Earnings Call Transcript - JHX Q2 2022

Operator, Operator

Thank you for your patience, and welcome to the James Hardie Industries Q2 FY '22 Results Briefing. I would now like to turn the conference over to Dr. Jack Truong, Chief Executive Officer. Please proceed.

Jack Truong, CEO

Good morning, and good evening, everyone. Thank you for joining us on our second quarter fiscal year 2022 earnings call. This is now the tenth consecutive quarter of our company delivering strong financial results with growth of our market and strong returns based on the consistent execution of our global strategy. I will begin today's call by providing a brief update on our global strategy, which includes sustainability; then our CFO, Jason Miele, will cover our financial results for the quarter and also provide an update on our full year guidance. After that, we'll open up for questions. Let's turn now to Page 5 for an update on our strategy. In our Investor Day and in our Q4 results presentations, both in May 2021, we described our 3 critical strategic initiatives that will enable us to drive consistent profitable growth globally by our company. Those 3 strategic initiatives are: number one, expand the James Hardie brand, a premier professional brand into a market-leading consumer brand that focuses on marketing directly to the homeowners to create true demand for our products. Number two, penetrate and drive growth in existing and new markets such as repair and remodel. And number three, commercialize global innovations that allow us to expand to other exterior looks and take advantage of adjacent opportunities in each of our 3 regions. In addition, we will continue to execute and build on a significant foundation we have built over the past 3 years. This foundation includes continuing our path of becoming a world-class manufacturer of LEAN, partnering closely with our customers with our push-forward strategy and integrating our supply chain with our customers to serve the market. Let's now turn to Page 6 to discuss the progress of our marketing directly to homes. During our Investor Day, we shared details about our 360-degree integrated marketing campaign that reaches homeowners directly to create true demand. We have put the homeowner's journey at the center of our attention. As I shared with you then, the 4 phases of homeowners' purchase journey are awareness, consideration, purchase, and amplification. We continue to build on this marketing capability within James Hardie to ensure that we reach homeowners with the right messages throughout the path to purchase. We will augment this internal capability with key social influencers and partners across a variety of media to create real demand for Hardie brand products. In May, we discussed and shared with you the TV campaign we launched with James Hardie. It is the foundation of the awareness phase. To date, the TV commercial has been very successful in raising awareness of the James Hardie brand with our target homeowners. After the homeowner is aware of the James Hardie brand, it is important that we reach them with the right content at the right time as they consider the option to beautify their home. Over the past 6 months, we have begun to reach homeowners through television, social media, print media, and regional influencers to help guide homeowners through the path to purchase. On the right-hand side of the page, we're pleased to share with you some of our key performance metrics related to our consumer market thus far. While we're still very early in our journey, we have seen brand awareness increase. We have driven more homeowners to our website. We have generated significant growth in leads year-on-year. Specifically, we have increased our aided awareness of our brand by 109%, increased website traffic by 81%, and increased leads in our target markets by 61%. We're very encouraged with the early momentum in the results and continue to invest significantly in this strategic initiative. As you can see on Page 7, we have recently partnered with television and media to continue to reach homeowners with our message with authenticity. On the left, you can see James Hardie products featured on 'Fixer Upper,' a very popular repair remodel TV show with over 19 million viewers per episode. It is a remarkable transformation of the experience at home with Hardie brand ColorPlus Shingles. On the right is another example of James Hardie brand products being featured in home renovation shows. This show, 'Secret Celebrity Renovation,' aired on the 9th of July 2021, and again showcased James Hardie's ability to deliver endless design possibilities. Lastly, at the bottom right is an example of print media with a feature ad on the back cover of 'Mongolia' magazine. This is one of the most followed magazines for devotees of home decoration and living. Working with key influencers and various forms of media extends our reach and helps to educate homeowners about the endless design possibilities with trusted products from the James Hardie brand. Let's now turn to Page 8. The second of the 3 core strategic initiatives is to penetrate and drive profitable growth in the repair and remodel segment. A key component of this strategy is driving the high-value product mix. On this page, you see the clear impact of this particular strategy continue to have on driving profitable growth in our North American business. Starting on the left-hand side, what we have here is a plot of our current product portfolio in North America across 2 key criteria: price and value. In North America, we define high-value products as our Hardie brand exterior products, Hardie brand exterior products with ColorPlus technology, and all of our Hardie brand innovations, including the recently launched Hardie Textured Panels. The focus of our strategy in driving the high-value product mix is to create awareness and higher demand for our differentiated line of products among homeowners in the remodeling segments where our value proposition is strong. In turn, it generates increased sales and margins for our customers and for us. On the right-hand side, you see the clear and significant impact this strategy has had on our recent financial results in North America. Our teams continue to partner with our customers to grow our overall business while shifting to a high-value product mix that homeowners want and need. The blue line on this chart represents percent volume growth for each quarter from fiscal year 2020 Q2 through Q2 of fiscal year 2022. The green bars represent the percentage price mix growth across the same time period. If you focus on Q1 and Q2 of fiscal year 2022, you will observe a real impact that our strategy of driving high-value product mix has had on our financial results. Notably, we see strong volume growth of 14% in Q2, but more importantly, we continue to experience significant step changes in price mix growth of 9%, resulting in 23% net sales growth in Q2 in North America. Note that this growth was on top of a strong corresponding quarter in the previous year. What this indicates is that by partnering closely with our customers, we have been successful in shifting to a higher-value product mix and driving profitable growth even in a highly inflationary period as this year. This is evidenced in our raised guidance, which Jason will speak to later. Turning now to Page 9. Our strategy is global. And on this page, you see the impact our strategy of driving the high-value product mix is having on our European business. Starting on the left-hand side, and similar to the prior slide, what you see is a plot of our current product portfolio in Europe across 2 key criteria: price and value. In Europe, we define high-value products as our Hardie brand flooring products, Hardie brand plank products, including panels, and all of our Hardie brand fiber cement innovations, including the recently launched Hardie brand VL Plank. Note that within Europe, we are driving price mix within our fiber gypsum product portfolio while also driving the broader price mix strategy. Specifically, we mean that you can see we have indicated our fiber gypsum flooring product in orange on the chart, which represents a higher price and margin for us compared to our fiber gypsum wall products. On the right-hand side, you see a clear and significant impact this strategy has had on our recent financial results in Europe. Our teams are partnering with our customers to drive a higher value product mix, and you can see the results are starting to build momentum with a step change in price mix in the last 2 quarters. The blue line on this chart represents percent volume growth for each quarter from fiscal year 2020 to Q2 of fiscal year 2022. The green bar represents percent price mix growth across the same time period. If you look at Q1 and Q2 of fiscal year 2022, you observe the real impact of our strategy of driving high-value product mix on our European financial results. Not only did we see strong volume growth of 15% in quarter 2, but more importantly, we also experienced a continued and significant step change in price mix growth of 8%, resulting in a 23% net sales growth in Q2 in Europe. Turning now to Page 10 for an update on innovation. In May 2021, we announced the launch of 3 new global innovations: One, the Hardie Textured Panels in North America; two, the Hardie brand VL Plank in Europe; three, Hardie brand Fine Textured Cladding in Australia. We continue to have very good traction with market acceptance and penetration of all 3 product platforms since the launch earlier this year. We continue to partner with our customers to drive awareness and adoption with homeowners. Feedback from homeowners and our customers in North America has been overwhelmingly positive. Hardie brand Textured Panels deliver contemporary design solutions that fit any home style that homeowners want and need. In addition, they offer protection properties such as durability, low maintenance, and noncombustibility. What you see here are 4 examples of Hardie brand Textured Panels on 4 different homes in Oregon, Washington, and Florida. What I would like to point out here about these other pictures is how Hardie brand Textured Panels are prominent in a variety of home designs from contemporary look to coastal to mixed design. Moving on to Page 11. In Europe, we are also very pleased with the progress of our Hardie brand VL Plank products. Installers have been consistent in their positive feedback about the time savings that Hardie brand VL Plank offers compared to competitive solutions, with our product saving approximately 20% of total installation time. On this page, you see an example of Hardie brand VL Plank in Germany, France, and Switzerland. What I would like to point out here is how Hardie brand VL Plank helped to provide a mixed design modern look that is becoming more popular with homeowners across Western Europe. Turning now to Page 12. Similarly to North America, feedback from homeowners and customers in Australia is very positive. These are 4 examples of Hardie brand Fine Texture Cladding in the Australian markets, which, as you can see, helps to augment the modern design and look that is prominent throughout the continent. Hardie brand Fine Texture Cladding offers endless design possibilities for homeowners while delivering on protections such as durability, low maintenance, and noncombustibility. On the left, you can see the transformation of a very plain standard brick home into a modern contemporary home utilizing Hardie brand Fine Texture Cladding as the primary exterior plates. We remain very excited about these new innovations and how they will allow us to continue to penetrate and grow in large adjacent markets in each of our 3 operating regions. While we're excited about the early success of these 3 new innovations, our global innovation program is much bigger than just these 3 product platforms. Our innovation team is focused on our innovation pipeline to ensure we will have additional new innovations to provide endless design possibilities with superior durability and protection for homeowners around the world. We anticipate being able to launch additional innovations within the next 6 months and regularly thereafter. Turning now to Page 13 for a summary of global results for the second quarter of fiscal year 2022. This is now the 10th consecutive quarter that we delivered consistent financial results, growth of our market and strong returns. Specifically, in the second quarter, we delivered global net sales of over USD 903 million, which is 23% growth versus the prior corresponding period. Importantly, this was underpinned by global price/mix of 9% growth. And we delivered global adjusted net income of USD 155 million, which is an increase of 29%. We again delivered strong financial results in all 3 regions. This quarter also marks 4 consecutive quarters where all 3 operating regions delivered exceptional double-digit growth in both net sales and EBIT. In North America, driven by the strong momentum of high-value product mix penetration, we delivered net sales of USD 635 million, representing 23% growth. Adjusted EBIT of USD 182 million demonstrates an increase of 23% and continued strong EBIT margin of 28.7% for the quarter. In Europe, we delivered 5 straight quarters of strong organic growth and strong returns, with net sales of more than EUR 104 million, marking 23% growth, adjusted EBIT of EUR 14.2 million, and a good EBIT margin of 13.6%. In Asia Pacific, with strong performance in all 3 countries, we achieved net sales of more than AUD 196 million, which represents a 15% growth. Adjusted EBIT of AUD 6.6 million corresponds to a 12% growth and a very strong EBIT margin of 30.8%. In the first half of the second quarter of fiscal year 2022, the strong execution of the high-value product mix strategy across all 3 operating regions has been the key driver in delivering strong financial results, all while maintaining a significant investment in marketing to consumers and innovation against the backdrop of high input cost inflation. Turning now to Page 14 to discuss sustainability. Earlier this year, we delivered our first sustainability report. Sustainability and ESG are integral to our strategy; it is not a separate and distinctive initiative but rather is woven into how we operate our business to help the company every day around the world. For James Hardie, sustainability is about building sustainable communities. This commitment extends from the smallest communities, the individual household, the homeowner, and the James Hardie community, to the local communities in which we live and operate, and to the largest of our communities, the global ecosystem we live in. In our sustainability report that we will publish in July, we highlighted our progress over the past year but, more importantly, set key goals for the future. I would like to highlight a few key areas. Number one, our products are made locally. This approach to manufacturing creates local communities that we support in numerous ways. For example, 98% of our employees are hired locally, providing wages and expendable income in local communities. 83% of raw materials are sourced within 100 miles of our manufacturing facilities. 63% of products have shipped within 500 miles of our manufacturing facilities. The products we sell in the United States are made in America. The products we sell in Australia are Australian made. The products we sell in the Philippines are made in the Philippines, and the fiber gypsum product we sell in Europe is made locally in Germany, Spain, and the Netherlands. This strategy of employing, selling, producing and shipping locally is not only good from an ESG standpoint but also critical to our business strategy. Currently, it is helping our business drive growth. It does not, however, make us immune to supply chain issues, but having a local community focus does enable flexibility and stability through many disruptions. Another critical component of our ESG focus is zero harm. We incorporate safety first into how we operate every day. Zero Harm is the foundation of our business strategy at our company, and we continue to make improvements in our recordable incident rate and our days away rate. As I stated previously, the primary objective of the zero-harm culture is to ensure the safety and well-being of our employees, customers, and communities above all business decisions we make. While I'm pleased with the progress in our metrics, zero harm is not a destination; it is a perpetual journey that we at James Hardie need to remain focused on daily and throughout every facet of our global operations. I would also like to highlight a few of our commitments for the future: a 40% reduction in Scope 1 and Scope 2 greenhouse gas intensity by 2030 compared to 2019; and a 50% reduction in landfill intensity by 2030 compared to 2019. At James Hardie, we're proud of our growing momentum in building sustainable communities. I would now like to turn over to our CFO, Jason Miele, to provide additional details on our financial results.

Jason Miele, CFO

Thank you, Jack. Good morning, and good evening, everyone. I will start on Slide 16 with our global results. This is now the tenth consecutive quarter we have delivered strong financial results with above-market growth and strong returns based on the consistent execution of our global strategy. Also, this is the fifth straight quarter with record global results, including quarterly records for net sales, adjusted EBIT, and adjusted net income. This now marks the fourth straight quarter where all 3 regions delivered double-digit net sales growth and double-digit EBIT growth. All 3 regions are executing our global strategy simultaneously. First and foremost, the continued strong execution of the foundational initiatives of our strategy: lean manufacturing, push-pull, and operating an integrated supply chain with our customers. In fiscal year 2022, all 3 regions have good momentum on executing the newer strategic initiatives, marketing directly to the homeowner, and commercializing global innovations. This strong strategic execution globally has led to global net sales increasing 23% to a record USD 903.2 million in the second quarter. This excellent top-line result was underpinned by price/mix growth of plus 9% as our teams in all 3 regions successfully built momentum in driving a high-value product mix. In addition, we delivered strong volume growth in all 3 regions with global volumes increasing 14%. Global adjusted EBIT increased 26% to USD 205.7 million, and global adjusted net income increased 29% to USD 154.9 million, both representing all-time record highs for our quarter. To maintain this momentum, we continue to invest significantly in our strategic initiatives, marketing, innovation, and capacity expansion. Despite operating in the current inflationary environment, we were able to expand our global EBITDA margin by 70 basis points to 27.2%. We will now review each region in more detail, starting with North America on Page 17. In North America, the team delivered another outstanding quarter. The team delivered record net sales of USD 635.3 million through strong volume growth of plus 14% and exceptional price mix growth of plus 9%. The exceptional price/mix growth was achieved through continued execution in driving high-value product penetration with our customers. Through continued execution of our foundational strategies, lean manufacturing, and integration of our supply chain with our customers, we were able to translate the outstanding top-line results into excellent bottom-line outcomes. Adjusted EBIT increased 23% to a record USD 182.5 million. The North American team continues to deliver consistent double-digit net sales growth and a step change EBIT margin level. Turning now to Page 18 to discuss the European results. In Europe, the team delivered a fifth straight quarter of strong results and a fourth straight quarter of double-digit net sales growth. In the second quarter, net sales increased 23% to EUR 104.6 million, and adjusted EBIT increased 51% to EUR 14.2 million. The exceptional net sales growth was achieved through the team's continued execution of a high-value product mix penetration strategy. Fiber cement net sales increased 40% in the quarter, contributing to an outstanding 8% growth in price/mix. A combination of improved price mix, strong volumes, and lean improvements more than offset the high inflationary environment, resulting in a second-quarter Europe adjusted EBIT margin expanding by 250 basis points to 13.6%. Let's move now to Page 19 to discuss Asia Pacific. You'll see a similar story in Asia Pacific compared to the other two regions as all 3 regions continue to execute the global strategy effectively. The Asia Pacific team delivered outstanding net sales growth of plus 15% to AUD 196.6 million in the second quarter. The ANZ business delivered continued execution in driving high-value product penetration, resulting in price mix growth of plus 9% in Australia and New Zealand. The strong top-line results in the second quarter translated into robust bottom-line results. Execution on lean manufacturing and focus on high-value product mix helped to offset the high inflationary environment, leading to adjusted EBIT growth of 12% to AUD 60.6 million with an adjusted EBIT margin of 30.8%. Moving now to Page 20, we'll discuss operating cash flows and capital expenditures. These strong operational results discussed in the past few slides continue to translate to a step change in operating cash flow. Operating cash flow for the trailing 12 months was up 18% to USD 727.6 million, and we will discuss cash flow further on the next slide. Shifting to the right-hand side of the slide, I'll give you a summary of our capital expenditures. In the second quarter, capital expenditures totaled USD 108.1 million. Focusing first on the shorter term, production at our Prattville, Alabama facility continues to ramp up successfully, and our restart of our Summerville, South Carolina facility is on track and still planned to restart in March 2022. Looking further ahead, we are now embarking on a transformational period of capacity expansion. In North America, we will expand our Prattville, Alabama facility to include 2 more shot machines. We expect this expansion at Prattville to provide saleable production in late calendar year 2023. In addition, we plan to purchase land in the United States for a greenfield site that will focus on the production of high-value products and innovation. In Europe, we will expand our fiber gypsum capacity in Orejo, Spain to enable continued strong growth of our fiber gypsum business in Europe, and we will purchase land and begin construction of a greenfield fiber cement facility to locally produce fiber cement for the European market. And lastly, in Australia, we plan to add greenfield fiber cement capacity in Victoria. Similar to the United States, this greenfield capacity is expected to focus on high-value products and innovation. Adding the right capacity at the right time positions us to continue to drive market share gains and organic growth. Now let's move to Page 21 to discuss capital allocation. Our transformation to a new James Hardie has resulted in a step change in operating cash flow. On the left, you can see we have generated more than USD 2 billion of cash over the past 36 months. These funds have allowed us to invest in future growth through capacity expansion, reduce our debt, contribute significantly to the ICI, and return capital to shareholders. On the right, you can see that our capital allocation priorities remain unchanged. Today, we are pleased to announce a first half dividend of USD 0.40 per share, which equates to approximately USD 178 million. The first half dividend will have a record date of November 19, and payment date of December 17. Let's move to Page 22 to discuss the funding of the asbestos injury compensation funds. On the left-hand side of the slide, you can see the growth in our contributions to the AICF, which is directly linked to our step change in operating cash flow we discussed on Slide 20. In the 5 years from fiscal year '15 to fiscal year 2019, our average annual contribution to the AICF was AUD 119 million, and now in fiscal year 2022 that has almost tripled to AUD 328 million. Since the inception of the AICF, James Hardie has now contributed over AUD 1.7 billion to AICF. Moving to the right-hand side of the page, you can see the impact of the increase in James Hardie contributions on AICF's cash and investment accounts. Over the past few years, AICF cash and investments have more than tripled from AUD 81 million on March 31, 2019, to AUD 253 million on October 31, 2021. We are pleased that our step change in operating cash flow has led to a stronger balance sheet for AICF, specifically showing robust cash and investment balances. Now let's turn to Page 23 to discuss guidance. Our significant momentum in high-value product mix penetration in all 3 regions, combined with continued market share gains and lean execution, gives us confidence in raising the adjusted net income guidance range. We raised our adjusted net income guidance to a range of USD 580 million to USD 600 million. The comparable figure for the prior year was USD 458 million. The revised guidance range represents a 27% to 31% year-on-year improvement in adjusted net income. Specifically, for our North America segment, we continue to provide two points of guidance: first, in North America, we expect net sales growth greater than 20% for the full fiscal year 2022; and we expect price/mix growth of between plus 8% and plus 9%. As we first guided in May, we are investing significantly in our strategic growth initiatives and expect to experience significant inflation in fiscal year '22. Finally, please turn to Page 24 for some financial highlights for the half year. Globally, the James Hardie team continues to execute our strategy at a high level. Our mission is to be a high-performing global company that delivers organic growth above market with strong returns consistently. In the first half of fiscal year '22, global net sales increased 28% and global adjusted EBIT increased 34%. This significant growth in net sales and EBIT was primarily driven by the strong execution in driving high-value product penetration. Importantly, we continue to invest in growth. This includes significant investment in marketing directly to the homeowner, investment in innovation, and a commitment to significant capacity expansion in all 3 regions. As we continue to invest in our future growth during a highly inflationary period, it's important to note that the strong execution of our strategy enabled us to expand our global adjusted EBITDA margin by 80 basis points. We continue to return capital to our shareholders with an announcement today of the USD 0.40 per share first half dividend. Lastly, we raised our adjusted net income guidance for the current fiscal year to a range of USD 580 million to USD 600 million. We have now concluded our prepared remarks. I will hand it over to the operator to commence the Q&A portion of today's meeting.

Operator, Operator

The first question comes from Peter Steyn from Macquarie.

Peter Steyn, Analyst

Just wanted to get a little more color on the mix effects and if you could give us a little bit of a sense of how the new products are faring from a sales contribution point of view, and how you're tracking against your LTI targets for FY '22?

Jack Truong, CEO

Yes, Peter. It's a good question. We're tracking well to the LTI targets that you mentioned. But right now, our approach to the new innovations is really market-driven, and that is all about making sure that we get our products on the wall and in the homes of the homeowners as the #1 priority. This creates a pull-through as opposed to a typical new product launch where we just shift a lot more to the channel and let it trickle out. Our approach is more about pull—creating demand with the homeowners and building momentum with demand creation. Until that reaches a critical mass, that's when you see a significant lift and sustain lift. And then relative to your first part of your question, as we continue to execute our high-value product mix, over time, the effect of price mix will be driven more and more through increased high-value products that drive that price mix growth that you observed from Q1 to Q2.

Jason Miele, CFO

So can I just clarify then in my mind, the interpretation there is that there isn’t a significant contribution coming from Textured Panel and VL Plank among others at this point, but it will accelerate in due course as the channel starts drawing that more definitively? So what we’re seeing at this point is still the early stages of that, but largely the shift from Cemplank to Hardie plank in the tail end of that playing out.

Peter Steyn, Analyst

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

Jason Miele, CFO

Yes, Peter. As we’ve laid out, when you exclude the CARES Act, it is up 2%. We’ve certainly shifted to a step-change level on a rolling 12-month basis. As with any quarter, there are some minor timing differences, but we’re very happy with where we’re at from a cash flow perspective. We expect continued improvement going forward.

Operator, Operator

The next question comes from Simon Thackray from Jefferies.

Simon Thackray, Analyst

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

Jack Truong, CEO

Yes, Simon. I want to highlight a couple of key aspects of our current strategy. We are focused on increasing the volume of high-value products, emphasizing that our goal is not just to sell a higher volume for the sake of it, which is an important distinction in our approach going forward. Our business model is centered around integrating our supply chain with our customers, which provides us with better demand visibility. This integration enables us to produce and ship more effectively, as well as optimize our production for storage.

Simon Thackray, Analyst

So Jack, just to better understand that lift, do you expect that, while the net sales growth sequentially from the first quarter to the second quarter in Europe was modest at 1.25%, that you would expect to see acceleration in growth as the demand profiles improve?

Jack Truong, CEO

Yes, we should see acceleration of our growth in net sales, as opposed to just for the sake of volume growth. If you look at the product portfolio in Europe today, I think on slide … you see that there is a big difference in pricing of the Hardie brand Panel versus plank and versus backer. It's really about creating more value for the homeowners in Europe. We understand homeowners' needs and provide the right value product.

Simon Thackray, Analyst

Okay, that's great. And in terms of the percentage of sales coming from R&R versus new housing, would you say that we're continuing to see a shift towards more R&R?

Jack Truong, CEO

Absolutely. Right now, our R&R business is quite similar around the world, with more than 70% and it's growing quite fast.

Simon Thackray, Analyst

Just in regards to COGS inflation, Jason, noting it's a change from the May update, but it's static on the first quarter regarding COGS inflation guidance. Is this COGS inflation increase a result of higher cost assumptions, or is it a function of better volume expectations for the business since May?

Jack Truong, CEO

A little bit of both, Simon. As we talked about last time, pulp remains elevated, as does freight. We're watching markets closely, but we're comfortable with the range we've provided of USD 120 million to USD 150 million globally, which would include our volume assumptions as well.

Simon Thackray, Analyst

That's great, Jason. And then, just quickly on the SG&A spend, which obviously stepped up as per guidance; is the marketing and advertising spend now at a steady run rate, or will it increase from here? Should we be looking at the spend for marketing and advertising in dollar terms or as a percentage of sales going forward?

Jason Miele, CFO

Yes, Simon. We'll continue to invest in marketing initiatives that drive top-line growth. We will expect to be investing more next year than we did this year. But obviously, we're monitoring to ensure we're getting the outcomes we expect. And that's how we'll continue to run it going forward.

Jack Truong, CEO

Simon, the way to think about this is that as we invest more in marketing to the homeowners, it will create demand for our high-value products that homeowners need. You should expect to see gross margin expansion because of the growth of high-value products and our expanding presence in the repair and remodel segment. You should expect that the absolute dollar terms of marketing investment will go up, but it will correlate to sales growth.

Simon Thackray, Analyst

Yes, that makes sense, Jack. Just quickly, on the New Zealand greenfields expansion. Is that designed to feed New Zealand? Just to clarify about the Victorian greenfields?

Jack Truong, CEO

As you know, Simon, we have a very big plant in Carole Park on the Gold Coast, and one in New South Wales. We see Victoria as a growth opportunity for us. It's important for us to have a big facility to serve that market for the long term. Furthermore, in alignment with our ESG strategy, we build plants based on where we operate to source more than 80% of our raw materials within 100 miles of our plants.

Operator, Operator

The next question comes from Lisa from JPMorgan.

Unidentified Analyst, Analyst

I just had a question on the gross margin as well in terms of North America Fiber Cement. I guess there was a 4.8 percentage point gross margin drag from input costs and also the start-up cost from Prattville. Can you just give us an idea of how much will be driven by the commissioning at Prattville and when that will be done exactly? Additionally, in the context of the capacity you’re planning to bring online over the next 3 years, should we continue to expect that line to be a drag in the future years as well?

Jack Truong, CEO

Yes, Lisa. When you think about start-up costs for a competent period with not a lot of start-up costs in the prior period, that's why it’s a drag year-on-year. As we continue with this transformational capacity expansion, you can expect start-up costs to be consistently part of our P&L going forward. When you compare periods, I wouldn't see it as a drag on future growth.

Jason Miele, CFO

We have seen a ramp-up costs with each expansion. In terms of that gross margin walk, we don't break out start-up costs specifically, but it would be a smaller percentage compared to freight and pulp cost increases.

Unidentified Analyst, Analyst

Okay, understood. And then just on ColorPlus more specifically, given the uptake, can you just provide commentary on what you’ve seen over the course of the second quarter and where you’re taking market share from up in the Northeast?

Jack Truong, CEO

Yes. It is a key part of our marketing campaign to the homeowners. It’s really about delivering the type of product that homeowners want with our Acerroduct made with ColorPlus. Our mix of ColorPlus has really been growing, particularly since the beginning of the year when we started the campaign, and we expect that to continue to grow healthily going forward with our continued investments in the consumer market.

Operator, Operator

The next question comes from Daniel Kang from CLSA.

Daniel Kang, Analyst

I have a question on price—specifically, it appears that North America is gaining momentum with Q2 contributing 9%, up from 7% in the prior 2 quarters. I realize that your guidance for price mix is only for FY ‘22 of 8% to 9%. Is there any reason why this momentum should not continue into FY ‘23?

Jack Truong, CEO

Daniel, we believe that the momentum will continue as we execute our strategy, which focuses on marketing directly to homeowners. Through extensive consumer research, we know what exactly the homeowners want, and we can market those high-value products effectively to meet their needs. Therefore, as we execute, we expect the growth of our ColorPlus products, which are in high demand.

Operator, Operator

The next question comes from Lee Power from UBS.

Lee Power, Analyst

Regarding the leads for direct-to-consumer, noting a 61% increase, is there any difference in conversion rates you find when dealing with direct-to-consumer through a contractor?

Jack Truong, CEO

When we generate great demand directly with the consumers, the messaging tends to be consistent and clear. This generates sales leads, which our contractor customers can then convert. So, it’s about the quality of leads as well as the ability to close sales more quickly. Connecting directly with homeowners and conveying the value of the right Hardie brand product is immensely beneficial.

Operator, Operator

The next question comes from Keith Chau from MST Marquee.

Keith Chau, Analyst

Could you give us a sense regarding the North American business? Were there any constraints that may have held back sales, particularly from hurricane activity? Additionally, how's the sales growth tracking in the quarter-to-date for both exteriors and interiors volumes?

Jack Truong, CEO

As I mentioned, we are focused on connecting and marketing directly to the homeowners. We are marketing the high-value products that consumers want. It’s critical for us to maximize our ability to produce and deliver the right products to maximize sales growth and EBIT, regardless of whether it's exterior or interior products.

Operator, Operator

The next question comes from Sam Seow from Citi.

Sam Seow, Analyst

If we consider the reinvestment of lean savings into supply chain improvements, could you provide insight into how many of your existing distributors you consider fully integrated versus those you still aim to partner with? I'm trying to understand the pathways forward for what has been a successful initiative.

Jack Truong, CEO

This is a journey. Today, we are miles ahead of where we were 2 years ago. This progress has enabled us to produce and serve markets better than most because of our integration of supply chain and partnerships with our customers. However, there is still more to improve and pathways to further integration.

Operator, Operator

The next question comes from Paul Quinn from RBC.

Paul Quinn, Analyst

Could you speak about global pulp markets? We’re seeing a significant rollover. How much volume do you use in a year, and are these contracts spot pricing or based on contracted volumes over a 3- to 6-month period?

Jack Truong, CEO

Yes, Paul. Pulp is one of our top 4 costs, and when there are bold moves in pricing, it can be significant. However, as we have discussed, the execution of our strategy has enabled us to expand margins during this high inflationary period. We have a variety of types of contracts—some spot and some that operate on a periodic basis, whether that’s a quarter or 6 months. It’s a mix.

Operator, Operator

The next question comes from Peter Wilson from Credit Suisse.

Peter Wilson, Analyst

Regarding North American volume in the context of your capacity expansion announced, should we consider the 2Q volume of 791 million square feet as the limit on your volume until this new capacity comes online? Or can you squeeze more out of the network?

Jack Truong, CEO

No, we will indeed be able to exceed that volume for 3 reasons. First, line execution will continue to increase more capacity on our existing assets. Secondly, as we integrate more with our customers, we can gain better visibility of demand for our products, allowing us to manage production more effectively. Finally, we're right in the middle of scaling up our production capacity, which will open up more in the coming months.

Operator, Operator

The next question comes from Andrew Scott from Morgan Stanley.

Andrew Scott, Analyst

Regarding price announcements expected around January 1, can you provide insights on what you're expecting there? Additionally, you have adhered to a value pricing methodology, while vinyl and LP may be pricing a bit more like a commodity. Have you found that this choice has made a significant difference in the cost comparison on-the-wall cost?

Jason Miele, CFO

Yes, Andrew. For January 1 price increases, we would expect price increases of about 5% in North America.

Jack Truong, CEO

The key here is that we are marketing directly to the homeowners. Our Hardie brand products, particularly the Hardie brand Exterior with Colors, provide endless possibilities that allow homeowners to remodel their homes beautifully while also protecting them from the elements. Homeowners are making decisions based on these intangibles. The on-the-wall cost is important, but it's not our primary focus.

Operator, Operator

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

Jack Truong, CEO

Before we end the call, I would just like to take the opportunity to extend my gratitude and thanks to all James Hardie colleagues around the world. Our exceptional financial results in the second quarter of fiscal year 2022 are a direct result of the continued execution of everyone within our company of our global strategy, and we do it together as a global company. This outstanding second quarter result is another indication that we are truly a new target. It’s a company that continues to leverage our global reach, capabilities, and scale to deliver strong financial results consistently across all 3 regions. I'm excited for the remainder of fiscal year 2022 and beyond as we continue this next phase of profit growth. Thank you.