Headwaters Incorporated F2Q09 (Qtr End 03/31/09) Earnings Call Transcript

| About: Headwaters Incorporated (HW)

Headwaters Incorporated (NYSE:HW)

F2Q09 (Qtr End 03/31/09) Earnings Call Transcript

May 5, 2009 11:00 am ET


Stacy Feit – Financial Relations Board

Steven Stewart – CFO

Kirk Benson – Chairman and CEO

Bill Gehrmann – President of Headwaters Resources

Jack Lawless – President of Headwaters Building Products


Trey Cobb – Stephens Incorporated

John Quealy – Canaccord Adams

Ankush Agarwal – JP Morgan

Al Kaschalk – Wedbush Morgan Securities

Pearce Hammond – Simmons & Company International


Ladies and gentlemen, welcome to the Headwaters Incorporated second quarter 2009 conference call. (Operator instructions).

I would now like to turn the conference over to you, Stacy Feit, of Financial Relations Board. Please go ahead ma'am.

Stacy Feit

Thank you. Welcome to the Headwaters Incorporated fiscal second quarter 2009 conference call. If you have not yet received a copy of today's press release, please contact my office at 213-486-6549 and we will get one to you right away.

Without further delay, I would now like to turn the call over to Steven Stewart, Headwaters Chief Financial Officer.

Steven Stewart

Thank you, Stacy. Welcome everyone and good morning to Headwaters second quarter fiscal 2009 conference call.

Before I make my comments, I would like to talk just a second about forward-looking information. Certain statements made during this call including statements relating to our expected future operation and financial performance may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934 both as amendment.

Forward-looking statements by their nature address matters that are to different degrees uncertain. These uncertainties which are described in more detail in the annual and quarterly reports filed with the SEC may cause our actual future results to be materially different than those expressed in our forward-looking statements, whether as a result of new information, future events or other activities.

You may find Headwaters Annual Report on Form 10-K and quarterly report on Form 10-Q and other SEC filings readily available from the SEC's Web site, Headwaters Web site or directly from the company.

Now I would like discuss the financial results of the March 2009 quarter. Attached to the press release, Stacy mentioned are condensed consolidated financial statements that include statements of operations for the quarters and the six months ended March 31, 2009 and 2008.

There are also balance sheets as of March 31, 2009 and September 30, 2008. My comments are derived primarily from those condensed consolidated statements and schedules included therein. We expect to file our Form 10-Q this week.

Our second fiscal 2009 quarter continue to be significantly impacted by the weakness in the new housing and residential remodeling markets, the decline in the demand and price for coal, particularly as it relates to metallurgical grade coal and severe weather conditions during the March quarter. January and February were significantly affected by these items. And while March saw some improvement, it was too little, too late, to reverse this trend for the quarter.

We continue to focus our efforts on identifying opportunities for operational improvement and cost reductions in all of our business units. We are starting to see the effect of these improvements and cost reductions in our operating results, which should help mitigate the continued effects of this recession on Headwaters operations.

There was no revenue from Section 45K operations in our March 2009 quarter. There was approximately 7.9 million of Section 45K operations in the March 2008 quarter. There was no Section 45K revenues after the March 2008 quarter.

We announced the consolidation of the coal cleaning operations with our coal combustion products or CCP operations. We expect to realize some immediate savings and synergies from this consolidation. We've also implemented significant cost reduction initiatives in our other business units segments and incorporate overhead.

These cost savings initiatives have consisted of headcount reductions, elimination of certain employed benefits, changing certain service providers, elimination of non-critical outside services, reduction in non-essential travel, a salary freeze, plan consolidations, reduced number of manufacturing shifts and a line-by-line review of operating expenses, with the goal of reducing total Headwaters SG&A and operating expenses.

The six months ended March 31, 2009 shows a reduction in SG&A expenses of approximately 22% when compared to 2008. We have also put activities in motion to reduce fiscal 2009 capital expenditures. We expect capital expenditures will be 50% less during the last half of fiscal 2009 than the first half and will totaled approximately $60 million or less compared to capital expenditures of a $116 million in fiscal 2008.

As we have said in the past, our operations are very seasonal and we are currently using our revolving credit facility during the winter months and spring months. We currently have $25 million drawn on a revolving credit facility. These seasonal borrowers have historically been paid off in July or August.

Our current revolver credit facility matures on September 7, 2009. We believe we have sufficient liquidity from our current operations to repay any balances on a revolving credit facility prior to its maturity. Headwaters is in compliance with all of our debt covenants of March 31, 2009.

If you remove section 45k operations and the mortar and stucco sales in 2008, revenues declined by $25 million or 15% in the March 2009 quarter compared to 2008. The gross profit margin decreased from 21% in the March 2008 quarter to 16% in the 2009 quarter. The decline in the gross profit margin is result of the negative gross margin on the coal cleaning operations in the March 2009 quarter.

Lower gross margins in our building product segment which resulted from lower sales and the impact fixed cost having being spread over a smaller revenue base and changes in product mix.

The gross profit margin in our CCP operations, increased from 22% in the March 2008, quarter to 24% in the 2009 period. During fiscal 2008, Headwaters reported a goodwill impairment of $205 million. We are required to test for goodwill impairment at least annually or sooner if indicators of a possible impairment arise.

Due to the continued decline in the new housing and residential remodeling markets and the lack of projections by market analysts that this trend is expected to improve in the near-term, management performed a goodwill impairment test in the March quarter. This goodwill impairment test concluded that additional goodwill impairment was warranted and accordingly Headwaters reported a goodwill impairment of approximately $466 million in the quarter ended March 31, 2009.

Headwaters has approximately $116 million of goodwill remaining on its balance sheet, all of this goodwill relates to the CCP segment operations. There have been no indications of impairment of this goodwill in the past, and we do not anticipate anything going forward.

I think, I once comment that one of the items in the goodwill impairment calculation that has one of the largest effects on the actual impairment amount is the discount rate used in connection with forecasted operating income and cash flows.

The significant change in the credit markets over the last six months has caused a significant increase in interest rates, which have had the direct effect of increasing the required discount rate used in the goodwill impairment calculations.

This increase in the discount rates caused the majority of the $466 million goodwill impairment reported, which would have resulted even if the performance and forecast of these business segments had not changed.

Consolidated operating expenses, excluding the goodwill impairment were 26% of revenue in the March 2009 quarter, compared to 29% in the 2008 quarter and they were

$5.5 million lower than the December 2008 quarter.

Research and development expense in the March 2009 quarter was lower by 52% when compared to 2008. This is a direct result of actions initiated in the December quarter. SG&A expenses in the March quarter that ended March 31, 2009 were $27 million and were lower by 33% when compared to the 2008 expenses of $41 million.

I think most of Headwaters' business segments enjoyed being number one in their markets. And I believe that strong market position and the strength of our products has proven beneficial to Headwaters during these difficult times and provides us with the ability to adapt and change.

Headwaters total indebtedness at March 31, 2009 was $525.8 million, which included $15 million drawn on the revolving credit facility and it represents a decrease of approximately $7 million when compared to September 30, 2008. This decrease is a result of the convertible debt exchange we completed, which I will discuss in more detail in a minute, but is offset by an additional $15 million of borrowings on the revolving credit facility that we did since September 30th.

As of May 1, 2009, we have $25 million drawn on the revolving credit facility. Headwaters generated approximately $24 million of cash flow from operating activities during the six months ended March 31, 2009, which is slightly higher than the similar period in 2008, but was based upon significantly lower revenues in 2009.

Our revolving credit facility provides for total borrowings of $60 million and we currently are utilizing revolver to support approximately $10 million of letters of credit, which leaves $25 million available to be drawn on the revolver.

At May 1 2009, Headwaters had approximately $6 million of cash and cash equivalents on hand, thus providing us today with slightly more than $31 million of total liquidity. We currently believe that our operations will continue to produce sufficient cash flow to repay any borrowings on the revolving credit facility, provide with maturity and will also provide sufficient cash flow to cash collateral lines or letters of credit.

We also believe that Headwaters had some alternatives, including sales and leaseback or sale of assets, which could be used to supplement cash flow from operations. At today's interest rates, total interest expense in 2009 could be $36 million, including as much as $5 million of non-cash amortization of debt issuance cost.

Depreciation and amortization was approximately $37 million for the six-month ended March 31, 2009 compared to $34 million for the similar period in 2008. We expect depreciation and amortization for fiscal 2009 to be around $80 million. In late March and early April, Headwaters exchanged $39 million of our 2.5% convertible notes that mature in 2014 for approximately $27 million of 14.75% convertible notes with a similar maturity date.

The exchange resulted in reduction of the outstanding convertible debt of approximately $12 million with a corresponding gain on extinguishment of $12 million. This gain will be included in Headwaters' EBITDA calculation for debt covenant purposes. Approximately $1.6 million of this gain was recognized in the March quarter and the balance of approximately $10 million will be recognized in the June 2009 quarter.

Weighted average shares outstanding used in our earnings per share calculation is approximately 41.6 million shares at March 31, 2009. This is net of approximately 412,000 treasury shares and 365,000 unvested restricted shares. At today's stock price, substantially all of Headwaters' options and SARs are out of the money and are therefore excluded in the diluted weighted average shares outstanding calculations.

With the goodwill impairment that was recorded in the March quarter, that will result in a net loss for Headwaters for the fiscal year and accordingly in the earnings per share calculation, none of the SARs restricted stock will be included in the EPS calculation.

We continue to believe that our business units are performing very well in a very difficult market. We are optimistic about the combination of our coal cleaning operations with our CCP business and the synergisms that this will create. It is difficult to predict where coal price will go over next 12 months, or when the new housing and residential remodeling markets will improve, but this rebound is closer today than it was a year ago. Because of this difficulty and the problems incurred in January and February, we have reduced our guidance for fiscal 2009, diluted earnings per share to $0.25 to $0.45.

As we mentioned in the press release, we expect a significant tax benefit that should be recorded in the June or September's quarters that contributes directly to this EPS guidance.

We will continue to manage our expenses and position Headwaters for the rebound when it occurs. I'd be glad to discuss specific questions about the March 2009 quarter results during the question-and-answer period.

I would now like to turn the call over to Mr. Kirk Benson, Headwaters' Chairman and Chief Executive Officer.

Kirk Benson

Thanks, Steve. I've invited Bill Gehrmann, President of Headwaters Resources and Jack Lawless, President of Headwaters Building Products to join us on the call today. So, my prepared comments will be limited to introduction of Bill and Jack and then no comment on the respective business.

As you know, we've consolidated our coal cleaning operations, into Headwaters resources. The synergies that we anticipate include changes in personnel. We've integrated our support functions like an accounting and finance into the resources business.

Equipment is an important part of this business and there is an overlap between resources and coal cleaning. We think we could get much better efficiency as we reallocate some of the coal cleaning equipment into the broader resources business.

We have our site-services where the coal cleaning that we believe can be performed by resources such as impairment construction. There's an overlap in technology in the separation of carbon from ash and that's something that both companies are involved in and something that we think that we can develop into a synergy.

Resources has multiple utility and customer relationships that overlap with coal cleaning and we anticipate that that will add value to the combined business. We believe that the savings is considerably stated in $8 million to $10 million range. The fully loaded impact from our total headcount reductions through April is in the range of $7 million alone which should result in total savings that will exceed our stated range.

We anticipate flat coal production and revenue that will be similar to the first six months of the year with an opportunity for a slight increase in revenue depending upon inventory levels at the end of year.

Now, I like to turn the time over to Bill, he'll comment on both the coal combustion products business and our consolidation of our coal training business. So, Bill?

Bill Gehrmann

Thanks, Kirk, good morning. Year-over-year revenue for the quarter in our coal combustion products business was down 21%. Product revenue continues to be impacted by slow economic activity in Californian and Florida.

Seasonal sales levels were also negatively impacted by winter weather and rain in other parts of the country. Service revenues increased slightly by $300,000 despite also being negatively impacted by weather.

Our lane continues improvement initiatives continue to positively impact our cost structure. Gross margins continue to improve year-over-year and our SG&A cost are also down year-over-year for both the March 2009 quarter and year-to-date, we expect these trends to continue.

We've continued to grow our site services work. This new work includes sites that we've not previously provided service work on locations where we've increased the scope of our work. We're also providing construction services on a new coal fire plant site. Once completed, this site will become one of our largest sites service operations and could potentially provide additional quality fly ash supply.

In the next two quarters, we will be bringing on additional quality fly ash supply. We are completing the installation of dry fly ash handling system that will provide us 200,000 tons per year of high quality fly ash. The installation of additional equipment will double that supply as the market recovers.

We're also completing a blending facility in a rail load out system that will improve the quality of fly ash we currently have under contract, will enable us to move fly ash into other markets by rail.

While the transportation department is currently distributed very little infrastructure money, some states have started some work in an anticipation of money that they will receive. We're seeing shovel ready projects being started in the Midwest in Utah.

The influence of sustainability is also expected to grow at the state DoT level. Department of Transportation staffs and more than 50% of the states expect concrete share of paving to increase based on life-cycle cost advantages and lower maintenance levels over higher fall paving.

As the market recovers, we continue to believe that our ongoing efforts to expand our supply of quality fly ash will have us positioned to meet the increased demands in the markets that we serve.

Coal cleaning revenue for the March 2009 quarter was $21 million on sales of 490,000 tons of coal. Operating cost continued to be high as we went through our ramp-up process. Operations at the plants have begun to show improvement as we continue to lower ash contents in the recovered coal and lower our overall cost structure.

Current global demand for steel production continues to be soft and electric demand in the US is down year-over-year. In response to the current market conditions, we've reduced plant operations in order to match production and inventory to the current market demands.

However, as the economy improves there are also 16 gigawatts of new coal based generation under construction expected to be online in the next few years representing an annually for 70 million tons of coal.

We have also consolidated our coal cleaning business into our coal combustion products business. We have this time identified and are implementing annualized cost reductions in the range of $8 million to $10 million.

These cost reductions include headcount reductions and SG&A in the field that were implemented on April 3rd, as well as operating cost that have been identified at the facilities. Equipment is also being reallocated between the two businesses and this is having a positive operating impact on both businesses.

Underutilized equipment in the coal cleaning businesses is being used to replace rental equipment and new operating sites in the coal combustion products business. These cost savings in our coal cleaning business have been identified as we have implemented our lane continuous improvement programs that have proven successful in the coal combustion products business.

The integration will also allow us to take advantage of our national presence, experience and knowledge that we have in the CCP business. This includes dredging, material handling and reclamation expertise. We will be able to internalize work in our coal cleaning business that we have currently contracted to others.

We have also begun to leverage our long-term relationships with utilities to explore opportunities for new coal sales. The coal combustion products business currently operates on over a hundred coal burning utility sites.

Kirk Benson

Thanks, Bill. I would like to make a few comments now about the building products business and then turn the time over to Jack, to continue that dialogue.

So first, market data. On housing starts, the total number of homes reported for the purpose of residential construction decreased moderately in March to 510,000 units. That's a 10% drop from the levels in February. Total starts in March was still 48% below the year ago figure and 66% below March 2007.

New home sales remains steady in March after rebounding from all-time lows in February, seasonally adjusted new home sales or on an annual rate of 356,000 units. In March, new homes inventories declined to 308,000. The number of new homes for sale continues to decline and has not recorded to monthly increase since May 2007.

Non-seasonally adjusted units of unsold inventory are now at lowest levels since March 2002, as builders have scaled back building activity. These trends are all positive towards pointing to the end of the down cycle in the residential construction as the inventory declines. We still have high months in inventory and that number need to come down.

Jack will now comment a little bit on our specific business and highlight what we saw in March in the way of improved sales, it was a significant change from the prior quarter and from January and February.

So Jack, why don't you go ahead and make a few comments.

Jack Lawless

Thanks, Kirk and good morning, everybody. Revenues from our building products business in the March quarter were $68.4 million, a decrease of 26% from $92.2 million in the March '08 quarter, after adjustment for the sale of the mortar and stucco business in 2008.

The gross margin of 80% in 2009, decreased from that 2008, gross margin of 22% and the operating margin of a negative 11% in the March 2009 quarter was a bit lower than a negative 9% operating margin in the March 2008 quarter after adjustment for a goodwill impairment in 2009 as Steve mentioned earlier.

However, our second quarter operating results mask the positive operating results achieved in the month of March. We saw a material seasonal rebound in sales and meaningful improvements in gross margins and operating margins with a higher level of sales combining with the cost saving initiatives already achieved in cost of goods sold and SG&A to achieve solid results.

For March, gross margin was 30%, while our operating margin was 5.8% for our building products unit. We exceeded our sales forecast for the month at all of our building product companies, Southwest Concrete, Tapco and Eldorado Stone.

Southwest Concrete continues to post record operating earnings largely as a result of a higher approval of school bonds in 2007 and 2008 across the State of Texas, which has translated into a higher level of schools being built in 2009. We anticipate that increased levels of school construction will continue for at least the next 24 months in Texas.

Tapco sales continue to improve as incoming orders for April exceeded forecast again and exceeded March sales by approximately 25%. Virtually all of Tapco's businesses are seeing positive sales trends over the past several months.

Eldorado Stone has also seen sales increases with April sales coming in higher than the level that was attained in March. We do not believe that the sale gains over the past several months were materially related to a build in wholesaler inventories as a vast majority of our building product unit sales were job lot quantities during this time period.

The change in sales pattern for Tapco going Eldorado could reflect a relative improvement in remodeling activity, especially in the Midwest and eastern part of the United States.

In addition to improving revenues, we are continuing to focus on cost improvements and working capital management. The annualized run rate on all of our cost saving initiative commenced since October 1st, total approximately $24 million.

Consistent with our seasonal revenue pattern and the timing of the cost savings, these savings are weighted towards the second half of our fiscal year and on a net basis it will give us approximately $10 million of cost savings in the second half.

One example is our employee headcount at the end of March of 2009 was over 36% less than March of 2008. In addition, inventory for the building products group is down 28% from year ago levels.

While the first two quarters of 2009 have been difficult and we expect to see no material improvement in the macro environment over the second half of the year, we do have some reasons for encouragement in the second half for the year.

One, we had solid operating results in March, followed by improved top line results in April. Two, 65% of our business in our building products unit is remodeling institutional or commercial, which has allowed us to perform at the top line much better than the significant decline in new home construction. In addition, we expect the remodeling side of the market to outperform the new construction market over the near-term.

Three, over the past 18 months, we have improved our number one market share positions at all three of our building product units. This was achieved by two relatively small acquisitions of our competitor as well as further organic inroads against our remaining competition. These inroads will help leverage our operating result as sales improved in the second-half of the year.

And four, while construction should continue to languish in the second half of the year, I am seeing some signs that remodeling and showing some signs of life. For instance, our unit of Tapco and Eldorado saw double-digit sale gains in March in our Central/Midwest regions in the month of March.

In summary, while we expect to continue to see some tough lending for the rest of the year, we believe that we will outperform our peers and come in with above average financial results for the year despite where the worst housing downturns on record.

In addition, we continue to take prudent steps to position our number one market share building products group to take full advantage of our product, geographic, market, customer and channel diversification, when the market returns to more normalize levels.

And, I guess Kirk, it goes back to you.

Kirk Benson

Yes. Thank you, very much, Jack. Just a couple of comments and conclusion on some of the other activities that were involved, and we are pleased with the completion of our joint marketing alliance with Criterion.

Criterion is a major supplier of supported Catalysts in to the affiliated debt market. I think they have the majority of the market share in that business. So we are aligning with the strongest catalyst provider in the market of interest to us.

We are already working with Criterion, we've had a number of joint marketing opportunities for the HCAT technology and we're happy to be serving alongside the industry leader in this business.

In addition, we successfully completed a very short trial of the HCAT technology. We were specifically testing the mix into HCAT with heavy oil feedstock and the test was successfully concluded.

Also, when we originally joint with the University of Utah to commercialize co2 sequestration capabilities, we didn't anticipate a near term impact on our revenues. However, the election of the Obama administration and the stimulus bill passage has altered original, fairly conservative view point.

There are multiple projects that we are now focused on and are moving forward across the country. We are personally most interested in Western projects, those in Utah and Wyoming.

There is a potential that we could generate revenue in the current calendar year from this activity and we see it as the potential of a significant growth industry over the next several years.

So that concludes our prepared remarks. We'd be happy to turn the time back over to the operator, and to respond to any questions that you might have.

Question-and-Answer Session


(Operator instructions). Our first question comes from the line of Steve Sanders with Stephens Incorporated.

Trey Cobb – Stephens Incorporated

Good morning, this is Trey for Steve. First question, Steve on the annual EPS guidance, can you give us the one half number that ties to $0.25 to $0.45 annual guidance?

Steven Stewart

If you look at the bottom of the condensed consolidated statements for operation, all '08 in the lower right, you see a number that excludes the goodwill impairment of $0.86 loss. That $0.86 loss is what I used for the first two quarters and the difference between that and my $0.25 to $0.45 guidance is what I would expect, we'll perform in the third and fourth quarters.

Trey Cobb – Stephens Incorporated

Great. I think it was noted in the press release that sales for vinyl accessories were up 64% from February to March. What is the percent of segment sales was this for the quarter and is this new low margin business or is just the traditional high margin products?

Kirk Benson

I'll respond to the margin, these are traditional products that we distribute with the wholesale distribution system. And so these are the products that have been the fundamental foundation for a number of years. And anything that Jack, wanted to add something to that answer?

Jack Lawless

It's our normalized high margin products that we have, higher margin products that we've seen for last five years or so. And that's really the Kirk's point.

Trey Cobb – Stephens Incorporated

Okay, and then is there a breakdown, what vinyl makes up building products?

Kirk Benson

Jack, I did just a quick calculation, I don't have real specifics on that Trey, but it's something less than 30%.

Jack Lawless

Yes. It's about 30%.

Kirk Benson

Of the total group.

Trey Cobb – Stephens Incorporated

Okay. Great, and then, on the CCP business, according to the guidance it looks like you expect second half of '09 sales to be comparable with '08. Can you talk a little bit about your assumptions there? Are you assuming a significant pickup in California and Florida or is this just normal weather, seasonal and stimulus benefits?

Steven Stewart

I think most of it is normal, seasonal activities. I think that, we're not anticipating a significant pickup in California. But we have made some progress in changing mixed designs. We have impacted the percentage of fly ash that is used and the other thing is important to consider is the service-oriented part of our business, which to a large degree is somewhat recession proof and it's a part of our business that we have been growing and it's becoming a bigger percentage of our total sales. Bill, why don't you add to that response?

Bill Gehrmann

Touching on what Kirk said, we are seeing an effort by ready-mix producers to continue to lower their mix design cost they have; continue to ramp up on their fly ash replacement of cement. Also we will be adding new supply into the market place which we haven't had in the past. We have added to our portfolio of site services work. If you look at site services work is percentage of overall revenue in year's past, its run at a 21%, 20% of the total revenue through the second quarter this year it is now at 30%. So, we have added additional site service work and supply in to our existing year-over-year supply, we continue to see some increases and utilization. In the year-over-year pricing is remaining flat, we still have some opportunities in some areas to increase prices but we have been able to maintain year-over-year pricing to this point.

Trey Cobb – Stephens Incorporated

That was very helpful. Moving to coal cleaning, it looks like you guys did about 33 million sales year-to-date and with guidance expected to be flat slightly up, how should we be thinking about annual for this year, so we would be thinking more in the 70 to 75 range versus the prior year 120 or 125.

Kirk Benson

I think that we are quite sure numbers are pretty accurate on the sales for the first six months. As we go through this consolidation, we are really trying to change some of that and focus on those actions in the cost structure not necessarily in the sales. But I think what it is going to have an impact on sales, as we look at some of our contraction relationships and how we are going to move the coal into the steam market versus the metallurgical market. And so as indicated, we are not anticipating significant metallurgical coal sales in second half of the year. So we have built up some inventory, as we have been transitioning from metallurgical to steam sales. So inventories build up a little bit and that's why if we have flat production, we have the potential of some increase in sales for second half. So if we ended up with total revenue for the year somewhere in the $65 million to $70 million range, I think that's probably a reasonable expectation.

Trey Cobb – Stephens Incorporated

Okay, great. Thanks, guys, I'll hop back in the queue.


Your next question comes from the line of John Quealy with Canaccord Adams. Please go ahead.

John Quealy – Canaccord Adams

Hi, good morning. First on the fly ash side, Kirk, can you comment about what your thoughts are and what your customers are saying about any pending fly ash regulation at least on the wet side coming down the road and how you guys are positioned there?

Kirk Benson

The first imports when one sees some of the news articles of fly ash is to view it as a negative, but from our perspective, it becomes a business opportunity and becomes quite a positive, because we are providing a significant amount of site services work. And so one of the things that we are trying to do is to position ourselves so that we can take advantage of any regulatory changes that make storage of the fly ash more sophisticated and requiring additional technical expertise. I think we are well positioned to be able to take advantage of that. In fact, I was pretty excited about some of the things that Bill was working on to help us in this area of taking advantage of any new regulatory scheme, so Bill why don't you add to that response?.

Bill Gehrmann

Sure, we are obviously are watching it. We have gone out and started to develop some strategic alliances, we feel that not only platform of other people's relationships, but also the relationships that we enjoy as I stated earlier on over a 100 power plant sites in the country. We do feel that obviously there is a push to move away from wet disposal, that was a situation in Tennessee.

As Kirk pointed out, opportunities obviously, when you have dry disposal, there is no access to material for the marketplace. Typically, it's got to go into the marketplace dry. We feel this will create some opportunities on the sales side. Hopefully there is more incentive in the utility industry to work with the marketers, to get that material into a dry state and get it into the marketplace. And as Kirk pointed out, we are now running at 30% run rate outside services in revenue. We think this creates a lot of additional opportunity. We've been very strong in providing our clients an overall management program in the past and we expect to continue to see this business expand. So as Kirk pointed out, currently, we are viewing as a pretty large opportunity.

John Quealy – Canaccord Adams

And on the CCP side, I know you talked about stimulus related impacts, but when should we see that? Obviously, the June period and September is traditional construction CCP high points. But do you really think you are going to get better mix out of stimulus or just volume is going to help you out?

Kirk Benson

Bill, why don’t you go ahead?

Bill Gehrmann

Yes. As I pointed out, we are starting to see some of the states take a little more aggressive approach, feeling that their funding is coming, so we expect to see some volume ramp up from those. Obviously, we are going to rely on shovel-ready projects, but also understanding that, typically in a shovel-ready project by the time they are ready to pour concrete, you are usually 9 months to 12 months out. Now there are opportunities for stabilization and some site prep work there. So obviously, the Department of Transportation has been taking their time, making sure they have the proper controls in place. But we hope to see some freeing up of the infrastructure money for these types of related project and see an uptick in volume going into the third quarter or fourth quarter of the calendar year.

John Quealy – Canaccord Adams

And just two more qualitatives. On the coal cleaning business, Kirk, you mentioned it's by far mostly steam in the back half. Can you comment how much is under agreement at this time for the back half?

Kirk Benson

We got the Illinois base in coal, it is basically under contract. And so that represents 3 facilities of our 11 facilities are fully contracted for and so of course than the all of the production been I think is sold from those sites. We are anticipating some increased production from the two facilities that are located in Northern Kentucky that are part of Illinois basin. So on the back half of the year, we are anticipating improved production at those sites and all that coal is basically already sold. So that could represent as much as probably in the range given that we have reduced production in the Alabama site. It probably represent somewhere around 40% to 50% of what we will be producing. Maybe it's 40% to 60% of what we will be producing on the back half of the year depending on how the ramp up occurs at those two Northern Kentucky sites. So, that's the coal that we produce at the other sites, the Central App, the largest Central App site, we have, we are doing that in conjunction with a coal company. On the Illinois basin, we have done the contract ourselves.

On the Central App site, those contracts are being done by the small coal companies that we are partnering with, and they are in the marketplace trying to establish longer-term contracts. But right now, the contracts are relatively short-term spot market kinds of sales out of that facility. The contracts in Alabama, we are just in the process of transitioning from the met coal into the steam coal, so those contracts are not yet set in the steam market. So all told, we are probably in the range of 40% to 50%, maybe as much as 60% but probably in the 40% to 50% range of our coal is contracted for.

John Quealy – Canaccord Adams

Okay, and there is two more. On the building product side of things, one, did you see a difference in strength in the month of March by type of distributor in the channel. And then maybe, obviously all the business lines performed well, the block business, as they are doing extremely well for several years. What business line surprised you the most in terms of revenue resiliency outside of block?

Kirk Benson

I will answer the last part and I'll let Jack you to answer the part of that, whether you saw any particular strength from individual distributors. In the last part, I was very pleasantly surprised with the increase in sales into our wholesale distribution system because, those sales represent the shutters, mounting blocks, and gable vents. Those core based products of which we have our highest margin. So I was very pleasantly surprised with that strength and also that our sales into some of the big box stores improved which is a clear indication, that you've got some strength in remodeling. So, those were in the March activity, the pleasant surprises there were the increase in the wholesale distribution sales, but also the sales in the big box stores, which are a direct link to the remodeling and that gives rise to a lot of the our comments that we maybe seeing some strength in the remodeling markets. So, Jack why don't you go ahead and fill in a little bit there?

Jack Lawless

We are seeing a pretty broad based improvement across all the different channels of distribution, both retail, wholesale, one-step, two-steps which is nice to see. As I mentioned in the comments earlier, we're seeing a particular improvement in the Midwest and Central regions of the United States and a little bit on the Eastern half of the United States as well. Clearly, California is still lagging a little bit, but it’s nice to see kind a general improvement in all the different channels of distribution and as I mentioned, most of our orders are job line orders, so it really speaks in inventory build. Then what we saw on March, again but at a higher level in April. So we are very encouraged by not only the March results but the April orders as well which are now in the books.

John Quealy – Canaccord Adams

Then lastly maybe Steve Stewart, in terms of cash flow 135 million to 145 million in EBITDA, I don't know if the tax benefit comes into you in the fiscal year or not, but can you walk us through expectations for cash flow, as you come to pay that revolver off?

Steven Stewart

Major adjustments, John, to the EBITDA would be the convert exchange that we are doing those do not generate cash, so we would have to reduce those numbers by the convert exchanges that we've done. The December one was about at $17 million, $18 million gain reduction in debt resulted from that and about $12 million. So you'd have to take that $17 million and $12 million and deduct it from that and tax benefits, we should be able to see most of that flow in the current period because we can reduce what would have other wise been estimated tax payment. So I would think that would be the major adjustment, John that I would make to the EBITDA guidance we gave you.

Kirk Benson

The other things that are going on that are important John, as you can see in our step down and expenses both from the R&D line and the SG&A line, some very significant step downs in cost in the March '09 quarter compared to the March '08 quarter. Of course, those are reflecting those EBITDA expectations, but the other thing that's going on is a very significant focus on working capital and so inventory accounts receivables and accounts are very important part of our cash flow over the next six months.

So the one indicator that we're doing a better job of managing working capital component with the cash flow generated this year compared to last year, we basically generated the same amount of cash on significantly lower sales. So what that reflects is, one, is reduced cost, but the other thing it reflects is a better job of managing our working capital and to us that is as important of a focus over the next six months as reducing cost.

John Quealy – Canaccord Adams

So, if I put all those reconciliations and not a lot of benefit from the working capital, I'm coming up with about $65 million in free cash, is that in the ballpark for '09?

Steven Stewart

It's on the low end of what I think the range might be, John.

John Quealy – Canaccord Adams

Excluding some of that working capital? Great, thanks a lot guys.


Our next question comes from the line of John Bridges with JP Morgan.

Ankush Agarwal – JP Morgan

Good morning. This is Ankush Agarwal on behalf of John Bridges. I've two questions, one quick bookkeeping. This 1.6 million of gain on extinguishment of debt, could you please tell us which line item in the income statement this goes through?

Steven Stewart

If you look on the condensed financials down at other income and expense, you see 3.25, it's included in that line item. The other item that's in there that adds up to the $3 million is we did have a small sale of facility, we're no longer utilizing that we sold, it had a gain of about 1.7. So those two items make up the majority of that other income line.

Ankush Agarwal – JP Morgan

Okay, great. And then coming back to the covenants, could you just detail us a bit on what ratios or what broadly the debt covenant ratios are and based on your current estimates of EBITDA and cash flows, how comfortably you think you would be within those ranges?

Steven Stewart

We have three covenants in our debt agreement, first covenants is totaled in indebtedness to EBITDA, the second covenant is senior indebtedness to EBITDA and the last covenant is fixed charge coverage which brings in rents and maturities. I think, if we look at the senior indebtedness to EBITDA and the fixed charge coverage, we are much more comfortable with those ratios. The ratio that we monitor very closely is total indebtedness to EBITDA and part of the reason that we have done a couple of these convertible debt exchanges is to bring down total indebtedness and then because we have extinguishment of the debt and our debt agreements are little bit dated so that extinguishment debt which is other income actually flows through our EBITDA calculation for debt covenant purposes. So it lowers our total indebtedness and it also increases our EBITDA, so the total indebtedness to EBITDA is one that probably hope to looking forward might become tighter than the other two.

Ankush Agarwal – JP Morgan

Okay. Thanks and good luck.


Our next question comes from the line of Al Kaschalk with Wedbush Morgan.

Al Kaschalk – Wedbush Morgan Securities

Good morning guys. Just wanted to follow-up on a couple more building material related questions. Jack, if I understood correctly your comment, you are comfortable with what you are seeing in terms of products that are in the inventory channel, and who knows when volumes would lift, but should they lift, you feel well positioned to take advantage of that from a margin perspective?

Kirk Benson

Jack, why don't you go ahead?

Jack Lawless

Yes, Al. I think that's right. I think, what we have seen really just really current demand increasing, it's really a reflection of the current demand increasing right now and nothing on the inventory side. And if inventory does build, you get an incremental push from that as well.

Al Kaschalk – Wedbush Morgan Securities

Okay, and then just another clarification. You mentioned that job lot orders that you saw on the quarter, I think targeted in two specific regions. Is that something, we could see occurring on the west coast, or is the product order pattern different in that market versus, say, the Midwest and the Northeast?

Steven Stewart

I would say that the Southwest and West is kind of a different market than the rest of the country. The rest of the country is doing appreciably better than the West and Southwest areas of the country.

Kirk Benson

The product mix is a little bit different too, Al, because Eldorado Stone for example, has a very strong market position in the California market, whereas some of the vinyl accessories don't. And so the product mix is a little bit different in the West compared to the East. And so what's very encouraging to us is that the markets where we have the strongest margins, which are these vinyl accessories, is in the Midwest and the Northeast, and that's where we are seeing a rebound in the remodeling.

Al Kaschalk – Wedbush Morgan Securities

Okay, and then one final one, and before I get to it, thanks a lot for putting both Bill and Jack on the phone line. But it's actually good to hear them from the business perspective, shared some comments and we look forward to further comments in the future on these calls from them. But Bill, can you just comment on pricing that you are seeing on the CCP side, and how comfortable you are with where we are sitting at today's environment going forward?

Bill Gehrmann

Bill, go ahead.

William Gehrmann

Sure, Al. What we have seen pricing wise is year-over-year, we are a little soft in the Central part of the United States. In the East and West regions we are up. When you take a look at the overall mix, we are basically flat pricing wise year-over-year. Obviously, some of it depends on prices of met, which we are still continuing to see some what stable maybe a slight softening in some regions, but we anticipate the same trend as we move forward into the next couple of quarters. So probably year-over-year, Al, as I stated previously, we do have in a few small regions in markets. We do have some upside potential, but basically through the rest of this fiscal year, we expect pricing to be somewhat flat year-over-year.

Al Kaschalk – Wedbush Morgan Securities

Thanks a lot, guys.

Kirk Benson

Thanks, Al.


Our next question comes from the line of Pearce Hammond with Simmons & Company. Please go ahead.

Pearce Hammond – Simmons & Company International

Good morning.

Kirk Benson

Hi, Pearce.

Pearce Hammond – Simmons & Company International

Steve, can you explain the tax benefit again that you expect to get this year?

Steven Stewart

Yes I was hoping you wouldn't ask me that question, Pearce.

Kirk Benson

Actually, it's a very complicated as you all know. We have three components of ours that makes audit more difficult. One of the components is the income tax credits that we earn. And those credits could have a significant impact on the income tax rate depending on what your taxable income is. The other issue is we have this goodwill impairment that's flowing through, which historically or typically you would think that the goodwill impairment is not tax deductible. So if you look at the statement of condensed consolidated statement of operations, you look at our goodwill impairment of $465 million. You look down below where we provided reconciliation net of taxes, you see $372 million. That means that there is $93 million of tax deductible benefit from our goodwill impairment.

So if you look at the $93 million then and compare to what our tax provision or tax benefit was of 77, you will realize that if we took out the goodwill impairment, we actually had net operating loss before taxes and also a tax expense, which is not what you would normally expect and just results from the way the mechanics of income taxes are computed. So what will happen in the next two quarters, in the third and fourth quarters of '09, as we have higher taxable income, we will be able to benefit from the losses we recorded in the first half of the year with benefits that we will record in the second half. So the $13 million to $19 million guidance that we gave in the press release, if you were to make normal calculations; you would have to add that to what you would otherwise expect our taxes to be in those last two quarters and we would expect our tax rate without ignoring the goodwill impairment to be less than 20% in the last half of the year. So you have to take that calculation and add to that $13 million to $19 million of tax benefit. So that $13 million to $19 million does have a significant impact on the EPS guidance that we provided.

Pearce Hammond – Simmons & Company International

Great. And now that you have written down the goodwill and everything, but what you have in your CCP goodwill, and obviously the rating agency just recently did a downgrade, but we are coming of the weakest quarter of the year for Headwaters. Is it a fair statement to say that kind of the balance sheet for risk and problems are behind us at this point, are you feeling more confident?

Kirk Benson

We are definitely feeling more confident. I think that the March results and what's happening in April provide us with some incremental confidence. We still have to be very careful on the debt covenants. It's something that we are going to continue to watch very closely, we are going into the third quarter with a little bit of wind in our sales, although it’s not exactly gale at this point. It's still a gentle breeze, and so it's something that we will need to watch very closely as we go into the next two quarters.

Pearce Hammond – Simmons & Company International

Great. And then, Kirk, this could be either you or for Jack. But within the building material segment, especially if you compare it to prior downturns, do you feel confident at this point, saying, hey, we have made the term, we are not going to get any worse, likely to get better from here?

Bill Gehrmann

I think that's a true statement. Right now, the economy is, it had some fragileness to it. And as long as you don't see something that impacts that fragile nature of the economy right now, I think things will continue to get marginally better as we get through the year, which with the cost reductions that we already have in place, I think we should continue to see improved results from the building product side.

Kirk Benson

The thing to add to that is that the confidence is more based on remodeling that it is our new residential construction. And it probably is going to take longer for new residential construction to come back. But what's happening is that folks are focusing more on remodeling what they have than buying a new residence and the age of homes in the United States continues to increase, which increases the remodeling opportunities. And so, the general breeze that are back is more oriented towards remodeling than it is new residential construction.

Steven Stewart

And if I may could just add to that to Kirk, what you are seeing, and what we believe is that with a higher level of the existing home sales being foreclosed homes, many of them need work done on them. I think that is something that is the benefit toward the Tapco-related accessories and they are generally lower priced. And $8,000 tax credit people are getting e-commerce in the entire exterior of the home for that $8,000. So, I think that really speaks to the position that Tapco has in the market and also on the Eldorado Stone side with some of the lower priced stone that we have in the marketplace as well with StoneCraft and with Dutch Quality. So I think we are particularly well positioned to take advantage of some of that activity going forward.

Pearce Hammond – Simmons & Company International

Great. And my final question is for Bill Gehrmann. But, within the coal combustion products business, now that we have utility this year, the coal burns are down quite significantly just on a coal conference call earlier today, they were talking about coal burns being down 6%. If burn is down and there is less fly ash to move, how does that flow through economically, just lower volumes for Headwaters or do you have some protections in place with your contracts?

Bill Gehrmann

Potentially, obviously, it maybe that we have reduced our access to quality supply during the seasonal months. Typically, if the sites depending on weather in the individual storage capabilities, we do have little headroom in supply. So, with some of these reduced burn and some of the areas, we may see some difficulties in regards to meeting supply, but typically we have enough headroom that this shouldn’t create too much of a problem.

Pearce Hammond – Simmons & Company International

Great. Thank you very much.

Steven Stewart

Operator, I think we are little over an hour now, so I think why don't we close off the question-and-answer period, please?


Okay. You may continue.

Steven Stewart

We appreciate everybody being with us today. If there was anybody in the queue that didn't get their questions answered, please feel free to give me a call or Kirk would love to respond to that. Again, we appreciate your interest in Headwaters. Have a nice day. Good bye.


Ladies and gentlemen that does conclude our conference for today. We thank you for your participation. At this time, you may now disconnect.

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