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Executives

Tricia Ross – IR, Financial Profiles

Sharon Madden – VP, IR

Steve Stewart – CFO

Kirk Benson – Chairman and CEO

Bill Gehrmann – President, Headwaters Resources, Inc.

Jack Lawless – President, Headwaters Construction Materials, Inc.

Analysts

Steven Sanders – Stephens Inc.

John Quealy – Canaccord Adams

Pearce Hammond – Simmons & Co

Dan Mannes – Avondale Partners, LLC

Headwaters Incorporated (HW) F2Q10 (Qtr End 03/31/10) Earnings Call Transcript May 4, 2010 11:00 AM ET

Operator

Good morning. My name is Melissa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Headwaters Incorporated second quarter 2010 earnings call. All lines have been place on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you. Ms. Tricia Ross of Financial Profiles, you may begin your conference.

Tricia Ross

Thank you. Welcome everyone to the Headwaters Incorporated second quarter fiscal 2010 conference call. If you do not receive a copy of this morning's financial results press release, please contact my office and we would get onto you right away at 310-478-20700. Without further delay, I would now like to turn over the call to Sharon Madden, Headwaters VP of Investor Relations.

Sharon Madden

Thank you, Tricia. Good morning everyone and thank you for joining us today as we report Headwaters fiscal 2010 second quarter results.

On today's Steve Stewart, Headwaters Chief Financial Officer will update you on the financial results for the quarter followed by Kirk Benson, Headwaters Chairman and Chief Executive Officer who will discuss second quarter results for Headwaters operating segment. Also joining are Bill Gehrmann, President of Headwaters Resources; and Jack Lawless President of Headwaters Construction Materials.

Now for the best part, so before we get started I need to remind you that certain statements made during the call including statements relating to our expected future business and financial performance maybe considered forward-looking statements within the meaning of section 27A of the Securities Act of 1933 and section 21E of the Securities Exchange Act as of 1934 both 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, except as maybe required by law. You may find Headwaters annual report on Form 10-K, our quarterly report on Form 10-Q, and other SEC filings readily available from the SEC's website, Headwaters website or directly from the Company itself.

I will now turn the call over to Steve Stewart. Steve?

Steve Stewart

Thank you, Sharon, and good morning everyone and thank you for joining us this morning on our second quarter earnings call. Attached to the press release that Tricia mentioned are condensed consolidated financial statements. That includes statements of operations for the quarter and the six months ended March 31, 2010 and 2009. We've also included their balance sheet as of the quarter-end March 31, 2010 and our fiscal year-end of September 30, 2009. My comments are derived primarily from those condensed consolidated financial statements.

We expect to file our Form 10-Q this week. We believe the indications of stabilization that we first noticed in our September 2009 fourth quarter appeared to be continuing into the March 2010 quarter even in light of the continued weakness in new housing and residential revolving markets, and the noticeable slowdown commercial construction and infrastructure activities that directly impacts our sales of fly ash.

However, these signs of stabilization have not yet resolved for the noticeable increases in sales and revenue. While we did see noticeable improvement in revenues in the March month, this could be a response to the poor weather conditions experienced in January and February with March being a catch up month.

We continue to be cautious in our expectations and believe we were correct in forecasting 2010 revenues to be essentially flat in comparison to 2009. However, we continue to believe we will realize improved operating results in 2010 because of operational improvements and cost reductions implemented in fiscal 2009 along with new items that are being identified and implemented in fiscal 2010.

Total consolidates revenues in the March 2010 quarter decreased by approximately $9.5 million or 6.5% when compared to the 2009 quarter, but our gross profit improved by $4.9 million or 21.6% when compared to 2009, and our operating loss improved by $8.4 million, which was a 66% improvement when you exclude the 2009 goodwill impairment.

I believe the improvement in our gross profit and operating loss confirms are discussions about the financial effect of the operational improvements in cost reductions implemented in fiscal 2009, which are carrying into the current fiscal year along with the cost reductions being implemented in 2010.

We continue to have a healthy balance sheet over 90% of Headwaters total debt has a maturity in calendar 2014 and with the balance of that due to be repaid in June of 2012. We currently have a $70 million asset-based revolving credit facility that as of March 31st, 2010 was undrawn and we had a borrowing base capacity of approximately $55 million.

At March 31, 2010 we had approximately $70 million of cash on our balance sheet, which provides Headwaters with approximately $125 million of liquidity. The working capital asset that support the ABL facility fluctuate during the year with the low point normally occurring in the March quarter and the high point normally occurring towards the end of the September quarter.

We believe that fiscal 2010 could be flat, or have a relatively small amount of free cash flow from operations after debt service and capital expenditures. However, we believe that going forward, we will generate cash flow from operations which along with our cash on hand will be sufficient to meet our operational needs and providing the necessary fund and even providing the necessary funds to entire a significant portion of the debt that we expect to repay in June of 2012.

Headwaters total indebtedness of March 31st, 2010 was $524.8 million on a gross basis. These debts reflected on our balance sheet at $493 million, which is net of debt discounts.

Headwaters debt has a weighted average interest on the face amount of approximately 9.9% at March 31, 2010. Cash interest in fiscal 2010 is expected to be approximately $52 million with total interest expense recorded in the financial statements to be approximately $65 million, which is a result of amortization of debt discount and debt issuance cost.

We have significantly reduced our capital expenditures in 2010. Total capital expenditures in fiscal 2009 were $64.2 million, which was 52 million less than the previous fiscal 2008 year. We expect capital expenditure for 2010 to be less than half as much as they were last year or approximately $30 million.

Capital expenditures through March 31, 2010 were $13.7 million, which is slightly below the $30 annual run rate. Our operations will continue to be seasonal as in the past. We expect to use cash in support of our operations to the winter months and to be cash neutral as we build working capital in our June quarter, and to generate cash in our September and December quarters.

Our strongest revenue quarters have historically been the June and September quarters, and we generate all of our operating income in those two quarters. We believe we have sufficient cash on hand to sustain our operations to the working capital winter trough in 2011 without the need to draw on our $70 million ABL facility.

In addition to the $328 billion of senior secures notes that we issued in October, Headwater has three trenches of convertible debt totaling $197 million. The accounting for convertible debt was changed in October 2009, and now results an increased non-cash interest expense being recorded in the financial statement as we amortize the debt discounts that were recorded.

We amortize those discounts over the life of the related convertible debt. There was approximately $1.8 million of additional non-cash interest recorded in the March 2010 quarter, and we estimate that this non-cash interest expense that's recorded in the financial statements will increase to over $7 million for fiscal 2010, all of those as a result of these new accounting rules for convertible debt.

At March 31, 2010 there are approximately 60.4 million shares of Headwaters common stock issued and outstanding, which is comparable to the prior quarter and to our September 30th, 2009 year-end balance. Since the March 2010 quarter results in a diluted loss per share, none of the common stock equivalent consisting of stock options, and SARs is included in these earnings per share calculation.

When you compare the 2010 quarter with 2009, there are a couple of non-recurring or non-routine items I'd like to discuss. In the March 2009 quarter, we recognized the gain of approximately $1.7 million related to the sale of property no longer being used, and an additional $1.7 million gain on the exchange of convertible debt.

In the March 2010 quarter, there is approximately $3 million of additional income tax expense related to changing Headwaters estimated effective tax rate from 51% to 44% as a result of reduced in the income tax credits that we expect to generate in fiscal 2010.

The recorded income tax benefit rate in the December 2009 quarter financial statements was approximately 38%, compared to 36% rate in the March 2010 quarter. The income tax benefit in the December 2009 quarter was net of approximately $3.3 million of income tax expense that resulted from a re-determination of prior's income tax liabilities.

And as mentioned the income tax benefit in 2010 quarter was net of approximately $3 million with additional income taxes. 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 $2 million of cash payments for state income taxes. We expect depreciation and amortization, including the stock-based compensation amortization in fiscal 2010 could be as much as 20% less than it was in fiscal 2009.

We believe the signs of stabilization we started to see towards the end of our fiscal 2009 are carrying into our fiscal 2010 year. We are pleased with the activities of the quarter, and in particular the noticeable financial affects of the operational improvement and cost reduction initiatives that have been implemented.

We will continue to look for additional operational improvements and cost reductions in all of our business through fiscal 2010 as we wait for the recovery from this recession. I would like now to turn the call over to Mr. Kirk Benson, Headwaters Chairman and Chief Executive Officer.

Kirk Benson

Thanks Steve. Operating trends in each of our reporting segments improved within the March quarter. The positive trends have continued in the April reflecting improvements in fundamental conditions. Of course, many of our end markets continued to be fragile and we need additional positive month to confirm a long-term upper trend, but for net shipments are at 15 year lows, fly ash continues to increase penetration.

The lower cost in positive fiscal attributes makes it an attractive substitute. Our shipments improved in March and April shipments were ahead of 2009. Three things happened in the March quarter that drove margins lower.

First, fly ash shipments were down in January and February due to weather. For example, western region shipments were off approximately 20% in January and February. Tons came back in March, and were ahead off 2009 that we lost high margin shipments in the first two months.

Although shipments of fly ash were down revenue was flat in the quarter. The revenue drop from the decrease in fly ash shipment was made up with increased service revenue, but at lower margins. Cost savings also made up some of the margin loss from the decrease in fly ash shipments in January and February.

Total fly ash shipments in March 21 exceeded March 2009, and operating margins in March were within 70 basis points of 2009. So, Bill will provide you with some additional detail on the fly ash business.

Building products demonstrated significantly better margins as our cost savings lose through the income statement. In addition, April 2010 sales exceeded 2009, so we may start to see some uptick in revenue as well as improved cost. We think the sales improvement are primarily coming from repair and remodeling while we still see some softness in the residential, commercial construction.

Our metallurgical coal sales started in December, and have increased during the March quarter. It appears that we are going to be able to ship coal directly in the international markets reducing reliance that we might have had on our domestic markets. So, Bill will now update us on the heavy construction materials. Jack will discuss light building products and Bill will finish up with coal cleaning.

So, Bill why don't you go ahead?

Bill Gehrmann

Thanks Kirk, and good morning everybody. Year-over-year revenue for the March quarter in coal combustion products, our coal combustion products business was essentially flat. Product revenues continued to be impacted in the three largest cement consuming regions of the United States with the largest weaknesses coming from the California, Arizona, and Nevada markets. .

January and February were also impacted by higher than normal snow in rainfall amounts in most areas of the country resulting in lower revenue, but as weather improved March revenue recovered was up over 13%, compared to March 2009. Year-over-year product revenues, for the quarter were down just over 7%.

Product revenues for the month of March were up over 10% on a year-over-year basis. Headwaters resources provide site services to many of its utility client. These services include constructing and managing landfall operations, operating and maintaining material handling system, and equipment maintenance.

While these services typically have lower margins than our product sales, they are not as seasonal and are not as impacted by the clients in construction spending. Site services revenues for the March quarter were up over 11% on a year-over-year basis, and were over 34% of our total revenue for the quarter.

Gross profit margin for the March quarter was $8.8 million, compared to $11.6 million for the March 2008 quarter. The year-over-year decrease in gross profit was driven by several factors. Weakness in some of higher margin product revenue markets particularly in the West was coupled with an unusually wet January and February.

The drop is also the result of changes in our overall product mix as the larger share of our total revenue came from site services, which as I mentioned earlier carry lower margins in our product sales. As we discussed on our last several calls, on October 16th EPA filed a proposed ruling with the OMB for the management of coal combustion residuals.

While the EPA continues to indicate that they support the beneficial reuse of coal combustion products because of the significant environmental benefits including reductions in greenhouse gas emissions. They are also concerned about the safety of landfills after the breach of the wet impoundment embankment in Tennessee in 2008.

The industry now anticipates is the proposed changes by the EPA will be announced this month. We will include three proposals none of which will be designated as the preferred regulate. These three proposals are expected to be one; the Sub-Title D destination for disposal was an exemption of approved utilizations of coal combustion residuals.

This would prove the EPA with jurisdiction over the management of coal combustion products. Two, the Sub-Title D designations, which means the coal combustions residuals would be managed under the same guidelines of solid and industrial waste. The individual state have jurisdiction for disposal regulations under Sub-Title D.

However, there have been discussions regarding an approach that could provide the EPA with regulations and forcibility for coal combustion products under Sub-Title D. and the third one in Sub-Title D designation for disposal in the banning of the use of wet impoundments for the disposal of coal combustion residual.

After the release of the EPA's proposed regulations, there will be a public domain period. These periods are specifically 60 days to 90 days in either side could be granted in extension. From then, the EPA will go back to the OMB with the final proposed regulations after reviewed by the OMB, the final proposed regulation will be released for another public commentaries.

Headwaters believes that this process will ultimately yield regulations to strength and disposal standard without jeopardizing beneficial use by creating an unnecessary and unwarranted hazardous stigma. According to ENR's quarterly cost report released on April 5th year-over-year cement prices were up 1.4%, ready mix prices were up 2%.

Year-over-year cement consumption is forecast to increase modestly in 2010 primarily coming in the back half of the year. Cement consumption is forecasted to increase over 16% in 2011 driven by stimulus funding and project time. 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 as strengthening our ability to meet the needs of our clients and customers as the economy rebound.

Now, Jack will update you on light building products.

Jack Lawless

Thanks Bill, and good morning everybody. Revenues for our light building products business in our March 2010 quarter were $61.3 million, a decrease of $8.4 million or 10.8% from the March 2009 quarter. Despite a decline in revenues, our gross margin percentage increased significantly to 23.8% in the March quarter, compared to 17.5% in the March 2009 quarter.

In addition, our adjusted EBITDA in our March quarter more than doubled to $5.7 million after factoring out non-recurring accounting adjustments that were recorded in the March 2009 quarter. Our continued improved operating results despite falling revenue are the result of many actions our management team has taken to drive cost and cutting efficiencies out of the system.

Even though revenue was down for the quarter as a whole, the trend was positive and demonstrated stabilization in our end markets. While our building product sales were down 10.8% for the quarter, our March sales were only down 3.4%. These trends have kept continued in April, and our final sales numbers are showing an increase in 2010 April sales, compared to 2009.

April would be the first positive month when sales are compared to our prior year for the building products groups since October 2007. On a product category basis, our architectural stone segment is starting to see some positive sales trends. Our year-over-year performance in our second quarter is materially better than our performance in our first quarter.

In addition, this past March was the best relative sales performance on the month-over-month yearly basis in 17 months. These positive sales trends have continued into April. Our April sales have come in well ahead of last year's sales pays reporting our first year-over-year monthly increase since October of '07.

In addition, we continue to improve our operating metrics despite our lower revenues. Our gross profit operating income and EBITDA margins were all materially better than a year ago levels as our entire management staff continues to make incremental improvements through our entire operation.

Our improved manufacturing productivity has enabled us to continue to own the cost side of this segment. As a result, we are currently contemplating some additional consolidations in our distribution centers and manufacturing facilities related to our architectural stone segment.

Once these evaluations are completed, our restructuring charge which would be predominantly non-cash could be recorded in the June quarter. Our concrete block segment continues to have negative revenue comps till last year's record sales and operating income results.

We forecasted to have lower revenues from the segment as we expected our commercial and retail sales to fall a bit from a year ago levels. Relatively poor weather has also impact our revenue in this segment.

However, despite a double digit drop in revenue, our management team in this segment has been able to deliver outstanding operating results. This operating income and EBITDA performance in our second quarter was only a few $100,000 lower than the last year's record levels.

We do feel that the revenue losses will moderate in the second half of the year as the weather impact lessens a bit, and our institutional sales remain reasonably strong. In our resin-based building product segment, our second quarter sales came in flat, compared to a year ago levels.

In addition our sales in this segment exceeded year ago levels in three of the last four months. Prior to these gains, we've not had yearly month-over-month gains since November of 2007.

In addition, our gross profit margin, operating income and EBITDA margins were all significantly improved in our second quarter due to the efforts of our management team that drive cost out of the system, and improve operational efficiency.

Lastly, our sales in this segment for April came in over 9% higher than year ago levels, which now gives us year-over-year increases in four out of the last five months. In summary, we believe that sales in our building products group are continuing to show further signs of stabilization. In previous calls, we mentioned that we thought our sales could start trending ahead of last year's pace in the second half of our year.

Our actual sales results over the past couple of months support this hypothesis. We remain hopeful that these sales trends will continue into the last six months of our year.

I'll now turn it back to Bill talk about coal cleaning.

Bill Gehrmann

Thanks, Jack. March 2010 quarter revenues from coal sales were down 41% year-over-year, while tons sold were down 15.3% including March 2009 tons from tolling operations. The average revenue per ton for coal sold in the March 2009 quarter was $36 per ton as compared to $55 for March 2009 quarter. The year-over-year revenue and revenue per ton variance was primarily driven by the decline in metallurgical coal sales from the Pinnacle facility in the general softness in thermal coal prices.

We continue to see positive impact from the integration of our coal combustion product and refined coal businesses. SG&A costs were over a $2.3 million lower for the March quarter, compared to the March 2009 quarter, and over $4 million for the fiscal year. Our ongoing focus on our continuous improvement initiatives resulted in another quarter where our fixed costs were lower by over $3 million, compared to the March 2009 quarter, and by over $7.3 million on a year-over-year basis.

As a result of these efforts, our direct operating income for the March quarter improved 13% over the March 2009 despite lower revenues. According to EIA's latest short-term energy outlook, total US electric consumption is forecasted to increase 2.9% in 2010.

Total natural gas generation in electric power sector is now expected to increase 2% in 2010. However, the delivered price of thermal coal delivered to utilities is expected to drop 3% in 2010. This continued softness in prices is driven by high inventories and import coals, which are projected to result in a 4% drop in US coal production in 2010.

On the metallurgical coal side, the world crude steel capacity utilization for February was 79.8%, a year-over-year increase of 12%. China was a net importer for coking coal in 2009 reporting over a 34 million ton. Demand for coking coal in South America is forecasted increase over 6.5% in 2010 driven by Brazil

Surprising outlook for 2010 continues to look strong. For the March 2010 quarter, we operated at volumes very close to those required to breakeven. During the quarter, we operated our rock crusher and Minuteman plant with the same personnel. As we discussed in the last call in December, we started our Pinnacle plant with a one shipped operation, we expected it to be operating it above breakeven volumes by the end of the March quarter.

We met that goal and expect volumes to increase as we modify permit there. We delivered the first of five metallurgical coal shipments to Brazil as part of the product shipments fines-only purchase orders. We began to move coal and preparation of shipping and fines-only shipment to China. This is another step in gaining acceptance in value for our clean coal.

While the domestic steam coal market remains soft, we anticipate that the continued acceptance of our refined coal in both the thermal and metallurgical coal market will create additional sales opportunities. That in a combination with the strengthening prices in the metallurgical coal market and continued focus on our overall cost structure make us cautiously optimistic that we will continue to see corresponding improvements in our operating income for 2010.

Steve Stewart

Thanks Bill. I just wanted to add a short note on HCAT for those that have some interest in our technology. HCAT is our catalyst additive that improves a version of heavy oil and the value of our products.

During the quarter, we completed a successful commercial trial at a major refinery. The technology performed as accepted reducing sediment that causes fouling allowing the refinery to increase conversion. We continue to work with multiple refineries that have demonstrated continued interest in the introduction of HCAT.

So with that I'd like to turn the time back to the operator for the question-and-answer period.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question is from the line of Steve Sanders of Stevens Incorporated. Your line is open.

Steven Sanders – Stephens Inc.

For Steve, Kirk or Bill. I guess regarding the EPA regulations, is there been any changes since the last call that gives you more or less comfort in the outcome, and then aside from their self imposed as deadline to issuing the proposal, is there anything that you could keep this from getting issued within the month going to be pushed back further, just anything you could provide there?

Kirk Benson

I think Bill will add color to this answer, but one of the things that gives me a little bit of comfort is that last fall, the EPA was pretty much predisposed to a split designation, and that seemed to be their preferred approach. Since then, there is been a lot of communication that is taken place with the EPA and the risks associated with that approach within I think fairly well demonstrated and as Bill said it appears that what the EPA is going to do now is propose three alternative, but have no preferred approach and that's a change in position that reflects the reality of the change in regulations, and I think the EPA has been responsive to the feedback that they've received from all across the country from multiple constituencies. Bill, have you seen anything else.

Bill Gehrmann

No. I've been inclined to agree with the takeaway that Kirk just shared. A few other things obviously, I think is stated by the OMB, they have never seen so much interest in a topic or post regulation like this just based on the number of industry environmental groups that have asked for time to present to them. Also it should be knowing that I think the EPA in their continued support of approved utilization recycling of the products has in some degree reached out the American Coal Ash Association, which is the industry representative for the markers and utility past unanimous resolution of within the last month supporting the Sub-Title D regulation.

I think EIA in your [ph] slide give shown similar movements in that act, and I think the key as Kirk pointed out as we the EPA, we've seen the EPA kind of move what away from a preferred regulation and then been a hybrid Sub-Title C regulation.

Steven Sanders – Stephens Inc.

Okay. That was helpful. And then I guess sticking with fly ash, it looks like whether affected you quite a bit, but how much of the margin softness in the queue was weather-related and how much was just a shift towards the lower margin service business?

Kirk Benson

I would say the larger piece of it is the softness in some of the product revenue driven by not only the weather, which impacted us on a national basis, but also the continued softness we seem to experience and I think everybody in the industry is experiencing out in the Southwestern part of the United States.

Bill Gehrmann

To add a little bit of color to that by January and February, our operating margins were off between 700 and 900 basis points. In March, our margins were up 70 basis points, so it's just about may back all of those margins in March which basically tells you that the client margins was almost entirely attributable to the January, February weather.

Steven Sanders – Stephens Inc.

Okay and then I guess for 2010, you still expect I guess revenues as a whole to be flat to slightly up in line kind of what the cement forecast is?

Bill Gehrmann

That's a question for to the fly ash business or the entire?

Steven Sanders – Stephens Inc.

Yes. No, just for the fly ash piece.

Kirk Benson

I would say that we are the -- somewhat flat as we've discussed and as the forecast is continued to come out and be updated. They expect slight increase in cement consumption 2010 over 2009 now lion share that will come over the back half of the calendar year, so we will pick that up in our last quarter to September quarter. So, yes we anticipate being somewhat flat year-over-year based on that pickup coming there.

Steven Sanders – Stephens Inc.

Okay, and then moving to the light building product, Jack you know the quarter sales began to stabilize last quarter. It looks like the segments are starting to see growth siding accessories mentioned in the release, obviously things got progressively better as Q1 along, can you talk a little bit of about what you are seeing this quarter and how things is improved relative to March? Do you feel better about the favorable year-over-year comp in the second half of the year given the recent trends?

Jack Lawless

Well, I think that's right. I think we've shown improved operating results, improved sales over the last several months. In April as I mentioned in the script came in about 6% ahead of last April, so we are reasonably, I guess we are cautiously optimistic that we hope that our sales momentum continues into the second half of the year.

Steven Sanders – Stephens Inc.

And I guess on the margin side of things, cost savings have been big for you, but what is taking out that additional facility view to you in terms of margins? What does it say going forward in any incremental margins expansion you would have?

Jack Lawless

Well, taking out if we do determine when you write down those assets that should give us probably about $300,000 a month of incremental EBITDA.

Steven Sanders – Stephens Inc.

Okay, and then just one quick house easy question. Steve, what was the cash flow from operations for the quarter?

Steve Stewart

It was about $19.5 million for the six month period. We don't disclose at the quarter, but you can [ph] did that down for now and compute it.

Steven Sanders – Stephens Inc.

Okay, great, thanks guys.

Operator

Your next question comes from the line of John Quealy of Canaccord. Your line is open.

John Quealy – Canaccord Adams

Hi, good morning folks. Just a couple of questions both for light and heavy duty products. Can you talk a little bit about the selling to the channel? Do we think this is Jack maybe for you first or Kirk, do we think this is the normal selling for the builder season in one step, two step; can you talk about where the strength is and then maybe Bill on the fly ash side, given infrastructure stimulus election season again is it just catch up or what do you think moving forward?

Kirk Benson

I will go first, Bill. I think John; the vast majority of what we are seeing on a sales increase side in the light building products are really sell through. It's very -- it's still now I think there is reasonably low levels of inventory build going on in any of the channels that we service. So I think most of what we are seeing today is real demand being higher than year ago levels.

John Quealy – Canaccord Adams

And then this is Jack for you on your mix of business, can you comment on the relatively new skews, how they are trending as this business picks back up versus the legacy skews. Can you give us an indication there?

Jack Lawless

Certainly, the newer products are performing better than some of the legacy products. Roofing products, our siding products, our trim products are all doing materially better than our core products. Without that being said, our core remodeling products continued to do quite well in the last couple of months being ahead of year ago level.

John Quealy – Canaccord Adams

Thanks. And Bill in terms of fly ash, in terms of channel fill or restocking is there any impact there?

Bill Gehrmann

John, from our side I think as we talk about a slight increase in cement consumption most of the forecast are lining that towards infrastructure project based on the delay from the time of project is laid. Some of these projects are already in the pipeline. Prep work is been done in the side prep work so, I think most of that 5% or so increase in cement consumption year-over-year is forecast at this point to fall into the infrastructure category.

John Quealy – Canaccord Adams

Bill, does ready mix layers hold very much fly ash as inventory?

Bill Gehrmann

No. Typically, ready mix supply is going have a load and a half to two load capacity to the plant.

Jack Lawless

So John, there is almost no inventory in the channel in the fly ash business at all.

John Quealy – Canaccord Adams

Okay, perfect and then just couple of one-off questions here. Kirk, can you give us an update on hydrogen peroxide, it looks like it impacted the results favorably, but where are we with the potential monetization of that asset?

Kirk Benson

I think we are getting very close to getting an agreement signed to sell the facility. We've gotten verbal approvement from the bank. There's some non-recourse debt that's on the facility and we needed to get approval from the lending institution. It has taken a while to get that approval. We got in there their verbal approval, and so we are moving ahead with documentation.

John Quealy – Canaccord Adams

And it leads into my next question in terms of cash, what sort of cash contribution, when it's done, Kirk should we expect to look for in the coming quarters?

Kirk Benson

From that transaction?

John Quealy – Canaccord Adams

Right.

Kirk Benson

$15 million to $16 million.

John Quealy – Canaccord Adams

Okay. And then just a couple of last financial ones. Steve Stewart, in terms of the effective rate we should look for in the tax rate the next couple of quarters, how should we model it out for the quarters and the year?

Steve Stewart

I would use that -- we're currently estimating it around 44%, so I would use something in that range.

John Quealy – Canaccord Adams

Okay. And then lastly on the cash walk, Kirk mentioned potentially $15 million monetization of hydrogen peroxide. Can you talk about some of the other bids of non-operating cash flow that we should look for as you guys build cash into the '11 period?

Steve Stewart

The only other one that's above significant is when we finish our tax returns for our '09 year, we will be carrying back loss into the prior years, and we expect to refund about $7 million which maybe would hit us in the July, August timeframe.

John Quealy – Canaccord Adams

Okay, and that's above operating cash flow, correct?

Steve Stewart

That is correct.

John Quealy – Canaccord Adams

Correct. All right, thanks.

Operator

Your next question is from the line of Pearce Hammond of Simmons. Your line is open.

Pearce Hammond – Simmons & Co

Good morning.

Kirk Benson

Good morning.

Pearce Hammond – Simmons & Co

I think the fly ash and so maybe the concern with the EPA and regulation of coal ash is been a bit of overhang on the stock, but based on the venue which you've laid out today that the EPA might come out would say this month, is it fair to say that investor should worry about the EPA and how that regulation of coal ash could end up impacting Headwaters?

Kirk Benson

Far be it from us to tell the investor got that how much wait they should place on any particular risk. I think we are greatly encouraged by the direction that the EPA is talking, and so I think we are getting to the point where we are cautiously optimistic that the result is going to be consistent with common sense and a good regulatory position by the EPA. There is probably going to be some tightening on disposal of fly ash particularly in wet impoundment. That's going to have an increase in cost to the utility industry as they change their disposal practices that could ultimately benefit Headwaters of course as we provide services to the utility industry.

But by and large, I think it's clearly moving in the right direction. It's not over until the EPA either does or doesn't change the current regulatory scheme, but we are certainly encouraged by the general direction that it's moving. Do you agree Bill?

Bill Gehrmann

Yes. I think it is moving in a favorable direction, but based on the public comment period extensions, one final regulation coming back out for public comments. This is probably a process. I think most people feel we are not probably fully play itself out until 2011.

Pearce Hammond – Simmons & Co

The option that Bill outlined is there a wind in particular that Headwaters would not like to see implemented?

Kirk Benson

I think not only Headwaters, but anyone in the industry wouldn't prefer not to see that the first one, the hybrid Sub-Title C that goes into the conversation and the hot topic of attaching a segment to a product it's been so successfully recycled up to this point.

Bill Gehrmann

I think it goes beyond just the fly ash industry. I think that state regulators, the folks that use concrete those if you look on the ACCAA website, you can see the broad array of different participants in this conversation that have contacted the EPA and is clearly a very broad group of different perspectives that has all come together and have communicated at the EPA that a Sub-Title D regulatory scheme is the appropriate way to manage fly ash. So, a lot of folks especially environmentalist don't like to work industry, but in this instance, it's just a fly ash industry, or the cement industry.

It's a very broad group of people that are supporting Sub-Title D regulation.

Kirk Benson

Yes. I think Pearce, if you look at that list you will find is high recall over 35 as various state environmental regulatory agencies have reached out in support of fly ash and not giving a Sub-Title C designation. Once again I think the EPA is somewhat on record saying that Sub-Title D landfill guidelines are sufficient to protect and secure landfills. It just comes down to jurisdictional issues, and that's Sub-Title C versus Sub-Title D though, and there is some question there. There is some clarification as stated in the earlier script that there is a move to somewhat maybe clarify, clarify some jurisdictional issues under Sub-Title D that would give EPA the security that they desire.

Pearce Hammond – Simmons & Co

Great. That's very helpful, and then just one final question. In the energy technology segment, relative to our expectations for coal cleaning coining in all, it looks like it's a better performance in that segment. So, what else accounted for that in energy technology?

Sharon Madden

We had in addition to the progress that Bill has made in coal cleaning along with all the folks that are working there. That's basically is a combination of increase in metallurgical coal sales as well as continued focus and taking cost out of the system. In addition to that, we had a good month and a good quarter in our ethanol facility in North Dakota.

The ethanol industry continued to have some pressure on crush margins. We got a very good management team in place at our ethanol plant, and because we aren't use coal or natural gas to provide the energy to the ethanol facility. We are basically using wastage from an existing coal power plant that gives us the one off; well it probably gives us the lowest energy cost in the ethanol industry.

And so that facility has continued to perform very well and contributed positively in the quarter. We also had a positive quarter in our South Korean hydroperoxide facility as well. So, both of those joint ventures contributed to the improvement in the energy segment.

Pearce Hammond – Simmons & Co

Thank you very much.

Operator

(Operator Instructions). Your next question is from the line of Dan Mannes of Avondale. Your line is open.

Dan Mannes – Avondale Partners, LLC

First question for Jack. You mentioned in your prepared comments that some of the improvement in March and April, it sounds like it was high primarily due to remodel. Is there any way to tell you from your standpoint how much this may have inside the new construction especially in light of the expiry of the tax credit, or is your perspective that it mostly on the remodel side?

Jack Lawless

My perspective is mostly on the remodeling side. I think you did see some with the Eldorado stone results, our architecture stone segment that gave results that they had in April I think was more in line with what's going at new structuring which is favorable on a year-over-year basis, but based on its -- on the product sales that we had that our -- how the product sales are trending right now, I think most of it -- most of the gains are coming through the remodeling side.

Dan Mannes – Avondale Partners, LLC

So at this point you don't see that as a concern the roll off of that credit, you don't see that negatively impacted your numbers because you weren’t really benefiting that much?

Jack Lawless

No, I do not.

Kirk Benson

The other thing that what happen is there's about a six months lag in the new residential construction, so what we are seeing now were really the homes that being built six month ago. As they come on to the homes towards the end of the construction cycle.

In the stone business, the other thing that going on there is introduced a new hydro living product and we are also trying to move towards the repaired remodeling sale in that line as well. So, Jack is absolutely correct that its repaired remodeling is clearly the most important part of what's going on.

Dan Mannes – Avondale Partners, LLC

Got it and then one last thing there on the cost side. We've seen some increases and maybe some of the input cost. I'm wondering have you guys anticipated, or are you guys already looking to raise pricing in any of your final products? I know we've seen a lot of bit that in the siding industry.

Kirk Benson

Actually, we use a lot more polypropylene than we do PVC, and we expect polypropylene prices actually coming down pretty materially over the next 45 days, and with what we are doing on the use of regrind PVC, we are actually seeing our per unit cost on PVC coming down as well.

Dan Mannes – Avondale Partners, LLC

Got it. And then quickly for Bill on the met coal side, could you give us an idea what your mix was this quarter on the 340,000 tons sold, how much was met versus steam coal?

Bill Gehrmann

Just under a third of it was met coal, Dan.

Dan Mannes – Avondale Partners, LLC

Got it. And then from a pricing perspective, I know you are trying to find ways to maximize pricing, have you seen any success or that five-shipment deal to South America, is that all sort of one price or we are just trying to get a feel given how firmer the pricing is?

Kirk Benson

First piece of it is and obviously with the purchase order we entered into in 2009 the first piece of it is flat rate, but there is an escalator shipment coming at the end of that purchase order very similar to these China shipments that we just begun to. There are escalators in that for future shipment.

Dan Mannes – Avondale Partners, LLC

But for instance of the $36 total average price you are getting, can you give some stratifications in when you are getting on met versus steam?

Kirk Benson

It's a little more difficult. Dan, I think we tried this year basically our pricing and our revenue is driven unlike most people in the met coal market we back us all the way to the price FOB to plant site, where most is typically driven by FOB, the shipping terminal, the sea-borne terminal. So, I'm a little hesitant between all the different sites to try to back in and curve out those numbers because of all the transportation and logistics pieces of those.

Dan Mannes – Avondale Partners, LLC

I guess more broadly are you getting a significantly higher price of the met coal produced at the mine sites that you are for the steam coal producing with mine site especially given the fact that your -- it sounds like you are moving some production from met, from steam to met and maybe losing the credit. Is this still sort of net beneficial transaction to the extent you are doing that?

Kirk Benson

Yes. I think it's right to say that, Dan.

Dan Mannes – Avondale Partners, LLC

Okay, and then lastly just in terms of volumes for the back of the year, any thoughts on where you could get met coal volumes to given what you have done at Pinnacle and the ramp in some of the larger mines?

Kirk Benson

Yes. Right now at Alabama based on what we see in the foreseeable future, yes we think we can sell everything we can produce there. Pinnacle as I discussed were going through a re-permitting there which will give us access to more reserves in those pond, so we think we can increase production there that we have been pleased. As we pointed out, our target for Q2 was to get Pinnacle up and running it a breakeven and we are above that to even a lower production rates than we originally anticipated.

Dan Mannes – Avondale Partners, LLC

And at Alabama, I think you did a little over 100,000 in the second quarter. Is that a reasonable run rate or can you ramp even from there?

Kirk Benson

We hope to be able to increase quite slightly.

Dan Mannes – Avondale Partners, LLCL

Got it. Thank you very much.

Operator

There are no further questions at this time. I would turn the call back over to you, the presenters.

Sharon Madden

We would like to thank you all for participating in today's call, so we will go ahead now and conclude it. Thank you again.

Operator

This concludes the conference call. You may now disconnect.

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Source: Headwaters Incorporated F2Q10 (Qtr End 03/31/10) Earnings Call Transcript
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