James Hardie Industries - Q4 2017

Transcript

Louis Gries (CEO)

Morning, everybody. We'll go ahead and get started. Appreciate you joining the results announcement call for fiscal year 2017. We're gonna do it pretty much like we normally do. I'll give an overview of the year, and then Matt will give you a financial overview. One thing I'm gonna do differently, since this isn't a typical Hardie year results-wise, I'm gonna give you a bit of a summary as I'm finishing up my overview of the businesses, give you a summary of 2017 and also a little indication, not guidance on 2018, but a little indication of how we're thinking about going into 2018, and then I'll hand it over to Matt after that.

You'll probably get there through Q&A anyway, but I thought I'd give you the kind of framework that we're thinking about the year. Looks like I need something to change. Clicker. I got it. Sorry. Okay, so a lot of red arrows in that. Quarter came in weaker than the full year, and almost everything's gonna come back to manufacturing, so I'm gonna get into it in some detail. We even put in a couple extra slides, so we can kinda show you what that looks like. Full year, pretty flat on the profit side, better on the earnings per share, better yet on the cash flow, but again, not a typical Hardie year when it comes to delivering financials.

When we go to North America, which is where the main story is, you can see volume was good, price was flat, basically down a hair. And, the EBIT, EBIT was the lost opportunity, both in the quarter and the full year. And this summary on the slide to the right side of the slide is a pretty good summary. It's all gonna come back to manufacturing, and, like I said, we'll go through that kind of step by step in a couple slides. But on our network of plants, our efficiencies were down some, so that affected us. We had less throughput than we thought we were gonna have for servicing orders, and, we also had higher costs due to the inefficiencies.

Then we had a big challenge at startups, which two of them didn't go as well as we'd wanted. One went really well. The one in Texas went really well, and the ones in Fontana, California and Florida didn't go as well as we would have wanted. Being short on throughput drove higher freight cost. And the last point, which is separate to manufacturing, we did put some more capability into the business, and that was a fairly significant step, so it wasn't lost in the bottom line, but manufacturing is still the story on the bottom line. Must be pointing this wrong direction. Okay, price. You can see we've been flat on price for a couple years. That'll change this year.

We did take a price increase April one, so we'll be up about 3% next year. Flat for two years on price when our inputs were going up, so that did put kind of an incremental drag on EBIT during that period. But that again, that's not the main story. It's how we performed on the operation side. The top-line growth slide, which we always show you, is fairly typical. Housing starts have been increasing year to year at a fairly moderate pace, and we expect it to look that way next year as well. This year, since volume and revenue are about the same growth rate, there's no separation between the two lines on the top.

They're the same slope, but you know, obviously, we got a slope advantage over the housing starts. We continue to do well in repair and remodel, which is actually our bigger segment. This is a new slide. We've never provided it and probably won't in the future, just kind of to give you a heads-up or tell part of the story. On the manufacturing, you can see, though, on the left is your kind of existing capacity that was running coming into the year. And we gave you a little bit of historical because we've been talking about you know, we're running with some inefficiencies we hadn't planned on, and that's what you see in the last four quarters.

We are coming off a very good trend line, which was almost eight quarters long, where we had really in fiscal year, end of 2015, start of 2016, we took on a pretty major manufacturing initiative that did drive up our throughput rates in the plants. So we started banking on those rates, and you can see this quarter, we obviously didn't go back to where we were previously, but we did drop down to the low part of what we consider our normal range for manufacturing. The right-hand side of the chart just tells a little bit of the story on capacity. So we have a nameplate capacity of 3.4 billion that are operating. That's for operating plants, and that includes your startups.

Then you have 0.3, so 300 million feet that isn't operating. That's the Summerville plant and one of our lines in Plant City. Currently, we're in early stages of starting both those lines up, but in fiscal year 2017, we didn't have any product off either of those. Now, when you drop down from 3.4 down to 2.6, which is really our current capacity, the 800 million feet is made up of basically three things, which we list on the bottom. The first is something that's in the business, and that's our nameplate capacity is based on five-sixteenths inch, you know, full width on a machine, medium density fiber cement.

And then you have a product mix that varies from that, and about half of the 0.8 or $800 million is $400 million in product mix. Now, we do have some technology projects working on speeding up some of the products that fall into that category, but you should think of that $400 million as kinda just built into the system. The other $400 million is either gross hours not run or the line efficiencies that we've talked about. It's either gross hours or it's rate, number of gross hours or rate per gross hour. The rate per gross hour, we've already talked about on the slide to the left, or the chart to the left. The gross hour utilization is not all kind of lost opportunity.

You have bottlenecks that drive some of that as well. So if you've increased the throughput in a plant, and you don't have enough silica supply, which we grind our own silica, then you can't run the gross hours whenever you've topped out on silica usage. And certain products use a lot more silica than other products, so a lot of times that comes to how well you're running and what products you're running. Sometimes as you expand a plant, you start putting the autoclaves in place, and they get delayed. And the other thing I'd tell you, on our nameplate capacity, we basically went to a theoretical design back in the late nineties.

At that time, we had mostly small scale plants, and we. In our calculation, we had eight hours a week to clean up a plant, you know, to do your maintenance, clean it up, and restart it. As we get into larger plants, the time to clean them up actually goes up, so now they're 12, 14, 16 hours. Now, we're, again, just like the example on the product mix, we have some projects in place that are starting to compress that time. The main reason I went into that long explanation, I want you to understand this is not a site problem necessarily, the gross hour, although there are some site opportunities.

It's more where we're at in the development of our network in the company. So this just steps up our capacity since the downturn. So, you'll remember, we idled a lot of capacity during the downturn, and then we also reduced gross hours on capacity that was running. So when we started to get volumes back coming out of the downturn, the first thing we did is just increased our hours on the lines that were running, and then we started to bring up capacity that had been idled. So you can see in fiscal year 2013, we brought up a line that was idled in Waxahachie. Then in 2014, at a very low level, we brought up the line that was idled in Fontana.

Now we kind of reengineered that facility because we pulled out one of the lines, put in a much larger, higher throughput line, and then shared the mixed plant autoclave, raw material supply for that plant. So it's kind of a reengineered facility, but the first step to start it up was just to start up the line that didn't have as many changes on it. The old line, not the new line. And then where we got here in fiscal year 2017 and kind of becomes our story for 2017. We got in a very tight supply situation. We had miscalculated the capacity that was gonna be needed and the amount of time to bring it up, and we were forcoed to bring up 700 million feet of capacity in one year.

And I think our organization has shown that even though the effort was good, we weren't ready to do that well. And that has driven our bottom line problems during the year. There's a few other parts to the story, which I'll cover, but. And you can see it starts showing up late in the year. You can see kind of from our working capital year to year, we came into the year with pretty good inventory levels and pulled those down as we weren't able to keep up with demand early in the year. And then as it became a hand-to-mouth situation on board, we started to really see the inefficiencies in freight and also the inefficiencies in spend as we throughput optimized the network.

There's kind of four things that are driving delivered unit cost up. One of them I covered. It's the inefficiencies of the current network were higher than prior year, and then the start-up costs for the new lines. But we also have an infrastructure cost that we took on as part of a commitment we made in July to go to best in class on safety, which we were at what we call a two and twenty rate, which is a good rate for our type of industry. I think it's in the top quartile or right around there, seventy-fifth percentile. We just had an accident in a plant.

When we investigated the accident, we didn't like what we saw, but also part of that investigation, it kind of opened our eyes to the fact that at a two and twenty, at the growth rate in our business, that's just a lot of accidents in our facilities, even though it's small on a relative basis, you know, per 200,000 work hours is still a lot for our company, and we felt we owed it to our employees to really aim for a much higher level of safety, which we call Zero Harm. We had a corporate task force.

Corporate, I say, it was led by our GC, but we had representation from each of our sites, and they did a six-month basically current state assessment, gap analysis. One of the big areas they identified early on is our infrastructure. Our spending on infrastructure wasn't keeping up. So we're letting things like ventilation, lighting, just cleanliness of the plant, how things were aging over time. We now have plants that are 25 years old. It just wasn't consistent with Zero Harm, best-in-class safety, so we put in a program to start catching up on that infrastructure spend. When I say catch up, we have to spend at a higher level. That's how we got behind, but it's not a catch-up like you'll see in maintenance.

Maintenance is more of a 9 to 12-month catch-up. This is more of a 3 to 4-year catch-up. So we'll continue to spend at about that $10-$15 million a year on upgrading existing facilities. And again, the base of infrastructure. I'm not talking about new machines or anything, lighting, concrete work, buildings, guarding, just everything that makes a work environment for the employees. So I covered startups, I covered inefficiencies, I covered infrastructure. I kinda alluded to high freight because you're now throughput optimizing, and the fifth thing is the maintenance catch-up.

So when we, you know, you saw the chart where we really shifted the rate of throughput per gross hour in our plants a couple years ago, so it was a surprise to us when we started to lose efficiencies in the plant. And one of the root causes of that has been that unfortunately we had taken a short-term view on maintenance spending in the plant over the last 18 months or so. And that was starting to run into higher unscheduled delay and some long, large delays.

And some of this was, you know, big things like ball mills, feed pumps, stackers, conveyors, and some of it was more just the, you know, the 47 pumps that are on a sheet machine. So, pumps, motors, stuff like that. That spending kinda peaked in Q4, which is one of the reasons you were probably a bit surprised by our result in Q4. It had kinda risen to a high level in Q3, peaked in Q4, and it's now starting to taper off. Now, we'll end up, obviously, 'cause we were underspending, we'll end up at a higher level than we had been the last couple of years, but a much lower level than we have been in fiscal year 2017. Okay, so that's the U.S.

Now, I do have a summary, and the summary is basically the U.S., 'cause the U.S. is, you know, the driver of the result this year. Asia Pac had a very good year. Pretty much everything points up. The only bump in the road this year in Asia Pac was the Philippines. Australia, very strong result, volume, price, cost was good. You can see we're starting to get the efficiencies out of Carole Park. We had the big start-up costs there last year, so that's kind of an easier comp, but it's also good that we're starting to get the efficiencies that we saw when we went with the investment.

New Zealand, not as good of a story as Australia, but again, another good contribution year out of New Zealand. And in the Philippines, we ran into a competitive situation, offshore competitive situation, that affected both our volumes and price to some degree. As far as how the business is operating, it's operating fine. Our market position is just being attacked, and we just have to work through that in a better way. It's just a new kinda playing field for the guys in the business, and they'll sort it out, but it'll take a little time to sort out.

It's not a big business, obviously, so it doesn't drive material numbers for the corporation, but we report. We talk about it separately in the Asia Pac business, so that was the negative. Everything else was positive. ANZ was very positive. Okay, I'll give you my summary. So fiscal year 2017, good growth, and the way to think about the good growth is we did get an increase in interiors, but the exteriors number was much larger, obviously. Vinyl continues to decline against its market index, which is kind of the plan. We see vinyl as a product line or a product that's in decline. Hard sidings, you know, kind of substituting for it, even though it sells at a much higher cost.

Both Hardie and LP were above their market index. Now, we have slightly different market indexes, but the reality is we are both above, and vinyl was below. On the volume in Q4, it looks very similar to the first three quarters, but I need to tell you, some of that is price increase pull forward. So about 20 million feet is our estimate, price increase pull forward. There's basically a current dampening in demand that's going on in our business right now, and I think it comes to, it's not so much the price increase pull forward. That's just a quarter-to-quarter switch.

It really comes down to that we had to put the business on allocation last year, that we extended lead times in some segments, and we're currently still working out of a service position that's below target for our industry. So normally, our industry, service positions run in the 95% range, mid-90s. We kind of aim toward 97%, and right now, our business is running more like 80s because we don't have enough buffer between capacity and supply and demand at this point. So, we're. I, I'll talk to that a little bit more.

On the supply restrictions last year, like I said, it was just, you know, we cut it too tight, and we brought too much capacity up, you know, in a what amounts to just over a one-year window. And that goes back to what I talked about Fontana. PC4 and Cleburne 3 were the main, that was the capacity coming up. Cleburne 3 went very well. That was the last one to come up, and PC4 and Fontana were both very difficult. And then we also had the isolated inefficiencies in the rest of the network. So I wanna, I want to point out there's this isn't an across-the-network inefficiency.

We had a couple plants that we usually count on pretty heavily that have stayed at that kind of better part of the range up there, and that would be Cleburne and Tacoma. And we have a couple plants that are really, really doing quite well against historical throughputs. Probably the most noteworthy would be Waxahachie. But at Peru, Pulaski, Plant City, Reno, we did have the inefficiency issues that affected our ability to supply. Right now, trend lines are positive on both startups and on the broader network. So, we've got some momentum back. We've worked through some of our issues. Like I said, we're maybe a little bit more than halfway through our maintenance catch-up, so that's helped us on machine performance.

And we have started to build back some buffer between supply and demand. A lot of that buffer was used for the price increase, so it got pulled down, and now it's being rebuilt again. So the, again, the manufacturing EBIT issues, startups, inefficiency, maintenance, catch-up, infrastructure increase, high freight, and all that basically just results in higher unit delivered costs. We had plenty of volume, we had a price we were expecting, but we had a much higher cost than we were expecting. So obviously, this time of year, we don't give you guidance for fiscal year 2018, so I'm just gonna talk about how we're thinking about fiscal year 2018.

Just, just as a bit of an update, the order file is soft right now, so how much of that is the price increase pull forward, and how much of that is the dampening due to the allocation situation we're out of now? The lead times have been pulled back to normal, but our service position is still tighter than we'd like to see. The higher delivery unit costs will decrease as we move through the year. So it's not over now. So I think most of you know, we got a... We have about a 45-day lag with cost of producing versus cost of goods sold. That's what, obviously, what goes into inventory. We are just tapering off on the maintenance spend.

I think that'll kind of get back to what we consider our new normal levels, maybe July or August, so we're still spending more than we will as a rule in the future. We do have the startup, I mean, the throughput improvements that are gonna help us, startup improvements helping us. Now, this year, we're only gonna start up 300 million feet of capacity, and that's not that easy, but it's not seven hundred, and they're not brand-new lines. So they're existing lines that have been kind of reengineered to a small degree for startup. We are in PC changing its product mix, so that's a little bit. Plant City, that is.

That's a little bit more of a challenge than Summerville, which is coming up with some improvements, but roughly the same production lines as we shut down. I already talked about infrastructure spends will continue, so that's 10-15. Freight will start coming off, but we gotta get the service position up before the freight starts coming off, so that probably starts coming off, you know, more toward the second half of the year. Raw material and then raw material and energy's gonna be up this year. Pulp looks like it's gonna be more expensive than last year. Cement, obviously, we sign annual contracts, so we know that'll be up. Gas is up a bit, coming off an historical low.

We'll have some more cost increases, like I commented, about 2017, but not at the same rate. So basically, my summary is, we're gonna start the year low in our range, and we're gonna build to high in our range late in the year. And I think the growth's gonna go the same way. I think we'll have a small comp, a small PDG comp, Q1, which is a little short for a PDG comp, but just how we think about above the index will be...

We'll start out small in Q1, and I think, as we get out of our service position and get back on the front foot in the field with our customers, get these allocation and lead time issues kind of further behind us, I think we'll be able to, you know, deliver bigger comps late in the year. So that's just a general kind of update, so when you ask your questions, it can drill down a bit. But at this point, I'm going to hand it over to Matt for the financial overview.

Matt Marsh (CFO)

Good morning. Thanks, Louis. We'll go through the financials like we normally do. We'll start with the fourth quarter group results. So net sales for the quarter were about $494 million. You can see they're up about 13%. Pretty similar growth on volume in both North America and International. They're both up around 12%-13%. International also saw, in the fourth quarter, as it did throughout the year, good price increase 6%-7%. About half of that is mix, and half of that is the annual price increase. Gross margins were down about 420 basis points, largely driven by the North America manufacturing discussion that Louis just took you through.

SG&A was up about 10% as we continued to add capability in all three of our business areas, North America, International, and at a corporate level. We added organizational capability, headcount, labor costs were up year-over-year, as well as in North America and in Australia. We also added marketing programs. You see adjusted EBIT was down 8% in the fourth quarter. Adjusted net operating profit of $546 million was down for the quarter as well. If we go to the year. So for the full year, group sales were $1.9 billion, up 11%. Gross profits of $674 million, up 7%. Group EBIT of $393 million, up 11%, and net operating profit on a reported basis of $276.5 million.

On an adjusted basis, when you take out the effects of asbestos, $248.6 million, up 2%. So net sales for the year up 11%. That was North America, up about 12%-13%. We had good growth on both the exteriors and the interiors business. Obviously, exterior is growing a greater degree than interiors, and good growth internationally, as Louis covered in his section. International got priced for the year pretty consistently throughout the year, both on mix and on list price increases. Gross profits were up 7%, but you can see margins got compressed largely due to the manufacturing and startup issues that we had in North America. SG&A for the year was up about 15%, similar to the fourth quarter.

It was in both business units and at a corporate level, primarily in labor, but also market and sales-related programs. If we go to foreign exchange. Foreign exchange really wasn't as big of a factor for the year. You can see it's about flat, had a pretty minor result overall on the face of the financials. A $2 million favorable impact on adjusted net income, marginal impact on revenues. Inputs. Input costs were a good tailwind last year. Most of the input costs across the board trended favorably in the first half of the year, and then, as we got to the second half of the year, both the indexes and then our buying resulted in increases in input costs.

Pulp in the first half of last year was on the decline, and then started to level out and starting to increase now. External forecasts have it up for next year. Cement prices, at least the index that we're using here, the external data source we're using here, says up 4%. I'm expecting it to be up higher for next year. Our purchasing is better than that, so we won't buy as high as the market increase, but you know, cement, particularly in North America, continues to be in an oversupplied situation. Gas prices are starting to trend up. They were up 5% in the fourth quarter.

They were, you know, down for the fiscal year, so, you know, that similar commodity trend is being seen on gas. Freight, Louis talked a little bit about freight costs from a performance standpoint, but the market rates are also up. So market rates are up, and fuel is up on top of some of the inefficiencies. Obviously, the inefficiencies are within our control, and we'll work through those throughout fiscal eighteen. But I expect that market rates are going to continue to trend up. And then electricity is up slightly as well. So material inputs for fiscal seventeen were a little bit of a tailwind for us, a little favorable. For fiscal eighteen, we're not expecting that to repeat. We'll go through the segments real quick.

So you can see for the quarter and the full year, EBIT in the North America business was down 11% in the quarter and 2% for the year. The fourth quarter's down more than the full year as some of the non-routine maintenance and the plant performance spend started to peak, particularly in the fourth quarter and late in the third quarter... The EBIT was obviously pressured by the three big items that Louis talked about. I think he broke them out into five categories: so plant performance, startup costs, and higher freight, and then outside of the variable costs, obviously, we continue to invest in the business to build capability to support the growth agenda that we have.

On the international, they, you know, they had a good year, both top line and bottom line. Even when you take out kind of the nonrecurring Carroll Park startup costs from the previous year, the team did a good job delivering on both top line and bottom line last year. The other business, as you know, is our strategic business development areas. You can see the losses in those areas decreased, as we expected that they would. Probably not at the rate that we expected that they would, but, you know, not materially off, certainly at a group result level. So losses for the quarter of about $2 million and for the year of about $6.7 million.

R&D's continues to be on strategy, right around 2%-2.5% of sales, right within our target range. The fluctuations that you see, either for the quarter or for the year over the last several years, is just normal fluctuations of the number of projects that we've got going on at any given time. About $5 million of increased general corporate costs, primarily labor. There's some discretionary spend and some foreign exchange that sort of offset each other, but I'd say the primary driver here is labor costs, both as we're increasing labor at a corporate level, plus, we're obviously recruiting for some of the open senior management roles, and that comes at a cost as well.

If we go to income tax on slide 23, so 24.5% adjusted effective tax rate for the year, right around where we had been guiding for most of the year. A bit lower, obviously, as the North America results were a bit short of where we thought they were gonna be. It has an effect overall on how we estimate income taxes. We continue to pay income taxes in Ireland, the U.S., Canada, New Zealand, and the Philippines, and we don't pay income taxes in either Europe due to the accumulating losses or in Australia due to the deduction of the asbestos obligation. If we go to cash flow, we generated about $292 million of cash flow from operations, up about 12%.

It was really a combination of income adjusted for non-cash items, plus a good working capital performance. Working capital was a combination of just normal receivables and timing there. Obviously, inventory was worked against us, so we used cash for inventory purposes. We had drained down inventories going into last year, and then we had, obviously, we built up some inventories coming into the fourth quarter this year and through the fourth quarter this year. So inventory was a use, and then accounts payable was more normal to kind of timing than any kind of programs. But for the year, you can see that working capital was better year on year.

And then, obviously, our annual contribution to AICF last year was higher than the prior year by about $30 million. We had almost $104 million of CapEx last year. I'll get into that in a moment. From a financing standpoint, we had total returns back to shareholders last year of about $273 million, both between the dividend and the share buyback. So up slightly from fiscal 2016, where we returned about $266 million, and fiscal 2016 was almost exclusively through the dividend. And this year, we had both the first and second half dividends in addition to the share repurchase program that we announced in May and executed during the first half. So for the full year on CapEx. There we go.

For the full year on CapEx of about $102 million, you can see that it was primarily maintenance CapEx. As we get into the latter half, second half of the year and into the fourth quarter, you can start to see the ramp-up of the capacity projects. So we obviously continued to start up both sheet machines in Fontana. We had the, we call it PC4, the third operating sheet machine in our Florida plant in Plant City. We started up the new line with Cleburne. We also completed the majority of the reengineering work that's gonna be required to start up Summerville. Summerville is on pace to start back up in the early first half of fiscal 2018.

It's in process of starting up here in the first quarter. We also announced, I think it was in February, the greenfield capacity expansion in Tacoma, and there's some early money that was spent in the fourth quarter in order to secure long lead time equipment, and we'll continue to spend that money throughout fiscal 2018, and then we're about halfway through, a little bit more than that now, on the build-out of capacity in the Philippines. Pretty inexpensive capacity, relative, you know, to the other startups, but we had that capacity going on throughout the year. Over the next several years, capacity is gonna continue to be. Capacity expansion is gonna continue to be a feature.

I'd expect that we would spend approximately $250 million a year for each of the next three years on a combination of capacity expansions and on maintenance CapEx. The primary drivers of the two fifty each year will be the Tacoma site that we've already announced. Most of the spend has not occurred on that yet. You'll see most of that come in fiscal 2018, and then we haven't announced an amount yet, but we're very close to announcing a new plant in Alabama, and that'll be a greenfield site, and I'm guessing by the time we get to August or so, we'll start talking about the cost of that facility.

And so when you take the two greenfields on top of about $100 million or so of maintenance CapEx a year, that's where you get to kind of this $750 million or so over the next three years. There we go. Capital allocation, no real change on how we're thinking about the balance sheet and how we're thinking about financial management of the company. It continues to start with, you know, overall strong financial management. Obviously, margins weren't as strong as we wanted them to be last year, and while cash flow is, operating cash flows were strong, we no doubt left some cash on the table given the inefficiencies, particularly in the North America business. You can see our ratings with the three agencies.

We received a positive outlook statement from S&P and a reaffirmation of the investment grade with Fitch during the fourth quarter. No change in the capital allocation priority, so our top priority continues to be organic growth and funding both R&D and capacity and manufacturing related investments in order to support future growth. The ordinary dividend is our number two priority, and then number three is kind of everything else, so you know, we're maintaining enough flexibility on the balance sheet so that we can be strategic in the event a good opportunity presents itself, as well as having plenty of buffer given the cyclicality of the industry and the markets.

And then, to the extent that there's additional amounts that are left over from us wanting to maintain a one to two X leverage ratio on the balance sheet, those additional amounts will be returned back to shareholders or at least be considered to return back to shareholders, largely through a share buyback program. On the balance sheet side, we're still well within and at the low end of kind of our one to two times leverage range. You can see our facilities are largely unchanged from February when we spoke last. Maturity overall is about 3.7 years, and total debt's close to five, and liquidity is in good shape.

If you go to a quick liquidity profile, so the balance sheet remains to be in a very strong position, both from a cash and our net debt position of just shy of $400 million... or just over $485 million in net debt. No change in the corporate debt structure from the last time we spoke, so a $500 million unsecured credit facility as well as a $400 million note. We're at 1:1 in terms of our net leverage at the moment, so on the low end of our range, but within the stated range of one to two times. In terms of asbestos, the KPMG and AICF updated the actuarial report as of March 31.

There's a AUD 48 million reduction in the undiscounted, uninflated central estimate down to AUD 1.386 billion. The decrease was about AUD 164 million on a net present value basis, down to AUD 1.740 billion. It was a combination of the actuarial assumptions, a decrease as a result of the payment that was made last year, as well as about AUD 117 million due to the lower future insurance proceeds. AICF kind of came to a commutation agreement with the insurance company and received a large chunk of cash, about AUD 117 million of cash during the year, which was a good outcome for them.

Total contributions last year were $91 million that we made during the fiscal year. Since we established the fund in February 2007, we've contributed almost AUD 920 million to the fund, and we anticipate we'll make another contribution this July of about $102 million per 35% of our free cash flow as it's defined in the AFA. If we go into the claims for a moment, you'll see that for both the quarter and the full year, all the claim trends were very favorable, both in total and for the key types of diseases, so mesothelioma in particular. For the quarter, the claims received were up about 6%.

For the full year, they decreased about 3%. For the full year, claims were about 11% below the actuarial estimate. You can see mesothelioma claims for the year were about 6% below last year and 7% below the actuarial estimate. Claims settlement sizes for the year and the quarter were also below the actuarial estimate by quite a bit. That was a combination of large claims. We're seeing favorable trends in age of claimants, which is a positive sign in terms of the overall liquidity of the fund. The number of non-large mesothelioma claims were also lower. Louis hit quite a bit of this in his comments at the end of his section.

As we think about fiscal 2018, we're thinking a U.S. market index that looks a lot like it did last year. So a new, you know, good new construction market that's up kind of high single digits, a repair and remodel market that continues to be very robust, around 4%, and new construction forecast at the moment, we've got 1.2 to 1.3, and we primarily rely on the Dodge construction starts data. EBIT margins were expected to be within the range.

Lou talked a little bit about we'll go into the year, the first half of the year, we'll be at the lower end of the range, and then we'll finish at the upper end of the range as we get to the second half of the year. The Australian business, you know, we expect again a market for fiscal 2018 that looked a lot like fiscal 2017, and we expect that business will continue to grow above its market index, and similarly for New Zealand. So with that, we'll go into questions.

Louis Gries (CEO)

Okay. Yep.

Emily Smith (Director and Research Analyst)

Hi, Lou. Hi, Matt. Emily Smith from Deutsche Bank. So just a couple of questions. I guess, looking into the first half, more specifically, the first quarter, I guess, you know, you put the information in the management discussion on page four, suggesting that the percentage change in the gross margin in the quarter was -5.5 points. I guess going into the Q1 of fiscal 2018, would you expect that -5.5 points should turn around quite a bit because you've got the price increases, a pretty significant offset at three percentage points.

I guess bearing in mind that Q1 2017, the Q1 2017 EBIT margin was 25%, I guess, it's sort of hard to see how you'd be at the low end of the range if you get a 3% price increase, even if the production and startup costs stay at the same sort of level. Just wondering if you can explain that?

Louis Gries (CEO)

Sure. Yeah, we do see it at the low end of the range. I'd say right through the year, fiscal year 2017 is not gonna be a good year to think about from a comp perspective. To me, the EBIT margins we were delivering early were a bit artificial. You know, they reflect too low of the spending on maintenance and some other things in the plants that had carried over from fiscal year 2016, and we started to correct or adjust for, I guess, a better way to put it, starting in July, and we kind of built that program over through the year, and it peaked in December, January, February. Part of that was because we were identifying things as we were going.

We, as most of you know, we were surprised by so many issues we ran into, first quarter, end of first quarter last year, and then we started to reset the business. I think the reset wasn't as efficient as it could have been, but it was okay. It was a big change for the organization. I think they handled it well. We didn't identify everything we wanted to do right off, right out of the chute, but we did, by the time we got to about October, November, have everything identified and programs to address it. So you're right, you're gonna get 3% on the price line, which is good. You're gonna have much higher delivered unit costs than you had last year due to things we've talked about, which is your maintenance spending is still high.

Your board you sell this quarter will be largely produced, you know, either in March or April, and freight costs are high. I can't remember if I said that, so anyway, we do see ourselves down there at the bottom, and then our volume comp's not gonna be as good as we'd want it to be. It's not gonna be as strong as it will be for the year, I don't believe.

Emily Smith (Director and Research Analyst)

So does that mean that you're not expecting startup costs and production costs to fall in the Q1 2018? So you expect them to stay?

Louis Gries (CEO)

We're starting Summerville right now. We're starting to turn the PC3 machine. We're still running PC4 at about a two-thirds efficiency. That's a big machine down there. Cleburne three is good. It's at a point now where it's producing at very near normal unit cost. And then Fontana is still. We still have efficiencies in the system. They're just not gonna be to the same degree as we had in 2017. They're gonna be significantly less. Now, the way you gotta think about startup costs for Hardie, I say, "Hey, we started up 700, and we didn't do it as well as we should have, and we never should have tried to start up that much in a year.

We're starting up 300 this year." Basically, if we wanna grow at the rates we want to grow, we're gonna have to start up 300 every year. So this is more of a 300. This is more of a normal year on startups. The only thing different is you still have, you know, the tail end of the PC4 inefficiencies and the Fontana inefficiencies always also coming into the business, you know, mainly early in the year. They're getting less by quarter, there's no question, but they're still there.

Emily Smith (Director and Research Analyst)

But, I guess just back to the numbers that you give us, I mean, it implies that versus the previous corresponding period, that the margin would only be down around... even if you assume that there's no reduction in the startup and production costs, it sort of only assumes that the margin will be down about 200 basis points with a 3% price increase, which is a 23% margin, not the low end.

Louis Gries (CEO)

Okay.

Emily Smith (Director and Research Analyst)

Does that make sense to you, or?

Louis Gries (CEO)

Well, I started to say, don't look at our comp.

Emily Smith (Director and Research Analyst)

Yeah.

Louis Gries (CEO)

Last year.

Emily Smith (Director and Research Analyst)

Okay.

Louis Gries (CEO)

So that's where I'm gonna end. Don't look at last year.

Emily Smith (Director and Research Analyst)

Okay. All right.

Louis Gries (CEO)

It's an artificial comp.

Emily Smith (Director and Research Analyst)

Okay, thanks.

Louis Pieterse (Analyst)

Louis Pieterse from Macquarie. Just in relation to the service issues that you outlined and the fact that you're, I suppose, calling out DIFOT levels in the 80s, is there any negative franchise impact from your customers? What's the sort of sense from the market?

Louis Gries (CEO)

Yeah. Yeah. Thanks, Louis. There's no question customers, you know, would have a little fatigue with Hardie at this point. Allocation last year, long lead times in a couple segments. And then this year, you know, we get ourselves back in pretty good shape. We have a price increase. Of course, they gotta take advantage of the pull-forward price increase 'cause they've got protection out there for their customers, so we give them an opportunity to buy about 10% more board at the old price, so they can take care of their price protection commitments. So we pull all that down, and then we're back into service, about 80%. Now, there's two parts to a service equation.

There's the on time and full, which is in the 80s, and then there's the severity, how late are you? And right now, we're in the 80s on the on time and full, but we're doing well with the how late are you, so normally two, three days late. So because we have a channel between us and the job site, there's no danger that we're holding up jobs if we stay with a severity of two, three, four, five days late. It's when you get two, three, four weeks out that you can run into those risks. So you say franchise damage makes it sound worse than I wanna make it sound. But yeah, there's fatigue out there with things.

You know, I mean, people that do business with Hardie would like to feel like they push a button, and what they expect happens to happen, happens, and that's kind of our reputation. And over the last 12 months, that hasn't been the reality, so the sooner we can pull out of that situation, the better. But it won't. You know, we're trying to do it in the big, you know, in the seasonal, you know, in the building season. So it's probably gonna take us, you know. I don't know.

I think it's gonna take us to get through the first half, and we start getting the seasonal, you know, downturn a bit, and then, then all of a sudden we'll, 'cause we gotta, we gotta pick up, you know, like, not a little bit of inventory. We gotta pick up 60-70 million feet of inventory to really feel comfortable. So, our run rate is not that high above our order rate at this point.

Louis Pieterse (Analyst)

Thanks, Lou. Just, could I indulge on one more? If you strip out the impacts of production costs and startup costs and just thought about raw material increase, cost push, versus your 3% price growth, do you think that at a fundamental level, you're offsetting the cost push that you get?

Louis Gries (CEO)

We're easily offsetting that. Do we have any kind of ballpark that we're gonna be external on raw material forecast?

Matt Marsh (CFO)

We're not sure.

Louis Gries (CEO)

We're not gonna ballpark it, but the 3% will easily offset it.

Louis Pieterse (Analyst)

Thanks.

Andrew Johnston (Head of Basic Industrials and Services)

Andrew Johnston, CLSA. Just if I can talk about your commentary around the last quarter, Lou, around what margins should look like at this point in the cycle, and I think the comments were that, were it not for the startup capacity issues you were having, you would expect margins to be. I can't exactly remember, it was at the top end or above the top end of the range, but what's changed in the last quarter? I suppose also as part of that as well, following on from Emily's comment about the gross margins, if you look at the gross margin in the third quarter versus the fourth quarter, it continued to decline.

Is that all just part of the comments you've made now, or is there something else that was going on?

Louis Gries (CEO)

Yeah, I think we covered it all. It's kind of where you know, we are flat. We're on a flat part with some of the startups now. We're improving on those startups. We're back with a positive slope. And then the other thing is, looking for our EBIT margin slide. Yeah, so you got about 45. I mean, the board we have in inventory now is expensive board, 'cause we just started tapering down as the throughput's going up. Now, when you have the denominator and the numerator moving at the same time in the right directions, it can change pretty quickly, but so far, we're just not there yet. So the leading indicators are very good on our, on the manufacturing side.

But until you deliver the result, you just, you know, you just don't have it. And then we, we actually get it 45 days after we deliver the result, you know, you start seeing it, you know, externally, you start seeing it. Even internally, we're seeing early signs rather than, "Okay, we got it." We're seeing that, "Okay, we're getting it," rather than, "We got it," at this point. So I think, back in November, I said this is a two to three-quarter issue we have in manufacturing. It's probably playing out to be three. Maybe, maybe you're gonna say, "Well, it sounds more like three. It sounds more like four than three." I don't know. It's... We're off the bottom. We got good trend lines.

So far, you and I have seen it in our results, and I don't. You'll see. I think maybe a hair of improvement in the first quarter, but not much. So the EBIT margin, you asked the question, and I kind of remember the, you know, do I think Hardie should be running at or above the 25%, this type of market? Yes. There's no question. We should. It's just internally on the operating side of the business, we haven't, we haven't managed it as well as we should have, and that's the difference between being 25% and 26% versus, you know, where we finished last year.

Andrew Johnston (Head of Basic Industrials and Services)

You made a comment earlier, and I just wasn't quite sure of the context, because you said that the margins that we saw were probably artificial.

Louis Gries (CEO)

Yeah. What I mean by that, and I... You know, there was nothing wrong with it. All the accounting was sound. It's a quarter, it's a quarterly thing, and we were in a period where we were underspending on maintenance and a few other things, and that was kind of also on a slope that was underspending every quarter. It was getting greater every quarter. So in July, like I said, we had a bit of a wake-up call in July, and you know, because about this time last year, we started getting short on board, okay? Before that, we were fat and happy, thinking everything was fine. We started getting short on board, and that pushes you right to throughputs. I think I have the capacity in place.

Why am I not getting the service position or the throughputs I want? And that led to a pretty good, pretty deep drill down on manufacturing. And like I said, it just even though we had taken that nice step up between 2015 and 2016, and we were still operating at a higher level, we weren't operating at the level we had planned, okay? And part of that 2015, 2016 startup, I think, had too much on the numerator as well as gains on the denominator, okay? So unit cost is, you know, numerator, denominator. I think we did a really good job on the denominator, and we maintained most of that, although you can see we went into a tailspin.

We're still at a much higher level than previous, but once we fully understood what the impact of programs on the numerator were, we had to reverse course, and that's what last year is all about. And that's why I say the first quarter—I artificial is the wrong thing, 'cause I don't want, you know, mislead anyone to thinking, you know, there was anything wrong with the numbers. It was the game plan that was wrong, you know. It was just not a way to run a business, and it delivered a good short-term EBIT result, but not in a sustainable EBIT result.

Andrew Johnston (Head of Basic Industrials and Services)

How do I reconcile that comment that, you know, those high margins above 25 were.

Louis Gries (CEO)

Yeah

Andrew Johnston (Head of Basic Industrials and Services)

Were unsustainable with your comments that the business at this point in time should be delivering those sorts of margins?

Louis Gries (CEO)

Yeah, it's a good comment, but I mean, we got the other thing you gotta remember. Last year, we skipped price.

Andrew Johnston (Head of Basic Industrials and Services)

Yeah.

Louis Gries (CEO)

Okay, so do I think Hardie should skip price when the market has inflationary factors and most of the rest of the market is taking price? Not unless there's some specific reason, you know, some specific initiative. And you know, so the way you get to your above 26 is good volume growth, some price improvement that more than takes care of your cost, and then good operation of your network. So last year we had, kind of. We didn't have the operating of the network. That was the big problem, and we didn't have the price going for us either. We did have the volume going for us, so we did one for three. We're like baseball players. We hit 333.

Andrew Johnston (Head of Basic Industrials and Services)

And just on the order book, you mentioned was a bit soft, any particular region?

Louis Gries (CEO)

You know, I didn't even look at it region by region, but if there is a particular region involved, it's just normal regional variance. So we have no regional problem in the business. Yeah.

Andrew Johnston (Head of Basic Industrials and Services)

Thanks.

Louis Gries (CEO)

Any other questions in the room? Geez, I'm gonna give you an overview every time. Got so many questions. All right, how about on the phone?

Operator (participant)

Thank you. We do have your first question. It comes from Brook Campbell-Crawford from JP Morgan. Please go ahead.

Brook Campbell-Crawford (Building Materials Analyst)

Good morning, Louis. I'm Brook Campbell-Crawford here from JP. I had a question on the SG&A expense. You've explained quite well the step up in FY 2017 due to increased labor costs and sales and marketing programs. Can you talk a little bit about what that figure looks like next year? Are you gonna continue to invest ahead of sort of penetration expectations into the market in the U.S.?

Louis Gries (CEO)

Yeah, we will continue to invest. You just won't see it year to year at the same level in actual cost. But yeah, one of the things we did do very well in 2017 is we kind of reset our market development initiative against vinyl, and we got a lot of resources. I think we improved the game plan. We got a lot of resources on that initiative, and like I said, there's two parts to our growth equation. One is, you know, what does vinyl do against its own market index, and they're declining, and I think they continue to decline or accelerate. And then you got us and LP as the two largest hard siding players kind of growing above our market index.

So LP, as you know, has kind of taken a good enough position against us, so there's work to be done there by Hardie. But we didn't get much of it done in 2017 'cause of our shortages in board. And we got to make sure we get that buffer built back in, so we can get more serious about our programs against close alternatives, which LP is one of them.

Brook Campbell-Crawford (Building Materials Analyst)

Thanks. That makes sense, and a question from Matt on the CapEx side. I think I recall the guidance being for CapEx to be north of 2025 for FY 2017, and that obviously came in a bit lower than that. Can you talk a little bit about what the differences was in the period, if those figures are correct?

Matt Marsh (CFO)

Yeah, I think it's just timing of when some of the CapEx hit for the future expansion projects. So we've obviously got Tacoma out there and timing of Summerville, and I think it's just timing on between the quarters. Nothing kind of no change in direction or strategy.

Brook Campbell-Crawford (Building Materials Analyst)

Okay, thanks. And then one more just on price. You talked about a 3% price increase for this year. Will there be any benefit or impact to the mix over and above the 3%?

Louis Gries (CEO)

Yeah. So product mix, segment mix, customer mix, all that'll add up to a positive.

Brook Campbell-Crawford (Building Materials Analyst)

Okay, thanks.

Operator (participant)

Thank you. Your next question comes from Ramon Lazaro from UBS Investment Bank. Please go ahead.

Ramon Lazaro (Managing Director)

Good morning. Just one follow-up on Brook's question on SG&A, Matt. So just wondering if that $75 million SG&A costs in the fourth quarter, which was similar to the third quarter, should we assume that is now the normal sort of quarterly run rate for fiscal year 2018?

Matt Marsh (CFO)

Yeah, I don't know if I'd. I don't think I'd. I'd probably be misleading you to say, you know, take the 75 and plug that into each quarter, you know, and that's kind of what you're gonna have in fiscal 2018. We're gonna continue to grow it, you know, in fiscal 2018, not to the same rate that we grew it in fiscal 2017, but I'd also expect it to, you know, to still grow at a fairly healthy clip as we're continuing to invest in the organization and in some of the sales and marketing programs. So it won't grow quite as much as it did in fiscal 2017 compared to 2016, but in fiscal 2018, it'll continue to expand.

Ramon Lazaro (Managing Director)

Okay, good. Thanks for that. And then just one for Lou, just your comments on PDG in the first quarter. Lou, just could you elaborate on those comments that PDG were a bit weaker?

Louis Gries (CEO)

Yeah.

Ramon Lazaro (Managing Director)

Than you expected?

Louis Gries (CEO)

Growth above market index quarterly is too short, but what you can see in our growth above the market index, as we went on the allocation and longer lead times, you could see some of the momentum in that area come off. Some of that was giving up business we already had that we considered not at a profitability level that you know made it worth keeping and trying to trade that off for new business or core business, either growth or core. So I do think next year we will be making some trade-offs on the volume we desire the most in order, you know, as I said earlier, to get our buffer there.

We went through the business, and repeating myself now, last year was manufacturing, okay? That's what I want you to remember. Last year's manufacturing. But part of having a EBIT problem in a business is you drill down in a lot of areas and not just manufacturing. So we went through, you know, what product lines were using capacity and at what rate, and then what the profitability of that those product lines is. And as you know, most things at Hardie are very profitable, but we did find that not all things were as profitable as you know, you would want them to be if you're gonna justify a new investment in capacity. So we had about 3% of our business that kind of falls into that category.

My thinking is we either got to get the profitability up on that 3% or we got to move away from that 3% and use that capacity for you know kind of product lines that can generate the kind of cash that you know supports capacity expansion. So that's part of the PDG equation. The other part is what I talked about you know on the allocation, followed by long lead times, followed by service position not being as strong as we want it to be in the building season.

Ramon Lazaro (Managing Director)

Okay, great. Thank you.

Louis Gries (CEO)

Yeah.

Ramon Lazaro (Managing Director)

That's helpful.

Operator (participant)

Thank you. Your next question comes from Andrew Peros from Credit Suisse. Please go ahead.

Andrew Peros (Building Materials Analyst)

Thank you. Lou, just a point of clarification around that safety initiative you talked about. I think you called it investing in infrastructure, $15 million per annum for three years or so. Is the allocation of that expense coming through in the North American EBIT line, or do we see that come through in the CapEx line?

Louis Gries (CEO)

Yeah, it's a bit of a mix. So some of it's operating CapEx and some is expense, but enough of it's expense to where you definitely see it in our bottom line.

Andrew Peros (Building Materials Analyst)

Okay, thanks. Also, in the windows business, it doesn't look as though the losses are slowing. I think previously you called out that that business, as a minimum, will be break even in FY 2018. Is that still, I guess, an expectation at this point in time?

Louis Gries (CEO)

No, I think we lost a year. We didn't lose a year in capability, but we didn't run that business model as well as we should have last year, so we kind of lost a year. So I'd push that back till 2019.

Andrew Peros (Building Materials Analyst)

Okay. Similar losses in 2018 as you saw in 2017, I guess?

Louis Gries (CEO)

A little bit better.

Andrew Peros (Building Materials Analyst)

Okay.

Louis Gries (CEO)

Little better.

Andrew Peros (Building Materials Analyst)

Okay, thanks. That's very good. Also, just maybe a question for Matt around depreciation. You know, following the material step-up in CapEx, wondering at what point we should expect to see the D&A charge start to step up? And if you could perhaps help us out with a bit of guidance around that, that would be very much appreciated.

Matt Marsh (CFO)

Sure. So I think in the appendix, there's a slide on depreciation. But it, I think it was around $80 something million or so last year. That was a step up from the prior year. I'd say if you looked at the last three years on depreciation, you'd see kind of a fairly modest $10 million or so a year increase in depreciation. Not even quite that much. And it will obviously continue to step up over the next couple of years. But what you gotta keep in mind is that while we're investing in new capacity, some of the old assets, obviously, you know, are getting to a point where they're fully depreciated.

Just with the timing of when we brought those assets on, call it 15-20 years ago, and now the new assets that we're bringing on, you do get... You don't get a one-for-one step up in depreciation the way you might be expecting. So, depreciation will expand. You'll note the last couple of years, it hasn't expanded quite at the rate that CapEx has expanded, and I think that's a pretty good framework to think about for the next couple of years.

Louis Gries (CEO)

You know, there.

Andrew Peros (Building Materials Analyst)

That's very helpful. Thank you.

Louis Gries (CEO)

It reminds me of the summary comment I was gonna make on our capacity. So you saw all that capacity we brought on, on 2017. We didn't bring it on as well as we should have, obviously, and it's had ramifications for this year. But that brownfield capacity from an investment standpoint is very efficient capacity. So as it gets up and running, we'll obviously be benefiting from that. As far as the greenfields, obviously, greenfield comes on at a higher cost per unit. But you know, we'd expect, number one, we're working NCRs to make sure we don't spend more than we need to in a greenfield situation.

And two, now for all our startups, we've finally learned our lesson, so we start our startup activity for Tacoma a year before actual startup at a plant. So we'll bring in people management. It'd be a much more formalized startup program. And I am certain, just like we did in Cleburne, I'm certain we'll do a way better job starting up the next three major capacity adds we have. But again, greenfield's gonna be higher cost per unit, where these brownfield additions were really efficient from a cost-per-unit standpoint. Okay, any other questions on the phone?

Operator (participant)

We have one final question. This comes from Simon Thackray from Citi. Please go ahead.

Simon Thackray (Director and Senior Industrial Analyst)

Thanks. Morning, Lou. Morning, Matt. Just want to start back a little while. Lou, your comments on sort of bringing facilities and process, I guess, into the current era around the Zero Harm and the cost of doing that. I think you referenced $10 million-$15 million a year. I just wanted to clarify, is that an ongoing expectation for cost for the next few years to bring facilities up to speed?

Louis Gries (CEO)

On the infrastructure?

Simon Thackray (Director and Senior Industrial Analyst)

Yes.

Louis Gries (CEO)

Yeah, that I think you're maybe two to five or something like that, two to five years.

Simon Thackray (Director and Senior Industrial Analyst)

Right, so we should assume that you'll be spending 10, 10-15 for 2-5.

Louis Gries (CEO)

Yeah.

Simon Thackray (Director and Senior Industrial Analyst)

Is that, is that right?

Louis Gries (CEO)

Yeah. And that's across, you know, nine facilities now.

Simon Thackray (Director and Senior Industrial Analyst)

Right.

Louis Gries (CEO)

Yeah, I mean?

Simon Thackray (Director and Senior Industrial Analyst)

How much was spent this year?

Louis Gries (CEO)

About that rate on the infrastructure part.

Simon Thackray (Director and Senior Industrial Analyst)

Okay.

Louis Gries (CEO)

But we spent it, spent it quicker than the full twelve years. We didn't start till, after July.

Simon Thackray (Director and Senior Industrial Analyst)

Yeah. Okay, got it.

Louis Gries (CEO)

Yeah.

Simon Thackray (Director and Senior Industrial Analyst)

Thank you. Just going back to something a little bit obscure. In your concentration of risk in your accounts, you talk about customer A, which I assume is the same customer year-on-year, 2015, 2016, and 2017. And I know you report customer concentration risks based on gross sales, not on net sales, as you report in your financials. But if I back solve for the concentration risk again, and look at the spread between gross sales and net sales, it would seem the discount or whatever it is, the spread between gross sales and net sales has been increasing year on year, and that customer concentration has been increasing, certainly 2017 on 2016. Can you just talk about the mix of customers with the major home builders, the price discounting?

What would be driving that spread? Or is that fake or something else that I need to think about, or...?

Matt Marsh (CFO)

Yeah. So on, I think you're probably referring to something that's in our 20-F?

Simon Thackray (Director and Senior Industrial Analyst)

Yep.

Matt Marsh (CFO)

Yep, and where we talk about kind of top customer?

Simon Thackray (Director and Senior Industrial Analyst)

Yep.

Matt Marsh (CFO)

Yeah, so obviously, we don't disclose what the top customer is, but, you know, we do have, obviously, different tactical pricing strategies by segment and in some cases within the builders, depending on what our market penetration objectives are. So what you're probably picking up on is just the difference between that particular customer and programs that may be available to them, depending on where they're operating, and then other customers where that same program doesn't exist.

Simon Thackray (Director and Senior Industrial Analyst)

I presume it's a U.S. customer, Matt, yeah?

Matt Marsh (CFO)

Yep, that's true.

Simon Thackray (Director and Senior Industrial Analyst)

So that makes it more like 15% of the U.S. net sales for the year.

Matt Marsh (CFO)

Yeah, I think that's a good estimate.

Simon Thackray (Director and Senior Industrial Analyst)

Okay. So, if there's a push towards greater concentration of the major home builders, does that mean that the discount potentially, or the gap between gross sales and net sales gets larger? Is that the idea, because they're on preferential treatment?

Louis Gries (CEO)

Yeah.

Matt Marsh (CFO)

Uh.

Louis Gries (CEO)

Let me. I'm not fully understanding. I guess the easiest way to tell you is we haven't changed it, so. There's been some consolidations in the market. Now, we don't sell builders direct, so it wouldn't be so much about builders. But we haven't changed our basic, you know, customer strategy. We sell through distributors, we sell direct to dealers, we sell direct to boxes, we sell direct to the pro channel. So we haven't changed anything. So I haven't paid attention to the information you're looking at, and I'll ask Matt to show it to me later. But we haven't made any changes. We haven't consciously done anything, and we don't think we're in a position that we have to react to anything.

We like, we like where we're at, customer to customer and, and from a risk perspective, also from a access to market perspective.

Simon Thackray (Director and Senior Industrial Analyst)

Cool. And then just going back, you made, you're pretty emphatic, Lou, about the 3% price rise covering any increase in cost expectations for the year in terms of the margin. So I think on a like-for-like basis, on your gross margin, you'd have to see a 9% increase in the cost of goods sold. So is there any area, I mean, looking at pulp, obviously, but looking at input costs, is there any area that you would be more worried than less over the next 12 months?

Louis Gries (CEO)

The, the question I think Peter asked me was, the material, the raw material input cost increases rather than cost of goods sold increases. I think cost of goods sold is gonna comp higher, or it won't comp higher than last year, but the reality is cost of goods sold above kind of like an efficient level this year, we won't hit the level we want in one year. But we think we're on a program that we drive the business back to a level we want. And like I said, that's both the numerator and the denominator. We're getting, we got programs on the numerator to kind of play that catch up and then let it taper down to a run rate level we're comfortable with in the future.

And then in the denominator, one thing I didn't cover is, as we've been working on these throughputs in the manufacturing, similar to what we saw in 2015, we do see some upside, you know, not only to get back to where we wanna be, the level we were at in 2016, but we also see some throughput opportunities beyond that, which we've put some technology projects in place to try and, I guess I did mention it, try and compress the downtimes for the product mix we're running. So, that, that's code for, you know, kind of, new products don't normally run at the same throughput rate as kind of the old established products that have long experience curves on. So we've accelerated some of that work.

So, yeah, I mean, generally, again, the summary in 2017 was a miss for us. It wasn't a miss on the market side, but it certainly was in operations, and it certainly was from a financial result. You know, just like anything else, when you have a miss, you got to learn from it. I think we're committed to a program in manufacturing that gets us, you know, exactly where we need to be, not overnight, but certainly for future growth. You know, we'll get our leverage back on the financials as we implement that program.

Simon Thackray (Director and Senior Industrial Analyst)

Sure. And just on that market side, Lou, you made, I think, the comment earlier that the order book at the moment was softer than you would have thought. I presume that the impact of the pull forward volume into March was dealt with predominantly in April, and early May. So is this tracking with what we're sort of seeing in slightly disappointing permit sort of data? Or how do you feel about the order book, you know, the recovery in the order book or the growth in the order book over the next months?

Louis Gries (CEO)

I got mixed feelings. If I had a real strong order book right now, I'd be more worried about service positions.

Simon Thackray (Director and Senior Industrial Analyst)

Yeah.

Louis Gries (CEO)

So, I'm okay where we're at. I mean, you can't run from the fact that we're on allocation, that we had long lead times, and we have a low service position. You know, the question was asked, you know, are you doing damage to the company? Hey, we've surprised the market on the downside, our customer market on the downside by getting short on capacity, just like we surprised our investors being short on capacity. So, the only thing I can tell you is we have the game plans in place. We're committed, we'll get it done, and we'll work through it.

I think our general guidance on this thing, you know, when we realized the extent of our problem back in probably, I can't remember exactly what we talked about in September, probably, didn't fully understand it till November, but we said it was a two, three-quarter problem, and I think it's a two, three, maybe three plus, a month or two problem. And we'll be on a good track, but we're just pointing in that direction right now. Like I said, the leading indicators are good. Resourcing on the manufacturing side of the business, we've built, filled some holes. We're doing a good job on, you know, kind of knocking some stuff over, but it's all leading indicators.

We still got to deliver the result, and we'll do that, you know, on the manufacturing side. As we move through the year, I think we'll have a more positive story every quarter for you on the manufacturing side.

Simon Thackray (Director and Senior Industrial Analyst)

Excellent. Thanks, Lou. Thanks, Matt.

Louis Gries (CEO)

Yeah. All right.

Operator (participant)

Thank you. Your final question comes from Matthew Burgess, from Bloomberg News. Please go ahead.

Matthew Burgess (Reporter)

Good morning, guys. I was just wondering if you could provide an update to the vacant senior management positions that are there at the moment, how the recruitment is going on for that?

Louis Gries (CEO)

Management positions. Senior management. Oh, management? Yeah. No, actually. So, most of you know, we've had some turnover of senior guys, long-term guys at Hardie, you know, for different reasons. But, Ryan Sullivan left last July, and then Mark Fisher left early August, I mean, early April. So, we're in a resetting of the GMT, which is our senior team at Hardie and the teams that work for the GMT. We have a major initiative strengthening those team. We brought in a new head of HR in January, Kirk Williams, he started. And, just recently, in this room, actually, Jack Truong has joined us as the Head of International.

So, we're happy with the progress we're making. We think we're in the final stages with a head of sales and marketing in the U.S., and we also have an active search for a CTO. So, we believe we'll fill out the kind of reset GMT, you know, this calendar year, maybe bring the CTO on in October, November timeframe. Yeah, I'm pretty excited. Jack certainly brings some background experience and capability to Hardie that we haven't had at the senior team in an operating executive, and I think we'll accomplish the same with the head of sales and marketing. And, we're very early in the CTO, so I haven't seen any individuals for that position yet, but I'm optimistic.

Yeah, it's been a pleasant surprise that a company like Hardie, you know, which is still, although we have a good market cap, we're still a relatively small company, and to attract an executive like Jack is very encouraging for me. I think we're gonna do a good job filling out the GMT and really resetting the capability at the most senior level at Hardie.

Matthew Burgess (Reporter)

Excellent. Thank you, guys.

Louis Gries (CEO)

Yeah. All right, thank you. I appreciate you joining today.