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Headwaters Inc. (NYSE:HW)

F4Q09 Earnings Call

November 4, 2009 11:00 am ET

Executives

Tricia Ross – Financial Profiles, Inc.

Sharon Madden – Vice President of Investor Relations

Steve Stewart – Chief Financial Officer

Kirk Benson – Chairman and Chief Executive Officer

Bill Gehrmann – President of Headwaters Resources, Inc.

Jack Lawless – President of Headwaters Construction Materials, Inc.

Analysts

Stephen Sanders – Stephens Inc.

Al Kaschalk – Wedbush Morgan Securities

John Quealy – Canaccord Adams

Pearce Hammond – Simmons & Company

Dan Mannes – Avondale Partners

[Brian Tadao] – Broadpoint Capital

John Segrich – Gabelli & Company

Operator

Welcome to the Headwaters Incorporated Fourth Quarter and Fiscal Year End 2009 conference call. (Operator Instructions) Tricia Ross of Financial Profiles, you may begin your conference.

Tricia Ross

If you have not yet received a copy of today's press release issued at 6:00 am Eastern this morning please contact my office at 916-939-7285 and we will get a copy to you right away. Without further delay I would now like to turn the call over to Sharon Madden, Headwaters Vice President of Investor Relations.

Sharon Madden

The call today will be conducted by Kirk Benson our Chairman and Chief Executive Officer and Steven Stewart Headwaters Chief Financial Officer. Also joining us are Bill Gehrmann President of Headwaters Resources, and Jack Lawless President of Headwaters Construction Materials, reporting on their individual business segments.

So before we get started I would like to remind you that certain statements made during this call including statements relating to our expected future business 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 amended.

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, further events or otherwise. You may find Headwaters annual report on Form 10-K, quarterly report on Form 10-Q, and other SEC filings readily available from the SEC's website.

I would now like to turn the call over to Steve Stewart, Headwaters Chief Financial Officer.

Steve Stewart

It's nice to have you on the call with us this morning. Attached to the press release that Sharon mentioned our condensed consolidated financial statements. They include a statement of operations for the years ending September 30, 2009 and 2008. It also includes balance sheets as of September 2009 and 2008. My comments are derived primarily from those condensed consolidated financial statements and schedules included at the bottom of those financials. We expect to file our Form 10-K prior to Thanksgiving holiday.

We are encouraged by indications of stabilization that were noticed in our fourth quarter and that appear to be continuing, even in light of the weakness of the new housing and residential remodeling markets, softness in the demand and price for coal, and noticeable slow down in commercial construction and infrastructure activities which directly impacts the demand and consumption of fly ash.

While we have budgeted 2010 revenues to be basically flat in comparison to 2009, we believe we will realize improved operating results because of the operational improvements and cost reductions implemented in 2009. Total consolidated revenues in the September 2009 quarter decreased by approximately $47.5 million when compared to the September 2008 quarter, but operating income decreased by only $7.6 million. This excludes the 2008 goodwill impairment that was recorded.

We are pleased with the operational improvements and the cost reductions implemented in fiscal 2009 and we will continue to look for additional improvements and reductions in our fiscal 2010 year. We're extremely pleased with the capital restructuring that we were able to accomplish in October.

We repaired in its entirety the term B debt and our revolving credit facility and retired the convertible debt that had a 2011 put provision which we've considered for some time to be its maturity date. This debt was all replaced with senior secured notes that mature in five years and have substantially no maintenance covenants.

These notes bear interest at 11.375%. We have sufficient cash on hand to retire a large portion of our convertible debt that has a 2012 put provision, which is the only debt remaining that has a maturity before 2014.

We also believe that we will continue to generate free cash flow from operations going forward that can also be used to retire this 2012 convertible debt. We were also successful in October in putting in place a $70 million asset based loan or ABL facility that will be available to use as a revolving credit facility to meet our seasonal working capital requirements if necessary.

The ABL facility is currently undrawn, but is subject to borrowing base limitations and will also probably be used to support our letters of credit, which today total approximately $9 million. All of these activities will affect the actual amount that can be drawn on the facility. Cash on hand at October 30 was approximately $70 million, thus providing Headwaters with up to $140 million of liquidity today.

In addition to the cost reductions implemented in fiscal 2009, we also significantly reduced our 2009 capital expenditures. Capital expenditures in fiscal 2009 were $64.2 million, which was about $52 million less than fiscal 2008. We expect capital expenditures for 2010 will continue this trend lower and will be as much as $35 million less than fiscal 2009 or approximately $30 million.

Our operations will continue to be seasonal and as in the past we expect to use cash in support of our operations through are winter months and to be cash neutral as we build working in our June quarter and to generate cash in our September and December quarters. We believe we have sufficient cash to sustain our operations through this period, but we also have the $70 million ABL facility if necessary.

Headwaters total indebtedness at September 30, 2009 was $456.3 million and today is approximately $525 million with approximately $70 million of cash on hand or net debt of approximately $455 million. Our weighted average interest rate today is 9.9%.

In addition to the senior secured notes that were just issued, Headwaters has three tranches of convertible debt. This convertible debt totals approximately $197 million. The accounting for convertible debt has changed several times over the last ten years as a result of changes in accounting rules. In our December 2009 quarter, we will be adopting the requirements of FASB staff position APB14-1.

This new accounting literature will require us to record interest expense at what is defined as a market rate, which will be higher than the coupon rate on the convertible debt. We have completed our analysis and determined that our interest expense recorded in the financial statements will increase by $7 million in fiscal 2010 as a result of these new accounting requirements.

While we expect cash interest payments to be approximately $51 million to $52 million in fiscal 2010, the interest expense recorded in the financial statement will likely be around $65 million after giving consideration to the new convertible debt accounting, the amortization of debt issuance and debt discounts, and also the inclusion of the accelerated amortization of debt issuance cost relating to the senior debt and convertible debt that we retired in 2009.

We have discussed in the past Headwaters convertible debt that is treated as if converted in computing the earnings per share. This was the convertible debt that was repaid in October, so we will not have this adjustment to the EPS calculation going forward.

At September 30, 2009, there were approximately 60.2 million shares of Headwaters common stock issued and outstanding. The increase in shares outstanding over the last 12 months is primarily the result of 8.3 million shares of stock that were issued in July in exchange for approximately $35 million of convertible debt, and the issuance of approximately 9.6 million shares of stock in September. The proceeds of which were used to retire an additional $35 million of our senior debt.

At today's stock prices, substantially all of Headwaters options and SARs are out of the money and are therefore not included in the diluted weighted average shares outstanding calculation. When you compare the September 2009 quarter with the 2008 quarter, there were a couple of significant non-recurring or non-routine items that I would like to discuss. We have previously discussed the goodwill impairment that was recorded in the September 2008 quarter and the March 2009 quarter.

Also in the September 2008 quarter there was approximately $5 million of revenue from the old section 45k business, which net of taxes was approximately $3 million. In the September 2009 quarter, there is an expense or inducement loss of approximately $22.4 million that current accounting literature requires to be recorded, even though the debt retired had a carrying value in excess of the market value of the stock by over $7 million.

This inducement loss, net of taxes, was approximately $13.9 million and was recorded in the September 2009 quarter. For the year ending September 30, 2009 and 2008, the details of these non-recurring or non-routine items are scheduled at the bottom of the condensed statements of operation attached to the press release.

The last item I would like to discuss is income taxes. In fiscal 2009, we had a couple of items that significantly impacted the income tax calculation. The goodwill impairment recorded in the March 2009 quarter of approximately $466 million provided less than $70 million of income tax benefit. Also, Headwaters generated approximately $8 million of income tax credit from its coal cleaning operations in 2009.

These items directly impacted the fiscal 2009 income tax benefit recorded in the financial statements causing the net benefit to be significantly below what might be expected at a statutory income tax rate of 39%. The income tax benefit for the year ended September 30, 2009 was approximately 17% and was slightly lower than what we had expected.

This lower income tax rate caused less income tax benefit to be recorded in the September quarter, which while not affecting EBITDA did increase the reported diluted loss per share. We would expect our income tax rate, excluding the affect of the income tax credits that will be generated from our coal cleaning operations, to approximate a statutory rate in fiscal 2010.

However, due to income tax credits expected to be generated in 2010 and those generated in prior periods that are being carried forward for tax purposes, Headwaters does not expect to make any cash payments for federal income taxes in fiscal 2010. Due to state apportionment rules, there could be a couple of million dollars of cash payments for state income taxes. I'd be glad to speak about income taxes in more detail with any of you offline, if you'd like.

We expect appreciation and amortization for fiscal 2010 to be comparable to fiscal 2009, which was approximately $72 million. The recession we are in and the collapse of the capital markets caused fiscal 2009 to probably be one of the most difficult years in Headwaters history. However, we are very pleased with the activities of the last few months. We also believe there are signs of stabilization in our light building products and heavy construction material segment.

We believe that the energy technology segment will generate positive EBITDA in fiscal 2010 and that the combination of our coal cleaning operations with our fly ash or CCP business will continue to create synergisms and opportunities to reduce costs and improve operations. We will continue to look for additional opportunities to reduce costs and improve out operational efficiencies in all of our businesses in 2010. Headwaters is well positioned to take advantage of the economic rebound once this recession ends.

I would like to turn the call over to Mr. Kirk Benson our Chairman and Chief Executive Officer.

Kirk Benson

Of course, we are very pleased to have completed our major financial restructuring, creating liquidity, removing EBITDA operating covenants and extending our debt maturities. With our cost reduction measures in place and our stronger balance sheet, we are well positioned to benefit from any improvement in the general economy.

Our fly ash business has been hurt by reduced data infrastructure spending, but we've entered into new contracts that will generate additional revenue in 2010 and we are beginning to see the first signs of stimulus spending. Bill Gehrmann will discuss our fly ash business in more detail.

Housing starts appear to have reached bottom in April of 2009 at approximately 480,000 units and have improved by more than 20% since then. Although our business will generally lag four to six months behind the housing start data, we are showing signs of stabilization on both the revenue line and on EBITDA.

Jack Lawless will provide you with an update on our building products business. After Jack has concluded, Bill Gehrmann will discuss the progress we have made in our coal cleaning business. Our focus in coal cleaning over the last two quarters has been to reduce costs. Today we believe that we are one of the lowest cost producers of eastern coal as we convert waste materials into high quality coal.

The combination of being a new entrant in the market, low contractual sales prices and a mix of Illinois Basin in western coals have kept our sales price lower than we would have liked. However, we believe that the metallurgical coal market is improving and the price of thermal coals should be more firm over the next 12 months.

Bill, please go ahead and update us on our fly ash business.

Bill Gehrmann

Our coal combustion products group completed the year with revenues of $260.9 million, an increase at 16.7% from 2008. This was in a construction economy where cement consumption is forecasted to be down 22% in 2009. Revenue for the September 2009 quarter was $81.2 million down 12% from 2008, but was up over 25% over the third quarter reflecting stabilization and implementation of new service contracts.

The gross margin for our coal combustion products group was up 80 basis points year-over-year for both the year and the September quarter. Operating margins for the year were down 50 basis points, while the operating margins for the September quarter was up ten basis points on a year-over-year basis. We believe that our business began to stabilize in the June quarter and this is also reflected in our September 2009 quarter results.

Our continuous improvement initiatives have resulted in annualized cost reductions of approximately $12 million and we continue to target our efforts to reduce our cost structure. We also feel confident that we will maintain the reduced cost structure as the market recovers and stimulus spending increases. This should also be reflected in our margins as the economy begins to rebound.

Over the last year, we continued to spend capital to increase our supply of quality coal combustion products and to expand our infrastructure and the logistics system. These efforts, along with our national footprint, have allowed us to continue to increase our market share.

The fly ash industry believes the U.S. EPA will propose new rules to address options under which the EPA will have enforcement capability over disposal regulations for coal combustion products while allowing for the continued beneficial uses of them.

As we have discussed before, increased regulation of coal combustion product disposal may require utilities to assess their management strategies and change certain operations. Our utility services division will provide valuable services to the utilities for complying with these changing disposal regulations, while we continue to develop options for increasing the safe and beneficial use of coal combustion products.

Cement consumption is forecasted to increase over 10% in 2010 and 13% in 2011, primarily driven by increased infrastructure spending under the stimulus package. We continue to believe that the efforts we have made to expand our supply, reduce our overall cost structure and increase our focus on utility services has strengthened our ability to meet the needs of our clients and customers as the economy rebounds.

In addition to our normal contract renewals and extensions, we have executed three material contracts that will benefit us in 2010. We helped one utility convert from a wet flurry disposal system to a dry system, and then we were able to sell the resulting high quality ash into the market as a replacement for Portland cement. The utility benefited from a reduction of costs and disposal of ash and we gained experience with disposal conversions.

Under a second contract, we were managing the construction of the disposal capabilities of a new coal fired power plant. After construction is completed, we will manage the disposal efforts for the utility. The third contract is also a service contract. In total, the three contracts should provide $14 million of incremental revenue in 2010.

I would now like to turn the time over to Jack to report on our light building products segment.

Jack Lawless

Revenue from our building product business in our fourth quarter was $91.5 million, a decrease of 23% from $119.4 million in our fourth quarter of 2008. Despite a relatively significant decline in revenues, our gross margin of 28.4% in this year's fourth quarter easily exceeded the 25.7% gross margin we had in last year's fourth quarter.

In addition, our operating margin of 7.1% in this year's fourth quarter also beat our 5.9% operating margin we had in our fourth quarter last year. We believe that our expanding margins in the face of declining revenues are attributable to the many cost reductions and efficiency improvements totaling over $20 million we have implemented over the past 12 months, as well as reflecting the market leadership positions that we have with each of our three building products companies.

We are also seeing signs that our market is stabilizing. Our building product revenues in our fourth quarter are generally lower than our third quarter revenues. Over the past three years, for example, our fourth quarter revenues have been on average 6% lower than our third quarter. This year our sales were approximately the same.

In addition, as an example of sales stabilizing around the country, Capco's core product categories began showing signs of shrugging off the sales declines that have been commonplace in our industry. In the month of August, these categories reported sales gains on a year-over-year basis in nine states. For the month of September, they had 23 states that reported sales increases on a year-over-year basis.

We are also seeing positive emerging trends on a macro basis. Since April of 2009, we have had annualized monthly housing start increases in excess of 20%. In addition, it was recently reported that existing home prices have increased in each of the past three months and inventories have fallen. On an individual business unit level, Capco has been successful in increasing its market share in a specialty siding business, while also enjoying the continued acceptance of its new specialty roofing and IQM exterior trim businesses.

Eldorado Stone, we believe, continues to have success increasing its market share in the high end of the stone veneer market as it leverages its national manufacturing platform and improved service levels. It also continues to enjoy success in its outdoor living campaign, as well as its interior jump stone wall program. Both of these programs are expected to enhance its number one market share position it currently enjoys in the stone veneer market.

Our Southwest Concrete business unit just completed another record operating earnings year in Texas. By all measures, it enjoyed a solid year in 2009 as it built on its market leadership position in the state of Texas. All in all, as I had mentioned on earlier calls, our cost structure in place today should yield materially higher operating earnings for 2010, even if our sales do not improve over 2009 levels.

As I have also mentioned earlier before, it is important to note that despite our aggressive restructuring, cost reductions and efficiency improvements, we have still retained the vast majority of our 2006 capacity levels. As our industry recovers from its historic lows, we will be able to materially increase our sales for our core products from our existing facilities.

While we do not expect to see meaningful improvements in the macro environment over the next six months, we continue to see areas that give us encouragement heading into 2010. One, our current cost structure in place today will yield materially higher operating earnings for 2010, even if our sales levels do not improve.

Two, we have a number of new products and programs that we have already or will soon launch that should provide meaningful sales and operating earnings over the next several years. And three, we believe that the market share gains that we have gained over the past 12 months will accrue to us as our industry recovers. In summary, it is our belief that our industry leading product companies have never been better positioned at taking advantage of the inevitable rebound in our industry.

Bill will now go through our coal cleaning business.

Bill Gehrmann

Coal inventories remain high while year-over-year demand is down. U.S. coal consumption fell 9% between the first and second quarters this year to 231.7 million short tons, the lowest quarterly level in 14 years.

Coal consumption in the electric power sector fell by 11% in the first half of this year compared to the first half of last year. The result of lower total electricity generation combined with increases in generation from natural gas, nuclear hydropower, and wind. Lower electric power sector coal consumption is expected to continue for the remainder of the year with the total annual decline projected at more than 9%.

Coal is expected to regain a larger share of the base load generation mix beginning in 2010 as demand for electricity grows and natural gas prices rise at the same time new coal fire generation comes on line. Projected coal consumption in the electric power sector increases by more than 2% in 2010, but remains below 1 billion short tons for the second consecutive year.

Coal consumed for steam, retail, and general industry in coke production declined by 21% in the first half of 2009 compared with the first half of last year. In the forecast, lower consumption of coal in both sectors continue for the remainder of the year, followed by an increase of 5% in the coke sector. EIA projects 4% growth in 2010 for coal use in the retail and general industry sector.

As we entered fiscal 2009, we completed construction and placed in service 11 coal cleaning facilities with 5.8 million tons of capacity. Unfortunately, commencing in the September 2008 quarter, the coal industry turned downward in both the metallurgical coal markets and the domestic steam markets. We were left in the beginning of the calendar year with no metallurgical coal sales, high start up and fixed costs, and high SG&A.

We took very definitive action to restructure our coal cleaning business to match our reality and position the company for 2010. First, we temporarily idled four facilities to match production to sales, concentrate production in few facilities and better manage inventory. This action results in fixed cost savings of over $3 million and helped to align sales and production.

Second, we merged our coal cleaning operation into our fly ash business. As we suspected, we identified synergies between the business, both at an operational level and in SG&A. The merger resulted in reducing SG&A by over 50%. The synergies included crossover sales relationships, utilization of yellow iron equipment, accounting, and back office systems.

Third, we focused on operations and reducing fixed costs. Fixed costs in our first quarter were nearly $14.5 million and by the fourth quarter our costs were reduced to approximately $8.5 million. Total fixed costs have been reduced by over 40%. Fourth, we have reduced our capital expenditures so that very little CapEx is expected in 2010. All of the efforts in 2009 have reduced our overall breakeven point to a level where we can operate our facilities at a cash flow positive level going forward. We anticipate a cash flow positive benefit from coal cleaning in 2010.

In addition to the benefits from a revamp cost structure, the coal market is beginning to improve. Domestic pricing for steam coal is firmed up and should improve in 2010. In addition, metallurgical coal demand in China and India has improved substantially over the past six months.

We anticipate that the Cleveland-Cliffs Pinnacle Mine will reopen soon and provide us an opportunity to sell our Pinnacle coal project to the domestic metallurgical coal market. Further, we may be able to start selling our product international met coal markets. We feel comfortable that 2010 has some upside to a breakeven scenario.

Steve Stewart

We've made tremendous progress on the cost side in each of our businesses. As a result, our margins have been more resilient than one might have expected, given the recession and the housing down cycle. As the recession ends and markets rebound, we are well positioned financial and operationally.

I'd now like to turn the call over to the operator for questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Steve Sanders – Stephens Inc.

Stephen Sanders – Stephens Inc.

Maybe a couple questions first for Bill. On your production capacity and coal cleaning, I think I heard the original 5.8 million. Has that changed significantly with the things you've done over the past couple of quarters?

Bill Gehrmann

No, we still feel that is basically our nameplate rating based on what we think is up time on the fleet of plants.

Stephen Sanders – Stephens Inc.

Can you, if you have not, can you give us just kind of ballpark the assumptions you're making for the EBITDA positive or the EBIT positive, either in tons or revenues or just whatever incremental color you can provide there.

Kirk Benson

What we did when we put together our EBITDA forecast is that if we operate the facilities at about 60% of capacity, we can breakeven with our new fixed cost structure. In 2009, we operated just slightly below the 60% and that resulted in some losses. So, the assumption that's in our EBITDA forecast is that we operate the facilities at about 60% capacity and the seven facilities that are operating now, that means that we'll be somewhere between 1.7 and 1.9 million tons of coal.

Stephen Sanders – Stephens Inc.

Kirk, just following up on that, the rough steam met mix?

Kirk Benson

I think in our modeling, we've assumed that the Pinnacle facility would probably come on line later in 2010, but we should be able to get to that breakeven assumption even if there isn't any met coal sold.

Stephen Sanders – Stephens Inc.

Bill, a follow-up on your EPA comment, new rigs coming on the disposal, but it sounds like you feel pretty good about utilization in the construction business. A couple of questions, first can you just expand on that a little bit and second, in terms of timing when will we hear? And in terms of implementation, what's kind of the reality of that?

Bill Gehrmann

Those are obviously good questions Steve, and as far as the timing I think we'd all like a little better idea. I think we continue to feel, based on comments made by the EPA, that after the TBA incident that they wanted a little bit more enforcement capability in regards to especially the disposal regulations. I think, as you're aware, they had their C2P2 program, which has promoted the reuse of CCPs.

So based on the comments, the industry is lead to believe that what they're after is enforceability on disposal activities without trying to impact the prudent reuse of coal combustion products. As it stands now, I think the industry feels that this is an issue based on proposals and alternatives review and hearings. It will probably stretch through 2010.

Stephen Sanders – Stephens Inc.

Then I'll ask a couple more together and then get out of the way. First maybe for Jack, if you could just make a general comment on whether your geographic footprint or leverage to various parts of the country has changed in the past year? Also, whether southwest is seeing any signs of weakness in the Texas market? I know it's been a great couple years, but how does it feel going forward? And then the final question maybe for Steve, if you were modeling the 2010 tax rate, what would you use?

Jack Lawless

I'll start. I think our geographic footprint on the building product side hasn't changed too much. Certainly we pretty much followed the population patterns in the United States from a sales perspective in the building products group and I don't expect that to really change.

One nice thing, with that type of geographic diversity, I mean as I mentioned, we have the 23 states and one part of the business on the Tapco side of the business and we've had 23 states that were up in October. It was seven in the northeast, five in the central region, four in the south-central, five in the west and two in the southeast, so I think our geographic diversities will continue to help us.

As far as the Texas side of the market, we ended the year reasonably strong. In Texas we're heavily tied to an institutional part of the business, which is really the school bond construction which we expect to continue for the next two to four years. So we see that continuing to be a big part of our sales going forward. I think for 2009 it represented about 43% of our business.

The commercial side is reasonably low in Texas. That we expect to soften a little bit but we expect the Texas market to continue to hold on strong, particularly as the oil prices continue to hover in the $75 to $80 a barrel range. I think that – was that the only – did I miss one Steve, a question?

Stephen Sanders – Stephens Inc.

No, that's it. The other one was Steve Stewart. I know you said think about the statutory tax rate but it sounds like there is a little uncertainty around the way the IRS is going to rule on the credit. So how are you thinking about that at this point, just from a reporting perspective?

Steve Stewart

Well, we have taken benefit for the tax credits that have been generated by our coal cleaning operation and we expect to continue to take benefits going forward. There have been some discussions around the IRS but we believe that that will not affect our ability to take those credits.

So the way I would model it I would take whatever pre-tax earnings number that you end up with and I would apply a statutory rate of 39% which would cover federal and state. We generated $8 million of tax credits in 2009. We'll generate that much or more in 2010. Those tax credits can be used to offset 90% of your tax liability.

So they can't bring it to zero but they can almost bring it to zero. So I would use a statutory rate and then I would take into account $8 million plus of tax credits and let that determine what your rate is. I mean clearly the rate will be lower than a statutory rate. I mean last year we gave guidance of less than 20%. I have not made those calculations this year but it could very well be in that low range again.

Operator

Your next question comes from the line of Al Kaschalk – Wedbush Morgan Securities.

Al Kaschalk – Wedbush Morgan Securities

Just wanted to follow up, see if you would add any color around the guidance for 2010 on the EBITDA line by segment whether you can give breakeven, up positive or a percentage on an EBITDA margin for the given segments?

Kirk Benson

We haven't provided any particular detail as to the segments but generally speaking, of course, there's going to be an improvement on the EBITDA line because as you can see as we build the bridge it's basically tied to the 2009 cost improvements and so there's, as we disclosed in the press release, we've got cost improvements in each of the segments.

And so if revenue is flat for 2010, then those cost improvements will result in an increased EBITDA and you can get a sense of that just by looking at how much of the savings was realized in 2009 and how much will flow into 2010.

So for example in the fly ash business we had $12 million of annualized savings, $6 million realized in the year, so that carries over $6 million into the next year and with billing price it was $20 million of cost savings that doesn't include by the way a reduction in material cost but the $20 million and then about 70% of that was realized in '09. So that gives you a sense, Al, of the cost savings in the different segments that are going to flow into 2010.

Al Kaschalk – Wedbush Morgan Securities

But if I heard correctly and just for a repeat standpoint clean coal you feel will be breakeven at the moment for fiscal 2010?

Kirk Benson

Yes, that was the assumption that we used in the bridge that we disclosed in the press release, that's right.

Al Kaschalk – Wedbush Morgan Securities

And then just one other item on clean coal and I'll hop out of the way. In terms of forward-looking revenue what can you comment in terms of contractual business at the moment versus fort coming to help drive that towards the breakeven or better for fiscal '10 and then an administrative one for Steve Stewart, what share count have you used for fiscal '10?

Kirk Benson

From the coal cleaning perspective we basically have taken a significant amount of costs out of our cost structure. Are revenue doesn't have to change dramatically to get to breakeven in that business because of a change in the cost structure. We operated – as I said we're at breakeven at about 60% utilization of these facilities and in 2009 we operated slightly below that utilization figure.

So we were below 60% so what we have forecasted in 2010 is that we'll be at 60% or a little bit higher which means on the sub-facilities that we're currently operating our sales will be between 1.7 and 1.9 million tons. At that level and with the current price structures for the sale of coal we should be very close to breakeven on our coal cleaning business.

So Bill, do you want to add something to that?

Bill Gehrmann

No I think unless Al wants a little more color on that.

Kirk Benson

So Steve the question was on shares.

Steve Stewart

Shares outstanding today are 60.2 million. So if you look in the September quarter we ended up with almost 49 million. That's just because you're averaging what was about 41 million against 60 million for part of the quarter. So going forward I think 60 million is a good number. The stock price would have to be north of $10 or $12 before any of the options and SARs would start entering in and we don't have any convertible debt that we have to treat as if converted any more. So I would just use $60 million, 60 million shares.

Al Kaschalk – Wedbush Morgan Securities

Well, Bill I would always look for more color but I realize our time is limited today.

Operator

Your next question comes from the line of John Quealy – Canaccord Adams.

John Quealy – Canaccord Adams

Congratulations on getting the balance sheet cleaned up. A couple of questions first on the light building materials what sort of time frame or level of revenues do you think you need to get double digit operating margins? Is that still on the table and could you give us a little bit of a walk qualitatively what would need to happen, sustained, moving forward over the next couple of years?

Steve Stewart

John we're in pretty good shape from a cost perspective now and if you look at the building product businesses we probably have between a 38% and a 41% incremental EBITDA margin. And that's based off our current cost structures so it's to the extent that our revenues exceed those from 2009, I think you can do the math from there.

John Quealy – Canaccord Adams

And again on the fly ash side of things can we just maybe, Bill, get your comments on the slowdown that we've seen trailing 12 months. How much was economic? How much was stimulus related, as all of these authorities look for free money before spending a dollar of their own? And can you bracket the types of growth rates that you think is fair in the next couple of years?

Bill Gehrmann

Well, John, I think we shared, obviously, typically we track a little better than the cement consumption forecast, just moving forward into that and hitting that first, obviously, the current cement forecast are for increases of 10% next year and 13% in 2011.

Our pricings remain stable; actually it is ticked up about 2% year-over-year in the business. We haven't seen a lot of infrastructure spending yet. We've seen pieces of that in the upper Midwest and a little bit out in the West so we start to see some incremental improvement from that perspective.

We shared our market share. It does continue to grow so we're seeing some volume pop up from that.

Overall business typically in a downturn, historically, ready mix producer's decrease mix design costs have actually upped their utilization of fly ash. We expect to continue to get a little bump from that. John, am I missing something?

John Quealy – Canaccord Adams

That's fine. I just wanted to get your first impressions of what the over/under could be, if you will, on the growth there. And Bill, if I could ask you a little bit more about the pending EPA rewrite, obviously since stuff came out Friday, that said they're looking at wet ponds as scrutiny versus some of the dry disposal methods.

Have you done any sort of sensitivity in terms of the revenue or the margins if the EPA were to go after those sites on the wet side? For example, the contract that you got incrementally, what sort of incremental margin or revenue was that to convert them from wet to dry? Just help frame it for us, if you could?

Kirk Benson

Do you mean from the utility perspective, John?

John Quealy – Canaccord Adams

Well, from Headwaters' revenue perspective. So, I realize sometimes you split some of the high quality fly ash revenues with the utilities, but if you can sensitize it. If they decide to call all wet hazardous, what does that do to the revenues and the margins in our existing contract structure and then conversely, as those folks transfer those stations into dry, how that could be incrementally positive or not? I'm just trying to sensitize how the model could change depending on what the EPA does.

Bill Gehrmann

John, typically right now where you have wet disposal taking place, typically because of that, you don't have the ash or the most the CCPs actually going to the marketplace. It's very easy disposal, basically sluicing into the pond. There may be dredging activity beyond that, such was taking place at [TVA], so as they tighten it up and get away from that, depending on the location and the availability to more land, including closure of these wet [empilements], obviously that creates opportunity.

From a margin standpoint, obviously, product revenues enjoy a higher margin contribution. Then disposal though does create new opportunities and potentially adds to the scope of work for disposal there. We obviously have demonstrated our ability to convert, so that creates engineering and installation design.

And obviously at that point in time, the evaluation of the quality of the product, such as the contract we discussed earlier, where even though it had been wet disposal over the years, it was probably one of the better quality materials in the region in that market, but because the wet disposal was never available.

The industry may change as the economy is softened up from a revenue share with the utilities. Obviously, we've been somewhat stagnant. We've got long-term contracts, obviously, so it's typically only when we're discussing extension or new opportunity, do we have a chance to go in there and take a look at the cost structure sharing with the utility.

I think one would have to safely assume under the new guidelines and incentives, to get material out in the marketplace in some of these beneficial reuses that there may be some changes to some of these cost structures, depending on capital required to make the change in getting some of these into the marketplace.

John Quealy – Canaccord Adams

And just lastly, when we overlap the resources at coal cleaning assets versus some of these wet pond issues, is this a mutually exclusive issue, or are the coal cleaning assets all mineral leases which are not involved with this disposal issue and the EPA, or if you could just give us a little bit more insight there?

Kirk Benson

They're not related.

Bill Gehrmann

No, they're not. There's no overlap between the two.

Operator

Your next question comes from the line of Pearce Hammond – Simmons & Company.

Pearce Hammond – Simmons & Company

I was just following up on John's question, I'm trying to get a sense of if we compare Q1 of 2010 to Q1 of 2009, is it a fair statement that in both Jack Lawless's group and Bill Gehrmann's group that we should see some revenue growth year-over-year?

Kirk Benson

From a revenue perspective, in 2009 we had a fairly strong 12-31-08 quarter. And so we're not expecting positive revenue comparisons between the 12-31-08 and the 12-31-09 quarters. So we do think that we may come closer to a positive EBITDA comparison because of the cost savings that we put in place, but from a revenue perspective, we are not anticipating a year-over-year revenue increase. As Jack and Bill both said, however, we're seeing signs of stabilization in the markets, but again the 12-31-08 quarter was a fairly strong revenue quarter.

Pearce Hammond – Simmons & Company

Thank you, Kirk. And then so, just to follow up on the guidance, that was based on revenues essentially being held flat year over year '10 versus '09?

Kirk Benson

Yes.

Pearce Hammond – Simmons & Company

And if you can give a little color on the issue with the Section 45 tax credits and the IRS.

Kirk Benson

Sure, I'd be happy to do that. The law was originally passed almost five years ago and taxpayers have been seeking some form of guidance from the Internal Revenue Service as we make decisions relative to the Section 45 credit. The Service has indicated that it's very close to being in a position to being able to issue that guidance.

And of course, no one has seen the guidance yet, but we've had some conversations with the Service. In fact, we've been talking to the Service for the last several years and we feel very comfortable that we're right down the middle of the fairway, relative to the statutory requirements to claim this credit.

There're really four requirements. One is that you increase the value of the feedstock material by 50%. Since we're using waste materials or very low value coal materials, the increase in value is quite easy for us to achieve, since we're going from waste to something that's useable. We have to have a 20% reduction in nitrogen oxide emissions and a 20% reduction of either SOx or mercury.

We have designed very tight, industry standard tests to measure both or NOx, as well as our SOx and mercury emissions results and we feel very comfortable. For example, we've talked with the EPA to ensure that our emissions tests are accepted, standard tests and so we feel very comfortable that we meet both of those emissions tests and then the final requirement, you sell the coal into the thermal market.

So although the guidance has not been issued yet, we feel quite comfortable that we're doing everything that is required by the statute and we believe that the IRS guidance will follow the statutory requirements.

Pearce Hammond – Simmons & Company

Great and then just one final question, which you may have already covered and I apologize if I missed it, but the actual number of coal cleaning facilities that are operating right now, and then the expectation for the full year fiscal year '10 the number of coal cleaning facilities that will be operating.

Kirk Benson

Bill, why don't you respond?

Bill Gehrmann

We currently, on a full time basis, have seven facilities operating. As we mentioned in the narrative, we fully expect our Pinnacle plant to start up. That would bring us to eight and based on some of the steam coal markets, and once again, also some of the met coal opportunities that we see beginning to emerge, we could possibly run that number up to nine or ten.

Operator

Your next question comes from the line of Dan Mannes – Avondale Partners.

Dan Mannes – Avondale Partners

A couple of follow up questions. Can you provide us actually segment EBITDA for '09?

Kirk Benson

You can compute that when we publish the K in the segment information. There's enough information that you can – that will be disclosed in the 10-K.

Dan Mannes – Avondale Partners

How long are we waiting on the K?

Steve Stewart

It's probably a couple of weeks out.

Jack Lawless

So we'll definitely file before the holiday, Thanksgiving holiday.

Dan Mannes – Avondale Partners

And the EBITDA guidance, and just going to the way you've calculated before, the value of the tax credit is embedded in your EBITDA forecast?

Steve Stewart

It is. That will be the method that we'll utilize in computing EBITDA going forward.

Dan Mannes – Avondale Partners

Any other major changes, I mean, now that you're sort of done with the bond exchanges. Is it going to look more like, I'll call it a typical company's EBITDA plus tax credits or is there a bunch of other moving parts there that we need to be thinking about?

Steve Stewart

There are specific definitions of the EBITDA calculation and both are senior secured notes at [inaudible], but the major difference if you compare it to what we did last year, as you know we did some convertible debt exchanges in December quarter and March quarter that generated about $29 million of EBITDA. A going forward, that type of activity would not create EBITDA. Except for that there's a 5% variance or less in the EBITDA calculation and the EBITDA results.

Kirk Benson

I think, Dan, the answer is that we'll have a fairly standard EBITDA calculation plus tax credits.

Dan Mannes – Avondale Partners

That's all I ask for. Last year was a little more difficult some quarters. On the fly ash business real quick, you mentioned the three contract wins that are likely to drive incremental revenue in '10 versus '09. Can you sort of talk through how many of those are sort of one- time, i.e. you do some service work in '10 and then they're done versus how many of them are likely to be recurring revenues streams post 2010?

Bill Gehrmann

They're all recurring, Dan.

Dan Mannes – Avondale Partners

So the service will be you'll be continuing to offer on site service and disposal?

Bill Gehrmann

Correct, yes.

Dan Mannes – Avondale Partners

So when you do the wet to dry, it's not just a one-time revenue item. You're continuing to actually either dispose over preferentially beneficially reuse the dry?

Bill Gehrmann

Yes, we installed the system with the reuse in mind.

Dan Mannes – Avondale Partners

And the cost of the installation is not sort of a one-time revenue item. That's when you recover over the life of the usage?

Bill Gehrmann

Yes, those types of capital expenditures are created obviously different, but based on a contract. But one of the mechanisms obviously is through some type of pay back through reduced revenue share.

Dan Mannes – Avondale Partners

Last thing, congratulations on getting the depth on obviously this materially reduces the risk profile, but you guys did upsize the deal to 328. You're sitting on $70 million in cash. You have an undrawn ABL. You're probably earning pretty close to zero in your cash and paying 11% plus of what you borrowed.

What was the thought on upsizing and where does that – how do you think through the next two three years as you turn hopefully substantially free cash flow positive and how you start to chip away at some of the debt outstanding and improve the income statement now that you sort of fixed the balance sheet?

Kirk Benson

One of the reasons that we upsized was because we have $48 million of 16% convertible debt that could be put to us in 2012. So one of the thoughts was we wanted to reduce the risk relative to the repayment of that debt and so now we have cash in excess of the amount of that debt. So one of the things that we negotiated in our high yield note agreement was the ability to prepay that $45 million – excuse me, $48 million of subordinated debt.

So that's one of the things that we'll be focusing on is eliminating that debt. There is of course some additional opportunities to change the capital structure a little bit from an operating lease and a capital lease perspective as we go forward and continue to reduce the risk profile of the company, as well as to improve EBITDA as we use some of that cash. But I think one of our focuses will be on the $48 million that's due in 2012.

Dan Mannes – Avondale Partners

So open market repurchases, at least in that one series, are allowed under the bonds?

Kirk Benson

Yes, that's correct.

Dan Mannes – Avondale Partners

Is that true across the board or just that one series?

Kirk Benson

Just for that one series because the other maturities are in 2014.

Dan Mannes – Avondale Partners

Last thing on this topic, as you went through this restructuring plan before the bond deal was done there were indications or incremental asset sales, etc. Is that off the table now that you're done or is that still something you're working towards?

Kirk Benson

We still have in our high yield note structure we negotiated an ability to sell a couple of our assets. For example, the hydrogen peroxide facility in South Korea. So we got the ability to do that and to use those proceeds to apply against the $48 million of 2012 convertible debt.

So we're still looking at a couple of those transactions that don't generate cash flow for us – cash, because even though the facilities generating EBITDA, that EBITDA is locked up in the joint venture. So it doesn't generate cash for us. And so if we could get that cash and apply it against the 16% debt from a cash perspective, we're certainly better off . So we're still considering a couple of the smaller transactions.

Operator

Your final question comes from [Brian Tadao] – Broadpoint Capital.

[Brian Tadao] – Broadpoint Capital

Just following up on the last question on the 16% notes, I mean those bonds now trade above par. I mean is there expectation or you're just going to hold the cash on the balance sheet until the put date or are you thinking about tendering for the bonds at a certain price. Any color kind of where you stand right now?

Kirk Benson

I think that we will be opportunistic about those bonds. There is some value in having a very strong cash balance. But if there is the opportunity to acquire those bonds at a reasonable price, I think that we might pursue doing that. It's clearly the interest rate is higher than our senior secured rate and so there is some incentive on our part to at least be opportunistic about taking out some of those bonds.

[Brian Tadao] – Broadpoint Capital

It sounds like you're willing to be patient. There's no rush, I guess.

Kirk Benson

There's no particular rush, although I think that there is, as I said, I think that there's some interest in doing it. We're going to be considering the alternative. We'll consider whether or not we tender for some of those bonds. I don't think we'll tender for all of them, but I think that we might consider looking at a tender for at least a portion of them to reduce the amount that matures or is put to us in 2012.

[Brian Tadao] – Broadpoint Capital

On the coal cleaning business, can you give a sense for next year you're talking about if you can get the 60% capacity factors, what the breakeven actual price of coal you will need is? And also kind of go along with that, if you can remind us the breakout in terms of the thermal coal. The regional, how much of it is eastern, how much of it is Illinois Basin and how much of it is western that kind of goes into the blended number?

Kirk Benson

I'll take a shot, Bill, at answering first and then feel free to add on. But from the regional perspective we have one facility that's located in Utah. That's our only Western coal facility. We have three facilities that are currently operating that produce Illinois Basin coal. We've got one facility in West Virginia and one facility in Eastern Kentucky. The one in West Virginia is the met coal facility and Eastern Kentucky is a Central App facility. And then we have five facilities in Alabama.

And so that kind of gives you a breakout of the 11 facilities and what kind of coal that each of those facilities would produce. We currently have an average sales price given that our contractual relationships and given the different qualities of coal that we're selling all around $30 per ton. If we operate the facilities at a 60% capacity level, we should be at breakeven at today's sales price and actually maybe even better than that. But even at today's sales price we should be operating, if we're at 60% capacity, we'll be very close to a breakeven.

[Brian Tadao] – Broadpoint Capital

Of the seven units that are currently running, so I assume that the one Utah, instead of three in Illinois, there's one in Illinois and one in Alabama instead of five. Is it pretty much spread out across all the regions or are there particular regions –

Kirk Benson

Yes, we're operating the Utah facility, the three Illinois Basin facilities and three facilities in Alabama. And that gets you to seven.

[Brian Tadao] – Broadpoint Capital

Three in Alabama. Okay.

Kirk Benson

Yes, three in Alabama, three Illinois Basin and then one Utah.

[Brian Tadao] – Broadpoint Capital

And is the Alabama plants, they sell – the pricing is based on Central Apps or some other pricing?

Kirk Benson

It's generally lower than Central App, isn't it Bill?

Bill Gehrmann

Yes.

[Brian Tadao] – Broadpoint Capital

Okay, so one based on [PRB] three based on Illinois Basin and three based on – do they discount the Central App to get to your $30?

Kirk Benson

Yes. Three –

Bill Gehrmann

That's probably a safe assumption.

[Brian Tadao] – Broadpoint Capital

And then lastly on the building product side, you mentioned that you were taking share, just kind of curious if you can give me a commentary as to who you're taking share from, large guys, small guys? Where do you think that amount of share is coming from?

Jack Lawless

It really breaks down on each individual entity on the Tapco side of the business. There isn't a lot of big people left, but we did buy our largest competitor on the injection molded side probably about a year or so ago.

On the Southwest concrete side of the business, we bought a couple of old Castle plants from them in south Texas which put us up probably in the mid-60 market share on the south, and on the Eldorado side of the business we do know that Owens Corning's cultured stone unit has been struggling mildly on the high end of the market. And we believe we've done a real nice job of grabbing some additional market share and distribution from them over the past year or so.

Kirk Benson

But Jack, on the specialty siding and come in a little bit on the specialty siding market share and on our trim board product who we're taking market share away from –

Jack Lawless

The specialty siding business which is our foundry business, we've done materially better than what the industry has done in each of the past four or five years so we believe we're gaining pretty good market share in that relatively fast growing side of the business.

One of the main competitors are there is a company called Nailite which will be going to a liquidation process over the next couple of months which we should be in a very good shape to pick up a meaningful amount of sales there.

As Kirk also mentioned, we introduced a trim board line of products which we introduced late last fiscal year and we're currently sold out of the production and we're adding a significant amount of productive capability over the next couple of months that we believe will continue to take market share from the people on that side of the industry.

So those three or four points, I think ,speak well to how well we're positioned to hopefully rebound and path back up in the building side of the business.

[Brian Tadao] – Broadpoint Capital

Definitely appreciate the color. One last item, just because I didn't catch it earlier when you mentioned it, is in the states or the regions where you saw the improvement in September and October, the 23 states, you kind of broke it out by region, can you repeat what you had mentioned before? I apologize.

Jack Lawless

The 23 states that were up over year-on-year basis in September, nine states were up in August. There's seven in the Northeast, five in the Central, four in the South-Central, five in the West and two in the Southeast. One more piece of information, those 23 states represented about 53% of our September wholesale sales on our core products.

Kirk Benson

Operator, let's take one more question and then we'll end the call.

Operator

Your next question comes from John Segrich – Gabelli & Company.

John Segrich – Gabelli & Company

Just a bit of a different type of a question here, you've obviously done a great job on getting the balance sheet in shape and then with all the cost cutting, but just wanted to look forward in your business a little bit.

In particular, there was an article today in The Wall Street Journal talking about how green building products are becoming more of an interesting opportunity for some of the venture capitalists. And they talked about a company that was building bricks out of fly ash and Coastal Ventures had put $50 million into the company and really seems to be really quite excited about it.

Obviously, you guys have a very strong position in the fly ash market. Maybe could you talk a little bit about how your supply chain, if there is a supply chain that you have, would maybe play into that opportunity or secondarily, is that something that you guys could see yourselves moving into and therefore, start to be positioned a little bit more in terms of a green or sustainable company?

Kirk Benson

Jack, why don't you comment a little bit about the distribution system and whether or not you feel that there's some opportunity for us to continue vet some of our sustainability themes that we're already working on.

Jack Lawless

Yes, I will. Clearly, we use fly ash today in the Southwest part of our business and the Eldorado part of the business and it creates a superior product at better price points for us, so that's number one. I think overall, I think we have put the best distribution in the building products industry to do it, whether retail, wholesale, masonry, one-step, two-step channels.

I think one of the things that people don't realize however, is that I think that the only way that you can sell a green product to the masses today is that is has to meet the price points that you need to have to sell an appreciable amount of it. And as of today, I don't think there's been a lot of products that have been able to meet that.

Clearly, with the stuff that we do with the fly ash and the recyclable nature of what we use on the building products side we're at the forefront of that. I just am a little bit hesitant to claim the one product that you mentioned a success in that I've yet to see a product like that really reach the masses and do well, so those are my comments.

Kirk Benson

One of the things that we are really happy about from a green perspective, for example the fly ash business this week, we do receive [leads] credits as the fly ash is used as a replacement for Portland cement. For every ton that we replace it reduces CO2 emissions by one ton. We're quite oriented towards the sustainable nature of our business, identifying opportunities take low value and underutilized resources to convert them into valuable products.

We have looked at opportunities in fly ash as you've mentioned. People have been attempting to use the material in bricks and building materials and as Jack said, we use it as a substitute right now for Portland cement.

We had developed a [flexcrete] product that is a high fly ash-oriented building product. We've had sales in the product. We're still working on making sure that we've got the right kinds of positioning to market that [flexcrete] product in the marketplace. And it's something that we think could continue to have some interest as we continue to build out our product line and move more toward a sustainable nature of different material.

Sharon Madden

Thank you, with that we'll go ahead and end the call. We want to thank you for joining us today.

Operator

This now concludes today's conference call. You may now disconnect.

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