Headwaters Incorporated (NYSE:HW) announced results for the quarter ended December 31, 2006, the first quarter of its fiscal 2007 year.
Headwaters’ total revenue for the December 2006 quarter was $274.9 million, down 2% from $280.5 million reported for the December 2005 quarter. Operating income decreased 33% to $33.9 million in the December 2006 quarter compared to $50.3 million in the December 2005 quarter. Net income for the December 2006 quarter was $17.0 million or $0.37 of earnings per diluted share, down 38% from the December 2005 quarter of $28.3 million or $0.60 of earnings per diluted share.
Highlights for the quarter include:
– Record quarter in coal combustion products driven by demand and pricing
– Completed acquisition of Dutch Quality Stone
– Strong performance in Section 45K synfuel business on lower oil prices
– Third HCAT(TM) commercial run successfully completed
– Investment in coal cleaning business continues; additional waste coal resources acquired
Continuing softness in the residential housing and remodeling markets impacted the December 2006 quarter results. Comparisons to the prior year include the partial phase-out of Section 45K in 2006, and the effect of the soft residential construction market on both revenue and margins of Headwaters’ construction materials business. Headwaters continues the process of transitioning away from its Section 45K business.
In January 2007, Headwaters commenced a recapitalization that will result in improved earnings and less dilution to shareholders. They have completed the first two steps in the recapitalization, consisting of a technical amendment to the existing senior credit facility and raising $160 million of 2.50% convertible senior subordinated notes with an effective conversion price, after taking into consideration a call spread, of $35 per share. Most of the proceeds have been used to retire senior debt. The net effect of the above refinancing actions will be to reduce interest expense by approximately $7.0 million annually due to the lower interest rate of 2.50% on the convertible senior subordinated notes versus the higher interest rate on existing indebtedness.
Operating Performance
Building Materials. Revenues from Headwaters’ coal combustion products (CCPs) segment during the December 2006 quarter increased $4.0 million or 6%, from $65.2 million to $69.2 million versus the December 2005 quarter. Operating margin increased to 18.0% compared to 14.5% in the December 2005 quarter.
The increases in revenue and operating margin resulted from strong product demand and upward pricing trends in several cement markets. The company is expanding its distribution and storage system to meet the increased interest in substituting fly ash for portland cement.
Consistent with industry trends, revenues from Headwaters’ construction materials segment during the December 2006 quarter continue to be affected negatively by a downturn in the residential housing and remodeling markets. Revenues for the December 2006 quarter were $122.8 million, compared to $130.0 million for the December 2005 quarter. Operating margin decreased to 5.3% for the December 2006 quarter compared to 11.5% in the prior year quarter, primarily caused by lower fixed cost absorption and increased raw material costs.
The company expects revenues and margins to improve in the June and September quarters because of higher seasonal demand and as industry conditions improve. As residential construction and remodeling rebound, they anticipate that margins should return to historical levels.
Alternative Energy Segment. Headwaters completed both its second and third commercial runs of its heavy oil upgrading technology in which HCAT is used as an additive to improve the operation of a commercial ebullated bed resid hydrocracker at a large scale refinery.
The company believes the economic opportunity associated with increased conversion of heavy crude oils into lighter transportation fuels like diesel and gasoline is quite large, potentially creating more than $50 billion of net present value for the refining industry.
The construction of Headwaters’ ethanol manufacturing facility continues on schedule and should begin production during the March 2007 quarter. Based on the equity method of accounting, and given today’s corn and ethanol prices, they expect the facility in fiscal 2007 to produce net revenue to Headwaters of $2 million to $3 million, on gross revenues to the joint venture of over $70 million.
Scott K. Sorensen, Headwaters’ Chief Financial Officer, stated, “Our financial performance for the first fiscal quarter was positively impacted by lower oil prices, which improved our Section 45K business, as well as continued strength in the coal combustion products business. However, we are also experiencing more downward pressure on our construction materials segment than expected. The December and March quarters are seasonally low quarters for Headwaters, and because of the seasonality, the profitability of our construction materials businesses is weighted to the June and September quarters. We will not know how our construction materials business will perform in 2007 until we are further into the year, but we are comfortable confirming our overall guidance of $1.60 to $1.80 for 2007, and we believe that there is upside to this guidance.”
“We are very excited about the positive results from our HCAT commercial runs,” said Kirk A. Benson, Chairman and Chief Executive Officer. “HCAT has the potential to be a disruptive heavy oil upgrading technology and alter the economics of the upgrading process. We look forward to continued coordination of additional commercial runs with refineries around the world.”
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