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Headwaters (NYSE:HW)

Q2 2012 Earnings Call

April 26, 2012 11:00 am ET

Executives

Tricia Ross - Vice President

Sharon A. Madden - Vice President of Investor Relations

Kirk A. Benson - Chairman and Chief Executive Officer

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

David Ulmer - President of Tapco International

William H. Gehrmann - President of Headwaters Resources Inc

Analysts

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

John Quealy - Canaccord Genuity, Research Division

Seth Yeager - Jefferies & Company, Inc., Research Division

Philip Volpicelli - Deutsche Bank AG, Research Division

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

Unknown Analyst

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Headwaters Incorporated Second Quarter 2012 Earnings Conference Call. [Operator Instructions] This conference is being recorded today, Thursday, April 26, 2012. And I would now like to turn the conference over to Tricia Ross of Financial Profiles. Please go ahead.

Tricia Ross

Good morning, everyone, and thank you for joining us for the Headwaters Incorporated Second Quarter 2012 Conference Call. There are slides accompanying today's presentation that can be found on the webcast link at Headwaters Incorporated under the Investor Relations section of Conferences and Presentations. Please go there to follow along with the slides. Should you have any trouble accessing the slides, please contact me at (310) 478-2700. I would now like to turn the call over to Sharon Madden, Vice President of Investor Relations at Headwaters.

Sharon A. Madden

Thank you, Trisha. Good morning, everyone, and thank you for joining us as we report Headwaters' fiscal 2012 Q2 results. Kirk Benson, Headwaters' Chairman and Chief Executive Officer; and Don Newman, Headwaters' Chief Financial Officer, will be conducting this morning's call along with Bill Gehrmann, President of Headwaters Resources and Heavy Construction Materials segment; and Dave Ulmer, President of Tapco International.

Before we get started on this morning's call, please remember that certain statements made during the call, including statements relating to our expected future business and financial performance, may be considered forward-looking within the meaning of section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, both as amended. Forward-looking statements by their very nature address matters that are, to different degrees, uncertain. These uncertainties are described in more detail in Headwaters' annual and quarterly reports filed with the SEC. 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'll now turn the call over to Kirk Benson. Kirk?

Kirk A. Benson

Thank you, Sharon. We're happy to report that we experienced our strongest March quarter since March 2007. Revenue increased 15% year-over-year and gross margin increased by 570 basis points to 24.3%. Operating expenses were held in check and actually decreased by about 11% after adjusting for nonroutine expenses and approximately $3 million of expenses such as cash-paid SARs that are tied to increases in the stock price.

Adjusted EBITDA increased nearly 380% year-over-year with both improvement in light building products and heavy construction materials. For the first 6 months of the year, adjusted EBITDA doubled compared to last year. Trailing 12-month adjusted EBITDA is up 21% to $94 million, which is on the upper end of our forecast for the year.

Multiple trends drove this improved performance in the quarter year-over-year. First revenue growth of [ph] 15%. We added key new customers to our distribution system. We had new coal combustion service projects that came online and started to produce revenues. Our end markets improved in both building products and fly ash sales. We also experienced strong growth in some of our newer products like roofing and specialty siding. And warmer weather, warmer than usual winter weather, favored construction activity.

The second thing that happened in the quarter is that our restructuring plan that we implemented as part of our continuous improvement culture is starting to show benefits that flow through the P&L, resulting in improvements to gross margins and lower operating expenses. After adjusting for the increase in expenses attributable to an increase in our stock price on an apples-to-apples basis, our total operating expenses declined by approximately 11%, as I previously noted. We're pleased with the overall improvements in our efficiency. It's certainly gratifying to see the positive impact that operating leverage has on free cash flow and adjusted EBITDA. 15% [ph] growth in the top line resulted in a 380% increase in adjusted EBITDA as we maintained some of the highest contribution margins in the industry. We are managing our variable costs as well as fixed costs and the positive leverage [indiscernible] result. Although we see continued benefits from improved efficiencies throughout the remainder of the year, we will experience an increase in incentive compensation in the second half of the year compared to last year based on our performance for the full year. We recognize incentive compensation expense based on growth in operating income and free cash flow. We anticipate that the incentive compensations will make SG&A year-over-year comparisons unfavorable in the second half of the year because we paid very little, almost no incentive compensation last year. However, due to the strong link between pay and performance in our plant structures, our incentive compensation will increase in 2012 because of the increase in operating income and free cash flow.

We are tracking ahead of the midpoint of our plan for the year. Last quarter, we indicated that our trailing 12-month adjusted EBITDA would be higher than the midpoint of our suggested range. Today, our guidance would be that we have an excellent opportunity to finish the year at the upper end of our range. We considered raising guidance, but most of our revenue and earnings occurred in the second half of the year. So we felt it was prudent to wait until we had experienced operating results in the early summer months before adjusting guidance. So our trailing 12-month EBITDA is on track to achieve our guidance range of $85 million to $95 million, and we'll look at guidance again at the end of the June quarter.

Now, I'd like to turn the call over to Don Newman for a discussion of the quarterly financial results.

Donald P. Newman

Thank you, Kirk. And thank you for joining us this morning. Before discussing Slide 3, I wanted to mention that we intend to file our Form 10-Q next week. My comments today will be directed to the slides that were sent out this morning and, to a lesser extent, the condensed consolidated balance sheets and statements of operations that were attached to the press release.

Starting with Slide 3. Our second quarter revenue from continuing operations is $130 million, a 15% increase from the prior year revenue of $113 million. Second quarter adjusted EBITDA from continuing operations is $12.5 million, a 380 basis points -- or, excuse me, a 380% increase from prior year EBITDA of $2.6 million. Our year-to-date revenue from continuing operations is $267 million, an $18 million increase from the prior-year revenue of $249 million. Year-to-date, adjusted EBITDA from continuing operations is $32.9 million, more than double the prior year's EBITDA of $16.3 million. Our margins expanded significantly year-over-year as a result of the improved revenue as well as cost improvements in raw materials, facilities and labor. Our gross margins for the quarter increased 570 basis points and adjusted EBITDA margins increased 730 basis points. Year-to-date, our gross margins increased 350 basis points and adjusted EBITDA margins increased 580 basis points.

Let's move on to Slide 4 for a closer look at the quarter's financial results. Revenue from continuing operations in Q2 increased $16 million, or 15%, year-over-year to approximately $130 million. Light building products siding sales increased nearly $12 million, or 19%, largely due to higher volumes and to increases in average sales prices. Heavy construction materials revenue also increased year-over-year with sales up more than $6 million, or 14%, from 2011 levels due to higher sales in the central and west regions and to improved sites service revenue.

Q2 gross profits increased 50% year-over-year from $21.1 million to $31.6 million, driven by the higher revenue and our cost to actions. Q2 SG&A dropped $15 million year-over-year largely due to legal reserve that was recorded in 2011 related to the Boynton litigation. Q2 adjusted EBITDA from continuing operations totaled $12.5 million, which represents more than a four-fold increase from adjusted EBITDA of $2.6 million in 2011. The nearly $10 million improvement reflects improved revenue as well as our cost actions. The year-over-year decrease in interest expense largely reflects a $69 million charge taken in 2011 related to the refinancing of our senior secured debt. Debt repayments and the 2011 senior secured -- senior debt refinancing have enabled us to reduce our cash interest cost by approximately $12 million to roughly $36 million. Discontinued operations reflect the results for coal cleaning. In fiscal 2011, we recorded a $37 million impairment charge. We continue to work on improving our operational results and making operational changes to the plants to improve cash performance, while the sales process continues. Dave, Bill and Kirk will talk about these dynamics in their presentations.

Now let's move to Slide 5, and let's talk about the year-to-date financial results. Year-to-date revenue from continuing operations increased more than $18 million year-over-year to approximately $267 million, which reflects our strong Q2 results. Light building products siding sales increased $15 million, or 12%, largely due to higher volumes and to increases in average sales prices. Heavy construction materials sales were up more than $6 million from 2011 levels due to higher sales in the central and west regions and improved site service revenue, offset by lower sales in the Eastern U.S. Energy sales were down $3 million year-over-year largely due to a customer turnaround in Q1 and to the timing of Q2 product shipments this year. Year-to-date gross profit increased 25% year-over-year from $53 million to $66 million, and that was driven by higher revenue and our cost actions. SG&A dropped approximately $18 million year-over-year due to the $15 million Boynton legal reserve recorded in 2011 as well as to our cost actions. Year-to-date adjusted EBITDA from continuing operations totaled $33 million which is more than double the $16 million of adjusted EBITDA in 2011. The nearly $17 million improvement reflects improved Q2 revenue as well as cost reductions.

The year-over-year decrease in interest expense largely reflects the charges taken related to the 2011 refinancing of senior secured debt and to our debt repayments. For coal cleaning, as noted, in fiscal 2011, we recorded a $37 million impairment charge. And in 2012, approximately $5 million of the current year loss relates to non-cash charges largely related to reclamation obligation charges booked in Q1.

Let's move to Slide 6 and spend a few minutes talking about our debt. Our debt position has continued to improve over the past 3 quarters as we have increased our trailing 12-month adjusted EBITDA from a low point of $74.5 million in the June 2011 quarter to $94.3 million in the current quarter. We closed the quarter with a net-debt-to-adjusted-EBITDA ratio of 4.9:1 after reaching a high point of 6.7:1 in the June 2011 quarter. We've repaid nearly $20 million of our subordinated debt in 2012, including $12 million in the second quarter. That leaves approximately $123 million of subordinated debt outstanding, including $9 million of 16% notes, which can be called at par this June.

Starting on Slide 7, Dave will talk about light building products.

David Ulmer

Thanks, Scott, and good morning, everybody. As you can see on Slide 7, revenues from our light building products segment in the second quarter were $74.3 million, an increase of $11.6 million, or 19%, compared to the March quarter last year. The 19% boost in revenue was the largest year-over-year quarterly growth rate since March of 2006. The strong growth came from our siding and architectural stone product groups. Year-to-date revenues in this segment have increased 12% over the first 6 months of last year.

According to the Census Bureau, non-seasonally adjusted single-family housing starts for the quarter ended March 31, 2012 were 17% higher than the housing starts for the quarter ended March 31, 2011. We are optimistic that we will see revenue increases into the June quarter. That being said, it is still to be determined how much of the 12% year-to-date revenue growth is pulled forward because of the mild winter versus improved market conditions. However, April sales are trending above last year. We continue to see improved gross profit margins. For the quarter, margins were 27% up from 17% in the 2011 second quarter. The improvement was a result of our continuous improvement strategy, restructuring initiatives implemented in the second half of fiscal 2011 and price increases to counteract increasing commodity prices. We anticipate that polypropylene and cement cost will increase over the second half of the year.

Adjusted EBITDA increased to $11.7 million for the quarter versus $2 million in the second quarter of 2011. The large $9.7 million increase in adjusted EBITDA on $11.6 million in revenue growth was due to restructuring initiatives and a decline in our SG&A costs. Adjusted EBITDA for light building products has increased by $14.4 million to $23 million for the first half of fiscal 2012.

We are pleased that we've made significant progress in the year, but we continue to look for ways to improve operating efficiencies. The architectural stone group has initiated its re-brand strategy to better serve the market, to minimize channel conflict and to best utilize its SG&A structure. Benefits are beginning to be realized from this approach. We have attracted new customers which should lead to an expansion of our market share. For our block business, the foundation products continue to run at all-time high levels due to the dry conditions in the Texas market. We have started production of our new polished block product and have delivered to our first jobs. Expanding our block business with lows by getting additional SKUs into the product offering has also benefited sales. In the siding group, we continue to work closely with our existing vendors and new vendors to control our input costs.

Now turning to Slide 8. As already discussed, you can see that the second quarter was better than last year in both revenue and adjusted EBITDA.

Now, I'll turn the presentation over to Bill.

William H. Gehrmann

Thanks, Dave, and good morning, everyone. On Slides 9 and 10, you can see the revenue for the March 2012 quarter in our coal combustion products business with $51.2 million compared to $45.1 million for the March 2011 quarter, resulting in a 14% year-over-year increase.

Overall product revenues for the March 2012 quarter were up 12% over the March 2011 quarter. The west region posted a positive year-over-year volume and revenue increase for the second quarter in a row, continuing signs that we may be nearer at the bottom of the California market. Headwaters' plant services provide site services to many of its utility client. These services include constructing and managing landfill operations, operating and maintaining material handling systems and equipment maintenance. Site service revenue for the March 2012 quarter was up 18% compared to the March 2011 quarter. Prairie State and Virginia City, 2 new long-term contracts, continue to ramp up their operations contributing to the increase in site service revenue. Site service revenue accounted for 33% of our overall revenue for the quarter. While these services typically have lower operating margins than our product sales, they are not as seasonal. As construction activity increases in the June and September quarters and product revenues expand, site service revenue will be a lower percentage of our overall revenue.

Gross profit for the March 2012 quarter increased by 30% to $9.9 million compared to $7.6 million for the March 2011 quarter. Gross profit margin increased 240 basis points year-over-year driven by improved product sales, sales mix and our continuous improvement efforts. The adjusted EBITDA for the March 2012 quarter increased by 64% to $6.4 million compared to $3.9 million for the March 2011 quarter. The adjusted EBITDA margin increased 380 basis points year-over-year. Operating leverage, combined with our ongoing continuous improvement efforts, is evident as revenue growth of 14% resulted in adjusted EBITDA growth of 64%.

Moving to Slide 11. As we mentioned on the previous call, on October 14, the U.S. House of Representatives passed legislation designed to protect fly ash beneficial use and strengthen coal ash disposal regulation. HR 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. Supporters of Senate Bill 1751 continue to seek additional sponsors and recent discussions that are focused on amendments that may garner more democratic support. These bills provide a rational balanced approach to managing the disposal of coal combustion products and are supported by a wide range of stakeholders.

On April 18, the House of Representatives added HR 2273 as an amendment to the Surface Transportation Extension Act. The House Transportation Extension, which would extend fundings for the Federal Highway Trust Fund through September is the House's response to the Senate transportation bill. The House's Surface Transportation Act Extension will now go to conference with the Senate. The EPA is conducting a risk evaluation of encapsulated beneficial use of coal ash, and it was initially announced that the study would be concluded this month, although that date appears to be slipping.

Upon completion of the risk evaluation, we anticipate that the EPA will confirm its long-term support for the environmental benefit associated with the use of fly ash as a substitute for Portland cement. Low natural gas prices and EPA regulation have combined to force both the temporary and long-term shutdown of several coal-fired power plant, impacting the supply of coal combustion products in some margins. However, our multiple sources of supply and broad distribution system allow us to backfill supply in market, where supply has been impacted. As a result, we believe that opportunities exist for us to increase market share and fare better than our competitors in the current regulatory environment.

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

Kirk A. Benson

Thanks, Bill. As you can see on Slide 12, the energy technology segment consists primarily of revenue from the sale of our HCAT technology. There is some revenue from other technology such as the development agreement that we have in place to work on upgrading coal to metallurgical standards. But our outlook in the segment is now focused on HCAT. Revenues were $4.1 million compared to $5.4 million in 2011. Primary reason for the change were a slight decline in consumption by one of our customers and the timing of shipments and refinery turnaround. Our customers continue to be pleased with HCAT's technical results. Adjusted EBITDA on revenue of $4.1 million was a positive $0.2 million. We continue to work with additional refineries to sell our HCAT technology. Slide 13 shows the year-over-year comparisons in revenue and EBITDA. Fixed cost has been stable over the last year, and we anticipate advances in free cash flow in addition to customer sales.

On Slide 14, we'd like to reiterate the continuation of our guidance in the $85 million to $95 million range. Last year, we had a very poor April as winter weather continued into May, and the construction season ramped up slowly. So far, this year, sales are tracking ahead of last year and slightly better than our plan. We will update the market after our June quarter on guidance for the rest of the year.

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

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Trey Grooms with Stephens Incorporated.

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

This is actually B.G. Dickey sitting in for Trey. I have a question. Last quarter, I believe you guys talked about some of the success stories related to distribution in light building products and picking up some market share there. And again, you mentioned in your prepared comments again today. Just wanted to know if you could give us some more color there? Is this incremental to the wins you announced last quarter? Or are we just seeing kind of a ramp-up of those wins? Or both?

Kirk A. Benson

It's a little bit of both. So we did have some new customers come online last quarter. They are now starting to ramp up. But, for example, in our stone product group, we continue to see acceptance of the idea of being able to segment the market into different price points, and our ability to provide those products into the marketplace is being well received and we are continuing to gain customer acceptance and expand our markets. Dave, why don't you comment a little bit on the siding part of the business relative to customers and market share?

David Ulmer

I mean, the answer really is a little bit of both. We had some new customer wins. As Kirk talked about last quarter, we're now finding that some of those wins that where we got initial orders, they're now reordering product and then we have picked up a couple additional customers as we get into the spring, primarily on our siding and our roofing line.

Kirk A. Benson

To complete, the specialty siding product has been a really good success story for us. So we're starting to get -- we think that we've got a product there that has some competitive advantages and is pretty easily distinguished from a competitive product. And that's one of the places that we've seen some growth that outpaces growth in the end markets, which means that we're getting some market share. And so we feel pretty good about that.

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

And then to go back to this -- the weather issue, obviously -- and you guys commented in the prepared comments that it was a factor in the quarter, but it's difficult to kind of quantify the impact there. But if, kind of, looking out, how concerned are you if any related to the kind of pull-forward demand effect that maybe taking place here? Said differently, what level of visibility do you have in your various businesses and given that visibility, is the fundamental demand still there if we look out a month or 2, or kind of what you're seeing right now?

Kirk A. Benson

One of the things as we went through the March quarter, we were quite concerned that a fair amount of our increased revenue was because of the warmer winter weather. And, of course -- so what we thought would have happened is that the sales in April would have been negatively impacted if there was a significant amount of our revenue brought forward into the March quarter.

What we're seeing now that we're into -- I think, we're at about 17 days or so of April from business days, and what we're seeing is a couple of things. One is that, from a pricing perspective or if you look at it, on like, on daily sales, our daily sales are up over last year. And so it's -- that's a very positive indication that there has been improvement in our end market. And so we think that the warmer winter weather had less of an impact than what we originally thought as we were going through the quarter. And the reason for that is that April sales on a daily basis are tracking positive to last year, and our backlog continues to be -- our backlog actually has gone up a little bit because of the increased sales. So we're feeling pretty good about it.

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

So in the light building products, is it just still, I guess, repair remodel that's driving that? Or are you seeing an uptick in some of the newest markets?

Kirk A. Benson

I think that, that having a positive impact on -- Dave, you want to add a little color to that question?

David Ulmer

I think that the remodel business is certainly -- for us, it's going to be the driver that pulls us out. But I also think that there are -- there is new construction activity that is starting that wasn't there last year, and the new homes are up year-over-year. I think the trend is that they're building smaller homes but none just the same, there are new housing starts that weren't there last year. But remodeling seems to be the lion's share of it.

Kirk A. Benson

And if you look at our siding business is more oriented towards remodeling than our stone product group. And if you look at daily sales again, our stone group is also showing positive year-over-year daily sales comparisons, and their orientation is towards new residential construction and less in remodeling. So I think we're starting to see a little bit of positive impact both from remodeling as well as the residential construction. There is -- the other thing that's positive is that we did have a poor April last year, as I've mentioned. And so one of the things that we were concerned about is we could have a positive year-over-year comparison compared to last year. But when we produced our operating plan for the year, we anticipated a normalized April. And our sales are tracking positive to our plan as well as positive to last year. So it gives us another indication that the pull-forward into the March quarter which, I'm sure, happened -- I think that we clearly had a better March quarter with mild weather than we would have had, had it been extreme winter weather. Nevertheless, there have been improvements in our end market.

Operator

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

John Quealy - Canaccord Genuity, Research Division

To go back to the Light side for a minute, if we could. When we look at correlations with new home starts, again, given what you just said in response to the last question. Is there any lag here, Kirk, just based on your materials? I imagine, lumber and windows go in 3 to 4 weeks earlier on a new home than some of the stone as the exterior gets finished up and the keys get turned over. Is there any lag factor here? Or do you think it's pretty good correlation in real time for your business in Light?

Kirk A. Benson

Generally, we think that there is a lag. And when -- we have fought and we haven't had an internal discussion on the subject of the lag. But in prior, when we have talked about it internally before, we thought that the lag was probably in the range of 3 to 4 months lag because a lot of our products do come towards the end of the construction. And so there is probably some lag.

John Quealy - Canaccord Genuity, Research Division

Okay. And then switching gears on Heavy. In terms of supply constraints, obviously we're hearing a lot vis-a-vis spark spreads and EPA mandates and things like that. You gave us a good update at the Analyst Day but can you just remind us, has anything materially changed? Had your outlook changed on sourcing? Does it impact margins in this year at all? Or are you still feeling comfortable there?

Kirk A. Benson

So, I'll answer first, Bill, and then you follow on. But I do think that we're clearly in a difficult environment from the perspective of natural gas prices and the EPA. So the EPA is continuing to roll out regulations that have a negative impact on the -- on coal-fired production. And that is resulting in plants either having to retool and improve their air quality processing and equipment or for some of the older facilities and smaller facilities, they shut down permanently. So, a lot of the older facilities don't produce high quality fly ash. And so when some of those older facilities shut down, it doesn't necessarily have a negative impact on the high quality fly ash that we can use as a replacement for Portland cement. But it -- but what is happening is it's causing some dislocations in the marketplace. And the positive thing about our position is because of our market share and our distribution system with our terminals in place and the wide variety of sources that we have so far, we've been able to backfill pretty effectively. I think Bill has done -- and his team have done an excellent job of ensuring that we can supply high quality fly ash to the concrete and -- ready mix and concrete users and keep them supplied with the high-quality ash. There is no question, however, that the EPA has had a negative impact on the recycling of ash.

Bill, why don't you add some additional color to that because it's a very important point?

William H. Gehrmann

Sure. And as we've talked about before, probably at this point, one of the biggest impacts that we started to see especially in regards to natural gas was last year in the Northeast. We made some changes last year and obviously we've had a year to take a look at what we could do moving into the future. With that being said, we feel comfortable with the supply we've got in our Great Lakes area. We've got enough supply to backfill into the Northeast. And with that being said, we are just in the final processes of opening up 2 new terminals in the Northeast. It will be third by rail to backfill supply that we do have located in the Northeast. Near-term, over the last couple of months, we had some supply issues along the Gulf Coast. Some was related to natural gas, a large piece of that was actually nothing more than normal spring planned outages. Typically in the South, during the mild weather in the spring and fall is when utilities will take some of these larger-base loaded coal-fired units down.

Poor maintenance outages, we have seen a little of that with some of the milder weather. Some of these outages have been extended a week or 2. We have had the supply to reallocate and meet the market needs. It has impacted margins in the near-term a little bit as we might have incurred a little more transportation cost for getting the supply into the market than what we normally would have done. But as we move into the next 2 or 3 weeks, we'll see these larger units come back up out of outages and we feel very comfortable with that supply. We've also had some opportunities outside of markets where we've typically been in or we've had our competitors have similar issues without the excess supply in their systems, the backfill where they've been impacted. And we're trying to take every opportunity possible to move into those markets, move with our supply and try to gain some more markets there.

John Quealy - Canaccord Genuity, Research Division

And my last question, in terms of the incentive comp, I think that last year in the back half of '11 you guys did about $47 million in SG&A, assuming that the charge gets in there. Can you just give us a scaled materiality of how much more we should be looking for in the back half of '12 for that?

Kirk A. Benson

Yes. As from an SG&A perspective, and then I'll have Don comment on this as well. But our fixed SG&A, we should probably be flat or trending down just a little bit. We put our restructuring plan in place in 2011. We had a little bit of benefit of that, I believe, in the 9/30 quarter of last year. But when we get to the 9/30 quarter of this year, we'll be comparing to the 9/30/11 where we did have some benefit, the benefits, weren't of course all in place. But you've got a little bit of benefits occurred in the 9/30 quarter of last year so that comparable will be a little bit tighter in 9/30 this year although those cost-saving should be greater than last year's run rate. On the variable cost side, we could -- we got several different variable costs going on. One that impacts us is that we have some cash-based SARs. That number is, in the quarter, I think our expense in our SG&A that's tied to the stock price was right around $3 million. And so that's one expense that I hope everybody on the phone buys our stock and drive that stock price up a bit which means that we'll have increased SG&A. But in any event, that's a variable is difficult to predict because we don't know what's going to happen to the stock price and it's down on a mark-to-market basis.

We also have some increased expenses that are variable as it relates to commissions. So in the quarter, our commission expense was up probably in, say $750,000 range, not quite to $1 million. As we -- as our sales increased then you could rightly expect an increase in commission expense attached to those sales.

And then finally, we've got some -- our incentive compensation last year was minimal and the incentive compensation this year will be -- will have an impact. We're going to have incentive compensation. Of course, we don't know for sure how much that incentive compensation is going to be because it's tied to operating income performance and it's tied to free cash flow. And so as you -- it's impacted by for example of cash-based SARs and becomes a bit of a computation because if cash-based SARs go up goes -- if the expense, I'm sorry, show that cash-based SARs goes up, that drives down the other incentive compensation.

So, we -- this variable compensation is something that clearly will have an impact in the second half of the year, but it's something that is -- that would have to be estimated because there's sufficient variables going on that impacts what that variable comp will be. So we would be reluctant to give you a set number because it really is a variable compensation.

Donald P. Newman

I think, Kirk, you covered that quite well. One thing we do expect is that that compensation will be higher in 2012 than it was in 2011. The question is how much higher? But it is driven by good things, right? It's driven by strong performance on the bottom line and it's also driven by good performance on the stock price which is good for our shareholders. So in balance, we think that, although it's complicated and it will cost us some money, at the same time it is part of an overall good.

Operator

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

Seth Yeager - Jefferies & Company, Inc., Research Division

In the LBP segment, how much of that revenue increase was price versus volume? And if I back out the restructuring charges in the prior year, it looks like incremental gross margins were around 35% or so. I recall you previously talking about something closer to 40%. Is that math off or what's a good run rate to use for that segment?

Kirk A. Benson

Go ahead, Don.

Donald P. Newman

So I think the 40% that you're talking about is actually the contribution margin versus the gross margin.

Seth Yeager - Jefferies & Company, Inc., Research Division

Got it. Okay.

Kirk A. Benson

And I think we're running pretty close to that, so, the contribution margins, that rate. So what makes it a little bit -- what makes it difficult to just do -- if you took our revenues in the light building products segment and used a 40% contribution margin. You would get an estimate of the increase in EBITDA that you would expect from increased sales. And that's holding pretty close to form. So -- but the other thing that's going on, of course, is the reduction in our costs. That's why we had a much higher increase in adjusted EBITDA than you would have expected just from the increase in sales. And so you have those 2 things going on. You have the increase in adjusted EBITDA from sales which is about in that 40% contribution margin range. But then in addition to that, you have the increase in adjusted EBITDA because we've lowered our cost structure. And so those -- that's what's going on. Relative -- what was the first part of your question?

Seth Yeager - Jefferies & Company, Inc., Research Division

In LBP, the volume versus price dynamic.

Kirk A. Benson

David, I'm happy to respond but, David, do you want to give that perspective at least from the siding side?

David Ulmer

Yes, that's fine. Really, the way we see our increase right now is that the price to volume, the pricing part of where we've been is roughly 35% to 40% of the increase that we've seen. So we have seen fairly significant volume increases that are not tied to price increases.

Kirk A. Benson

And on the stone side of the business, the pricing has held firm through the down cycle. But their -- but the increase in revenue is almost entirely related to volume and not price. And in our -- and of course, our revenue in the block business was -- it's actually down a little bit.

So, on the siding side, if you're like 30% or 35% it's price oriented in total, we're probably in the -- we're probably closer to 15% when you adjust for the volume and on the stone group. So, it's probably in the 20% range that is price and 80% is volume in the light building product's group in total.

Seth Yeager - Jefferies & Company, Inc., Research Division

Okay, perfect. And then as it relates to the comments you made around the cost savings. Just for the $9.1 million or so for the full year that you guys had anticipated. How much of that has flown through so far? And what should we look for in the second half?

Donald P. Newman

It's generally coming through relatively flat although, in maybe Q1, was $1.8 million, Q2 would have been up to about $2.2 million. We're working our way up with marginally more each quarter to that $9 million amount.

Seth Yeager - Jefferies & Company, Inc., Research Division

Okay, perfect. That's helpful. And then, for the fly ash business. Have you guys seen any nat gas switch over in Utah? I would think the PRB coal given its cost competitiveness would be sort of the last to be impacted by the lower nat gas prices.

Kirk A. Benson

I think we're getting -- our supplies in the Western regions have not been materially impacted by the low natural gas prices.

Seth Yeager - Jefferies & Company, Inc., Research Division

Okay. And I know that you guys sell quite a bit of fly ash to California. Do you have just like a rough sense of the percent of your sales that go into that state?

Kirk A. Benson

Bill, you might have to add to this. But the Western region, if it -- back in -- before the down cycle, it was probably in about the 35% range and -- but it got -- it was impacted more by the down cycle. It's probably in like the 20% range now, in that range 20%, 25%. So, Bill, how accurate is that?

William H. Gehrmann

That's probably fairly close. We break it out by area where we do isolate northern California. But off the top of my head, I think that your numbers are definitely in the ballpark there.

Seth Yeager - Jefferies & Company, Inc., Research Division

Okay, great. Appreciate it. And then just the final ones here. You guys have made if I recall some forward purchases on the resin. I think you had mentioned in your prepared comments that you may have some price increases coming up. Can you just talk about the price cost relationship in resin or is just the -- as well as an update on the sale of the coal cleaning business?

Kirk A. Benson

Generally, our material cost run about 30% of cost of goods sold. And so -- but the material cost of course, are broken out into not just polypropylene. It's broader than that. But you could use that as a general sense as to what kind of impact that could have.

Poly, of course, relates to the siding products not to the stone or to the block and, so it of course, has a lesser percentage on our overall cost of goods sold than 30%. So I don't know, Dave, if you could. I don't know if you have an estimate of the percentage relative to the siding products that Poly in particular impacts or if you have that number in your head? But go ahead and comment and add some color.

David Ulmer

I don't have the specific number in front of me on it. I'm not sure what I would add to what you said Kirk.

Seth Yeager - Jefferies & Company, Inc., Research Division

Well, I guess just as a follow-up. Do you guys -- you've done a good job in the past of offsetting increases in resin. Do you have plans to put out any price letters to offset any possible increases or do you feel comfortable right now where you're at that most of that should be offset?

Kirk A. Benson

On that part, we are very engaged in trying to ensure that we address resin price increases. And so there's 2 general ways that we attempt to do that. One is to have the price increase passed through into the marketplace. And that -- when we're contemplating that, we think not just of resin prices but also of other cost increases. And then the other thing that we would do is look at other ways to change the mix of our raw materials or to change an effective recipe that you would use and to be more efficient with the use of those raw materials. So our objective is to be able to offset those cost increases either through price increases or through changes in our manufacturing process. So we are very much engaged to try to address those cost pressures as they occur.

Seth Yeager - Jefferies & Company, Inc., Research Division

Got it. And then just if you could give an update on the coal cleaning business. And if there's anything to update there much.

Kirk A. Benson

I think the one thing is that we -- I guess dramatically is an okay word to use. We did decrease the cost run significantly from the 12/31 quarter. So we have been very actively engaged in managing the cost. On the sales side, we continue to negotiate and interact with potential buyers. We've been saying that now for multiple quarters and it happens to continue to be factual as we move closer to getting some of these coal cleaning facilities sold. I think that we have -- I would assess our current situation that we have made progress over the last quarter. One of the decisions that we made coming out of the 12/31 quarter is that we would not look to sell all of the facilities to a single buyer. What that decision did was it opened up multiple new buyers that we could then bring into the process. And we've done that over the last 90 days and have been able to engage additional buyers in the process. We obviously still don't have these facilities sold but we did make a lot of progress in reducing the run rate of the facilities and the carrying costs and we'll see some additional improvement I think in the normal operating expenses in the June quarter. And I think we'll continue to make progress in getting these facilities sold and we still believe that relative to discontinued operations, one of the commitments you make is that you get the facility sold in 12 months from that change to discontinued operations. That continues to be our objective.

Operator

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

Philip Volpicelli - Deutsche Bank AG, Research Division

My question is with regards to cash. If you do meet the high end of your target range of EBITDA at $95 million you should generate a significant amount of cash in the second half of the year. And I was wondering beyond this calling, the 15% note that you plan to do in June, could you prioritize what you would do with that cash, further acquisition? Would you pay down some of the 2.5% converts? Would you repurchase shares? Just give us some color there.

Kirk A. Benson

I think our first priority is to reduce debt. And so the primary goal would be to use free cash flow to reduce the subordinated debt. So first, the 16% debt we currently intend to exercise our call and repay that debt. Then what we are focused on will be the -- primarily, will be the 2.5% debt, that comes due in 2014. And so that's what you should expect the bulk of our free cash flow to be applied towards. The -- we will look at, however, opportunities where we could do small pack-on acquisitions. When those opportunities occur, that's something that we will be interested in doing. We're not in the position from a balance sheet perspective to do a larger transaction, but we feel pretty comfortable that we can do smaller transactions that would be adjacent to our core business and something that would be relatively, a relatively low risk from an acquisition perspective. And then the third use of capital would be our maintenance CapEx is probably in the $20 million range. This year, we're running around $25 million, maybe a little bit more than that, depends on timing to some degree. But you've got a little bit of -- and, of course, coming up of free cash flow, we back out CapEx. But there is an opportunity for some room for -- because our maintenance CapEx is around 20%, we budget it at around $25 million. So there's some -- that $5 million of growth CapEx is something that we will look to how we spend that money in 2013.

So, there may be an opportunity, I mean, we could theoretically drop our maintenance CapEx down to $20 million. But on the other hand, there could be some opportunities for some organic growth that would require some CapEx and that would be our third use of cash.

Philip Volpicelli - Deutsche Bank AG, Research Division

That's great. And the acquisitions, the tuck-ins that you were mentioning Kirk those are mostly I think in the light building products?

Kirk A. Benson

The acquisition opportunities?

Philip Volpicelli - Deutsche Bank AG, Research Division

Yes.

Kirk A. Benson

I think that we would look at opportunities in either segment. I think there may be more opportunities in light building products than there might exist in Heavy Construction Materials. But in the right circumstances, particularly if it had a positive synergy impact in the Heavy Construction Materials side, if it was the right transaction, we could potentially do something there as well.

Operator

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

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

First, a quick question on the Heavy Construction Materials. You gave sort of the price volume analysis on Light Building. Can you do the same for Heavy Construction? How much of the revenue growth was price versus volume here?

Kirk A. Benson

It is weighted towards volume on the Heavy side. We're still getting some price increases but it is -- it has less of an impact in heavy than it does in light. It's mostly volume.

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

Okay. Second quick question on heavy. Just so I understand. In the past you've talked about maybe selling half of the usable flash you collect given demand. With some reduction in usable flash, is that still a 50% number given where ash production levels are? Or is that number maybe a little bit lower and maybe a little bit higher now? I mean you're selling more of what you're collecting given lower raw collection rates.

Kirk A. Benson

Yes. I think generally and Bill you can add some color to this, but generally I think that percentage is going to be higher, just exactly what you just said. I think it's absolutely correct.

William H. Gehrmann

It's obviously been higher near-term based on some of the natural gas issues we've seen. But the regional teams have been quite successful in securing new supply. So we continue to add a new supply that we haven't had. So obviously we'd like to continue on and keep it in kind of at that 50-50 split.

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

So you can still -- so you're still in this position where you can benefit as demand for some -- in ash improves. You're not getting anywhere close to constrained, yet?

Kirk A. Benson

The answer to that question is absolutely.

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

Okay, good. Two more quick ones on the regulatory front. With the lawsuit by both UN well Earth Justice as well. What's sort of the time frame under which that plays out the lawsuit side? Because we can sort of watch what's going on in I guess in the House and the transportation bill. What's going on legally?

Kirk A. Benson

So, a litigation can go on for a long time. So we're not anticipating any quick settlement to the litigation. In fact, the EPA has indicated to us. whereas -- one of the reasons that we filed was to make sure that we would have a seat at the table in case there was a settlement particularly with the environmental NGOs. What has happened historically has been that the NGOs have filed a lawsuit. I'm going to take a drink of water. And maybe that will help. In any event, what's happened in the past is that the NGOs have -- they filed a lawsuit with the EPA. And then there has been a favorable settlement between the NGOs and the EPA. And that was the primary reason that we filed, was to try to ensure that we would have a seat at the table and there wouldn't be a settlement that excluded recycling interest. And that was weighted in favor of the environmental organization. What the EPA has told us is that they don't intend to settle with the environmental organizations, that they intend to fight this lawsuit. And that would be fine with us and we're quite comfortable in that approach from the EPA. What that means, of course, is that the litigation will be lengthened because at this point in time, we don't anticipate an early or easy settlement with the EPA. So it could go on for a long time, bottom line.

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

Okay. Just a last question. You mentioned incentive comp. I'm looking at the March quarter corporate EBITDA or our corporate operating income number being down being worse year-over-year and certainly worse than we've seen in the last few quarters. Is that indicative that maybe accruals for incentive comp were already picking up this quarter? Or is that something else going on?

Kirk A. Benson

It's primarily our cash-based SARs.

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

And that occurred during the second quarter?

Kirk A. Benson

Correct.

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

Okay. And that level is that expected? You said part of that's going to be tied to the price of the stock. So it would be fair to assume that maybe that level is going to continue to be at a -- a couple of million higher than last year.

Kirk A. Benson

It will be I think the stock price stayed flat, then in the June quarter, we wouldn't record any incremental expense.

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

Got it.

Kirk A. Benson

So it's basically, it's mark-to-market.

Operator

We'll take our last question from the line of Joe Dawson [ph] with Bodel and Greek.

Unknown Analyst

Looks like familiar stock prices and SG&A is going to go up a little bit. I got a question on, you used the word backfill, when you say that was with respect to the fly ash do you mean just shipping from regions where we have an excess of supply to regions where you have a shortage or you're dipping into inventory?

Kirk A. Benson

No. That's correct, what you said was correct. It's if you got one coal-fired plant that shuts down because of the EPA or because of natural gas prices, we can ship to those customers that were previously supplied by that facility that shut down from another facility. And that's what we mean by backfilling. We're backfilling the supply that was shut down.

Unknown Analyst

Okay. And how did fly ash pricing look this last quarter versus the year ago? And I'm also curious if you're seeing strength in flash sales in any particular reason.

Kirk A. Benson

The most positive thing that we're seeing relative to regional sales is that the Western region which is basically like Utah, Arizona, Nevada, Washington, Oregon, California, the Western part of the United States. Those sales are positive year-over-year. Rather I mean the volume. We're shipping more fly ash year-over-year and it's the last 2 quarters, it's the first time in years that we had a positive year-over-year comparison. And so that's positive. We did, as Bill indicated, we'd picked up some new sources of supply in the middle part of the country and that has increased -- when you get past some of the normal turnaround with the utilities, we'll have an increase in volume in the middle part of the country because we picked up additional source of supply which is another way of saying that is we think our market share may have increased a little bit. And so that's all quite positive. But from an end market perspective, I think the most dramatic thing we're seeing is an improvement in the Western part of the United States. On a pricing perspective, we're probably in the range of 0.5% to 1% increase in pricing year-over-year.

Sharon A. Madden

And with that, we will go ahead and end our call. Thank you, all, for joining us today.

Operator

Thank you. Ladies and gentlemen, that concludes the Headwaters Inc. Second Quarter 2012 Earnings Conference Call. If you would like to listen to a replay of today's conference, you can dial (303) 590-3030 or 1(800) 406-7325 and enter the access code of 453-2136 followed by the pound sign. We thank you for your participation. You may now disconnect.

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