Owens Corning (OC) 2013 Q2 法說會逐字稿

Good morning and welcome to the second quarter 2013 Owens Corning Earnings Conference Call. All participants will be in listen-only mode.

(Operator Instructions)

Please note, this event is being recorded. I would now like to turn the conference over to Mr. Thierry Denis, Director of Investor Relations. Please go ahead.

Thank you, Amy, and good morning, everyone. We appreciate you taking the time to join us for today's conference call in review of our business results for the second quarter of 2013. Joining us today are Mike Thaman, Owens Corning's Chairman and CEO, and Michael McMurray, Chief Financial Officer. Following our presentation this morning, we will open this one hour call to your questions. Please limit yourself to one question and one follow-up.

Earlier this morning we issued a press release and filed a Form 10-Q that detailed our financial results for the second quarter. For the purposes of our discussion today, we've prepared presentation slides that summarize our performance and results for the quarter. We will refer to these slides during the call. You can access the earnings press release, Form 10-Q and slides on our website, OwensCorning.com. We have a link on the investor section of our website. The transcript and recording of this call and the supporting slides will be available on OwensCorning.com for future reference.

Please review slide number 2 before we begin where we offer a couple of reminders. First, today's presentation remarks include forward-looking statements based on our current forecasts and estimates of future events. Actual results may differ materially from those projected in such statements. Additional information about the risks, uncertainties and factors that could cause these material differences can be found in today's press release as well as in our 2012 Form 10-K and second quarter 2013 Form 10-Q. This presentation and today's remark contain non-GAAP financial measures. Reconciliations of non-GAAP financial measures to the most comparable GAAP measures may be found within the financial tables of our earnings release on OwensCorning.com. Adjusted EBIT is our primary measure of period-over-period comparisons, and we believe it is a meaningful measure for investors to compare our results from period to period.

Consistent with our historical practice, we have excluded nonrecurring items and items that we believe are not representative of our ongoing operations when calculating adjusted EBIT. We adjust our effective tax rate to remove the effect of quarter-to-quarter situations which have the potential to be significant in arriving at adjusted earnings and adjusted earnings-per-share. In the second quarter, we have utilized an effective tax rate of 26.5%, the midpoint of our anticipated annual effective tax rate range on adjusted earnings for 2013.

For those of you following along with our slide presentation, we will now move to slide 4. And now, our Chairman and CEO, Mike Thaman, will make some opening remarks followed by remarks from our CFO, Michael McMurray. Mike then will then provide some closing comments prior to the Q&A session. Mike?

Thank you, Thierry, and good morning everyone. We appreciate you joining us today to discuss our second-quarter results.

Owens Corning completed a successful second quarter and first half. Our results reflect positive execution and provide the momentum for strong second half and full-year improvement over 2012. We are pleased with our progress in all three businesses in the quarter and the first half of 2013. We saw strong margin performance in our Roofing business, price increases and operating leverage in Insulation, and improved performance in Composites. We are positioned for strong second half EBIT growth and achieving our full-year 2013 guidance. We delivered $124 million in adjusted EBIT, up $7 million from the second quarter last year, driven by improved Roofing margins and profitability in Insulation. Consolidated revenue for the second quarter was $1.35 billion, compared to $1.39 billion in the same period of 2012, and adjusted earnings were $69 million, an increase of $2 million from the same period last year.

At the start of 2013, we discussed a number of expectations for improved performance across our business. Let me review them now, starting with safety. As is the case each quarter, we said that we would continue to make progress towards our goal of creating an injury-free workplace at Owens Corning. We had a 16% improvement over the comparable period last year and regained momentum in this important performance area. We remain focused on an injury-free workplace and are committed to achieving a 12th consecutive year of safety improvement in 2013.

In Roofing, we said that we would improve margins and see better pricing. For the quarter, we made progress on this call, with EBIT margins of 23%. We benefited from price increases, strong operating performance, and sales of our Duration product line. Second quarter volumes declined significantly across the Roofing market. Michael will talk further about our outlook for second-half demand, but we believe that this is a constructive development for our second half outlook.

In the Insulation business, we said the continued improvement in US housing market would translate to a return to profitability for the business in 2013. Insulation delivered a profitable second quarter for the first time since 2008, and completed the eighth consecutive quarter of year-over-year EBIT improvement. The Owens Corning Insulation business is gaining significant momentum in volume and pricing. In addition, our first half operating leverage was in line with our expectations.

In Composites, we expected to improve financial performance as the year progressed by demonstrating operating leverage in the stable price environment. During the second quarter, the plants operated at a level consistent with demand and prices were stable. Pricing actions in key geographies are now in effect. Composites had sequential EBIT improvement of $23 million in the quarter and the business is positioned to deliver a strong second half versus 2012.

In addition, Owens Corning had a number of strategic achievements in the quarter that I would like to note. We acquired Thermafiber, a mineral wool insulation manufacturer that expands our product portfolio, provides broader access to commercial and industrial application, and increases our ability to benefit from the recovery in the US construction markets. We announced a $130 million investment in North America to expand our global non-wovens business. This investment will support further growth opportunities in the North American construction market. This facility will compliment our existing non-wovens facilities in North America and Europe. In Composites, we partnered with two Chinese-based manufacturers, Taishan and Jinniu. These arrangements will enable the business to leverage our commercial strengths, while reducing capital investments, and eliminating high-delivered cost assets. Finally, we published our 2012 sustainability report. We announced that we had achieved all seven of our 10-year goals for footprint production. We are very proud of our reputation and execution in the area of sustainability.

Now I would like to take a moment to discuss the outlook for the year in each of our businesses, beginning with Roofing. In Roofing, we expect to achieve improved full-year margins versus 2012. We continue to expect the full-year market shipment to be flat versus last year. Based on first-half shipments, we expect higher volumes in the second half versus 2012, and demand distribution more consistent with our historical pattern. The US housing market outlook continues to support improvements in new residential construction and modest growth in re-roof. Without significant fall storm activity, we would expect storm-related volumes for 2013 to compare unfavorably with last year, but consistent with our overall market estimates.

Insulation should have a stronger second-half volume driven by continued growth in residential new construction and seasonality, with higher capacity utilization and improved pricing. We expect continued price recovery to support our outlook for full-year profitability in 2013. We also have positive expectations for the June price increase. However, prices still remain significantly below historical levels.

The Composites business is positioned to deliver second-half improvements, supported by pricing actions in key geographies. While global growth will continue to drive some improvement in the Composites business in the second half, the market growth rate will be below long-term trends due to uneven industrial production growth globally.

We continue to expect all three businesses to improve versus 2012. For Owens Corning, the strength of an improving housing market in the US and modest global growth will drive overall improvement of at least $100 million in EBIT, and we expect that the rate of the US housing recovery in the second half and its impact in ongoing margin performance in our Building Materials businesses will largely determine the upside to our guidance.

We are pleased with the progress that we made in the first half of the year. As you can tell for my comments, we're entering the second-half confident that both our operational execution and market outlook support improved performance in all of our businesses. Further, the competitive position of our businesses and the market drivers that underpin our second-half optimism are expected to carry into 2014 and beyond. With Insulation returning to profitability, we believe that we are poised to demonstrate the full performance potential of our portfolio.

With that, I now turn it over to Michael, who will further review details of our business and corporate performance. I will then return to recap and open it up for questions. Michael?

Thanks, Mike, and good morning everyone. As Mike mentioned earlier, we are pleased with our execution in the first half of the year, and we are positioned to deliver strong EBIT growth in the second half. In our Roofing business, we grew first half EBIT margins 4 points through improved pricing and strong manufacturing performance. In our Insulation business, we achieved our first profitable second quarter since 2008 with higher prices and improved volumes. This marks our eighth consecutive quarter of improved EBIT performance for this business. And our Composites business achieved significant sequential EBIT growth in the second quarter and is positioned to deliver improved second-half performance.

Now let's start on slide 5, which summarizes our key financial data for the quarter. You will find more detailed financial information in the tables of today's press release and the Form 10-Q. We look for the second quarter 2013 consolidated net sales of $1.3 billion, down 3% compared to the same period in 2012. In our Roofing business, net sales were down 16% on lower sales volumes partially offset by improved pricing. Net sales in our Insulation business were up 22% on stronger volumes and higher selling prices. Lastly, net sales in our Composites business were down 5%, due primarily to unfavorable mix, slightly lower sales volumes, and the impact of foreign-exchange translation. In a moment, I will review our reconciliation of items to get to adjusted EBIT, our primary measure to look at period-to-period comparisons.

Adjusted EBIT for the second quarter of 2013 was $124 million, compared to a $117 million in the same period one year ago. Adjusted earnings for the second quarter of 2013 were $69 million, or $0.57 per diluted share, compared to $67 million, or $0.55 per diluted share, in 2012. Depreciation and amortization expense for the quarter was $79 million, including $1 million of accelerated depreciation related to our asset repositioning in Europe. Depreciation and amortization was $12 million lower than the second quarter of 2012, which included $17 million of accelerated appreciation related to our asset restructuring in Europe. Our capital expenditures for the quarter were $80 million.

Next, we reconcile our second-quarter adjusted EBIT of $124 million to our reported EBIT of $118 million. We have adjusted out $3 million of net losses related to the flood that occurred in October 2012 at our New Jersey roofing facility as a result of Hurricane Sandy, and that loss includes the impact of a $15 million insurance advance received during the quarter. As we noted on recent calls, the incident is insured, and we believe that the overall financial impact will be minimal. However, the timing within the recoveries may result in expenses being taken in periods before insurance receipts are recorded or received which is why we are adjusting the impact of this event out of our results. My thanks to a great job on this project by our team. We restarted production late in the second quarter and expect the plant to be back at full operating capacity later this month. In addition, we've adjusted out $3 million related to our 2012 Composite restructuring actions.

Now, please turn to slide 6, and I will provide a high-level review of our adjusted EBIT performance, comparing the second quarter of 2013 with the same period one year ago. Adjusted EBIT improved $7 million. The $20 million improvement in our Insulation business was partially offset by declines in our Roofing EBIT of $7 million, and our Composites EBIT of $2 million. General corporate expenses were $4 million higher versus the prior year, primarily due to higher variable compensation expense.

With that review of key financial highlights, I ask you to turn to slide 7, where we provide a more detailed review of our businesses, starting with Building Materials. For the second quarter, Building Materials net sales were $923 million, a 2% decrease compared to the prior year. Building Materials delivered $120 million in EBIT, up from $107 million for the same period in 2012.

Slide 8 provides an overview of our Roofing business. Roofing net sales for the quarter were $508 million, a 16% decrease compared with the same period a year ago. EBIT in the quarter was $116 million, down $7 million compared to the same period in 2012. In the second quarter, we estimate that manufacturer shipments were down over 25% and for the first half were down over 10%. Our customers and our markets operate regionally, and there can be significant variations in demand region-to-region. While manufacturer shipments were down significantly in the first half, we believe out-the-door sales for our customers were down in the mid-single digits for the total market. We view this gap between manufacturer shipments and out-the-door sales as a healthy development. This will drive a more balanced demand pattern in 2012 than we saw in -- excuse me, in 2013 than we saw in 2012, when over 60% of our volume had been shipped by the end of the second quarter. Our shipments in the second quarter were down just over 15% as we benefited from channel diversity within the quarter. Channel mix had a negative impact in the first quarter. On a year-to-date basis, our overall market share has remained stable.

The outlook for US housing supports improvement in the new residential construction market and modest growth in re-roof demand, which together will likely offset a potential negative comparison from storm demand. Based on our full-year outlook for an overall flat roofing shingle market, we expect stronger year-over-year volumes in the second half. We have continued to demonstrate improved pricing and strong manufacturing performance through the first half of the year. EBIT margins improved to 23% during the quarter, and are 21% year-to-date, a 4 point improvement over the first half of 2012. Based on our outlook of relatively flat volumes compared to last year, and our margin performance year-to-date, we maintain our expectation of improved performance in our Roofing business for 2013.

Now slide 9 provides a summary of our Insulation business. Net sales for the quarter in insulation of $415 million were up 22% over the same period last year. The business delivered its first profitable second quarter since 2008 with $4 million in EBIT, compared to a loss of $16 million in 2012. The last time we were break-even was in 2008 at just over 1 million lagged starts on generally higher prices. Over the last 12 months, our Insulation business has returned to break-even levels on about 800,000 lagged US housing starts. Our team has done a great job of lowering our break-even point, resulting from strong cost execution and manufacturing performance.

US construction insulation volumes are healthy. They continue to track with growth trends in new residential starts. About 80% of the revenue growth in the second quarter was driven by stronger sales volumes. In addition, the business continued to demonstrate strong price realization in the quarter. As the US housing market continues to recover, we expect to see further sales growth with improved pricing as industry capacity utilization tightens. With the pricing actions we have taken and the improved manufacturing performance we have demonstrated year-over-year, we remain confident in our guidance of double-digit revenue growth and a return to profitability for full year 2013.

Now I asked to turn your attention to slide 10 for a review of our Composites business. Net sales in our Composites business for the quarter were $472 million, a 5% decrease compared to the same period in 2012. The decline in revenue was driven equally by unfavorable mix, slightly lower sales volumes, and the impact of foreign exchange translation. While overall volumes are relatively flat year to date, we still expect to see modest year-on-year glass reinforcements growth for 2013. EBIT for the quarter was $32 million, compared to $34 million in the same period last year. EBIT margins for the quarter were 7%. During the second quarter, production levels were aligned with demand and volumes were relatively flat compared to last year. We also saw pricing stabilize during the quarter, and have announced price actions for non-contracted volumes in key geographies. As we look to the full-year, we continue to expect that the benefits of utilization of our low-cost asset base, third-quarter pricing action, and modest growth in global reinforcement demand will result in improved margins in 2013 compared to 2012. With the sequential improvement in the second quarter, we are well-positioned to deliver second half improvement versus last year.

With that review of our second-quarter performance, I now ask you to turn to slide 11 where we review other financial guidance for 2013. We continue to expect capital spending to be about $380 million. Reported capital spending will include the rebuild of our New Jersey roofing facility. As a result, normalized capital spending is expected to be roughly in line with depreciation and amortization of about $315 million. We continue to expect corporate expenses to be about $120 million.

Our $2.2 billion US tax NOL will significantly offset cash taxes for some time to come. In 2013, we expect our effective tax rate on adjusted pre-tax earnings to be 25% to 28%, and our cash tax rate to be 10% to 12%. We have used the midpoint of our effective tax rate guidance as the pro forma rate to calculate our adjusted EPS as disclosed in Table 3 of our earnings release.

10 million shares remain available for repurchase under the Company's stock repurchase program as of June 30. As we balance our priorities for the deployment of free cash flow, stock re-purchases will continue to be an important mechanism to return capital to shareholders. While we did not have any share repurchase activity in the first half, we have purchased some shares early in the third quarter given our outlook for improved financial performance, and our expectation of strong second half free-cash flow generation.

Again, we are please with our first-half results. This performance and our outlook reaffirms our confidence in improving full-year margins in all three of our businesses, and delivering improved EBIT of at least $100 million with potential upside determined by the pace of the US housing recovery and its impact on building materials margins. Thank you, and I will now hand the call back to Mike.

Thank you, Michael. As I noted at the outset of today's call, Owens Corning's success in the second quarter was a result of continued execution in all three of our businesses, which positions the Company for strong second half EBIT growth. We are pleased with the expanding Roofing margins in the first half, improved pricing and volume in Insulation, an a positive outlook for second half financial performance in Composites. We have demonstrated our commitment to continually grow our market-leading businesses, through the acquisition of Thermafiber, the announcement of a new non-wovens facility in the US, and our strategic partnerships in Composites. We are well positioned to deliver strong second half performance. I would now like to turn the call over to Thierry, who will lead us in the question-and-answer session. Thierry?

Thank you, Mike. Amy, we are now ready to begin the Q&A session.

(Operator Instructions)

Our first question comes from Garik Shmois at Longbow.

I thank you. The first question is just on Roofing. I think in the key, you indicated you had $15 million in cost benefits in the second quarter. Just wondering if you could talk about the trend on the cost side as you look at the second half of the year?

Yes, sure. Garik, this is Mike. Obviously when we talked about the second quarter Roofing performance, we cited good price performance in the second quarter as having a nice impact on operating margins, but in addition, we talked about very good operating performance and also the sales of our Duration product line. And it really is a pretty good mix of drivers that have helped us with our margin performance in the quarter and in the first half.

We've had good performance from our Roofing operations. Roofing is a little bit different than our Insulation or Composite businesses. It's not nearly as utilization driven; it's a materials conversion business. So very tight control of materials, effective sourcing of materials, high quality levels in our manufacturing operations can have a meaningful contribution to our performance. I think you saw that in the Q where we did say that operating performance contributed nicely on the cost reduction side to help us with our margins.

Okay. Do you think that trend is, on the cost side, sustainable to the second half?

Yes. We will see some variability in raw material costs. Right now, obviously, oil prices have been elevated a bit for the last 30 days, and that could start to come through in a little bit more dramatic asphalt-cost inflation, and I think our experience has been that, that can be a catalyst for price recovery in the market. So if we were to see more inflation on the materials side, potentially that would require pricing actions or some actions to offset that. For the most part, if we are sourcing our materials well and we're manufacturing well, I would expect we will continue to have very good performance in the second half.

Okay, thanks. And then switching to Composites, previously I think you had indicated somewhere around $20 million to $30 million of EBIT growth was possible in Composites depending on how much pricing you were able to achieve this year. You talked that you have some pricing in place middle of the year. It looks like maybe inflation was coming in below trend. Correct me if I'm wrong there. Just wondering where you are here middle of the year in Composites relative to that prior forecast you had put out there?

Yes. I think our outlook for Composites is still consistent with what we said in the first quarter. We had kind of come into the year saying we had a lot of operating leverage coming from our asset restructuring and also coming from some demand growth, and that was going to be offset by inflation. I think inflation, we've done a good job of managing inflation. That's not just overall market rates have maybe not have been quite as high as we expected coming into the year, but we've had a focused program on sourcing and managing the inflation of raw materials. We've made some progress there that really is productivity and cost performance on the operating side.

I think volumes have been maybe have been a touch weaker than we had expected coming into the year. In my comments I described industrial production globally as a bit uneven, so we've seen some portions of the market where we're meeting our expectations. Some that have been downgraded a bit, but we are seeing overall growth. But the simple driver of improvement in Composites this year is really operating leverage net of inflation, and I think we are still in the range of where we were on the last call when we talked about that.

Okay, great. Thanks so much.

Thanks, Garik.

Our next question comes from Stephen Kim at Barclays.

Yes, thanks very much, guys. Steve Kim at Barclays.

Good morning, Steve.

I wanted to ask you a question about Composites if we could. Can you give us a sense of what percent of your annual sales are done to customers who are not on an annual fixed contract? What do you think the outlook is for price opportunity for those sorts of channels?

Sure. I mean it is a great question, Steve, and let me kind of step back a little bit and just frame how the market works and then I'll speak directly to your question.

Unlike our Building Materials businesses where we largely sell to distributors who buy and resell our products, where when we move prices, it moves prices in the marketplace in their end-use, and they're able to recover that price increase. A lot of our customers' business in Composites is done based on bidding, products or actual fabrications into end-use markets. And so generally, that market has worked with our customers wanting to support them with annual pricing so they could go out and they can quote business and they could stand behind the prices that they quoted. So the nature of the business, because it is an OEM and it's a processing market, not a distribution market, tends to dictate that our customers are looking for a little bit more price stability in the year and maybe looking more for an annual price discussion. Now some of that is, in fact, contractual the way you would think about it as a contract, and then some of that is just an annual pricing agreement that we reach with our customers.

We have said that probably more than half of the business is on either contracted prices or some type of annual price agreement where we don't feel much flexibility through the year to try to restate those prices outside of some major change in the dynamic of the market. And then less than 50% of the market would be what we call non-contracted volume. When we are putting mid-year price increases into the market that vary by geography and product line on the portion of our business that is non-contracted, the materiality to the outlook of the performance in the second half may not be that large, but the materiality to our outlook over the 2014, 2015 time frame is very, very important because, obviously, if it's that non-contracted business where we start to pick up some positive momentum on pricing, that starts to frame the annual price negotiations and the annual price contracts with our other customers who are annual arrangements or even multi-year arrangements, into a more positive pricing dynamic.

We put some materials out on our investor website that we presented at an Investor Day in Amarillo, which is one of our Composites plants in Texas. In that chart, we made public a fair amount of our competitive analysis that shows there's really been a dearth of capital investment coming into this market since the financial crises in 2009. Returns on capital have been low, and not just Owens Corning, but really our competition has responded by not bringing new capacity to the market at the rate of demand growth. So we see utilizations tightening. We think going into 2014, it's going to be a better utilization environment and therefore a more positive price environment. And then as we look past 2014, you actually start to see some really genuinely difficult market conditions in '15 and '16 in terms of availability of Composites. This pendulum is shifting. We've been in a flat-to-negative nominal price environment now for really the better part of a decade. Our goal is to start to reverse that trend, get ourselves at least into positive nominal pricing, and then at some point here, get the positive real price and actually have margin-accretive pricing.

Yes, and certainly the Chinese downtime that is going to be coming is going to be a tailwind as well, you would think, longer-term. My next question relates to Insulation. The incremental margins this quarter were a little light. They were strong obviously for the first half, but I was wondering whether there were any one-time items that we can sort of peel out that would have increased the incremental margins more up to sort of the 40%, 50% type range that we have been getting used to? Also, if you could just remind me, what kind of pricing increase is baked into your outlook for incremental margins in Insulation?

Okay. I think you are right that we have guided that over a 3-year period of time, we expected about 50% operating leverage in the Installation business. We gave that guidance, I think, in late '10 or early '11, so we were kind of talking about the time period '11, '12, '13. So we're kind of late into that time period, and generally through '11 and '12, we were pretty much spot-on or a little bit better than that guidance and actually through the first half of this year, our Insulation business has grown by a little over $70 million and we've grown EBIT by about $33 million. In fact, through the first half, we are pretty much on track with that guidance. We didn't see anything in the quarter that was worrisome or a surprise to us in terms of the progression of operating leverage.

We have said, I think again and again on this call, and we try to say when operating leverage is fabulous like it was in the first quarter, effectively in the first quarter we had EBIT growth on zero revenue growth and didn't really crow about that because we said there's a lot of timing issues in this and we should accumulate it over time. I would look at the first half and the operating leverage in the first half and say that was pretty much in line with our expectations. I would probably say, the one area where I think we could see some pick-up in the second half that would probably help our business is we commented in the first quarter that Canada was a bit weak and mostly cited weather. That is an important market to us.

In the second quarter, we have had a lot of flooding in Alberta. We had a strike in Quebec. So some of the rebound we expected to see in Canada we did not see. Again, we think that is timing. So we think anything that didn't get done in the first half because of weather and didn't get done in the second quarter because of the strike in Quebec or the flooding in Alberta, we would see in the second half. That probably will help our profitability a little bit.

Yes, that's great. And the pricing assumption?

I'm sorry about that. We announced about a 10% price increase for June 1, and then in our prepared comments we said that we felt like our realization of that price increase was good and that that should continue through the second half of the year. We are, in our outlook, expecting that we will operate at higher price levels in the second half of the year than we did in the first half.

Okay. Thank you very much.

The next question Ken Zener at KeyBanc Capital.

Good morning. Just want to follow-up on the question on price really quick, specific to insulation. In the Q, you talk about roughly $35 million in price in Insulation this year. How much of that dropped to the bottom line? Do you view that as 100% versus the incremental volume which is maybe coming through at a 30% incremental?

Yes. In our Q, we do break out pricing. That price would be across all markets. Generally, when we are on the call when we are talking about the real driver of profitability in the Insulation business, we are very focused on that US residential new construction market, which is a market that suffered the most from 2006 through 2012 as we've gone through this big downturn, and it's really the place where we are most focused on trying to rehabilitate pricing and recover [particularly] back to historical levels.

The $35 million would be across all segments of the market. In some cases, some of the industrial and commercial markets we've had some inflation on some input materials, et cetera. So all of that wouldn't get to the bottom. Some of it is to cover input costs and other market dynamics. Some of that, obviously, is margin accretive, particularly the US residential side where prices have been well underwater. We need to get a fair amount of margin accretive pricing to get anywhere near historical price levels and certainly to get anywhere near peak levels that we saw in '05 or '06.

Okay, and then moving over to Roofing which always colorful industry. It sounded like if you are using ARMA data down 25 or 16 so there's differences there, but there's a big difference between sell in and the sell out.

Can you highlight what that means for the inventory at distributors in your opinion, A, and B, I want to revisit the question I asked you last quarter where I thought COG changes actually drive pricing more than anything else. And while last quarter I view that as potentially a neutral element to price. Is there risk? This is a negative considering how strong your margins were, but is there a risk of price deflation in the second half if asphalt doesn't move up relative to the run-rate?

Sure. Let me talk about the sell-in versus the sell-through, kind of as you characterized it. Michael, in his comments, said that last year we shipped more than 60% of our shingles in the first half of the year. We went back and looked at about 15 years worth of data and a pretty good average for Owens Corning than about 55% first half, 45% second half. We were well, well ahead of historical trends last year and knew, and I shouldn't say knew, suspected at some point in the first half of this year we were going comp negatively with last year, unless that was kind of the new normal. We're actually, I think, pretty pleased to see, at least for the time being, it's not the new normal. Inventory levels in the channels today we would expect are quite a bit more in control than they were this time last year.

Now that's, I think, attributable to a couple of things. One was last year the Roofing market got off to a very fast start. So we had a very early spring, we had lots of early season storm activity. Business was vibrant in a lot of the country, and I think there was an optimism in the April/May time frame that was not met with demand pull in the June/July time frame. So a lot of our distribution and retail customers had to pull back pretty quickly on what had become elevated expectations for the year.

I think this year is a little bit of the opposite. We had a little bit of late spring. We didn't have huge spring storms. We had some, but we did not have the level of storm activity. Most of distribution has kind of grown into the year and seen their business building through the year which is good. It means their sell-throughs are relatively stable and that their inventories are in good control which would suggest that their re-order rate for us in the third quarter should hold up better than it held up last year. We see that as a positive to pricing. One of the things that causes price deflation is if you go through prolonged periods of very weak demand. That is a time where manufacturers might get a bit more anxious that they've misgauged the market, get more aggressive in discounting to try to move some of their inventories.

I think as long as our customers are seeing decent re-orders, and as long as our customers are buying in a fairly stable pattern, it is pretty easy as a manufacturer to remain patient to realize that demand. You have to remember, price deflation is not good for our customers for the most part. If we were to see a second half decline in prices, that's de-valuing any inventories that they do have. Generally, I think the market dynamic will support an outlook which would say stable pricing margins are what's good for us as a manufacturer and what's good for our customers.

Thank you.

Our next question comes from Mike Wood at Macquarie.

You spoke about the Composites and Insulation price realization. Can you comment a bit on Roofing given the fact there were two price announcements out there and some confusion in the market as to whether one of your competitors was discounting? And then also on that effect, whether or not there was any timing issues as to whether or not that would be fully realized when you reported results this quarter? I believe you had a 4% price increase in the quarter in Roofing.

Well, you know, I mean, specific to price realization, we don't really like to comment on specific price increases or specific price realization on what's been announced in the market. Obviously, at the time of the first quarter call which was in late April, we expressed a fair amount of optimism about the effectiveness of the April price increase, and our expectation that it would have a positive impact on margins in the second quarter and then carrying into the second half of the year. I think if you look at the margin rate in the second quarter, we clearly were able to achieve enough pricing, even with some of the well-documented discounting that took place in the market, that we were able to produce 22% margins for the second quarter and 21% margins for the first half.

Despite some noise around individual price increases, I think our overall message would be that the market environment we are in today and the price levels we are currently selling at, support really an outstanding outlook for our Roofing business.

Okay, but does that price increase that was disclosed in the Q fully reflect the price increase that was in the market, or is there some kind of timing issue that we wouldn't see it fully in results until third quarter?

I don't -- so if you are looking for, was there a delay to the price increases or something that we're going to hit another point of catalyst where suddenly prices will come up and margins will further widen, no, I don't think the guidance we are giving today was built off of that point of view. I do remind you, though, that a lot of things can happen in the Roofing business that can be catalysts for price, and obviously one is inflation. We're watching oil prices very, very carefully. Certainly there's enough price announced in the market that if we were to see a lot more inflation on the asphalt side that the ability and the focus on achieving some gains to those price increases to offset our inflation I think would be felt not just by Owens Corning, it would be felt industry-wide. We think, generally, asphalt cost inflation is an area where that cuts across the marketplace and is well understood by our customers.

I think the second potential catalyst is we haven't had a fall storm event for now 4 or 5 years. Historically, the big run-up in volumes in the Roofing market was when we saw hurricanes, and we've kind of been out of the hurricane business now for 4 or 5 years. If we did see a tight demand environment in the second half because we had a storm event, obviously that's going to support stronger pricing as people are paying up in order to try to get volumes to meet the rebuilding efforts.

Okay. Finally, can you just comment on the Insulation pre-buy, and how demand trends may have shaped up post the June price increase that you referred to? Thank you.

Yes, there was some pre-buy in the second quarter so I think our revenue numbers in the second quarter were influenced a bit by, in particular, the US new construction market wanting to get inventories in at lower prices. Obviously, that's a very, very positive sign for us. It means that the price increase is well understood and it's going to stick in the marketplace. People want to get low-cost inventories in.

I would reiterate, though, at the end of the first quarter when our revenue number was basically flat, we did say that we thought, not just on a year-to-go basis but a full-year basis, we thought Insulation would grow at double-digit levels. So if you are flat in the first quarter and you leave three quarters to get to double digits, you're going to have to put some quarters in at very strong growth rates. We saw that in the second. We would expect to see continued strong growth in the third and the fourth. The seasonality of the business and the underlying economics in new construction, or the underlying dynamics in new court construction, support good top-line growth for Insulation.

Our next question from George Staphos of Bank of America Merrill Lynch.

Thanks. Hi, everyone. Good morning. I want to come back to the question on incremental margin in Insulation and not trying to be pedantic about it, Mike, but would you have been at your target range on operating leverage incremental margin of 40% to 50% in the quarter if not for the one-off factors that you cited? Is there a way to -- I think Stephen asked you the question earlier, is there a way to parse out what the aggregate amount of those factors was in the quarter? Would your outlook expect incremental margin in that range in the second half of the year? Obviously you have more volume momentum than you did in the first quarter and you're getting more pricing. That would suggest that you should be able to get to target ranges, no?

Yes. I think there's a couple of mixed things that I would point to, and when you say could you parse it out. We don't provide enough disclosure in order to what we think would be constructive to provide disclosure at the individual market segment level. If you look at the second quarter, we would have produced better leverage in the first half probably if Canada were a bit stronger and if there had been less pre-buy in the US residential construction market. The US residential construction market, I think we've been pretty candid, that that's been our lowest performance market segment, that we've been losing a fair amount of money in that market. So whenever you see a pre-buy in a market that is struggling with profitability, there's going to be a headwind to operating leverage. If you lose some volume in a market that is making money, that obviously is going to hurt your operating leverage.

If we could remix the quarter, you would probably want Canada a little bit stronger, and you'd want a little bit of that residential new construction business in the third quarter, not the second. That said, I think we wound the spring in Canada where we have got good volumes coming in the second half because of the delays, and I think pre-buys are always a good sign in any market because it means the market is expecting higher prices. I wouldn't give it back. I'm very happy to be looking ahead to strong demand in the second half in Canada, and I'm very happy that our customers were able to bring in some inventories in the second quarter that they will be able to margin out a bit and make some money.

From a guidance point of view, I think we stand by our original guidance which was 3-year guidance that over a 3-year period of time, we expected about 50% operating leverage. I would punctuate the point Michael made, and I think those of you have been on the call for a while, it was probably 4 or 5 years ago that we said the last time the Insulation business broke even was at 1 million housing starts, and that we thought the next time we passed 1 million housing starts that we'd make about $100 million. A lot of our analysts, I think correctly, said, well, you're at 600,000 starts now, so if I draw a straight line between $100 million of losses at 600,000 starts and $100 million of EBIT at 1 million starts, you guys should break even around 800,000. We never explicitly gave that guidance but we always nodded and said that's a reasonable conclusion.

Well, here we are today. If you look at LTM, LTM EBIT for the Insulation business I think is about a $3 million loss. I mean, it's effectively break even, and LTM housing starts are just a touch over 800,000. We are tracking along very nicely in terms of our understanding of the business. We did that at the end of the second quarter, so if you look at the LTM we are using here, it is the second half of last year which is our seasonally stronger period, and then the first half of this year which is seasonally weaker. So we're now an LTM basis break even looking ahead to the strongest part of the year for us in 2013, and then looking ahead to 2014, another year of good growth in Insulation.

We feel like we are right on track in our Insulation agenda. We're really pleased to have seen now two price increases that were effectively executed in the market, one late last year, the second one in June by our team with our customers, and we think that we are now moving back down the path where improved housing starts, better pricing, and with the story we have around building codes, more insulation for home in order to meet the new energy efficiency standards, that this business is going to get back to very, very high levels of performance well before we need to see anything like that the housing starts we saw in '05 and '06. It is a big moment I would say in the Company's progression to be sitting here today talking about Insulation making money in the second quarter, Insulation breaking even on an LTM basis. We now have three great businesses we can talk about in terms of earnings growth, and three great businesses we can talk about in terms of earnings power.

Okay. Well, I appreciate the thoughts there. I had one more question on Roofing. Given all the dialogue on pricing over the last couple years, and I guess that's the norm to some degree with Roofing, do you think we're hitting a relative ceiling on real roofing prices, given the fact that you have such strong operating margins? I realize that if asphalt costs go up or input costs go up in general that you'll have to recover that, but barring any change in the cost of manufacturing, should we be expecting real roofing price to be more or less now status quo on a going forward basis? Thank you.

Thanks. I don't know that the absolute level of roofing price is something that would be a big driver in the market from our perspective. If you look at an average roofing job, let me kind of estimate some numbers. If you take an average American home, maybe 2,500 or 3,000 square feet, it might have something around 20 or 25 squares of roofing material on the roof, and it might cost $8,000 to $10,000 to re-roof that home. At the distribution level, we would sell those 25 squares of material for somewhere in the $1,500 range. If you think about it from a homeowner's perspective, I've got an $8,000 to $10,000 re-roof job, and at the first buyer, I'm buying $1500 worth of roofing material. If we're making 20% margins on that $1500 worth of roofing material, we're making $300, and we are going to be around for 20, 25, 30 years, standing behind our warranty, keeping moisture out of the person's attic, beautifying their home and increasing the value of their home. That doesn't strike me as an outrageous ask, and it certainly doesn't strike me from a value point of view that if we need to cover asphalt costs or for some reason that 25 squares of roofing material is going to need to cost $1,600 or $1,650 and the value of the re-roof job goes up to $8,150 or it goes up to $8,200, that somehow we've change the dynamics of the market.

There aren't strong alternative materials. You get into metal and other much more expensive materials than an asphalt shingle. We make a very, very high quality product that improves the aesthetics of your home. We offer a very good warranty, and it's a great value. If anything, you go back to some of the historical times when we were operating at single-digit margins, and you kind of scratch your head and say, why were we willing to sell $1200 worth of material on that job and make $70, in what was probably a $7,500 re-roof job at the time. So from a value proposition point of view, the value proposition certainly supports the roofing manufacturer making money.

Now, it is a competitive market, so obviously we have to compete every single day. We have to make great products. We have to offer our contractors a value proposition that they can go and sell in the home. We have to offer our distributors end-use demand that they can sell through. That's really where our margin comes from is our ability to do those things effectively.

Okay. Thanks, Mike. Good luck in the quarter.

Thanks.

Our next question comes from Bob Wetenhall, RBC Capital Markets.

Hi, good morning.

Hi, Bob.

I wanted to see, do you expect Composite sales to comp positive in the second half based on your guidance? And what is the anticipated impact on revenues and margins of the strategic partnerships that you've announced in China?

The answer to your first question -- in Michael's prepared comments he said volumes were about flat through the first half, and that we did expect volumes to be up for the full year. I think it is a reasonable conclusion to kind of back out the second half and say we'll comp positively in the second half. Part of that is stable demand where we're sitting right now. And then the other part of that is Europe slowed down in the second half of last year. The US wood market slowed down in the second half of last year because of the PGCs. So the comps last year are kind of against two of our big markets going through a bit of a slowdown last year, and we're hoping that we won't see that again this year. So we would expect to see some volume pick up in the second half, although I don't think it is a dramatic driver. And the second half of your question, Bob?

You are doing a lot in terms of announcements with strategic partnerships in China and I just wanted to understand what the potential impact on Composites is for both revenues and margins.

Yes. I think, in terms of materiality of the impact on the business, both those partnerships are a bit on the margin. We'll get a little bit of capacity that will give us some growth over the next couple of years. We will get a little lower cost position in a very important product line for us and avoid a significant capital investment that we would have needed to put in order to support that product line. So we're really working a little bit of top-line, a little bit of margin, a little bit of balance sheet in each of those deals. But I think they say a couple of things. One is a continuation in an evolution of our strategy, which is we made significant investments in the 2009 to 2012 time frame, kind of repositioning our asset base, taking out some high cost assets, building some low cost assets, and getting the asset base that we wanted.

We also said that we were going to pull back our investment until we saw a little bit better margins and a little bit better return on capital from the business. I give the team a lot of credit. I think they are finding creative ways to continue to expand the footprint and impact of our business without needing additional capital. In fact, actually offsetting capital in some cases, creating cost reductions.

I think the second thing it points to, though, is a lot of the themes we've been talking about in China are coming to bear, which is, if you go back 5 or 6 years ago, what we just saw was aggressive across-the-board investment by our Chinese competitors. We're now seeing openness for partnership, need to find technology partners who can help them get lower-cost, the inflation, the currency translation rate, the demand for higher-quality products. A more specified environment is putting pressure on some of our Chinese competitors as is the credit market in China, and they're looking for more creative solutions and reaching out to people like Owens Corning. That allows us to be selective. It allows us to find right partners for the right types of situations. We think it is a constructive step forward to see that we can actually do business with our Chinese competitors in a way that we can give them some technology and some licensing and provide us some tolling and some low cost product that we can then extend our commercial agreement.

Got it, and just one quick follow-up on Roofing. Good margin movement in the first half of the year compared with 2012. Just wanted to get your view on where do you think long-term, normalized EBIT margins are in the roofing business based on your current thinking for that? Thanks so much.

Well, you know, Bob, our official guidance on that has been mid-teens or better. I think given the volatility we have seen in margins, that is probably good, safe guidance and guidance I would stick to. If you look at slide 8 of our investor presentation, I continue to look at that slide when I talk to the team. You kind of see 2010, 2011, right around 20%. You see a dip in 2012 and then you see LTM margins right back around that 20% level.

I tend to feel really good about the business when we are at these margin levels. I know we're going to have some bumps in the road. I see structural reasons why mid-teens or better is probably the right way for us to guide the business. I think some people interpreted our mid-teens or better guidance to be a margin deflation outlook. I think we guided to exactly what we believe which is what you'd should expect that business to pretty consistently deliver mid-teens or better margins than where we are now with 21% margins year-to-date is in fact better than mid-teens.

Got it. Thanks so much.

Amy, this is Thierry. We have time for one more round of questions.

Our last question comes from Dennis McGill with Zelman.

Good morning. On the Insulation segment, the two drags that you've talked about have been raw material inflation and mix. Can you maybe dig into raw material inflation a little bit more, and just talk to what the pressure points are there and what the outlook is there for the second of the year?

And then on the mix side, given that new res domestically is going to be the growth engine for a while, is there any opportunity to see that headwind abate or is that with you for a while?

Well, Dennis, I want to make sure that I -- the comments I made around inflation, which I don't want to blow these out of proportion, it was more in the context of the price number we offered for the insulation business in our 10-Q, cuts across all segments of the business. If you look at our pie chart, it's 37% US new residential construction at the end of 2012. We've always said probably 20% of that is Canada, so it's maybe less than one-third US residential construction. When we talk about the business on these calls, that is where the leverage is in terms of earnings. That's where we tend to spend our time talking about price and inflation.

If you look at international, we're doing business in some developing countries there where we could have labor cost inflation and exchange rate-driven inflation. If you look at commercial and industrial, we have got a fairly sizable extruded polystyrene foam business that sells a fair amount of product into that marketplace. Polystyrene tends to track oil. We've seen some polystyrene inflation. Now the pricing mechanism in that market looks a lot more like roofing. It is a materials conversion business so when we have polystyrene pricing, you tend to get better pricing on board stock, and as a result we manage to margins in that business. I would just caution when we look at Insulation as a reportable segment, there's a fair number of things that would be going on in both the price number, which is inflation recovery, and the cost number. I think when we come back and look at the US residential new construction segment, we've said that we had good price realization at the end of the year on kind of a high-single price increase, and then again on the June 1st price increase, we said that we have nice price realization on that price increase. We are starting to move prices specifically in that segment.

Okay, just to clarify. If you just isolate the raw material side of it or the inflationary side of it, as you look to the second half of the year, is that still a headwind in the overall segment?

It hasn't actually been a headwind to date because most of the polystyrene inflation we would've experienced, we've recovered in price. So from a margin point of view, where we've had inflation, we've been able to recover it with price. I answered the previous question in the context of, did all of that price fall to the bottom? Some of that price was recovery of inflation. I don't see it as a headwind in terms of how we look at the businesses or we manage price.

Okay, and then the mix side of it for the domestic new construction, is that mix that becomes or remains a headwind, for the foreseeable future?

Well, you know, we're still -- we've said in the past that new construction insulation prices are probably 30% to 35% below their peak, is kind of where we pegged them at the end of last year. Even with our positive pricing actions they're probably still 25% below the peak or somewhere in that range. We have a lot of work to do to get pricing up and get back to an investment-grade business with good margins. We will soon kind of get to the point where we are no longer losing money at the manufacturing level. That is no goal for any business I know of, but it's certainly a first step in trying to improve the profitability of business.

Once we get to making money at the manufacturing level, then some of the mix issue start to go away a bit. But we're in a position today where as some segments grow and some segments shrink a bit, depending on their relative margin performance, you're going to see big impacts on operating leverage. Once we get all the segments of that business profitable, then as each of them grow, each of them will contribute to operating leverage. We are pretty close to that. I think when you see the overall business break even, you can conclude that the losses have been significantly narrowed where we are losing money and that the businesses are contributing or offsetting those losses but that the rising tide will eventually raise all boats.

Okay, thanks, Mike

Thanks, Dennis.

This concludes the question-and-answer session. Would you like to make any closing remarks?

Thanks, Amy, very good. Thank you everyone for joining us for today's call, and with that I will turn it back over to Mike Thaman for a few closing thoughts.

Okay, thank you, Thierry. First, as always, thank you for all the people on the call for your interest in our Company. Obviously, we are working very hard on your behalf to create great businesses and deliver lots of shareholder value.

In that regard, we think in the first of the year and in the second quarter of the year, we have made very good progress as a Company in extending and executing our agenda of improving each of our businesses and really getting all parts of Owens Corning's business portfolio operating at high levels of performance at the same time. Getting Insulation back to profitability on an LTM basis and a full year 2013 basis is a big milestone for us. Seeing positive progress sequentially in Composites from the first quarter to the second with a good outlook for the second half is a big milestone for us, and producing 21% EBIT margins in the first half of the year in Roofing with 23% EBIT margins in the 2nd quarter obviously is a big milestone for us. We are really happy with the people of Owens Corning who have been working very, very hard in what have been some challenging market conditions in both Composites and Insulation. I think we're now starting to see the fruits of our labor across all of our businesses, and we're awfully proud of our team.

As you can tell from my comments, we're entering the second half of the year confident, not just in our operational execution but also in our market outlook, and we do believe that that outlook supports improved performance in all of our businesses. And I think we want to emphasize, the competitive positions of our businesses and the market drivers that underpin our second-half optimism are not second-half specific, that these are market drivers and competitive positions that underpin continued progress in 2014 and beyond. This is kind of a moment in time for our Company where we are feeling like the fruits of our work are going to pay off and that we are getting closer to that moment in time where all three of our businesses can perform at very, very high levels and we can deliver the kind of shareholder value that we know is built into this Company. Thank you for your interest. We look forward to talking to you again in our October call.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.