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Headwaters Incorporated (NYSE:HW)

Q4 2013 Earnings Call

November 05, 2013 11:00 am ET

Executives

Tricia Ross - Vice President

Sharon A. Madden - Vice President of Investor Relations

Kirk A. Benson - Chairman and Chief Executive Officer

Donald P. Newman - Chief Financial Officer and Principal Accounting Officer

David S. Ulmer - President of Siding Division

William H. Gehrmann - Former President of Headwaters Resources Inc

Analysts

John Quealy - Canaccord Genuity, Research Division

Albert Leo Kaschalk - Wedbush Securities Inc., Research Division

Daniel J. Mannes - Avondale Partners, LLC, Research Division

Seth B. Yeager - Jefferies LLC, Fixed Income Research

Philip Volpicelli - Deutsche Bank AG, Research Division

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Headwaters Fourth Quarter Fiscal Year 2013 Earnings Conference Call. [Operator Instructions] This conference is also being recorded today, November 5, 2013. I would now like to turn the conference over to our host, Tricia Ross with Financial Profiles. Please go ahead.

Tricia Ross

Thank you. Good morning, everyone, and thanks for joining us for the Headwaters Incorporated Fourth Quarter and Fiscal Year 2013 Conference Call. There are slides accompanying today's presentation that can be found on the webcast link at the Headwaters Incorporated website under the Events and Presentations tab. Please go there to follow along with the slides. If you have any issues accessing these, please feel free to e-mail me at tross@finprofiles.com, and I can also e-mail you a PDF copy.

I would now like to turn the call over to Sharon Madden, Vice President of Investor Relations at Headwaters.

Sharon A. Madden

Thank you, Tricia. Good morning, everyone. We appreciate you joining us as we report Headwaters' fourth quarter fiscal 2013 year-end results. Kirk Benson, Headwaters Chairman and Chief Executive Officer; along with Don Newman, Headwaters' Chief Financial Officer, will be conducting today's call. Joining them will be Bill Gehrmann, who is President of Headwaters Resources; and Dave Ulmer, President of Tapco International.

Before we get started, please remember that certain statements made during the call, including statements relating to our expected future business and financial performance, may be considered forward-looking within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, both as amended. Forward-looking statements, by their very nature, address matters that are, to different degrees, uncertain. These uncertainties are described in more detail in Headwaters' annual report and quarterly reports filed with the SEC. You can 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, Headwaters' website or directly from the company.

I will now turn the call over to Kirk Benson. Kirk?

Kirk A. Benson

Thank you, Sharon. Before looking forward to 2014, I'd like to spend a little bit of time on the highlights and achievements from 2013.

We completed the sale of our coal cleaning operations, clarifying our focus on building products and heavy construction materials. We acquired a cellular PVC trim board product line and realized projected synergies as planned in order to move the EBITDA range into the 15% level. We should be able to increase revenue in 2014 as we expand distribution.

We continued our debt repayment strategy, repaying $47 million in debt and improving our debt-to-EBITDA ratio from 4.3 to 3.3. Revenues improved 11%, from $633 million to $703 million. Operating income was up 58%, from $34 million to $54 million. Net income from continuing operations increased $35 million to a net profit of $8 million. And we finished the year close to the midpoint of our EBITDA guidance of $116 million.

So all segments of our business performed well in the fourth quarter. After a slow start to the construction season, our fly ash shipments in the fourth quarter exceeded 2012 shipments. Block and stone recorded strong revenue increases in the quarter, although we are still waiting to see improvement in our siding products. 2013 was a good year, as reflected in our 58% growth in operating income. Our free cash flow increased, with the reductions in interest expense and controlled CapEx at budgeted amounts.

Now looking forward to 2014, we will focus on a number of opportunities to continue Headwaters' evolution as a premier building products company. We are projecting adjusted EBITDA margins to expand in both our light and heavy building products segment. Our internal targets are to have adjusted EBITDA margins in the 20% range. The expansion will come from increased stone sales, which has a strong contribution margin, price increases and efficiency gains in our block product line.

We also have the opportunity to improve margins in trim board through greater utilization of our manufacturing capacity. We expect organic growth to be in the mid- to high single digits. We will be introducing new roofing, siding and stone products during the year. Our fly ash shipments are beginning to grow again after a slow summer, and we believe that our price increases will be similar to 2013.

We have been waiting for some time for our repair and remodel end markets to improve in siding, and October was the strongest month that we've had in some time, showing year-over-year revenue increases. We will have labor material and cost -- and overhead cost increases in 2014, but we believe that our cost increases will be offset by continuous improvement efforts.

Each segment and product group is fully committed to operational improvements. And when combined with an increase in revenue, it should result in margin expansion.

We will manage our balance sheet to maintain an appropriate balance between equity and debt. Over the last 5 years, we were too highly leveraged. But with increases in cash flow and lower debt levels, it appears that we are close to our goal of a debt-to-EBITDA ratio in the 2.5 to 3x. We will be working on a capital structure strategy that takes into account the progress we have made, recognizing that our debt is much less expensive than equity.

In 2013, we showed solid operating improvement, and our end markets are still at historically low levels of demand. Based on household formation estimates for 2014 and beyond, demand in our end markets will continue to increase over the next several years. We are very well positioned to capitalize on this increasing demand and look forward to participating in the up cycle.

So thank you for your participation on the call, and I would now like to turn the time over to Don.

Donald P. Newman

Thank you, Kirk. Good morning, and thank you for joining us. Before discussing Slide 4, I wanted to mention that we intend to file our Form 10-K later in November. My comments today will be directed to the slides that were sent out this morning and, to a lesser extent, the condensed consolidated balance sheets and statements of operations that were attached to the press release.

Revenue from continuing operations for Q4 was $215 million, up $24.9 million, or 13%, from the prior year revenue of $190.1 million. Adjusted EBITDA from continuing operations for the quarter was $40.8 million, a 15% increase from the prior year EBITDA of $35.6 million.

We had even larger improvements in our operating income, which increased 66%, from $15.9 million in 2012 to $26.3 million in 2013. Earnings per share for the year improved from a loss of $0.43 last year to a positive $0.12 in 2013.

Also this quarter, we have presented for the first time adjusted earnings per share, which increased from $0.41 for the full year 2012 to $0.54 this year. I'll talk through the adjustments that we've made to derive the adjusted EPS in a few minutes. We ended the year with liquidity of nearly $123 million, including $75.3 million of cash on the balance sheet.

Let's move on to Slide 5 for a closer look at the quarter's financial results. Revenue from continuing operations for the quarter increased $24.9 million, or 13% year-over-year, to $215 million. Light building products revenue increased $20 million, or 21%, due to growth in all our product groups. Heavy construction materials revenue increased $3.1 million, or 3%, from 2012 levels. That was due to increased shipments of high-quality fly ash as well as price increases. Energy technology revenue was up $1.7 million, or 64%, year-over-year due to increased shipments of our HCAT catalyst to both of our customers.

Gross profit was $64.3 million, a $7.6 million, or 13%, increase from the prior year gross profit of $56.7 million. The increase was driven by the higher revenue as well as cost reductions. SG&A decreased $2.6 million year-over-year largely due to decreases in performance-based compensation tied to stock price.

Adjusted EBITDA from continuing operations totaled $40.8 million, which represents a 15% increase year-over-year. Interest expense decreased $0.9 million as a result of lower average debt balances. There was a small amount of other income in 2013 compared to other income of $3.2 million -- other expense rather of $3.2 million in 2012, which related to the write-off of an investment in a hydrogen peroxide joint venture.

Income taxes relate primarily to state income taxes and jurisdictions where we earn taxable income. We ended the year with nearly $190 million of pretax NOL carry-forwards and over $25 million of tax credits that will shelter significant income from cash taxes into the future.

Discontinued operations reflect the results for coal cleaning. We recorded a loss in the quarter of $2.9 million, most of which relates to an adjustment of the estimated gain recognized earlier in the year when we completed the sale of all of the remaining coal cleaning facilities. We currently expect that additional adjustments to the gains and losses from the sale of coal cleaning assets may be recognized in 2014 as certain contingencies are resolved.

Now let's move to Slide 6 and talk about the full year financial results. Our full year revenue from continuing operations was $702.6 million, up $69.8 million, or 11%, from the prior year revenue of $632.8 million. Light building products sales increased $55 million, or 16%, due to growth in all major product categories. Heavy construction materials sales were up $11 million, or 4%, from 2012 levels due to both higher product sales and improved site service revenue, even though the U.S. infrastructure construction industry remains weak by historic standards. Energy technology sales were up $4 million year-over-year due to consistent, ongoing customer purchases of HCAT.

Gross profit increased 10% over -- year-over-year, from $175 million in 2012 to $192 million in 2013. That was driven by higher revenue and reductions in our cost structures. Gross margins are consistent with last year as we had higher revenue growth in our block and trim board business lines, which have slightly lower margins than our other businesses.

Our SG&A expense were flat compared to last year, even with additional expenses from the Kleer acquisition and other costs related to our revenue growth as we had less cash-based incentive compensation tied to stock price in 2013 as compared to 2012. Full year adjusted EBITDA from continuing operations was $116.2 million, up $13.5 million, or 13%, from the prior year's adjusted EBITDA of $102.7 million. The year-over-year decrease in interest expense largely reflects lower outstanding debt balances in 2013 and fewer costs associated with the early retirement of our convertible debt.

Income tax expense was $3.9 million in 2013, reflecting approximately $2 million of state income taxes and roughly $1.3 million of discrete items. Income from continuing operations swung nearly $35 million, from a loss of $26.4 million to an income of $8.3 million. Our loss from discontinued operations, net of income taxes, was $1.1 million in 2013.

Let's move to Slide 7 and spend a few minutes discussing debt. Our debt position has continued to improve over the past 9 quarters as we've increased our trailing 12-month adjusted EBITDA from a low point of $74.6 million in the June 2011 quarter to $116.2 million at the end of the current quarter. We've decreased our net debt by nearly $119 million over that same period of time. We closed the current quarter with a net debt-to-adjusted EBITDA ratio of 3.3:1, after reaching a high point of 6.7:1 in the June 2011 quarter. We've repaid approximately $95 million of debt in the past 9 quarters and $47 million in 2013. As of September 30, 2013, we have less than $8 million of debt maturing during the next 12 months.

Let's move to Slide 8. As noted earlier, we've decided to begin presenting adjusted earnings per share since we believe EPS will become a more important metric as we grow and increase our profitability. In addition to adjusting for the nonrecurring and nonroutine items we use for adjusted EBITDA, we've also adjusted for the amortization of intangible assets, all of which relate to past acquisitions, and the acceleration of interest related to early debt repayments.

Starting on Slide 9, Dave will cover light building products.

David S. Ulmer

Thanks, Don, and good morning, everybody. On Slide 9, you can see revenues from our light building products segment for the fiscal year increase by $55 million to $394 million, an increase of 16% over last year. Revenues increased 8% for the year, excluding our trim board product line that was acquired during the year. Revenues continue to benefit from growth in new housing starts.

Non-seasonally adjusted single-family housing starts for the 11 months ended August 31, 2013, were 21% higher than the housing starts for the 11 months ended August 31, 2012. Due to the government shutdown last month, September numbers won't be available until later this month.

Our 28% exposure to new residential construction in light building products would imply revenue growth year-to-date of 6%, and our organic revenue has grown 8% year-to-date. So our growth corresponds well to our end market exposure.

Our architectural stone product group has the largest exposure to new residential construction and showed strong revenue growth in fiscal year 2013. The increase in revenue led to improved margins as our contribution margins were slightly higher than expected. Our 3-stone brand approach has provided pricing and channel clarity to the market and as a successful adoption of a good, better, best strategy.

We expect it to continue to be beneficial moving forward in attracting new customers and increasing our market share. In 2014, we will focus on gaining market share from major homebuilders that we believe will have an interest in using our low-priced entry product and the potential for upgrades to our Eldorado Stone brand.

The rebounding commercial and institutional markets in Texas and Louisiana had a positive impact on our block product group sales. Texas continues to be the fastest-growing state in the nation in both jobs and housing. This growth has historically translated to construction of schools and other institutional projects as well as commercial buildings, all of which have long been core of our regional block business. We benefited from our solid position in this great market and expect to continue to do so.

We experienced production inefficiencies in our block product group as demand increased and we introduced several new product lines. As a result, we experienced lower-than-expected margins. The main reasons were overtime for labor and higher transportation costs as we shifted product between plants to meet the higher demand. As we balance production at these higher levels, our overall costs will improve in 2014, which, combined with recently implemented price increases on some products, will improve margins and cash flow.

2013 sales from our siding group and the recently acquired trim board business declined slightly, as weather negatively impacted the Northeast and North Central regions and our end markets continued to be weak. We expect repair and remodel end markets to improve as home prices and sales continue to increase and the market -- and the economy improves.

We are pleased to add trim board as a new product line in 2013. The integration was successful, which will help move adjusted EBITDA margins to the 15% to 16% range. In 2014, we believe we can expand trim board sales outside of the New England area by selling trim products into our existing 2-step distribution network and also into new lumber distribution customer targets. The increase in light building product revenues led to a 15% improvement of adjusted EBITDA for the year, improving from $63.3 million in 2012 to $72.9 million in 2013. Excluding the trim board product that was acquired this year, adjusted EBITDA margins improved from 18.6% to 18.9%.

The improvement in margins came in spite of a higher mix of our sales coming from block products, which have lower-than-average margins. The trim board product margins are expected to improve over time to levels consistent with our other light building products.

For fiscal year 2013, our sales mix of higher block and trim board sales resulted in a 120-basis-point reduction in gross margin, without which gross margin would've improved 60 basis points. Despite this sales mix impact, operating margins for the year improved from 7.5% in 2012 to 8.7% in 2013.

Slide 10 summarizes this discussion. Revenue grew in all 4 quarters this year, making it 9 straight quarters of revenue growth. Adjusted EBITDA increased in 3 quarters while the second quarter was essentially flat due to worse weather conditions year-over-year.

Now I'll turn the presentation over to Bill.

William H. Gehrmann

Thanks, Dave, and good morning, everyone. On Slides 11 and 12, you can see that our coal combustion products group completed the year with revenue of $293 million compared to revenue of $281.7 million for 2012, a 4% year-over-year increase. Revenue for the September 2013 quarter was $95.7 million compared to revenue of $92.6 million for the September 2012 quarter, a 3% year-over-year increase.

Headwaters Resources provides site services to many of its utility clients. While these services typically have lower margins than our product sales, they're not as seasonal and are not as impacted by declines in construction spending. Site service revenue for 2013 was up 5% on a year-over-year basis but was down 6.5% on a year-over-year basis for the September quarter.

In the quarter, the revenue decline from work completed in discontinued contracts was greater than the revenue from new contracts and onetime projects. Based on our current run rate, we anticipate that service revenue may decline in 2014 from 2013 levels. Site service revenue was 28% of our overall revenue for the year and 25% for the September 2013 quarter.

In 2014, we expect service revenue will be a lower percentage of overall revenue because our ash sales are projected to increase. Tons of high-value fly ash sold for 2013 were down 1.6% year-over-year, primarily because weakness in the Upper Midwest and Northeast offset strength in the South, principally Texas.

Total product revenue increased during the year, even though volumes were down slightly because realized price increases were in the 4% range. Tons shipped of high-value fly ash for the September 2013 quarter were up 4.7% year-over-year, and the September 2013 quarter product revenue increased 7.3% year-over-year due to both the increase in tons shipped and price increases.

Gross profit for the year increased by 2% to $73 million compared to $71.5 million for 2012. Gross profit for the September 2013 quarter increased 6% year-over-year to $27.3 million compared to $25.8 million for the September 2012 quarter.

Adjusted EBITDA for 2013 increased 3% year-over-year to $56.6 million compared to $54.8 million for 2012. We finished the year with adjusted EBITDA margins of 19.3%. Adjusted EBITDA for the September 2013 quarter increased 13% to $22.8 million compared to $20.1 million for the September 2012 quarter. The adjusted EBITDA margin for the September 2013 quarter increased over 200 basis points year-over-year. The improved margins resulted from a shift in product mix and continued cost reductions through continuous improvement.

October was a relatively mild month, and our fly ash shipments were up slightly over last year, so we're starting out 2014 positively. We believe that our ash sales will more than make up for any potential decline in service revenue, which should result in improved margins on total revenue. We're very positive on the opportunity to continue to raise prices as well as increase our tons shipped.

Recently, a federal district court issued an order to the EPA requiring it to submit a deadline for the issuance of new regulations. We believe that the deadline to be proposed by the EPA will not be earlier than December 2014. Alignment of new water standards with proposed CCP disposal rules could provide strong support for a conclusion that regulation of coal combustion products under RCRA Subtitle D would be adequate. Based on the EPA's statements, we believe that the new regulations will be structured under RCRA Subtitle D.

The Senate has not yet taken up the fly ash disposal bill passed by the House, House Bill 2218, the Coal Residuals Reuse and Management Act of 2013. We believe that the House bill adequately protects human health and the environment and meets all reasonable standards necessary for the safe disposal of coal combustion products. Potentially, the Senate version of the House bill could develop EPA support and increase the likelihood of final passage. But at this time, no Senate bill has been introduced.

I'll now turn the call back to Kirk Benson for comments on our energy technology segment. Kirk?

Kirk A. Benson

Thanks, Bill. Now turning to Slide 13 for a brief discussion of our third segment, energy technology. 2013 was a gratifying year from a revenue perspective. They grew revenue by over 30%, and from an EBITDA perspective, which grew by almost $4 million.

But most importantly, during the year, we signed 2 new license agreements that eventually could double our revenue when you consider a full year of operations. It depends upon the level of dosage that the customers require. We need to complete trial periods with both customers. The trial period on the first customer should begin this week and should be completed by the end of December. Sometimes feedback on trials comes slowly, but we're optimistic because of the experience that we've had with our existing customers.

The second trial will begin late next summer as the refinery is building the mixing equipment necessary to run HCAT. With these 2 customers, we have a onetime expense associated with the start-up of approximate $2 million. The payback will be measured in months after the facilities are purchasing HCAT.

In 2014, we anticipate that we will sign 1 to possibly 2 new customer licenses. We've already started negotiations on one new agreement, and we are working with several new potential customers.

The market for our technology is expanding, driven by lower natural gas prices as a source for hydrogen and a desire to increase utilization of heavy oils. You can see the quarterly performance and the year-over-year improvements in revenue and EBITDA on Slide 14.

Turning to Slide 15, we are setting 2014 adjusted EBITDA guidance in the range of $125 million to $140 million. Of course, there are the natural precautions that the final outcome is dependent upon our end markets, particularly new residential construction and cost increases such as material and transportation.

Our projected CapEx for 2014 is approximately $40 million as we are increasing our investment in growth opportunities. Headwaters is well positioned to benefit from increasing demand derived from household formation and an increase in repair and remodel activity. Our investments in new product development and participation in adjacent product lines like trim board will add to our growth opportunities. We're very excited to participate in the extended up cycle over the next several years.

I'd now like to turn the time back over to the operator for the question-and-answer period.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of John Quealy with Canaccord Genuity.

John Quealy - Canaccord Genuity, Research Division

First, on light duty, if we could, you talked about some macro headwinds in repair and remodel. Can you just talk to us in a little bit more specifics about the difference between whether Kleer was closer to budget or the legacy vinyl product, how they're trending or outperforming vis-à-vis each other? And then also, I know you talked about growth in the distribution channel for a number of different products in light in '14. Can you comment about penetration thus far, for example, in Kleer, in that 2-step channel? And then I have a follow-up.

Kirk A. Benson

So one of the things that was interesting to us is that the revenue changes in Kleer, which is our trim board product, were relatively similar to the revenue changes in our legacy products like shutters, blocks, vents, products that are primarily vinyl-oriented. And so we did have a little bit of a weather issue in the Upper Midwest and New England because the winter was extended a little bit, and those are the primary regions in which we sell these products. And so they were -- the trends were quite similar between the different groups of products. The one thing that I mentioned in the script is we seem to have seen a little bit of change in that trend towards the very end of September and into October. The October trends were quite positive, and so we're expecting that the repair and remodel markets for our products will improve. In fact, we think that there's a significant amount of pent-up demand. And as you get increases in home valuations, there's going to be a greater capacity for home equity loans and the ability to do these outside remodel projects. So we think that clearly, based on the October sales, we may be starting to see some of that pent-up demand. So, Dave, why don't you speak a little bit about the distribution, particularly as it relates to Kleer outside of the New England region?

David S. Ulmer

Yes, I mean, we -- the -- when we made it, the acquisition of Kleer was primarily a Northeast -- Northeastern business. And as we've gotten further into this business, our -- one of our main goals is geographic expansion of where those trim board products are sold and distributed, and we're starting to make some positive inroads in distribution in areas outside of the Northeastern United States. Especially in the Plains States, the Midwest and the Southeast, is really where we've started to see some areas of growth up to this point.

Kirk A. Benson

So, John, did you have a follow-up question?

John Quealy - Canaccord Genuity, Research Division

Yes, I did. So just in terms of staying with light for a minute, trends in stone, both the synthetic stone, Eldorado product as well as the block business in Texas, I'm taking the October anecdotes that suggest those businesses are strong as well. What's your thoughts about the cadence of those businesses, seasonally aside? Are we expecting Texas to be still strong in '14?

Kirk A. Benson

Yes, they -- we feel very good about stone sales and the trends in stone participating in the new residential construction growth. And we continued to see that in October. So there isn't -- nothing has dissuaded us from the improvements that we anticipate in stone sales. We're -- our focus on block is that we had fairly rapid growth, and we introduced a -- some new products. And what happened is it created some manufacturing inefficiencies. So then we are going to -- we're going to raise prices in Texas, and that could have a -- if you've got an elastic demand curve, if you're raising prices, you might actually slow some of your growth. And our goal is to have an expansion of margin in our Texas market. We're going to be doing that from -- by doing 2 things: raising prices and also from improving these inefficiencies that crept into the system in 2013. The Texas economy, I think, is going to continue to stay strong, and so there is going to be an opportunity for revenue growth as we participate in that economy. But our primary focus is going to be on raising prices, and not raising prices to offset increased costs, but raising prices to improve margins. And so our -- that's what our focus is going to be on, is the -- is margins by raising prices and by improving the operational efficiencies.

John Quealy - Canaccord Genuity, Research Division

And then just one last one, if I could, on the heavy side. Bill talked about service going down. Well, it was down in the quarter as a percentage of the mix in heavy and then down again next year. Can you talk about the relative magnitude? Is that a couple hundred basis points? Or how should we be thinking about that mix?

Kirk A. Benson

We feel really good about what happened in 2013, and we feel that's helped us position for a very strong 2014. Relative to service and the impact on our heavy construction materials segment, as Bill indicated, we anticipate that service revenue could be down as much as 6% or 7%. But what happens in the service business is that the lives of the contracts are shorter than the ash marketing agreements. And so you have a typical contract in the service side of the business is about 3 years. A typical contract in the ash marketing part of the business is 10 years. So what happens is that you've got the potential of the contracts in the service side turning over more rapidly than the contracts on the ash side. And so what absolutely could happen in 2014 is we could win some new contracts. And so that we wanted to share with the market that based upon the run rate in the fourth quarter, one could reasonably anticipate that service revenue will be 6% to 7% lower in 2014. But that's not written in stone because we are competing for new contracts in the service side of the business. And so hopefully, we'll be able to offset some of that run rate decline. The very positive thing about the heavy construction materials segment is that we are -- we're projecting strong growth in ash sales. And so the service part of the business will become a lower percentage in 2014 not just because there potentially could be lower revenue, but more importantly, it's because there could be an increase in revenue, and we believe there will be an increase in revenue through volume, as well as price increases on the ash side of the business. And that should lead to some margin expansion. So I -- so we're very much looking forward to -- for 2014 in our heavy construction materials side of our business, both from a product mix perspective as well as the sales and increased volume of ash.

Operator

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

Albert Leo Kaschalk - Wedbush Securities Inc., Research Division

Kirk, I just wanted to clarify, on your commentary on adjusted EBITDA margin, I believe that was fiscal '14 for both segments. You laid out about a 20% range?

Kirk A. Benson

Well, what we said was the 20% range, that 20% at the SBU [ph] levels, that's clearly our goal. And so we are moving in that direction, and we anticipate at the SBU [ph] levels that we should be in that 20% range.

Albert Leo Kaschalk - Wedbush Securities Inc., Research Division

And do you want to put a time frame on that? Or what's the expectation that we should think through that given the cost efficiencies and maybe some not-so-helpful cooperation on certain end markets at the moment?

Kirk A. Benson

No. I mean, we -- yes, we're happy to put the time frame on it. We believe that we'll be in that 20% range in 2014 in both of our segments.

Albert Leo Kaschalk - Wedbush Securities Inc., Research Division

That's an exit speed, is that right? Run rate exit speed?

Kirk A. Benson

Well, no. I think if you look at 2014 and realize, of course, the seasonality of the business -- and so what happens is that you have lower adjusted EBITDA margins in 12/31 quarters or 3/31 quarters, and you have higher margins in the June and September quarters. Our expectation is that when you look at the comp, at the 2 segments for the year, we will be in the 20% adjusted EBITDA range.

Albert Leo Kaschalk - Wedbush Securities Inc., Research Division

On the strong cash flow generation here and the comments about adjacent products, I'm wondering if you could comment on the need to expand beyond the R&R market and take advantage of maybe some of the other -- the new resi, et cetera, and in specific geographic regions to benefit from where the market may be growing at a better rate than you have product placement at the moment. So I guess that's a backward question I'm asking about M&A opportunities, where you're looking, but also about the need to be less dependent on R&R just from what -- that it seems to be what's driving sentiment on the stock.

Kirk A. Benson

So we're very interested in adjacent product lines, and we're also cognizant of -- different parts of the country have stronger growth. So, for example, Florida has had very strong new residential construction growth, and we don't have a significant presence in Florida. So we could -- we would be looking at geographic expansion for our, like, for our block product group into the southeastern part of the United States, including Florida. We're looking for expansion of our architectural stone group into that same geography, particularly into Florida. We would be interested in roofing products in the Florida market and in the Southeast generally. And so we'll be looking for new product development. Some of the -- some of our Inspire Roofing is the brand for our polymer-based roofing products. Dave has done a very good job in our new product developments. We've got some new roofing products that we're going to be bringing to market starting in January, when we go to the building products show. And so I think that we are focused on expanding in areas where new residential construction is strong and participating with adjacent product lines.

Albert Leo Kaschalk - Wedbush Securities Inc., Research Division

And my final question, if I may, is geared at Bill's business. One, I was wondering if you could share color on either the quantity of facilities you're servicing, the number, what's that down from or is it flat. And as we think through -- what's the reason the service agreements may terminate, other than just terming out? And if so, what's happening to the forward service on those particular locations?

Kirk A. Benson

So, Bill, I'm going to -- Al, I'm going to talk a little bit to the service side. The only -- what happens when you have these short-term agreements, as opposed to what we do in ash, and it's really important that we distinguish between ash contracts for the sale of ash and the service contracts. Because when we're in these ash marketing agreements, we are very good at extending those agreements. Most of them never go out to bid because we are constantly finding ways to engage the suppliers, and we maintain those contracts. On the service side of the business, the contracts are in the 3-year range, and they get competitively bid. On one of the things that we're unwilling to do is to bid these contracts at margin levels that we think are too low. And so we have more risk when a -- when we get to the end of a 3-year service agreement, we have more risk as to whether or not that contract is going to be renewed because we are not going to renew the contract at margins that we think are too low. And so you end up with -- you end up like with local competitors. We're clearly the largest national competitor. But what can happen is you can have a local competitor that will bid a contract to the point where there may be no margin. That's something that we're not going to do. It isn't the core part of our business. The core part of our business is marketing ash, and those are long-term contracts, and they're contracts in which we have significant experience of extending the contracts. And so there's really -- I wanted to make sure that we shared the different views on those contracts. So, Bill, if you want to talk a little bit about our supply sources or what kind of trends that you see in supply.

William H. Gehrmann

Yes. I think, Al, basically from a supply perspective, over the last year, we've lost a couple of sites not competitively. They've just been shuttered basically due to demand and ages of plants. We picked up some new supply. So basically, from a year-over-year standpoint, I think our supply has basically been flat. We will continue to look at new opportunities. I mean, we're still -- the industry's facing the mass compliance by the end of 2015. So there's still a lot of decisions being made out there, but we still feel very comfortable with existing supply. Even when adjusted for seasonality, we have a lot of headroom in our supply. And with additional storage, we can actually increase that headroom of supply. A little more additional color on the site services. As Kirk pointed out, most of those contracts are typically short term. Three years is the average, as we stated. One of the things we've been seeing now with the regulatory uncertainty, they haven't been extending agreements. Some of the terms have actually gotten a little shorter. And a piece of that site service revenue is also onetime projects, onetime projects where we go out and bid on a new site or onetime projects on a site where we currently have a contract. And looking into next year, we're constantly bidding new work, and we hope to be successful. But it -- we've kind of given the color based on what we saw in the September quarter. But we're optimistic that we'll continue to pick up new work on that side of the business.

Kirk A. Benson

I think on the supply side, we've continued to view what's taking place with the low natural gas prices and the increased complexity of the regulatory environment as something that provides us with an opportunity. So there's clearly has been some disruption. As Bill mentioned, there's -- we've had a couple of facilities that have been shut down, and that's exactly what we anticipated as we move towards full mass compliance in 2016. So there hasn't been anything extraordinary at all relative to supply. And as Bill indicated, we've got -- we have more supply sources than any competitor, and it allows us to continue to bring that high-quality supply to areas of the market where there may be opportunities because of the EPA and low natural gas prices.

William H. Gehrmann

And a little additional. As Kirk talked about, typically in most markets, we have multiple sources. So the 2 plants that were shuttered over the last year, we've been basically able to reallocate supply from other plants. So we're still continuing to supply customers in those markets.

Operator

Our next question comes from the line of Dan Mannes with Avondale.

Daniel J. Mannes - Avondale Partners, LLC, Research Division

A couple of quick follow-ups. First, on your guidance for '14 on the adjusted EBITDA, can you maybe bound for us maybe your expectations in terms of the macro environment that helped you come out with this number, i.e., what kind of expectations do you have for new home starts, what's kind of embedded there and what's kind of embedded there in terms of cement shipments year-over-year? And thus -- and on a related note, then fly ash sales?

Kirk A. Benson

I think on the new residential construction, we think that we'll get somewhere in the range of between 1 million and 1.1 million starts. So the -- maybe the midpoint of that 1 million to 1.1 million start range. From a cement shipment perspective, we're following the PCA forecast, is the basic forecast that we use relative to anticipating shipments in the -- in 2014 and the out years.

Daniel J. Mannes - Avondale Partners, LLC, Research Division

Okay. And you're also assuming you're going to get some pricing particularly on ash. I think you said 4% for '13, and maybe you're -- we should be targeting maybe a similar amount for '14?

Kirk A. Benson

Yes, we feel pretty good, and that 3% to 4% range is something that's quite realistic for 2014.

Daniel J. Mannes - Avondale Partners, LLC, Research Division

Okay, great. And then secondly, you had some pretty interesting comments on the balance sheet. Obviously, there's been a focus for a long time. You've really improved things both by paying down debt as well as through an improving EBITDA. And now that you're getting close to your target range, you mentioned M&A, but do you have opportunities to potentially return capital to shareholders? Or how constrained are you, and could that be worked through?

Kirk A. Benson

We have some constraints placed upon us by our covenants in our senior debt. And so we have -- in the past, we have purchased our stock in the marketplace. We're certainly not adverse to do that -- adverse to doing that, and we've seen -- we've had a good experience doing that in the past. We would have to work through the covenants in the senior debt in order to do that. But we are finding opportunities for appropriate use of capital as we grow our business. And so if we can get a 15% to 20% return on investing that capital in the business, then that's something that we need to seriously consider. As an example, in 2014, we intend to put in a new trim board line. And we want to expand capacity, as Dave has identified multiple distributors outside of the New England area, and we feel very comfortable that we're going to be able to expand trim board sales. So looking forward to 2014, 2015, we're going to need additional capacity in order to meet the revenue growth that's going to come from geographic expansion. So we feel very good about being able to use capital to continue to grow the business and create shareholder value.

Daniel J. Mannes - Avondale Partners, LLC, Research Division

Got it. So taking out the next step, I think you mentioned M&A to some degree. When you look at some of the geographic expansion, how much of it can you do either organically or through increased distribution, rather than focusing on -- potentially on M&A?

Kirk A. Benson

We can do a fair amount of growth from organic expansion, particularly in -- like in the Kleer product line and through new product development in roofing. It's more difficult to do in shutters, vents and blocks because we have fairly strong market share. And so it's difficult to grow those particular products through geographic expansion because we have the best distribution system in the industry. And so we're -- so you're not going to get that same kind of growth from those products. But in the other product lines, specialty siding, roofing and our trim board product, I think we've got great opportunity for organic growth outside of the existing geographies where those products are being served. We have -- we've expanded geographically our block into Louisiana, and we've, since that acquisition, which was probably, I don't know for sure, about 15 months ago, we doubled sales in Louisiana. So we've had very good success in our geographic expansion in taking our business model out of Texas and expanding it into Louisiana. So we're going to look at opportunities to do that, to repeat that process that has been so successful for us in Louisiana. We have areas of the country that we can expand our distribution in stone. And I mentioned the Southeast and into Florida markets, some of that could be done through M&A of a regional stone manufacturer. I think that's clearly a possibility. But there is also -- as we bring our good, better and best 3-stone strategy into the marketplace, we get very good reaction from our distributors. About fewer than 20% of our existing distributors sell all 3 of our stone lines, so flipping some of these distributors from one of our competitors' products -- so if we have a good, better and best strategy, they may be selling our best product but not selling our good or better product. They may be selling a competitor's product for good or better. So if we can flip them on the good or better product to our products at those price points, that's kind of similar to a geographic expansion within a brand. And so that's clearly -- we've got -- we have a lot of opportunity to consolidate some of our sales in our existing distribution to all 3 brands that we bring to the marketplace.

Operator

Our next question comes from the line of Seth Yeager with Jefferies & Company.

Seth B. Yeager - Jefferies LLC, Fixed Income Research

Just a couple of just sort of cleanup items. Can you give us some detail around siding shipments for the quarter and maybe how you fared versus the industry? And just as a follow-up on that, on the siding and trim side, where are you seeing resin costs now? And you had mentioned some price increases into next year. What sort of magnitude are you looking to push through into the beginning of next year?

Kirk A. Benson

So when we first order the price increases that we're anticipating relate to our block product group, we should have some price increases in the 4%, 5% range in block. We're anticipating some targeted price increases in stone. We're not anticipating price increases in the siding part of our business. We're not seeing pressure on -- from resin pricing. The resin prices have been relatively stable. We did some reengineering of our use of resins, and we changed our vendors, and we're in pretty good shape going into 2014 relative to our raw material costs and resin pricing, specifically in the siding part of our business. So we aren't anticipating any significant price increases in 2014 in the siding part of the business. Our revenue from some of our -- these siding products was lower year-over-year in the fourth quarter. And as I indicated, that seems to have changed, and that trend has reversed. So we're going into 2014 very optimistically about volume in the siding part of the business. And then clearly, October pointed us in that direction. To some degree, you can look at VSI relative to volume in that -- in the volume of vinyl as well -- in pricing to some degree, I guess, but mostly volume, you can look at VSI, and you can get a sense of -- as to what is taking place relative to overall shipments.

Seth B. Yeager - Jefferies LLC, Fixed Income Research

Got it. Okay, that -- now that's helpful. I appreciate it. And just one follow-up on some prior questions around allocation of capital. Just looking at your -- I guess you sort of call it your optimal cap structure guidance of 2.5 to 3x leverage and just the guidance around EBITDA next year, it implies, to me at least, unless I'm reading this wrong, that you're either taking out a large chunk of debt or allocating cash elsewhere. With the -- I guess your bond's not callable until 2015. Is the expectation that it continue to take out your converts? And I guess just otherwise, what's the primary use of cash? And then what sort of CapEx are you looking for next year?

Kirk A. Benson

So I think what we're looking at from a CapEx budget next year is higher than in 2013. So the CapEx budget's going to be $10 million, $11 million higher. The principal reason that the CapEx budget is going to be higher is because of the focus on growth. And so you're absolutely right. There has been -- we're now in a position where we can act to accelerate the growth of the business. And one of the ways that you do that is through investing in growth CapEx. And so we have opportunities to do that. And as we have -- we've repaid nearly all of our 2014 maturity -- there's a little more than $7 million left, and that will be paid in the March quarter of next year, we are limited by our senior debt covenants relative to the amount of debt that we can take out of our $50 million tranche that is due in 2016. So we're not going to be able to go into the marketplace and prepay that 2016 debt. That's going to stay until its maturity date. So we're -- we will be using our -- the primary change in the use of cash is to focus on our top line and to focus on growing the business. If we have opportunities to redeem stock in order to return money to shareholders, I said before, we're not adverse to that at all. But we will have to make some changes in the senior debt covenants in order to accomplish that.

Tricia Ross

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

Operator

Our final question comes from the line of Philip Volpicelli with Deutsche Bank.

Philip Volpicelli - Deutsche Bank AG, Research Division

My questions regard the energy technology business. You mentioned there are 2 new contracts coming on, and then there's a potential 2 more after that. But you said that your revenues would double. Is that with the 4 contracts coming in or just the first 2 that you expect to come in?

Kirk A. Benson

If we are -- on the first 2 contracts that we signed, if those 2 customers order HCAT at the same dosage rate as our existing long-term customer, then that will result in doubling our revenue from those 2 customers.

Philip Volpicelli - Deutsche Bank AG, Research Division

That's great. And, Kirk, what kind of contribution margin should we think about with that incremental revenue?

Kirk A. Benson

In the 45% to 50% range.

Philip Volpicelli - Deutsche Bank AG, Research Division

Great. And then 2 cleanups. You've mentioned in the past potentially spinning out or selling technology. What size do you think you would need to get it to just spin it out or sell it?

Kirk A. Benson

The -- we are clearly focused on heavy construction materials and light building products. That is -- that's who Headwaters is. So we need to be focused on those areas of our business, and we think that there's tremendous upside and opportunity in both of those areas. So as we -- as I -- as can be understood from those 2 new contracts, if you can double revenue with 2 new contracts, you've got some significant upside in this opportunity. So we want to capture as much shareholder value as we can. And so we are not looking to sell this asset in 2014, as we think that there are a number of customers that will be adopting our technology. So we're probably looking -- I'm giving you a time frame rather than a size. But we're -- probably won't be looking for a buyer for this business probably until 2015 because if you can double revenue with 2 contracts, there -- that upside opportunity is there. So as we drive EBITDA into the $20 million range -- $20 million, $25 million range, that's -- and we've got still growth opportunities, that's probably the time frame when you start to look for a buyer.

Philip Volpicelli - Deutsche Bank AG, Research Division

Great. And just one last one for Don. The restricted payments basket, I think, is what you're all alluding to in terms of the ability to buy back equity. What is the RP basket capacity at the end of the year?

Donald P. Newman

At the end of the year, it's going to be in the range of probably $55 million as far as...

Kirk A. Benson

No, the basket, not the [indiscernible].

Philip Volpicelli - Deutsche Bank AG, Research Division

The restricted payments basket...

Kirk A. Benson

The basket is around $5 million...

Donald P. Newman

Right, right. The basket is $5 million [indiscernible].

Kirk A. Benson

The basket around $5 million. If we're $55 million, we could buy [indiscernible].

Donald P. Newman

Sorry, I'm -- I was talking about how much we would need to increase the basket...

Kirk A. Benson

Right.

Donald P. Newman

In order to -- but we have a standing basket of about $5 million. It's a limit over the term of the senior secured. Beyond that, like when you calculate the restricted payment amount, right now, we've got effectively a hole that we're digging out of, which amounts to roughly negative $55 million, which should be covered through -- largely through profits from the business.

Philip Volpicelli - Deutsche Bank AG, Research Division

Got you. So the maximum stock you could buy back would be $5 million until you dig out of that hole?

Donald P. Newman

True story.

Operator

That concludes the questions. I'd now like to turn it back to Headwaters for closing remarks.

Tricia Ross

Thank you. With that, we will go ahead and conclude the call. Thank you for joining us.

Operator

This does conclude the conference call for today. If you'd like to listen to a replay of the conference, please dial (303) 590-3030 or 1 (800) 406-7325 with access code 4646500. We'd like to thank you for your participation. You may now disconnect.

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