UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549


                                    FORM 10-Q


         [X]      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                  SECURITIES EXCHANGE ACT OF 1934

                  For the quarterly period ended March 31, 2004

                                       or

         [ ]      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                  SECURITIES EXCHANGE ACT OF 1934

                 For the transition period from ______ to ______

                         Commission file number 0-27808


                             HEADWATERS INCORPORATED
              -----------------------------------------------------
             (Exact name of registrant as specified in its charter)


            Delaware                                      87-0547337
  --------------------------------          ------------------------------------
  (State or other jurisdiction of           (I.R.S. Employer Identification No.)
   incorporation or organization)

       10653 South River Front Parkway, Suite 300
                   South Jordan, Utah                           84095
       -------------------------------------------            ----------
        (Address of principal executive offices)              (Zip Code)

                                 (801) 984-9400
               ---------------------------------------------------
              (Registrant's telephone number, including area code)


                                 Not applicable
               ---------------------------------------------------
              (Former name, former address and former fiscal year,
                         if changed since last report)


Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]


The number of shares outstanding of the Registrant's common stock as of April
23, 2004 was 33,571,000.

<PAGE>

                             HEADWATERS INCORPORATED

                                TABLE OF CONTENTS


PART I - FINANCIAL INFORMATION
                                                                        Page No.
     ITEM 1.  FINANCIAL STATEMENTS (Unaudited):
              Condensed Consolidated Balance Sheets - As of
                September 30, 2003 and March 31, 2004........................ 3
              Condensed Consolidated Statements of Income - For the three
                and six months ended March 31, 2003 and 2004................. 4
              Condensed Consolidated Statement of Changes in Stockholders'
                Equity - For the six months ended March 31, 2004............. 5
              Condensed Consolidated Statements of Cash Flows - For the six
                months ended March 31, 2003 and 2004......................... 6
              Notes to Condensed Consolidated Financial Statements........... 7
     ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
             AND RESULTS OF OPERATIONS.......................................18
     ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK......24
     ITEM 4. CONTROLS AND PROCEDURES.........................................24

PART II - OTHER INFORMATION

     ITEM 1.  LEGAL PROCEEDINGS..............................................25
     ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS......................25
     ITEM 3.  DEFAULTS UPON SENIOR SECURITIES................................25
     ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............25
     ITEM 5.  OTHER INFORMATION..............................................26
     ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K...............................26

SIGNATURES...................................................................27


Forward-looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995 regarding
future events and our future results that are based on current expectations,
estimates, forecasts, and projections about the industries in which we operate
and the beliefs and assumptions of our management. Actual results may vary
materially from such expectations. Words such as "expects," "anticipates,"
"targets," "goals," "projects," "believes," "seeks," "estimates," variations of
such words and similar expressions are intended to identify such forward-looking
statements. In addition, any statements that refer to projections of our future
financial performance, our anticipated growth and trends in our businesses, and
other characterizations of future events or circumstances, are forward-looking.
For a discussion of the factors that could cause actual results to differ from
expectations, please see the captions entitled "Forward-looking Statements" and
"Risk Factors" in Item 7 of our Annual Report on Form 10-K for the year ended
September 30, 2003. There can be no assurance that our results of operations
will not be adversely affected by such factors. Unless legally required, we
undertake no obligation to revise or update any forward-looking statements for
any reason. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date of this report.

Our internet address is www.hdwtrs.com. There we make available, free of charge,
our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports
on Form 8-K and any amendments to those reports, as soon as reasonably
practicable after we electronically file such material with, or furnish it to,
the Securities and Exchange Commission ("SEC"). Our reports can be accessed
through the investor relations section of our web site. The information found on
our web site is not part of this or any report we file or furnish to the SEC.

                                       2
<PAGE>

ITEM 1.  FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
                                                 HEADWATERS INCORPORATED

                                          CONDENSED CONSOLIDATED BALANCE SHEETS
                                                       (Unaudited)

                                                                                           September 30,        March 31,
(in thousands, except per-share data)                                                               2003             2004
--------------------------------------------------------------------------------------- ----------------- ----------------

ASSETS
<S>                                                                                         <C>              <C>
Current assets:
     Cash and cash equivalents                                                              $     18,732     $      4,535
     Short-term trading investments                                                                2,921           33,568
     Trade receivables, net                                                                       52,399           87,024
     Inventories                                                                                   7,827            9,924
     Other current assets                                                                          6,005            5,957
                                                                                            ------------     ------------
            Total current assets                                                                  87,884          141,008
                                                                                            ------------     ------------

Property, plant and equipment, net                                                                52,743           53,747
                                                                                            ------------     ------------

Other assets:
     Intangible assets, net                                                                      112,414          110,121
     Goodwill                                                                                    112,131          112,131
     Debt issue costs and other assets                                                             8,103            4,703
                                                                                            ------------     ------------
            Total other assets                                                                   232,648          226,955
                                                                                            ------------     ------------

            Total assets                                                                    $    373,275     $    421,710
                                                                                            ============     ============

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
     Accounts payable                                                                       $     17,177     $     10,957
     Accrued personnel costs                                                                       8,669           11,919
     Other accrued liabilities                                                                    16,522           23,936
     Current portion of long-term debt                                                            27,475            5,012
     Current portion of unamortized non-refundable license fees                                    3,865            2,066
                                                                                            ------------     ------------
            Total current liabilities                                                             73,708           53,890
                                                                                            ------------     ------------

Long-term liabilities:
     Long-term debt                                                                              104,044           45,035
     Deferred income taxes                                                                        50,663           51,273
     Unamortized non-refundable license fees and other long-term liabilities                       4,703            3,860
                                                                                            ------------     ------------
            Total long-term liabilities                                                          159,410          100,168
                                                                                            ------------     ------------
            Total liabilities                                                                    233,118          154,058
                                                                                            ------------     ------------

Commitments and contingencies

Stockholders' equity:
     Common stock, $0.001 par value; authorized 50,000 shares, issued and
       outstanding 27,878 shares at September 30, 2003 (including 467 shares
       held in treasury) and 33,413 shares at March 31, 2004 (including 437
       shares held in treasury)                                                                       28               33
     Capital in excess of par value                                                              130,936          229,562
     Retained earnings                                                                            12,213           40,932
     Treasury stock, at cost                                                                      (2,783)          (2,683)
     Other                                                                                          (237)            (192)
                                                                                            ------------     ------------
            Total stockholders' equity                                                           140,157          267,652
                                                                                            ------------     ------------

            Total liabilities and stockholders' equity                                      $    373,275     $    421,710
                                                                                            ============     ============


                                                     See accompanying notes.

                                                               3
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
                                                   HEADWATERS INCORPORATED

                                         CONDENSED CONSOLIDATED STATEMENTS OF INCOME
                                                          (Unaudited)

                                                                          Three Months Ended                 Six Months Ended
                                                                                   March 31,                        March 31,
                                                            --------------------------------- --------------------------------
(in thousands, except per-share data)                                  2003             2004             2003            2004
----------------------------------------------------------- ---------------- ---------------- ---------------- ---------------
<S>                                                            <C>              <C>              <C>             <C>
Revenue:
     Sales of chemical reagents                                $     33,123     $     32,229     $     62,191    $     63,109
     License fees                                                     8,948           36,277           17,726          45,832
     Coal combustion products revenues                               31,168           39,592           69,454          84,692
     Sales of construction materials                                 11,700           11,248           22,784          23,181
     Other revenues                                                   1,114              175            2,607           4,175
                                                               ------------     ------------     ------------    ------------
          Total revenue                                              86,053          119,521          174,762         220,989
                                                               ------------     ------------     ------------    ------------

Operating costs and expenses:
     Cost of chemical reagents sold                                  21,782           21,759           40,793          43,019
     Cost of coal combustion products revenues                       23,422           28,501           51,418          60,746
     Cost of construction materials sold                              8,672            9,789           17,077          19,256
     Cost of other revenues                                           1,135              252            2,132             317
     Depreciation and amortization                                    3,167            3,239            6,251           6,507
     Research and development                                         1,106            1,460            2,120           3,456
     Selling, general and administrative                             10,001           16,498           20,225          27,617
                                                               ------------     ------------     ------------    ------------
        Total operating costs and expenses                           69,285           81,498          140,016         160,918
                                                               ------------     ------------     ------------    ------------

Operating income                                                     16,768           38,023           34,746          60,071
                                                               ------------     ------------     ------------    ------------

Other income (expense):
     Interest and net investment income                                  81              314              171             362
     Interest expense                                                (3,541)          (6,011)          (8,068)        (11,350)
     Losses on notes receivable                                      (2,142)            (504)          (2,142)         (1,038)
     Other, net                                                          23           (1,385)              84          (1,356)
                                                               ------------     ------------     ------------    ------------
          Total other income (expense), net                          (5,579)          (7,586)          (9,955)        (13,382)
                                                               ------------     ------------     ------------    ------------

Income before income taxes                                           11,189           30,437           24,791          46,689

Income tax provision                                                 (4,400)         (11,810)          (9,950)        (17,970)
                                                               ------------     ------------     ------------    ------------

Net income                                                     $      6,789     $     18,627     $     14,841    $     28,719
                                                               ============     ============     ============    ============

Basic earnings per common share                                $       0.25     $       0.57     $       0.55    $       0.95
                                                               ============     ============     ============    ============

Diluted earnings per common share                              $       0.24     $       0.55     $       0.53    $       0.91
                                                               ============     ============     ============    ============



                                                     See accompanying notes.

                                                               4
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
                                                     HEADWATERS INCORPORATED

                         CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)
                                             For the Six Months Ended March 31, 2004



                                         Common stock       Capital in                                                   Total
                                      -------------------     excess       Retained      Common stock                stockholders'
(in thousands)                         Shares    Amount    of par value    earnings    held in treasury     Other       equity
----------------------------------    --------- --------- -------------- ------------ ------------------ ---------- --------------
<S>                                     <C>      <C>        <C>           <C>           <C>             <C>         <C>
Balances as of September 30, 2003       27,878       $28       $130,936     $12,213        $(2,783)        $(237)      $140,157

Common stock issued for cash, net
 of offering costs of $6,387             4,958         5         90,298                                                  90,303

Exercise of stock options and
 warrants                                  577        --          5,082                                                   5,082

Tax benefit from exercise of
 stock options and warrants                                       2,910                                                   2,910

30 shares of treasury stock
 transferred to employee stock
 purchase plan, at cost                                             336                        100                          436

Amortization of deferred
 compensation from stock
 options                                                                                                      45             45

Net income for the six months
 ended March 31, 2004                                                        28,719                                      28,719
                                        ------   -------    -----------   ---------     ----------      --------    -----------
Balances as of March 31, 2004           33,413   $    33    $   229,562   $  40,932     $   (2,683)     $   (192)   $   267,652
                                        ======   =======    ===========   =========     ==========      ========    ===========


                                                     See accompanying notes.

                                                                5
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
                                                     HEADWATERS INCORPORATED

                                         CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                                           (Unaudited)

                                                                                                 Six Months Ended March 31,
                                                                                               --------------------------------
     (in thousands)                                                                                      2003             2004
---------------------------------------------------------------------------------------------- --------------- ----------------
<S>                                                                                              <C>             <C>
  Cash flows from operating activities:
  Net income                                                                                     $     14,841    $     28,719
  Adjustments to reconcile net income to net cash provided by (used in)
    operating activities:
      Depreciation and amortization                                                                     6,251           6,507
      Non cash interest expense related to amortization of debt discount
       and debt issue costs                                                                             1,604           7,631
      Deferred income taxes                                                                               322             743
      Income tax benefit from exercise of stock options                                                   750           2,910
      Amortization of non-refundable license fees                                                        (589)           (590)
      Net loss (gain) on disposition of property, plant and equipment                                    (116)            663
      Write-down of notes receivable                                                                    2,142           1,038
      Decrease (increase) in trade receivables                                                            493         (34,625)
      Decrease (increase) in short-term trading investments                                             3,121         (30,647)
      Other changes in operating assets and liabilities, net                                          (11,011)            592
                                                                                                 ------------    ------------
  Net cash provided by (used in) operating activities                                                  17,808         (17,059)
                                                                                                 ------------    ------------

  Cash flows from investing activities:
    Purchase of property, plant and equipment                                                          (2,910)         (4,890)
    Proceeds from disposition of property, plant and equipment                                            162              53
    Increase in intangible assets                                                                          --          (1,045)
    Net increase in other assets                                                                         (407)         (1,406)
                                                                                                 ------------    ------------
  Net cash used in investing activities                                                                (3,155)         (7,288)
                                                                                                 ------------    ------------

  Cash flows from financing activities:
    Net proceeds from issuance of common stock                                                             --          90,303
    Net proceeds from issuance of long-term debt                                                           --          49,205
    Payments on long-term debt                                                                        (15,137)       (134,876)
    Proceeds from exercise of options and warrants                                                        692           5,082
    Employee stock purchases                                                                              390             436
                                                                                                 ------------    ------------
  Net cash provided by (used in) financing activities                                                 (14,055)         10,150
                                                                                                 ------------    ------------

  Net increase (decrease) in cash and cash equivalents                                                    598         (14,197)

  Cash and cash equivalents, beginning of period                                                        7,284          18,732
                                                                                                 ------------    ------------

  Cash and cash equivalents, end of period                                                       $      7,882    $      4,535
                                                                                                 ============    ============


                                                     See accompanying notes.

                                                               6
</TABLE>
<PAGE>

                             HEADWATERS INCORPORATED

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 March 31, 2004
                                   (Unaudited)


1.   Nature of Operations and Basis of Presentation

     Operations - Headwaters Incorporated is incorporated in Delaware.
     Headwaters owns 100% of Industrial Services Group, Inc. ("ISG"), a
     Utah-based company acquired by Headwaters in September 2002, and 100% of
     Headwaters Technology Innovation Group, Inc. ("HTI") (formerly Hydrocarbon
     Technologies, Inc.), a New Jersey company acquired by Headwaters in August
     2001. In addition, as described in more detail in Note 11, Headwaters
     acquired VFL Technology Corporation in April 2004 and has entered into a
     purchase agreement to acquire the ownership interests of Eldorado Stone,
     LLC. Headwaters' focus is on enhancing the value of coal, gas, oil and
     other natural resources. Headwaters currently generates revenue from
     licensing its chemical technologies to produce synthetic fuel and from
     managing coal combustion products ("CCPs"). Headwaters intends to continue
     to expand its business through growth of existing operations,
     commercialization of technologies currently being developed, and strategic
     acquisitions of entities that operate in adjacent industries.

     Through its proprietary Covol Fuels process, Headwaters adds value to the
     production of coal-based solid synthetic fuels primarily for use in
     electric power generation plants. Headwaters currently licenses its
     technologies to the owners of 28 of a company-estimated 75 coal-based solid
     synthetic fuel facilities in the United States. ISG, through its
     wholly-owned subsidiary ISG Resources, Inc., is the nation's largest
     provider of CCP management and marketing services to the electric power
     industry, serving more than 100 coal-fired electric power generation plants
     nationwide. Through its distribution network of over 110 locations, ISG is
     the leading provider of high quality fly ash to the building products and
     ready mix concrete industries in the United States. ISG's construction
     materials segment develops, manufactures and distributes value-added bagged
     concrete, stucco, mortar and block products that utilize fly ash. ISG also
     develops and deploys technologies for maintaining and improving fly ash
     quality. Headwaters, through its wholly-owned subsidiary HTI, conducts
     research and development activities directed at catalyst technologies to
     convert coal and heavy oil into environmentally-friendly, high-value liquid
     fuels. In addition, HTI has developed a unique process to custom design
     nanocatalysts that could be used in multiple industrial applications.

     Basis of Presentation - The accompanying unaudited condensed consolidated
     financial statements have been prepared in accordance with the rules and
     regulations of the Securities and Exchange Commission ("SEC") for quarterly
     reports on Form 10-Q. In the opinion of management, all adjustments
     considered necessary for a fair presentation have been included, and
     consist of normal recurring adjustments, including adjustments for the
     transactions described in Notes 6, 9, 10 and 11. Certain information and
     footnote disclosures normally included in financial statements prepared in
     accordance with accounting principles generally accepted in the United
     States have been condensed or omitted. These financial statements should be
     read in conjunction with the consolidated financial statements and notes
     thereto included in Headwaters' Annual Report on Form 10-K for the year
     ended September 30, 2003 ("Form 10-K") and in Headwaters' Quarterly Report
     on Form 10-Q for the quarter ended December 31, 2003.

     Headwaters' fiscal year ends on September 30 and unless otherwise noted,
     future references to 2003 refer to Headwaters' fiscal quarter and/or
     six-month period ended March 31, 2003, and references to 2004 refer to
     Headwaters' fiscal quarter and/or six-month period ended March 31, 2004.
     The consolidated financial statements include the accounts of Headwaters
     and all of its subsidiaries, only two of which have significant operations,
     ISG and HTI. All significant intercompany transactions and accounts are
     eliminated in consolidation. Due to the time required to obtain accurate
     financial information related to HTI's foreign contracts, for financial
     reporting purposes HTI's financial statements have historically been
     consolidated with Headwaters' financial statements using a one-month lag.
     Effective October 1, 2003, Headwaters eliminated this one-month lag because
     of the decreased significance of HTI's foreign contracts. Accordingly,
     seven months of HTI's results of operations have been included in the
     consolidated statement of income for the six months ended March 31, 2004.
     Due to the seasonality of ISG's business and other factors, Headwaters'
     consolidated results of operations for 2004 are not indicative of the
     results to be expected for the full fiscal 2004 year.

     Common Stock Options - Headwaters has elected to continue to apply the
     intrinsic value method as prescribed by APB 25 in accounting for options
     granted to employees, officers and directors and does not currently plan to
     change to the fair value method unless required by changes in accounting
     standards. The alternative fair value method of accounting prescribed by
     SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"),

                                       7
<PAGE>

                             HEADWATERS INCORPORATED

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 March 31, 2004
                                   (Unaudited)


     requires the use of option valuation models that were developed for use in
     valuing traded stock options, as discussed below. Under APB 25, no
     compensation expense is recognized for stock option grants to employees,
     officers and directors when the exercise price of stock options equals or
     exceeds the market price of Headwaters' common stock on the date of grant.

     In years prior to 1998, certain options were granted with terms considered
     compensatory. In such instances, the related compensation cost is amortized
     to expense over the applicable vesting period on a straight-line basis.
     Amortized compensation expense related to compensatory options granted in
     prior years was approximately $22,000 for each of the three-month periods
     ended March 31, 2003 and 2004 and approximately $45,000 for each of the
     six-month periods ended March 31, 2003 and 2004. If the fair value
     provision of SFAS No. 123 would have been applied to all options granted,
     compensation expense would have been approximately $932,000 and $1,021,000
     for the three months ended March 31, 2003 and 2004, respectively, and
     approximately $1,765,000 and $2,015,000 for the six months ended March 31,
     2003 and 2004, respectively, and net income and earnings per share would
     have been changed to the pro forma amounts shown in the table below.
<TABLE>
<CAPTION>
                                                         Three Months Ended March 31,    Six Months Ended March 31,
                                                      -------------------------------- -----------------------------
         (in thousands, except per-share data)                   2003            2004          2003            2004
         -------------------------------------------- ---------------- --------------- ------------- ---------------
         <S>                                             <C>             <C>           <C>             <C>
         Net income - as reported                        $      6,789    $     18,627  $     14,841    $     28,719

         Pro forma additional compensation expense               (910)           (999)       (1,720)         (1,970)
                                                         ------------    ------------  ------------    ------------
         Net income - pro forma                          $      5,879    $     17,628  $     13,121    $     26,749
                                                         ============    ============  ============    ============


         Basic earnings per share - as reported          $       0.25    $       0.57  $       0.55    $       0.95
                                  - pro forma            $       0.22    $       0.54  $       0.49    $       0.88

         Diluted earnings per share - as reported        $       0.24    $       0.55  $       0.53    $       0.91
                                    - pro forma          $       0.21    $       0.52  $       0.47    $       0.85
</TABLE>


     The fair values of stock option grants for 2003 and 2004 were determined
     using the Black-Scholes option pricing model and the following assumptions:
     expected stock price volatility of 40% to 60%, risk-free interest rates
     ranging from 1.3% to 4.0%, weighted average expected option lives of 4 to 5
     years, and no dividend yield. The Black-Scholes option valuation model was
     developed for use in estimating the fair value of traded options that have
     no vesting restrictions and that are fully transferable. In addition,
     option valuation models require the input of highly subjective assumptions
     including expected stock price volatility. Because Headwaters' stock
     options have characteristics significantly different from those of traded
     options, and because changes in the subjective input assumptions can
     materially affect their fair value, in management's opinion, the existing
     models do not necessarily provide a reliable measure of the fair value of
     stock options.

     Reclassifications - Certain prior period amounts have been reclassified to
     conform with the current period's presentation. The reclassifications had
     no effect on net income or total assets.

     Recent Accounting Pronouncements - Headwaters has reviewed all recently
     issued accounting standards that have not yet been adopted in order to
     determine their potential effect, if any, on the results of operations or
     financial position of Headwaters. Based on that review, Headwaters does not
     currently believe that any of these recent accounting pronouncements will
     have a significant effect on its current or future financial position,
     results of operations, cash flows or disclosures.

                                       8
<PAGE>

                             HEADWATERS INCORPORATED

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 March 31, 2004
                                   (Unaudited)


2.   Segment Reporting

     The following segment information has been prepared in accordance with SFAS
     No. 131, "Disclosure about Segments of an Enterprise and Related
     Information," all as explained in more detail in the notes to the financial
     statements in Headwaters' Form 10-K. Performance of the segments is
     evaluated primarily on operating income. Intersegment sales are immaterial.
     Segment costs and expenses considered in deriving segment operating income
     include cost of revenues, depreciation and amortization, research and
     development, and segment-specific selling, general and administrative
     expenses. Amounts included in the "Corporate" column represent expenses not
     specifically attributable to any segment and include administrative
     departmental costs and general corporate overheads. Segment assets reflect
     those specifically attributable to individual segments and primarily
     include accounts receivable, inventories, property, plant and equipment,
     intangible assets and goodwill. Other assets are included in the
     "Corporate" column.
<TABLE>
<CAPTION>
                                                   Alternative                Construction
       (in thousands)                                Energy        CCPs         Materials      Corporate     Totals
       ------------------------------------------ ------------- ------------ ---------------- ------------ -----------
       <S>                                          <C>          <C>              <C>           <C>         <C>
       Three Months Ended March 31, 2003

       Segment revenue                              $   43,185   $   31,168       $   11,700    $      --   $    86,053
                                                    ==========   ==========       ==========    =========   ===========

       Depreciation and amortization                $     (317)  $   (2,638)      $     (124)   $     (88)  $    (3,167)
                                                    ==========   ==========       ==========    =========   ===========

       Operating income (loss)                      $   17,480   $    1,918       $    1,145    $  (3,775)  $    16,768
                                                    ==========   ==========       ==========    =========
            Net interest expense                                                                                 (3,460)
            Other income (expense), net                                                                          (2,119)
            Income tax provision                                                                                 (4,400)
                                                                                                            -----------
       Net income                                                                                           $     6,789
                                                                                                            ===========


       Capital expenditures                         $       20   $    1,789       $      372    $      11   $     2,192
                                                    ==========   ==========       ==========    =========   ===========

       Three Months Ended March 31, 2004

       Segment revenue                              $   68,681   $   39,592       $   11,248    $      --   $   119,521
                                                    ==========   ==========       ==========    =========   ===========

       Depreciation and amortization                $     (310)  $   (2,700)      $     (162)   $     (67)  $    (3,239)
                                                    ==========   ==========       ==========    =========   ===========

       Operating income (loss)                      $   40,893   $    4,814       $     (904)   $  (6,780)  $    38,023
                                                    ==========   ==========       ==========    =========
            Net interest expense                                                                                 (5,697)
            Other income (expense), net                                                                          (1,889)
            Income tax provision                                                                                (11,810)
                                                                                                            -----------
       Net income                                                                                           $    18,627
                                                                                                            ===========

       Capital expenditures                         $      165   $    1,553       $       47    $      19   $     1,784
                                                    ==========   ==========       ==========    =========   ===========
</TABLE>

                                       9
<PAGE>

                             HEADWATERS INCORPORATED

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 March 31, 2004
                                   (Unaudited)

<TABLE>
<CAPTION>
                                                   Alternative                Construction
       (in thousands)                                Energy        CCPs         Materials      Corporate     Totals
       ------------------------------------------ ------------- ------------ ---------------- ------------ -----------
       <S>                                          <C>          <C>              <C>           <C>         <C>
       Six Months Ended March 31, 2003

       Segment revenue                              $   82,524   $   69,454       $   22,784    $      --   $   174,762
                                                    ==========   ==========       ==========    =========   ===========

       Depreciation and amortization                $     (640)  $   (5,177)      $     (298)   $    (136)  $    (6,251)
                                                    ==========   ==========       ==========    =========   ===========

       Operating income (loss)                      $   33,792   $    5,948       $    1,934    $  (6,928)  $    34,746
                                                    ==========   ==========       ==========    =========
            Net interest expense                                                                                 (7,897)
            Other income (expense), net                                                                          (2,058)
            Income tax provision                                                                                 (9,950)
                                                                                                            -----------
       Net income                                                                                           $    14,841
                                                                                                            ===========

       Capital expenditures                         $      129   $    2,357       $      400    $      24   $     2,910
                                                    ==========   ==========       ==========    =========   ===========

       Six Months Ended March 31, 2004

       Segment revenue                              $  113,116   $   84,692       $   23,181    $      --   $   220,989
                                                    ==========   ==========       ==========    =========   ===========

       Depreciation and amortization                $     (660)  $   (5,392)      $     (329)   $    (126)  $    (6,507)
                                                    ==========   ==========       ==========    =========   ===========

       Operating income (loss)                      $   59,429   $   11,136       $     (165)   $ (10,329)  $    60,071
                                                    ==========   ==========       ==========    =========
            Net interest expense                                                                                (10,988)
            Other income (expense), net                                                                          (2,394)
            Income tax provision                                                                                (17,970)
                                                                                                            -----------
       Net income                                                                                           $    28,719
                                                                                                            ===========

       Capital expenditures                         $      312   $    4,436       $      111    $      31   $     4,890
                                                    ==========   ==========       ==========    =========   ===========

       Segment Assets as of March 31, 2004          $   71,855   $  282,208       $   21,716    $  45,931   $   421,710
                                                    ==========   ==========       ==========    =========   ===========
</TABLE>

3.   Issuance of Securities

     Issuance of Common Stock - Headwaters has an effective universal shelf
     registration statement on file with the SEC that can be used for the sale
     of common stock, preferred stock, convertible debt and other securities. In
     December 2003, Headwaters filed a prospectus supplement to the shelf
     registration statement and issued 4,750,000 shares of common stock under
     this shelf registration statement in an underwritten public offering. In
     January 2004, an additional 208,457 shares of common stock were issued upon
     exercise of the underwriters' over-allotment option. In total, proceeds of
     $90,303,000 were received, net of offering costs of $6,387,000. Following
     these issuances of common stock, approximately $53,000,000 remains
     available for future offerings of securities under the shelf registration
     statement. A prospectus supplement describing the terms of any additional
     securities to be issued is required to be filed before any future offering
     would commence under the registration statement.

     2003 Stock Incentive Plan Awards - In March 2004, Headwaters' stockholders
     approved an increase in the number of shares available for award grants
     under Headwaters' 2003 Stock Incentive Plan by 1,500,000. In April 2004,
     Headwaters granted to officers and employees options to purchase
     approximately 430,000 shares of common stock and issued approximately
     54,000 shares of restricted common stock, all under terms of the 2003 Stock
     Incentive Plan. The stock options vest over five years and have an exercise
     price of $23.79 per share, the fair market value of Headwaters' common
     stock on the date of grant. The restricted stock was issued at no cost to
     the recipients and also vests over five years.

                                       10
<PAGE>

                             HEADWATERS INCORPORATED

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 March 31, 2004
                                   (Unaudited)


4.   Inventories

     Inventories consisted of the following at:

                                               September 30,
          (in thousands)                                2003   March 31, 2004
          ----------------------------------- --------------- ----------------

          Raw materials                           $    1,059       $      938
          Finished goods                               6,768            8,986
                                                  ----------       ----------
                                                  $    7,827       $    9,924
                                                  ==========       ==========

5.   Intangible Assets

     Intangible Assets - Headwaters has no intangible assets that are not being
     amortized. The following table summarizes the gross carrying amounts and
     the related accumulated amortization of all amortizable intangible assets
     as of:
<TABLE>
<CAPTION>
                                                           September 30, 2003                 March 31, 2004
                                                     -------------------------------- --------------------------------
                                                         Gross                            Gross
                                        Estimated       Carrying       Accumulated       Carrying       Accumulated
        (in thousands)                useful lives       Amount       Amortization        Amount       Amortization
        ----------------------------- -------------- --------------- ---------------- --------------- ----------------
        <S>                                               <C>               <C>            <C>               <C>
        ISG contracts                   20 years          $ 106,400         $  5,499       $ 106,400         $  8,159
        HTI patented technologies       15 years              9,700            1,293           9,700            1,670
        ISG patents                   7 1/2 years             2,764              373           2,764              557
        Other                         9 - 17 years            1,522              807           2,567              924
                                                          ---------         --------       ---------         --------
                                                          $ 120,386         $  7,972       $ 121,431         $ 11,310
                                                          =========         ========       =========         ========
</TABLE>

     Total amortization expense related to intangible assets was approximately
     $1,626,000 and $1,659,000 for the three months ended March 31, 2003 and
     2004, respectively, and approximately $3,252,000 and $3,338,000 for the six
     months ended March 31, 2003 and 2004, respectively. Total estimated annual
     amortization expense for fiscal year 2004 is approximately $6,630,000.
     Total estimated annual amortization expense for fiscal years 2005 through
     2007 is approximately $6,560,000 per year. Total estimated annual
     amortization expense for fiscal year 2008 is approximately $6,400,000.

6.   Long-term Debt

     Long-term debt consisted of the following at:
<TABLE>
<CAPTION>
                                                                           September 30,
        (in thousands)                                                              2003  March 31, 2004
        --------------------------------------------------------------- ----------------- ---------------
        <S>                                                                   <C>             <C>
        Senior secured debt                                                   $       --      $   50,000

        Senior secured debt with a face amount totaling $114,851,
         repaid in full as of March 31, 2004                                     111,766              --

        Senior subordinated debentures with a face amount totaling
         $20,000                                                                  19,682              --

        Other                                                                         71              47
                                                                              ----------      ----------
                                                                                 131,519          50,047
        Less: current portion                                                    (27,475)         (5,012)
                                                                              ----------      ----------
        Total long-term debt                                                  $  104,044      $   45,035
                                                                              ==========      ==========
</TABLE>

     New Senior Secured Credit Agreement - In March 2004, Headwaters entered
     into a credit agreement with a syndication of lenders under which a total
     of $50,000,000 was borrowed under a term loan arrangement and which
     provides for an additional $50,000,000 to be borrowed under a revolving
     credit arrangement. The initial $50,000,000 of proceeds were used to repay
     in full the remaining balance due under Headwaters' former Term B senior
     secured credit agreement.

     The $50,000,000 term loan is secured by all assets of Headwaters, bears
     interest at a variable rate (approximately 3.4% at March 31, 2004), and is
     repayable in quarterly installments of $1,250,000, commencing June 2004 and

                                       11
<PAGE>

                             HEADWATERS INCORPORATED

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 March 31, 2004
                                   (Unaudited)


     continuing through September 2007. The remaining principal of $32,500,000
     is repayable in November 2007, the termination date of the credit
     agreement. Optional prepayments of the term loan can be made at Headwaters'
     discretion, subject to certain minimum amount requirements specified in the
     credit agreement. Beginning December 31, 2004 and continuing each year
     thereafter, Headwaters must make mandatory prepayments to the extent of 50%
     of Headwaters' fiscal year "excess cash flows," as defined. Once repaid in
     full or in part, no further borrowings under the term loan arrangement can
     be made.

     The credit agreement contains restrictions and covenants common to such
     agreements, including limitations on the incurrence of additional debt,
     investments, merger and acquisition activity, asset liens, capital
     expenditures in excess of $15,000,000 in any fiscal year and the payment of
     dividends, among others. In addition, Headwaters must meet minimum net
     worth requirements and maintain certain financial ratios, including
     leverage ratios and a fixed charge coverage ratio, as those terms are
     defined in the credit agreement. The initial net worth requirement is
     $200,308,000 and is increased by 50% of Headwaters' consolidated net income
     earned subsequent to March 31, 2004. Headwaters must maintain a total
     leverage ratio of 2.5:1.0 or less and a senior debt leverage ratio of
     1.5:1.0 or less. Headwaters is in compliance with all debt covenants as of
     March 31, 2004.

     Borrowing terms under the revolving credit arrangement are generally the
     same as those described in the preceding paragraphs except that
     reborrowings of any available portion of the $50,000,000 revolver can be
     made at any time. Finally, the credit agreement allows for the issuance of
     letters of credit, provided there is capacity under the revolving credit
     arrangement. Currently, two letters of credit totaling $3,150,000 are
     outstanding, with expiration dates in April 2005. There have been no other
     letters of credit issued and no funds have been borrowed under the
     revolving credit arrangement. Headwaters currently pays a fee of 0.375% on
     the unused portion of the revolving credit arrangement.

     Former Senior Secured Credit Agreement - In connection with the ISG
     acquisition in 2002, Headwaters entered into a $175,000,000 senior secured
     credit agreement with a syndication of lenders, under which a total of
     $155,000,000 was borrowed as a term loan on the acquisition date. The
     credit agreement also allowed up to $20,000,000 to be borrowed under a
     revolving credit arrangement. The debt was issued at a 3% discount and
     Headwaters received net cash proceeds of $150,350,000. The original issue
     discount was accreted using the effective interest method and the accretion
     was recorded as interest expense. The debt was secured by all assets of
     Headwaters, bore interest at a variable rate and was repayable in quarterly
     installments through August 30, 2007.

     During the quarter ended December 31, 2003, principal repayments totaling
     $39,714,000 were made, including $33,471,000 of optional prepayments.
     During the quarter ended March 31, 2004, the remaining balance was repaid
     in full using available cash and $50,000,000 of proceeds from the new
     senior debt facility described above. In connection with the full repayment
     of this debt, non cash interest expense totaling approximately $5,023,000
     was recognized in the March 2004 quarter, representing amortization of all
     of the remaining debt discount and debt issue costs related to this debt.

     Senior Subordinated Debentures - In connection with the ISG acquisition,
     Headwaters also entered into a $20,000,000 subordinated loan agreement,
     under which senior subordinated debentures were issued at a 2% discount,
     with Headwaters receiving net cash proceeds of $19,600,000. The original
     issue discount was accreted using the effective interest method and the
     accretion was recorded as interest expense. ISG management participated in
     one-half, or $10,000,000, of the $20,000,000 of debt issued. The other half
     was issued to a corporation. The debentures were due in 2007; however, in
     December 2003, the debentures were repaid in full, including a 4% or
     $400,000 prepayment charge paid to the corporation holding $10,000,000 of
     the debentures. This charge, along with all remaining unamortized debt
     discount and debt issue costs, is included in interest expense in the
     consolidated statement of income.

     Interest Costs - During the three- and six-month periods ended March 31,
     2004, Headwaters incurred total interest costs of approximately $6,124,000
     and $11,624,000, respectively, including approximately $5,043,000 and
     $7,631,000, respectively, of non-cash interest expense and approximately
     $113,000 and $274,000, respectively of interest costs that were
     capitalized. During the three- and six-month periods ended March 31, 2003,
     Headwaters incurred total interest costs of approximately $3,577,000 and
     $8,114,000, respectively, including approximately $653,000 and $1,604,000,
     respectively, of non-cash interest expense and approximately $36,000 and
     $46,000, respectively of interest costs that were capitalized. The

                                       12
<PAGE>

                             HEADWATERS INCORPORATED

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 March 31, 2004
                                   (Unaudited)


     weighted-average interest rate on the face amount of outstanding long-term
     debt, disregarding amortization of debt issue costs and debt discount, was
     approximately 7.2% at September 30, 2003 and 3.4% at March 31, 2004.

7.   Income Taxes

     The income tax provision consisted of the following:
<TABLE>
<CAPTION>
                                                        Three Months Ended March 31,     Six Months Ended March 31,
                                                     -------------------------------- ------------------------------
         (in thousands)                                          2003           2004           2003            2004
         ------------------------------------------- ----------------- -------------- -------------- ---------------
         <S>                                                <C>            <C>            <C>             <C>
         Current tax provision:
              Federal                                       $   5,060      $  10,800      $   8,510       $  16,192
              State                                               518            573          1,118           1,035
                                                            ---------      ---------      ---------       ---------
         Total current tax provision                            5,578         11,373          9,628          17,227

         Deferred tax provision:
              Federal                                          (1,050)           428            300             710
              State                                              (128)             9             22              33
                                                            ---------      ---------      ---------       ---------
         Total deferred tax provision                          (1,178)           437            322             743
                                                            ---------      ---------      ---------       ---------
         Total income tax provision                         $   4,400      $  11,810      $   9,950       $  17,970
                                                            =========      =========      =========       =========
<CAPTION>
8.   Earnings per Share

                                                        Three Months Ended March 31,     Six Months Ended March 31,
         (in thousands, except per-share data)                   2003           2004           2003            2004
         ------------------------------------------- ----------------- -------------- -------------- ---------------
         <S>                                                <C>            <C>            <C>             <C>
         Numerator - Net income                             $   6,789      $  18,627      $  14,841       $  28,719
                                                            =========      =========      =========       =========

         Denominator:
         Denominator for basic earnings per share -
          weighted-average shares outstanding                  26,983         32,782         26,909          30,371

         Effect of dilutive securities - shares
          issuable upon exercise of options and
          warrants                                              1,118          1,322          1,224           1,222
                                                            ---------      ---------      ---------       ---------
         Denominator for diluted earnings per
          share - weighted-average shares
          outstanding after assumed exercises                  28,101         34,104         28,133          31,593
                                                            =========      =========      =========       =========

         Basic earnings per share                           $    0.25      $    0.57      $    0.55       $    0.95
                                                            =========      =========      =========       =========

         Diluted earnings per share                         $    0.24      $    0.55      $    0.53       $    0.91
                                                            =========      =========      =========       =========
</TABLE>

     Anti-dilutive securities not considered in the diluted earnings per share
     calculation, consisting of out-of-the money options, totaled approximately
     510,000 and 0 shares for the three months ended March 31, 2003 and 2004,
     respectively, and 400,000 and 10,000 shares for the six months ended March
     31, 2003 and 2004, respectively.

9.   Other Revenue

     In December 2003, Headwaters recorded $3,625,000 of other revenue
     representing fees for technology licensed by HTI to a Chinese company. This
     amount was paid to HTI in January 2004.

10.  Commitments and Contingencies

     Commitments and contingencies as of March 31, 2004 not disclosed elsewhere,
     are as follows:

     Purchase Commitments - Certain ISG contracts with its suppliers require ISG
     to make minimum purchases. During the quarter ended December 31, 2003, one
     of ISG's minimum purchase contracts was amended. The amendment decreased
     the annual purchase commitment and also extended the term of the contract
     for several years. Due to the extended life of the contract, ISG's total

                                       13
<PAGE>

                             HEADWATERS INCORPORATED

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 March 31, 2004
                                   (Unaudited)


     future minimum purchase requirements increased by approximately $17,925,000
     during 2004 through 2011.

     Medical Insurance - Effective January 1, 2003, Headwaters adopted a
     self-insured medical insurance plan for its employees and the employees of
     all of its subsidiaries. Currently, this plan has stop-loss coverage for
     amounts in excess of $100,000 per individual and approximately $7,500,000
     in the aggregate for the plan year ending December 31, 2004. Headwaters has
     contracted with a third-party administrator to assist in the payment and
     administration of claims. Insurance claims are recognized as expenses when
     incurred and include an estimate of costs for claims incurred but not
     reported at the balance sheet date. As of March 31, 2004, approximately
     $992,000 is accrued for claims incurred from January through March 31, 2004
     that have not been paid.

     Incentive Agreements with ISG Principals - In January 2003, Headwaters
     executed incentive agreements with three of the former stockholders and
     officers of ISG, all of whom were officers of either Headwaters or ISG
     following the ISG acquisition. The agreements called for contingent
     payments totaling up to $5,000,000 in the event of (i) a change in control,
     as defined, or (ii) continuing employment through September 2004 and an
     average stock price for Headwaters' common stock for any calendar quarter
     exceeding $20 per share. The maximum payments would be required if there
     were a change in control prior to October 2004, or if the officers remain
     employed through September 2004 and the average stock price for any
     calendar quarter reaches $25 per share or more. During the quarter ended
     December 31, 2003, two of the three officers resigned their positions. As a
     result, the maximum payment that could be required under the remaining
     incentive agreement is $1,500,000 for the remaining officer. During the
     quarter ended March 31, 2004, Headwaters recorded an expense of
     approximately $940,000 related to this obligation.

     Property, Plant and Equipment - As of March 31, 2004, Headwaters was
     committed to spend approximately $7,000,000 to complete capital projects
     that were in various stages of completion.

     Legal or Contractual Matters - Headwaters has ongoing litigation and claims
     incurred during the normal course of business, including the items
     discussed below. Headwaters intends to vigorously defend and pursue its
     rights in these actions. Management does not currently believe that the
     outcome of these actions will have a material adverse effect on Headwaters'
     operations, cash flows or financial position; however, it is possible that
     a change in the estimates of probable liability could occur, and the change
     could be significant. Additionally, as with any litigation, these
     proceedings will require that Headwaters incur substantial costs, including
     attorneys' fees, managerial time, and other personnel resources and costs
     in pursuing resolution.

     Boynton. In October 1998, Headwaters entered into a technology purchase
     agreement with James G. Davidson and Adtech, Inc. The transaction
     transferred certain patent and royalty rights to Headwaters related to a
     synthetic fuel technology invented by Davidson. (This technology is
     distinct from the technology developed by Headwaters.) This action is
     factually related to an earlier action brought by certain purported
     officers and directors of Adtech, Inc. That action was dismissed by the
     United States District Court for the Western District of Tennessee and the
     District Court's order of dismissal was affirmed on appeal. In the current
     action, the allegations arise from the same facts, but the claims are
     asserted by certain purported stockholders of Adtech. In June 2002,
     Headwaters received a summons and complaint from the United States District
     Court for the Western District of Tennessee alleging, among other things,
     fraud, conspiracy, constructive trust, conversion, patent infringement and
     interference with contract arising out of the 1998 technology purchase
     agreement entered into between Davidson and Adtech on the one hand, and
     Headwaters on the other. The complaint seeks declaratory relief and
     compensatory and punitive damages. The District Court has dismissed all
     claims against Headwaters except conspiracy and constructive trust. Because
     the resolution of the litigation is uncertain, legal counsel cannot express
     an opinion as to the ultimate amount, if any, of Headwaters' liability.

     AGTC. In March 1996, Headwaters entered into an agreement with AGTC and its
     associates for certain services related to the identification and selection
     of synthetic fuel projects. In March 2002, AGTC filed an arbitration demand
     in Salt Lake City, Utah claiming that it is owed commissions under the 1996
     agreement for 8% of the revenues received by Headwaters from the Port
     Hodder project. Headwaters asserts that AGTC did not perform under the
     agreement and that the agreement was terminated and the disputes were
     settled in July 1996. Headwaters has filed an answer in the arbitration,

                                       14
<PAGE>

                             HEADWATERS INCORPORATED

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 March 31, 2004
                                   (Unaudited)


     denying AGTC's claims and has asserted counterclaims against AGTC. Because
     the resolution of the arbitration is uncertain, legal counsel cannot
     express an opinion as to the ultimate amount, if any, of Headwaters'
     liability.

     AJG. In December 1996, Headwaters entered into a technology license and
     proprietary chemical reagent sale agreement with AJG Financial Services,
     Inc. The agreement called for AJG to pay royalties and to purchase
     proprietary chemical reagent material from Headwaters. In October 2000,
     Headwaters filed a complaint in the Fourth District Court for the State of
     Utah against AJG alleging that it had failed to make payments and to
     perform other obligations under the agreement. Headwaters asserts claims
     including breach of contract, declaratory judgment, unjust enrichment and
     accounting and seeks money damages as well as other relief. AJG's answer to
     the complaint denied Headwaters' claims and asserted counter-claims based
     upon allegations of misrepresentation and breach of contract. AJG seeks
     compensatory damages as well as punitive damages. Headwaters has denied the
     allegations of AJG's counter-claims. Because the resolution of the
     litigation is uncertain, legal counsel cannot express an opinion as to the
     ultimate amount of recovery or liability.

     ISG Matters. There is litigation and pending and threatened claims made
     against certain subsidiaries of ISG with respect to several types of
     exterior stucco finish systems manufactured and sold by its subsidiaries
     for application by contractors, developers and owners on residential and
     commercial buildings. This litigation and these claims are controlled by
     such subsidiaries' insurance carriers. The plaintiffs or claimants in these
     matters have alleged that due to some failure of the stucco system itself
     or its application, the buildings have suffered damage due to the
     progressive, latent effects of water penetration through the building's
     exterior. The most prevalent type of claim involves alleged defects
     associated with an artificial stucco system manufactured by one of ISG's
     subsidiaries, Best Masonry. Best Masonry continued to manufacture this
     system through 1997, and there is a 10-year projected claim period
     following discontinuation of the product.

     Typically, the claims cite damages for alleged personal injuries and
     punitive damages for alleged unfair business practices in addition to
     asserting more conventional damage claims for alleged economic loss and
     injury to property. To date, claims made against such subsidiaries have
     been paid by their insurers, with the exception of minor deductibles,
     although such insurance carriers typically have provided "reservation of
     rights" letters. None of the cases has gone to trial, and while two such
     cases involve 100 and 800 homes, respectively, none of the cases includes
     any claims formally asserted on behalf of a class. While, to date, none of
     these proceedings have required that ISG incur substantial costs, there is
     no guarantee of insurance coverage or continuing coverage. These and future
     proceedings may result in substantial costs to ISG, including attorneys'
     fees, managerial time and other personnel resources and costs. Adverse
     resolution of these proceedings could have a materially negative effect on
     ISG's business, financial condition and results of operation, and its
     ability to meet its financial obligations. Although ISG carries general and
     product liability insurance, ISG cannot assure that such insurance coverage
     will remain available, that ISG's insurance carrier will remain viable or
     that the insured amounts will cover all future claims in excess of ISG's
     uninsured retention. Future rate increases may also make such insurance
     uneconomical for ISG to maintain. In addition, the insurance policies
     maintained by ISG exclude claims for damages resulting from exterior
     insulating finish systems, or EIFS, that have manifested after March 2003.
     Because resolution of the litigation and claims is uncertain, legal counsel
     cannot express an opinion as to the ultimate amount, if any, of Headwaters'
     liability.

     Former Director. Headwaters granted stock options to a member of its board
     of directors in 1995. The director resigned from the board in 1996.
     Headwaters believes that most of the former director's options terminated
     unexercised. The former director has claimed that he is entitled to
     exercise the options. No lawsuit has been filed in this matter. Resolution
     is uncertain and legal counsel cannot express an opinion as to the ultimate
     amount, if any, of Headwaters' liability.

     Other. Headwaters and its subsidiaries are also involved in other legal
     proceedings that have arisen in the normal course of business.

     Senate Permanent Subcommittee on Investigations - On October 29, 2003, the
     Permanent Subcommittee on Investigations of the Government Affairs
     Committee of the United States Senate issued a notification of pending

                                       15
<PAGE>

                             HEADWATERS INCORPORATED

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 March 31, 2004
                                   (Unaudited)


     investigations. The notification listed the synthetic fuel tax credit as a
     new item. In March 2004, the Subcommittee described its investigation as
     follows: "The Subcommittee is continuing its investigation of tax credits
     claimed under Section 29 of the Internal Revenue Code for the sale of
     coal-based synthetic fuels. This investigation is examining the utilization
     of these tax credits, the nature of the technologies and fuels created, the
     use of these fuels, and other aspects of Section 29. The investigation will
     also address the IRS's administration of Section 29 tax credits." The
     Subcommittee is expected to hold a hearing in June 2004 regarding its
     investigation of Section 29 tax credits.

     The effect that the Senate subcommittee investigation of synthetic fuel tax
     credits may have on the industry is unknown. While the investigation is
     pending, buyers may be unwilling to engage in transactions to purchase
     synthetic fuel facilities. If current owners are unable to sell their
     facilities, production may not be maximized, materially adversely affecting
     Headwaters' revenues.

     Legislation - Under current law, Section 29 tax credits for synthetic fuel
     produced from coal expire on December 31, 2007. There have been initiatives
     from time to time to modify Section 29. Recently, a member of the House of
     Representatives introduced legislation to repeal Section 29. If Section 29
     is repealed or adversely modified, synthetic fuel facilities would probably
     either close or substantially curtail production, having a material adverse
     effect on the revenues and net income of Headwaters.

     License Fees - Pursuant to the contractual terms of an agreement with a
     certain licensee, the license fees owed to Headwaters, which have
     accumulated during the past two and a half years, have been placed in
     escrow for the benefit of Headwaters, pending resolution of an audit of the
     licensee by the Internal Revenue Service ("IRS"). As of March 31, 2004, the
     escrowed license fees and earned interest, net of the amount Headwaters
     will be required to pay to a third party, were approximately $28,000,000.
     Approximately $3,000,000 of this amount related to revenue recorded in the
     March 2004 quarter and approximately $25,000,000 was recorded as revenue
     related to prior periods.

     Prior to December 31, 2003, certain accounting rules governing revenue
     recognition, requiring that the seller's price to the buyer be "fixed or
     determinable" as well as reasonably certain of collection, appeared to
     preclude revenue recognition for the amounts placed in escrow because they
     were potentially subject to adjustment based on the outcome of the IRS
     audit. Accordingly, none of the escrowed amounts were recognized as revenue
     in the consolidated statements of income through December 31, 2003. During
     the March 2004 quarter, the fieldwork for the tax audit of the licensee was
     completed and there were no proposed adjustments to the tax credits claimed
     by the licensee. As a result, Headwaters recognized revenue relating to the
     funds deposited in the escrow account totaling approximately $27,900,000.
     Interest income of approximately $164,000 was also recognized. The IRS
     audit is currently in administrative review and disbursements from the
     escrow account are expected to occur upon resolution of the IRS review, as
     defined in the license agreement.

     In addition to the escrowed amounts, this same licensee has also set aside
     substantial amounts for working capital and other operational contingencies
     as provided for in the contractual agreements. These amounts will
     eventually be paid out to various parties having an interest in the cash
     flows from the licensee's operations, including Headwaters, if they are not
     used for working capital and other operational contingencies. As a result,
     Headwaters currently expects to receive at some future date a portion of
     those reserves, the amount of which is not currently determinable and
     therefore, not recognizable.

11.  Acquisitions

     As described in the following paragraphs, in April 2004, Headwaters
     completed the acquisition of one company and signed a definitive agreement
     to acquire a second company.

     VFL Technology Corporation - On April 9, 2004, Headwaters acquired 100% of
     the common stock of VFL Technology Corporation, based in West Chester,
     Pennsylvania, for a total purchase price of approximately $29,000,000,
     consisting of cash and debt. This acquisition broadens the scope of
     services Headwaters' CCP segment offers, as well as its client base,

                                       16
<PAGE>

                             HEADWATERS INCORPORATED

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                 March 31, 2004
                                   (Unaudited)


     principally on the east coast of the United States. VFL's results of
     operations will be included in Headwaters' consolidated statement of income
     beginning April 9, 2004.

     Eldorado Stone, LLC - On April 21, 2004, Headwaters entered into a purchase
     agreement to acquire the ownership interests of Eldorado Stone, LLC, a
     leading manufacturer of architectural manufactured stone based in San
     Marcos, California. Eldorado Stone will become a wholly-owned subsidiary of
     Headwaters, integrated into its construction materials segment. The
     acquisition, which is subject to regulatory approvals, completion of
     financing, and other customary conditions, is expected to close in May
     2004.

     The total purchase price for Eldorado Stone, excluding direct acquisition
     costs of approximately $3,500,000, is expected to be approximately
     $202,500,000. The calculation of the final purchase price will vary based
     on certain adjustments at the time of closing as well as total closing and
     transaction costs. Headwaters will use existing cash, financing available
     under its new credit facility (see Note 6) and new financing to be obtained
     prior to closing to pay for the acquisition.

     Deferred Acquisition Costs - In the March 2004 quarter, Headwaters expensed
     approximately $829,000 of deferred acquisition costs related to other
     acquisition projects that were abandoned.

                                       17
<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

         The following discussion and analysis should be read in conjunction
with the accompanying unaudited consolidated financial statements and notes
thereto included elsewhere herein. Headwaters' fiscal year ends on September 30
and unless otherwise noted, future references to 2003 refer to Headwaters'
fiscal quarter and/or six-month period ended March 31, 2003, and references to
2004 refer to Headwaters' fiscal quarter and/or six-month period ended March 31,
2004.

Consolidation and Segments

         The consolidated financial statements include the accounts of
Headwaters and all of its subsidiaries, only two of which have significant
operations, ISG and HTI. All significant intercompany transactions and accounts
are eliminated in consolidation. Due to the time required to obtain accurate
financial information related to HTI's foreign contracts, for financial
reporting purposes HTI's financial statements have historically been
consolidated with Headwaters' financial statements using a one-month lag.
Effective October 1, 2003, Headwaters eliminated this one-month lag because of
the decreased significance of HTI's foreign contracts. Accordingly, seven months
of HTI's results of operations have been included in the consolidated statement
of income for the six months ended March 31, 2004.

         Segments. Headwaters operates in three business segments, alternative
energy, CCPs, and construction materials. These segments are managed and
evaluated separately by management based on fundamental differences in their
operations, products and services.

         The alternative energy segment includes Headwaters' traditional
coal-based solid synthetic fuels business and HTI's business of developing
catalyst technologies to convert coal and heavy oil into
environmentally-friendly, higher-value liquid fuels as well as nanocatalyst
processes and applications. Revenues for this segment primarily include sales of
chemical reagents and license fees.

         The CCP segment includes ISG's business of providing fly ash to the
building products and ready mix concrete industries. This segment markets coal
combustion products such as fly ash and bottom ash, known as CCPs. ISG has
long-term contracts, primarily with coal-fired electric power generation plants,
pursuant to which it manages the post-combustion operations for the utilities.
ISG markets CCPs to replace manufactured or mined materials, such as portland
cement, lime, agricultural gypsum, fired lightweight aggregate, granite
aggregate and limestone. CCP revenues consist primarily of the sale of products,
with a small amount of service revenue.

         The construction materials segment manufactures and distributes
value-added bagged concrete, stucco, mortar and block products. ISG has
introduced high volumes of CCPs as substitute ingredients in the products the
construction materials segment produces.

         Due to the seasonality of ISG's business and other factors, Headwaters'
consolidated results of operations for 2004 are not indicative of the results to
be expected for the full fiscal 2004 year.

Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003

         The information set forth below compares Headwaters' operating results
for the three months ended March 31, 2004 ("2004") with operating results for
the three months ended March 31, 2003 ("2003").

         Revenue. Total revenue for 2004 increased by $33.4 million or 39% to
$119.5 million as compared to $86.1 million for 2003. The major components of
revenue are discussed in the sections below.

         Sales of Chemical Reagents. Chemical reagent sales during 2004 were
$32.2 million with a corresponding direct cost of $21.8 million. Chemical
reagent sales during 2003 were $33.1 million with a corresponding direct cost of
$21.8 million. The decrease in chemical reagent sales during 2004 was due
primarily to decreased synthetic fuel production by customers with which
Headwaters does not have a license agreement, largely offset by increased
synthetic fuel production by Headwaters' licensees. The gross margin percentage
decreased from 2003 to 2004 due primarily to differing chemical reagent formula
requirements of certain licensees and other customers, higher chemical reagent
costs, and to a lesser extent, pricing discounts.

         License Fees. During 2004, Headwaters recognized license fee revenue
totaling $36.3 million, an increase of $27.4 million or 308% over $8.9 million
of license fee revenue recognized during 2003. The primary reason for the
increase in license fee revenue in 2004 compared to 2003 was the recognition of
approximately $24.9 million of net revenue relating to funds previously
deposited in an escrow account by one of Headwaters' licensees relating to funds
deposited prior to December 31, 2003 and approximately $3.0 million of net
revenue relating to funds deposited and recorded as revenue in the March 2004
quarter.

                                       18
<PAGE>

         Pursuant to the contractual terms of an agreement with the licensee,
the license fees owed to Headwaters, which have accumulated during the past two
and a half years, had been placed in escrow for the benefit of Headwaters,
pending resolution of an audit of the licensee by the Internal Revenue Service
("IRS"). As of March 31, 2004, the escrowed license fees and earned interest,
net of the amount Headwaters will be required to pay to a third party, were
approximately $28.0 million.

         Prior to December 31, 2003, certain accounting rules governing revenue
recognition, requiring that the seller's price to the buyer be "fixed or
determinable" as well as reasonably certain of collection, appeared to preclude
revenue recognition for the amounts placed in escrow because they were subject
to adjustment based on the outcome of the IRS audit. Accordingly, none of the
escrowed amounts were recognized as revenue in the consolidated statements of
income through December 31, 2003. During the March 2004 quarter, the fieldwork
for the tax audit of the licensee was completed and there were no proposed
adjustments to the tax credits claimed by the licensee. As a result, Headwaters
recognized revenue relating to the funds deposited in the escrow account
totaling approximately $27.9 million.

         In addition to the escrowed amounts, this same licensee has also set
aside substantial amounts for working capital and other operational
contingencies as provided for in the contractual agreements. These amounts will
eventually be paid out to various parties having an interest in the cash flows
from the licensee's operations, including Headwaters, if they are not used for
working capital and other operational contingencies. As a result, Headwaters
currently expects to receive at some future date a portion of those reserves,
the amount of which is not currently determinable and therefore, not
recognizable.

         CCP Revenues. CCP revenues for 2004 were $39.6 million with a
corresponding direct cost of $28.5 million. CCP revenues for 2003 were $31.2
million with a corresponding direct cost of $23.4 million. The increase in CCP
revenues during 2004 was due primarily to the renegotiation of certain service
agreements and increased demand for high quality fly ash products. The gross
margin percentage increased from 2003 to 2004 due primarily to benefits realized
from the renegotiation of the service agreements.

         Sales of Construction Materials. Sales of construction materials during
2004 were $11.2 million with a corresponding direct cost of $9.8 million. Sales
of construction materials during 2003 were $11.7 million with a corresponding
direct cost of $8.7 million. The decrease in sales of construction materials
during 2004 was due primarily to unfavorable weather conditions in 2004 which
impacted the construction industry. The decrease in gross margin percentage from
2003 to 2004 was due primarily to certain inventory and other balance sheet
adjustments, some of which related to original purchase price allocations.

         Depreciation and Amortization. These costs were comparable in 2004 and
2003 at $3.2 million.

         Research and Development. Research and development expenses increased
by $0.4 million to $1.5 million in 2004 from $1.1 million in 2003. The increase
was primarily attributable to increased HTI research and development activities.
Management currently expects fiscal 2004 research and development expenses to
outpace the level of expenses for 2003 as a result of continued emphasis on
HTI's activities.

         Selling, General and Administrative Expenses. These expenses increased
$6.5 million to $16.5 million for 2004 from $10.0 million for 2003. The increase
in 2004 was due primarily to increased incentive pay expenses, along with
certain increases in various other costs incidental to growth, such as
payroll-related costs, professional services and insurance. The increase in
incentive pay expenses was the result of obligations arising from Headwaters'
bonus plans, due in turn to improved operating results in 2004 compared to 2003,
a significant portion of which related to revenue recognized from escrowed funds
as previously discussed. Cash payments for the incentive pay obligations related
to the escrowed funds revenue will be disbursed upon receipt by Headwaters of
the escrowed funds.

         Other Income and Expense. During 2004, Headwaters reported net other
expense of $7.6 million compared to net other expense of $5.6 million during
2003. The change of $2.0 million was attributable to an increase in interest
expense of $2.5 million in 2004, the write-off of $0.8 million of deferred
acquisition costs related to projects that were abandoned in 2004, and an
increase in the loss on disposition of property, plant and equipment of $0.5
million, offset by a reduction of $1.6 million in note receivable losses and an
increase of $0.2 million in interest income.

         Interest expense increased from $3.5 million in 2003 to $6.0 million in
2004 due primarily to accelerated non-cash interest expense related to the
substantial increase in debt repayments that were made in 2004 compared to 2003.
In 2004, debt repayments totaled approximately $74.8 million, which consisted
primarily of early repayments. In 2003, debt repayments totaled approximately
$5.2 million. As a result of the increase in repayments in 2004, non-cash
interest expense, representing amortization of debt discount and debt issue
costs, increased from $0.7 million in 2003 to $5.0 million in 2004. Partially
offsetting this large increase in non-cash interest expense was a decrease in
cash interest expense in 2004 due to the significantly lower levels of
outstanding long-term debt in 2004 compared to 2003.

                                       19
<PAGE>

         A loss of $0.5 million was recorded on a note receivable in 2004
compared to a loss on a note receivable of $2.1 million in 2003. Interest income
increased by $0.2 million in 2004, representing interest on funds held in escrow
as described previously.

         Income Tax Provision. In 2004, Headwaters recorded an income tax
provision at an effective tax rate of approximately 38.8%. In 2003, the
effective tax rate was approximately 39.3%. The primary reason for the decrease
in the effective tax rate was decreased state income taxes due to tax planning
strategies implemented for fiscal year 2004.

Six Months Ended March 31, 2004 Compared to Six Months Ended March 31, 2003

         The information set forth below compares Headwaters' operating results
for the six months ended March 31, 2004 ("2004") with operating results for the
six months ended March 31, 2003 ("2003").

         Revenue. Total revenue for 2004 increased by $46.2 million or 26% to
$221.0 million as compared to $174.8 million for 2003. The major components of
revenue are discussed in the sections below.

         Sales of Chemical Reagents. Chemical reagent sales during 2004 were
$63.1 million with a corresponding direct cost of $43.0 million. Chemical
reagent sales during 2003 were $62.2 million with a corresponding direct cost of
$40.8 million. The increase in chemical reagent sales during 2004 was due
primarily to significantly increased synthetic fuel production by Headwaters'
licensees, largely offset by decreased synthetic fuel production by customers
with which Headwaters does not have a license agreement. The gross margin
percentage decreased from 2003 to 2004 due primarily to differing chemical
reagent formula requirements of certain licensees and other customers, higher
chemical reagent costs, and to a lesser extent, pricing discounts.

         License Fees. During 2004, Headwaters recognized license fee revenue
totaling $45.8 million, an increase of $28.1 million or 159% over $17.7 million
of license fee revenue recognized during 2003. The primary reason for the
increase in license fee revenue in 2004 compared to 2003 was the recognition of
$24.9 million of net revenue relating to funds previously deposited in an escrow
account by one of Headwaters' licensees relating to funds deposited prior to
December 31, 2003 and approximately $3.0 million of net revenue relating to
funds deposited and recorded as revenue in the March 2004 quarter.

         CCP Revenues. CCP revenues for 2004 were $84.7 million with a
corresponding direct cost of $60.7 million. CCP revenues for 2003 were $69.5
million with a corresponding direct cost of $51.4 million. The increase in CCP
revenues during 2004 was due primarily to the renegotiation of certain service
agreements and increased demand for high quality fly ash products. The gross
margin percentage increased from 2003 to 2004 due primarily to benefits realized
from the renegotiation of the service agreements.

         Sales of Construction Materials. Sales of construction materials during
2004 were $23.2 million with a corresponding direct cost of $19.3 million. Sales
of construction materials during 2003 were $22.8 million with a corresponding
direct cost of $17.1 million. The decrease in gross margin percentage from 2003
to 2004 was due primarily to certain inventory and other balance sheet
adjustments, some of which related to original purchase price allocations.

         Depreciation and Amortization. These costs increased by $0.2 million to
$6.5 million in 2004 from $6.3 million in 2003. The increase was primarily
attributable to higher property, plant and equipment balances in 2004 and an
extra month of depreciation and amortization of HTI's tangible and intangible
assets in 2004.

         Research and Development. Research and development expenses increased
by $1.4 million to $3.5 million in 2004 from $2.1 million in 2003. The increase
was primarily attributable to increased HTI research and development activities
and an extra month of HTI expenses in 2004.

         Selling, General and Administrative Expenses. These expenses increased
$7.4 million to $27.6 million for 2004 from $20.2 million for 2003. The increase
in 2004 was due primarily to increased incentive pay expenses, along with
certain increases in various other costs incidental to growth, primarily
payroll-related costs and insurance. The increase in incentive pay expenses was
the result of obligations arising from Headwaters' bonus plans, due in turn to
improved operating results in 2004 compared to 2003, a significant portion of
which related to revenue recognized from escrowed funds as previously discussed.
Cash payments for the incentive pay obligations related to the escrowed funds
revenue will be disbursed upon receipt by Headwaters of the escrowed funds.

         Other Income and Expense. During 2004, Headwaters reported net other
expense of $13.4 million compared to net other expense of $10.0 million during
2003. The change of $3.4 million was primarily attributable to an increase in
interest expense of $3.3 million in 2004, the write-off of $0.8 million of
deferred acquisition costs related to projects that were abandoned in 2004, and
an increase in the loss on disposition of property, plant and equipment of $0.8
million, offset by a reduction of $1.1 million in note receivable losses and an
increase of $0.2 million in interest income.

                                       20
<PAGE>

         Interest expense increased from $8.1 million in 2003 to $11.4 million
in 2004 due primarily to accelerated non-cash interest expense related to the
substantial increase in debt repayments that were made in 2004 compared to 2003.
In 2004, debt repayments totaled approximately $134.9 million, which consisted
primarily of early repayments. In 2003, debt repayments totaled approximately
$15.1 million. As a result of the increase in repayments in 2004, non-cash
interest expense, representing amortization of debt discount and debt issue
costs, increased from $1.6 million in 2003 to $7.6 million in 2004. Partially
offsetting this large increase in non-cash interest expense was a decrease in
cash interest expense in 2004 due to the significantly lower levels of
outstanding long-term debt in 2004 compared to 2003.

         Losses of $1.0 million were recorded on notes receivable in 2004
compared to a loss on a note receivable of $2.1 million in 2003. Interest income
increased by $0.2 million in 2004, representing interest on funds held in escrow
as described previously.

         Income Tax Provision. In 2004, Headwaters recorded an income tax
provision at an effective tax rate of approximately 38.5%. In 2003, the
effective tax rate was approximately 40.1%. The primary reason for the decrease
in the effective tax rate was decreased state income taxes due to tax planning
strategies implemented for fiscal year 2004.

Liquidity and Capital Resources

         Summary of Cash Flow Activities. Net cash used in operating activities
during the six months ended March 31, 2004 ("2004") was $17.1 million compared
to $17.8 million of net cash provided by operations during the six months ended
March 31, 2003 ("2003"). The primary reason for the significant use of cash in
operating activities in 2004 was an increase in short-term trading investments
of $30.6 million. Absent the use of cash to purchase short-term trading
investments, there would have been $13.6 million of cash provided by operations
in 2004, attributable primarily to net income. In addition, trade receivables
increased by $34.6 million in 2004 primarily due to recording a receivable from
a licensee relating to funds previously deposited in an escrow account, pending
resolution of an audit of the licensee by the Internal Revenue Service ("IRS").
The fieldwork for the IRS audit of the licensee was completed in the March 2004
quarter and there were no proposed adjustments to the tax credits claimed by the
licensee. The audit is currently in administrative review and disbursements from
the escrow account and collection of the receivable are expected to occur upon
resolution of the IRS review, as defined in the license agreement.

         In 2004, Headwaters issued 5.0 million shares of common stock under an
effective shelf registration statement for net cash proceeds of $90.3 million.
Headwaters used $50.0 million of the cash generated from the issuance of common
stock to repay debt and the remaining proceeds were invested in short-term
trading investments as previously discussed. During 2004, a total of $134.9
million of debt was repaid, which amount includes $50.0 million of cash obtained
from the refinancing of Headwaters' senior debt. During 2004, investing
activities consisted primarily of payments for the purchase of property, plant
and equipment. More details about these activities are provided in the following
paragraphs.

         Investing Activities. In 2004, payments for the purchase of property,
plant and equipment totaled $4.9 million. These capital expenditures primarily
related to ISG's business, in particular the CCP segment. Total capital
expenditures for fiscal year 2004 are expected to be comparable with fiscal year
2003 levels.

         Headwaters had two notes receivable with a combined carrying value of
approximately $2.5 million at September 30, 2003. In 2004, Headwaters wrote-off
the balance of one of these notes and recorded a write-down of the other note
receivable, which has a carrying value at March 31, 2004 of approximately $1.5
million. This note receivable is supported by collateral; however, Headwaters
could incur additional losses if the remaining balance on the note is not repaid
or if the collateral value declines.

         Headwaters intends to continue to expand its business through growth of
existing operations, commercialization of technologies currently being
developed, and strategic acquisitions of entities that operate in adjacent
industries. As described in Note 11 to the consolidated financial statements, in
April 2004, Headwaters completed the acquisition of one company and signed a
definitive agreement to acquire a second company.

         On April 9, 2004, Headwaters acquired 100% of the common stock of VFL
Technology Corporation for a total purchase price of approximately $29.0 million
paid in cash (approximately $10.0 million) and debt (approximately $19.0
million), of which $13.0 million is repayable in May 2004 and $6.0 million is
repayable over a three-year period ending in 2007.

         On April 21, 2004, Headwaters entered into a purchase agreement to
acquire the ownership interests of Eldorado Stone, LLC. This acquisition, which
is subject to regulatory approvals, completion of financing, and other customary
conditions, is expected to close in May 2004. The total purchase price for
Eldorado Stone, excluding direct acquisition costs of approximately $3.5
million, is expected to be approximately $202.5 million. Headwaters will use

                                       21
<PAGE>

existing cash, financing available under the new credit facility (described
below) and new debt financing to be obtained prior to closing to pay for the
acquisition. The new debt financing is currently expected to total approximately
$150.0 million; however, the ultimate amount of financing to be obtained, as
well as the acquisition itself, is subject to completion.

         It is possible that some portion of cash and cash equivalents and
short-term trading investments will be used to fund other acquisitions of
complementary businesses in the chemical, energy, building products and related
industries. Acquisitions are an important part of Headwaters' business strategy
and to that end, Headwaters routinely reviews complementary acquisitions,
including those in the areas of CCP marketing and construction materials and
coal and catalyst technologies. The new senior secured credit agreement
generally requires approval for acquisitions funded with cash in excess of $30.0
million individually or in excess of $50.0 million in the aggregate. Approval is
required for aggregate acquisitions in excess of $20.0 million not funded with
cash. These limits apply to acquisitions in any single fiscal year. Approvals
from the lenders for the acquisitions of both VFL Technology Corporation and
Eldorado Stone were obtained when the new credit agreement was executed. In
2004, Headwaters expensed approximately $0.8 million of deferred acquisition
costs related to other acquisition projects that were abandoned.

         Financing Activities. Headwaters has an effective universal shelf
registration statement on file with the SEC that can be used for the sale of
common stock, preferred stock, convertible debt and other securities. In
December 2003, Headwaters filed a prospectus supplement to the shelf
registration statement and issued 4.75 million shares of common stock under this
shelf registration statement in an underwritten public offering. In January
2004, an additional 0.2 million shares of common stock were issued upon exercise
of the underwriters' over-allotment option. In total, proceeds of $90.3 million
were received, net of offering costs of $6.4 million. Following these issuances
of common stock, approximately $53.0 million remains available for future
offerings of securities under the shelf registration statement. A prospectus
supplement describing the terms of any additional securities to be issued is
required to be filed before any future offering would commence under the
registration statement.

         New Senior Secured Credit Agreement - In March 2004, Headwaters entered
into a credit agreement with a syndication of lenders under which a total of
$50.0 million was borrowed under a term loan arrangement and which provides for
an additional $50.0 million to be borrowed under a revolving credit arrangement.
The initial $50.0 million of proceeds were used to repay in full the remaining
balance due under Headwaters' former Term B senior secured credit agreement.

         The $50.0 million term loan is secured by all assets of Headwaters,
bears interest at a variable rate (approximately 3.4% at March 31, 2004), and is
repayable in quarterly installments of $1.25 million, commencing June 2004 and
continuing through September 2007. The remaining principal of $32.5 million is
repayable in November 2007, the termination date of the credit agreement.
Optional prepayments of the term loan can be made at Headwaters' discretion,
subject to certain minimum amount requirements specified in the credit
agreement. Beginning December 31, 2004 and continuing each year thereafter,
Headwaters must make mandatory prepayments to the extent of 50% of Headwaters'
fiscal year "excess cash flows," as defined. Once repaid in full or in part, no
further borrowings under the term loan arrangement can be made.

         Former Senior Secured Credit Agreement - In connection with the ISG
acquisition in 2002, Headwaters entered into a $175.0 million senior secured
credit agreement with a syndication of lenders, under which a total of $155.0
million was borrowed as a term loan on the acquisition date. The debt was issued
at a 3% discount and Headwaters received net cash proceeds of $150.4 million.
The original issue discount was accreted using the effective interest method and
the accretion was recorded as interest expense.

         During the quarter ended December 31, 2003, principal repayments
totaling $39.7 million were made, including $33.5 million of optional
prepayments. During the quarter ended March 31, 2004, the remaining balance was
repaid in full using available cash and $50.0 million of proceeds from the new
senior debt facility described above. In connection with the full repayment of
this debt, non cash interest expense totaling approximately $5.0 million was
recognized in the March 2004 quarter, representing amortization of all of the
remaining debt discount and debt issue costs related to this debt.

         Senior Subordinated Debentures - In connection with the ISG
acquisition, Headwaters also entered into a $20.0 million subordinated loan
agreement, under which senior subordinated debentures were issued at a 2%
discount, with Headwaters receiving net cash proceeds of $19.6 million. The
original issue discount was accreted using the effective interest method and the
accretion was recorded as interest expense. ISG management participated in
one-half, or $10.0 million, of the $20.0 million of debt issued. The other half
was issued to a corporation. The debentures were due in 2007; however, in
December 2003, the debentures were repaid in full, including a 4% or $0.4
million prepayment charge paid to the corporation holding $10.0 million of the
debentures. This charge, along with all remaining unamortized debt discount and
debt issue costs, is included in interest expense in the consolidated statement
of income.

         In 2004, cash proceeds from the exercise of options, warrants and
employee stock purchases totaled $5.5 million, compared to $1.1 million in 2003.

                                       22
<PAGE>

Option exercise activity is largely dependent on Headwaters' stock price and is
not predictable. To the extent non-qualified stock options are exercised, or
there are disqualifying dispositions of shares obtained upon the exercise of
incentive stock options, Headwaters receives an income tax deduction generally
equal to the income recognized by the optionee. Such amounts, reflected in cash
flows from operations in the consolidated statements of cash flows, were $0.8
million in 2003 and $2.9 million in 2004. These income tax deductions do not
impact income tax expense and the effective income tax rate; rather they are
reflected as increases in capital in excess of par value in the consolidated
balance sheet.

         Working Capital. In 2004, Headwaters' working capital increased by
$72.9 million, to $87.1 million as of March 31, 2004. The most significant
changes in the components of working capital were an increase of $16.5 million
in cash and investments, an increase of $34.6 million in trade receivables and a
decrease of $22.5 million in the current portion of long-term debt. The increase
in cash and investments was due primarily to the issuance of common stock
described above. Headwaters expects operations to produce positive cash flows in
future periods, which, combined with current working capital, is expected to be
sufficient for operating needs for the next 12 months.

         Long-term Debt. Management currently believes Headwaters has the
ability, if needed, to obtain additional amounts of long-term debt in the
future, either by amendment to the current senior secured credit facility or
through issuance of other debt securities. Headwaters may, in the future, make
optional prepayments of the senior debt depending on actual cash flows,
Headwaters' current and expected cash requirements and other factors deemed
significant by management.

         The senior secured credit agreement contains restrictions and covenants
common to such agreements, including limitations on the incurrence of additional
debt, investments, merger and acquisition activity, asset liens, capital
expenditures in excess of $15.0 million in any fiscal year and the payment of
dividends, among others. In addition, Headwaters must meet minimum net worth
requirements and maintain certain financial ratios, including leverage ratios
and a fixed charge coverage ratio, as those terms are defined in the credit
agreement. The initial net worth requirement is $200.3 million and is increased
by 50% of Headwaters' consolidated net income earned subsequent to March 31,
2004. Headwaters must maintain a total leverage ratio of 2.5:1.0 or less and a
senior debt leverage ratio of 1.5:1.0 or less. Headwaters is in compliance with
all debt covenants as of March 31, 2004.

         Borrowing terms under the revolving credit arrangement are generally
the same as those described in the preceding paragraphs except that reborrowings
of any available portion of the $50.0 million revolver can be made at any time.
Finally, the credit agreement allows for the issuance of letters of credit,
provided there is capacity under the revolving credit arrangement. Currently,
two letters of credit totaling $3.2 million are outstanding, with expiration
dates in April 2005. There have been no other letters of credit issued and no
funds have been borrowed under the revolving credit arrangement. Headwaters
currently pays a fee of 0.375% on the unused portion of the revolving credit
arrangement.

         Income Taxes. As discussed previously, cash payments for income taxes
are reduced for disqualifying dispositions of shares obtained upon the exercise
of stock options, which totaled $2.9 million for 2004. Headwaters' cash
requirements for income taxes in fiscal 2004 are expected to approximate the
income tax provision, with some lag due to the seasonality of operations and
because estimated income tax payments are typically based on annualizing the
fiscal year's income based on year-to-date results.

         Summary of Future Cash Requirements. Significant future cash needs, in
addition to operational working capital requirements and acquisition-related
funding requirements, are currently expected to consist primarily of debt
service payments on outstanding long-term debt, income taxes and capital
expenditures.

Senate Permanent Subcommittee on Investigations

         On October 29, 2003, the Permanent Subcommittee on Investigations of
the Government Affairs Committee of the United States Senate issued a
notification of pending investigations. The notification listed the synthetic
fuel tax credit as a new item. In March 2004, the Subcommittee described its
investigation as follows: "The Subcommittee is continuing its investigation of
tax credits claimed under Section 29 of the Internal Revenue Code for the sale
of coal-based synthetic fuels. This investigation is examining the utilization
of these tax credits, the nature of the technologies and fuels created, the use
of these fuels, and other aspects of Section 29. The investigation will also
address the IRS's administration of Section 29 tax credits." The Subcommittee is
expected to hold a hearing in June 2004 regarding its investigation of Section
29 tax credits.

         The effect that the Senate subcommittee investigation of synthetic fuel
tax credits may have on the industry is unknown. While the investigation is
pending, buyers may be unwilling to engage in transactions to purchase synthetic
fuel facilities. If current owners are unable to sell their facilities,
production may not be maximized, materially adversely affecting Headwaters'
revenues.

                                       23
<PAGE>

Legislation

         Under current law, Section 29 tax credits for synthetic fuel produced
from coal expire on December 31, 2007. There have been initiatives from time to
time to modify Section 29. Recently, a member of the House of Representatives
introduced legislation to repeal Section 29. If Section 29 is repealed or
adversely modified, synthetic fuel facilities would probably either close or
substantially curtail production, having a material adverse effect on the
revenues and net income of Headwaters.

Recent Accounting Pronouncements

         Headwaters has reviewed all recently issued accounting standards that
have not yet been adopted in order to determine their potential effect, if any,
on the results of operations or financial position of Headwaters. Based on that
review, Headwaters does not currently believe that any of these recent
accounting pronouncements will have a significant effect on its current or
future financial position, results of operations, cash flows or disclosures.

Forward-looking Statements

         Statements in this Quarterly Report on Form 10-Q regarding Headwaters'
expectations as to the managing and marketing of coal combustion products,
operation of facilities utilizing alternative fuel technologies, the marketing
of synthetic fuels, the receipt of licensing fees, royalties, and product sales
revenues, the development, commercialization and financing of new technologies
and other strategic business opportunities and acquisitions and other
information about Headwaters that is not purely historical by nature, including
those statements regarding Headwaters' future business plans, the operation of
facilities, the availability of tax credits, the availability of feedstocks, and
the marketability of the coal combustion products and synthetic fuel, constitute
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Although Headwaters believes that its
expectations are based on reasonable assumptions within the bounds of its
knowledge of its business and operations, there can be no assurance that actual
results will not differ materially from its expectations. In addition to matters
affecting the coal combustion products and synthetic fuel industries or the
economy generally, factors which could cause actual results to differ from
expectations stated in these forward-looking statements include, among others,
the Risk Factors described in "Risk Factors" in Item 7 of our Annual Report on
Form 10-K for the year ended September 30, 2003.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         Headwaters is exposed to financial market risks, primarily related to
changes in interest rates. Headwaters does not use derivative financial
instruments for speculative or trading purposes, and no derivative financial
instruments were outstanding as of March 31, 2004 or subsequent thereto.

         The majority of Headwaters' short-term investments, all of which are
classified as trading securities, consist of fixed-rate U.S. government
securities or securities backed by the U.S. government. Changes in interest
rates can affect the market value of these investments, which are carried at
market value in the consolidated balance sheets. The periodic adjustments to
reflect changes in market value are included in interest and net investment
income in the consolidated statements of income. Based on the current amount of
short-term investments and expected near-term changes in the amount of
short-term investments, Headwaters does not expect any material near-term
investment losses to result from changes in interest rates.

         As described in more detail in Note 6 to the consolidated financial
statements, Headwaters has outstanding $50.0 million of variable-rate long-term
debt as of March 31, 2004, which is repayable through November 2007. The
interest rate on this debt as of March 31, 2004 was approximately 3.4%. In March
2004, Headwaters locked in this rate for three months and in June 2004,
Headwaters can lock in a new rate for periods ranging from one month to one
year. A change in the interest rate of 1% would change interest expense by
approximately $0.5 million during the next 12 months, considering required
principal repayments.

ITEM 4.  CONTROLS AND PROCEDURES

         Disclosure controls are procedures that are designed with an objective
of ensuring that information required to be disclosed in Headwaters' periodic
reports filed with the SEC, such as this Quarterly Report on Form 10-Q, is
recorded, processed, summarized and reported within the time periods specified
by SEC rules and forms. Disclosure controls include, without limitation,
controls and procedures designed to ensure that such information is accumulated
and communicated to Headwaters' management, including the Chief Executive
Officer ("CEO") and the Chief Financial Officer ("CFO"), in order to allow
timely consideration regarding required disclosures.

                                       24
<PAGE>

         The evaluation of Headwaters' disclosure controls by the CEO and CFO
included a review of the controls' objectives and design, the operation of the
controls, and the effect of the controls on the information presented in this
Quarterly Report. Headwaters' management, including the CEO and CFO, does not
expect that disclosure controls can or will prevent or detect all errors and all
fraud, if any. A control system, no matter how well designed and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Also, projections of any evaluation of the disclosure
controls and procedures to future periods are subject to the risk that the
disclosure controls and procedures may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may
deteriorate.

         Based on their review and evaluation as of March 31, 2004, and subject
to the inherent limitations as described above, Headwaters' CEO and CFO have
concluded that Headwaters' disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) are
effective. In addition, they are not aware of any change in Headwaters' internal
control over financial reporting during the quarter ended March 31, 2004 that
has materially affected, or is reasonably likely to materially affect,
Headwaters' internal control over financial reporting.


                          PART II -- OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

         See "Legal or Contractual Matters" in Note 10 to the consolidated
financial statements for a description of current legal proceedings.

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

Recent Sales of Unregistered Securities

         During the quarter ended March 31, 2004, pursuant to the exercise of
options and warrants, approximately 96,000 shares of Headwaters restricted
common stock were issued. Headwaters has several outstanding effective
registration statements filed on Forms S-3 and S-8. All but 4,000 of the shares
of restricted common stock issued during the quarter have been registered under
one of these registration statements.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

         None.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         An annual meeting of stockholders of Headwaters was held on March 12,
2004 for the following purposes:

         1.       To elect three Class I directors of Headwaters to serve until
                  the 2007 annual meeting, or until their successors are duly
                  elected and qualified;
         2.       To ratify the selection by the Board of Directors of Ernst &
                  Young LLP as independent auditors of Headwaters for the fiscal
                  year ending September 30, 2004; and
         3.       To approve an amendment to the 2003 Stock Incentive Plan
                  increasing the number of shares available for award grants
                  under the plan by 1,500,000.

         A total of 30,693,144 shares were voted on proposals no. 1 and 2. A
total of 22,933,899 shares were voted on proposal no. 3. The results of voting
on these proposals were as follows:

         1.       To elect Mr. R. Sam Christensen as a Class I director: for -
                  29,794,358; withheld authority - 898,786. To elect Mr. William
                  S. Dickinson as a Class I director: for - 29,849,058; withheld
                  authority - 844,086. To elect Mr. Malyn K. Malquist as a Class
                  I director: for - 29,790,643; withheld authority - 902,501.
         2.       To ratify the selection of Ernst & Young LLP as auditors for
                  fiscal 2004: for - 29,907,308; against - 766,475; abstain -
                  19,361.
         3.       To approve Amendment No. 1 to the 2003 Stock Incentive Plan:
                  for - 16,775,815; against - 6,098,056; abstain - 60,028.

                                       25
<PAGE>

ITEM 5.  OTHER INFORMATION

         None.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

         (a)      The following exhibits are included herein:

                  12     Computation of ratio of earnings to combined fixed
                         charges and preferred stock dividends                 *
                  31.1   Rule 13a-14(a)/15d-14(a) Certification of Chief
                         Executive Officer                                     *
                  31.2   Rule 13a-14(a)/15d-14(a) Certification of Chief
                         Financial Officer                                     *
                  32     Section 1350 Certifications of Chief Executive
                         Officer and Chief Financial Officer                   *
                  ---------------------
                  *        Filed herewith.


         (b)      The following Forms 8-K were filed with the SEC during the
                  quarter ended March 31, 2004:

                  o        Form 8-K dated January 23, 2004 to file the press
                           release announcing Headwaters' results for the
                           quarter ended December 31, 2003.

                  o        Form 8-K dated March 25, 2004 to file two press
                           releases announcing i) the execution of a commitment
                           letter with Bank One to provide for the refinancing
                           of Headwaters' senior secured credit facilities, and
                           ii) the recognition in the March 2004 quarter of
                           revenues relating to certain funds previously
                           deposited in an escrow account.

                                       26
<PAGE>

                                   SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

                                  HEADWATERS INCORPORATED

Date: May 3, 2004                 By: /s/ Kirk A. Benson
                                      ------------------------------------------
                                      Kirk A. Benson, Chief Executive Officer
                                      (Principal Executive Officer)

Date: May 3, 2004                 By: /s/ Steven G. Stewart
                                      ------------------------------------------
                                      Steven G. Stewart, Chief Financial Officer
                                      (Principal Financial Officer)

                                       27