James Hardie Industries - Q3 2018

Transcript

Operator (participant)

Thank you for standing by, and welcome to the James Hardie Q3 Results Briefing. All participants are in a listen-only mode. There will 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 Mr. Louis Gries, Chief Executive Officer. Please go ahead.

Louis Gries (CEO)

Thank you. Hi, everybody. Thanks for joining the call. I'm in Europe with Matt Marsh. We'll walk through the results in our normal way. If you go to slide five, you see the agenda. We actually have added an item, Fermacell update, but you'll soon find there's not much of an update 'cause we haven't closed, so we can't talk about it. But then we'll go to the operating review. I'll hand it over to Matt for the financial review, and then we'll come back to questions and answers, so going to slide seven, we've got our Fermacell slide, which is something we covered in November after we entered and made a purchase agreement.

We did put the bridge loan facility in place in December, and everything is tracking on plan, and we expect to close the acquisition late fourth quarter. Slide number nine, we'll get started on the just business overview. It's gonna be an easy result to talk to because everything in the businesses did go pretty much as expected and pretty much how we've been indicating we thought we'd perform through fiscal year 2018. The EBIT margin in the quarter was higher than I think most people expected, including us, and that's just a reflection of most things in the business in the last quarter kind of went to the positive variance side. That's the operations. The pricing was good.

The volume was good, and I'll comment on that in North America. Asia Pac continued to perform very well. So you put it all together, we got a little bit more EBIT margin line than we were expecting. But it is consistent with the story we started the year with, and that's, it was kind of gonna be a backwards year, meaning we're gonna get better as we went through the year, which is unusual as to the seasonal impact in the US. But that's how it has played out. And we kind of expect to continue with the current momentum. You can see the cash flows down a bit. We talked to you...

In the U.S., we went to a new program for the winter distribution of inventory close to the market. So that program's been running well and seems to be working for us the way we wanted it to work. But it does result in a higher inventory this quarter being pulled down in the first quarter of next year. North America, specifically, you can see price is pretty much what we've been doing throughout the year. A good price comp of 5%. Sales volume, the comp is 2%, which is better than the second quarter, obviously. We got there by getting to market rate on exteriors a quarter quicker than we thought we were going to. So our guidance had been, we'd be 2% or 3% up on last year.

This quarter, things played out the way we thought they would. We actually came in more at the average market index rate of about 5% on the exteriors. Pulling it down to 2% was negative interiors comps. The negative interiors comps, not necessarily half and half, but it was driven by the product line exits we did early last year or early this year, late last year. Then we just lost our traction in some regions in retail. We lost traction in some regions, and we need to regain that. So that's how we got there on volume. Obviously, the EBIT came in strong.

Like I said, everything kind of just just went just a little bit better than expected, and that added up to EBIT margin coming in very high for the third quarter. Third quarter is normally our lowest EBIT margin quarter. Go to page 11, unit costs. We give you that graph now because obviously we got off track with our unit costs. And you can see we've kind of gotten ourselves back on track. The low you know indications for Q1 and Q2 of 2017, I think we have communicated that we didn't think those were sustainable. We didn't think. We thought they were lower than they should be. We weren't spending at the plants at the you know ideal level. We were underspending in our plants.

So we kind of took care of that, and, that's what pulled, that's a big part of what pulled the unit cost up, and we pull now come back down, drifted back down. We're comfortable with, spending levels in the plant. We've, done a lot of the catch-up work we thought we had to do. You can see our Q3 2018's about the same as Q3 2017. That's despite the fact that, input costs are up and, freight costs are up. So we've offset it, pretty much offset that with, improved performance over, same quarter last year. Go to slide twelve.

You know, I commented it was gonna be a backwards year, and it is turning into a backwards year, meaning you know, either Q1, Q2 is normally your best EBIT margin month, and then you take a dip in three and then four, and you usually have a bit of a bounce back. So we came in very weak in the first quarter, starting to get some of our financial traction back or bottom line back in the second quarter. And like I said, it came in a little bit higher in the third quarter, although we were expecting it to improve in the third quarter, not to the degree that it did. Slide 13. I commented earlier, our price has been solid all year. Not much going on there.

We took an increase this time last year. It was an effective increase. We have a mix advantage going for us this year, partly due to the product line exits I referred to earlier. But also, you know, when Interiors is tracking behind Exteriors, Interiors is a lower price product line. So that gives you a little mix advantage when it comes to price. And then our tactical pricing has been well managed. We've gotten better with our tactical pricing efficiency over the last two or three years, and that's been showing up pretty good for us. Top line growth, obviously, you guys know that's a story. We've talked about getting our traction back in the market.

We got top line growth from price and a little bit of volume this quarter. We expect that to improve as we move into next year. We're not really changing. You know, when you get to your Q&A, you're gonna find we're not really changing our story of how we think this plays out. We think the quarter was pretty much as expected, so it doesn't lead us to a more bullish view at this point. You know, I think our PDG; we talked about three to maybe five next year. We still feel the same way about that. We feel our EBIT margin will be good. We have the capacity lined up to service the market. We have our programs to drive PDG fully funded.

So everything's kind of as we've been talking right through the year, and this is just this quarter is, to me, more of a confirmation that we're on the track that we thought we were on, rather than something that would, you know, a quarter that would lead us to change our expectations. Slide 14. International Fiber Cement. It's just had a really solid year, continues to perform well month to month, quarter to quarter. Go to slide 15, you'll see the only real negative is our New Zealand plant hasn't performed as well as it should, and we've had a little bit of a EBIT drop there. But other than that, you know, Asia Pac's been a really strong performer for us, and we expect that to continue.

You see down in Europe, in the Europe comments, it says lower volume in certain regions, and then it says, a little better EBIT result due to lower SG&A. Basically, we're more selective on our market participation than we were over the last couple of years. We've kind of got out of some product markets that we didn't think had much, you know, much value for us. Obviously, with the purchase of Fermacell, we're gonna reset our whole approach to fiber cement in Europe. So it's not really... I wouldn't want it to be read as any kind of pullback.

It's just kind of a fixing up of the base business in Europe, which is still pretty small, until we get into a relaunch and a more high growth organic strategy, post-Fermacell acquisition, after it closes. Okay, I'll hand it over to Matt Marsh.

Matt Marsh (CFO)

Thanks, Louis. Good morning to everybody joining us from Australia, and good evening and afternoon to everybody else in the world. On slide 17, we'll go through the, we'll start with the financial review. For the third quarter, we had sales of $495 million, up 9%. As Louis indicated, it was a combination of net sales price and volume in North America, as well as a strong volume quarter internationally. Gross profits increased 18%. Gross margin rates up 270 basis points, as the plants continue to come in line with our performance expectations.

And you get an improvement year over year, due to the comparable a year ago, where we were just coming into some of the troubles in North America on the capacity constraint. SG&A expenses were up modestly, at about 4%. We do continue to fund our growth programs, and at the same time, manage our discretionary costs. And then adjusted net operating profit for the quarter of 79.9 million, up 33%. Again, on the backs of a good quarter in North America and International. On page 18, for the nine months, net sales were up 7% to $1.5 billion.

On largely priced in North America, the momentum is building on volume in the third quarter, from a volume standpoint in North America, certainly helping. And then, again, just another good quarter out of international on both volume and revenue. Gross profits for the nine months are up 5%. Gross margins down seventy basis points. You know, I think what's important on gross profits is that the third quarter is an improvement on the first half, and we're continuing to, you know, make good progress throughout the year, as Louis talked about in the delivered unit cost chart, as manufacturing continues to get back on track.

SG&A expenses for the nine months, pretty consistent with the third quarter up 5%, and adjusted net operating profit of $203.7, up 6%, with North America EBIT up 4%, and international EBIT up 15%. On page 19, you can see the dollar weakening a bit is having a small impact on an adjusted net income basis of about 1%. Not all that material to the overall result, but certainly a bit of a reversal of the trend that we saw in the first half of the year. On slide 20, input costs, you know, for North America continue to be an inflationary pressure for the business.

They've been that way for the year, and you know, what we saw in the third quarter is no different. Kind of what we're expecting to close the year out and going into next year is that input costs will remain kind of a headwind for the business. You see freight costs. The freight market is very tight, and you can see freight market prices are up almost 21%. Pulp continues to increase, up nearly 20%, electricity up 9%, and cement up 5%. So, particularly pulp and freight, and electricity are all trending higher than we would have thought at the beginning of the year, freight and pulp to a more significant degree.

You see gas prices are down five, but most of our raw materials are up, and you know, despite that, the plants have been able to get delivered unit costs back, you know, trending down, but nonetheless, it's creating a headwind to margin rates. On page 21, third quarter, nine-month business performance, so the North America segment, you see, for the quarter, EBIT was up 34%. For the nine months, it was up four, and as we've discussed, it's primarily volumes are coming at the same time that the manufacturing issues that we had talked about last year and coming into the early parts of this year are continuing to... improvements are continuing to be made on them.

For the nine months, it's a very similar dynamic with just, you know, momentum building, obviously, in the quarter and the nine months being dragged down from the first half performance. Internationally, you know, very good nine-month performance. You can see, for the nine-month, EBIT's up 15%. Similarly, in the third quarter, they've just had a very good string of results here. So they're doing a good job on volume and market penetration, as well as running manufacturing is on a good performance trend as well. And the markets are, you know, favorable conditions overall, in our Asia Pacific markets.

On page 22, our other business, you know, is trending right where we kind of thought it would throughout this year. We're continuing to make some product and manufacturing investments in the Windows business. We like the performance that the team's given us in Windows. Obviously, it's still at an EBIT loss, but, you know, we still like what we see out of the business, and it's tracked in the third quarter, more or less where we thought it was gonna be. No real change in R&D in either the quarter or the nine months. Still continues to be on strategy in our 2-3% band as a % of sales.

You can see general corporate costs are up on a headline basis, what looks to be a substantial amount. Most of that is just stock compensation. Obviously, with the appreciation of their share prices in the quarter, it drove an increase. If you take stock compensation out and just look at the underlying general corporate costs, they are up a bit. We're continuing to spend in discretionary funds around training and organization, and continue to invest, you know, in the business. But nothing, you know, out of the ordinary in the general corporate costs. On a couple pages on income tax, our estimated adjusted effective tax rate for the year is at 23.1%.

So, you know, still in that range that we had been talking about the last two results. The remainder of the comments on the page are pretty similar to prior periods. The year-to-date adjustment in the quarter decreased, driven by the reduction of the U.S. tax rate, so that's obviously a new dynamic. I'll talk a little bit more about the tax law on the next slide. But income taxes are, you know, continuing to be paid in Ireland, the U.S., Canada, New Zealand, the Philippines, and they're not payable or paid in either Europe or Australia due to the losses. I think everyone's familiar that our tax losses in Australia are primarily the result of the deduction relating to the Asbestos Fund.

On page twenty-four, obviously, the U.S. Tax Cuts and Jobs Act was enacted in late December. A pretty significant regulatory reform and law reform from a tax standpoint. It has a kind of a variety of effects for the quarter. It didn't have a net effect, you know, that was that significant. We had a $32.5 million provisional charge as a result of deemed repatriated earnings, which is a new aspect of the tax law that was almost entirely offset by about $30 million as we revalued our deferred tax liability. And so as those rates came down, obviously, the liability comes down.

The impact of U.S. tax reform, which I'm sure we'll get to in some of our questions, for us, is a bit, you know, has some uncertainty around it. Obviously, the corporate rate dropping from 35% to 21% is a positive. And you know, so the revaluation of the deferred tax liability is also a positive. But there are some things like the deemed repatriation as well as probably more significantly the base erosion and anti-abuse tax, which is in concept the same thing as an alternative minimum tax on corporations. Those two things are obviously negative. And so the net impact for us, we think, is about neutral and probably more uncertain than, you know, than anything else.

And as we get into fiscal 2019 and we start talking about next year and how guidance will play out, we'll provide more comments in May and in August. The law was passed relatively late in December, and so a lot of the interpretation and a lot of the guidance on it is still coming out. And so, that's really the nature of the commentary that we've got in the presentation and in the disclosures this time that is creating some of the uncertainty. From a cash standpoint, we generated $239 million for the nine months, down about 10%. For the most part, it's on just building inventory levels.

We had mentioned early in the year that we were gonna do that as a way to both take advantage of an efficient way to get product in the market and go into fiscal 2019 with certainty of supply. We're executing to that plan. We like the way the distributor inventory program is working. Obviously, that resulted in a higher level of inventory that we'd expect would come down starting in the fourth quarter and then throughout fiscal 2019. There was also an increase in the payment to AICF. I'd say the other working capital adjustments that you'll probably note in the financial statements, there's nothing unusual in them.

You know, it just happened to be a quarter where we had some foreign exchange on dividend payments and just some normal ordinary course of business items that seemed to be more of an outflow than inflow for the quarter, but certainly nothing unusual. The key feature on the cash for the quarter is definitely inventory. I'll talk more about CapEx on the next page. You can see on cash flow on page 25 that there is a higher level of investment activity around capacity expansion, and we'll talk more on the financing activity in the quarter when we get to the capital allocation pages. On page 26, year-to-date, CapEx spend of about $149 million, increased $90 million. In North America, we've got the three capacity projects.

We're continuing to start up our Somerville facility. We like where we are with that startup. We are continuing to construct the Greenfield expansion project in Tacoma. For those of you that joined us in September at the U.S. tour, you saw that construction project was just getting off and running, and we're right about on track for that project. And we should start running machines in the first quarter in that facility, first quarter of fiscal 2019. And then our third capacity project is in Prattville, Alabama. We're continuing to do work on civil and completing the construction and engineering plans for that facility. We expect to commission that facility in the first half of our fiscal 2020.

Additionally, in the Philippines, you know, we're wrapping up the expansion of our Philippines facility, and that's expected to be completed during the fourth quarter of the current fiscal year. Then additionally, today, we're announcing a $22 million brownfield expansion at our Carole Park facility in Australia, with an expected commissioning date in early fiscal 2021. On page 27, no change to how we're thinking about the financial management framework in the company. It continues and it remains to start with strong margins and operating cash flows and ensuring that we're being transparent. We've got good governance over the way that we're using cash.

We continue to, you know, internally, think of our financial management framework and an investment grade as an investment-grade credit. You'll see the ratings are unchanged down below. During the quarter, we received affirmed ratings from all three of the agencies, as we went to market with the bond. The capital allocation really hasn't changed in any significant way. You know, the top priority continues to remain R&D and capacity expansion to support organic growth, followed by maintaining the ordinary dividend within our defined payout ratio.

You can see, just given some of the activity between the purchase of Fermacell that we're anticipating to close, as well as the capacity you know, expansion, you can see the flexibility priorities, as you might imagine, are a lot more focused now around ensuring that we've got adequate liquidity, you know, for any changes in the external market or any other kind of volatility. From a liquidity standpoint, I'll talk more about it on the next couple of pages. We'll remain above our one to two times adjusted EBITDA target for some period of time, probably for about six to eight quarters, as we close Fermacell, and we get that operating. That combined with...

The elevated level of CapEx in the business as it's temporarily above the range, we certainly intend to bring it back down. If we go to page 28, the liquidity profile, the balance sheet remains in very good condition. We've ended the quarter about $231 million of cash. We had a successful bond offering in the fourth quarter, where we refinanced an existing bond as well as, you know, took out an additional amount on the bond and took advantage of good market rates and strong execution.

We were able to refinance from the 6% bond that we had prior to this offering down to, as you can see here, $400 million tranche at 4.75% and a $400 million tranche at 5%. We continue to have the $500 million unsecured revolving credit facility. That was extended out to a December 2022 maturity in the quarter. And then we closed on the bridge financing for Fermacell, and we've got that in place as well.

The favorable market conditions and the good execution on the bond, we were able to upsize that offering up to the $800 that you see noted and secure those good rates for Fermacell's for the purchase of Fermacell. We're still planning on refinancing the bridge at some point over the next 12 months and most likely in a euro bond call it in the first half of fiscal 2019. On page 29, as a result of the redemption of the former 2023 unsecured notes, we had a make-whole premium that redemption premium on $19.5. This chart just simply lays out why, economically, that ends up being a good event.

So you can see, you know, on an undiscounted basis, in about four and a half years, you get to on a cumulative basis where it's a good economic decision. In addition to that, you pick up two years of tenor. And so, while it creates a little bit of, you know, short-term volatility, it's certainly from an economic standpoint and from a credit management perspective, seemed like a wise decision. On slide 30, on guidance, we've taken our guidance range up to $260-$275.

As Louis said, you know, a lot of the story this quarter is that it more or less has played out the way that we expected it to play out, with a couple things in the third quarter, you know, kind of all going in the same direction in the quarter. So we think we're gonna end up. Obviously, at the beginning of the year, we gave a much wider range of, like, $240-$280. This has us in the upper end of that range as, you know, which is just a reflection of volume starting to come along, as well as manufacturing, you know, pacing where we thought it would be at this stage of the game.

And so, the $2.60-$2.75 is the updated guidance. So with that, we'll open it up to questions.

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 two. If you are on a speakerphone, please pick up the handset to ask your question. The first question comes from Lee Power from Deutsche Bank. Please go ahead.

Lee Power (Analyst)

Thanks. Louis, you mentioned Q1, Q2 2017, you underspent, so the delivered unit cost was lower than they should have been. I mean, your unit costs are obviously coming back down at a steady rate. Do you think you're at the point where you kind of expect them to be, or should we expect a little bit more in Q4? And then second question, do you think you've seen any meaningful uplift from in demand from last year's hurricanes, or is that more of a Q4 story? Thanks.

Louis Gries (CEO)

Yeah, yeah, the question on spending and manufacturing, that chart only had, you know, Q1 and Q2 of 2017. Unfortunately, the underspending started a bit before that and started to really impact the performance in the operation, so we did have a lot of catch-up to do, so I don't think we get back to those levels. I'm pretty comfortable that our spending is right now in the plants. I do think there's future gains on performance, so that'll maybe give us some benefits going forward. We have higher input costs hitting us, we think, again, next year.

So it's unclear to me kind of how it all balances out, because on performance gains, you know, they're hard to predict exactly when you kind of get where you want to be on those. So the way I'm looking at the business is our delivered unit cost is at an acceptable level. We still have programs we're going for more, but from a forecasting perspective, I'd say we're comfortable where we are at right now. As far as the hurricane, we would've picked up a little bit of business during the hurricane for the retail stores, mainly G2, with people boarding up windows and that. Not enough to really see it in our results. As far as any rebuild down in Houston, yeah, it's very early days.

I'm not sure it would come in the fourth quarter, and I'm not sure it's big enough to, you know, really move the PDG number around very much. I think just market traction across the board is what's moving us back into what we think is very quickly gonna be, positive PDG.

Lee Power (Analyst)

Thanks.

Operator (participant)

Thank you. Your next question comes from Simon Thackray from Citigroup. Please go ahead.

Simon Thackray (Analyst)

Thanks very much. Morning, Lou, morning, Matt. A couple of quick questions, if I may. Could we just talk about your expectation or your satisfaction in that quarter, Lou, with volume in terms of customers are on allocation, share that you'd lost? How are you feeling against those targets specifically, and will we see increasing traction in the current quarter? Would be my first question.

Louis Gries (CEO)

Yeah, I'd say the quarter came in a little better. You know, when we had our Q&As in November, you know, I kind of indicated I thought maybe we'd be up three on previous year, which would still leave us a couple points behind market index. We actually ended up, you know, five, right at market index, so on exterior products. So, you know, fourth quarter is gonna be hard to read. We had a price increase last year. We had a price increase we announced just recently. So theoretically, they should balance each other out.

But when you have a price increase, and you allow some forward buying, we're allowing the same amount of forward buying, so it should all match up pretty well, but you're still less certain how much of that, you know, board goes in the inventory versus out to the market very quickly. But my guess would be we're either gonna be flat to the index or up a little bit on the index. I don't expect to be behind the index in the fourth quarter.

Simon Thackray (Analyst)

Okay, so the price rise is in the market, and I know that the pricing is different in different markets, different products. But, you know, assuming a fairly constant mix, are we talking about a similar level to what we've realized this year, and that's sort of 3.5%-4% range? Is that what we should be thinking about?

Louis Gries (CEO)

No, I think, we're thinking three. Again, this year, we got a little bit over three, and then we've got the mix, giving us another one or so, and then we got tactical pricing giving us another half point or so.

Simon Thackray (Analyst)

Got it.

Louis Gries (CEO)

So we don't know how all the mixes work out next year. But as far as just the market increase, if, like, the balance of regional mix or product mix is relatively similar-

Simon Thackray (Analyst)

Mm.

Louis Gries (CEO)

I think three is the right number for us this year.

Simon Thackray (Analyst)

Okay, that's perfect. So I guess with all of that in mind, with momentum in volume, with the improvement in production and startup costs, with the price rise potentially bringing some volume forward into Q4 like it historically has done, can you explain to me simplistically how it is you will have a flat, the sequential impact on the fourth quarter to get to the top end of the guidance you provided?

Louis Gries (CEO)

I can't explain it in detail, like you say. I agree with you that kind of all the indicators are pointing in the right direction. That has not really changed in January. We had a pretty nice January.

Simon Thackray (Analyst)

Okay.

Louis Gries (CEO)

...

Simon Thackray (Analyst)

Nothing's changed dramatically.

Louis Gries (CEO)

No, nothing's changed dramatically, and I just go back to the fourth quarter is the hardest quarter to predict, when you have a price increase. 'Cause a lot of your customers will stop buying if they don't need the board, once they're done with their allocation. Now, on some years, you get them right buying right through the allocation 'cause the, you know, the market demand is there, and we won't know that till, you know, well into March. So we just don't know for sure where our volume ends up. I think that's the only answer to your question.

Simon Thackray (Analyst)

No, that's absolutely fair enough. And I guess the other part would be, Matt, to your point about rising pulp, rising freight, rising cement, you know, there was a gross margin improvement, you know, versus the PCP in this quarter. Obviously, it was an easier comp, if you like to think about it that way, given the problems in 3Q17. But is there any expectation that these price rises... Sorry, the cost increases are gonna be margin detractors in the fourth quarter or indeed going into FY19? You made the comment, Lou, you think it's an FY19 event, the inflation in cost?

Louis Gries (CEO)

I think it's a continuation of what we've seen this year. We're in the ballpark of, like, $20 million input costs that we had out-offset this year.

Simon Thackray (Analyst)

Got it.

Louis Gries (CEO)

So if it were, if you were to divide it by four, you'd say, "Well, we're gonna offset five more, you know, in the fourth quarter." But, you know, we like to top it a range, you know, but obviously, you know, it's, you know, I mean, nothing's guaranteed that, you know, comes in right where we think it will. But, you know, and again, I think it's more volume driven than manufacturing driven. The other thing you gotta remember is, we do take time off during the holidays, and that more expensive board in December, because of the hours we took off, will show up in our, in our Q4 results. Again, I don't think it's a big deal.

I think we're kind of tracking like we said we would. We're getting better as we go through the year. So I just think fourth quarter is gonna be a good quarter, but I don't want everyone to start, you know, thinking that if things point up, that we're ready to spike. You know, that's-

Simon Thackray (Analyst)

No, I get it. I understand that. And just with the price rises, Lou, in terms of competitive behavior, you know, LP and Elementia and others have the market feels solid in terms of the external signals and the company results are doing good. Is everybody sort of following in the market? Because they're obviously experiencing similar inflation, so the industry is experiencing inflation. Are price rises, you know, that you are noting from competitors, similar or better or more or less?

Louis Gries (CEO)

Yeah, I think, you know, the problem in our industry, Hardie is a pricer that when we announce an increase, we don't come off it, because we don't go for a lot and then see what we can back down to where we're happy with it. When we announce three, you know, we get three. The rest of the industry or a lot of the other players in the industry are out there with higher numbers, but again, with those businesses typically come off some of their headline numbers. So, we may be a little bit on the low side with our three, but I'd say we're kind of in a range that most of the industry will go for. You know, you probably see the same things as us.

Simon Thackray (Analyst)

Yes.

Louis Gries (CEO)

We stuff on from Allura, LP, and USG, so.

Simon Thackray (Analyst)

Okay. And then just finally, the Carole Park 28.5, which is new, the brownfield expansion. Just a little bit of detail on that for us, what, what's happening there? What's the detail on that one?

Louis Gries (CEO)

Yeah, when we did the Carole Park kind of rebuild, we had a phase one, phase two, so we always had this in our planning, but we didn't need both, you know, floods of demand right out of the chute.

Simon Thackray (Analyst)

Mm.

Louis Gries (CEO)

Carole Park's actually one of our really good stories this year. Their ramp up of that new line in Carole Park has been very good this year, so they're right up to where they're almost right at design utilization and then new line, but at the same time, they've been doing well enough in the market that they're still getting tight on capacity, so we're doing a little bit more capacity than we had in the original planning, but it's very cost effective investment, so it's gonna have very high returns attached to it.

Simon Thackray (Analyst)

That's perfect. Well, just in terms of capacity increase percentage wise or square feet wise, just for us to get our head around?

Louis Gries (CEO)

You have me going by memory here. Four million, yeah, four million standard meters.

Simon Thackray (Analyst)

Right. Well, thanks so much, Bill. Appreciate it.

Louis Gries (CEO)

Yeah.

Operator (participant)

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

Peter Steen (Senior Analyst)

Hi, Lou and Matt. Excuse me. Thanks very much for your time. Just wanted to explore the movements in gross margins in the North American segment, for a moment. In the, in the context of 400 basis points improvement, higher net sales contributing 310 of that, you know, lower production costs at 0.4, I would've thought that, you know, we would probably see a little bit more in, in lower production costs and, and perhaps less in, in net sales, particularly in the context with you know, unit cost, reductions, production unit cost reductions.

Just curious whether there's still a sort of tail of restricted discretionary expenses going into production, or perhaps below the production line from a cost point of view, that may be impacting or impinging on just how fully you realize the gross margin benefits of that cost trend?

Louis Gries (CEO)

Yeah. I mean, we got a lot of different machines running. We're still fairly, you know, we're in a pretty inefficient window in Fontana as far as unit cost. We got Somerville starting up, their unit costs wouldn't be where it will be, you know, in the future. But having said that, we're pretty comfortable on the spend side. We think, you know, unfortunately, we got into a period of underspending without realizing we were doing that. You know, unfortunately, we weren't on top of it the way we should have been. We've gone through what I think is a big correction. You know, we ramped up, did a lot of catch-up.

That catch-up is over, but what we do have is more regular kind of facilities upgrade spending going on in pretty much every facilities. So we're gonna spend at a higher level, probably pretty close to the same level as we are now, I would say, for the next two or three years. We're not looking for efficiencies on the spending side in the plants. What I think is available to us, and we've talked about it before, is we still have some gains on the rate and the utilization in our sites. Now they don't come overnight, and they're pretty big initiatives. We have some plants obviously ahead of the curve and some behind the curve.

I think that's the next time you see, you know, maybe a shift in our delivered unit cost outside of the freight becomes more affordable or something like that, but I wouldn't, you know, it sounds like you had some numbers built in your model where your delivered unit costs just gonna keep coming down, and what I would say is, yeah, there's probably an opportunity there, but it's not on the spend side, and it's not that predictable as far as when we'll get it. I think there's no doubt we will get it, it's just a matter when, so I would kind of think our delivered unit cost at current input cost, you know, kind of rates and current freight rates is about right.

And keep in mind, we had to offset about $20 million ballpark last year, meaning current year, so fiscal year 2018. You know, I guess 2019, if it continues at the same rate, we might have to offset another $20 million or so next year. So it's not that we're not still getting some efficiency benefits in the plants, but most of the overspend has been, or catch-up spending, I want to call it, rather than overspending. Most of the catch-up spending has been completed, and now we're kind of settling into our run rate level of spending.

Peter Steen (Senior Analyst)

... Perfect. Thanks, Lou. Matt, just, I appreciate that it's early days on the tax, and I think we're all kind of scratching our heads on it, and for you guys, it's a lot more significant, but could you give us a very quick sense, so the repatriation tax, presumably that's on the undistributed earnings that you haven't provided tax for before, that you're going to bring back to the U.S., but what I'm interested in is maybe just the slightly longer term view. In light of the fact that you've got accelerated CapEx trials coming your way, that should be a positive.

I just wanted to think about how the Irish domicile in that context could be an offsetting factor that potentially neutralizes the value of those accelerated CapEx trials going forward?

Matt Marsh (CFO)

Yeah, you certainly picked up on a lot of the provisions that create the uncertainty for us. You know, the most certain of the provision is the headline rate. You mentioned the CapEx. You know, there's a pretty significant change in CapEx, where they've moved it to in-service date versus when you spend it. And you know, so that creates quite a bit of uncertainty and may create a little bit of you know, frankly, some volatility as you know, in service dates. We should be able to predict, but nonetheless, is very different than certainly how we're thinking about it today, especially in the context of the other major change in the tax provision, which is you know, BEAT or the base erosion anti-abuse tax.

So it's a, that's a long-winded way of saying we're pretty neutral at this stage of, and uncertain, frankly, of kind of how both ETR and cash taxes paid, the impact, how it's gonna impact the company kind of going forward. So we think it's gonna end up being neutral, but, you know, I think we've got a lot to learn on how the provisions of the tax law get interpreted and what guidance we get from the regulators, before we can provide you real forward guidance on either a cash or on an ETR basis.

Peter Steen (Senior Analyst)

And, sorry, just one quick follow-up. So presumably you're viewing this as so significant that it may or may not change corporate structures as a result?

Matt Marsh (CFO)

Yeah. Yeah, sorry, I meant to answer that, Peter, so thanks for bringing it back to the domicile. I mean, you know, we're happy with how the corporate structure is set up. So we like being an Irish company, and it works very effectively for us, and I think you should- that's a safe assumption for you to carry forward.

Peter Steen (Senior Analyst)

Yeah. Perfect. Thanks. Thanks very much.

Operator (participant)

Thank you. Your next question comes from Keith Chau from Evans and Partners. Please go ahead.

Keith Chau (Analyst)

Oh, good evening, Louis and Matt. Well, it's just a couple questions. Firstly, on the response from some of those customers that you lost in late FY seventeen, early FY eighteen, I think obviously the company's been putting some, I guess, high marketing spend into the market just to get some of the customers back. What are some of the responses that you're seeing at the moment from the customers that you lost, and is there a prospect that you'll regain some of those, including some of the larger home builders as well?

Louis Gries (CEO)

Sorry. Yeah, two large home builders you're probably referring to would be our national deal with Toll and our national deal with KB, acquired last year. No movement on that front. They haven't changed. As far as the customers that had to move to a different product when we were constrained in capacity, and then their movement back to Hardie that we have talked about a couple different times. We have those programs in place. We've got basically an S curve of, you know, the track, and we're bringing back.

Like I said, in the third quarter, we were a couple points off of where we thought we'd be, and that would probably be chipping away at those customers that were natural Hardie customers on all of our product lines, had moved off maybe one of our product lines to start doing stocking when we were short, and now we're moving back in a position where, you know, they become natural Hardie customers again and get the preferred board, and they got guaranteed supply. So that's been going well. That was mainly in the south, so that's been going well.

Like I said, when earlier, I guess in an earlier result, one of our kind of flawed assumptions was that there'd be a pretty quick win back, and it's starting you know kind of generate momentum, but it's not quick, not because you know the customers have to think you know hard about coming back. It's just that it's not always their highest priority you know in their business to you know kind of make that decision and maybe either de-emphasize the other product or destock the other product and then bring ours back on. But we've been doing a pretty good job with that, so we're pretty happy with it.

Keith Chau (Analyst)

Okay, thanks a lot. So then, just, secondly, on the competitive dynamics in the market, one of the key alternative fiber cement competitors has just switched on a bit of capacity in the US. Are you seeing anything irrational or overly aggressive from that participant? And what are your expectations of that going forward as they ramp up capacity utilization?

Louis Gries (CEO)

Yeah, no, I know you know that business well, Keith, so anyone sells at a discount to Hardie if they sell fiber cement.

Keith Chau (Analyst)

Mm-hmm.

Louis Gries (CEO)

For that competitor has always sold at a discount. Discounts are never kind of the same by market, same by customer. We, we've seen some numbers that look like they're different, and then later on, you've seen some numbers that look like they're the same. And they have announced a price increase. So my general feeling, you can never be sure on it, is they're not trying to buy market share. I think their cost position and their price position probably is maybe at an acceptable level now, but if they pull that price down too much, then it's not. So I think everything will be, you know, new capacity is coming on, just like we're bringing new capacity on.

So there'll be a little bit more intensity, you know, between competitors, but that's not the main thing. That's never been the big challenge at Hardie. The big challenge at Hardie, you know, has always been market development against vinyl, and then more recently, it's been kind of controlling the close alternatives that are coming behind us and with a discounted position and a good enough brand promise. And, you know, we've got our programs, and I think our programs will continue to work, especially, you know, they've been very successful about fiber cement. I mean, they got their volume bump when we ran out of material, so we got our capacity back, so now it's more of a fair fight again.

Keith Chau (Analyst)

Fantastic. Thanks, Louis. Maybe just one on the Tacoma startup. Just wondering if you'd be able to provide us with just a bit more insight into how that one's tracking, some of the key work streams and risks remaining on the project before startup, and also maybe an estimate of the startup costs relating to that project that'll be incurred on the P&L in FY 2019?

Louis Gries (CEO)

Yeah, I guess I can give you the headlines just 'cause we just came out of a board meeting where we reviewed that. The project's tracking time-wise really, really well. We will start commissioning in first quarter 2019. Right now we're thinking startup costs you know approaching $20 million, but maybe not quite hitting $20 million. And you know it's gonna be a low unit cost plant. It doesn't have as much reach as a plant in the middle of the country, so we'll just start it up on two shifts and only bring it up to four when that west—either the West Coast capacity justifies it, or possibly if overall capacity gets tight, they could pick up a market like Denver and that.

I think it'll be. I think it was very difficult for Hardie when we were tight on board and had to bring new capacity up, so we had to kind of take a throughput approach to the startup, meaning try to optimize throughput so we could service more customers. That becomes very cost ineffective. In Tacoma, because that situation, we're not facing that situation, we'll take more of a cost optimization approach to the startup. So you'll see whatever startup costs we have spread over more months, more quarters. But we are thinking maybe approaching 20 for next year in startup costs for Tacoma. It is a big site.

It's got some automation in it that we've never put in one of our plants before, so we'll have to learn how to do that. So I'm sure there'll be a learning curve involved there. We get a very experienced salaried staff and a lot of experienced hourly operators transferring into that site. So we're optimistic it's gonna be a good startup, but as you know, that's been a bit of a sore spot for us over the last several years. So we wanna kind of show you, you know, show you how we can do a startup and tell you it's gonna be at a certain level. But certainly, our planning looks good, and our execution so far looks good.

Keith Chau (Analyst)

That startup will just, with respect to those costs, just be an FY 2019 phenomenon, not necessarily traveling into FY 2020? So the startup there-

Louis Gries (CEO)

Yeah.

Keith Chau (Analyst)

Right here, right-

Louis Gries (CEO)

It's hard to say. It really depends on how much board we need out of that site, so your startup costs are kind of a per-day cost, so, so you know, if you run more days in a year, you would get it all pulled into a year, but, you know, if the startup goes pretty well, we have, you know, less need for the board, so those days, those startup days could, you know, slip into twenty, so it could, you know, it's just too hard to call. I mean, we just got to see what the overall demand is and how much is on the West Coast.

Matt Marsh (CFO)

The other thing to keep in mind, Keith, is right behind Tacoma is Alabama. So the startup costs in Tacoma, you know, are primarily next year, but then the following year, we're gonna get Alabama started up.

Keith Chau (Analyst)

Yeah, great.

Matt Marsh (CFO)

That's also a greenfield site. Slightly, it's a bigger site, and you'd expect startup costs for that to be at least equivalent to kind of Tacoma.

Keith Chau (Analyst)

Sure, sure. And Matt, maybe just a quick one on tax, and apologies for harping on about this, but there's a provision or a couple of provisions taken, one positive, one negative. How do you expect the cash impact and benefits of those provisions to transpire over the next year, two years?

Matt Marsh (CFO)

Yeah, I wish I was certain, as much for our own benefit as being able to answer the question. You know, I think the biggest cash, there's two provisions that are gonna play pretty significantly on cash taxes, and that's BEAT the what we're referring to, and I think a lot of others are referring to, is the Base Erosion and Anti-Abuse Tax. The way that's gonna play with the change in, you know, CapEx and those assets, you know, being tax deductible at the time they're placed in service versus when the cash is actually spent.

Those two provisions are very codependent upon one another, and we've really got to still work through both the interpretation of the rules as well as our own business assumptions to have a better sense on cash taxes.

Keith Chau (Analyst)

Okay. Thanks, Matt. Thanks, Louis. Appreciate it.

Operator (participant)

Thank you. Your next question comes from Andrew Johnston from CLSA. Please go ahead.

Andrew Johnston (Analyst)

Yes, good evening. So just a couple of questions. Just, I want to go back to the makeup of the delivered unit cost. In the past, you've provided some guidance around the contribution to change in gross margins from freight to raw materials. How did that look for 3Q for those two items?

Matt Marsh (CFO)

Sorry, Andrew, can you-

Louis Gries (CEO)

Put it in the wrong terms. So what?

Matt Marsh (CFO)

Oh, yeah. I mean, for the year, I don't have in front of me the quarter, you know, Andrew, but for the year, you know, we've had material and freight inflation and inflationary pressures in the business, you know, kind of accelerating throughout the year. So meaning, we'll incur more in the second half on both material and freight inflation than we did in the first half. So the third quarter was higher than the second quarter, and we think the fourth quarter will be at least as high as the third quarter. And for the year, we think that's about $20 million, as Louis mentioned.

It looks like that's gonna be a feature, at least going into the first quarter of fiscal 2019, and then we'll kind of have to see how the commodity markets play out. But within the quarter, I don't have a quick split for you of how freight and input costs, you know, impact the third quarter result.

Andrew Johnston (Analyst)

I mean, suffice to say that your manufacturing cost, so, you know, if you break up that contribution to gross margin between freight, raw materials, you know, startup costs and manufacturing costs, suffice to say, there's been a pretty substantial improvement in contribution to gross margin from those lower production costs. Would that be fair?

Matt Marsh (CFO)

Yeah, that is fair. I think the other thing just to sort of keep in mind is, you know, we've obviously have certain levels of inventory in at any given, you know, at any given point in the year. And it would normally take about 60 days for, especially during the summer months, about 60 days for board that we make this month, actually come out of inventory and end up in the, in our financials on the P&L side. We're in the winter, so obviously, we're building inventory, and on top of that, you know, through the distributed inventory program, we're building additional inventory. So that, inventory turn will obviously be slightly longer in the third quarter than that two months.

It's probably closer to three months at the moment. So a little bit of what you're getting in the third quarter is mainly product that was made, you know, in some combination in the second quarter and the third quarter. So I don't think if you're trying to do it by quarter, that's not where I would encourage you to have the focus. I would try to do it for the year. The underlying dynamics are still about right, that manufacturing performance in comparison to where we were coming into the year has obviously improved pretty significantly. And what's, you know, offsetting that is primarily, or at least partially the material cost inflation, as well as the freight market.

Andrew Johnston (Analyst)

Okay. And, Louis, your comment about delivered unit costs are about right. But for the next couple of quarters, won't we continue to see improvement in gross margin compared to PCP? Can you speak to what we're looking at? Because we're cycling much higher unit costs in for the next two, the next three quarters.

Louis Gries (CEO)

Yeah. You know, I mean, like I said, I don't, I don't want everyone to get carried away with all things are pointing in the right direction and, you know, just extending that all out. We're doing a lot in the business. You know, we've got everything stabilized. We're back on our front foot in the market. We're spending on programs in both, on the market side for PDG and on the manufacturing side, trying to get these future gains. You know, we've got headwinds on the input costs for freight. We got startups kind of on the back end at Somerville, but we're getting ready to start Tacoma. There's just a lot of moving parts, and I wouldn't want everyone to kind of just misread all that.

Our read is pretty simple. We got our delivered unit cost back in an acceptable band, not saying we won't improve on it, but our main focus now is we got capacity, we got it at the right delivered unit cost. Let's get the PDG ramped up. I'm quite sure the manufacturing guys will get their gains, but I wouldn't be trying to forecast them by quarter.

Andrew Johnston (Analyst)

Got it. I mean, if I look at the input cost, that would appear to be the biggest drag on the fourth quarter. I think they're up to about 18% on PCP. I haven't got the numbers in front of me, but I think it's pretty substantial. So, it looks like you're getting your delivered, the rest of the delivered unit cost, is getting back to a level that's offsetting that. But looking forward, are you just in terms of forecasting your, the pulp price, do you just take the current pulp price and just run that out into the rest of this year and next year?

Louis Gries (CEO)

No, we don't forecast pulp that far out. I mean, we have to take a guess for our financial count planning, but we use the same forecast as you'd probably look at for the market.

Andrew Johnston (Analyst)

Okay.

Louis Gries (CEO)

So yep. But anyway, you know, several times in the last six quarters, I said, we're not comfortable with this, we're not comfortable with that. We need to fix it. We're no longer in that position. We like where the business is heading, and we feel we have the opportunity now to really get focused on the growth side again, and you know, we're maybe a quarter ahead of where we thought we'd be, but it's still the same challenge. We want to get back up six or eight PDG, and we can't do that overnight. We gotta work our way there.

Andrew Johnston (Analyst)

Yeah. Okay, great. Thanks very much.

Operator (participant)

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

Andrew Scott (Analyst)

Good evening, guys. Thank you. Matt, you spoke to inventory levels just a minute ago. I just... I remember in September you talked to having a new target for February. I think it was 20% of prior year sales in inventory, and if you didn't have that, you'd look to adjust shift patterns to get there. I wonder if you could just give us an update on where we are for that and what you think you need to get to those levels?

Matt Marsh (CFO)

Yeah. The, let me just clarify the, kind of the 20%. We wanted to come into fiscal 2019 being able to protect up to 20% volume upside, and we really looked at multiple different ways to accomplish that. One of which is inventory. You know, the other two most common ways is you want hours in existing assets that are already performing at design, and then you got new assets that you're either constructing or starting up. And you know, you, in our ideal state, you want us to have we wanna have kind of those insurance levels built into all three of those areas. And we're executing to that plan. So we've obviously got inventories back up.

The distributed inventory program was on top of our normal inventory levels and provided kind of additional assurance and allowed us to pilot a program where we also thought we could take advantage of putting some inventory close to market and getting a delivered unit cost benefit via freight, efficient freight, and that program is being, you know, we like where that program is right now, and it, it's about where we thought it would be right now, and you know, I'd say the other two areas, we've got hours in the existing network. The network's, you know, continuing to perform well quarter to quarter, and then we've got assets that are either in construction, in the case of Tacoma, or are being planned in the case of Alabama.

You know, the startup of Somerville and Prattville are right where, you know, we kind of thought they'd be at this stage of the game when we gave you that guidance back in September. So yeah, we kind of think we're where we thought we would be at this stage of the game, and we feel good about having supply ahead of demand, going into next fiscal year.

Andrew Scott (Analyst)

In that case, inventory levels more build into the fourth quarter, or we're about right?

Matt Marsh (CFO)

Yeah, you'll start to see them come off in the fourth quarter. They should start to come off in the fourth quarter. I think a lot of that just depends on, you know, how, as Louis said, probably the biggest unknown for the fourth quarter is volume with respect to, you know, price, the price increase and where we are with customers on their buy forward program. So, that'll play into it a bit, but for the most part, inventory, we, you know, we think we've got it right about where we thought we'd get it. It'll continue to build here a little bit, and then start to come down in the second half of the current quarter, and it'll just depend on how volumes, how strong volumes are and when in the quarter those come in.

Andrew Scott (Analyst)

Great. Thank you and Lou, I think the other thing happening this winter was maybe a bit of a trial where you were flexing to flex up your lower cost plants more and maybe bringing the higher cost plants down a little bit. Just wonder if you can tell us how that went and what the learnings were, and is that something we expect going forward?

Louis Gries (CEO)

Yeah, that, that's all built into the distributed inventory program. So, you know, Cleburne's 24/7, Peru's 24/7, Tacoma's 24/7, Reno's 24/7, and then you get to, like, Pulaski's, I mean, sorry, Fontana's just running one line at a time. Waxahachie, we took hours off Wax, we took hours off PC. And part of that was, you know, the unit cost out of those plants, but part of it was just how well the plants were running and what we wanted to try to accomplish to get them running better. I think that'd be Waxahachie and PC are both, you know, kind of, potentially very low unit cost plants, but they weren't running as well as they should be running.

So, we took the hours off just to give those organizations a chance to kind of get ahead of their game plans a bit. So it's actually worked out very well. Like, Matt said, at the end of the, you know, at the end of the year, we'll do the analysis. I have a feeling we'll have some version of distributed inventory pretty much going every winter. It's good for our employees. If it's good for our cost, if it's good for our customers, obviously we're gonna do it, and it looks like there's benefits for all three if you do it to some degree. Obviously, you can overdo it. We're not gonna do that, but we're pretty happy with how it's gone.

Andrew Scott (Analyst)

Thanks, Lou. And finally, Matt, just to confirm the sale, you sort of confirmed you expect it to close this quarter. I know there's an element of some upfront costs there. Can you give us an idea on how you expect that to phase and maybe what's embedded in that guidance that you've provided today?

Matt Marsh (CFO)

Yep. In the guidance we gave you today was excluding, you know, transaction costs related to Fermacell. Once it closes, we'll obviously, you know, be very transparent on what those costs are. There's obviously the financing and closing costs that are associated with the transaction. There's some due diligence costs that we're incurring here in the fourth quarter that we'll, you know, make sure are visible. And then, you know, there'll be ongoing integration costs as we get into fiscal 2019. So those are the types of costs, you know, that you should expect to see when we announce them, the deal's been closed.

Andrew Scott (Analyst)

Thank you.

Operator (participant)

Thank you. Your next question comes from Brook Campbell-Crawford from J.P. Morgan. Please go ahead.

Brook Campbell-Crawford (Analyst)

Yeah. Hi, Louis and Matt, just a question following on from a comment earlier on the interiors business. You mentioned it's been weakened in certain regions and retail channels. So just interested to learn a bit more about what caused that and what you're doing to sort of address this issue.

Louis Gries (CEO)

Yeah, unfortunately, that's one of the areas we just have to fess up, we haven't managed it as well as we should have. So, we did a good analysis of the interior business profitability about six quarters ago. We made some good decisions on not participating in a different channel and not participating with four by two two. So that's a fair chunk of the reduction in volume. But in addition to that, I think our effectiveness in the retail channel just got down on us. And you know, we just need to get it turned around. Is it more than normal variance?

It's probably a little bit more than normal variance, but I don't want you to think it's any, it's not a huge issue for the business. We'll get it turned the other way. And you know, we know how to do that. Our boards, the preferred board in the market, it sells at a big premium to competitive boards. Market shares are high compared to the other boards. So it's just you know, a loss of focus by that organization, and we just need to get back.

Brook Campbell-Crawford (Analyst)

Okay, thanks. And just a question on fiber cement in Europe. So I appreciate the deal hasn't completed yet, but has the strategy to leverage Fermacell to sell fiber cement manufactured by you guys in the U.S., evolved at all over the next few months? Anything that you've picked up on? And-

Louis Gries (CEO)

Yeah, not other than starting to think about how to put the organization in place and how to, you know, do the strategy development work. Basically, the first year we own Fermacell, we're gonna try and make sure Fermacell comes into our company. And, you know, it. The business, the Fermacell business has a lot of momentum now, and we don't want to lose any of that momentum. So, we'll just be focused on, you know, continuing to run Fermacell well as it becomes part of James Hardie. And then you'll have a separate team, you know, starting to work on fiber cement strategy development now that we got the Fermacell platform to work with.

There will be some small changes that first year, where we have common customers, whether you know it'd be mainly our customers and our guys, meaning fiber cement guys, bring fiber gypsum in or vice versa. There'll be small changes like that. But I don't want you to expect any big declaration of here's our new strategy in fiber cement Europe, you know, before about two years. We got some platform R&D development work to do. It's a missionary, you know, frame construction is growing, but still a missionary market. We'll be working on products with a different value proposition than what we have in either U.S. or Australia.

So like everything in Hardie, it's not gonna happen overnight. We got a long-term view of where we wanna be, and we'll start moving down that track once we close the deal, at least on the strategy development side.

Brook Campbell-Crawford (Analyst)

All right, thanks. And last question, maybe from Matt. Following on from the raw materials conversation, just hoping you might be able to provide us with a figure. You know, if you look at the last twelve months or financial year to date, could you share with us what percentage of your COGS in North America relates to raw materials?

Matt Marsh (CFO)

Yeah. I don't think I'll answer it in a percentage, you know, but like we've said, for the year, it's about $20 million of material cost inflation. And really the way to think about that is, you know, it's accelerated, that inflationary pressure has accelerated as we've gone quarter to quarter throughout the year. So there was some evidence of some cost inflation exiting last year, and that continued into the first quarter. We saw that really starting to, to, you know, elevate itself in the second quarter. Pulp in the second half of the year has definitely stayed, you know, at a much higher level, from a market price standpoint than I think any of the forecasts expected it to, and certainly, you know, than we expected it to.

And then now you've got energy price inflation kind of right behind it. Freight's been high, you know, now for the better part of probably the last four or five quarters. It's definitely accelerated, you know, throughout the current fiscal year. And it's accelerating both on utilization with not enough trucks on the road due to a driver shortage and,

... as well as, you know, fuel costs are going up and market rates are up on top of it. So, you know, that $20 million is a good number for the year, and that gives you some sense for kind of how it's phased, you know, throughout the year. And we're forecasting that it'll continue going into the early part of next year, and we'll certainly, you know, provide commentary in the May result. And then in August, when we get into forward guidance for fiscal 2020, you know, we'll have a better view on kind of what the next 15 months will have, you know, will look like from an inflationary standpoint.

Brook Campbell-Crawford (Analyst)

Thanks. So just to clarify, you're saying $20 million for the first three quarters of this financial year, is it? Or for the whole financial year?

Matt Marsh (CFO)

No, for the whole of the year.

Brook Campbell-Crawford (Analyst)

Appreciate it. Thanks.

Matt Marsh (CFO)

Operator, to the extent that we've got more questions, we're happy to take two more questions, and then, I think we'll wrap it up.

Operator (participant)

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

Peter Wilson (Analyst)

Thank you. Yep, two questions will do me. Can we just pick apart the 2% volume growth that you got in North America this quarter, and maybe paint a path for where it trends? So 2% growth, you said exteriors grew 5%, which on an 80-20 split, would seem to imply that the interiors were 15%... or interiors were down 15%, which you attributed to a product line exit and some retail channel. So I'm just wondering, when does the drag on interiors roll off? So can you—which quarter? And then in terms of the market growth you're expecting, so you said flats in this quarter, but then you reference a 9% increase in starts.

So, yeah, when does the interior, you know, the interior drag start to remove? And, if you could paint a path for the growth coming in the next few quarters.

Louis Gries (CEO)

Yeah, we went down 15%, so our arithmetic's a little different than yours on interiors. But I don't have. I just scribbled out my calculation. You probably just did. I came up with a little different answer. So, but, but let's not, let's not worry about that. So we dropped the product line April one last year. We shifted, we shipped, you know, remaining orders through that first quarter, and I think a few slipped over in the second quarter. So we're almost getting past that story of product line drop. The only real story for us, the only real story for us on interiors is, you know, the, what I, what I mentioned earlier is, hey, we've lost some momentum with our, our retail store program.

It's not across the board, and it's not necessarily with both retailers, but it's enough to drive the negative comp on top of the exited product lines. Most of you are aware, the cement board market is in a little bit of decline. So all of the loss on our, you know, on our part, isn't necessarily market share loss. But having said that, we still think we have market share opportunities, so we have an internal goal to grow the interiors business, even facing decline of the cement board market in the U.S., which is not a rapid decline. So we just got off our game a little bit. We'll get back on our game.

I don't know if it'll take us a quarter or two. It's not like... Well, as you can see from the quarter, it's not like driving any material results at Hardie, but it's still something that, you know, we should fix and we will fix. And it's nothing more than just running our game plans better. So there's no pricing, there's no product, there's no customer issues. It's just running our game plans better so we get our fair share in the stores. Again, the premium retailer surcharge for our product has steadily gone up over the years. But we don't even think that's the driver of market share, the market share dip we had in some regions. We just think we didn't run our programs as good as we should.

Peter Wilson (Analyst)

Okay. So on that basis, when you talk PDG of 3-5%, we should be thinking exterior growth of X plus 3-5% PDG, less, some continued drag from interiors, given the, you know, that market is in decline.

Louis Gries (CEO)

You know, I'd like to think we're back to flat volume on interiors next year, so you can just throw it out of the equation, but today we're not flat. Today we're comping negative. You know, again, I said it's not a big deal to fix, so I say flat's not a high bar, and we just gotta start moving in that direction and get back to where we should be. It's a small variance in our business. I know because there's so much focus on PDG, and when it makes that arithmetic harder to understand, it becomes bigger than it should be, but believe me, this is beyond normal variance, but not much beyond normal variance.

Peter Wilson (Analyst)

Okay, excellent. Thank you.

Louis Gries (CEO)

Yeah.

Operator (participant)

Thank you. There are no further questions at this time. I'll now hand back for closing remarks.

Louis Gries (CEO)

Oh, yeah, no closing remarks. We do appreciate everyone joining the call, though. Everyone, have a good day. Thanks. Bye.