James Hardie Industries - Q2 2022

Transcript

Operator (participant)

Thank you for standing by, and welcome to the James Hardie Industries JHX Q2 FY 2022 results briefing. All participants are in a listen-only mode. There'll be a presentation, followed by a question-and-answer session. If you wish to ask a question, you will need to press the star key, followed by the number one on your telephone keypad. I would now like to hand the conference over to Dr. Jack Truong, Chief Executive Officer. Please go ahead.

Jack Truong (CEO)

Good morning, and good evening, everyone. Thank you for joining us on our second quarter fiscal year 2022 earnings call. This is now the tenth consecutive quarter of our company delivering on strong financial results, with growth of our market and strong returns, based on the consistent execution of our global strategy. I will begin today's call by providing a brief update on our global strategy, which includes sustainability. Then our CFO, Jason Miele, will cover our financial results for the quarter and also provide an update on our full year guidance. After that, we'll open up for questions. Let's turn now to page five for an update on our strategy. In our Investor Day and in our Q4 results presentations, both in May 2021, we described our three critical strategic initiatives that will enable us to drive consistent, profitable growth globally for our company.

Those three strategic initiatives are, number one, expand the James Hardie brand from a premier professional brand into a market-leading consumer brand that focuses on marketing directly to homeowners to create true demand of our products. Number two, penetrate and drive growth in existing and new markets, such as repair and remodel. And number three, commercialize global innovations that allow us to expand into other exterior looks and to take advantage of adjacent opportunities in each of our three regions. In addition, we will continue to execute and build on a significant foundation we have built over the past three years. This foundation includes continuing our path of becoming a world-class manufacturer via Lean, continuing to partner closely with our customers via our push-pull strategy, and continuing to integrate our supply chain with our customers to serve the market.

Let's now turn to page six to discuss the progress about marketing directly to homeowners. During our Investor Day, we shared details about our 360-degree integrated marketing campaign that reaches homeowners directly to create true demand. We have put the homeowner, Christine, at the center of our attention. As I shared with you then, the four phases of homeowner's path to purchase are awareness, consideration, purchase, and amplification. We continue to build on this marketing capability within James Hardie to ensure that we reach a homeowner with the right messages throughout their path to purchase. We will augment this internal capability with key social influencers and partners across a variety of media to create real demand for Hardie brand products. In May, we discussed and showed you the TV campaign, "It's Possible with James Hardie." It is the foundation of the awareness phase.

Today, the TV commercial has been very successful in raising awareness of Hardie brand with our target homeowners, the Christines. After the homeowners are aware of Hardie brand, it is important that we reach them with the right content at the right time as they consider the option to beautify the exterior of their home. Over the past six months, we have begun to reach Christine through television, social media, print media, and regional influencers to help guide Christine through a path to purchase. On the right-hand side of the page, we're pleased to share with you some of our key performance metrics related to our consumer market thus far. While I'm still very early in our journey, we have seen brand awareness increase. We have driven more homeowners to our website. We have generated significant growth in leads year-on-year.

Specifically, we have increased our aided awareness of our brand by 109%, increased website traffic by 81%, and increased leads in our target markets by 61%. We're very encouraged with the early momentum in the results and continue to invest significantly in this strategic initiative. As you can see on page seven, we have recently partnered with television and media to continue to reach Christine with our message with authenticity. On the left, you can see James Hardie products featured on Fixer Upper, a very popular repair and remodel TV show with over 19 million viewers per episode. It is a remarkable transformation of the exterior of this home with Hardie brand ColorPlus shingles. On the right is another example of James Hardie brand products being featured in home renovation shows.

This show, Secret Celebrity Renovations, aired on the 9th of July 2021, and again, showcased James Hardie's ability to deliver endless design possibilities. Lastly, at the bottom right is an example of print media with a feature ad on the back cover of Magnolia Magazine. This is one of the most followed magazines for devotees of home decorations and living. Working with key influencers in various forms of media extend our reach and help to educate homeowners about the endless design possibilities with trusted protection the James Hardie brand building solutions can deliver. Let's now turn to page eight. The second of three core strategic initiative is to penetrate and drive profitable growth in the repair and remodel segment. A key component of this strategy is driving a high-value product mix.

On this page, you see the clear impact this particular strategy continues to have on driving profitable growth in our North American business. Starting on the left-hand side, what we have here is a plot of current product portfolio in North America across two key criteria, price and value. In North America, we define our high-value products as our Hardie brand exterior products, Hardie brand exterior products with ColorPlus Technology, and all of our Hardie brand innovations, including the recently launched Hardie Texture Panels. The focus of our strategy in driving a high-value product mix is to create awareness and higher demand for our differentiated line of products with homeowners in the remodeling segment, where our value propositions are strong. In turn, it generates increased sales and margins for our customers and for us.

On the right-hand side, you see the clear and significant impact this strategy has had on our recent financial results in North America. Our teams continue to partner with our customers to grow our overall business, while shifting to high-value product mix that homeowners want and need. The blue line on this chart represents % volume growth for each quarter from fiscal year 2020, Q2 through Q2 of fiscal year 2022. The green bars represent the % price mix growth across the same time period. If you focus on Q1 and Q2 of fiscal year 2022, you will observe a real impact that our strategy of driving high-value product mix has had on our financial results.

Not only did we see strong volume growth of 14% in Q2, but more importantly, we also saw a continued and significant step change in price mix growth of 9%, resulting in 23% net sales growth in Q2 in North America. Note that this growth was on top of a strong corresponding quarter in previous year. What this indicates is that by partnering closely with our customers, we have been successful in shifting to a higher-value product mix and driving profitable growth, even in a highly inflationary period as this year. This is evidenced in our raised guidance, which Jason will speak to later. Turning now to page nine. Our strategy is global, and on this page, you see the impact our strategy of driving the high-value product mix is having on our European business.

Starting on the left-hand side, and similar to the prior slide, what you see here is a plot of our current product portfolio in Europe across two key criteria, price and value. In Europe, we define a high-value product as our Fermacell brand flooring products, Hardie brand plank products, including panel, and all of our Hardie brand fiber cement innovations, including this recently launched Hardie brand VL Plank. Note that within Europe, we are driving price mix within our fiber gypsum product portfolio, while also driving the broader price mix strategy. Specifically, what I mean by that is that you can see we have indicated our fiber gypsum flooring products in orange on the chart, which represent higher price and margin for us compared to our fiber gypsum wall products.

On the right-hand side, what you see here is a clear and significant impact this strategy has had on our recent financial results in Europe. Our teams are partnering with our customers to drive a higher-value product mix, and you can see the results are starting to build momentum with a step change in price mix the last two quarters. The blue line on this chart represents volume growth % for each quarter from fiscal year 2020 to Q2 of fiscal year 2022. The green bar represent price mix growth % across the same time period. If you look at Q1 and Q2 of fiscal year 2022 you will observe the real impact our strategy of driving high-value product mix have had on our European financial results.

Not only did we see a strong volume growth of 15% in quarter two, but more importantly, we also saw a continued and significant step change in price mix growth of 8%, which resulted in a 23% net sales growth in Q2 in Europe. Turning now to page 10 for an update on innovation. In May 2021, we announced the launch of three new global innovations. One, the Hardie Texture Panels in North America. Two, the Hardie brand VL Plank in Europe. Three, Hardie brand Fine Texture Cladding in Australia. We continue to have very good traction with market acceptance and penetration of all three product platforms since the launch early this year. We continue to partner with our customers to drive awareness and adoption with the homeowners... Feedback from homeowners and our customers in North America has been overwhelmingly positive.

Hardie brand Texture Panels deliver contemporary design solutions that fit any home style that homeowners want and need. In addition, they offer protection properties such as durability, low maintenance, and non-combustibility. What you see here are four examples of Hardie brand Texture Panels on four different homes in Oregon, Washington, and Florida. What I would like to point out here about these other pictures is how Hardie brand Texture Panels are prominent in a variety of home designs, from contemporary look to coastal to mixed design. Moving on to page 11. In Europe, we are also very pleased with the progress of our Hardie brand VL Plank products. Installers have been consistent in their positive feedback about the time savings the Hardie brand VL Plank offer compared to competitive solutions, with our product saving approximately 20% of total installation time.

On this page, you see example of Hardie brand VL Plank in Germany, France, and Switzerland. What I would like to point out here is how Hardie brand VL Plank helps to provide a mixed design, modern look, which is becoming more popular with homeowners across Western Europe. Turning now to page twelve. Similarly to North America, feedback from homeowners and customers in Australia is very positive. These are four examples of Hardie brand Fine Texture Cladding in the Australian markets, which, as you can see, help to augment the modern design look that is prominent throughout the continent. Hardie brand Fine Texture Cladding offer endless design possibilities for homeowners while delivering on protections that homeowners need: durability, low maintenance, non-combustibility.

On the left, you can see the complete transformation of a very plain standard brick home into a modern, contemporary home, utilizing Hardie brand Fine Texture Cladding as the primary exterior cladding. We remain very excited about these new innovations and how they will allow us to continue to penetrate and grow in large adjacent markets in each of our three operating regions. While we're excited about the early success of these three new innovations, our global innovation program is much bigger than just these three product platforms. Our innovation team is focused on our innovation pipeline to ensure we will have additional new innovations to provide the endless design possibilities with superior durability and protection for homeowners around the world. We anticipate being able to launch additional innovations within the next six months, and regularly thereafter.

Turning now to page 13 for a summary of global results for the second quarter of fiscal year 2022. This is now the 10th consecutive quarter that we deliver consistent financial results, growth of our market, and strong returns. Specifically, in the second quarter, we delivered global net sales of over $903 million, which is 23% growth versus the prior corresponding period. Importantly, this was underpinned by a global price mix of 9% growth. We delivered global adjusted net income of $155 million, which is an increase of 29%. We again delivered strong financial results in all three regions. This quarter also marks four consecutive quarters of all three operating regions delivered exceptional double-digit growth in both net sales and EBIT.

In North America, driven by strong momentum of high-value product mix penetration, we delivered net sales of $635 million, 23% growth. Adjusted EBIT of $182 million, an increase of 23%, and continued strong EBIT margin of 28.7% for the quarter. In Europe, we delivered five straight quarters of strong organic growth and strong returns. Net sales of more than EUR 104 million, a 23% growth. Adjusted EBIT of EUR 14.2 million, and good EBIT margin of 13.6%. In Asia Pacific, with strong performance in all three countries, we achieved net sales of more than AUD 196 million, that's a 15% growth.

Adjusted EBIT of AUD 60.6 million and 12% growth, and a very strong EBIT margin of 30.8%. In the first half of the second quarter of fiscal year 2022, the strong execution of our high-value product mix strategy in all three operating regions has been the key driver in delivering strong financial results, all while maintaining significant investment in marketing to the consumers and innovation against a backdrop of high input cost inflation. Turning now to page 14 to discuss sustainability. Earlier this year, we delivered our first sustainability report. Sustainability and ESG are really an integral part of our strategy. It's not a separate and distinctive initiative, but rather is woven into how we operate our business and our company every day around the world.... For James Hardie, sustainability is a about building sustainable communities.

This commitment is to the smallest of communities, the individual household, the homeowner, the James Hardie community, the local communities in which we live and operate, and the largest of all communities, the global ecosystem that all of us live in. In our sustainability report that we published in July, we highlighted our progress over the past year, but more importantly, set our key goals for the future. I would like to highlight a few key areas. Number one, our products are made locally. This approach to manufacturing creates local communities in which we support in numerous ways. For example, 98% of our employees are hired locally, providing wages and disposable income into the local communities. 83% of raw material sourced within 100 miles of our manufacturing facilities. 63% of products are shipped within 500 miles of our manufacturing facilities.

The products we sell in the United States are made in America. The products we sell in Australia are Australian-made. The products we sell in the Philippines are made in the Philippines, and the fiber gypsum product we sell in Europe are made locally in Germany, Spain, and the Netherlands. This strategy of employing, selling, producing, and shipping locally is not only good from an ESG standpoint, but also critical to our business strategy. Currently, it's helping our business thrive. It does not, however, make us immune to supply chain issues, but having a local community focus does enable flexibility and stability through many disruptions. Another critical component to our ESG focus is Zero Harm. We incorporate safety first into how we operate every day.

Zero Harm is the foundation of our business strategy and for our company, and we continue to make improvements in our recordable incident rates and our days away rates. As I have stated previously, the primary objective of our Zero Harm culture is to ensure the safety and well-being of our employees, customers, and community above all business decision we make. While I'm pleased with the progress in our metrics, Zero Harm is not a destination, but rather is a perpetual journey that we at James Hardie need to remain focused on a daily basis and throughout every facet of our global operations. I'd also like to highlight a few of our commitments for the future.

A 40% reduction in Scope 1 and Scope 2 greenhouse gas intensity by 2030, compared to 2019, and a 50% reduction in landfill intensity by 2030 compared to 2019. At James Hardie, we're proud of our growing momentum in building sustainable communities. I would now like to turn it over to our CFO, Jason Miele, to provide additional details on our financial results.

Jason Miele (CFO)

Thank you, Jack. Good morning, and good evening, everyone. I will start on slide 16 with our global results. This is now the tenth consecutive quarter we have delivered strong financial results with above-market growth and strong returns based on the consistent execution of our global strategy. Also, this is the fifth straight quarter with record global results, including quarterly records for net sales, Adjusted EBIT, and adjusted net income, and this now marks the fourth straight quarter all three regions delivered double-digit net sales growth and double-digit EBIT growth. All three regions are executing on our global strategy simultaneously. First and foremost, the continued strong execution of the foundational initiatives of our strategy: lean manufacturing, push-pull, and operating an integrated supply chain with our customers.

In fiscal year 2022, all three regions have good momentum on executing the newer strategic initiatives, marketing directly to the homeowner, and commercializing global innovations. This strong strategic execution globally has led to global net sales increasing 23% to a record $903.2 million in the second quarter. This excellent top-line result was underpinned by price mix growth of +9%, as our teams in all three regions successfully built momentum in driving a high-value product mix. In addition, we delivered strong volume growth in all three regions, with global volumes increasing 14%. Global Adjusted EBIT increased 26% to $205.7 million, and global adjusted net income increased 29% to $154.9 million. Both represent all-time record highs for a quarter.

To maintain this momentum, we continue to invest significantly in our strategic initiatives: marketing, innovation, and capacity expansion. With significant investment in growth and while operating in the current inflationary environment, we were able to expand our global EBITDA margin by 70 basis points to 27.2%. We will now review each region in more detail, starting with North America on page 17. In North America, the team delivered another outstanding quarter. The team delivered record net sales of $635.3 million, through strong volume growth of +14% and exceptional price mix growth of +9%. The exceptional price mix growth was delivered through continued execution in driving high-value product penetration with our customers.

Through continued execution of our foundational strategies, lean manufacturing, and integration of our supply chain with our customers, we're able to translate the outstanding top-line results into an excellent bottom-line outcome. Adjusted EBIT increased 23% to a record $182.5 million. The North American team continues to deliver consistent double-digit net sales growth at a step change EBIT margin level. Turning now to page 18 to discuss the Europe results. In Europe, the team delivered a fifth straight quarter of strong results and a fourth straight quarter of double-digit net sales growth. In the second quarter, net sales increased 23% to EUR 104.6 million, and Adjusted EBIT increased 51% to EUR 14.2 million. The exceptional net sales growth was delivered through the team's continued execution of a high-value product mix penetration strategy.

Fiber cement net sales increased 40% in the quarter, which contributed to an outstanding 8% growth in price mix. The combination of improved price mix, strong volumes, as well as lean improvements, more than offset the high inflationary environment and resulted in second quarter Europe Adjusted EBIT margins expanding by 250 basis points to 13.6%. Let's move now to page 19 to discuss Asia Pacific. You'll see a similar story in Asia Pacific compared to the other two regions, as all three regions continue to execute the global strategy effectively. The Asia Pacific team delivered outstanding net sales growth of +15% to AUD 196.6 million in the second quarter. The ANZ business delivered continued execution in driving high-value product penetration, resulting in price mix growth of +9% in Australia and New Zealand.

The strong top-line results in the second quarter were translated into robust bottom-line results. Execution on lean manufacturing and a focus on high-value product mix helped to offset the high inflationary environment, leading to Adjusted EBIT growth of 12% to AUD 60.6 million at an Adjusted EBIT margin of 30.8%. Moving now to page 20, we'll discuss operating cash flows and capital expenditures. The strong operational results discussed in the past few slides continue to translate to a step change in operating cash flow. Operating cash flow for the trailing twelve months was up 18% to $727.6 million. We will discuss cash flow further on the next slide. Shifting to the right-hand side of the slide, you see a summary of our capital expenditures.

In the second quarter, capital expenditures totaled $108.1 million. Focusing first on the shorter term, production at our Prattville, Alabama facility continues to ramp up successfully, and our restart of our Summerville, South Carolina facility is on track and still planned to restart in March 2022. Looking further ahead, we're now embarking on a transformational period of capacity expansion. In North America, we will expand our Prattville, Alabama facility to include two more sheet machines. We expect this expansion at Prattville to provide saleable production in late calendar year 2023. In addition, we plan to purchase land in the United States for a greenfield site that will focus on the production of high-value products and innovation. In Europe, we will expand our fiber gypsum capacity in Orejo, Spain, to enable continued strong growth of our fiber gypsum business in Europe.

And we will purchase land and begin construction of a greenfield fiber cement facility to locally produce fiber cement for the European market. And lastly, in Australia, we plan to add greenfield fiber cement capacity in Victoria. Similar to the United States, this greenfield capacity we expect to focus on high-value products and innovation. Adding the right capacity at the right time positions us to continue to drive market share gains and drive organic growth. Now, let's move to page 21 to discuss capital allocation. Our transformation to a new James Hardie has resulted in a step change in operating cash flow. On the left, you can see we have generated more than $2 billion of cash over the past 36 months. These funds have allowed us to invest in future growth through capacity expansion, reduce our debt, contribute significantly to the AICF, and return capital to shareholders.

On the right, you can see that our capital allocation priorities remain unchanged, and today, we're pleased to announce a first-half dividend of $0.40 per share, which equates to approximately $178 million. The first-half dividend will have a record date of November 19th and a payment date of December 17th. Let's move to page 22 to discuss the funding of the Asbestos Injuries Compensation Fund. On the left-hand side of the slide, you can see the growth in our contributions to the AICF, which is directly linked to our step change in operating cash flow we discussed on slide 20. You can see in the five years from fiscal year 2015 to fiscal year 2019, our average annual contribution to the AICF was AUD 119 million.

Now, in fiscal year 2022, that has almost tripled to AUD 328 million. Since inception of the AICF, James Hardie has now contributed over AUD 1.7 billion to the AICF. Moving to the right-hand side of the page, you can see the impact the increase in James Hardie contribution has had on the AICF's cash and investments balance. Over the past few years, the AICF cash and investments has more than tripled from AUD 81 million on March 31st, 2019, to AUD 253 million on October 31st, 2021. We are pleased that our step change in operating cash flow has led to a stronger balance sheet for AICF, specifically a robust cash and investments balance. Now, let's turn to page 23 to discuss guidance.

A significant momentum in high value product mix penetration in all three regions, combined with continued market share gains and Lean execution, gives us confidence in raising the adjusted net income guidance range. We raised our adjusted net income guidance to a range of $580 million-$600 million. The comparable figure for the prior year was $458 million. The revised guidance range represents a 27%-31% year-on-year improvement in adjusted net income. Specific to our North America segment, we continue to provide two points of guidance. First, North America, we expect net sales growth greater than 20% for the full fiscal year 2022. We expect price mix growth of between +8% and +9%.

As we first guided in May, we are investing significantly in our strategic growth initiatives and expect to experience significant inflation in fiscal year 2022. Finally, please turn to page 24 for some financial highlights for the half year. Globally, the James Hardie team continues to execute our strategy at a high level. Our mission is to be a high-performance global company that delivers organic growth above market with strong returns consistently. In the first half of fiscal year 2022, global net sales increased 28% and global Adjusted EBIT increased 34%. This significant growth in net sales and EBIT is primarily driven by the strong execution in driving high value product penetration. Importantly, we continue to invest in growth. This includes significant investment in marketing directly to the homeowner, investment in innovation, and commitment to significant capacity expansion in all three regions.

As we continue to invest in our future growth during a highly inflationary period, it's important to note that the strong execution of our strategy enabled us to expand our global Adjusted EBITDA margin by 80 basis points. We continue to return capital to our shareholders with an announcement today of a $0.40 per share first half dividend. And lastly, we raised our Adjusted Net Income guidance for the current fiscal year to a range of $580 million-$600 million. We have now concluded our prepared remarks. I will hand it over to the operator to commence the Q&A portion of today's meeting.

Operator (participant)

Thank you. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press star then two. If you are using a speakerphone, please pick up the handset to ask your question. The first question comes from Peter Steyn from Macquarie. Please go ahead.

Peter Steyn (Equity Analyst)

Hi, Jack and Jason. Thanks very much for your time this evening, your time. Just wanted to get a little more color on the mix effects, and if you could give us a little bit of a sense of how the new products are faring from a product or from a sales contribution point of view, and how you're tracking against your LTI targets for FY 2022?

Jack Truong (CEO)

Yeah, good morning, Peter. That's a good question. We're tracking well to the LTI targets that you mentioned. But right now, our approach to new innovations is really about market driven, and that is all about making sure that we get our products on the wall and in the homes of the homeowners as the number one priority, and that create the pull-through, as opposed to a typical new products launch, where you just ship a lot more into the channel and then just let it trickle out.

So our approach is more about the pull, about to create the demand with the homeowners and really build more momentum with the demand creation with the homeowners, and then until that get to a critical mass, and that's when you see really the big lift and the continued lift, and then relative to your first part of your question, is that we as we continue to execute our high value product mix, that as time goes on, the effect of price mix will be driven more and more through the increase in higher value products that drive that price mix growth that you saw the difference between Q1 versus Q2 that we just showed.

Peter Steyn (Equity Analyst)

Thanks, Jack. So can I just clarify then in my mind the interpretation there is that there's not a heck of a lot of contribution coming from Hardie Texture Panels and Hardie VL Plank, among others, at this point, but it will accelerate in due course as the channel starts drawing that or the customer starts drawing that more definitively. So what we're seeing at this point is still the very early stages of that, but largely the shift from Cemplank to HardiePlank and the tail end of that playing out?

Jack Truong (CEO)

Yeah, so it's really about the, what you see in the price mix right now is really driven more from our shift from Cemplank to Prime, and also the shift from Cemplank and Prime to Color.

Peter Steyn (Equity Analyst)

Okay, perfect. That makes sense. And then just a question for Jason, just on cash flows, excluding the tax effect of CARES, you mentioned that your operating cash flow is up 2% in the context of EBIT, obviously growing quite substantially faster. Looking at the balance sheet, there's no appreciable movements in working capital that would account for that. So I was just curious what this quarter delivered from a cash perspective, in trying to get a little bit more color on that 2% improvement in op cash.

Jason Miele (CFO)

Yeah, Peter, as we've laid out, when you exclude the CARES Act, it is up 2%. And we've certainly shifted to a step change level on a rolling twelve-month basis. As with any quarter, there's some minor timing differences, but, we're very happy with where we're at from a cash flow perspective. We expect continued improvement going forward.

Peter Steyn (Equity Analyst)

Okay. Perfect. I may leave it there for now. Thanks.

Operator (participant)

Thank you. The next question comes from Simon Thackray, from Jefferies. Please go ahead.

Simon Thackray (Senior Equities Analyst)

Thanks. Good morning, Jack, and good morning, Jason. I've just got a few questions, if I may. Can we just talk about the observation of any sort of capacity constraints, bottlenecks, supply chain constraints in the quarter just gone? I'm sort of particularly curious in light of the sequential growth in European sales, which was only 1.25%, notwithstanding the good margin performance. I just want to understand if growth could have been better, but for some capacity constraint factors, and in contrast to Europe, North America, and APAC results, beg the question whether there are any regions where capacity constraints now exist, where you could have done better or you might be constrained as we track through to the end of the year.

Jack Truong (CEO)

Yeah, good morning, Simon. Just a couple-

Simon Thackray (Senior Equities Analyst)

Thanks, Jack.

Jack Truong (CEO)

One of the things just to highlight the strategy of what we are driving toward right now, Simon, is that the way we look at our, how we serve the market is really a combination of driving more volume of high-value products. So it's not just about selling volume for the sake of selling volume. So that's a very big distinction of strategy going forward, is really about maximizing that value. And then, two, is that we since our business model is really about integrating our supply chain with our customers, so that we can really have the visibility of the demand a lot further out, so that we can produce to ship rather than just produce to store.

So it's really about. So based on those two strategic criteria, that's how we really been driving our business growth based on net sales of the high value products. So we do have the free flowing capacity for Europe, and this is why you see a very good growth for our European business. And as we continue to be more integrated with our customers in Europe, we'll have a much better demand profile that will allow us to plan out a lot better, even to serve the market better.

Simon Thackray (Senior Equities Analyst)

So Jack, just so I understand that, and thank you for the clarification. Is that suggesting that while the net sales growth sequentially, first quarter to second quarter in Europe was pretty modest, 1.25%, that you would expect under the, you know, using those strategic initiatives, that that should accelerate? Is that what you're saying to me?

Jack Truong (CEO)

And so what we should see is that the acceleration of our growth in net sales, as opposed to just for the sake of volume growth. So if you look at our product portfolio in Europe today, and on I think what slide was it? Slide eight or something, that

Simon Thackray (Senior Equities Analyst)

Mm.

Jack Truong (CEO)

You see there's a big difference in the pricing of the Hardie brand panel versus Plank and then versus Backer. So it's really about us creating more value with the homeowners in Europe, as well as in North America and Europe. In Australia and New Zealand and the Philippines, it's really about understanding the needs of the homeowners and really provide the right value product for them, as opposed to just shipping in or selling in units.

Simon Thackray (Senior Equities Analyst)

Okay, no, that makes sense. And if you characterize now, Jack, your percentage of sales coming from R&R versus new housing, would you say that we're continuing to see a shift towards R&R, more R&R?

Jack Truong (CEO)

Absolutely. I think, right now, our R&R as a percent of business around the world is quite similar. More like 70%+, and it's like growing pretty fast.

Simon Thackray (Senior Equities Analyst)

Okay, that's great. And then just in terms of the COGS inflation, Jason, noting it's a change from the May update, but it's static on the first quarter in terms of the COGS inflation guidance. Is this COGS inflation increase because of higher cost assumptions, or is it a function of the better volume expectations for the business since May?

Jason Miele (CFO)

That's a little bit of-

... A little bit of both, Simon, as we talked about last quarter, you know, pulp remains elevated, as does freight. We're watching markets closely, but we're comfortable with the range we've provided of $120 million-$150 million globally, and that would include our volume assumptions as well.

Simon Thackray (Senior Equities Analyst)

That's great, Jason. And then while I've got you, just on the update on page six, just on the in terms of the SG&A spend, which obviously, you know, stepped up as per guidance. Is the marketing and advertising spend now at a steady run rate, or will it increase from here? And as we look forward with the growth that those marketing initiatives are delivering to the business, should we be thinking about this spend for marketing and advertising in dollar terms or in terms of percentage of sales going forward?

Jason Miele (CFO)

Yeah, Simon. So we'll continue to invest in marketing initiatives that drive top-line growth. So, we will expect to be investing more next year than we did this year. But obviously, we're monitoring to ensure we're getting the outcomes we expect, and that's how we'll continue to run it going forward. As we get deeper into that, we'll then, you know, potentially think about doing provide guidance of should we be thinking of that in whole dollars or percentage of sales? But it's all about investing to drive future growth.

Simon Thackray (Senior Equities Analyst)

Excellent, excellent.

Jack Truong (CEO)

Simon, the way to think about this is that as we invest more in the marketing to the homeowners, that's really about for us to really create the demand of our high-value products that really the homeowners need. So in terms of our business mix, what you should expect to see a gross margin expansion, because of-

Simon Thackray (Senior Equities Analyst)

Mm.

Jack Truong (CEO)

The growth of high margin, and as we expand more into growth, more into repair and remodeling segment. So then within, you should expect that the absolute dollar term market investment will go up, but we will be more in terms of correlating to the percentage sales.

Simon Thackray (Senior Equities Analyst)

Yeah, that makes sense, Jack. And then just quickly on the New Zealand greenfield expansion, is that designed to feed New Zealand? Just so I'm—I understand the Victorian greenfield.

Jack Truong (CEO)

Just as you know, Simon, we have a really very big plant in Carole Park, in the Gold Coast, and one-

Simon Thackray (Senior Equities Analyst)

Uh-huh.

Jack Truong (CEO)

in New South Wales, Sydney. And then we see that the Victoria sort of growth opportunity for us, that's an area that we... Therefore, it's important for us to have a really big facility to serve that market for the long term. And then you probably heard from my opening remarks, that's our ESG strategy as well, we strategically build plants around where we operate in such a way that we source more than 80% of our raw material within 100 miles of our plant, to be able to ship our products to at least two-thirds of it to within 500 miles of our plant.

Consistent with that strategy, and this is why we are looking to build a plant in Victoria. Not to mention that-

Simon Thackray (Senior Equities Analyst)

Yeah, clear.

Jack Truong (CEO)

It's a big growth area for us.

Simon Thackray (Senior Equities Analyst)

Okay, no, that, that makes sense. Okay, thank you so much, gentlemen. Appreciate your time.

Jack Truong (CEO)

Thank you.

Operator (participant)

Thank you. The next question comes from Lisa Huynh, from J.P. Morgan. Please go ahead.

Lisa Huynh (Head of Building Materials Research)

Hi, guys. I just had a question on the growth margin as well, in terms of North America Fiber Cement. I guess there was a 4.8 percentage point growth margin drag from input costs, and also the start-up costs from Prattville. Can you just give us an idea of how much was driven by the commissioning at Prattville, and when that will be done exactly? And I also guess, in the context of the capacity you're planning to bring online over the next three years, should we continue to expect that line to be a drag in the future years as well?

Jason Miele (CFO)

Yeah, Lisa, when you think about start-up costs, we're comping a period with not a lot of start-up costs in the prior period, so that's why it's a drag year-on-year. As we continue forward with this transformational capacity expansion, you can expect start-up costs to be consistently part of our P&L going forward. When you're comping period versus period, I wouldn't view it as a drag, the investment into the future growth.

Lisa Huynh (Head of Building Materials Research)

Yeah. And so what was the contribution from that for the quarter? Do you have that number?

Jason Miele (CFO)

Add stream three and four in Prattville as well. So I think earlier in your question was, when will it cease in Prattville? We'll continue to have ramp-up costs as we expand. And then we don't, we give you that gross margin walk. We don't break out start-up costs specifically, but it would be smaller percentage in that table compared to freight and pulp cost increases.

Lisa Huynh (Head of Building Materials Research)

Okay, sure. Thanks, and then just on ColorPlus, more specifically, given the uptake, can you just comment on, you know, what you're seeing, what you've seen over the course of the second quarter, and where you're taking market share from up in the Northeast?

Jack Truong (CEO)

Yeah. So, Lisa, you know, it is a key part of our marketing campaign to the homeowners. It's really about delivering the type of product that, you know, that the Christines want. And what Christine wants are those homes with our exterior product made with ColorPlus. And so our mix of ColorPlus has really been growing, particularly since the beginning of the year, when we started the campaign. And we expect that to continue to have some very healthy growth going forward with our continued investments in consumer market awareness.

Operator (participant)

Thank you. Once again, to ask a question, please press star one on your phone. Given time restraints, we ask that questions be limited to one per person to allow all to enter the queue. The next question comes from Daniel Kang from CLSA. Please go ahead.

Daniel Kang (Research Analyst)

Hi, good morning, Jack. Good morning, Jason. First question on price. Morning. A question on price mix. North America looks to be gaining momentum with 2Q, contributing 9%, up from 7% in the prior two quarters. I realize that your guidance for price mix is only for FY 2022 of 8%-9%. Is there any reason why this momentum should not continue into FY 2023?

Jack Truong (CEO)

You know, Daniel, I mean, we believe and that it will continue as we execute on our strategy, which is really about marketing directly to the homeowners. And then when we market directly to the homeowners, we know after doing a lot of extensive consumer research that we know what exactly the consumers, the homeowners want, and we then market those our what we call high value products that the homeowners need and the one that we have. So, and of course, the exterior products from James Hardie with color is one of the key products that the homeowners really want and need.

So, it is something that as we continue to execute, that we would expect that the color product will continue to grow.

Operator (participant)

Thank you. The next question comes from Lee Power, from UBS. Please go ahead.

Lee Power (Equity Research Analyst)

Hi, Jack. Hi, Jason. Just on looking at the lead for direct consumer, 61%, is there any difference in conversion rates that you find when you're dealing with, like, direct to consumer versus, you know, through a contractor?

Jack Truong (CEO)

Oh, you mean when we create demand directly with the consumer, we then the message is always very consistent and very clear. And that would then generate the sales lead, of which then our customers, our contractor and customer would be able to convert. So it's really about the quality of leads, and then not only that, but also the ability to close that quicker as well. So the ability for us to now to connect directly to the homeowner and tell that story directly on the value of our of the right Hardie brand product is immense.

Lee Power (Equity Research Analyst)

Mm-hmm.

Operator (participant)

Thank you. The next question comes from Keith Chau from MST Marquee. Please go ahead.

Keith Chau (Senior Basic Industrials Analyst)

Oh, good evening, Jack and Jason. So my question is just in relation to the North American business. Could you just give us a sense, and this is in following with the previous question, whether there were any constraints in North America that may have held back sales, you know, through any issues from the hurricane activity? And then, in keeping with that, where the sales growth is tracking in the quarter to date for both exteriors and interiors volumes, please?

Jack Truong (CEO)

Yeah. So, Keith, you know, as we mentioned is that we are driving as we now connect and market directly to the homeowners, that we would market the high value products that the consumers or the homeowners want and need. So it's really for us, it's about maximizing our ability to produce the right products, so that we can maximize our sales growth and EBIT. And so where you would see more of it, it's about a lot more growth in the high value products. And for us, it's kind of irrespective, is that in exterior or interior, it's really about where can we create more of that value?

Operator (participant)

Thank you. The next question comes from Sam Seow, from Citi. Please go ahead.

Sam Seow (VP and Equity Research Analyst)

Oh, hi, Jack. Hi, Jason. I think if we think back, reinvesting, I guess, Lean savings into supply chain was a bit more of a concept, and you're still kind of proving it up. And at the time, logically, you were only working with a few of the main distributors. Rolling forward to today, could you maybe give us a feel of how many of your existing distributors you'd say you're fully integrated or where you'd like to be with, versus how many, I guess, are still yet to be partnered with? And I guess I'm just trying to understand the pathway left to run on what's been a really successful initiative.

Jack Truong (CEO)

This is about the integration. Yeah. It is a journey, and what I can say is that today we are miles ahead of where we were two years ago, and this is why it allow us to really produce and serve the markets better than most, because our integration, our supply chain with our customers, and certainly integration, our supply chain, our suppliers, too. But it is about, you know, it's a journey, and we still have more that would like to come on board. It is, but we will continue to improve, but it is a path, it is a strategic path that we will continue.

Operator (participant)

Thank you. The next question comes from Paul Quinn, from RBC. Please go ahead.

Paul Quinn (Analyst)

Yes, thanks, guys. Good evening. Just a question on global pulp markets. We're seeing them really roll over and just wondering how much volume you use in a year, and how are those contracts, are they on spot pricing, or are they on contracted volumes over a three or six-month period?

Jason Miele (CFO)

Yeah, thanks, Paul. Pulp would be one of our, you know, top four costs in our business. So it's significant when pulp moves to. However, as we talked about, you know, the execution of our strategy has enabled us to expand margins through this high inflationary period. We have a variety of types of contracts, some spot, and some that operate on a set periodic basis, whether that's a quarter or six months. So it's a variety.

Operator (participant)

Thank you. The next question comes from Peter Wilson, from Credit Suisse. Please go ahead.

Peter Wilson (Equity Research Analyst)

Right. Thank you. Just another one on North America volume in the context of your capacity expansion announced. So Jack, I take your point that it, it's not all about volume, it's about high value volume. But we put that just one side and just focus on volume. Should we consider the 2Q volume of 791 million sq ft, should we consider that to be the limit on your volume until this new capacity comes online, or is there more that you can eke out of the network?

Jack Truong (CEO)

No, it is, we've actually, it should be more for three reasons. One, that, you know, Lean execution will continue to open up more capacity of our existing asset. And two, is that as we continue to integrate more with our customers, that allow us to have a much more of a lead time view on terms of demand on our products, so that we can run our a network of plant more effectively and flow product from production to the market better, then that will be more. And then three, is that we're also in the right in the middle of scaling up our Prattville line one and line two.

And then we are gonna be open up the reopening our Summerville plant, which will be slated to be opened in the March of next year, calendar year, in about four more months. So those are some of the key factors that would allow us to continue to drive not only growth in volume, but also mix, and of course, that would give us the revenue.

Operator (participant)

Thank you. The next question comes from Andrew Scott, from Morgan Stanley. Please go ahead.

Andrew Scott (Head of Industrials Research)

Hi, Jack. Just a question, if I can, on price. We're at that point now where list price announcements will have gone out for 1 January. Can you just let us know what you're expecting there? And then around that, you have throughout this year stuck to that value pricing methodology, whereas vinyl and also LP have maybe priced a bit more like a commodity. Can you just tell us if you think that's made a meaningful difference to the on-the-wall cost comparison?

Jack Truong (CEO)

Yeah, answer the first one, Andrew.

Jason Miele (CFO)

Yeah, Andrew, so, your first question about January 1st price increases, we'd expect price increases to be about 5%, or they are about 5% for North America.

Jack Truong (CEO)

Yeah, so, Andrew, I think the key thing here that is that we are now. I mean, this is a true push-pull, that we are marketing directly to the homeowners. So it is about, you know, our Hardie brand products, that Hardie brand exterior with colors. It really give endless possibilities that allow the homeowners to remodel their home that looks fantastic with different designs, but yet it can protect their home from all the elements. So that is the value. And that's what the homeowners make their decisions on, mostly, is that really about that, the intangible effects.

So and then, of course, the on-the-wall cost is important, but it's not as important as in terms of having the homeowners making the decisions that she want to remodel her home, to have the to really give her that pride and joy, particularly with post-COVID environments, where home is a castle. So it is, that is where we focus on, and it's not so much as important in terms of what the price between this board versus the other board.

Operator (participant)

Thank you. That does conclude the question and answer session. I'll hand the conference back to Dr. Truong.

Jack Truong (CEO)

Well, before we end the call, I would just like to take the opportunity to extend my gratitude and thanks to all James Hardie colleagues around the world. Our exceptional financial results in the second quarter of fiscal year 2022 are a direct result of the continued execution of everyone within our company of the global strategy, and we do it together as a global company. These outstanding second quarter results are another indication that we are truly a new James Hardie. It's a company that continues to leverage on our global reach, global capabilities, and global scale, to execute together and deliver strong financial results consistently across all three regions. I'm excited for the remainder of fiscal year 2022 and beyond, as we continue this next phase of profit growth. Thank you.