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Executives

Sharon A. Madden - Vice President of Investor Relations

Donald P. Newman - Chief Financial Officer

William H. Gehrmann - President of Headwaters Resources Inc

Kirk A. Benson - Chairman and Chief Executive Officer

David Ulmer - President of Tapco International

Tricia Ross - Vice President

Analysts

Albert Leo Kaschalk - Wedbush Securities Inc., Research Division

Chip Moore - Canaccord Genuity, Research Division

B.G. Dickey - Stephens Inc., Research Division

Brian Taddeo - Broadpoint Capital

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

Seth Yeager - Jeffries & Company

Headwaters (HW) Q4 2011 Earnings Call November 1, 2011 11:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Headwaters Incorporated Fourth Quarter and Fiscal Year End 2011 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded today, Tuesday, November 1, 2011. At this time, I'd like to turn the conference over to Tricia Ross of Financial Profiles. Please go ahead, ma'am.

Tricia Ross

Good morning, everyone, and thank you for joining us for the Headwaters Incorporated Fourth Quarter and Fiscal Year End 2011 Conference Call. There are slides accompanying today's presentation that can be found on the webcast link at the Headwaters Incorporated website in the Investor Relations section under the Events Conferences and Presentations. Please go there to follow along with the slides. Should you have any issue, please feel free to email me at tross@finprofiles.com. I would now like to turn the call over to Sharon Madden, Vice President of Investor Relations at Headwaters.

Sharon A. Madden

Thank you, Tricia. Good morning, everyone, and thank you for joining us as we report our fourth quarter and fiscal 2011 year end results.

Today's call will be conducted by Kirk Benson, Headwaters' Chairman and Chief Executive Officer; along with Don Newman, Headwaters' Chief Financial Officer. Also joining the call will be Bill Gehrmann, who is President of Headwaters Resources; and Dave Ulmer, who is President of Tapco International. Both will be reporting under individual business segments.

As always, before we get started, I need to remind you about the forward-looking language in our press release and in our slides, that certain statements made during the call, including statements related to our expected future business and financial performance, may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities 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 new information, future events or otherwise, except as may be 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 would now like to turn the call over to Kirk Benson. Kirk?

Kirk A. Benson

Thank you, Sharon. Thank you for your attendance with Headwaters' year end conference call. I'd like to begin by making some overall comments on our year from Slide 2. Don Newman will then comment on the financials, followed by Dave Ulmer discussing Light Building Products and Bill Gehrmann, discussing our Heavy Construction Materials segment.

ThKere were 3 themes that dominated 2011: First, our end markets continued to be soft at the bottom of the construction cycle, and we have not seen long-term trends that would consistently signal growth; second, we experienced increased costs, particularly in the December and March quarters, and those increases have carried over into the second half of the year. Fortunately, we were able to implement a price increase to our Light Building Product segment that helped alleviate a portion of the cost increase; and third, we have restructured many parts of our business, reduced our cost structure, such that on flat revenue we expect 2012 margins to improve over 2011. We expect significant improvements in free cash flow in 2012.

We experienced some notable achievements during the year. The senior debt refinancing in the second quarter greatly reduced our financial risk, extended debt maturities, increasing interest coverage and free cash flow. During the year, we repaid $24.4 million of high-rate convertible debt, reducing our total high coupon debt by more than half. Our adjusted EBITDA to run rate interest coverage ratio is now 2.2, indicating that we have sufficient cash cushion and minimal financial risk that could adapt if there are any additional disruptions in our end markets.

We have gone through 2 restructuring efforts in 2011 in the second and fourth quarters. We believe that as a result of lower interest expense and improved operations, our free cash flow in 2012 should be in the range of $20 million to $30 million, allowing us to continue to repay our subordinated debt prior to maturity.

We had exposure of approximately $20 million in the Internal Revenue Service audits, and the audits were successfully concluded during the year. Our cash interest expense peaked at an annualized level of $47.9 million and is now $37.7 million, representing an improvement of $10.2 million.

Although the sale of non-core assets has taken an extended period of time, the difficulty in selling unique assets was anticipated. We previously indicated that it would require an extensive effort to sell the assets. Nevertheless, we continue to make progress and anticipate that the assets will be sold in 2012. As a result of our conviction that the assets will be sold and that we abandoned the concept of retaining tax credits, we were able to adopt discontinued operations accounting treatments to better focus the business on our continuing operations.

Looking forward to 2012, we have projected our performance assuming stable revenue and costs. With those assumptions in mind, we project a range of 2012 adjusted EBITDA from continuing operations to be between $85 million and $95 million, a 3% to a 16% improvement over 2011. The midpoint of the range is a 10% improvement in adjusted EBITDA year-over-year.

The improvements are not dependent upon an increase in revenue, but rather margin improvements primarily related to our restructuring efforts. We anticipate a 50% increase in 2011 normalized free cash flow and feel very comfortable with our strategy to pay down subordinated debt. The improvements that we have made are encouraging even in the face of soft end markets.

We continue to have a high degree of operating leverage. Our projected contribution margin in 2012 is in the range of 45%, so that a recovery in our end markets and an increase in revenue will have an exaggerated positive impact on operating income, net income and adjusted EBITDA.

So now, let's turn the time over to Don to discuss the quarter and year end financial statements. Don?

Donald P. Newman

Thank you, Kirk. Good morning, and thank you for joining us. Before discussing Slide 3, I wanted to mention that we intend to file our Form 10-K later in November.

My comments today will be directed to the slides that were sent out this morning, and to a lesser extent, the condensed consolidated balance sheets and statement of operations that were attached to the press release. Before getting too far into the financial results, I want to note that the coal cleaning business has been classified as a discontinued operation in our financial statements starting this quarter.

As you know, Headwaters has been actively marketing the coal cleaning assets. In late September, it was determined by management and the Board of Directors that the coal cleaning business met the qualifications for discontinued operations accounting treatment, including the likelihood of the sale would be completed within one year, and that Headwaters would not have significant continuing involvement in the operation after the sale. As a result, and as required by the accounting rules, operating results for the coal cleaning business in the current quarter, as well as for the prior periods going back to 2009, have been consolidated into a single line on the income statement entitled Loss from Discontinued Operation, Net of Income Taxes.

You'll also note that in our September 30 balance sheet, coal cleaning assets and liabilities are grouped together into line items labeled as Held for Sale. In today's presentation, you will hear reference to financial results from continuing operations, which refers to the business activities excluding the coal cleaning operation. Bill will also provide a brief update on the coal cleaning business.

Year-to-date, our revenue from continuing operations is $592 million, a 1% decrease from prior year revenue from continuing operations of $598 million. Year-to-date, adjusted EBITDA from continuing operations is $82 million, down 13% from prior year adjusted EBITDA from continuing operations of $94 million. Revenue from continuing operations for the fourth quarter was $178 million, which is slightly above the revenue from continuing operations for the same period in 2010. And adjusted EBITDA from continuing operations for the fourth quarter was $32 million, up $31 million from 2010.

We will add color regarding the year-to-date and Q4 performance as we progress through the presentations. Our liquidity remains strong with $51 million of cash and $53 million availability under the ABL Revolver at the end of the quarter. Net debt-to-adjusted EBITDA from continuing operations was approximately 5.9:1 at the end of the quarter, which is higher than the ratio at the end of Q4 2010 but below last quarter. The increase from Q4 2010 reflects the senior debt refinancing, lower cash balances and a decrease in LTM adjusted EBITDA.

During Q4, we retired $10 million of face value of 14.75% notes at a cash cost of $11 million. As you know, unlike the 16% notes, the 14.75% and 2.5% notes do not have a call provision. As a result, in the past quarter, we negotiated the purchase of the 14.75% notes when approached by a seller of the notes. The 16% notes can be called at par in June of 2012.

As a result of the debt repayments and the senior debt refinancing in 2011, we have reduced our annual cash interest costs by $10 million to roughly $38 million. Our plan for reducing debt remains the same as discussed previously. Our goal is to reduce debt through the sale of non-core assets and through free cash flows. We continue to execute our plan to sell non-core assets, including the coal cleaning portfolio. And additionally, we continue to improve our cost structures and our working capital management, all of which should improve free cash flow and enable us to continue to pay down our debt.

Let's move on to Slide 4. Slide 4 reflects year-to-date earnings. 2011 financial results were significantly impacted by non-routine charges, including $127 million of charges recorded in Q2. In Q4, $12 million of restructuring and related charges were recorded as part of our strategy to improve ongoing cost structures and cash flow. We also recognized $35 million of non-cash impairments related to coal cleaning.

Year-to-date, our revenue from continuing operations is $592 million, a 1% decrease from prior year revenues from continuing operations of $598 million. The $6 million decrease reflects a $5 million revenue decline for Heavy Construction Materials and a $3 million decline for Light Building Products, offset by a $2 million increase in Energy Technology, largely due to HCAT sales.

Year-to-date, gross profit from continuing operations was $150 million, down 13% from $172 million in 2010. The decrease in gross profit reflects the impact of higher material and other costs, higher depreciation expense, as well as lower revenue and sales mix. The 2010 also includes $4 million of gross profit from the hydrogen peroxide joint venture, which was sold in late 2010, and includes $5 million of RINS ethanol credits, which have ended. Price increases have been instituted in Light Building Products, which should largely cover the increases in commodity prices that were experienced in fiscal 2011.

Year-to-date, adjusted EBITDA from continuing operations is $82 million, down 13% from $94 million in 2010, which also reflects the impact of higher raw material and other costs, as well as lower revenues and sales mix.

Now let's move to Slide 5 for a closer look at the fourth quarter results. Revenue from continuing operations for the fourth quarter was $178 million, which was consistent with revenue from continuing operations for the same period in 2010. Adjusted EBITDA from continuing operations for the fourth quarter was $32 million, up from $31 million in 2010.

I draw your attention to the bridge in the lower right corner of Slide 5. This bridge highlights some of the key drivers in the year-over-year change in adjusted EBITDA. Declines in corporate SG&A, compensation and professional services favorably impacted EBITDA roughly $3 million. Increases in revenue, largely due to HCAT sales, favorably impacted Energy EBITDA. Decreases in revenue and higher transportation costs negatively impacted Heavy Construction Material EBITDA, and EBITDA for Light Building Products was negatively impacted by increases in raw material and other costs. Dave and Bill will talk more about those dynamics in their presentations.

Now let's move to Slide 6 and discuss restructuring initiatives. In Q2, we announced that a series of restructuring activities have been initiated. Those efforts continued in the closing months of 2011. Our restructuring efforts are designed to improve operating efficiencies and reduce manufacturing and overhead costs, all in an effort to increase margins and improve free cash flows.

The restructuring activities consisted of workforce reductions, facility closures and consolidations, as well as operating efficiency improvements and sourcing initiatives. The results were cash and non-cash charges related to employee severance, facility shutdown and relocation, as well as certain asset impairments and write-downs.

Year-to-date, we recorded $18 million, and during Q4, we recorded approximately $12 million of restructuring and related impairment charges. Of the $18 million recorded in fiscal 2011, approximately $7 million are cash related. In 2012, we expect to recognize an additional $1 million of cash-related charges to complete the restructuring activities initiated in 2011, as well as invest $2 million in related capital expenditures. Headwaters anticipates that the restructuring activities undertaken in 2011 will result in an annualized operating income benefit of approximately $14 million, of which approximately 65% will be realized in fiscal 2012. The benefits are largely cash related.

Starting on Slide 7, Dave will cover Light Building Products.

David Ulmer

Thank you, Don, and good morning, everybody. Revenues for Headwaters Light Building Products segment were up 1% in the fourth quarter relative to last year. The new housing market continues to be soft as housing starts declined 11% in 2011 relative to 2010. Remodeling and commercial construction have been close to flat.

We have successfully instituted a price increase in our ancillary siding business and have been able to maintain pricing in our stone and block business. In the Houston market, we have developed a world-class showroom to display our products to homeowners, contractors and more importantly, architects and designers that specify our products on jobs. As a result, our sales of stone, brick and block have expanded in this Texas market.

We have additional revenues in custom ground phase products, sales of existing and new products to big-box stores and increases in foundation product revenue in the Texas market. We have introduced multiple product extensions in the siding markets and anticipate stable revenue in 2012, even in the current soft end market environment.

Gross profit margins for the quarter declined from 29% in 2010 to 26% in 2011 due to increases in raw materials, transportation and other production costs. For example, costs on our primary resin material increased 27% in the September 2011 quarter compared to the September 2010 quarter and have increased 17% on a year-over-year average. Most of our resin materials have experienced similar cost pressures over the prior 12 months. We have been successful in mitigating some of this upward pressure through the use of alternative suppliers and recycled materials. We will continue to pursue cost reductions in all of our raw inputs through improved sourcing and alternative materials.

As it has become clear over the last 6 months that the construction markets will remain flat over the next year, we began an aggressive program to reduce our manufacturing cost as well as SG&A costs. In the fourth quarter, we made significant cuts on the SG&A side of the business and consolidated some of our manufacturing facilities. Some of the SG&A savings are already apparent in the fourth quarter results, but the main impact will be felt in fiscal 2012. Two plant consolidations were completed in October and the related benefits will begin in the December quarter, and our overall restructuring activities are continuing pursuant to plan.

Headwaters has its flagship Eldorado Stone brand, as well as 2 other increasingly effective stone brands, Stone Craft and Dutch Quality Stone. The 3 have operated somewhat independently in the past. We have recently announced to the marketplace that we are bringing all 3 brands under a single operating unit and sales force, which will allow us to more effectively respond to a very competitive marketplace. This will not only better leverage our sales and marketing resources, it will make it easier to get each brand into a sweet spot from a market position and pricing standpoint and respond quickly to changing market conditions.

Slide 8 shows that revenue recovered in the fourth quarter compared to last year, but we continue to feel the pressure of increased costs. The restructuring that we concluded in the fourth quarter should result in some improvement in margins going into fiscal 2012, and we expect that margins for the full year will significantly improve.

Bill is now going to discuss the results of Heavy Construction Materials, starting with Slide 9.

William H. Gehrmann

Thanks, Dave, and good morning, everyone. Our coal combustion products group completed the year with revenue of $253.3 million, the year-over-year decrease of 2%. Revenue for the September 2011 quarter was $82.6 million, a year-over-year decrease of $2.2 million. Product revenue was up 6% year-over-year for the September quarter, and overall product revenue for the year increased by 3%.

Product revenues continue to be impacted in the 3 largest cement-consuming regions of the United States, with the largest weakness coming from California, Arizona and Nevada.

Headwaters Resources provides site services to many of its utility clients. These services include constructing and managing landfill operations, operating and maintaining material handling systems and equipment maintenance. While these services typically have lower margins than our product sales, they're not as seasonal and are not as impacted by declines in construction spending.

Site service revenue for the September quarter was down over 18% on a year-over-year basis and for the overall year was down by over 12%. As we mentioned on the June call, the decline was primarily due to completion earlier in the year of work being done to install the material handling systems at the Prairie State generating station in anticipation of commercial startup. Prairie State is beginning commercial operations and we're starting to provide long-term site services there.

Also mentioned on the June call was that we have a client where we provide site services that declared bankruptcy and has idled the plant. Site services revenue was just over 20% of our overall revenue for the quarter and was 26.5% of our overall revenue for the year.

Slide 10 shows some quarterly trends for fiscal 2011. Gross profit for the year was $60.3 million compared to $65.5 million for 2010. Gross profit for the September quarter was $22.6 million compared to $25 million for the September 2010 quarter. Adjusted EBITDA for the September quarter was $19.2 million versus an EBITDA of $20.4 million for the September 2010 quarter. Adjusted EBITDA for the year was $46.3 million compared to $51.4 million for 2010.

Margins were lower primarily for 3 reasons: the client bankruptcy; shift of geographic mix and product sales away from California, which were higher margin sales; and increased transportation costs due to weather-related supply issues in the Midwest and Northeast.

Moving to Slide 11, development of proposals by the U.S. Environmental Protection Agency to regulate coal ash disposal continues at a slow pace, while potential congressional action to resolve the issue has taken major steps forward. The U.S. House of Representatives on October 14 passed legislation designed to protect coal ash beneficial use and strengthened coal ash disposal regulations without a hazardous waste designation for the material. H.R. 2273, the Coal Residuals Reuse and Management Act was approved by a bipartisan vote of 267 to 144. Less than a week later, a group of 5 Democrats and 5 Republicans filed a comparable bill in the United States Senate.

Meanwhile, EPA has published a Notice of Data Availability, seeking additional public comments on information related to the agency's proposed options for regulating coal ash disposal. More than 450,000 public comments on the proposals were submitted to EPA during 2010. EPA said that nearly 13,000 of those comments, comprising nearly 2 million pages of data, contain unique content requiring analysis. The agency has stated that a proposed final rule will not be completed during 2011, and many speculate that the earliest EPA maybe expected to propose a final rule would be late in 2012.

Headwaters has been actively engaged in efforts to ensure that any regulations enacted by Congress or EPA will protect beneficial use by avoiding a hazardous waste designation for ash that is disposed. These efforts have included major support for recycling organizations, retention of Washington D.C. lobbying resources exclusively devoted to the coal ash issue and underwriting of major studies by Harris Interactive and the American Road and Transportation Builders Association.

Moving to Slide 12. Coal cleaning finished the year with revenues of $48.5 million and an adjusted EBITDA loss of $3.5 million. For the year, the business generated $5.5 million of tax credits. The project at the Pinnacle site has been completed, increasing the reserve life of the empowerment[ph]. And during the year, the Alabama #7 plant was successfully restarted, and it is now supplying metallurgical grade coal to the market.

Metallurgical coal pricing increased to $67 per ton, resulting in a year-over-year increase of $7 per ton when adjusting for the change in the way revenues are being booked. We remain committed to selling our coal cleaning assets and focusing on light and heavy construction materials.

During the quarter, we have shown the facilities to multiple parties and we continue to have discussions with multiple parties that have expressed interest in the entire 11-plant portfolio. We anticipate selling the facilities in due course.

Kirk will now comment on the continuing energy business in the end of the presentation.

Kirk A. Benson

Moving to Slide 13. Revenue and adjusted EBITDA in our energy-related continuing operations were higher in fiscal year 2011 than 2010, primarily because of the increase in sales and adjusted EBITDA from our HCAT heavy oil additive. Improvement is even more impressive when you consider that 2010 included revenue and EBITDA from a South Korean joint venture that was sold and RINS ethanol credits that have ended. We are happy with the performance of HCAT in 2011.

Slide 14 illustrates the improvement in revenue adjusted EBITDA that occurred in the second half of the fiscal year. Looking forward to 2012, we anticipate that HCAT will not generate incremental revenue from new customers. The sales cycle will require most of 2012 to execute agreements and to construct the mixing equipment necessary to implement HCAT.

Our 2012 revenue from our existing customers will depend entirely upon the amount of material used at the refineries, which is currently -- which we currently anticipate to be less than the amount used in 2011. We are optimistic that we will execute multiple new license agreements in 2012, resulting in an increase in revenue in 2013.

In our Heavy Construction Materials and Light Building Products segments, we're looking forward to 2012 with a high degree of optimism. We expect to have sold our non-core coal cleaning business and our ethanol business, improved our free cash flow and operating margins. Our subordinated debt will continue to decline as we generate cash flow and sell assets, resulting in improved credit ratios and reduced risk.

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

Question-and-Answer Session

Operator

[Operator Instructions] And our first question is from the line of Trey Cobb with Stephens Inc.

B.G. Dickey - Stephens Inc., Research Division

This is actually B.G. Dickey in for Trey. I just had a question regarding the Light Building Products segment. I noticed that you guys said that the Texas block was up 12%. Just kind of curious to see how sustainable the growth there is as we head into '12. And then kind of looking at your other segments, subsegments there, the accessories and manufactured stone, can you talk a little bit about the potential there for market share losses and how comfortable you are with that, taking the context of trying to maintain margins next year?

Kirk A. Benson

Yes. In the Texas market, what's been driving the increase in revenue has not been an increase in school construction, which does represent a fair amount of our revenue. The school construction market has actually declined a little bit in that market. But what we've been able to do is increase revenue by focusing on our strategy to sell a diversified product group. And so we have -- the sales are actually up because of new products that have been sold into the retail distribution system and from our continuing expansion of new products. What we expect in 2012 is that one of the CapEx expenditures that we've made is the introduction of a new polished concrete product, and so the installation of the equipment to manufacture that product, which there's only one other facility in the United States that can manufacture a comparable product. So that CapEx has been approved and we're in the process right now of putting that equipment in place. We've got folks in the marketplace that have begun the sales process for that new product, and we expect to have some sales in the March quarter. So one of the major reason that we've had some expansion in the Texas market has been our ability to expand our distribution system, selling into the retail system, as well as the introduction of new products into that market. If we do happen to have a rebound in some of the institutional construction, then that will be incremental revenue because that's not where our growth is coming from currently in the Texas market. Our stone business, we're quite excited about the integration of our 3 brands that Dave mentioned in the script. We haven't been particularly efficient about coordinating the sales activities between those brands. And I think that, that has created a little bit of market share pressure on us. We feel pretty comfortable with the restructuring that we've done with those brands, and particularly focusing on our Dutch Quality brand, that will be able to continue the process of gaining market share in our stone business. I think that the trends towards the end of the year were positive, and going into October, the trends are positive for the stone group. In the siding accessories product group, I think we have -- Dave, of course, comment on the siding accessories a little bit. We've had a little bit of -- from some of our -- some of the core products, we've had a little bit of market share erosion. We don't expect that to continue into 2012. And in fact, I think we're picking up some -- a little bit of market share in our specialty siding business and feel pretty good about the repair and remodel part of that business. Dave, why don't you add comments to anyone of the 3 product groups, but particularly to the siding accessories?

David Ulmer

Yes, I think that we feel really good about picking up market share in the specialty siding and our roofing category and some of the other specialty categories. We think we're going to be able to really outperform where the market will be. I think on our injection molded business, we have had some share -- market share losses, but I think we're in a position to maintain that and potentially even start to gain back some of those positions that we might have lost in the past. I think overall, we feel good about our market share position and where we're heading into 2012 fiscal year.

Operator

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

Seth Yeager - Jeffries & Company

Can you give us a sense as to the change in volumes and the price costs relationship for vinyl products during the quarter?

Kirk A. Benson

Yes. I think that the general answer, and Dave can give some more specific detail, but the general answer is that the volume, the units are down in the quarter, but revenue is up in the quarter, primarily because of the price increase that we instituted. But Dave, why don't you add some color to that?

David Ulmer

Yes, I mean I think that volume is pretty much dead flat on unit volume. We're up -- I mean, or slightly down and revenue is slightly up, and most of that is because of the price increases that we've had and we've been able to maintain them in the market, and we're looking to improve on that position as we find other efficiencies within our plants and our facilities and also buying better and doing things better.

Seth Yeager - Jeffries & Company

Okay, that's helpful. And then as far as the EBITDA and free cash flow guidance that you guys provided for next year, how much of that includes a benefit of tax credits? And in the free cash flow, what sort of CapEx levels do you have baked in there?

Kirk A. Benson

Don, you want to respond?

Donald P. Newman

Sure. In terms of the tax credits, it would assume no tax credit. In terms of CapEx, it would be in the $27 million range.

Seth Yeager - Jeffries & Company

Okay, perfect. And as far as the asset sales, looks like you've bracketed $20 million to $30 million of cash proceeds. Is that an amount that you expect to see upfront or paid out over time? As far as the ethanol business, have you determined an amount that you may get from that business as well?

Kirk A. Benson

The cash that was indicated in the press release was the amount of money we expect to be paid at closing. And what we said about the ethanol facility would be that the cash generated would be in the range of $15 million.

Operator

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

Albert Leo Kaschalk - Wedbush Securities Inc., Research Division

Kirk, just to follow on the coal cleaning, which I think all of us are glad to see you've got that bracketed now as a disco op. Could you comment on the additional value to shareholders that could come beyond the bracketed cash proceeds you talked about or are you suggesting that expectations that that's the potential value given what you've booked on the asset for sale on the balance sheet?

Kirk A. Benson

No, I think that we -- one of the things -- I guess 2 comments. One is that if you went back 6 months or so, we were considering transactions that included a tax structure that would have allowed Headwaters to participate in tax credits going forward. One of the issues with that type of a structure is that it is quite complicated, and it created negotiating difficulties as we tried to pursue a tax structure. Those negotiating difficulties ended up extending the period of time that would have taken to sell these assets, and our primary focus is paying down our subordinated debt. And so we've basically abandoned the approach of retaining these tax credits. What that did was that it allowed us then to move to a discontinued operations accounting presentation, which of course provides a greater insight into our continuing business and allows people to value Headwaters based on continuing operations. So that's one of the major things that's happened over the last 6 months. The relative to value in excess of the cash number that we provided, we think that there may be an opportunity for additional value, either directly from the sale of the facilities or from the sale of some of the intellectual properties associated with the facilities. So we think that there may be an upside opportunity to the cash number that we disclosed.

Albert Leo Kaschalk - Wedbush Securities Inc., Research Division

Okay. And then just to conclude on the ethanol side, is there a period of expectation on that sales that's potential? That you can share or where you're at in that process?

Kirk A. Benson

Yes, I think that we would look for that asset sale to occur in the same 12-month period. On the sale of both of these assets, the sale may occur much earlier than a 12-month period because we are -- on the coal cleaning assets, we're having conversations with parties and there is the potential for a much quicker sale than 12 months. But the discontinued operations, that's one of the requirements, the discontinued operations treatment.

Albert Leo Kaschalk - Wedbush Securities Inc., Research Division

Okay. And then by providing the information you did in the release, it looks like margins, particularly at the gross side, have certainly ran into a little bit of raw material costs and some other inflationary costs. I'm wondering, given that we're going into the 2 slower periods here, have you aggressively caught enough costs out or altered some of the procedures to prevent maybe some of this margin erosion or, better yet, protect the margin despite what is a difficult forecasted period on commodities?

Kirk A. Benson

I think that the margins, just like revenue, is seasonal. The margins are seasonal as well. And so our lower margins -- lowest margins are in the 3/31 quarter. And so you end up having lower margins in the 12/31 and 3/31 quarters and improved margins in the June and September quarters. And, of course, we expect that seasonality to continue. We feel quite comfortable that we have reduced our cost structure sufficiently that if raw material costs are flat and if our revenue is flat, our margins will improve. And so we're anticipating improved Light Building Products margins in the next fiscal year. And so about 60% of our restructuring activities will impact cost of goods sold at about 40% impact to SG&A. So on the gross margin line, you should see -- you'll see some of that improvement in fiscal 2012.

Albert Leo Kaschalk - Wedbush Securities Inc., Research Division

But if I did Don's math right, if I take this year's EBITDA number for the adjusted business, gave you 60% of the savings, it gets you to slightly ahead of the midpoint of that range you gave for fiscal '12. Is that -- you're comfortable at that spot?

Kirk A. Benson

Yes.

Operator

Our next question comes from the line of John Quealy with Canaccord Genuity.

Chip Moore - Canaccord Genuity, Research Division

It's Chip Moore for John. Kirk, maybe you can give us an update on HCAT, where we stand in terms of trials and potentially moving some of those to commercial.

Kirk A. Benson

Yes. Of course, we continue to service our 2 existing customers, but the thing that has happened is we have -- we're gaining recognition in this relatively small community of users of ebullated-bed reactors that our additive increases the efficiency of the particular type of equipment, these ebullated-bed reactors in these refineries. And if you are able to raise temperature in these ebullated-bed reactors, we allow that refinery to increase the efficiency by as much as 15% to 20%. And so a refinery can increase throughput and it can increase the conversion of the heavy material into lighter products like diesel. And so what's happening over the last 12 months is that the knowledge of what has occurred at our first 2 customers has spread in that industry. So you end up with folks then looking at their own situation and determining whether or not HCAT can add value to their particular situation. And so what's occurring is we're getting a very favorable response from multiple refineries relative to the potential application of HCAT. So we've got -- we have 2 proposals that are in the hands of refineries currently, and both of those refineries are moving ahead on a path that would be favorable to us. We don't how know how that's going to turn out yet because we don't have the deals done, and when we do, we'll announce new license agreements and so we're not finished yet. But we're having positive interaction with those refineries. In addition to that, there's another 2 to 4 refineries that are in an earlier phase of investigating HCAT, and we feel pretty good that those refineries will move forward. So we think that 2012 is going to be a year in which we will be identifying, negotiating and hopefully executing additional license agreements than you have to construct the mixing equipment and mixing scheds to put HCAT into refineries. That's why in my comments, I don't think we're going to see incremental revenue in 2012 from new refineries. But I do think that we're going to be able to position ourselves so that you'll have a bit of a hockey stick kind of revenue increase in 2013 as additional refineries come online.

Chip Moore - Canaccord Genuity, Research Division

Yes. And maybe you could just give us, along those lines, the 2 current customers, sort of a volume update, how we stand there? And I think you referenced maybe seeing volumes down slightly, maybe a little color there?

Kirk A. Benson

Yes. So in 2011, we generated about $16 million of HCAT sales, and we are budgeting a lower revenue number in 2012. And the reason that we're doing that, the primary season that we're doing that, there's 2, but the primary reason that we're doing it is because one of our customers is using HCAT for opportunity crudes. So if they typically have a lighter crude, they have less of a need for HCAT. But if they run an opportunity crude, where the quality of the crude is worse, then they'll increase the amount of HCAT that they're using. So they're running a particular level and when they get a more difficult crude that they have to run through their refinery, they'll increase the amount of HCAT being used so that they can appropriately refine that heavier crude material, which really speaks to the value proposition of HCAT, and it's a very positive message how HCAT is being utilized. And so that's basically one of the -- that's the major reason, is that we're being conservative relative to anticipating the number of times that the particular refinery will purchase an opportunity crude. Now they could purchase more, and they could because they may have -- they may run more opportunity crudes, but what we've done is we tried to be conservative because we really don't know how many times they're going to run the opportunity crudes and increase the amount of HCAT that they'll put into their system. And so we tried to be more conservative about that. The other thing that occurs is refineries do shutdowns, and so they do that so they can decope their facilities and they can do maintenance. And so we tried to be a little bit conservative as to the periods of shutdown for our other refining customers. That's basically why we've been more conservative in our revenue projection for 2012.

Chip Moore - Canaccord Genuity, Research Division

Okay. Great, that's helpful. And then I guess last for me, if you take that in context of the other 2 segments, just how should we think about revenue expectations for the other segments in terms of supporting those EBITDA projections for next year?

Kirk A. Benson

Yes, I think generally that our assumptions into our models is that the general assumption is a flat revenue and flat commodity costs going into 2012. And on flat revenue and flat costs, we'll be able to achieve the guidance, the adjusted EBITDA guidance. And the midpoint of the guidance is basically consistent with the cost savings that we're capturing from our restructuring activities.

Operator

.

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

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

A couple of questions, first for Bill. On the ash side, it looks like we've seen some improvement at least in the third quarter, well, the calendar third, your fiscal fourth quarter, in terms of cement volumes. Would you say you saw any of that in terms of demand for ash or can you talk a little bit about volume demand trends?

William H. Gehrmann

Dan, you can look at it from 2 different ways, and we've looked at it from both cement and in ready mix, and they're basically both flat. But yes, it's -- as we discussed, we were up a little bit year-over-year in product revenues, and obviously, that's driven by a slight uptick in volume.

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

Okay. And then the second piece is we've heard that the cement producers obviously talking about some price increases for next year. They have -- likely have some cost issues they're dealing with. Can you talk, first of all, are you seeing anything of that playing out? And secondly, to the extent prices do increase, can you talk about if you'd be able to participate and how much sharing might occur with your utilities?

William H. Gehrmann

Well, we have -- just on the pricing upside, yes, we're just getting into that part of the year where typically is cement producers will start to flow out their anticipated price increase. They are out there, we are seeing them. It's probably a little too early to speculate as to how much of that price increase will stick. We probably won't start to see that for another month or 2 as we get closer to year end. In regards to that, obviously, we will pursue any pricing upside potential that's in the marketplace. We also continue to push the mix design savings from utilizing more ash, replacing more cement. In regards to how much of that gets passed along, cost of goods with our clients, as we've discussed in the past, we have a variety of different cost share structures, some will participate in that and some won't.

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

Okay. But it's fair to say that your guidance for '12 doesn't assume any price increases, so to the extent the cement guides are successful, that maybe an opportunity that you can outperform the guidance you guys have laid out?

William H. Gehrmann

Yes. Obviously, if cement goes up, we will participate in some upside there.

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

Got it. Real quick first for Kirk. On HCAT, can we assume that the Energy segment, will you be making enough from HCAT to cover R&D and fixed costs? Should that be breakeven or is that going to still be a bit of a drag?

Kirk A. Benson

Well, for 2011, it was positive EBITDA, so there was cash contributed to our overall free cash flow in 2011. As I indicated, we're projecting revenue for 2012 will be down and the EBITDA projection for 2012 is roughly flat.

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

Got it. And then last thing on ethanol. First, I just wanted to clarify, you did say you thought in the $10 million to $15 million range would be the sale proceeds?

Kirk A. Benson

From ethanol, at the higher end of that range.

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

Okay, great. And then secondly, what sort of changed in your decision making there because, obviously, this has been -- something that's been discussed for multiple quarters as to a potential divestiture candidate. What sort of changed your mind that now it sort of makes more sense to look at versus 6, 12 months ago?

Kirk A. Benson

Well, one of the -- we're a joint venture partner in our ethanol facility, and we are very interested in the well-being of our partner. And so I don't think our feelings necessarily have changed relative to selling the ethanol plant. But what we have been doing is trying to work very closely with our partner to ensure that our sale of our interest in an ethanol plant is not in any way disruptive to our partnership relationship. And that's what we've been working through, is making sure that we can exit in such a manner that we've maintained an excellent working relationship with our partner.

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

Right. If I remember it, they're also an ash supplier to you as well, correct?

Kirk A. Benson

Yes.

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

Okay. And then just the last thing, sorry to spend so much time on a small piece of the business. But in the past, if I remember right, there was some debt on Blue Flint. Is that still the case? And just again to confirm, the $15 million would be even after the debt paydown or that would just be the sale of your equity beef?

Kirk A. Benson

Yes. That's our -- that's what we anticipate from a cash perspective from the facility to us. The facility has operated very, very well, and the debt, there is project financing that's associated with Blue Flint and that debt has been paid down over the last 3 or 4 years. And so the cash proceeds we're talking about is net of the debt.

Operator

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

Philip Volpicelli

Most of my questions have been answered, but I just want to drill a little bit more into H.R. 2273 that passed, and if you have any sense to the timing of when the Senate Bill could come to the floor. If that were to pass and go to the President, get signed into law, would that force the EPA to make their decision sooner? How would that all work?

Kirk A. Benson

What the House Bill basically -- is an alternative to what the EPA has proposed. So if the House Bill passes, it basically resolves any issues of the EPA relative to the disposal of ash. And so it is an alternative solution. The EPA could resolve the issue regulatorily and we hope that they do, but the legislation that's moving through Congress is an alternative to a regulatory solution to the disposal issue. The Senate is a complicated chamber to pass legislation. We feel very good about the bipartisan support that we received in the House. There was -- the vote of 37 Democrats that supported the legislation is the highest number of Democrats that has supported any EPA-based legislation that has come out of the House, and so it speaks well of the bipartisan nature of this legislation, and that it is a very sound alternative to what the EPA has proposed. So on the Senate side, we had 10 senators that were original co-sponsors, 5 Republicans and 5 Democrats. In order to be successful in the Senate, we need to increase the number of Democrats that support the legislation, and we're actively involved in working with a number of different offices to try to gain their support. But all that said, and we do think that we're going to get additional support from Democrats in the Senate because the bill is an excellent solution to the problem, and so we'll find additional Democrat support. It's still difficult to get a bill passed out of the Senate. So we're going to continue to work on it because it's one of a very -- it's a very viable solution, and we're going to continue to work on getting that done.

Operator

Our final question comes from the line of Brian Taddeo with Gleacher & Company.

Brian Taddeo - Broadpoint Capital

A couple of questions. First, with regard to the debt reduction as we look into 2012, can you give us an update as to where things stand? I think there was a carve out for the 2 high coupon bonds. What's the RP baskets look like now to do with any of the 2.5s? And are you going back to the bank to look for a carve out for those as well? Or can you just give us an update to where that stands?

Kirk A. Benson

As far as the senior debt is concerned, we don't have any restrictions in being able to purchase any of our subordinated debt, so we don't have any restrictions there. We do have to work with the ABL on the repurchase of the 2.5% debt. We don't have any restrictions on the 16s or the 14.75s. And, of course, the 2.5% debt is trading at a discount to face, and so we should be able to require incremental face amount for every dollar that we invest in repurchasing that subordinated debt. So we feel very good about our strategy to reduce the subordinated debt. Don, you want to add...

Donald P. Newman

No, I think I agree with that. We feel good about our strategy, generating the cash, that between now and the maturity profile of the sub debt we should be able to pay down a significant portion.

Brian Taddeo - Broadpoint Capital

Have you had any conversations with the banks thus far about changing the carve out?

Kirk A. Benson

We don't perceive a significant issue with the ABL banks at all. We think that we're going to -- we have that conversations with them, and we don't think that there will be an issue with our ability to repurchase the 2.5%.

Brian Taddeo - Broadpoint Capital

Is there any -- from the asset sale proceeds from ethanol and coal cleaning, is there any of that cash that cannot be used for retiring debt?

Donald P. Newman

Yes, it's a good question. This is Donald. I'll take a shot at answering that. First, under -- when it comes to the ethanol, there aren't any restrictions in terms of using the cash proceeds to pay down debt because the joint venture investment is not part of the security package for the senior debt. When it comes to proceeds from selling other assets such as the coal cleaning, it's not as a direct path. In effect, the senior debt debenture requires that we reinvest -- you do 1 or 2 things, either reinvest the proceeds in the business, and reinvestment includes things like CapEx, it could include acquisitions, if we so choose to do that. But it also includes investment in other secured assets such as raw materials and inventories, et cetera. And so what that -- what we would likely do with the proceeds is we would use those proceeds to fund CapEx, to fund investment and raw material purchases, et cetera. What that will then do is the free cash flow of the business would then be higher, which would generate cash and would generate cash available to put toward debt reduction. So hopefully that's clear.

Brian Taddeo - Broadpoint Capital

Understood. And one last thing then. If you could just -- I don't know if you can give any more color as to where things actually stand with regards to the coal cleaning sale from the standpoint of, I think last time you talked about that the expected proceeds were a little higher than the $20 million to $30 million range. And also it sounded, I believe, last time there was narrowing down the number of parties you were still speaking with. Are there new parties that have become involved in the process now? Or is it still the same groups that you've been working with in the past?

Kirk A. Benson

Principally, it's the same groups that we've been working with, and that implies that if we're successful with those groups, we'll be able to conclude a transaction earlier than the end of the 12-month period that was necessary for the adoption of discontinued operations. We have had some new parties that have expressed interest. But what we're intent on doing is concluding the process that we have undertaken with the existing parties before we open up the process to new parties. But if we're unable to get the assets sold to the existing parties, there has been expression of interest from new folks, and so we feel very comfortable we're going to be able to get the assets sold within a 12-month period.

Brian Taddeo - Broadpoint Capital

And on the dollar amount side, has it been general market conditions, it's something with respect to the assets, the lower expectation for cash than the previously?

Kirk A. Benson

Yes, I'm not sure that our expectation for cash has changed that much. The overall valuation has changed primarily because we have abandoned the concept of retaining tax credits. And so that's had a narrowing effect on the overall valuation. I think our perspective at least on the upfront cash piece is roughly the same as it has been. We may not have been really clear, I guess, in our communication of that because we were kind of focused on the overall value rather than the individual pieces. But the cash piece of $20 million to $30 million is roughly consistent with what we've expected for some period of time. But again, the overall value is lower because we're pursuing a transaction that does not include tax credits.

Donald P. Newman

With that change, we think it significantly simplifies the transaction and puts us on a path of a quicker sale.

Kirk A. Benson

It increases the likelihood that we'll get a deal done.

Brian Taddeo - Broadpoint Capital

Let me ask -- if you're giving up the tax credits now, wouldn't that, in essence, mean you should be receiving more cash upfront than less?

Kirk A. Benson

Depends on the perspective of the buyers because what we were trying to accomplish was a simplification of the transaction so we could get a deal done. And so I don't -- it doesn't have that much of an impact on the upfront cash.

Donald P. Newman

It also has to do with what the intended use of the assets are by the buyer. If they intend to use the facilities in, let's say, more of a mining and processing met coal. Met coal doesn't qualify for tax credits, and so it really comes down to how the buyers, the potential buyers view the assets and their appetite for the credits.

Brian Taddeo - Broadpoint Capital

Understood. And just one last clarification on one of your earlier comments regarding to the coal cleaning. If I heard you correct before, you mentioned there was the potential for some additional value above the $20 million to $30 million. Wouldn't you just be selling -- would you be selling all 11 coal cleaning units, what would be left that there could potentially be some value for above the $20 million to $30 million?

Kirk A. Benson

Well, that basically -- that means deferred payments.

Operator

And at this time, I'd like to turn the conference back over to management for any closing comments.

Sharon A. Madden

With that, we will go ahead and end the call. We'd like to thank you all for your participation. Thank you.

Operator

Thank you, ma'am. Ladies and gentlemen, if you'd like to listen to a replay of today's conference, please dial 1 (800) 406-7325 or (303) 590-3030 using the access code of 4483410. This does conclude the Headwaters Incorporated Fourth Quarter and Fiscal Year End 2011 Conference Call. Thank you for your participation. You may now disconnect.

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