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| HW > SEC Filings for HW > Form 10-Q on 31-Jan-2013 | All Recent SEC Filings |
31-Jan-2013
Quarterly Report
The following discussion and analysis should be read in conjunction with the interim condensed consolidated financial statements and related notes included in this Form 10-Q. Our fiscal year ends on September 30 and unless otherwise noted, references to years refer to our fiscal year rather than a calendar year.
Overview
Consolidation and Segments. The consolidated financial statements include the accounts of Headwaters, all of our subsidiaries, and other entities in which we have a controlling interest. All significant intercompany transactions and accounts are eliminated in consolidation.
We currently operate primarily in two construction-oriented industries: light building products and heavy construction materials. Our third non-core operating segment is in energy technology. In the light building products segment, we design, manufacture, and sell manufactured architectural stone, exterior siding accessories (such as shutters, mounting blocks, and vents), concrete block and other building products. Revenues consist of product sales to wholesale and retail distributors, contractors and other users of building products. Revenues in the heavy construction materials segment consist primarily of CCP product sales, including fly ash used as an admixture for the partial replacement of portland cement in concrete, along with a smaller amount from services provided to coal-fueled electric generating utilities relating to the disposal of CCPs. The energy technology segment has been focused on reducing waste and increasing the value of energy-related feedstocks, primarily in the areas of low-value coal and oil. In the past, revenues for the energy technology segment consisted primarily of coal sales; however, in September 2011 we committed to a plan to sell our coal cleaning facilities and since then the coal cleaning business has been presented as a discontinued operation. In January 2013, we sold all of our remaining coal cleaning facilities and continuing revenues for the energy technology segment currently consist primarily of catalyst sales to oil refineries.
Operations and Strategy. We operate a variety of businesses in the light building products and heavy construction materials industries. Our construction-oriented end markets include new residential, residential repair and remodeling, commercial, institutional and infrastructure. We manufacture our light building products in approximately 15 locations, selling our products primarily through wholesale distributors. We have expanded our light building products segment margins through improved productivity and reduced indirect costs, resulting in a gross margin in fiscal 2012 of 29%. Our heavy construction materials business sells fly ash as an admixture for the partial replacement of portland cement directly to concrete manufacturers. Through continued improvements in operations, we achieved a gross margin in fiscal 2012 of 25%.
During 2008 and 2009, we developed the coal cleaning business in the energy technology segment. This business, which has been classified as a discontinued operation since September 2011, was sold in January 2013. As the economy deteriorated beginning in late 2008, we focused on operational efficiency improvements and cost reductions, particularly in the light building products and heavy construction materials segments, in order to strengthen our balance sheet. The emphasis on cost reductions culminated in a restructuring effort initiated in fiscal 2011 and completed in March 2012, although cost control remains an area of ongoing focus.
Light Building Products Segment. Our light building products segment has been significantly affected for several years by the depressed new housing and residential remodeling markets. Accordingly, we have significantly reduced operating costs to be positively positioned to take advantage of a sustained industry turnaround when it occurs.
Although new housing construction continues to be substantially below the median for the last 50 years, there has been some improvement in end markets recently. Demand for new homes is rising, although we still face an environment characterized by overly tight credit conditions which are constraining new building and purchases. Nevertheless, new residential construction starts improved over the prior year and as of December 2012 are at an annualized level of approximately 1.0 million units.
Existing home sales have also been trending up. The National Association of Realtors reported that December 2012 total existing home sales were at a seasonally adjusted rate of 4.9 million units, compared to 4.4 million units for December 2011. Total housing inventory as of December 31, 2012 decreased to 1.8 million existing homes for sale, which represents a 4.4-month supply, and is the lowest level of housing supply since it was 4.3 months in May 2005, near the peak of the housing boom. The median sales price for existing homes of all types in September 2012 was up 12% as compared to December 2011. We believe the following factors have resulted in positive momentum: pent-up household formations, rising consumer confidence, increased builder confidence and growing rental demand. However, builders are facing a lack of credit availability, qualified buyers face difficulties obtaining mortgage loans, delinquent mortgages continue to result in foreclosures, and there is a limited inventory of developed lots.
We, like many others in the light building products industry, experienced a large drop in orders and a reduction in our margins in 2008 and 2009 relative to prior years. In 2007, 2008 and 2009, we recorded significant goodwill impairments associated with our light building products business, although none of those impairment charges affected our cash position, cash flow from operating activities or debt covenant compliance. Weakness continued in 2010 through 2012 and still exists. It is not possible to know when improved market conditions and a housing recovery will become sustainable and we can provide no assurances that improvements in our light building products markets will continue through 2013 or beyond.
While mortgage and home equity loan interest rates have decreased, volatility continues to exist in credit and equity markets, increased borrowing requirements prevent many potential buyers from qualifying for home mortgages and equity loans and there exists a continued lack of consumer confidence. Continued tightness of mortgage lending or mortgage financing requirements could adversely affect the availability of credit for purchasers of our products and thereby reduce our sales. There could be a number of follow-on effects from the credit crisis on our business, including the inability of prospective homebuyers or remodelers to obtain credit for financing the purchase of our building products. These and other similar factors could continue to cause decisions to delay or forego new home construction or improvement projects, cause our customers to delay or decide not to purchase our building products, or lead to a decline in customer transactions and our financial performance.
Heavy Construction Materials Segment. Our business strategy in the heavy construction materials industry is to negotiate long-term contracts with suppliers, supported by investment in transportation and storage infrastructure for the marketing and sale of CCPs. Demand for CCPs is somewhat dependent on federal and state funding of infrastructure projects, which has decreased in recent years as compared to earlier periods. We are continuing our efforts to expand the demand for high-quality CCPs, develop more uses for lower-quality CCPs, and expand our CCP disposal services and site service revenue generated from CCP management. While all of our businesses have been affected by the recent recession, the impact on our heavy construction materials segment has been somewhat less severe than on our light building products segment. However, to the extent that coal combustion power plant units are shut down or idled in the future, our business may be adversely affected.
Energy Technology Segment. Until January 2013, we owned and operated coal cleaning facilities that remove impurities from waste coal, resulting in higher-value, marketable coal. In fiscal 2011, we assessed the strategic fit of our various operations and decided to divest certain businesses in the energy technology segment which do not align with our long-term strategy. In September 2011, the Board of Directors committed to a plan to sell the coal cleaning business, which has been classified as a discontinued operation since that time.
During fiscal 2010, 2011 and 2012, many of our coal cleaning assets were idled or produced coal at low levels of capacity and were cash flow negative for these or other reasons. As a result, we recorded asset impairments in those years, including an impairment charge in fiscal 2012, to reduce the carrying value of the assets to fair value less estimated selling costs. Management used its best efforts to reasonably estimate all of the inputs in the cash flow models utilized to calculate the impairment charges; however, materially different input estimates and assumptions, including the probabilities of differing potential outcomes, would necessarily result in materially different calculations of expected future cash flows and asset fair values and materially different impairment estimates. We currently expect to recognize a gain on the January 2013 sale transaction, which will be recorded in the March 2013 quarter.
Currently, continuing revenues for the energy technology segment consist primarily of catalyst sales. In fiscal 2011, we announced the decision by a refinery to commercially implement our HCAT® heavy oil upgrading technology following a lengthy evaluation of the technology and we currently expect to have additional HCAT® customers in future years. We continue to invest in research and development activities focused on energy-related technologies and nanotechnology, but at decreased levels compared to earlier years. Through December 31, 2011, we participated in a joint venture that operates an ethanol plant located in North Dakota. We sold our interest in that joint venture effective January 1, 2012. We also participated in a joint venture that owns a hydrogen peroxide plant in South Korea, but we sold our interest in that joint venture in 2010.
Seasonality and Weather. Both our light building products and our heavy construction materials segments are greatly impacted by seasonality. Revenues, profitability and EBITDA are generally highest in the June and September quarters. Further, both segments are affected by weather to the extent it impacts construction activities.
Capitalization and Liquidity. We became highly leveraged as a result of acquisitions consummated several years ago, but we reduced our outstanding debt significantly through 2008 by using cash generated from operations, from underwritten public offerings of common stock and from proceeds from settlement of litigation. From 2005 through 2008, we made several early repayments of our long-term debt and beginning in fiscal 2011 we recommenced making early repayments as our business improved and free cash flow increased.
In fiscal 2010, we issued 11-3/8% senior secured notes for net proceeds of approximately $316.2 million. We used approximately $260.0 million of the proceeds to repay all of our obligations under our former senior secured credit facility and our outstanding 2.875% convertible senior subordinated notes. We also entered into a $70.0 million asset based revolving loan facility (ABL Revolver) which is currently available but undrawn. During fiscal 2010 and 2011, we repaid most of our 16% convertible senior subordinated notes and a large portion of our 14.75% convertible senior subordinated notes, largely with proceeds from the sale of our interest in the South Korean hydrogen peroxide joint venture and a 2010 federal income tax refund. In fiscal 2011, we again restructured our long-term debt by issuing $400.0 million of 7-5/8% senior secured notes for net proceeds of approximately $392.8 million. We used most of those net proceeds to repay the 11-3/8% senior secured notes issued in fiscal 2010 and the related early repayment premium of approximately $59.0 million. The 7-5/8% senior secured notes mature in April 2019 while the 11-3/8% notes were scheduled to mature in 2014. During fiscal 2012, using proceeds from the sale of our interest in the Blue Flint ethanol joint venture and other sources of cash, we repurchased $38.2 million of our convertible senior subordinated notes and we also issued approximately $49.8 million of new 8.75% convertible senior subordinated notes due in February 2016, in exchange for cancellation of an equal amount of outstanding 2.50% notes due in February 2014. We have no debt maturities until 2014.
In December 2012, we issued 11.5 million shares of common stock for net proceeds of approximately $77.8 million. Approximately $43.0 million of these proceeds were used to acquire the assets of Kleer Lumber, Inc., a company in the light building products industry. Kleer Lumber's results of operations will be included with our consolidated results beginning January 1, 2013; however, no results of operations for Kleer Lumber were included in our results for the December 2012 quarter. Kleer Lumber is a manufacturer of high quality and eco-friendly cellular PVC trim board and moulding products. The acquisition of Kleer Lumber will add a full range of cellular PVC products to our light building products offerings, including trim boards, millwork, sheet stock, paneling, and moulding, as well as recently introduced decking and railing products.
Capital expenditures in fiscal 2010 and 2011 were significantly lower than in prior years and this trend continued in fiscal 2012 and into fiscal 2013. This has allowed us to focus on liquidity and the early repayment of debt and has enabled us to continue implementing our overall operational strategy. As of December 31, 2012, we have approximately $78.4 million of cash on hand and total liquidity of approximately $116.3 million. Additional cash flow is expected to be generated from operations over the next 12 months.
In summary, our strategy for fiscal 2013 and subsequent years is to continue activities to improve operational efficiencies and reduce operating costs, continue capital expenditures at reduced levels and to pay down our outstanding debt to the extent possible using cash on hand, cash flow from operations and cash from the sale of non-core assets. We also may review additional strategic acquisitions of products or entities that expand our current operating platform when opportunities arise.
Three Months Ended December 31, 2012 Compared to Three Months Ended December 31, 2011
The information set forth below compares our operating results for the three months ended December 31, 2012 (2012) with operating results for the three months ended December 31, 2011 (2011). Except as noted, the references to captions in the statements of operations refer to continuing operations only.
Summary. Our total revenue for 2012 was $149.6 million, up 9% from $137.4 million for 2011. Gross profit increased 8%, from $34.4 million in 2011 to $37.2 million in 2012. Our 2012 operating income was $6.0 million compared to operating income of $4.4 million in 2011, and the loss from continuing operations decreased to $(3.9) million, or $(0.06) per diluted share, from $(13.3) million, or $(0.22) per diluted share, in 2011. Our net loss including discontinued operations decreased from $(23.7) million, or a diluted loss per share of $(0.17), in 2011, to a net loss of $(5.9) million, or $(0.09) per diluted share, in 2012.
Revenue and Gross Margins. The major components of revenue, along with gross margins, are discussed in the sections below, by segment.
Light Building Products Segment. Sales of light building products in 2012 were $76.7 million with a corresponding gross profit of $20.2 million. Sales of light building products in 2011 were $73.3 million with a corresponding gross profit of $18.0 million. We experienced revenue growth from our product groups that have primary exposure to new residential construction, particularly our stone group. In addition, our concrete block group experienced revenue growth in the quarter based on increased retail and brick sales, which also serve the residential markets. Repair and remodel end market revenue was relatively flat in the quarter. We anticipate increased raw material costs over the next several quarters, particularly in cement and polypropylene. In order to address these cost pressures, we have raised prices in some of our markets and are improving efficiencies in manufacturing.
The significant weakness in the new housing and residential remodeling markets which began several years ago appeared to ease somewhat in calendar 2012. We believe our niche strategy and our focus on productivity improvements and cost reductions have tempered somewhat the impact of the severe slowdown in the housing market; however, it is not possible to know when improved market conditions and a housing recovery will become sustainable over the long-term.
According to the National Association of Home Builders, the most current 10- and 50-year averages for new housing starts were 1.2 million and 1.5 million units, respectively. New housing starts were 0.6 million units and 0.8 million units in calendar 2011 and 2012, respectively. Further, during the last 50 years, the five years with the lowest number of housing starts were the five calendar years 2008 through 2012. In December 2012, the seasonally adjusted annual number of new housing starts was 1.0 million units.
Given our market leadership positions and reduced cost structure, we believe that we are positioned to benefit from a sustained recovery in the housing market when it occurs. We believe the long-term growth prospects in the industry are strong because the current seasonally-adjusted annualized housing starts are still well below the 10- and 50-year averages. Also, according to a 2012 report by the Harvard Joint Center for Housing Studies, household growth is projected to average 1.2 million units a year from 2010 to 2020.
Heavy Construction Materials Segment. Heavy construction materials revenues for 2012 were $68.2 million with a corresponding gross profit of $14.6 million. Heavy construction materials revenues for 2011 were $63.1 million with a corresponding gross profit of $16.0 million. We experienced revenue growth in CCP services provided to utilities, as incremental revenue from new projects more than offset the effect of unplanned outages and lower electricity demand at other utility sites. Primarily due to seasonality, CCP service revenue as a percent of total segment revenue is higher in the December and March quarters, and represented approximately 33% of heavy construction materials revenue for 2012, compared to 28% for the 2012 fiscal year. Revenues from the sale of fly ash were relatively flat in the quarter, notwithstanding the impact of normal weather patterns in the Texas and Midwest markets this year and the completion of major projects in the West.
Gross profit decreased by 9% to $14.6 million in 2012, compared to $16.0 million in 2011 and gross margin decreased by 400 basis points to 21.4%. Operating income was $7.6 million in 2012 compared to $8.8 million in 2011. The declines in gross profit and operating income were primarily due to lower demand for services from certain utilities, geographic changes in fly ash sales, and to non-recurring high-margin project revenue recorded in 2011.
According to the Portland Cement Association (PCA), calendar 2012 cement consumption increased 8.9% over calendar 2011. It is not possible to accurately predict the future trends of either cement consumption or cement prices, nor the correlation between cement usage and prices and fly ash sales and prices. Nevertheless, because fly ash is sold as an admixture for the partial replacement of portland cement in a wide variety of concrete uses-including infrastructure, commercial, and residential construction-statistics and trends for portland and blended cement sales can be an indicator for fly ash sales. The PCA recently increased its cement consumption forecast for calendar 2013 to an estimated annual growth rate of 8.1%, citing improved new residential construction as the major driver. The PCA projection for calendar 2014 estimates an 8.3% growth rate and the long-range projections for calendar years 2015 - 2017 estimate annual growth rates could be as high as 9.2%. The PCA also indicated that the year-over-year comparison for the March 2013 quarter may not be positive due to a more normal weather pattern in 2013 as compared to the mild winter conditions experienced last year.
Low natural gas prices and EPA regulations, along with reduced power demand, have combined to force the long-term shutdown or temporary idling of several coal combustion power plant units (primarily older, smaller units), negatively impacting the supply of CCPs for beneficial use in certain areas. This trend, which is currently expected to continue in 2013 and beyond, until the industry adjusts to requirements to update coal burning plants, has impacted somewhat our CCP supplies in certain regions of the country; however, we have multiple sources of supply and a broad distribution system, which allows us to move CCPs to locations where power plant units have closed, creating an opportunity for potential growth. Reallocating CCP supplies can increase our transportation costs, some but not all of which we have historically been able to pass on to customers.
During the December 2012 quarter, there were no further developments in Congress related to a legislative solution for the EPA's proposed rules for the disposal of fly ash. A senior EPA official indicated in early January 2013 the EPA still cannot provide a definitive time for promulgating final regulations on the management of coal ash from power plants. However, he also said the EPA "want[s] to continue to support the safe beneficial reuse of coal ash [and believes] the safe and environmentally sound recycling [of coal ash] is protective of all public health and provides economic opportunities and jobs. The proposed rule maintains the regulatory exemption for beneficial reuse." We do not anticipate any significant developments in the near term unless action is required by the courts as a result of litigation filed by environmental organizations last year. We remain optimistic that the ultimate outcome of either a legislative solution or rule making by the EPA will support beneficial use of fly ash.
Energy Technology Segment. Energy technology segment revenues for 2012 were $4.7 million with a corresponding gross profit of $2.5 million. Revenues for 2011 were $1.0 million with a corresponding gross profit of $0.4 million. Following the decision to sell the coal cleaning business in fiscal 2011 and the sale of our interest in the Blue Flint ethanol plant in January 2012, our energy technology segment currently consists primarily of operations related to our heavy oil upgrading catalyst. HCAT sales in 2012 were at a more normal level than in 2011, when our major customer was completing a turnaround at its refinery and had inventory on hand to meet its reduced needs. Currently, two customer refineries are using HCAT to improve conversion of heavy oil to lighter liquids.
Operating Expenses. Amortization of intangible assets decreased in 2012 from 2011 due to assets that have been fully amortized. Selling, general and administrative expenses increased approximately $3.4 million, from $21.3 million in 2011 to $24.7 million in 2012. The increase was primarily attributable to a $1.6 million increase in performance-based compensation expense in 2012 over 2011 and $0.9 million of costs in 2012 for the Kleer Lumber acquisition. The increase in performance-based compensation related primarily to outstanding cash-settled SARs. Our stock price increased significantly during the December 2012 quarter, resulting in an increased liability for those awards in 2012.
In 2011, we recorded $1.4 million of restructuring costs as a result of actions taken in fiscal 2011 to lower operating costs and improve operational efficiency, primarily in the light building products segment. This restructuring effort was completed in the March 2012 quarter and no additional restructuring costs related to the fiscal 2011 actions have been incurred since that time.
Other Income and Expense. For 2012, we reported net other expense of $10.4 million, compared to net other expense of $16.6 million for 2011. The decrease of $6.2 million was comprised of a decrease in net interest expense of approximately $2.0 million and a decrease in net other expense of approximately $4.2 million.
Net interest expense decreased from $12.5 million in 2011 to $10.5 million in 2012, due primarily to reduced debt discount and debt issue cost amortization related to our convertible senior subordinated notes. The average balance of outstanding convertible notes decreased in 2012 from 2011 and there was approximately $0.9 million of accelerated debt discount and debt issue costs charged to interest expense in 2011 related to the early repayment of $7.5 million of convertible notes. Absent interest expense related to any future early retirements of long-term debt, interest expense in fiscal 2013 is currently expected to total approximately $42.0 million.
The decrease in net other expense of $4.2 million in 2012 compared to 2011 was primarily the result of approximately $6.1 million of loss in 2011 related to our equity interest in the Blue Flint joint venture which was sold effective January 1, 2012, partially offset by a gain of $2.0 million from the early repayment of convertible debt in 2011.
Income Tax Provision. See Note 8 to the consolidated financial statements for a description of the reasons for the negative (14)% estimated effective income tax rate (exclusive of $0.6 million of benefit for discrete items) used to record income tax expense for 2011 and the 12% rate used to record income tax benefit for 2012, including the reasons for recording a valuation allowance on our net operating losses, tax credits and other deferred tax assets in both periods. We currently do not expect to recognize benefit for tax credit carryforwards or net operating loss (NOL) carryforwards in fiscal 2013 except to the extent of projected fiscal 2013 earnings. In addition, we also expect to record a valuation allowance on our net amortizable deferred tax assets until some point in time after our return to profitability.
Discontinued Operations. The loss from discontinued operations for 2012 was approximately $(2.0) million, compared to a loss in 2011 of $(10.5) million, which included approximately $5.2 million of non-cash accruals. In January 2013, we sold all of the remaining coal cleaning facilities and we currently expect to recognize a gain on this sale transaction, which will be recorded in the March 2013 quarter. We also expect to have some operating losses in the March 2013 quarter, primarily related to operations for the period of time prior to the date of sale.
Impact of Inflation and Related Matters
In certain periods, some of our operations have been negatively impacted by increased raw materials costs for commodities such as polypropylene, poly-vinyl chloride and cement in the light building products segment. During fiscal 2011 and 2012, we experienced some significant cost increases for certain raw materials and transportation fuel. We currently believe it is possible that costs for raw materials and other commodities such as fuels, along with the prices of other goods and services, could continue to increase in future periods. We have passed through certain increased raw materials costs to customers, but it is not possible to accurately predict the future trends of these costs, nor our ability to pass on future price increases.
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