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Headwaters Incorporated (NYSE:HW)

F3Q10 Earnings Call

August 3, 2010; 11:00 am ET

Executives

Kirk Benson - Chairman & Chief Executive Officer

Steve Stewart - Chief Financial Officer

Bill Gehrmann - President of Resources

Jack Lawless - President of Construction Materials

Sharon Madden - Vice President, Investor Relations

Tricia Ross - Investor Relations, Financial Profiles

Analysts

Al Kaschalk - Wedbush Morgan Securities

Chip Moore - Canaccord Genuity, Inc.

Ed Meakem - Clean Value Partners

John Quealy - Canaccord Genuity

Dan Mannes - Avondale Partners, LLC

George Berman - JP Turner

Operator

Good morning. My name is Nason and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Headwaters Incorporated Q3 2010 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session. (Operator Instructions)

I would now like to turn the call over to Ms. Tricia Ross. You may now begin.

Tricia Ross

Hello. Welcome and thank you for joining us for Headwaters Incorporated, fiscal third quarter 2010 conference call. If you have not yet received a copy of today’s press release, please call my office at 310-478-20700 and we will get a copy to you right away.

In addition, we wanted to point out that there are corresponding slides that go with today’s presentation that can be accessed on Headwaters website, if you go to the Investor Relations section and then click on the Presentations and Webcasts section, you will find a place to register for the slides.

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

Sharon Madden

Thank you Tricia. Good morning and thank you for joining us today as we report our fiscal third quarter 2010 results.

On call today we have Steve Stewart, who is Headwaters Chief Financial Officer. He will update you on the financial results for the quarter, and Kirk Benson, Headwaters Chairman and Chief Executive Officer, who will discuss Headwaters third quarter operating, results. Also joining us are Bill Gehrmann, who is President of Headwaters Resources, and Jack Lawless who is President of Headwaters Construction Materials.

So before we get started, I will read the forward-looking language to you. I’d like to remind you that certain statements made during this call, including statements related 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 of 1934, both as amended.

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

You may find Headwaters Annual Report on Form 10-K, Quarterly Report on Form 10-Q, and other SEC filings readily available from the SEC’s website, headwaters website or directly from the company.

I will now like to turn the call over to Kirk Benson, our Chairman and CEO.

Kirk Benson

Thank you, Sharon. The June quarter was the best follow-on that we had in several years, reflecting improvements in all three of Headwaters reporting segments. So turn to slide two; I’d like to discuss some of the highlights of the quarter.

First, consolidated revenue increased by 10% or $192 million. The $17 million increase in revenue was attributable to 9% growth in heavy construction materials, 3% in light building products and 47% in energy services.

Gross margin, operating margin and adjusted EBITDA margins, all improved. In fact, we are approaching our peak cycle margins on substantially lower revenues. The improvement in performance was a result of efficiency gains over the last two years, lowering our fixed cost and our variable cost.

For the nine months end of June 30, our consolidated contribution margin was approximately 49%. In an up cycle, Headwaters had tremendous operating leverage that will drive margin improvements and we showed strength of the business model in the June quarter.

We repaid $10 million by 2012 debt this quarter. Since the end of the quarter we received a substantial tax refund increasing our cash balance. We are going to look for opportunities to use excess cash to continue the process of reducing debt.

Steve now will provide an overview of the financial results starting on slide 3.

Steve Stewart

Thank you Kirk and good morning everybody, and thank you for taking the time to join us this morning. Before I just discuss slide three, I want to mention that we expect to file our Form 10-Q by the end of this week. Comments that I will make will come from the slide to present over this morning, and to a lesser extent from the balance sheets and statement of operations that were attached to the press release.

Last quarter we indicated both our light building products and heavy construction materials businesses had stabilized, even in light of the continued weakness in new housing and residential remodeling markets, and a noticeable slowdown in commercial construction and infrastructure activities that directly impacted our flay ash sales.

These observations were confirmed with the operating results of the third quarter that ended on June 30.

As Kirk mentioned, all business segments experienced increase in revenues compared to June 2009 quarter. However, even more significant were the increases in gross profit of both the light building products and the energy technology segments. This continues to demonstrate the benefit of the operational improvements and the cost reduction programs that we have been actively working with over the last 18 months.

Gross profit for the consolidated group increased to 26.8% in the June 2010 quarter compared to 24% in the June 2009 quarter. The gross profit in the June 2010 quarter is within 3 percentage points of our best performance since 2006, even though revenues are down by over 30%.

Recurring cash interest for the quarter was approximately $13 million and is consistent with the expected $52 million of annual interest expense that we have talked about in prior quarters. Total interest expense for our 2010 fiscal year is expected to be around $68 million.

The income tax benefit recognized in the June 2010 quarter is substantially higher than the statutory rate, as a result of approximately $4.5 million of tax credits recognized in the quarter. Of this amount, approximately $2 million resulted from activities in the June quarter and approximately $2.5 million related to a change in the estimate of tax credits earned in previous quarters.

We are comfortable with our balance sheet and we have no material debt maturities until 2014. We currently have an undrawn $70 million asset base revolving credit facility. At June 30, 2010, we had approximately $46 million of cash on our balance sheet, which provides Headwaters with approximately $115 million of liquidity. We received an income tax refund during July of approximately $25 million, which brings our total liquidity today to around $140 million.

As shown on slide four, the trailing 12-month adjusted EBITDA improved by almost 20% to $92.9 million, when compared to the March 2010 trailing 12-months adjusted EBITDA. At June 30 our net debt to adjusted EBITDA was 4.8. We reduced our 16% debt by $10 million during the quarter and we intend to continue to pursue utilization of cash deemed to be in excess of our needs to further reducing our debt before it comes due.

Reduction in our debt should positively impact our equity value by reducing financial risk and converting a portion of our enterprise value into equity value. In addition, we are trading at the very bottom of the cycle multiple of EBITDA. As we reduce our leverage this should have a significant positive impact on our valuation multiple.

We have significantly reduced our capital expenditures in fiscal 2010. Total capital expenditures for fiscal 2009 were $64.2 million, which was $52 million less than the prior in 2008. Capital expenditures through June 30, 2010 were approximately $20 million and we expect total capital expenditures for fiscal 2010 to be less than $30 million.

Finally on slide five, it shows quarterly revenues and adjusted EBITDA for the last three quarters compared to the prior year. While the positive revenue comparison didn’t happen until the June quarter, there was improvement in each of the prior two quarters as the GAAP and year-over-year comparison narrowed.

Positive year-over-year adjusted EBITDA comparisons occurred in the March quarter and significantly improved in the June quarter. This again demonstrates the impact of our operational improvements and cost reduction initiative.

And now, I would like to turn it over to Bill Gehrmann who will take you forward from slide 6.

Bill Gehrmann

Thanks Steve and good morning everybody. Revenue for the June quarter in our coal combustion products business increased by 9% year-over-year. Overall product revenues increased by almost 3% year-over-year, though they continue to be impacted in the three largest cement consuming regions in the United States, with the largest weaknesses coming from the California, Arizona and Nevada markets.

Headwaters resources provide site services to many of its utility clients. These services include constructing and managing landfall operations, operating and maintaining material handling systems and equipment maintenance. While these services typically have lower operating margins in our product sales, they are not a seasonal and are not as impacted by the clients in construction spending.

Site services revenues for the June quarter were up over 23% on a year-over-year basis and were 28% of our total revenue for the quarter. Gross profit for the June quarter was $19.1 million, compared to $18 million for the June 2009 quarter, after adjusting for a non-cash write down of $3.5 million. The EBITDA margin for the quarter after adjustment was up by 100 basis points year-over-year.

As you can see on slide seven, both revenue and adjusted EBITDA had positive year-over-year comparisons. We are not seeing dramatic improvements in revenue from the stimulus bill, but the tons of fly ash sold compares favorably to last year and that trend continued into July.

Slides eight and nine summarizes the current situation with the EPA. 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.

In May, the EPA released a draft proposal that was submitted for public comment in June. This proposal outlines two broad potential regulatory approaches for the disposal of coal combustion products. One approach is Sub-Title C designation for disposal, classifying coal combustion residuals as a special waste. This would provide the EPA with jurisdiction over the management of coal combustion products.

The other approach is a Sub-Title D designation, which means that coal combustion residuals would be managed under the same guidelines as solid and industrial waste. Under this approach, individual states would have jurisdiction for disposal regulations under Sub-Title D. The engineering standards for landfills are essentially the same under both approaches.

Wet impoundment like the one in Tennessee will essentially be phased out under either approach. The beneficial use of coal combustion products remains exempt from regulation under both approaches.

Many university groups have filed for an extension in the 90-day public comment period. After the public comment period, the EPA will go back to the OMB with the final proposed regulation. The EPA is under no legislative or jurisdictional deadline and the publication of the final rule may come months or years after the end of the public comment period. Litigation over the final rule will likely delay enactment for several years, and now I’d like to discuss coal planning.

Moving to slide 10, you will see that the June 2010 quarter revenues from coal sales were up 38% year-over-year, while the 461,000 tons of non-coaling coal sold included a record tons of metallurgical coal. The average revenue per ton for the non-coaling coal sold in the June 2010 quarter was over $39, an increase of over $3 per ton as compared to the prior quarter and almost $7 per ton year-over-year.

The year-over-year increase in revenue was driven by an increase in our metallurgical coal sales, led by the first fines-only shipment to China. Revenue for the June quarter was over $18.3 million. EBITDA including tax credits was $4.7 million, compared to an EBITDA loss of $3 million for the June 2009 quarter and essentially breakeven EBITDA for the March 2010 quarter.

Slide 11 illustrates the tremendous improvement that we have accomplished in our metallurgical coal facilities, comparing revenue and adjusted EBITDA year-over-year. Revenue for the June quarter on just metallurgical coal sales was $10.8 million, an increase of 74% over the March 2010 quarter. Adjusted EBITDA for the June quarter, metallurgical coal sales was $2 million, compared to a $2 million loss in the December quarter.

Slide 12 summarizes our overall strategy in our coal cleaning business. We are continuing to focus our sales efforts on a metallurgical coal market at all of the plants that have access to reserves that meet metallurgical coal specifications. We also continue to lower our ash content, in order to improve quality and increase value.

We are working on permits at our Pinnacle plant that will allow us to expand our production capabilities, allowing for more volume into the metallurgical markets. We also feel that we can continue to increase the value of our metallurgical coal products by blending it with the coal being produced by our site house.

On the steam side of the business, we continue to reduce our cost structure. We are matching production to sales in order to manage inventory. We continue to look for opportunities to introduce new utility customers to our refined coal, so that we are positioned when the market for steam coal rebounds. We also continue to work to qualify our refined coal sales for Section 45 tax credits.

While the domestic steam coal market remains soft, we anticipate that the continued acceptance of our refined coal in the thermal market will recreate additional sales opportunities. Our increased focus on the metallurgical coal market and our efforts to improve quality and blend with other high quality metallurgical coal will continue to increase the acceptance in value our met products.

These efforts in the steam and metallurgical markets, combined with our continued focus on our overall cost structure make us optimistic that we will continue to see corresponding improvements in our operating income for 2010.

Now, I will turn over the call to Jack Lawless, and he will discuss light building products starting on slide 13.

Jack Lawless

Thanks Bill and good morning everyone. Revenues for our light building products segment for the June quarter were $95.1 million, an increase of 3% from our June 2009 quarter. Gross profit grew faster than sales because of our operating leverage, increasing by 17% over year ago levels, an increase in our gross margin percent of 380 basis points.

Further illustrating our operating leverage, operating income increased by 47% to $10.6 million. This represents an improvement in margins of over 300 basis points to 11.1%. Improved revenue, coupled with cost improvements and efficiencies led to a solid improvement in our adjusted EBITDA. It increased to $19.1 million, a 17% improvement over the $16.4 million from year ago levels.

This year we implemented an outdoor living program at Eldorado stone. Using our backyard stone system reduces cost and simplifies the installation of a custom designed outdoor living space. Sales are ramping up over the summer and we anticipate continued growth through fiscal 2010.

If you turn to slide 14, you can see that our Texas concrete block segment continues to have negative revenue comparisons to last year’s record sales and operating earnings. While we expected revenues to be soft in 2010, they are coming in lower than we anticipated. However, despite a 20% decline in revenue, our management team has continued to improve operations. EBITDA margins are only down 40 basis points year-over-year. While we expect business to be challenging for the rest of the year, we do see some opportunities that could add meaningful upside as we enter 2011.

Slide 15, shows a year-over-year comparison of revenue and EBITDA for the first three quarters of our 2010 fiscal year. On a year-to-date basis revenue is down 8.7% while EBITDA is up 15.8%. While revenue is down for the year, revenue has improved compared to last year in each of the past three quarters culminating in a year-over-year positive comparison in our current third quarter just ended.

As we have discussed in previous calls, we believe that in total our national end markets are beginning to show some improvement. For example, our light building product segment that sells our stone and our resin-based accessory lines nationally increased sales by 10% in the third quarter and drew EBITDA by over 35%.

In our resin-based products, our newer products in our remodeling end markets continue to do reasonably well. This segment has reported sales gains in six out of the last seven months.

Our architectural stone segment is also seeing positive revenue comparisons. April of 2010 was a first month of positive year-over-year comparisons since October of 2007. May and June of 2010 were also positive with our sales ending up for the quarter. EBITDA in this segment was up 80% for the quarter and is now up for the year despite year-to-date sales still lagging by about 13%.

Despite the difficult conditions, we continue to invest in our brand and expect to see meaningful gains in market share as the industry rebounds. Our gem stone wall program focusing on interior spaces and our outdoor living program continue to gain traction.

In summary, while the past few years have been difficult, we have spent a great deal of time improving all of our operations. The results have been tangible. We have improved our operating metrics despite revenue shortfalls. We have reinvested these savings into our business in a form of new products and programs that when coupled with our core product lines should provide a platform for above market growth in sales and EBITDA when our industry emerges from its historic lows.

Now, I would like to turn it over to Kirk Benson on slide 16, for his concluding remarks.

Kirk Benson

Thank you, Jack. Bill has already reported on the quarter for coal cleaning, so I won’t add to his comments. The remaining elements of our energy segment also had a good quarter, but by $2 million in HCAT sales and positive hydrogen peroxide and ethanol contributions. Revenues for the segment were at 46.6%.

On slide 17, you can see the continued improvement in revenue performance through the first three quarters of the fiscal year. Much of this improvement is driven by metallurgical coal sales as Bill has mentioned. Adjusted EBITDA also substantially improved over last year from a negative $5.1 million to a positive $5.8 million.

There has been consistent improvement in each of the three quarters for this year. We look forward to the challenges for continued performance improvements in the segment as we begin to realize some of the upside opportunity.

I’d now like to turn the time back to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Al Kaschalk from Wedbush Securities. Your line is now open.

Al Kaschalk – Wedbush Morgan Securities

I just I want to start first with the easiest question, which is what have you done in terms of the anticipated ruling or by the EPA in terms of building out maybe or I should say anticipating what they are going to rule, have you done any investments in the business to capture any change in volumes that could be coming from the waste, James.

James Herickhoff

There is a couple of things that are probably worth mentioning, one is that no one should anticipate that there is going to be a final rule on fly ash disposal anytime soon. The likelihood of an early determination is not very high, I think we are into a fairly lengthy rule making process, and we’ll have to see how that turns out, but there is almost clearly going to be an extension of the comment period. There could be further extension to the comment period.

The EPA is under no time pressures to respond to comments and to propose a final regulation to the OMB. That could take an extended period of time. So, it isn’t something that anyone should anticipate a quick resolution to any changes that are going to be proposed by the EPA.

Second thing is, which is a more direct response to your question Al, is that Bill and his team have been very focused on the proposed rule change. We are looking at a specific reorganization of part of our business to focus on the service element of the business with the intent to capture a share of any changes that might be made in the disposal regulations. So, there is internally, we are clearly interested in these changes and trying to benefit from the changes and so one of the things that Bill has been working on is a reorganization that focuses on taking advantage of any opportunities that are created from the EPA.

So, we are making internal changes and internal investments to allow us to take advantage of those changes.

Al Kaschalk – Wedbush Morgan Securities

Would that preclude any external investments or acquisitions of, whether it’s front end chain or back end of the chain to augment your service capabilities?

James Herickhoff

No, I think that’s something that we’ll certainly consider. We don’t have a lot of M&A capabilities because of the balance sheet and stock price, those kinds of things, but clearly if there was something that we were capable of executing that would create value for shareholders, we would be very interested in doing that.

Al Kaschalk – Wedbush Morgan Securities

Shift gears here, I realized the market and the outlook. You are maintaining a bit of conservatism, but given the results and the delivery of margin performance, is there any change in your level of visibility on the next couple of quarters? Whether it’s one particular segment or across all of your businesses, and if you could then -- and just a follow up and my last question would be, how do you then take advantage or how do you strategically use what could be viewed as a little bit of excess cash coming from the refund and then second I think the planed or ultimately closing of the hydrogen peroxide sale?

James Herickhoff

I think that the macro indicators are still relatively flat and so I think we want to be conservative, both from a balance sheet prospective and looking forward because we’ve come through the worst down cycle of course in the history of the residential construction, starting 2006 through 2010, and the last couple of months have not had positive indicators of new residential construction starts. So, I think we are going to be conservative, which means that one of the things that we want to do is focus on our balance sheet and reduce some of our financial leverage.

We are clearly going to be interested in opportunities that have their term benefit and can increase our EBITDA and create value for shareholders. So, we are interested in that, but we are also going to be careful relative to the macro environment.

Al Kaschalk – Wedbush Morgan Securities

Should I take that Kirk, as meaning you don’t have increased confidence in the next six to twelve months based on what you just put up for the quarter or your customers telling anything different that will give you more confidence that volumes should be returning, albeit at modestly and therefore we don’t need to see anymore cost adjustments on the operating side?

Kirk Benson

We don’t have any reason to think that we haven’t been at the -- that we are not at the bottom of the cycle, the question is how quickly it’s going to recover and that’s starting to debate by a lot of people who are smarter than I am about that. I think that about that, I think that we are taking some market share from some folks, that’s going to be a positive from a revenue perspective whether the macro indicators change or not, we are quite comfortable with the changes we made in operations and our cost structure.

So, we are enthusiastic about the future. The one thing that’s very hard to predict is the timing of a macro recovery. We feel very good about how we are positioned, but it has been proven to be true. It’s very difficult to predict over macro perspective what’s going to happen.

Operator

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

Chip Moore - Canaccord Genuity, Inc.

Actually, Chip Moore for John. I was wondering if you could talk about the drivers of the write-down in fly ash, was that more demand related or whether some other issues going on?

James Herickhoff

There weren’t really any drivers, it was one load out facility that was designed to facilitate export of ash to Puerto Rico and the Puerto Rico sales are not what we anticipated that they would be and so it really doesn’t have to do with the domestic market at all. It was a very isolated instance that dealt primarily with as I said Puerto Rico.

Chip Moore - Canaccord Genuity, Inc.

Okay, and then I guess the weakness that you did see in some of the bigger markets, can you just break that down? Was there weather impact or if you could break that down a bit further?

Kirk Benson

[Inaudible] your question like the flash. Bill do you want to respond to that as far as what you are seeing in different regions of the country?

Bill Gehrmann

Sure. On a year-over-year basis, I mean we operate with three regions in the country. Year-over-year for the quarter, our west region was essentially flat, our essential region actually had increases in volumes and let me take that back.

The west was down, I’m sorry and that was noted in my narrative that typically came in southwestern part of the United States in Southern California, Arizona, Nevada. The central was actually up significantly year-over-year and the east was flat from a pricing standpoint. The central was actually down just a hair in the east and the west, were up.

So we’ve seen stabilization, a little bit of stabilization in the southeast. The other large cement consuming market would be the Texas market and it’s had some rainy impact, it’s continued on into July. Any softness there, we do think at this point is, as far as year-over-year comp, is rain related and obviously we will get a little better indicator as we move into August and into September. This quarter obviously being typically our best quarter of the four from a seasonal standpoint.

Chip Moore - Canaccord Genuity, Inc.

Great, that’s helpful, and if I can move over to building materials, maybe you could just talk about selling versus sell through strength particularly now that the tax credit has ended. Kind of where do we stand there, what kind of impacts do you see from that?

Steven Stewart

I would say that right now we are seeing some strength in pretty much throughout the country right now except for the southeast, a little bit in the southwest and Texas is a little bit soft, but we are seeing a remodeling part of the market, Chip being pretty strong, reasonably strong throughout the country right now which is helping drive the sale, both at the resin-based accessory segment as well as our architectural stone segment.

Certainly, new construction has been pretty beleaguered for quite some time and we expect that to come back a little bit over the next six to twelve months and show modest improvement there, but at this point the thing that’s doing reasonably well for us is the remodeling part of our business at all of our businesses that we have.

Chip Moore - Canaccord Genuity, Inc.

Okay thanks. And just lastly you touched on it earlier, but can you give us an update on where you stand on monetizing some of the assets, the hydrogen peroxide and the ethanol particularly?

James Herickhoff

I think we continue to make some progress on the monetization. I fully expect the hydrogen peroxide to close this quarter, it’s been a long time getting it done, but there haven’t really been significant issues and so we have been comfortable, and continued to be comfortable. I think it will close this quarter. The ethanol plant has been producing and there is still, although the

market has come back somewhat for M&A in ethanol at the, my understanding is the current pricing which is actually a lot stronger now than it was 12 months ago.

Our analysis of the facility is that we continue to be better off as owners rather than selling that facility. So, it will continue to monitor the markets. As I said there has been some improvement and if the right opportunity presents itself, then it’s something that we will certainly consider.

It’s something that we are interested in of course because one of our focuses is to reduce our overall leverage, so none of that’s going to happen very quickly, but it’s something we continue to make progress on. As I said, I think the hydrogen peroxide is going to close this quarter.

Chip Moore - Canaccord Genuity, Inc.

Great, thanks.

Operator

Your next question comes from the line of Ed Meakem from Clean Value Partners [Ph]. Your line is open.

Ed Meakem - Clean Value Partners

Couple of questions, one is can you just kind of give us a sense of where each of the businesses are? You touched on some of them, for the month of July that you just completed.

Steven Stewart

I think that generally the sales seem to be a little bit softer in July than the June quarter. It’s marginally softer, so no significant changes. I think that’s true for the light building products as well as heavy construction materials. What happened relative to the September quarter last year in the month of August was more important than the other two months. Last year, we had a significant drop in revenue in the second half of August.

Now, I’ve no idea whether that is going to happen, again because that was an aberration last year. We’ll see how the remaining months of the quarter are going, but I think there is a little bit of softness in July.

From an energy prospective, it’s not having the same cyclical forces that are impacting that and we are still building our relationships from a net coal perspective and that revenue is going to be a little lumpy because of those large shipments, but by large you don’t see the same kinds of -- the trends aren’t yet meaningful, because we are still growing that business.

So it really happened in July, which I think we had a decent July in the clean coal, but there isn’t [Inaudible] had it long enough to really to have much of a trend other than significant improvement. So, we’ll have to see how that -- again that’s going to be a little bit lumpy because of the large shipment.

So, I think we are going to -- what we said, we reiterated our $95 million of EBITDA for the year and we feel pretty comfortable that we are going to get to -- we will be in that range of $95 million.

Ed Meakem - Clean Value Partners

That’s great. And as it regard deleveraging, I’m well aware when your maturities are and I’m well aware of some of the coupons on some of those charges of debt, and I’m also aware they are held by holders that you need to negotiate with. Someone of them know that have a very good piece of paper frankly, but do you have, as a company targets and milestones for levels of leverage you want to be at in certain time frames?

Steven Stewart

I think at some degree when you are talking about, both the numerator and the denominator and so with a sort of combination of increased EBITDA and the repurchase of debt, our goals to be in the two to two and half times range. Now whether we can get there by 2014 depends an awful lot upon what happens to the EBITDA.

If by 2014, if we are in the say the million two kind of range on new housing starts and we are well into an up cycle given our 49% contribution margin our EBITDA is going to be a lot higher, and so there is yet to take that into account as well as our debt reduction. With both of those things, I think we got a shot by 2014, of getting to the two to two and a half, but it really depends on EBITDA more than paying on debt. So that’s the end goal.

In the near term, the goal is to focus on the 2012 put date. Now, people may not put that debt to as anyway, but we can’t be in the position where we are at risk from a liquidity perspective, so we are going to continue to focus on that particular piece of paper. Getting it down in the below $20 million is probably the right thing to do, and then we would clearly have the ability to take that debt out with our ABL. So, you really eliminate any 2012 exposure and so I think that our primary near-term focus is to take that 2012 debt to say a $20 million number.

Ed Meakem - Clean Value Partners

Great, and then with just one final question, I mean I’ve followed you guys for awhile, you guys have done a lot of work, kind of behind the scenes operationally, cutting expenses, cutting CapEx, refinancing the debt, basically this was a company that had reasonable amount of enterprise risk or bankruptcy risk not too long ago and that in my view seems averted.

However, stock is kind of where it was a year ago roughly and I guess my question to you is from a shareholder’s standpoint and I know you guys are probably frustrated with this as well, but these are kind of a collection of unrelated businesses and don’t take that the wrong way, but at least to some degree.

Frankly when I look at the valuations on material stocks and then I look at the valuations on building product stocks, and then I look at your kind of conglomerate valuation which is typically the case, some of the parts are worth more than the enterprise altogether, and private equity market seems to have picked up and the high yield market seems to have improved and again.

Is there interest from soothers, whether they’d be strategic or they be private equity? Is their interest from the company, from your guys prospective in trying to realize that value by disaggregating some of these assets?

James Herickhoff

In fact, we are interested in separating the energy part of our business from the light and heavy construction materials that you saw the improvement in the energy segment of our business in this quarter, and so we want to be able to do that separation in a way that maximizes values to value shareholders.

So, we planned on those improvements coming and the markets are now getting stronger and so there are chances to reach a point and in the not too distant future, where we will be able to execute that separation.

So, we hear your frustration and you are right, we feel the same frustration and we think that our, we never really thought ourselves as a conglomerate, but using that word we don’t disagree that we have a conglomerate discount on our list of issues that are negatively pressing stock price, the conglomerate nature of the company is on that list, but you are seeing the improvement and that improvement is going to drive our ability to be able to do that separation in a way that maximizes values.

So, we got that message and we are finding people, we are finding some people interested in the energy part of our business and so that’s our first and major goal from a broad restructuring perspective to get that done.

Ed Meakem - Clean Value Partners

That’s great. Thanks for all those answers.

Operator

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

John Quealy - Canaccord Genuity

Hey folks, congratulations. Just had a couple of follow-ups to Chip. First maybe Jack on the light building side, when you look at your forecast and what you are channel is telling you, is this sort of a 300,000 or 400,000 home start type in number? How do you calibrate the macro to the micro in Headwaters business right now?

Jack Lawless

John, I think we were looking at the total housing starts for this year in the 575 to 650, six and a quarter range for this year and we are expecting some modest improvement of those numbers for 2011 as. As I mentioned to Chip, I think the thing that’s driving our business right now is the remodeling side of the business has been reasonably strong for us for the last six months which has led our nationally based building products businesses to be up over 10% in the last quarter.

So, I think that’s where the real energy is coming from right now, is on the remodeling side of the business and we do expect to see some kind of improvement, although modest on the new construction site over the next 12 months to 18 months as well.

John Quealy - Canaccord Genuity

Okay and just final two questions, I don’t know if you touched on this. With regard to coal cleaning in that positive EBITDA, is that something that you expect to continue or it’s going to depend on how that market shapes up and if you can get more permit to Pinnacle.

Steven Stewart

Generally, there wasn’t anything that was particularly unique about the run rate in the June quarter, so we think that there is still a fair amount of upside potential in that business. As I said, some of the shipments might be lumpy, but I think there is a fair amount of upside that is still not reflected in the June quarter and so you would anticipate continuing improvement. So, Bill you want to add something to that?

Bill Gehrmann

I agree. I think we expect to see continued improvement as we discussed earlier, we have got some volume upside, Pinnacle based on some permit modifications, we hope those modifications are in hand shortly. It will continue to be lumpy based on large volume movements. We have got another shipment to China that’s on water right now.

We hope to potentially level some of those out, John by working a little more with our side host, especially in Alabama on some blended moves with some of their products, but the group has improved quality, we are getting our production up where it needs to be and so based on that I think we expect to continue to see some improvements there.

John Quealy - Canaccord Genuity

Okay, in my last question Kirk, based on the previous discussion on unlocking some of the optionality inherent in some of the business, and you mentioned the energy business, you mentioned that it was a priority near term, can you sort of time frame, is this a multi-quarter, multi-year initiative? What should we be looking for, for milestones for you folks moving forward on this?

Kirk Benson

I hope it’s not multi-year, but it’s clearly going to be multi-quarter. As the segment has turned positive, you don’t have as much pressure from a cash flow perspective, the pressure comes because we want to maximize value on our shares and I think that in our building product space, our multiple is low compared to where it should be and one of the reasons is because we are little more complex as for the size of company that we are. Now, I think that separation is clearly multi-quarter but not multi-year.

John Quealy - Canaccord Genuity

Okay, thanks very much.

Operator

Your next question comes from Dan Mannes from Avondale. Your line is now open.

Dan Mannes - Avondale Partners, LLC

A couple of follow-up questions. First for Bill, on the ash segment in your testimony I think for the house you commented that maybe a small number of customers may be one off or two were concerned about usage given even the prospect of where the rule could come out. Is that a material issue or is that more of just couple of one off people have disappeared and can you sort of frame that risk for us a little bit.

Bill Gehrmann

They have -- express concern is lack of clarity at this point, Dan on how the material will be handled, stored not so much into the reuse market right now, but just in the handling chain from the utility on their plant site. What would happen if there is a spill along the way, minor spill on their site while they are maintaining equipment? That seems to be where the most of their concern is coming at this point of time.

Obviously as this continues to play out as you are well aware there has been a lot of discussion on the stigma and actually on the use in their products, but right now most of their conversations they are inclined, I think there will be a rational resolution to this, but regardless of subtitle C or subtitle D, a lot of their questions now are just on the handling and in the storage of the material before it gets into some of the end use products.

Dan Mannes - Avondale Partners, LLC

Okay. More broadly, I guess just I wanted to frame it as if given your commentary, is it fair to say you haven’t actually seen reductions in demand, just more questions and potential concerns?

Bill Gehrmann

Yes, I can’t say that we have seen any noticeable reductions at this point in time. Obviously, there is a lot more noise, a lot more discussions with customers regarding some of the, what if? But I can’t say at this point of time we have seen any noticeable reduction in sale.

Dan Mannes - Avondale Partners, LLC

Got it, that’s helpful. Briefly on coal cleaning in terms of your met coal capacity, what sort of run rate are you at and where can you get to because it sounded like you sold around 200,000 or so in the quarter. Is that about what you can produce right now or is that what you are producing now?

Bill Gehrmann

We are essentially selling everything, we are producing now. We do have some upside, we had few equipment issues. We’ve got the permits that we are trying to modify, its Pinnacle. So we do have head room in production and we are obviously focused on getting it there, but yes from a volume perspective we intend to increase the material we got available to get into that met coal market.

Dan Mannes - Avondale Partners, LLC

And from your perspective while you are selling directly right now and you are getting better prices than historical, you do think your maximized values though blending, assuming you can get reasonable concessions from the site owners.

Bill Gehrmann

Yes, I think we’ve got a lot of opportunity there. It will levelize, help us with some of our inventory issues. Right now the China moving to Panamax [Ph] there involves stock piling, a large volume of material in moving it down, the loaded vessel very quickly.

So we went to some of the fines-only shipments just to get market acceptance, get some visibility of the product out there. I think we’ve achieved that. We’ve also had some success with the blends that we’ve been doing with our side host, and I think long term there is a lot of value upside that continues moving in that direction, in blending with our side host.

Dan Mannes - Avondale Partners, LLC

Sounds great. And then the last thing; just on the steam coal side, we’ve had a lot of discussion about potential divestitures. It seems like while met-coals moving in the right direction, steam isn’t necessarily, even with the credit, and it seems like you are producing well blow capacity there.

I guess I am trying to understand, are the economics of the credit not that attractive, isn’t it acceptance of the product, and I guess while you talk about divesting the entire energy segment, how does this piece fit in and could this be one of the first pieces to go?

James Herickhoff

I think we are looking at it in a fair amount of granularity. So if we have a level of coal cleaning plans, it may be in our best interest to sell the plants that are currently idled. Right now, they basically represent a drain on our EBITDA because of their idle state, and so we may have opportunities to sell the entire group or we may have opportunity to sell the facilities one at a time.

I think we are looking at all of those different paths that ultimately are a way to separation of the energy segment as a whole from Headwaters. So I think we are very comfortable that in the right situation the steam facilities can be quite profitable and they can generate -- maybe if you got met coals sales at $200 per tone, it’s so hard to compete with that from the steam prospective.

But I think we can generate very good returns in the light steam situation and so what we got to be able to do is move these facilities either to sell them or to get them, so that they are in that right situation and so that they are not idled. So there is a fair amount of details then that we are going through to look for the best way to maximize the value of the coal planning business.

Dan Mannes - Avondale Partners, LLC

Got it. Thanks.

Operator

And we have time for one final question from the line of George Berman from JP Turner.

Your line is now open.

George Berman – JP Turner

Good afternoon. Congratulations. Thank you for taking my call.

Kirk Benson

You are welcome.

George Berman – JP Turner

I have one quick follow-up question on the coal cleaning operations. What would your total capacity be if all your plants were up and running?

James Herickhoff

About between 5 million and 5.5 million tones.

George Berman – JP Turner

Okay, and you are saying in your press release that this quarter you only shipped $461,000, so you are pretty much under utilized there right?

James Herickhoff

That’s correct.

George Berman – JP Turner

Numerous coal companies have reported that stockpiles are coming down and pretty significantly with the current heat wave that we have. Where would steam coal prices have to be if you were to restart those plants?

James Herickhoff

I think we have some; we’ve got coal in the Central App coal and made that Illinois Basin Coal. So we are running one of our Illinois Basin plants that are operating right now and there the price is quite a bit different between the two areas. So if you had Illinois Basin coal in the $35 to $40, that’s something that probably, would work quite well, and if you have central App coal in the $60 to $70 range, that probably works okay. You want to add something on that Bill.

Bill Gehrmann

I think you are right on there. Yeah, a lot of our plants have a cost advantage. We’ve done a good job getting our per tone cost, per fixed cost down into competitive area in the various regions. Pricing obviously is playing a small part, but where we’ve been impacted is just demand and once again, getting acceptance introducing our final products.

So as to what I said already, we continued to look for opportunities to introduce these utilities to our fine products and demonstrate to them how it handles, we are getting acceptance. So if the inventories decrease, I think we’ll see more opportunities to get our coal on the power plant side.

George Berman – JP Turner

It seems at least be moving in the right direction there.

James Herickhoff

Yeah. Absolutely.

George Berman – JP Turner

Yes. And another question; you have a quick mention here that you did some catalyst operations in upgrading the heavy oil situation. Can you comment a little bit more on that. That was I think a couple of years back a very high profile area, and you had some tests with refineries going on. Is this progressing as you expect?

James Herickhoff

I think we continue to make progress and what you just said is absolutely correct. It has been much slower than we would have ever anticipated that it would be, and that is factual and that’s their observation.

The utilities, I think rather the refineries are complicated and conservative. We continue to work with the refineries, because the upside opportunity for them is fairly significant, and so they continue to be interested. It’s too early to have a predictable revenue stream from the wage cap sales, but it certainly is definitely in the right direction.

George Berman – JP Turner

Okay. The process itself would take essentially heavy crude and upgraded it to a more usable form, which would be particularly advantageous for the Canadian oil sands correct?

James Herickhoff

Yes, the technology was originally developed at the Alberta Research Counsel. So it had tar sands in mind when it was developed, and we think that there is an opportunity in Canada for sure.

George Berman – JP Turner

Okay. Last but not the least, the hydrogen peroxide plant going through, what would you expect the proceeds for the company to be and do you expect to record a gain on the sale?

James Herickhoff

I think that there will be a gain on the sale, yeah, and so the total cash proceeds would be north of $10 million.

George Berman – JP Turner

Okay great. Thanks very much.

Sharon Madden

Operator, with that we’ll go ahead and conclude the call. We’d like to thank you all for joining us today. Good bye.

Operator

And this concludes today’s conference call. You may now disconnect.

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Source: Headwaters Incorporated F3Q10 (Qtr End 30/07/2010) Earnings Call Transcript
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