more price than the industry. So the things we compete against would have similar price curves.

And then, top-line growth, obviously, is a bit short of what we wanna be, where we wanna be. Asia Pac also has a less clear result than they usually do. This business is running very well, I mean, the Australian business is running very well. Good top-line growth, obviously facing the input cost. When you look at the U.S. EBIT, obviously that has FX in it, but even when you get down to Australian dollars EBIT, very flat with a good top line. And they are funding initiatives in two of the countries, Philippines and Australia. They started out capacity in the Philippines, and the New Zealand plant's not running as well as it should.

Now, recently, it's kind of bottomed out and started performing better, so hopefully, that improves as we go through the year, but there's just a few things dampening the bottom line growth on the good top-line growth in Asia Pac. You can see the arrows. For Australia, they all point up, but certainly, the sales is a bigger arrow than the EBIT, even in Australia, so the top line's running better than the bottom line. New Zealand, you can see their EBIT's down, and that's mainly plant related with the input cost on top of it, and then the Philippines did have a write-off on inventory, basically obsolete inventory. But other than that, that business has done really well.

They did a good job start resetting their market over the last, say, about five or six quarters, and they did a nice job starting up their new capacity. Europe's going as planned, both the operations and integration, so it's kinda no news is good news out of Europe. It's going as forecasted, pretty much in line with what I think we indicated we thought it would look like this year. Sales in euros are up about 6%, and similar discount to the operating profit improvement in euros, so but it's going well in Europe. Okay, I'll hand over to Matt.

Matt Marsh (CFO)

All right, good morning, everybody. I'll go through the financials, and then we'll open it up for some questions. In Q2, we had net sales that were up 23%. We reported $644.6 million of US sales. It's up about $119 million, primarily driven by the acquisition of Fermacell. Of the $118.8, almost $77.8 of that is Fermacell. Louis has already made comments on the underlying businesses, and I'll do the same when we get to the segment results. Prices are up in the North America Fiber Cement segment, as well as volume.

Asia, and has both higher volumes and just good overall performance on the top line, in both the Philippines and Australia. You see, gross profits are up 11% on a dollar basis. Margins are down about 350 basis points. You'll see as we get into the input cost section, that market rates on all the commodities and freight are up pretty significantly, and don't seem to be cooling off, and that's for the most part what's driving the compression. We reported an adjusted net operating profit in the quarter of almost $81 million, so up about 7%. You can see for the half year, we reported about just shy of $1.003 billion of net sales, up 25%.

Again, $164 million of that increase from the prior year was a result of the acquisition. Very similar, I'd say, top-line dynamics at the half and the quarter, so I won't make specific comments here on those. Similarly, on gross profits, up 20% on a dollar basis. Margins down about 140 basis points. The margin compression, for the most part, is input cost related. And then adjusted net operating profit, we're reporting $160.8 million, up about 17%. Primarily North America, Fiber Cement, EBIT, excluding the MCT and product discontinuations, increased about 17%. Okay, so we'll go through some of the segments.

For the second quarter, EBIT, and for the half, was up 2% and 17% respectively. We've excluded both MCT and Affordable Color, kinda non-recurring items, so you could see the underlying business. We tried to give good visibility, both in the MA and in the management presentation, as you guys could see those costs, and I'll take you through a slide on that in a second. As I commented on earlier, both freight rates in the market, fuel cost, truck availability, the market price for pulp, cement, most of our raw materials, utilities, are all up pretty significantly year on year and continue to be up to a much greater degree than we originally anticipated, or even when we had visibility to in the August discussion.

And that's what's compressing margin rates in North America. It's also having some impact on Asia Pacific, and I'll talk about that when I get to that segment. On page 22, here's the details to the product line discontinuations. I'll just sort of remind everyone that in North America, in the Fiber Cement segment, we had both MCT and ColorPlus. Those business lines report up through that segment. Windows was in the other business segment, and so all you're seeing in North America is MCT and ColorPlus. We had $3.6 million of charges in the first half related to the discontinuing of MCT. I'd say those are very normal costs associated with product line discontinuation.

Things like fixed assets and excess and obsolete inventory and a little bit of IP impairments are included in that $3.6 million. ColorPlus was E&O, excess and obsolete inventory reserves on some of the inventory that is impacted by our decisions to discontinue some of those SKUs. The discontinuation of the Windows business has charges of $15.8 million in the quarter and the half, and those are made up of a combination of inventory and asset impairments. The asset impairments is a combination of goodwill, intangibles, some fixed assets, and the like. We tried to do as much of that in the quarter as we could.

I do anticipate some additional one-time costs in the second half of the year, in the third or the fourth quarter, as we get towards the exit of that business. And there'll be some residual amounts on the balance sheet that we'll have to properly reflect into the results that weren't estimatable in the September period. Here's the chart we normally talk about on input costs. You'll see, you know, pulp's up 24% year on year, and it's stayed elevated, I think, for a much longer period of time than certainly than we forecasted. And I don't think we're the only ones that were assuming that it would start to come back down. Freight's another one. You got market rates that are up nearly 20%.

We're seeing it both in terms of rates and fuel. Truck availability's tight on top of it, so the Freight market's pretty challenging in North America at the moment. Those two, by far, are having the most significant impact when we talk about input costs compressing margins for the year. We still, you know, believe that those are commodity markets. They're gonna cycle up and cycle down. We just happen to be at a peak at the moment, which is having some headwinds on the result. Cement's also up. You can see gas prices are down versus a year ago, but there's still an inflationary trend on gas, and you can see electricity prices are kind of more flat, that green line.

But, you know, gas prices going back almost two years ago are still pretty elevated. So almost across all of our major input costs, we're seeing, you know, single-digit to very high double-digit type increases in input costs. And both the combination of that dynamic and a bit of the uncertainty around how much longer that'll persist versus when kind of normal supply and demand kicks in, and they'll start to cool back down as they have in the past is creating a bit of uncertainty in the result that we'll talk about when I get to guidance. Asia Pacific, these results are obviously reported in U.S. dollars. I'm gonna show you what they look like in Australian dollars.

You know, on a U.S. dollar basis for the quarter, and the half, EBIT was down 10% and 2%. On a local currency basis, it was up 13% and 2%, so a pretty different dynamic in local currency versus U.S. dollar, and you'll see that in the next couple of charts. Strong volume growth, both in the Australia business and in the Philippines. Those businesses are continuing to perform well commercially, and gaining both category and market share. Well, in addition to the input costs, I'll just remind everyone that we buy pulp for our APAC businesses in U.S. dollars, so you get both a higher pulp cost on top of the translation adjustment, which kind of negatively affects the segment.

Louis already mentioned the Philippines kind of non-recurring inventory item and foreign exchange. Those are all working to kind of compress margins in the first half for the Asia Pacific business. We've talked, I think, in August, that the New Zealand plant is performing unfavorably at the moment. We think that's in the normal boundary of kind of plant performance. It just happens to be not performing during a period where we need it to perform. We like the trend, the recent trend lines that that plant's on and expect it to kind of get back into kind of where we need it to be. But it no doubt caused some first half and second quarter compression for the Asia Pacific business.

Here's a chart on that we typically show on translation. You know, we -- At March 31, we were talking about an Aussie to the U.S. dollar translation rate of, like, 0.77. That's down to, you know, 0.72, so a 6% devaluation in the Aussie dollar in a pretty significant segment of our business. So as the U.S. dollar's gotten stronger, that's certainly hurt us. You can see how different the impact looks if you look at the Asia Pacific business on an Australian dollar basis versus a U.S. dollar basis. I've kind of highlighted in a shading what the results in the quarter and the half look like in Australian dollars versus what we've reported in U.S. dollars.

So, you know, almost a 7% change in average sales price, a 9% change between U.S. and Australian dollars in net sales, and a seven-point, you know, difference in the EBIT percent change. So significant enough that, while U.S. dollars is no doubt kind of what we report, the business that we're measuring and that we're, you know, that we're looking at for performance is performing very different in a local currency basis. On Europe, just remind everyone that we've decided to take transaction and integration-related costs this year above the line in EBIT. So the EBIT has been impacted. That $1.2 million loss in the first half that you see in the green bar includes the charges that you see noted on the right side.

If you, in both in the M&A and in a slide in the appendix, when you add back the inventory fair value, the transaction costs, the integration costs that are included in that first half result, we've got a $19.9 million EBIT number for the Europe segment, in comparison to $8.5 million a year ago. So we kind of like two quarters in where the Europe business is, both from a top line and a bottom line and the returns. It's kind of doing what we thought it would do. We recognize we've got a lot of work still to do in this segment, but it's certainly performing the way that we hoped it would when we purchased it. The other segment is obviously Windows.

Louis has already covered our decision to exit it, so you can see, for the first half, we had $19.1 million of losses, which, for the most part, are the impairments and, the adjustments that we've made on inventory valuation, writedowns, and other liabilities. And again, we think we've gotten most of that in the September period, but I do think in the second half, either in February or May result, we'll be talking a little bit more about some additional, charges. On 28, I'd say no real change in R&D. You know, we're continuing to kind of invest around 2% of our sales on R&D projects.

It's an area of focus as Jack and the team are going through the strategic planning process to make sure that we've got those projects oriented on the right things going forward. But you know, I'd say that segment's is really no surprise in its performance. General corporate costs, again, a bit more noise in here, so I'll just remind everyone of some of the items that are making some of the comparables look a bit odd. So we had about $2 million of stock comp, $2 million of New Zealand weather tightness, that if you remember back in August, that we had in the first quarter, and then a year ago, about $3 million of a gain from the sale of the Fontana building.

So when you add those up, that really helps bridge you from the 14.6%, sorry, the 22.9% to the 29.5% year-on-year. The underlying general corporate cost, in terms of the investment that we're making in the corporation, that we capture here, are approximately flat. The movements are those non-recurring items that I've just highlighted. Quickly on tax, we've updated our estimated adjusted effective tax rate for the year to 15.5%. In August, we were talking about a 17.1% number.

Obviously, as the year goes on, we get better information, we have a better line of sight to what we think the full year earnings will be, and cash taxes paid, and you adjust effective tax rate accordingly. The adjusted income tax expense decrease is primarily driven by that accounting treatment for amortization of intangibles, as well as a reduction in the U.S. statutory corporate tax rate. Pretty consistent with kind of what we've talked about in May, and what we talked about in August. And just as a reminder, income taxes are not paid or payable in Australia due to the AICF contributions. We try to note on the lower left of this chart, kind of cash taxes paid, as well.

Those used to always be in the financial pages as part of our filing, but we've brought that forward to highlight, you know, kind of the reduction that we're seeing at the half there as a result of the transaction that we did at the end of fourth quarter last year. From a cash flow standpoint, we had $137.6 million of operating cash flow for the first half. That was up 40%. The increase in net operating cash flow was up primarily for the cash-related net income with the underlying businesses. There's some favorable movement in inventory as a year ago, for the first six months of last fiscal year, we were building inventories.

We're running, I'd say, at a more normal level of capacity and supply, and those inventories came back down in this period. You'll see in other net operating activities, you know, some movement between the first half of this year and the first half of last year. I'd say that's just normal variance, you know, in the results of the normal course of business, kind of nothing to really highlight there. In investing activities, you can see the $558.7 million for the Fermacell acquisition, as well as an increase in capacity-related CapEx.

That's consistent with what we've been saying, the last several months, that CapEx this year would be elevated in comparison to prior years as we work on the Tacoma 2, the Prattville, and the Australian brownfield at Carole Park. So for the half CapEx, we had to spend about $140 million. That was up from the same period last year of about $56.4 million. I've highlighted the three major projects that we've got going on, which is Tacoma 2, the Greenfield in Prattville, that you know we started construction on, and then in Australia, the brownfield capacity of another sheet machine in our Carole Park facility.

In addition to that, today, we announced a $20.6 million investment in ColorPlus, which is equipment in two of our existing facilities in Peru and Pulaski. So two new premium color lines that'll help us automate and kind of this premium color offering that we're gonna go to market with and do it in an efficient way, as well as some building and facilities and land in the Northeast for a future greenfield project related to color. On the financial management framework, no real change from previous quarters. You know, the financial management starts with strong margins and cash flow, and we adjust based on our capital allocation priorities. There's no change in our capital allocation priorities from the last time that we talked.

Our number one priority continues to be investing in R&D and commercial activity support organic growth. Number two priority is around ordinary dividend, and number three is kind of flexibility for everything else, starting with market cyclicality and having the ability to be strategic. We had an offering in October in the European debt markets. The three rating agencies reaffirmed both our ratings, which you can see noted in the first column in the lower left, as well as the outlook statements. From a funding and liquidity standpoint, we were gonna continue to maintain our target range of one to two times leverage. You can see the funding structure below, which I'll go through in a second.

We're temporarily above that one to two times range and will be for several quarters, as we've talked about in prior discussions, and remain committed to coming back down within that target range and getting leverage back below two. Quickly on the debt profile, you know, our balance sheet continues to be very strong. At the end of September, for the period, we had almost $109 million of cash, $1.261 billion of net debt, and almost $371 million of revolving credit facilities. Our corporate debt structure, you know, has continued to mature and evolve.

So you can see, we now have the two U.S. notes maturing in 2025 and 2028, respectively, as well as a very good inaugural offering into the European high-yield debt markets in October, where we offered $400 million of debt maturing in 2026 at 3.65%, also unsecured. And we still have a $500 million unsecured revolving credit facility, and that's maturing in 2022. I like the overall liquidity profile for the company and the debt maturity profile that we have. On leverage, you can see we ended the period at about 2.2%, again, above the range, but, you know, we remain committed to coming back down within the range.

I do think that that'll continue to take us, you know, another four to six, six to eight quarters, something like that, to get back down within the range. But our net leverage target remains one to two times adjusted EBITDA. Okay, on guidance, we've adjusted the guidance range down from our last discussion, down to $280 million-$320 million. That's an adjustment down from the previous guidance, where we were talking in August of $300 million-$340 million. There's really four things, you know, that are causing us to adjust the range, and number one is volume and the uncertainty in the U.S. market.

You know, as Louis said, the first half comps were good. They were a little bit short of what we wanted. But, you know, you can see when you look at a lot of the competitive results, the builder results, the economic news in the U.S., there's no doubt some uncertainty with respect to the U.S. market. And, you know, so we're a bit, you know, I guess, uncertain as to how much of the performance in that we've seen for the first half of the year is us versus the U.S. market. There's no doubt we think that it's a combination of the two, and that uncertainty is factoring into a lower level of.

We are anticipating a lower level of market performance on top of a slightly lower performance from ourselves. Number two is input cost. So I had previously talked about $40 million-$50 million of pressure or inflationary cost pressure on this year's result back in August, and that's probably about $20 million higher today than it was when I was talking to you guys three months ago. So we're seeing now $60+ million of kind of year-on-year inflation. I would have expected by now that we would have seen a bit of a curtailing, particularly in pulp. We're just not seeing that. Freight markets continue to stay very elevated on top of already inflationary environments for the other key raw materials, and that's having an adverse effect.

On top of that, you know, and this is primarily a feature since our last result, foreign exchange is starting to factor in. So the Aussie dollar's decline and the U.S. dollar increase has kind of accelerated over the last 90 days in comparison to the first 90 days of the year. So we've kept the range at $40 million, so we would typically start to tighten it. We're keeping it wide at $40 million at this stage, really for two things. We're a bigger business today than we were, you know, a year ago. We've got the integration of Fermacell now as part of our result, but a lot of what I just talked through is uncertainty on the market side.

So there's no doubt there's some performance on our side that we're trying to work through, and I'm sure we'll talk more about as the day goes on. But a lot of the uncertainty in the range is not in our control, and so we've tried to lay out the assumptions that are sort of underpinning it, and then set a range that we think wraps around what we see as the potential low and the potential high case, you know, for the year. So with that, I'll be glad to take questions and open up the floor.

Simon Thackray (Analyst)

Thanks, Matt. Good morning. I'm Simon Thackray from CLSA. Can we just unpack that last comment, Matt, a little bit about system versus PDG, and you weren't sure how much, what was happening ultimately in the first half and what's going to happen in the second half? Did you come up with a number for PDG confidently in this first half that you think you achieved? I mean, you create the index, so we can't track the index-

Louis Gries (CEO)

Yeah, yeah, yeah.

Simon Thackray (Analyst)

You do.

Louis Gries (CEO)

Yeah, we know what our fourth quarter rolling index is, and we're slightly above that, I think about 2%, if I heard the number right. So, you know, our range for the year, we originally forecasted was 3%-5%. 3% is probably still in play, but we might come up a little bit short of that. But right now, I think the external market demand is actually harder to forecast than internally what's going on. So that's why we say we've actually, in the business, just kind of, for a couple quarters, just simplified it and focused on volume.

Certainly in our forecasting, we're focused on volume, and we'll do the back calculation for PDG once we got the official starts and our R&R index from Hanley Wood.

Simon Thackray (Analyst)

So just again, just to understand that, it's harder to forecast the external market.

Louis Gries (CEO)

It's definitely the external market, and I'm sure you've seen other results, is not tracking as it was for, say, four to six quarters. In other words, the market was very steady for a long period of time.

Simon Thackray (Analyst)

Yeah.

Louis Gries (CEO)

Now it's not. It's not coming off, meaning we don't expect starts to reduce necessarily, but the activity in the market is below what it used to be.

Simon Thackray (Analyst)

Okay. So does that get reflected in your order book? Because you've always talked about your order book.

Louis Gries (CEO)

Yeah, yeah, it definitely does. Yeah. So our order file is softer than what we want right now. That's getting to be a common comment by me. But yeah, it is. And we think, you know, because you can look at it regionally, obviously, we think some of it is, you know, external, and some of it's we haven't done a few of the things we wanted to get done and book some business we thought we'd book by now.

Simon Thackray (Analyst)

You never call out weather, but, but we obviously saw a pretty wet September with Texas and the Carolinas. We've had hurricanes. Most of the peers who have exposure in those areas have called that out.

Louis Gries (CEO)

Yeah.

Simon Thackray (Analyst)

Did it have an impact?

Louis Gries (CEO)

No, that's why I said there are several factors that are kind of affecting external demand in the industry right now-

Simon Thackray (Analyst)

Right

Louis Gries (CEO)

... Whether it's us or someone else. And of course, that would be one of them, and I can hardly say weather. You forced me to. But you know, and then just the, you know, builders, builder demand seems to be a bit softer as well. So we think there's a bit of a slowing, a slowing down, meaning that everyone's not in such a hurry to kind of move things forward. I think there's a lot of companies just doing a little bit of a wait and see, which is basically what we're saying, is, hey, if you know, if the, if the recent dampening of orders below our expectations, you know, is weather related, obviously, that's gonna wear off.

Simon Thackray (Analyst)

Yep.

Louis Gries (CEO)

It'll bounce back. And if it's related to something else, whether it be housing demand due to interest rates or anything else, a lot of people said there was a lot of, you know, wondering about what was gonna happen with the midterms. We don't have to wonder anymore, so we'll just see what the impact of that is.

Simon Thackray (Analyst)

Got it.

Louis Gries (CEO)

So again, we're not trying to flag a big issue either internally or externally. We were about 2.5% or 3% short of where we planned to be this quarter. So we delivered eight instead of 11. And you know, right now, as we sit here in November, five weeks in, we're a hair below what we were forecasting for the third quarter, a similar amount below what we were forecasting for the third quarter. So we're just not bullish on our volume right now.

Simon Thackray (Analyst)

Yep.

Louis Gries (CEO)

Yeah.

Simon Thackray (Analyst)

Just on that comment previously about the Interiors, it was down 6%.

Louis Gries (CEO)

Yeah.

Simon Thackray (Analyst)

You're still saying it finishes the year down one. How does that-

Louis Gries (CEO)

Flat, flat to two. I mean, that six is, you know, if you take the six months, it's down two, and we think that's more typical, and we entered the year with some of that, you know, product line exits still impacting numbers to a small degree. It's, we're not losing share, so we have visibility of share, so it's a market opportunity situation. But the quarter was just bad comp, you know, good comp, bad comp type had a factor in there.

Simon Thackray (Analyst)

Got it. Got it.

Yeah.

Louis Gries (CEO)

So I wouldn't worry about the six. I'd be thinking about the two, and I'd be thinking about a market opportunity that's likely in slow decline. And Hardie's not losing share in our channels, but Hardie is working to increase share incrementally or marginally in our channels to kind of offset some of that slow decline. And right now, I'd say we're staying flat share-wise, which puts us a little bit down because of the opportunity.

Simon Thackray (Analyst)

Okay. And Matt, just in terms of the tax rate, I know you normally say you can only assume for the full year what you've seen up to the half, so about 15.86%. Call it 16%. That's what we assume for the full year?

Matt Marsh (CFO)

Yeah, that's right. That tax rate just adjusts as our, you know, as we get better visibility.

Simon Thackray (Analyst)

Appreciate that.

So if I sort of back calc for that and maybe $50 million of interest costs and then kind of get back to an EBIT number, it's looking like the second half will be down on the first half. That's the implication, therefore, for the guidance, at the midpoint of that guidance?

Matt Marsh (CFO)

Yeah, I think that math's probably about right.

Simon Thackray (Analyst)

Yeah. Okay.

Matt Marsh (CFO)

Yeah.

Simon Thackray (Analyst)

And driven presumably out of this input, $20 million of input costs, that you've increased the sort of range of the input costs. That's a big driver. And then the second part is this uncertainty around the second-half outlook for the market. Is that the way to interpret it?

Matt Marsh (CFO)

I think it's a pretty good way to look at it.

Simon Thackray (Analyst)

Okay. Thank you.

Keith Chau (Analyst)

Morning, Lou and Matt. Keith Chau from Evans and Partners. Lou, just going back to your comment around the expectations for exteriors growth in the third quarter. So in the second quarter, just to recap, so the expectation was, or sorry, the internal forecast was 11%, and 8% was delivered. For the third quarter, you're a similar level below compared to the second quarter. What is your forecast, internal forecast for the third quarter, please?

Louis Gries (CEO)

Yeah. We're not gonna give you our internal forecast, but it wasn't 11%. That's the... No, we expected the back half volume comp to be lower because they're tougher comps from last year winter than they were summer. So that's why the reason we had 11% for this quarter was more we had a weak comp-

Keith Chau (Analyst)

Sure.

Louis Gries (CEO)

Same quarter last year.

Keith Chau (Analyst)

Okay. But I guess the long and short of it, the 3%-5% PDG, the bottom end looks-

Louis Gries (CEO)

I think-

Keith Chau (Analyst)

likely more achievable.

Louis Gries (CEO)

Yeah, like I said, I think the three's in play. I mean, I don't want, I don't wanna... Again, I'm not flagging anything major, but I am flagging that our organization's ability to get out in front of it has been less than I would expect it to have been.

Keith Chau (Analyst)

Sure.

Louis Gries (CEO)

So now, like I say, it's kind of hard to triangulate 'cause you see vinyl's down over the last three quarters, LP's up just marginally like we are, and a little less, a little bit less than us. So it's kind of hard to triangulate. That's why. But we know which business we're aiming at, and we're not knocking it off at the rate we think we can knock it off. So there's an internal component. Now, is there more traction now than there were six quarters ago? Yeah, there's more than six quarters ago. But like in September, you know, when we saw a lot of you in September, we say, "Hey, this company and everything we do is around 6% PDG," and the reality is, we're not there again.

We still have a lot of work to do to get back into that regular, you know, five, six, seven PDG type four-year trailing results. We're two now, and who knows, maybe we, by the end of the year, we end up two again or maybe three, but it's still not six, so we still have work to do.

Keith Chau (Analyst)

Sure. And just circling back to Interiors, I think last quarter we were talking about a 1%-3% up result for Interiors for the full year.

Louis Gries (CEO)

Yeah.

Keith Chau (Analyst)

Now we're talking flat to down.

Louis Gries (CEO)

Yeah, Jason reminded me of that.

Keith Chau (Analyst)

As we look kind of beyond this year.

Louis Gries (CEO)

Yeah

Keith Chau (Analyst)

Is there a point where you think the market for interiors will actually flatten off and stop deteriorating, or is that a longer-term issue that-

Louis Gries (CEO)

Yeah, I'm gonna be honest with you. Again, keep in mind, we're the big player on the floor.

Keith Chau (Analyst)

Mm-hmm.

Louis Gries (CEO)

And the floor is what we're talking about. So it's, it's hurting us more than our competitors-

Keith Chau (Analyst)

Mm-hmm

Louis Gries (CEO)

'Cause again, the companies that make their living on the wall aren't seeing the same thing... Do I think it's gonna continue? I do, I do think it's gonna continue. I think it'll be a slow decline for a lot of years, and then who knows, tastes change again, and maybe it swings back the other way, I'm not sure, but I said Jack and the team just started to work on their strategic plan, and certainly they're looking at product opportunities in interiors to offset the decline in the flooring opportunity.

Keith Chau (Analyst)

When do you think those benefits could start to materialize? I mean, it's not maybe in the next few quarters.

Louis Gries (CEO)

I mean, they're kind of six weeks into a, you know, three-month project.

Keith Chau (Analyst)

Right.

Louis Gries (CEO)

But I would say, we do have product development going on, so it's not like way down the road. But I wouldn't put it in next year's results.

Keith Chau (Analyst)

Okay, thanks. And just, one from Matt. I think you mentioned on the guidance, input costs are about a $20 million higher drag than, expected previously. I mean, given the, I guess, the lag between your market index costs and actually what, Hardie's, sees in its numbers, how come there's been such a, a large change within such a short amount of time? I mean, you know, kind of for a $20 million delta within three months, when there's been clear visibility in the past or input costs on a lag basis, is there anything else in there that's resulted in that higher number for the full year?

Matt Marsh (CFO)

No, not really. I mean, it's mainly input costs. I mean, you know, when we're doing a guidance discussion in early August, you know, we've got visibility in, call it late July. I think back in late July, we thought that they, we had seen the peak for the year, and that they were gonna come back down in the second half. So you've got, at that stage of the game, kind of nine months in the fiscal year, you probably got six to eight months, you know, if you exclude kind of any of the cost of goods manufactured that stays in the balance sheet via inventory. So you got a solid six months of raw material cost still to go that, you know, at that point, we're assuming starts to reverse.

It just didn't, you know, start to reverse on the raw material side. On the Freight side, we are starting to see some efficiency, but still pretty elevated levels. You know, but that's a good three to five months later than what we would have expected, you know, back in August when we were talking. So I think the cost had just remained elevated. We've had as good of a visibility into it as as I think we can have. The price of pulp, the NBSK price for pulp has just stayed high, and it hasn't come down. So, you know, we were starting to assume a normal cycle of it's gonna start to come down, and it just hasn't. So I've stopped assuming it's gonna come down until I actually see it come down.

Keith Chau (Analyst)

So is the embedded assumption that pulp prices stay high or continue to rise?

Matt Marsh (CFO)

Continue at the current trends.

Keith Chau (Analyst)

To go up?

Matt Marsh (CFO)

They've been flat. I mean, just depends on what your reference point is.

Keith Chau (Analyst)

Yeah.

Matt Marsh (CFO)

You know, so they've been flat, I'd say, more recently over the last, I think, 30-60 days, they've started to flatten out. But if you were to look at over a six-month period, they're up. I don't remember the exact assumption I've gotten the second half of the year, but I've got it at least flat to where it currently is.

Keith Chau (Analyst)

Okay. Thanks, Matt. Thanks, Lou.

Sophie Spartalis (Analyst)

Good morning, Sophie Spartalis from Merrill Lynch. Just going back to the cost profile, is there anything that you can do, going forward or have done in terms of initiatives to get on top of some of these external factors, whether it be hedging in terms of your gas costs or, you know, trying to do a different sort of balance on the Freight?

Matt Marsh (CFO)

Yeah, I mean, I'm not a big fan of hedging. I think all you're trying to do is outguess the market, and if you're really good at that, you're probably not working in a manufacturing company, you're probably working somewhere else. I'd rather have, you know, the business and the organization focused on trying to get operational efficiencies, and there's a big focus, you know, that we talked a little bit about in September, that, you know, I think it will become a core part of the strategy around getting operational efficiencies and driving lean into the manufacturing processes. That's not a short-term fix. We, for better or for worse, you know, make a product that uses commodities, and we just happen to be at the part of the cycle where all the commodities are going against us.

Two, three years ago, you know, they were all-- it was all tailwind, and we also didn't spend a whole lot of time then thinking about, you know, how to kind of maximize or optimize on the tailwind. What we're primarily trying to do is convert raw materials into a great product for the market and then gain market share, you know, by substituting out vinyl and wood-like products. So we're not spending almost any time in the short term or almost at all, trying to figure out what we could do other than the normal sourcing and procurement strategies. So if pulp's up, you know, 20-something percent, we're not up 20%. So we're looking at a combination of blend, you know, the types of materials, sourcing arrangements, where we're buying it from.

We're not trending up 20%. The market's up 20%. We're gonna trend below that. Same thing on cement. I think the cement market in the U.S., you know, pricing's up 6%-8% again this year on top of it was up 6%-8% last year. Our impact on that is not 6%-8%. We've got sourcing strategies in place that try to reduce that and minimize that, and we measure the teams on their sourcing effectiveness. But we're not spending almost any time, you know, trying to figure out how to, you know, financially use derivatives or hedging or other financial engineering as a way to prop up short-term results.

Sophie Spartalis (Analyst)

Okay, and then that does tail into the next question. In terms of your ability to keep pushing through price increases, you know, against a backdrop of an uncertain market, where do you see your ability to offset those cost pressures in the current market?

Matt Marsh (CFO)

Yeah, I mean, I'll just remind everyone that, you know, we value price. You know, we, we generally sort of think about three types of pricing models, you know, in building materials. You can price based on cost, you can price based on capacity, and you can do what we try to do, which is we look at the value of our product in the marketplace relative to the alternative product in the market, and then it becomes a decision about recovering any value that we see versus that competing product in the market, and balancing that with our primary objective in life, which is to gain market share. So when we make a pricing decision on an annualized basis, we're not doing it in the context of kind of what's happening on the input cost or the manufacturing performance.

That being said, in a 10-year period, you'll probably see us take a pretty modest price 2-3% nine out of those 10 years, eight out of those 10 years. We're gonna kind of be modest price takers in most years, where we want to recover some of that value, that 3%, the way that 3% gets talked about as a national average, the way it actually gets executed and strategically gets set, is a matrix of by product, by region, where we're making specific product and regional pricing decisions on an annual basis, based on what our market share objectives are and what the alternatives are in the marketplace. So, we took a, you know, about a 3% price increase this year.

What you're seeing in the reported numbers, you know, is a little bit of mix on top of that, a little bit of tactical pricing, you know, on top of that. So we're, we'll probably take another, you know, 3% in most of the future years. You know, that's a pretty reasonable assumption. We haven't determined what we're gonna take for next year yet, but we certainly won't do it per se, in the context of what input costs are doing, because the main objective with pricing is to balance pricing with gaining market share.

More profitability? Is there gonna be anything meaningful there that might help offset some of those input costs?

It, it's more about the future cash flows, you know, in those. In two of the three situations with MCT and Windows, you know, it was more about the ongoing investment in, you know, in comparison to the ongoing, you know, future costs or sorry, the ongoing future, you know, cash inflows. And obviously, based on the decision, you know, it's easy to conclude that we thought the future cash flows weren't as attractive. And so you probably, with both MCT and with Windows, you know, you can see the Windows losses because we report it as a segment.

It's basically the only thing in that segment, so it's pretty reasonable to expect once we get out of the Windows business, and we've exited it, that those losses that have been, you know, occurred, that certainly comes back into the group result. You get rid of those losses, and you're not having that drag on the business. MCT is pretty marginal in the grand scheme of kind of North America. That's more about getting the business focused on a set of development technologies and R&D efforts and commercialization of a product that, you know, it's just about trade-offs and where we're gonna deploy resources, and we didn't feel like based on the returns and the growth that we were seeing in the MCT business, that we were effectively deploying resources.

But I'd say it'd be pretty hard to see kind of the MCT, you know, benefit, if you will, directly in the North America result. It'll be there. It'll just sort of get overwhelmed by the size of that segment, so you won't kind of necessarily see it. On Affordable Color, you know, that's very different I think. You know, that's more about repositioning a product line for where we see future growth, and the Win with Color strategy is about driving color penetration in parts of the U.S. market that we think have the largest market growth opportunities as we drive towards 35/90.

So as we drive towards 35/90, we need Affordable Color as a way to bring value into certain regions, and we think that by segmenting, you know, premium and core colors, it allows us to deliver value to different customers, you know, based on what problems they're trying to solve.

Okay. And also in the first half, part of the reason for the margin decline was that the volumes haven't come through, so cost of running at a volume. So as we're moving to the second half, should the volume growth not come through or the volume growth slow down, how does that play out in your margins and your ability to offset some of these costs coming through?

Yeah, I think, you know, we probably won't give you all the pieces in the second half, that I think some of the questions are kind of driving towards. You know, what we're trying to do, you know, for the year is tell you that we think we're gonna be in the top half of the range. So you can kind of see where we are at the half, and, you know, I think you can start to back into what a second half margin profile looks like if we're gonna stay in the top half of that guidance range, 20%-25%.

Keep in mind, the 20%-25% for us is about balancing internally as well as externally, you know, a message around, we want returns along with growth, and we're trying to always, in both the short and the long term, balance those two things. We could optimize margins in any quarter or year and drive towards a bigger result, but we're trying to balance the long-term objective of driving market penetration, you know, in all of our regions. I, I'd say on volume, you know, I think Lou's given, Louis has given a pretty good profile already, a first half versus second half.

Our comps in the first half were a bit more in our favor, so the comp numbers, I think, that you see in the reported result for the first half are gonna be better than they are in the second half. That's pretty consistent with what we would've said back in May and in August. You know, with respect coming into this year, we saw the first half as being an easier comp than the second half will be.

Okay, and Fermacell transaction integration costs, I'm a little bit confused with what you've booked in the second quarter. So I think first half, total costs were $21 million. But you booked 15 in the first quarter and then another 12 in the second quarter. Has there been some kind of restatement? To me, the math just doesn't quite add up.

Yeah, I mean, in total for the year, we expect about $30 million in total. Okay, it's got three major types of costs in there. Number one's a non-cash cost. It was the inventory fair value as a result of purchase price accounting, about $7 million. That was done in the first quarter. It was reflected in the August result. You can see it in the first half result. The second is ongoing integration costs, real, true integration costs, for one-time costs to largely, you know, drive integration as well as set up a back office, and some of the similar, I'd say, integration-related expenses.

And then the third is the transaction costs, which were all incurred as of the April closing date, you know, so that it's. I'd say very customary type of transaction-related costs. So two of those three are sort of done. Purchase price accounting is, for the most part, we think is done. You got up to a year to kind of make an adjustment. We're not anticipating having to do that. The transaction costs are paid upon the close, and so what you're down to is really integration costs. We think we've got about $10 million of integration costs that are remaining in the third and the fourth quarter.

So kind of what you see in that table in the M&A or in the results on the slide that I went through, in the first half, if you were to add about $10 million, that's kind of where you'll get to for the full year, and that'll take you up to, you know, I think it's $27 million, $28 million, $30 million, something like that, of total year cost related to Fermacell. Does that answer your question?

Gives me enough to go on. Thanks.

Okay.

Lou, maybe one on North American competitive environment. So LP has been working on a smooth product for a long time, now targeting first quarter to go to market with that. And it's part of their. I guess they see it as an enabler for them to go after the R&R market, which is Hardie's bread and butter. So I was wondering if you can give us a comment on, you know, whether you think that's a, you know, a material change to the competitive environment, and give us some feel for what percentage of sales in that R&R segment is a smooth product or similar?

Louis Gries (CEO)

So, you're asking me if smooth product, if they're successful, is a game changer for LP as far as-

Yeah. They comment along the lines of they, they're seeing it as an inhibitor of their growth.

No, I... The short story on why you don't make OSB out of smooth and with smooth surfaces, 'cause it swells, and smooth shows it more than textured. So I'm not exactly sure how they're pursuing smooth. If they feel they have a way to make sure their product doesn't swell as much when it gets wet or if they... You know, I'm not sure how the product ends up trying to perform in a smooth profile. We don't have it factored in as a big change for us competitively.

Smooth product in the U.S. has grown over the years, and it's really been enabled by fiber cement because hardboard OSB, which was the market before fiber cement came along, they went away from smooth because of the swelling issues. So you see it at the joints, and back in, you know, the early nineties, you face-nailed siding, so you saw it at the nail heads, and you saw it at the joints. Now most siding is not face nailed. We introduced blind nailing to the market in the 90s, and they've been able to follow with blind nailing applications as well. So they don't have the swelling around the nailing, nails problem, but they still do have swelling at the joints problem. Now, what is it?

It's less than 20, but it's grown from 2% or 3% when we entered the market to whatever it is now, 17% or 18%. Certain regions like it a lot more, so like the Northeast has a strong preference for smooth, but just generally, most markets have gone toward more of a preference for smooth. And, you know, we're talking about flooring and interiors in the market moving away from us. They would be experiencing the same thing with the market moving towards smooth, so I think they have a compelling reason to try and launch a smooth product. But as far as us, I mean, I think most of the people that buy siding know kind of the difference.

You know, if they're gonna position a good enough smooth to the price-conscious buyer, they'll have some target customers. But anyway, we don't see it as a big change for us competitively. There's just the biggest opportunity for us against wood products remains selling maintenance, and selling maintenance really requires a full wrap exterior from Hardie. So, we've done that regionally in certain areas and not in others. So, I think you know, the basic position in our products versus LP doesn't change if they have smooth or just textured. They are more limited if they don't have smooth, but at basic product positioning, if you value map the products, it's the same. No, it wouldn't change.

Okay, great. Thanks.

Andrew Scott (Head of Industrial Research)

Matt, Andrew Scott, Morgan Stanley. Just, can you just remind me on your... You had a reasonably lengthy downtime for the Fermacell business with one of the facilities. Can you just remind us on the timing on that and the extent that made a noticeable difference in the financials?

Louis Gries (CEO)

It went really well. The guys, guys handled that extremely well. We had set aside as much as 12 weeks to do the job. They did it in 8, and they brought it in, just slightly under budget. So, everything with the Fermacell business is going, at plan or slightly better than plan. And-

Andrew Scott (Head of Industrial Research)

If we look at the numbers, is it a noticeable difference across the numbers there for the Fermacell business overall?

Louis Gries (CEO)

We came in higher than we forecasted for Fermacell because we had forecasted a 12-week down, which has, you know, increased cost of being down for twelve weeks, but also has higher freight rates because you're covering for that plant with higher freight. So being down only eight weeks did help us on EBIT for the quarter.

Andrew Scott (Head of Industrial Research)

Lastly, Lou, you experimented a bit with it through the winter with a bit of distributed inventory and flexing your plant patterns. What's the view on that? Is that, was that a success, and is it something you're gonna do again this year?

Louis Gries (CEO)

Yeah. They'll keep our low-cost lines running, you know, higher utilizations, basically four shifts through the winter. We talked about volume to a great degree, so we don't need as much board as we projected we need in the winter. So we'll have some of our higher cost plants come down to either three shifts or two shifts.

Andrew Scott (Head of Industrial Research)

Great, thanks.

Louis Gries (CEO)

I did, questions on the phone?

Operator (participant)

Lee Power from Deutsche Bank. Please go ahead.

Thanks. Thanks, Lee. Thanks, Matt. Just for clarity, the 3% PDG, is that a full-year target, or is that a end-of-year run rate that you're looking toward?

Louis Gries (CEO)

Yeah, full year target, run rate. You know, originally, we set a three to five full year, fiscal year target. Everyone knows the math on PDG is not like small numbers math, so you don't wanna do less than four quarters, and you really wanna do it nationally rather than any specific region. When your numbers get small, the variance gets too big, and it kind of gets lost. So when I said, three still in play, but we might come up a bit short, I was talking, April 1, look back four quarters.

Okay, got it. Thanks. And then, volumes, just on the margin piece, volumes gonna be the largest driver recovering that, or do you think a big component is gonna be the other levers you can pull when Matt's talked to Lean and a couple other things?

I think Lean's a good, you know. I mean, we've been talking about even though we're by far the highest throughput producer of cement, there's a lot of manufacturing upside, and we've been talking about it for a couple of years, and it's starting to become right in front of us now. And that's a Lean initiative that Jack, you know, ran in Asia Pac, and we get very good results, Rosehill, Carole Park, Philippines. New Zealand's been slow to get on the program, but they're now moving in that direction. And so the mystery's over for the U.S. We don't have to design our game plan. It's a Lean game plan. We've already implemented it in the Asia Pac.

We've got the capabilities in Asia Pac to help the U.S. guys get started. But that's still, you know, it's still like two or three years benefits. I mean, I guess the whole term continuous improvement, as you get the benefits, last a long time, but it's not low-hanging fruit, so you don't get it right out of the chute. You don't go backwards right out of the chute, but you know, you have to build to get your, you know, performance that starts showing up in, in financial results. But yeah, and then it gives me an opportunity to circle back. There were some good optimization questions.

Yeah, we don't hedge 'cause people who provide hedges make money, and we have plenty of cash flow, so we never really thought we should give them our money to just smooth out our earnings. So that's the reason we don't hedge. We believe that commodities go up and down, and we're more than happy to ride up and down with them rather than, you know, pay a third party to, you know, provide the hedge. If a pulp mill, we did explore this a lot over the years. If a pulp mill was willing to sell us at a fixed rate, we would be willing to buy at a fixed rate.

So if there wasn't a third party in the middle trying to, you know, kind of smooth out, smooth it out, we would consider it. But in their industry, basically, they can't sell at a fixed rates because they gotta keep up, they gotta keep up with their competitors, so they're worried what happens when pulp's expensive, they're missing the boat. So we don't hedge. We do do a lot of optimization, but we don't have the same, we don't have the same flexibility as, as most building materials. Most building materials can really start substituting different raw materials. When one gets expensive, they substitute another that's maybe not as expensive. When I ran this recycling mill, that was, you almost did that monthly, depending on what was happening in recycled prices.

Because we're selling durability as our number one attribute to the market, we stay on a set formula. We don't start moving cement, silica, additives, or pulp up and down based on how expensive it is. We're a little bit tied there, but there's still a lot of optimization out there that goes on in Hardie. It's just not with the formulation of the product. Of course, just like I talked, we have different costs at different plants, so we also optimize around sourcing. Now that we're ahead of capacity, you know, more of that's available to us than it has been in the last couple of years.

As far as keeping the EBIT margin kind of where we want it, of course, our EBIT margin is supposed to be a wave, and, you know, it dips down when things get expensive, and it goes up when things get cheaper, meaning the inputs. So we understand we're at the dip-down period, but we also see things in the business, like any business, we can do better. So, the focus will be on doing some things better and propping up that EBIT margin at a relative volume. And, it will be necessary in the winter months, as some of you guys have picked up on....

Our volumes are going to be lower, and we got our ore costs a little bit ahead of volume, so that situation is unlikely to get better in the winter, so we got to get better at a few other things to offset it.

Okay. And then, maybe just to Matt, I think you guided to $350 million in CapEx for the full year. How has that changed? And then my line just broke up a little bit on Tacoma startup comment. Are the startup costs still in line with the expectations?

Matt Marsh (CFO)

Yeah, there's no change on the full year guidance on CapEx. The $350 million that we've talked about previously is still a good number. It's really two big projects, sorry, the three big projects, which is finishing up Tacoma 2, getting going on Prattville and the Brownfield and Carole Park, and that still remains. Then obviously, that we've got kind of ongoing maintenance CapEx. So we're still, I think, tracking towards that $350 million number for the year. Yeah, Tacoma startup costs are right on, right where we thought they'd be.

Okay. Excellent. Thanks.

Operator (participant)

Thank you. Your next question comes from Peter Steyn from Macquarie Group. Please go ahead.

Peter Steyn (Managing Director)

Morning, James. Thanks for your time. Lou, you mentioned a number of times the internal factors for weighing on your sales execution. Could you maybe just give a bit of a sense of the detail there? So what are the things that you would see you could improve on?

Louis Gries (CEO)

Yeah, I mean, we are talking about even though in volume it comes out to be a lot of trucks, it's a small percentage. And, you know, you just really can't dissect it. But, you know, I mean, basically, we run market development against vinyl, and we run an R&R program that basically builds an annuity for you, and then you either defend or grow against close alternatives. So, I would say generally, we're kind of starting to get up to where we want to be in each of the three areas, but we're just not quite there yet. So, I've seen the organization perform better in the past, and I expect it to perform better in the future, and part of that is game plan design, and part of that is game plan execution.

I think there's just marginal improvements in a lot of different areas that is the difference between the PDG we're currently delivering and the PDG we're aiming for. Now, like I said, Jack and his team have been doing some pretty good assessment work, in my view, and I do think there'll be some reallocation of resources. I think we've gotten a little bit behind on, you know, moving the investment where the opportunity is, rather than keeping the investment where the volume is too long. So there's gonna be some game plan design changes, which I think will help, but we also need some game plan execution improvements as well.

But I, again, I want to stress, it's not like we haven't gotten them, but the slope of the line's a little bit less than I would have anticipated.

Peter Steyn (Managing Director)

Perfect. Thanks, Lou. And then maybe just a quick question around costs and the impending application of tariffs. Is there anything to worry about there via either direct or indirect impacts?

Matt Marsh (CFO)

Sorry, Peter, you, you broke up just a little bit. The impending what, what type of costs?

Peter Steyn (Managing Director)

The tariff-related issues going into calendar 2019, Matt, if we get the 25% imposed?

Matt Marsh (CFO)

Uh, yeah-

Peter Steyn (Managing Director)

Are there any product categories that worry you?

Matt Marsh (CFO)

Probably the one that comes to mind is steel, you know, costs. As we're looking to build out plants, you know, it's definitely gonna have an impact and an adverse impact on the steel component of building new factories. You know, outside of that, you know, I don't think it's as big of a driver as kind of the market fluctuations that we're seeing.

Peter Steyn (Managing Director)

Hmm. And there's nothing that worries you in an indirect sense?

Matt Marsh (CFO)

Lots of things worry me indirectly. Nothing else that sort of comes to mind, though, Peter.

Peter Steyn (Managing Director)

Okay. We might cut down that rabbit hole. Thanks.

Louis Gries (CEO)

It does give me an opportunity to comment. So the market for what we're trying to do is good. So I don't want anyone to think that, you know, builders are repositioning how they're setting up their business models. They still wanna build more houses, sell more houses, sell at a higher price. It's just a little bit, like I said, I refer to it as kind of a dead period in the market. So the question is, does that kind of self-correct, or is that a signal that, you know, maybe the market won't be as good next year? But we're not anticipating we won't have a good market to sell in fiscal year 2019.

So whether it's, you know, stuff that goes on at the government level or interest rates or whatever it is, we're anticipating a pretty flat, slightly better housing market next year, and, you know, we should do well in that market.

Operator (participant)

Thank you. Your next question comes from Daniel Kang from Citigroup. Please go ahead.

Daniel Kang (Head of Basic Industrials and Australian Equity Research)

Oh, thanks, guys. Just a question on Europe, if I may. Excluding integration costs, EBIT margins, underlying, looks to have fallen versus the first quarter. Was that primarily due to higher raw material and freight costs? And where do you expect EBIT margins to be in the second half?

Louis Gries (CEO)

... I mean, I would see it more as a quarterly variance.

Matt Marsh (CFO)

Yeah, I was gonna say, there's not a big difference between what we said in the first quarter and the second quarter. If you go back to what we talked about in August, we would've said that, I think it was 11% something that we posted in the first quarter. We would've said that that was on the high side, and that we thought that that was just normal quarterly variance. And now we're at, you know, I think 9%, 7% or something like that this quarter. When we gave initial guidance on kind of what we thought the Fermacell business looked like once it was part of Hardie, you know, we were talking about kind of 10-plus% margin rates. And, you know, I'd say that's kind of right where we're at. We're pretty happy with it.

We think the second half's gonna look a lot like the first half. You're gonna get any quarter to quarter a little bit of variance. The 9%, 7%, you gotta sort of keep in mind that we had a plant down for a little bit, so that's gonna drag it down, you know, a bit. It's not like I would tell you that the 11%, 8% is any more likely in the second half than the 9%, 7% from the second quarter. We think Fermacell is about a 10-plus% type of margin business, and we're working hard to try to drive margins up from there.

Daniel Kang (Head of Basic Industrials and Australian Equity Research)

Great. Thanks, Matt. Just while you've got the floor, are you able to quantify the impact of weather disruptions in the quarter? Also, the impact of the stronger dollar. And just while we're there, I know it may be a little bit early, but are you able to provide some guidance as to the tax rate in FY 2020?

Matt Marsh (CFO)

I'll start with the easy one. No, on FY 2020. I mean, it's just. You know, you can see we're in a pretty different tax landscape, you know, than we've ever been. I think we are, you know, we've got our arms around, but we're still trying to digest the corporate tax reform from last year. Obviously, there's a fair bit of variation, you know, within with what we think is happening within the year, and all that's kind of got an effect on effective tax rate. I will say that the number that we're reporting for this year, we think is a good number, and, you know, should be a decent proxy for kind of a future year.

But I'm definitely not in a spot to talk about FY 2020 from a tax standpoint. I'm sorry, what were the other-

Louis Gries (CEO)

The other one was weather.

Matt Marsh (CFO)

Oh, yeah, I know.

Louis Gries (CEO)

So, we didn't use the word weather, we used external. So, we...

Matt Marsh (CFO)

Yep.

Louis Gries (CEO)

You know, like I said, we're, we're maybe, like, two or three points behind where we thought we'd be on volume growth for the year. We don't think all that's external, but we don't think it's all internal either. So I think the market is definitely softer than we anticipated it would be at this point in the year. So whether that's you know, 2/3 external and 1/3 internal, it's just too fine of a calculation at this point, so we're not gonna speculate. But I would say it's... You know, everyone seems to be a little slower than they thought they'd be at this point, and that's our dealers, you know, our distributors, our builders, our competitors. Everyone seems to be a little bit slower than they thought they'd be.

Daniel Kang (Head of Basic Industrials and Australian Equity Research)

Got it. And, there's one that you missed in terms of the impact of the stronger dollar, Matt?

Matt Marsh (CFO)

Yeah, we tried to outline that, it was in one of my slides. So at the half, you know, on pages 25 and 26, you know, it looks like on an adjusted net operating profit basis for the half, it looks like it had about a 1% adverse effect.

Daniel Kang (Head of Basic Industrials and Australian Equity Research)

Perfect. Thanks, guys.

Operator (participant)

Thank you. There are no further questions from the sides at this time.

Louis Gries (CEO)

All right. Thank you very much. Appreciate it. Thanks.