Louisiana-Pacific - Q2 2023

Transcript

Operator (participant)

Good day, and thank you for standing by. Welcome to LP's second quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there'll be a question-and-answer session. To ask a question during the session, you'll need to press star 11 on your telephone.

You will then hear an automated message advising your hand is raised. To remove yourself from the queue, please press star 11 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Aaron Howald, Vice President of Investor Relations and Business Development. You may begin.

Aaron Howald (VP of Investor Relations and Business Development)

Thank you, operator, and good morning, everyone. Thank you for joining us to discuss LP's results for the second quarter of 2023, and our outlook for Q3 and the remainder of the year. My name is Aaron Howald, and I am LP's Vice President of Investor Relations and Business Development. Joining me this morning are Brad Southern, LP's Chief Executive Officer, and Alan Haughie, LP's Chief Financial Officer.

During this morning's call, we will refer to an accompanying presentation that is available on LP's IR webpage, which is investor.lpcorp.com. Our 8-K filing is also available there, along with our earnings press release and other materials detailing LP's strategy and sustainable business model.

Today's discussion will contain certain forward-looking statements and non-GAAP financial metrics, as described on slides two and three of the earnings presentation. I will incorporate those slides by reference rather than reading them. The appendix of the presentation also contains reconciliations that are further supplemented by this morning's 8-K filing. With that, I will turn the call over to Brad.

Brad Southern (CEO)

Thanks, Aaron. Good morning, and thank you all for joining us. I'll briefly describe LP's results for the quarter before I turn my attention to the future and discuss LP's strategy of growth, innovation, and efficiency, and how it positions us exceptionally well to benefit not only from the ongoing rebound in new construction, but also from the improvement in repair and remodeling that we expect will eventually follow.

The second quarter ended with encouraging signs of an improving housing market. While single-family starts are down 21% for the first half of the year compared to 2022, May and June saw stronger-than-expected building activity. As housing starts have rebounded, demand for LP's Oriented Strand Board has followed, pushing prices meaningfully higher and improving LP's EBITDA and cash flow outlook.

By contrast, the repair and remodeling market appears to be comparatively weak and softening, likely due, at least in part, to constrained home inventory and reduced home sales. Existing home sales, which in a typical year outnumber starts by 4 or 5 to 1, are down 23% for the 1st half of the year, and vacancy rates and active listing counts suggest that trend will persist.

The shed market, where LP has a dominant share of exterior siding panels, closely follows existing home sales and has been similarly weaker so far in 2023. Against this backdrop, LP generated $611 million in net sales, $93 million in EBITDA, $88 million in operating cash flow, and $0.55 in adjusted diluted earnings per share.

While our EBITDA performance exceeded guidance from the prior quarter, siding revenue was lower than expected, with sheds the softest component of the siding business in the quarter. Overall siding volume dropped 16% versus prior year quarter, roughly equal to the drop in single-family starts for the quarter.

Partially offsetting this, siding prices were 6% higher than prior year, with the result that net sales were 11% below prior year. On slide 6, you can see that while single-family starts dropped 22% on a trailing 12-month basis, siding volume was flat and siding prices were up 11%. Comparing the first half of 2023 to the first half of 2019 before the pandemic, siding revenue has grown at a compound annual rate of 14%. Over the same 4-year period, single-family starts were essentially flat.

The first half of this year is certainly softer compared to the COVID year, since siding was on allocation. Siding growth consistently exceeds that of the underlying market. A bright spot for the quarter was ExpertFinish prefinished siding, which saw a flat volume in Q2 compared to prior year, despite the general R&R slowdown. Our newest ExpertFinish facility, located in Bath, New York, will open in Q3, bringing increased automation and improved efficiency to LP's prefinished siding production.

To support ongoing product innovation, in the second quarter, LP opened our new innovation center at the Natural Resources Research Institute in collaboration with the University of Minnesota Duluth. The innovation center will accelerate our development of high-performance and sustainable building solutions. We're also happy to announce the introduction of two new additions to the siding product portfolio.

The new products are Brushed Smooth, ExpertFinish Lap, and Pebbled Stucco Panels. These new offerings retain LP SmartSide's durability, efficiency of installation, and industry-leading sustainability, and will help us gain share in markets that prefer these aesthetic characteristics. For the OSB segment, the ongoing improvement in single-family new construction has led to increased demand for OSB, which has in turn led to higher prices.

Given the 2-3-week OSB order file, the price increases in the last days of Q2 will mostly be reflected in Q3. Impressive operating efficiency and a sequentially higher Structural Solutions mix of 54%, helped the OSB business contribute $37 million in EBITDA in Q2. Both businesses have done an impressive job so far this year, operating efficiently despite lower capacity utilization as we manage our operating footprint with discipline.

While the current market environment for repair, remodeling, and siding may be softer than anticipated, our commitment to our strategy is unwavering. We will continue to grow through innovation, manage our capacity with discipline and efficiency, and preserve the strong balance sheet that lets us invest in our future. Our strategy is working.

We will continue to invest in capacity to produce and deliver the best siding and Structural Solutions products in the industry. The acquisition of what will become our next siding mill in Wawa, Ontario, is an example of this. We are pleased with the progress we have made integrating the Wawa team into LP Siding business.

We are engaging with the local community and First Nations as we prepare to sustainably harvest the local Aspen fiber, and we have begun the engineering work necessary to prepare Wawa to become a state-of-the-art siding mill so that we can meet growing customer demand. Our capital allocation strategy gives us the flexibility to adjust the timing of investments in growth to match customer demand, decoupled from the volatile cash flow generated from OSB price fluctuations.

Before I turn the call over to Alan, I want to conclude by spending a moment talking about safety, which is a core value at LP. Our goal is zero injuries, and while we will never be perfect, we work every day to continuously improve safety at LP. We were recently notified that LP won the 2022 Safest Company Award from APA, the Engineered Wood Association.

This is the 11th time in 15 years that LP has earned this award. Safety is not about winning awards, it's about building a culture where we look out for ourselves and each other, so we can all go home to our families safely every single day. I'm happy to say that LP safety performance in Q2 has continued to build on our safety legacy.

In the 2nd quarter of 2023, LP Siding business had a 1 recordable injury. The rest of our North American employees, including the OSB business and all corporate functions, ended the quarter without a 1 recordable injury. That means LP team members in North America completed almost 2 million work hours with only 1 recordable injury.

One is too many. We will learn from it and improve, but we are incredibly proud of this result, and I know that every employee shares my commitment to being the safest company in our industry. With that, I will turn the call over to Alan for a more detailed review of the financial results before we take your questions.

Alan Haughie (CFO)

Thanks, Brad. The waterfall on page 7 of the earnings deck shows sidings results for the second quarter compared to the prior year. The reduction in volume is the largest driver of both the year-over-year revenue decline and the revenue guidance miss. This 16% volume decline resulted in $54 million less revenue and $26 million less EBITDA, given siding's high variable margin.

Price increases partly offset the volume decline. The combination of list price increases last July and this January lifted net prices by about 6%. Outside of volume and price, other factors in the quarter include continuing mill conversion costs. On our first quarter call, we identified $16 million of such costs embedded within EBITDA. As predicted, that cost has fallen to roughly $10 million this quarter as Sagola ramps up production.

Five million dollars of this is identified on the waterfall, a further $5 million is a repeat cost from last year. Same cost, different mill, so does not pop as a variance, it's there nonetheless. On the plus side, input prices have stabilized in some cases already falling. Year-over-year, freight costs fell by $4 million, partially offsetting a $6 million headwind from raw material inflation.

Thankfully, a much smaller impact than in recent quarters. The resulting EBITDA of $59 million at a margin of 18% would have been 3 points higher, for the mill conversion and ramp-up costs, which I must stress, are entirely discretionary and incurred in the interest of long-term growth. The OSB waterfall on page 8 is similar to those of previous quarters, in that the price change dwarfs all other factors.

As in recent quarters, I will dispense with price and describe the remarkable performance delivered by the OSB team, managing the business safely and efficiently in a challenging market environment. Commodity volume was down 12% year-over-year, with market curtailments and the removal of Sagola partially offset by substantial improvements in operating efficiency.

Structural Solutions mix was up sequentially and year-over-year, accounting for 54% of second quarter volume. As in siding, raw material inflation plateaued and is receding for many input categories. Perhaps most impressive, the OSB business achieved a 5% reduction in cash cost of production compared to the second quarter of last year, despite volumes being nearly 20% lower.

The $17 million benefit from lower cost of production, combined with $4 million in freight savings and the transfer of Sagola overhead to the siding business, added $32 million of year-over-year EBITDA benefit in the quarter, more than offsetting all other non-price factors. This highlights the considerable value of our strategy of operating OSB efficiently while maximizing the incremental contribution from the Structural Solutions portfolio.

Cash flow is shown on slide 9. As expected, it improved sharply in the second quarter, with a net outflow of $56 million, compared with a $257 million outflow in the first quarter. Clearly then, absent the $80 million payment for the Wawa facility, cash flow would have been positive in the quarter, even with ongoing investments in Sagola, Bath, and other maintenance and growth capital spending.

In addition to spending $74 million on CapEx and acquiring Wawa, LP paid $17 million in dividends and paid $12 million in cash taxes. We ended the quarter with $30 million drawn on our revolver, leaving us with about $600 million of liquidity.

Cash flow has continued to improve in recent weeks, in large part due to increased OSB prices, with the result that the revolver has now been fully paid down. LP's capital allocation strategy is unchanged, as is our commitment to it. We'll continue to earn cash, invest in growth, and return a significant portion of the remainder to investors via dividends and share buybacks in that order.

With Sagola producing A-grade lap siding and Bath starting soon, the bulk of 2023's CapEx is behind us, the rate of expenditure should be significantly lower in the back half of the year. As a reminder, LP retains $200 million in board authorization for share repurchases, and as OSB prices and cash flows improve, so too does the probability of share buybacks.

Now, it was rather a busy quarter regarding the reconciliations of net income to both EBITDA and adjusted net income. Let me spend a moment to describe three items that appear on slide 10 of the presentation, covering, in this instance, the net income to EBITDA reconciliation. Reading top to bottom on the slide, the first item of note is a $21 million tax provision. We decided to repatriate $45 million of cash from LPSA in the second quarter.

This means that we can obviously no longer assert that cash held in South America is permanently invested there, which triggers the obligation to book a tax entry to reflect the potential tax we would pay, if and only if, we choose to repatriate the remainder of LPSA's cash. That charge was about $22 million, $5 million of which relates to the $45 million actually repatriated, leaving $17 million of the $22 million charge as a non-cash entry.

The next item on the list is a $17 million other operating charge, of which $16 million relates to the resolution and settlement of a patent dispute within the OSB business. Finally, you'll note $34 million in business exit charges in the quarter. This refers to Entekra, the exit of which was referenced on our first quarter earnings call and is mostly non-cash.

Brings us to guidance. I've already mentioned the near completion of 2023's major capital projects, that's where I'll start. Remaining expenditures for the year should bring full year CapEx to about $300 million, implying roughly $110 million of spending in the second half of the year, with a roughly 60/40 split between growth and sustaining maintenance.

With reference to siding growth, in previous quarters, the long lead times resulting from our managed order file enabled greater near-term visibility and made quarterly revenue guidance both useful and meaningful. The combined effects of moving off from managed order file and our increased focus on one-step distribution has resulted in a new normal order file of roughly two weeks. While this makes us much more responsive to our customers, it also makes quarterly revenue less predictable.

We'll take a longer-term focus going forward. First, recall that the third and fourth quarters of last year set records for siding volume and revenue. While we expect second half revenue to be roughly 5% higher than first half revenue, this will result in a year-over-year decline in the second half of 12%-13%, and therefore a full-year siding revenue decline of roughly 10%. With respect to OSB, the rapid increase in OSB prices also complicates our algorithmic approach to revenue guidance, in part because LP's price realization tends to lag price movements in either direction.

That being said, if we assume that prices remain flat at last Friday's levels, published by Random Lengths, and if we adjust for the lag time induced by our order file and other factors, we would expect OSB revenue to be at least 50% higher sequentially compared to the second quarter of this year. It should go without saying, but just for the avoidance of doubt, this is not a price prediction, merely an assumption for modeling purposes.

Under these assumptions, and including the cost of a third-quarter press rebuild in siding, as well as some maintenance in the OSB business deferred from earlier in the year, we would expect total company EBITDA to be between $160 million and $180 million in the third quarter. With that, we'll be happy to take your questions.

Operator (participant)

Thank you. As a reminder, to ask a question, you'll need to press star one one on your telephone. To withdraw your question, please press star one one again. Please wait for your name to be announced. We ask that you please limit your questions to one with one follow-up. Please stand by while we compile the Q&A roster. One moment for our first question. Our first question comes from Susan Maklari with Goldman Sachs. Your line is now open.

Susan Maklari (Senior Equity Research Analyst)

Thank you. Good morning, everyone. Thanks for taking the questions. My first question is,

Brad Southern (CEO)

Good morning.

Susan Maklari (Senior Equity Research Analyst)

...Good morning, Can you talk a bit about the volumes in, in Siding as we think about the back half? Any color perhaps on where the channel inventories are, and then as we think about you, you increasingly lapping the pricing actions that were taken last year and even earlier this year, is it fair to assume that a lot of that decline in the back half comes through volumes?

Brad Southern (CEO)

Susan, let me start with the inventory question. Yeah, we're still experiencing higher inventories than what would have been normal pre-COVID, in our opinion. Those inventories were worked down, say, really starting in March through the second quarter, for certain parts of our distribution channel, they're still elevated higher than we, than we would like to see, though I do think we'll work through all that in Q3.

From a pricing standpoint, just to remind everyone, we did do a price increase mid-year last year and the beginning of this year. You know, all that price that we'll be lapping in your terminology, that mid-year last year price increase during Q3, and then we'll obviously enjoy the increase that we had this year. The, you know, the revenue guidance that we have given, does incorporate those 2, price increases, but doesn't anticipate another mid-year price increase.

Susan Maklari (Senior Equity Research Analyst)

Okay. Perhaps turning to the margin in Siding, can you give any color on how you're thinking about the cost structure in the back half? Any potential relief in terms of raw materials, transportation that could come through in there? As you think about that coming through, is it possible that we could see those second half margins in Siding moving closer to perhaps that 20% range, even as the volumes continue to be lower?

Alan Haughie (CFO)

Well, that's, that's a tough call, Sue. Certainly, we are seeing raw material costs, some, some raw material cost relief, which is beginning to show through. I did mention the existence of a press rebuild in Q3, specifically so that kind of so that wasn't treated as being sort of incremental because we will have the falloff from Q2 to the second half of some of the ramp-up costs, to be kind of replaced by the cost of the press rebuild. There's nothing sort of particularly unusual that we're modeling in, in the cost base within Siding for the second half of the year.

Susan Maklari (Senior Equity Research Analyst)

Okay.

Alan Haughie (CFO)

There is a little, but yes, there's a little bit of relief on raw materials.

Susan Maklari (Senior Equity Research Analyst)

Yeah. Are you seeing that there's some year-over-year deflation that could come through on those raws and maybe transportation as well?

Alan Haughie (CFO)

Yeah, yeah, there's some. Yeah.

Susan Maklari (Senior Equity Research Analyst)

Yeah. Okay.

Alan Haughie (CFO)

Certainly, there's certainly a good, a good tailwind there. Yeah.

Susan Maklari (Senior Equity Research Analyst)

Yes. Okay. All right. Thank you for the color. Good luck with everything.

Alan Haughie (CFO)

Thank you.

Brad Southern (CEO)

Thank you.

Operator (participant)

One moment for our next question. Our next question comes from Michael Roxland with Truist Securities. Your line is now open.

Michael Roxland (Managing Director and Equity Research)

Thank you, Brad, Alan, Aaron, for taking my questions. Can you just follow up with Siding, can you help us think about the you know, future volume growth in Siding? Obviously, you know, shed demand, which I think is about 20% of your mix, was notably weaker this quarter. Demand was also pulled forward during COVID. Just trying to figure out how you, how you see demand shaping up in Siding on a go-forward basis and what, what type of growth we should ultimately expect maybe once channel inventory is clear.

Brad Southern (CEO)

Yeah. So, yeah, we're, we're optimistic about growth going forward in Siding. If you think about the, all the work and effort and product innovation that has gone into, start with our ExpertFinish, pre-finish program, you know, the facility that we're building in Bath, New York, to provide East Coast volume in an efficient way, we're, you know, we're really, feel like we're positioned well. From starting with a pretty low market share in the repair and remodel area outside of the Midwest, to really, to really grow that, repair and remodel through through our ExpertFinish penetration across the country.

Then from, you know, we launched Builder Series early last year, and that's a product that is focused on the, the large national builders, and who, who we all know are, are taking market share in this current environment. We feel like that, that really positions us well to grow because within new construction, we are underpenetrated with large national builders.

Now that we have this product in place, you know, really encouraged that as housing continues to improve, as the large builders continue to take share, we're really in a fine position from a competitive product standpoint to take advantage of that growth. You know, so we're super optimistic about the portfolio.

Let me just add one other thing: We do have an initiative to place lap and trim at consumer retail, which is another area where we've been very underpenetrated historically. All, you know, all that really gives us a lot of confidence to, to believe that, you know, after this year, we're gonna be back on that, that solid growth rate that we've enjoyed, you know, over the last decade in Siding. You know, and plus, we've got 200 salespeople whose job it is and whose comp is related to growing Siding.

So, you know, we feel like we've got the right product, we've got a good brand, a really, really good value proposition, and we've got a sales force, you know, that is in the process of transitioning from 2 years of operating under a managed order file to, you know, actively selling, picking up market share. Super excited about continued growth in siding over the midterm to long-term time, time horizon.

Michael Roxland (Managing Director and Equity Research)

Thanks, Brad. Just in terms of your, your forecast, does your forecast in terms of siding growth still assume that sheds comprise 20% of the mix, or is the growth predicated more on, you know, new construction in areas, other areas where you may be underpenetrated?

Brad Southern (CEO)

Yeah, I would say it's still around that. Like one little caveat, you know, we do have to estimate that somewhat because some of the shed SKUs are accessed by the shed manufacturers through regular two-step distribution. Certainly, we can kind of tell from our panel sales. You know, during COVID, as we, as we talked about, you know, that was a really strong part of our portfolio.

While, you know, I mean, when you look at panel sales this year versus 2019, it's still gonna be way up, but it is certainly off of what we experienced, you know, during COVID. You know, I would say that, that is certainly a weak market right now. We feel like we're holding our own everywhere else.

that one, that's gonna, you know, that, that the first half in shed was extremely weak, and the second quarter actually, you know, caught us by surprise how weak it was. I mean, I, I don't think there's any long-term. I'm sorry, just one more. I don't think there's any long-term issues with shed. You know, historically there, we've had when we've been able to grow market share in shed during kind of downward trend periods in shed.

our, our, our panel market share is pretty dominant there, so we're gonna, you know, we're in a position where we have to ride through the, the ups and downs in the shed market because our ability to gain market share, at least with panel product and shed, is pretty low right now given our position.

Michael Roxland (Managing Director and Equity Research)

Got it. I appreciate all the comment. One final question before I turn it over. Just in terms of pricing on, on the siding side, you mentioned obviously it's, it's up year-over-year, but sequentially, pricing was down. Can you just provide some color on what drove the decline on a sequential basis? Is it, is it a mix factor? Is it concession? Just trying to get a sense of why pricing would decline sequentially.

Alan Haughie (CFO)

Yeah, it was, it was entirely mix, mix of, mix of product within the, within the portfolio that, that drove it down. It wasn't a function of list price increases or anything like that. Just mix.

Michael Roxland (Managing Director and Equity Research)

Got it. Thank you very much, and good luck in the second half.

Alan Haughie (CFO)

Thanks, Michael.

Operator (participant)

Thank you. One moment for our next question. Our next question comes from the line of George Staphos with Bank of America Securities. Your line is open.

George Staphos (Managing Director and Senior Equity Analyst)

Hi, everyone. Good morning. Thanks for all the details. A couple of sort of micro questions to start, and then I had some other questions on, on siding. You called down capital spending a bit, and then comparing the slides 1Q versus 2Q, you know, there's both some trimming, both on the conversion and also strategic growth capital.

Obviously, maybe with the year proceeding a little bit less quickly than you would have expected, that'd be natural. If there's any other color you could share in terms of why those numbers moved. On the $16 million of OSB patent-related claims, if you could remind us what's behind that, recognizing it's now in the past, what was in, in those figures and, and, and drove the settlement claim?

Alan Haughie (CFO)

Let, let me start in, in order then. With, with the CapEx, there's, there's a little bit of modest trimming, but the majority of this is that we were fairly conservative on both the upfront payments we may need to make for Wawa, as well as payments to which we were committed for Houlton two, prior to us putting Wawa next in line, and therefore delaying Houlton two by virtue of Wawa going in front of that.

The, the team's done a sort of an excellent job in negotiating our way out of some of the payments that we would have had to make for Houlton two. That's, that, the, the primary-- that conservatism in Wawa and negotiating our way out for certain payments for Houlton two, were the primary reasons for the for the reduction in capital. Good news all around, fundamentally.

George Staphos (Managing Director and Senior Equity Analyst)

Got it. On the, the patent claim?

Alan Haughie (CFO)

Yes, I'm not, I'm not really at liberty to disclose a great deal. It was, it was. I, I just. Yeah, thank you. I can't, I can't disclose the. It's, but it's, it's the matter is closed and behind us, and, and it's, it's, it's settled. In case it's not clear, it relates to something within the OSB business.

George Staphos (Managing Director and Senior Equity Analyst)

Okay. Now, we'll, we'll, we'll leave it there. Can you talk to us a bit about how the distribution strategy has evolved for siding over the last couple of years? You know, are there any reasons, again, you-- in, in answering some of the earlier questions, a lot of the weakness in, in 2Q was with sheds, we get it. Are, are you finding your distribution strategy is allowing you to grow at the pace you'd want? Are you-- How does your distro strategy compare with some of the other siding companies? Any changes, any needs to change tactics at all? How does it compare versus peers?

Brad Southern (CEO)

Yeah, great question, George. Well, going into COVID in 2019, let me just take a macro view, macro answer to that question and move to our strategy. You know, pro retailer, well, there's consolidation going on in the channel, and pro retailers and other one-step market access vehicles through consolidation have grown in importance.

You know, traditionally, we have been a two-step distribution as our primary means of, of accessing the builder and contractors historically. Look, two-step distribution is still really important to us, but our ability to access the large national builders through the pro retail channel really speaks to a need to have a more direct relationship, more direct sales into pro retail.

By the way, and not that this is ever that controversial, but also similarly for the one-steppers that access repair and remodel. We had an initiative going into 2019 of placing reloads in strategic, you know, urban populations and having a more direct access for certain parts of our portfolio to access national builders and contractors.

Obviously, during COVID and the demand for the product, you know, we put that, that initiative on hold, and, you know, we did, did everything we could do just to keep up with the orders. As product became available this year and we had inventory internally, we have stepped up the pace of this kind of reload strategy in the marketplace to have a more direct access.

While there can be some pain associated with that, right? You know, as we build that infrastructure to access that directly, I, I am, I'm confident that that is going to pay off in the long term as we continue to execute our big builder strategy and our repair and remodel strategy.

As you implied in your question, that is consistent with what other large specialty manufacturers have done over the years to make sure the market access is keeping up with the times. Just let me say, I am not, you know, I, I didn't, in no way want to imply that this year's volume is somehow constrained by lack of distribution quality or anything like that.

We have really good distribution in place, but we are in this transitionary period where we're going more direct with the pro retailer and, and one stepper for R&R. That because we have the inventory available to do that and open these reloads. It is a bit of a transitionary period for us, but in the long run, I believe it's gonna pay off, or we wouldn't be doing it.

George Staphos (Managing Director and Senior Equity Analyst)

For sure, Brad. Okay, thanks. I'll turn it over and come back and thank you.

Brad Southern (CEO)

Mm-hmm, welcome.

Operator (participant)

Thank you. One moment for our next question, please. Question comes from the line of Ketan Mamtora with BMO. Your line is now open.

Ketan Mamtora (Director of Building Products Equity Research)

Good morning, and thank you for taking my question. Perhaps starting with, you know, Q2's siding volume drop, is there any way you can quantify, you know, you've, you've mentioned several times that the shed business was weak. Can you quantify how much volumes in the shed business, you know, were down in Q2, and has that sort of trend changed at all so far in Q3?

Brad Southern (CEO)

Yeah, well, fortunately, there has been a little, there has been a shift where some of those shed manufacturers are back in our order file, which is where, where there was very little of that activity in the first half, and particularly in Q2. We have seen a bit of a strengthening there.

Then as far as the quantifying the amount down, we were, we were down about 20% over prior, say, first half volumes in, in, in, shed versus prior year, you know? Look, it's, you know, we're, we're estimating, you know, our, our shed business to be, you know, somewhere around 30% of our volume, you know, 25... Again, it's hard to get too fine a point on it because some of it goes through distribution.

Just given the weakness in the direct set, direct shed and direct shed distributors volumes that we've seen in the second half, you know, and our conversations with shed manufacturers, that segment is down significantly.

Ketan Mamtora (Director of Building Products Equity Research)

Got it, that's helpful. Then as my follow-on, can you, you know, can you give us some sense in terms of, you know, the, the inventory destocking that you saw in siding, how much, you know, kind of that impacted your volumes, in, in Q2? To put it differently, you know, can you give us some sense of sell-through trends, the underlying customer demand in, in siding in Q3, Q2, and, and what you are seeing there?

Brad Southern (CEO)

Yes. Sell-through sell-through demand at our distribution, you know, given the best information we have, which isn't 100%, has been, obviously been stronger than our sales into distribution. We do know the inventories have been worked down since March. The, you know, the sell-through is gonna be healthier than what we're experiencing right now.

Again, you know, as you know, Ketan, I mean, you've been following us for a while, once once we get to a, a stable inventory situation in distribution, you know, then all that volume will show up in our order file, where it's not, where it's not doing that today. You know, I will just add a little color to it. You know, it is complex right now.

I think distribution is still trying to figure out what the new normal inventory level should be, given, you know, given the COVID experience, given the fact that, you know, throughout COVID, I don't mean to keep speaking to COVID, but during that period of time, let's just say that 2-year period, you know, the introduction of ExpertFinish, which requires a lot more inventory to carry the color palette.

Our distribution and us, LP, are trying to figure out, you know, what is the right amount of inventory needed to service the market. I think there's some of that uncertainty is playing into the, you know, the order strategy of our distributors.

You know, once again, once we get to a point where we're, where all folks are comfortable with the inventory level, then we'll see that, you know, that direct sale, that sell-through showing up in our order file. It certainly has, it has been a contributing factor in the first half to, to our overall volume. It's just that, the inventory level that we've had to work through.

Ketan Mamtora (Director of Building Products Equity Research)

Got it. That's helpful perspective. I'll jump back in the queue. Thank you.

Operator (participant)

Thank you.

Brad Southern (CEO)

Thank you, Ketan.

Operator (participant)

One moment for our next question. Our next question comes from the line of Sean Steuart with TD Securities. Your line is now open.

Sean Steuart (Managing Director)

Thank you. Good morning. I won't ask any siding questions. I think those have uncovered there. On CapEx, Alan, you touched on some of the nuance with the Houlton payments being deferred. Can you give us a sense as you look ahead to 2024, the spending on siding conversions next year, how that would stack up versus $120 million-$130 million this year?

Alan Haughie (CFO)

It, you know, it is actually genuinely too early for me to make a good call on that. Gut call, though, right now, as we're, you know, as we're developing our plans, probably similar, is my gut call right now. No, no significant change. It's a weak answer, but that's closest to the truth, thankfully.

Sean Steuart (Managing Director)

That's good enough for me. Another question on OSB. Brad, I'd be interested in your thoughts on the run we've seen, year to date, but especially of late. It feels like new home construction is surprised versus muted expectations. Your perspective on what's driven the run we've seen, and, you know, at what point do you consider industry supply growth as a mitigating factor that, that could undermine the momentum we've seen of late?

Brad Southern (CEO)

Well, you know, I think what we've experienced this year has been, you know, manufacturers and LP coming into the year predicting a soft housing market and kind of gearing production plans. Then speaking for what we did, gearing our production plans accordingly, and then having, you know, stronger than pretty much every month, stronger than expected housing forecast.

I also say, unlike siding, you know, OSB inventories were lean coming into the year as distributors worked those inventories down. So, you know, well, not minimal, but low inventories in the channel, say, in February, so that when the building season hit and was stronger than anticipated, you know, there was some scrambling for volume. You know, it's.

I mean, even as big as the OSB business is, the industry, I mean, you know, once distribution gets behind on inventory, but sales are strong, you know, it's, it's, it's difficult to catch up, and that translates into pricing. You know, I'll just say, you know, I, I have.

Listen, I've predicted OSB pricing to our board of directors and got it wrong every time, you know, the last 6 years. I'm, I can no longer even pretend that I know what's going to happen, you know, tomorrow with OSB pricing. I would just say, we're, you know, this is, this is August, and, you know, we've got 3 more months of really good housing, building, and construction weather ahead of us.

It's typically September and October are really strong demand months in this industry for both OSB and siding. So I, you know, I, we feel good about the outlook for the next little while. I'm not saying the pricing can't bounce around, up or down, given the elevated levels that we're seeing today. I mean, the, the, the channel's still pretty tight, and I, and I, you know, I, I feel good about our, our near-term outlook for OSB.

Then I think once we get to Thanksgiving, we'll, we'll have to reassess, and we, and we're already doing that analysis of what we're gonna do in order to match our capacity to the demand that we see in our order file. We can, you know, I guess we'll talk about that on the next call, but, I, I feel good about the outlook in the near term as far as the, the, demand and capacity situation for our production and for the industry.

Sean Steuart (Managing Director)

That's great detail. Thanks very much. That's all I have.

Operator (participant)

Thank you. One moment for our next question, please. Our next question comes from the line of Kurt Yinger with D.A. Davidson. Your line is now open.

Kurt Yinger (SVP and Research Analyst)

Great. Thanks. Good morning, everyone. I just wanted to stick with OSB here.

Brad Southern (CEO)

Good morning.

Sean Steuart (Managing Director)

Good morning.

Kurt Yinger (SVP and Research Analyst)

-for a minute. Yeah, I, I think you referenced some kind of deferred maintenance and some market curtailments. Maybe that was primarily a Q1 comment, can you just help us kind of frame what the upside could be in, in terms of OSB volumes in the back half of the year? Just on Peace Valley specifically, I mean, how is production going at that mill? Any, any recent impacts from wildfires or anything like that?

Brad Southern (CEO)

Yeah. We've had no, start the easy, easy answer first. We've had no wildfire-related downtime at any of the Canadian mills. Then we've had some, you know, in the area, but not anything that's impacted wood flow or our ability to produce. You know, we are running three shifts in Peace Valley, three in Maniwaki, and forecast no change of that throughout the rest of this year.

Then as we, you know, at any given time, in our, in our production planning, as we see demand weaken, you know, we're not, and we're not putting, you know, unneeded volume into the market. We, we ship downtime around in our system, just giving the, you know, the cost situation or the demand situation in that given week.

We'll, we'll continue to run that balancing act as we go through the year, and it has been part of each quarter's operating plan, you know, that moving, moving downtime around. That's how it will run for the rest of the year. You know, when you say second half versus first half, I mean, if demand is higher in the second half, we'll run more production. You know, when you look at the half of the year, again, let's just keep in mind, you know, November and December can be light from a demand standpoint.

Typically, you know, there's really no typical with the year, but typically, you know, we do take downtime around the, the Christmas holiday season, you know, as, as we-- as demand slows, and then we give, you know, you use that, use that time and we do some maintenance work. We'll be planning. As I mentioned earlier, we'll, we'll be doing that planning throughout the rest of the year, and we'll make the right moves to, to, to make sure we have the right balance, you know, as we proceed into, into, into early next year.

Kurt Yinger (SVP and Research Analyst)

Got it. Okay, thanks for that. Just my second question. I mean, at a high level, can you just talk about what you think kind of annualized siding volumes or, or maybe from an operating rate perspective, what that would need to look like, kind of excluding some of these short-term factors, to get back to that kind of long-term goal of 25% EBITDA margins?

Alan Haughie (CFO)

The simple answer is, if you think about the take a look at the Q2 waterfall, where it's the EBITDA margin is so volume dependent. If you were to take, you know, I can't say I've actually done the math, but it's relatively simple. If you take that Q2 waterfall and you add back the volume, at that higher variable margins, you're very close to that. You know, but for the volume decline this year, we'd be at that rate. That, as we all know, is temporary. This is a business that's on a growth trajectory, therefore, that growth will deliver the margins that we've committed to.

Kurt Yinger (SVP and Research Analyst)

Okay. Thanks for that, Alan. Good luck here in Q3, guys.

Brad Southern (CEO)

Thank you, Kurt.

Operator (participant)

Thank you. One moment for our next question. Our next question will come from the line of Mark Weintraub, with Seaport Research Partners. Your line is open.

Mark Weintraub (Senior Analyst and Head of Business Development)

Thanks. Maybe following up a little bit on your answer, Alan, to the last question. I mean, one difference obviously, is you now have Sagola as well. Your EBITDA margins, for a number of different reasons, were not 25%, last year either. I guess what I'm just trying to sort through, with all these different moving parts, you know, if I look at where, including Sagola, your capacity would be and kind of the indicated volumes for this year, you're kind of 70%, recognizing, again, Sagola is not really able to run full this year.

So kind of the first question is like, w- h- how do you think through the volume increase to that point where you are at, you know, pretty healthy utilization rates and, and where you need Wawa as, as, you know, capacity to be available? Can you sort of just walk us through the thinking there?

Alan Haughie (CFO)

I'm gonna try, because I'm, I'm not sure I fully understand the question, and it can be a dangerous thing to let my mouth run when I'm not sure I fully understand the question. I'm, I'm gonna make the attempt. As we... Two things. If we look at our business right now, as I tried to point out, we are maintaining, we're, we're ramping up Sagola, so that we are in a position to benefit from the volume, the upside, and the growing market, and the growth that, that is coming. We're carrying that cost deliberately. We're already carrying some of the costs of, of that, essentially, future growth.

When we do bring on Sagola, yes, you're right, that will, that will add, a fixed cost base in advance of the volume, as, as always happens, but it will be a smaller proportion of the whole. So the bigger we get, it, it's hard to run at a faster rate, bear with me on this, than one extra, one mill being ramped up per year. The larger we get, if you bear with me on the logic, with one extra mill being added to the fleet per year, let's imagine that's our long-term trajectory, that extra mill will be a smaller proportion of the whole, and the remainder of the business will, will continue to harvest those high margins.

We mustn't forget the continued pricing power of the business and the mix shift towards exposed finish, and so on, that also will continue to enhance the margin. We should not, not forget our ability, as, as I think we're demonstrating right now, to run our mills extremely efficiently again.

Mark Weintraub (Senior Analyst and Head of Business Development)

Right. All, all good points, and, and, and absolutely, kind of that, that embedded cost is, is impacting the margin quite a bit this year, as, as you, you wrap Sagola. I, I guess sort of though, the, the heart of the question was, and there's so many of these moving parts that I, I realize it's difficult to answer, but, how, how do you see the, the track to the, what, what would be a significant increase in volume? So, I mean, how much of it is a function that you think destock?

I know if you can quantify how much destock is suppressing, how much sheds is under normal, and then once we adjust for those two factors, how long in a kind of normal growth environment, if it's flat housing, does it take us to get to the points where your, your system is fully utilized? I, I realize it's probably unfair to ask that question on the fly like this. I tried.

Alan Haughie (CFO)

Thank you. It, it is unfair, and I'm gonna half-answer it. I, I'm so, so just as you're being unfair, yes, I'll, I'll be unfair and say, you know, our long-term growth algorithm or promise to everybody listening, is that we'll grow something like 8-10 points better than the market, we still believe that's the case.

The definition of the market may be a bit hazy from time to time, but over the long run, just as we have over the last decade, we're highly confident in that, in that growth trajectory, as well as the pricing power of the product. We are highly confident in our, in our long-term strategy, being able to deliver that growth. Let it stop there, not let my mouth run further.

Mark Weintraub (Senior Analyst and Head of Business Development)

I'll stop, too. Thanks, Alan.

Operator (participant)

Thank you. One moment for our final question. Our next question comes from the line of Paul Quinn, with RBC Capital Markets.

Paul Quinn (Managing Director and Equity Research Analyst)

Great. Thanks, guys. Morning. Maybe just following up on this thesis of growing 8%-10% better than market. You know, that sort of the guidance for 2023 is down 10% on revenue. If we flip that, you know, that, that thesis around, you know, do you feel quite comfortable that you're shrinking less fast than the rest of the competition? You know, put it another way, how are you doing, you know, when you sit back, you know, relative to the other competition and deciding, how well are you performing?

Brad Southern (CEO)

Well, I'll, I'll, I'll take it. If you, if you allow me, I'll take that in three parts. Shed, you know, and let's just say roughly, I mean, we've been throwing out numbers. A third of our business, just for illustrative reasons, we are our competitors in shed, we're no, no worse off than anybody else because, with, you know, the, that market's down, we have dominant market share for panel, for the panel component of shed.

Our repair and remodel, our ExpertFinish, I feel good about. I think we are taking share this year in that, in that, with that product, given that we're holding our own, from, from a, a revenue standpoint. I, I feel like share gain is possible there. Now, the, the more interesting one is, is new construction.

I feel good about our position with new construction and that we're holding our own, if not gaining share, with the... where our strength has been historically, which is the smaller or regional builders. With the big builder, we, we are, you know, we launched a product, as you know, Builder Series, in order to have a competitive position there. We are taking market share there, but from a tiny starting point. We can't ring a bell about that one saving us right now because of the, you know, the, the, the market share that we had with lap siding at the big builder was, you know, pretty low, 18 months ago.

The product that we have there, there is competitive and, you know, it's, it's a, it's a, you know, it's a competitive landscape to play in, but, you know, we, we are recording wins there, that, you know, that I feel like demonstrates our ability to gain market share there. It's not enough at this point in time, from a volume standpoint, to overcome shed being down like it has been. It's not enough to overcome housing starts being down the way they're down year over year. For the long term, it plays well with, with our ability to position ourselves to take advantage of the coming upswing in housing.

Paul Quinn (Managing Director and Equity Research Analyst)

All righty. That's helpful. Then just, any change in South America for the balance of the year versus first half?

Brad Southern (CEO)

You know, Our team down there feels like the second half could be a little stronger than the first half, I think for modeling purposes, Paul, just replicate it, you'll be pretty accurate. Then hopefully there's a little upside to that.

Paul Quinn (Managing Director and Equity Research Analyst)

All right. That's all I had. Best luck.

Brad Southern (CEO)

Thank you, Paul.

Paul Quinn (Managing Director and Equity Research Analyst)

Thanks.

Operator (participant)

Thank you. That concludes our Q&A portion. I would now like to hand the conference back to Mr. Aaron Howald for closing comments.

Aaron Howald (VP of Investor Relations and Business Development)

Okay, thanks, Norma, and thanks everyone for joining us this morning. With no more questions, we'll bring the second quarter call for LP Building Solutions to a close. Have a great day, stay safe, and we'll look forward to talking to you soon.

Operator (participant)

This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.