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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 June 30, 2008

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: 1-32459

HEADWATERS INCORPORATED

(Exact name of registrant as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 87-0547337                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|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 a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).

Large accelerated filer    x            Accelerated filer   ̈

Non-accelerated filer   ̈            Smaller reporting company   ̈

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes   ̈    No  x

The number of shares outstanding
of the Registrants common stock as of July 31, 2008 was 41,993,136.









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HEADWATERS INCORPORATED

TABLE OF CONTENTS



|                               |  |                                                                                                               |  |         
|------------------------------ |  | ------------------------------------------------------------------------------------------------------------- |  | --------
|                               |  |                                                                                                               |  | Page No.
|PART I  FINANCIAL INFORMATION |  |                                                                                                              
|                               |  |                                                                                                              
|ITEM 1.                        |  | FINANCIAL STATEMENTS (Unaudited):                                                                             |  |         
|                               |  | Condensed Consolidated Balance Sheets  As of September 30, 2007 and June 30, 2008                            |  | 3       
|                               |  | Condensed Consolidated Statements of Income  For the three and nine months ended June 30, 2007 and 2008      |  | 4       
|                               |  | Condensed Consolidated Statement of Changes in Stockholders Equity  For the nine months ended June 30, 2008 |  | 5       
|                               |  | Condensed Consolidated Statements of Cash Flows  For the nine months ended June 30, 2007 and 2008            |  | 6       
|                               |  | Notes to Condensed Consolidated Financial Statements                                                          |  | 7       
|ITEM 2.                        |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                         |  | 20      
|ITEM 3.                        |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                    |  | 26      
|ITEM 4.                        |  | CONTROLS AND PROCEDURES                                                                                       |  | 26      
|                               | 
|PART II  OTHER INFORMATION    |  |                                                                                                              
|                               |  |                                                                                                              
|ITEM 1.                        |  | LEGAL PROCEEDINGS                                                                                             |  | 27      
|ITEM 1A.                       |  | RISK FACTORS                                                                                                  |  | 27      
|ITEM 2.                        |  | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                                   |  | 27      
|ITEM 3.                        |  | DEFAULTS UPON SENIOR SECURITIES                                                                               |  | 27      
|ITEM 4.                        |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                           |  | 28      
|ITEM 5.                        |  | OTHER INFORMATION                                                                                             |  | 28      
|ITEM 6.                        |  | EXHIBITS                                                                                                      |  | 28      
|                               |  |                                                                                                              
|SIGNATURES                     |  |                                                                                                               |  | 29      

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, plans, or variations of such words and similar expressions, are intended to help
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 risk factors described in Item 1A of our Annual Report on Form 10-K for the year ended September 30, 2007.
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.headwaters.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 with or furnish to the SEC.



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|ITEM 1. | FINANCIAL STATEMENTS
|------- | --------------------

HEADWATERS INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)



|                                   |  |                   |           |              |   |          
|---------------------------------- |  | ----------------- | --------- | ------------ | - | ---------
|(in thousands, except par value)   |  | September 30,2007 |           | June 30,2008
|ASSETS                             |  |                   |           |              |   |          
|Current assets:                    |  |                   |           |              |   |          
|Cash and cash equivalents          |  | $                 | 55,787    |              | $ | 33,536   
|Trade receivables, net             |  |                   | 188,334   |              |   | 137,422  
|Inventories                        |  |                   | 53,201    |              |   | 61,651   
|Current and deferred income taxes  |  |                   | 30,171    |              |   | 37,242   
|Other                              |  |                   | 20,903    |              |   | 24,421   
|                                   |  |                   |           |              |   |          
|Total current assets               |  |                   | 348,396   |              |   | 294,272  
|                                   |  |                   |           |              |   |          
|Property, plant and equipment, net |  |                   | 225,700   |              |   | 282,639  
|                                   |  |                   |           |              |   |          
|Other assets:                      |  |                   |           |              |   |          
|Intangible assets, net             |  |                   | 238,144   |              |   | 224,752  
|Goodwill                           |  |                   | 787,161   |              |   | 784,161  
|Other                              |  |                   | 56,488    |              |   | 50,306   
|                                   |  |                   |           |              |   |          
|Total other assets                 |  |                   | 1,081,793 |              |   | 1,059,219
|                                   |  |                   |           |              |   |          
|Total assets                       |  | $                 | 1,655,889 |              | $ | 1,636,130
|                                   |  |                   |           |              |   |          



|                                                                                                                                                                                                                                          |  |   |           |   |  |   |           |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | - | --------- | - |  | - | --------- | -
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                                                      |  |   |           |   |  |   |           |  
|Current liabilities:                                                                                                                                                                                                                      |  |   |           |   |  |   |           |  
|Accounts payable                                                                                                                                                                                                                          |  | $ | 39,379    |   |  | $ | 33,151    |  
|Accrued personnel costs                                                                                                                                                                                                                   |  |   | 37,539    |   |  |   | 33,004    |  
|Other accrued liabilities                                                                                                                                                                                                                 |  |   | 108,084   |   |  |   | 53,369    |  
|Current portion of long-term debt                                                                                                                                                                                                         |  |   |          |   |  |   | 35,000    |  
|                                                                                                                                                                                                                                          |  |   |           |   |  |   |           |  
|Total current liabilities                                                                                                                                                                                                                 |  |   | 185,002   |   |  |   | 154,524   |  
|                                                                                                                                                                                                                                          |  |   |           |   |  |   |           |  
|Long-term liabilities:                                                                                                                                                                                                                    |  |   |           |   |  |   |           |  
|Long-term debt                                                                                                                                                                                                                            |  |   | 542,500   |   |  |   | 542,500   |  
|Deferred income taxes                                                                                                                                                                                                                     |  |   | 91,721    |   |  |   | 87,635    |  
|Unrecognized income tax benefits                                                                                                                                                                                                          |  |   |          |   |  |   | 20,928    |  
|Other                                                                                                                                                                                                                                     |  |   | 6,416     |   |  |   | 16,400    |  
|                                                                                                                                                                                                                                          |  |   |           |   |  |   |           |  
|Total long-term liabilities                                                                                                                                                                                                               |  |   | 640,637   |   |  |   | 667,463   |  
|                                                                                                                                                                                                                                          |  |   |           |   |  |   |           |  
|Total liabilities                                                                                                                                                                                                                         |  |   | 825,639   |   |  |   | 821,987   |  
|                                                                                                                                                                                                                                          |  |   |           |   |  |   |           |  
|Stockholders equity:                                                                                                                                                                                                                     |  |   |           |   |  |   |           |  
|Common stock, $0.001 par value; authorized 100,000 shares; issued and outstanding: 42,365 shares at September 30, 2007 (including 138
shares held in treasury) and 41,993 shares at June 30, 2008 (including 590 shares held in treasury) |  |   | 42        |   |  |   | 42        |  
|Capital in excess of par value                                                                                                                                                                                                            |  |   | 511,496   |   |  |   | 508,257   |  
|Retained earnings                                                                                                                                                                                                                         |  |   | 319,920   |   |  |   | 314,480   |  
|Treasury stock and other                                                                                                                                                                                                                  |  |   | (1,208    | ) |  |   | (8,636    | )
|                                                                                                                                                                                                                                          |  |   |           |   |  |   |           |  
|Total stockholders equity                                                                                                                                                                                                                |  |   | 830,250   |   |  |   | 814,143   |  
|                                                                                                                                                                                                                                          |  |   |           |   |  |   |           |  
|Total liabilities and stockholders equity                                                                                                                                                                                                |  | $ | 1,655,889 |   |  | $ | 1,636,130 |  
|                                                                                                                                                                                                                                          |  |   |           |   |  |   |           |  

See accompanying notes.



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HEADWATERS INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)



|                                      |  |                            |         |   |                           |   |         |      |  |   |         |   |  |   |         |  
|------------------------------------- |  | -------------------------- | ------- | - | ------------------------- | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                      |  | Three Months EndedJune 30, |         |   | Nine Months EndedJune 30, |  
|(in thousands, except per-share data) |  | 2007                       |         |   | 2008                      |   |         | 2007 |  |   | 2008    |  
|Revenue:                              |  |                            |         |   |                           |   |         |      |  |   |         |   |  |   |         |  
|Building products                     |  | $                          | 155,576 |   |                           | $ | 129,283 |      |  | $ | 393,878 |   |  | $ | 337,609 |  
|Coal combustion products              |  |                            | 83,237  |   |                           |   | 82,640  |      |  |   | 214,502 |   |  |   | 221,048 |  
|Energy                                |  |                            | 97,516  |   |                           |   | 18,533  |      |  |   | 276,978 |   |  |   | 92,675  |  
|                                      |  |                            |         |   |                           |   |         |      |  |   |         |   |  |   |         |  
|Total revenue                         |  |                            | 336,329 |   |                           |   | 230,456 |      |  |   | 885,358 |   |  |   | 651,332 |  
|Cost of revenue:                      |  |                            |         |   |                           |   |         |      |  |   |         |   |  |   |         |  
|Building products                     |  |                            | 103,327 |   |                           |   | 93,960  |      |  |   | 281,065 |   |  |   | 248,639 |  
|Coal combustion products              |  |                            | 58,394  |   |                           |   | 58,117  |      |  |   | 154,636 |   |  |   | 161,676 |  
|Energy                                |  |                            | 56,037  |   |                           |   | 14,087  |      |  |   | 156,632 |   |  |   | 72,334  |  
|                                      |  |                            |         |   |                           |   |         |      |  |   |         |   |  |   |         |  
|Total cost of revenue                 |  |                            | 217,758 |   |                           |   | 166,164 |      |  |   | 592,333 |   |  |   | 482,649 |  
|                                      |  |                            |         |   |                           |   |         |      |  |   |         |   |  |   |         |  
|Gross profit                          |  |                            | 118,571 |   |                           |   | 64,292  |      |  |   | 293,025 |   |  |   | 168,683 |  
|Operating expenses:                   |  |                            |         |   |                           |   |         |      |  |   |         |   |  |   |         |  
|Amortization                          |  |                            | 5,730   |   |                           |   | 5,469   |      |  |   | 17,388  |   |  |   | 16,412  |  
|Research and development              |  |                            | 4,343   |   |                           |   | 3,480   |      |  |   | 13,470  |   |  |   | 11,448  |  
|Selling, general and administrative   |  |                            | 38,717  |   |                           |   | 34,290  |      |  |   | 113,063 |   |  |   | 110,278 |  
|                                      |  |                            |         |   |                           |   |         |      |  |   |         |   |  |   |         |  
|Total operating expenses              |  |                            | 48,790  |   |                           |   | 43,239  |      |  |   | 143,921 |   |  |   | 138,138 |  
|                                      |  |                            |         |   |                           |   |         |      |  |   |         |   |  |   |         |  
|Operating income                      |  |                            | 69,781  |   |                           |   | 21,053  |      |  |   | 149,104 |   |  |   | 30,545  |  
|Other income (expense):               |  |                            |         |   |                           |   |         |      |  |   |         |   |  |   |         |  
|Net interest expense                  |  |                            | (6,664  | ) |                           |   | (5,556  | )    |  |   | (24,001 | ) |  |   | (17,607 | )
|Other, net                            |  |                            | (2,860  | ) |                           |   | (280    | )    |  |   | (9,011  | ) |  |   | 7,498   |  
|                                      |  |                            |         |   |                           |   |         |      |  |   |         |   |  |   |         |  
|Total other income (expense), net     |  |                            | (9,524  | ) |                           |   | (5,836  | )    |  |   | (33,012 | ) |  |   | (10,109 | )
|                                      |  |                            |         |   |                           |   |         |      |  |   |         |   |  |   |         |  
|Income before income taxes            |  |                            | 60,257  |   |                           |   | 15,217  |      |  |   | 116,092 |   |  |   | 20,436  |  
|Income tax provision                  |  |                            | (13,860 | ) |                           |   | (1,520  | )    |  |   | (25,500 | ) |  |   | (6,030  | )
|                                      |  |                            |         |   |                           |   |         |      |  |   |         |   |  |   |         |  
|Net income                            |  | $                          | 46,397  |   |                           | $ | 13,697  |      |  | $ | 90,592  |   |  | $ | 14,406  |  
|                                      |  |                            |         |   |                           |   |         |      |  |   |         |   |  |   |         |  
|Basic earnings per share              |  | $                          | 1.10    |   |                           | $ | 0.33    |      |  | $ | 2.15    |   |  | $ | 0.35    |  
|                                      |  |                            |         |   |                           |   |         |      |  |   |         |   |  |   |         |  
|Diluted earnings per share            |  | $                          | 0.98    |   |                           | $ | 0.31    |      |  | $ | 1.94    |   |  | $ | 0.35    |  
|                                      |  |                            |         |   |                           |   |         |      |  |   |         |   |  |   |         |  

See accompanying notes.



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HEADWATERS INCORPORATED

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY(Unaudited)

For the Nine Months Ended June 30, 2008



|                                                                                                                |  |              |   |                              |        |    |                  |   |         |                       |  |   |         |   |  |                          |         |   |  |   |        |   |  |   |         |  
|--------------------------------------------------------------------------------------------------------------- |  | ------------ | - | ---------------------------- | ------ | -- | ---------------- | - | ------- | --------------------- |  | - | ------- | - |  | ------------------------ | ------- | - |  | - | ------ | - |  | - | ------- | -
|                                                                                                                |  | Common stock |   | Capital inexcessof par value |        |    | Retainedearnings |   |         | Treasurystock,at cost |  |   |         |   |  | Totalstockholdersequity |        
|(in thousands)                                                                                                  |  | Shares       |   |                              | Amount |    |                  |   |         | Other                 |  |  
|Balances as of September 30, 2007                                                                               |  | 42,365       |   |                              | $      | 42 |                  | $ | 511,496 |                       |  | $ | 319,920 |   |  | $                        | (1,223  | ) |  | $ | 15     |   |  | $ | 830,250 |  
|Purchase of 1,205 shares of treasury stock, at cost                                                             |  |              |   |                              |        |    |                  |   |         |                       |  |   |         |   |  |                          | (14,841 | ) |  |   |        |   |  |   | (14,841 | )
|Cancellation of 623 shares of treasury stock                                                                    |  | (623         | ) |                              |        |   |                  |   | (7,335  | )                     |  |   |         |   |  |                          | 7,335   |   |  |   |        |   |  |   |        |  
|130 shares of treasury stock transferred to employee stock purchase plan, at cost                               |  |              |   |                              |        |    |                  |   | 133     |                       |  |   |         |   |  |                          | 1,153   |   |  |   |        |   |  |   | 1,286   |  
|Issuance of restricted stock, net of cancellations                                                              |  | 214          |   |                              |        |   |                  |   |         |                       |  |   |         |   |  |                          |         |   |  |   |        |   |  |   |        |  
|Exercise of stock options                                                                                       |  | 37           |   |                              |        |   |                  |   | 6       |                       |  |   |         |   |  |                          |         |   |  |   |        |   |  |   | 6       |  
|Stock-based compensation                                                                                        |  |              |   |                              |        |    |                  |   | 3,957   |                       |  |   |         |   |  |                          |         |   |  |   |        |   |  |   | 3,957   |  
|Other comprehensive income (loss)  net of taxes  cash flow hedge and foreign currency translation adjustments |  |              |   |                              |        |    |                  |   |         |                       |  |   |         |   |  |                          |         |   |  |   | (1,075 | ) |  |   | (1,075  | )
|Cumulative effect of change in accounting for uncertain tax positionsadoption of FIN 48                        |  |              |   |                              |        |    |                  |   |         |                       |  |   | (19,846 | ) |  |                          |         |   |  |   |        |   |  |   | (19,846 | )
|Net income for the nine months ended June 30, 2008                                                              |  |              |   |                              |        |    |                  |   |         |                       |  |   | 14,406  |   |  |                          |         |   |  |   |        |   |  |   | 14,406  |  
|                                                                                                                |  |              |   |                              |        |    |                  |   |         |                       |  |   |         |   |  |                          |         |   |  |   |        |   |  |   |         |  
|Balances as of June 30, 2008                                                                                    |  | 41,993       |   |                              | $      | 42 |                  | $ | 508,257 |                       |  | $ | 314,480 |   |  | $                        | (7,576  | ) |  | $ | (1,060 | ) |  | $ | 814,143 |  
|                                                                                                                |  |              |   |                              |        |    |                  |   |         |                       |  |   |         |   |  |                          |         |   |  |   |        |   |  |   |         |  

See accompanying notes.



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HEADWATERS INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)



|                                                                                  |  |                           |          |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | ------------------------- | -------- | - | ---- | - | ------- | -
|                                                                                  |  | Nine Months EndedJune 30, |         
|(in thousands)                                                                    |  | 2007                      |          |   | 2008 |  
|Cash flows from operating activities:                                             |  |                           |          |   |      |   |         |  
|Net income                                                                        |  | $                         | 90,592   |   |      | $ | 14,406  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                           |          |   |      |   |         |  
|Depreciation and amortization                                                     |  |                           | 53,990   |   |      |   | 50,791  |  
|Stock-based compensation expense                                                  |  |                           | 4,794    |   |      |   | 3,957   |  
|Interest expense related to amortization of debt issue costs                      |  |                           | 3,987    |   |      |   | 1,996   |  
|Net losses of unconsolidated joint ventures                                       |  |                           | 1,167    |   |      |   | 6,199   |  
|Amortization of non-refundable license fees                                       |  |                           | (16,551  | ) |      |   | (5,517  | )
|Deferred income taxes                                                             |  |                           | (9,578   | ) |      |   | 9,000   |  
|Net loss (gain) on disposition of property, plant and equipment                   |  |                           | 112      |   |      |   | (7,750  | )
|Decrease (increase) in trade receivables                                          |  |                           | (65,581  | ) |      |   | 50,912  |  
|Decrease (increase) in inventories                                                |  |                           | 4,352    |   |      |   | (6,994  | )
|Increase (decrease) in accounts payable and accrued liabilities                   |  |                           | 19,130   |   |      |   | (26,036 | )
|Other changes in operating assets and liabilities, net                            |  |                           | (10,583  | ) |      |   | (37,212 | )
|                                                                                  |  |                           |          |   |      |   |         |  
|Net cash provided by operating activities                                         |  |                           | 75,831   |   |      |   | 53,752  |  
|                                                                                  |  |                           |          |   |      |   |         |  
|Cash flows from investing activities:                                             |  |                           |          |   |      |   |         |  
|Purchase of property, plant and equipment                                         |  |                           | (37,744  | ) |      |   | (86,052 | )
|Proceeds from disposition of property, plant and equipment                        |  |                           | 400      |   |      |   | 13,135  |  
|Payments for acquisitions, net of cash acquired                                   |  |                           | (50,219  | ) |      |   | (19,000 | )
|Investments in joint ventures                                                     |  |                           | (1,160   | ) |      |   | (247    | )
|Net increase in other assets                                                      |  |                           | (162     | ) |      |   | (5,290  | )
|                                                                                  |  |                           |          |   |      |   |         |  
|Net cash used in investing activities                                             |  |                           | (88,885  | ) |      |   | (97,454 | )
|                                                                                  |  |                           |          |   |      |   |         |  
|Cash flows from financing activities:                                             |  |                           |          |   |      |   |         |  
|Treasury stock purchases                                                          |  |                           |         |   |      |   | (14,841 | )
|Employee stock purchases                                                          |  |                           | 1,669    |   |      |   | 1,286   |  
|Proceeds from exercise of stock options                                           |  |                           | 477      |   |      |   | 1       |  
|Income tax benefit from exercise of stock options                                 |  |                           | 24       |   |      |   | 5       |  
|Net proceeds from issuance of long-term debt                                      |  |                           | 154,424  |   |      |   | 35,000  |  
|Payments on long-term debt                                                        |  |                           | (160,087 | ) |      |   |        |  
|Convertible note hedge and related warrants, net                                  |  |                           | (11,830  | ) |      |   |        |  
|                                                                                  |  |                           |          |   |      |   |         |  
|Net cash provided by (used in) financing activities                               |  |                           | (15,323  | ) |      |   | 21,451  |  
|                                                                                  |  |                           |          |   |      |   |         |  
|Net decrease in cash and cash equivalents                                         |  |                           | (28,377  | ) |      |   | (22,251 | )
|Cash and cash equivalents, beginning of period                                    |  |                           | 79,151   |   |      |   | 55,787  |  
|                                                                                  |  |                           |          |   |      |   |         |  
|Cash and cash equivalents, end of period                                          |  | $                         | 50,774   |   |      | $ | 33,536  |  
|                                                                                  |  |                           |          |   |      |   |         |  
|Supplemental schedule of non-cash investing and financing activities:             |  |                           |          |   |      |   |         |  
|Purchase of assets in exchange for future obligations                             |  | $                         |         |   |      | $ | 9,967   |  
|Cancellation of treasury stock                                                    |  |                           |         |   |      |   | 7,335   |  
|Increase (decrease) in accrued liabilities for acquisition-related commitments    |  |                           | 2,639    |   |      |   | (3,000  | )

See accompanying notes.



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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(Unaudited)



|1. | Nature of Operations and Basis of Presentation
|-- | ----------------------------------------------

Description of Business and Organization  Headwaters Incorporated (Headwaters) is incorporated in Delaware and is a diversified company providing products, technologies and services in three industries: building products, coal
combustion products (CCPs) and energy. Headwaters uses technology to differentiate itself from competitors and to create value in its businesses.

In the building products segment, Headwaters designs, manufactures, and sells architectural stone and resin-based exterior siding accessories (such as shutters, mounting blocks, and vents) and other products. Headwaters believes that many
of its branded products have a leading market position. Revenue from Headwaters building products businesses are diversified geographically and also by market, including the new construction, remodeling and home improvement markets.

In the CCP segment, Headwaters is a nationwide leader in the management and marketing of CCPs, including fly ash used as a substitute for
portland cement. Headwaters CCP business is comprised of a nationwide storage and distribution network and revenue is diversified geographically and by market.

In the energy segment, Headwaters is focused on reducing waste and increasing the value of energy-related feedstocks, primarily in the areas of low-value coal and oil. In coal, Headwaters owns and operates several
coal cleaning facilities that remove rock, dirt, and other impurities from waste coal, resulting in higher-value, marketable coal. Headwaters also licensed technology and sold reagents to the coal-based solid alternative fuel industry through
December 31, 2007. In oil, Headwaters believes that its heavy oil upgrading technology represents a substantial improvement over current refining technologies. Headwaters heavy oil upgrading process uses a liquid catalyst precursor to
generate a highly active molecular catalyst to convert residual oil feedstocks into higher-value distillates that can be refined into gasoline, diesel and other products.

Basis of Presentation  Headwaters fiscal year ends on September 30 and unless otherwise noted, references to 2007 refer to Headwaters fiscal quarter and/or nine-month period ended
June 30, 2007 and references to 2008 refer to Headwaters fiscal quarter and/or nine-month period ended June 30, 2008. Other references to years refer to Headwaters fiscal year rather than a calendar year. The consolidated
financial statements include the accounts of Headwaters, all of its subsidiaries and other entities in which Headwaters has a controlling interest. All significant intercompany transactions and accounts are eliminated in consolidation. Due to the
seasonality of most of Headwaters operations and other factors, the consolidated results of operations for 2008 are not indicative of the results to be expected for the full fiscal 2008 year.

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. Certain information and
footnote disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles 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, 2007 (Form 10-K) and in Headwaters Quarterly Reports on Form 10-Q for the quarters ended
December 31, 2007 and March 31, 2008.

Recent Accounting Pronouncements  In September 2006, the Financial Accounting
Standards Board (FASB) issued SFAS No. 157, Fair Value Measurements which addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally
accepted accounting principles. Headwaters must adopt SFAS No. 157 no later than the first quarter of the fiscal year ending September 30, 2009. Headwaters uses fair value measurements to determine the reported amounts of assets acquired
and liabilities assumed in purchase transactions, in testing for potential goodwill impairment, for disclosure of the fair value of financial instruments, and elsewhere. It is therefore possible that the implementation of SFAS No. 157 could
have a material effect on the reported amounts or disclosures in Headwaters consolidated financial statements in future periods.



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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(Unaudited)



In December 2007, the FASB issued SFAS No. 141R, Business Combinations, and SFAS
No. 160, Accounting and Reporting of Noncontrolling Interest in Consolidated Financial Statements, an Amendment of ARB No. 51. These new standards will significantly change the accounting for and reporting of business
combination transactions and minority interests in consolidated financial statements. Headwaters must adopt these standards simultaneously as of October 1, 2009, the beginning of its fiscal 2010 year, which adoption will have a material effect
on the accounting for any business combination consummated thereafter or for any minority interest that exists at that time.

In March 2008,
the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an Amendment of SFAS No. 133. This new standard requires enhanced disclosures about how and why an entity uses derivative
instruments, how such instruments and related hedged items are accounted for under SFAS No. 133, and how those instruments and items affect an entitys financial position, financial performance, and cash flows. Headwaters must adopt SFAS
No. 161 no later than October 1, 2009. Headwaters has entered into certain hedge transactions in the past, primarily to limit variable interest rate exposure, but there are no such hedges outstanding as of June 30, 2008. Accordingly,
the adoption of this standard could affect future disclosures related to any derivative instruments or related hedges that are entered into in future periods.

In May 2008, the FASB issued FASB Staff Position No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement) (the FSP). The FSP
specifies that issuers of convertible debt that can be settled in cash should separately account for the liability (debt) and equity (conversion option) components in a manner that reflects the entitys nonconvertible debt borrowing rate when
interest cost is recognized. The FSP therefore will require different accounting for Headwaters 2.50% Convertible Senior Subordinated Notes due 2014 issued in January 2007 (see Note 6) upon adoption of the FSP, which for Headwaters will be
October 1, 2009. The provisions of the FSP must be applied retrospectively to all periods presented, or all periods subsequent to January 2007.

The adoption of the FSP will result in a redetermination of the carrying amount of Headwaters 2.50% Convertible Debt, calculated by measuring the fair value of a similar debt instrument that does not have the conversion feature, and
recording an equity component for the difference between the original proceeds of the debt and the redetermined amount of debt. Any basis difference that arises from this accounting that represents a temporary difference will also require the
recording of deferred taxes. The original debt issuance costs will be allocated pro-rata between debt and equity issuance costs and accounted for accordingly. Debt discount recorded as a result of the redetermination of the debt carrying value will
be amortized using the interest method and will result in recognition of additional interest cost for all periods subsequent to January 2007. If material, a portion of the increased interest cost will be capitalized, as required by SFAS No. 34,
Capitalization of Interest Cost. Headwaters has not yet determined the specific impact of adoption of the FSP on its historical or future financial position and results of operations beyond the foregoing statements.

Headwaters has reviewed all other recently issued accounting standards which 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 other recent accounting pronouncements will have a significant effect on its current or future
financial position, results of operations, cash flows or disclosures.

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



|2. | Segment Reporting
|-- | -----------------

Headwaters currently
operates three business segments: building products, CCPs and energy. These segments are managed and evaluated separately by management due to differences in their markets, operations, products and services. Revenues for the building products
segment consist of product sales to wholesale and retail distributors, contractors and other users of building products. CCP revenues consist primarily of product sales with a small amount of service revenue. Revenues for the energy segment through
December 31, 2007 consisted primarily of sales of chemical reagents and license fees related to Headwaters former Section 45K business. Beginning January 1, 2008, and for the foreseeable future, revenues for this segment consist
primarily of coal sales.



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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(Unaudited)



The following segment information has been prepared in accordance with SFAS No. 131,
Disclosure about Segments of an Enterprise and Related Information. Segment performance is evaluated primarily on revenue and operating income, although other factors are also used, such as income tax credits generated by activities of
the energy segment. Intersegment sales are immaterial.

Segment costs and expenses considered in deriving segment operating income (loss)
include cost of revenue, 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 overhead. Segment assets reflect those specifically attributable to individual segments and primarily include accounts receivable, inventories, property, plant and equipment,
intangible assets and goodwill. Cash and cash equivalents and certain other assets are included in the Corporate column.



|                              |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   |         |  
|----------------------------- |  | -------------------------------- | ------- | ---- | - | ------ |  | - | --------- | - |  | ------ | ------ | - |  | - | ------- | -
|                              |  | Three Months Ended June 30, 2007 |        
|(in thousands)                |  | BuildingProducts                 |         | CCPs |   | Energy |  |   | Corporate |   |  | Totals |       
|Segment revenue               |  | $                                | 155,576 |      | $ | 83,237 |  | $ | 97,516    |   |  | $      |       |   |  | $ | 336,329 |  
|                              |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   |         |  
|Depreciation and amortization |  | $                                | 12,528  |      | $ | 3,192  |  | $ | 2,412     |   |  | $      | 108    |   |  | $ | 18,240  |  
|                              |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   |         |  
|Operating income (loss)       |  | $                                | 24,292  |      | $ | 17,961 |  | $ | 33,387    |   |  | $      | (5,859 | ) |  | $ | 69,781  |  
|                              |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   |         |  
|Net interest expense          |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   | (6,664  | )
|Other income (expense), net   |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   | (2,860  | )
|Income tax provision          |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   | (13,860 | )
|                              |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   |         |  
|Net income                    |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  | $ | 46,397  |  
|                              |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   |         |  
|Capital expenditures          |  | $                                | 6,419   |      | $ | 1,405  |  | $ | 4,360     |   |  | $      | 90     |   |  | $ | 12,274  |  
|                              |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   |         |  
|                              | 
|                              |  | Three Months Ended June 30, 2008 |        
|(in thousands)                |  | BuildingProducts                 |         | CCPs |   | Energy |  |   | Corporate |   |  | Totals |       
|Segment revenue               |  | $                                | 129,283 |      | $ | 82,640 |  | $ | 18,533    |   |  | $      |       |   |  | $ | 230,456 |  
|                              |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   |         |  
|Depreciation and amortization |  | $                                | 11,585  |      | $ | 3,114  |  | $ | 2,359     |   |  | $      | 100    |   |  | $ | 17,158  |  
|                              |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   |         |  
|Operating income (loss)       |  | $                                | 10,816  |      | $ | 17,341 |  | $ | (2,747    | ) |  | $      | (4,357 | ) |  | $ | 21,053  |  
|                              |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   |         |  
|Net interest expense          |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   | (5,556  | )
|Other income (expense), net   |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   | (280    | )
|Income tax provision          |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   | (1,520  | )
|                              |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   |         |  
|Net income                    |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  | $ | 13,697  |  
|                              |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   |         |  
|Capital expenditures          |  | $                                | 9,283   |      | $ | 3,108  |  | $ | 22,001    |   |  | $      | 168    |   |  | $ | 34,560  |  
|                              |  |                                  |         |      |   |        |  |   |           |   |  |        |        |   |  |   |         |  



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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(Unaudited)



|                                   |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   |           |  
|---------------------------------- |  | ------------------------------- | --------- | ---- | - | ------- |  | - | --------- | - |  | ------ | ------- | - |  | - | --------- | -
|                                   |  | Nine Months Ended June 30, 2007 |          
|(in thousands)                     |  | BuildingProducts                |           | CCPs |   | Energy  |  |   | Corporate |   |  | Totals |        
|Segment revenue                    |  | $                               | 393,878   |      | $ | 214,502 |  | $ | 276,978   |   |  | $      |        |   |  | $ | 885,358   |  
|                                   |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   |           |  
|Depreciation and amortization      |  | $                               | 37,086    |      | $ | 9,630   |  | $ | 6,947     |   |  | $      | 327     |   |  | $ | 53,990    |  
|                                   |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   |           |  
|Operating income (loss)            |  | $                               | 33,023    |      | $ | 38,614  |  | $ | 96,136    |   |  | $      | (18,669 | ) |  | $ | 149,104   |  
|                                   |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   |           |  
|Net interest expense               |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   | (24,001   | )
|Other income (expense), net        |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   | (9,011    | )
|Income tax provision               |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   | (25,500   | )
|                                   |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   |           |  
|Net income                         |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  | $ | 90,592    |  
|                                   |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   |           |  
|Capital expenditures               |  | $                               | 20,767    |      | $ | 4,718   |  | $ | 12,127    |   |  | $      | 132     |   |  | $ | 37,744    |  
|                                   |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   |           |  
|Segment Assets as of June 30, 2007 |  | $                               | 1,170,268 |      | $ | 306,164 |  | $ | 166,587   |   |  | $      | 97,561  |   |  | $ | 1,740,580 |  
|                                   |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   |           |  
|                                   | 
|                                   |  | Nine Months Ended June 30, 2008 |          
|(in thousands)                     |  | BuildingProducts                |           | CCPs |   | Energy  |  |   | Corporate |   |  | Totals |        
|Segment revenue                    |  | $                               | 337,609   |      | $ | 221,048 |  | $ | 92,675    |   |  | $      |        |   |  | $ | 651,332   |  
|                                   |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   |           |  
|Depreciation and amortization      |  | $                               | 34,741    |      | $ | 9,146   |  | $ | 6,619     |   |  | $      | 285     |   |  | $ | 50,791    |  
|                                   |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   |           |  
|Operating income (loss)            |  | $                               | 11,417    |      | $ | 37,845  |  | $ | (4,405    | ) |  | $      | (14,312 | ) |  | $ | 30,545    |  
|                                   |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   |           |  
|Net interest expense               |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   | (17,607   | )
|Other income (expense), net        |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   | 7,498     |  
|Income tax provision               |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   | (6,030    | )
|                                   |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   |           |  
|Net income                         |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  | $ | 14,406    |  
|                                   |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   |           |  
|Capital expenditures               |  | $                               | 34,530    |      | $ | 3,997   |  | $ | 46,907    |   |  | $      | 618     |   |  | $ | 86,052    |  
|                                   |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   |           |  
|Segment Assets as of June 30, 2008 |  | $                               | 1,072,324 |      | $ | 303,191 |  | $ | 173,062   |   |  | $      | 87,553  |   |  | $ | 1,636,130 |  
|                                   |  |                                 |           |      |   |         |  |   |           |   |  |        |         |   |  |   |           |  



|3. | Stock-Based Compensation
|-- | ------------------------

Total stock-based
compensation expense was approximately $1.4 million and $1.5 million for the three months ended June 30, 2007 and 2008, respectively, and $4.8 million and $4.0 million for the nine months ended June 30, 2007 and 2008, respectively. As of
June 30, 2008, there is approximately $6.9 million of total compensation cost related to nonvested awards not yet recognized, which will be recognized in future periods subject to applicable vesting terms.



|4. | Inventories
|-- | -----------

Inventories consisted of the
following at:



|               |  |                    |        |               |   |       
|-------------- |  | ------------------ | ------ | ------------- | - | ------
|(in thousands) |  | September 30, 2007 |        | June 30, 2008
|Raw materials  |  | $                  | 14,192 |               | $ | 11,716
|Finished goods |  |                    | 39,009 |               |   | 49,935
|               |  |                    |        |               |   |       
|               |  | $                  | 53,201 |               | $ | 61,651
|               |  |                    |        |               |   |       



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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(Unaudited)



|5. | Intangible Assets and Goodwill
|-- | ------------------------------

Intangible Assets  All of Headwaters identified intangible assets are being amortized. The following table summarizes the gross carrying amounts and the related accumulated amortization of intangible assets as of:



|                                  |  |                       |  |                     |         |                         |   |                     |  |                         |         |  |   |       
|--------------------------------- |  | --------------------- |  | ------------------- | ------- | ----------------------- | - | ------------------- |  | ----------------------- | ------- |  | - | ------
|                                  |  |                       |  | September 30, 2007  |         | June 30, 2008          
|(in thousands)                    |  | Estimateduseful lives |  | GrossCarryingAmount |         | AccumulatedAmortization |   | GrossCarryingAmount |  | AccumulatedAmortization
|CCP contracts                     |  | 8 -20 years           |  | $                   | 117,690 |                         | $ | 31,718              |  | $                       | 117,690 |  | $ | 36,767
|Customer relationships            |  | 71/2-15 years         |  |                     | 71,503  |                         |   | 15,580              |  |                         | 71,503  |  |   | 19,514
|Trade names                       |  | 5 - 20 years          |  |                     | 68,412  |                         |   | 10,614              |  |                         | 68,412  |  |   | 13,324
|Patents and patented technologies |  | 6 - 19 years          |  |                     | 53,469  |                         |   | 18,152              |  |                         | 54,635  |  |   | 22,038
|Other                             |  | 11/2-15 years         |  |                     | 7,411   |                         |   | 4,277               |  |                         | 5,685   |  |   | 1,530 
|                                  |  |                       |  |                     |         |                         |   |                     |  |                         |         |  |   |       
|                                  |  |                       |  | $                   | 318,485 |                         | $ | 80,341              |  | $                       | 317,925 |  | $ | 93,173
|                                  |  |                       |  |                     |         |                         |   |                     |  |                         |         |  |   |       

Total amortization expense related to intangible assets was approximately $5.7 million and $5.5
million for the three months ended June 30, 2007 and 2008, respectively, and $17.4 million and $16.4 million for the nine months ended June 30, 2007 and 2008, respectively. Total estimated annual amortization expense for fiscal years 2008
through 2013 is shown in the following table.



|                          |  |                |       
|------------------------- |  | -------------- | ------
|Year ending September 30: |  | (in thousands)
|2008                      |  | $              | 21,948
|2009                      |  |                | 22,017
|2010                      |  |                | 21,389
|2011                      |  |                | 20,978
|2012                      |  |                | 19,211
|2013                      |  |                | 18,302

Goodwill  SFAS No. 142 requires Headwaters to periodically test for goodwill
impairment, at least annually, or sooner if evidence of possible impairment arises. Headwaters performs its annual impairment testing using a test date of June 30. In previous years, Headwaters has had five reporting units with allocated
goodwill, three of which were in the building products segment. There is one reporting unit with goodwill in each of the CCPs and energy segments. As a result of changes in the operations and management of the businesses in the building products
segment, and in accordance with the requirements contained in SFAS No. 142, SFAS No. 131 and EITF Abstract Topic D-101, Clarification of Reporting Unit guidance in Paragraph 30 of SFAS No. 142, commencing with its 2008
fiscal year Headwaters has aggregated the three reporting units in the building products segment into one reporting unit for the purpose of goodwill impairment testing.

Due primarily to the depressed new housing and residential remodeling market, there is risk that Headwaters building products reporting unit may fail the SFAS No. 142 goodwill impairment test, requiring a
write-down of goodwill. The goodwill impairment testing is expected to be completed in the quarter ending September 30, 2008, with any necessary non-cash impairment charges recorded in that quarter.



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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(Unaudited)



|6. | Long-term Debt
|-- | --------------

Long-term debt consisted of
the following at:



|                                      |  |                   |         |              |   |        
|------------------------------------- |  | ----------------- | ------- | ------------ | - | -------
|(in thousands)                        |  | September 30,2007 |         | June 30,2008
|Senior secured debt                   |  | $                 | 210,000 |              | $ | 245,000
|Convertible senior subordinated notes |  |                   | 332,500 |              |   | 332,500
|                                      |  |                   |         |              |   |        
|                                      |  | $                 | 542,500 |              | $ | 577,500
|Less current portion                  |  |                   |        |              |   | 35,000 
|                                      |  |                   |         |              |   |        
|Total long-term debt                  |  | $                 | 542,500 |              | $ | 542,500
|                                      |  |                   |         |              |   |        

Senior Secured Credit Agreements  Headwaters senior secured credit facility
currently consists of a first lien term loan in the amount of $210.0 million, plus $35.0 million outstanding under the revolving credit arrangement. The credit facility provides for up to $60.0 million of borrowings under the revolving credit
arrangement. The first lien term loan is senior in priority to all other debt and is secured by all assets of Headwaters. The terms of the credit facility, as currently amended, are described in more detail in the following paragraphs. Headwaters is
in compliance with all debt covenants as of June 30, 2008. However, given the decrease in building products revenues during the continued downturn in the new housing and residential remodeling market and the planned level of capital
expenditures in coal cleaning facilities during calendar year 2008, there is a possibility of noncompliance with certain covenants in the September 30, 2008 quarter. Therefore, Headwaters is seeking an amendment to its senior secured credit
agreement to provide additional flexibility for capital leases and sale-leaseback transactions and to temporarily modify certain of the leverage and fixed charge coverage ratios described in more detail below. The proposed amendment will require
consents from a majority of the debt holders and Headwaters expects to pay a fee to the consenting lenders. In addition, Headwaters expects an amended senior credit facility will carry higher interest rates than the current facility stipulates.

The first lien term loan bears interest, at Headwaters option, at either i) the London Interbank Offered Rate (LIBOR) plus 2.0%,
2.25%, or 2.5%, depending on the credit ratings that have been most recently announced for the loans by Standard & Poors Ratings Services (S&P) and Moodys Investors Service, Inc. (Moodys); or ii) the Base
Rate plus 1.0%, 1.25%, or 1.5%, again depending on the credit ratings announced by S&P and Moodys. Base rate is defined as the higher of the rate announced by Morgan Stanley Senior Funding and the overnight rate charged by the
Federal Reserve Bank of New York plus 0.5%. Headwaters current rate is LIBOR plus 2.0%. Headwaters can lock in new LIBOR rates for the first lien term loan for one, two, three or six months. The weighted-average interest rate on the first lien
term loan was approximately 4.5% at June 30, 2008. Interest on the first lien term loan is generally payable on a quarterly basis.

The
first lien term loan is repayable $84.8 million in February 2011 and $125.2 million in April 2011, the termination date. There are mandatory prepayments of the first lien term loan in the event of certain asset sales and debt and equity issuances
and from excess cash flow, as defined in the agreement. Optional prepayments of the first lien term loan are permitted without penalty or premium. Once repaid in full or in part, no reborrowings can be made.

Borrowings under the revolving credit arrangement are generally subject to the terms of the first lien term loan agreement and bear interest at either
LIBOR plus 1.75% to 2.5% (depending on Headwaters total leverage ratio, as defined), or the Base Rate plus 0.75% to 1.5%. Borrowings and reborrowings of any available portion of the $60.0 million revolver can be made at any time
through September 2009, when all loans must be repaid and the revolving credit arrangement terminates. The fees for the unused portion of the revolving credit arrangement range from 0.5% to 0.75% (depending on Headwaters total leverage
ratio, as defined). As of June 30, 2008, Headwaters had $35.0 million of borrowings outstanding under the revolving credit arrangement, all of which has been classified as current because of the intent to repay the borrowings within 12
months. The credit agreement also allows for the issuance of letters of credit, provided there is capacity under the revolving credit arrangement. As of June 30, 2008, stand-by letters of credit totaling approximately $9.2 million were
outstanding, with expiration dates ranging from July 2008 to September 2009.



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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(Unaudited)



The credit facility contains restrictions and covenants common to such agreements, including
limitations on the incurrence of additional debt, investments, merger and acquisition activity, asset sales and liens, annual capital expenditures in excess of $100.0 million annually plus the unused amount from the prior fiscal year, and the
payment of dividends, among others. In addition, Headwaters must maintain certain leverage and fixed charge coverage ratios, as those terms are defined in the agreements, as follows: i) a total leverage ratio of 3.75:1 or less, declining to 3.5:1 in
2010; ii) a maximum ratio of consolidated funded indebtedness minus subordinated indebtedness to EBITDA of 2.75:1, declining to 2.5:1 in 2010; and iii) a minimum ratio of EBITDA plus rent payments for the four preceding fiscal quarters to scheduled
payments of principal and interest on all indebtedness for the next four fiscal quarters of 1.25:1.

2.875% Convertible Senior
Subordinated Notes Due 2016  Headwaters has outstanding $172.5 million of 2.875% convertible senior subordinated notes due June 2016, with interest payable semi-annually. These notes are subordinate to the senior secured debt described
above and rank equally with the 2.50% convertible senior subordinated notes due 2014 described below, and any future senior subordinated debt. Holders of the notes may convert the notes into shares of Headwaters common stock at a conversion
rate of 33.3333 shares per $1,000 principal amount ($30 conversion price), or 5.75 million aggregate shares of common stock, contingent upon certain events. The conversion rate adjusts for events related to Headwaters common stock,
including common stock issued as a dividend, rights or warrants to purchase common stock issued to all holders of Headwaters common stock, and other similar rights or events that apply to all holders of common stock.

The notes are convertible if any of the following five criteria are met: 1) satisfaction of a market price condition which becomes operative if, prior to
June 1, 2011, in any calendar quarter the closing price of Headwaters common stock exceeds $39 per share for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of the calendar quarter, or, at any
time on or after June 1, 2011 the closing price of Headwaters common stock exceeds $39 per share; 2) a credit rating, if any, assigned to the notes is three or more rating subcategories below the initial rating; 3) the notes trade at less
than 98% of the product of the common stock trading price and the number of shares of common stock issuable upon conversion of $1,000 principal amount of the notes, except this provision is not available if the closing common stock price is between
100% and 130% of the current conversion price of the notes; 4) Headwaters calls the notes for redemption; or 5) upon the occurrence of specified corporate transactions.

Headwaters may call the notes for redemption at any time prior to June 4, 2011 if the closing common stock price exceeds 130% of the conversion price for 20 trading days in any consecutive 30-day trading period
(in which case Headwaters must provide a make whole payment of the present value of all remaining interest payments on the redeemed notes through June 1, 2011). Headwaters may redeem any portion of the notes at any time on or after
June 4, 2011. In addition, the holder of the notes has the right to require Headwaters to repurchase all or a portion of the notes on June 1, 2011 or if a fundamental change in common stock has occurred, including termination of trading.
Subsequent to June 1, 2011, the notes require an additional interest payment equal to 0.40% of the average trading price of the notes if the trading price equals 120% or more of the principal amount of the notes. Headwaters includes the
additional shares of common stock contingently issuable under the convertible notes in its diluted EPS calculations on an if-converted basis (see Note 8).

2.50% Convertible Senior Subordinated Notes Due 2014  In fiscal 2007, Headwaters issued $160.0 million of 2.50% convertible senior subordinated notes due February 2014, with interest payable
semi-annually. These notes are subordinate to the senior secured debt and rank equally with the 2.875% convertible senior subordinated notes due 2016 described above, and any future senior subordinated debt. The conversion rate for the notes is
33.9236 shares per $1,000 principal amount ($29.48 conversion price), subject to adjustment. Upon conversion, Headwaters will pay cash up to the principal amount of the notes, and shares of common stock to the extent the price of Headwaters
common stock exceeds the conversion price during a 20-trading-day observation period. The conversion rate is adjusted for certain corporate transactions referred to as fundamental changes. As described in more detail in Note 1, the
accounting for these notes will change upon adoption of FSP No. APB 14-1 in October 2009.



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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(Unaudited)



The notes are convertible at the option of the holder prior to December 1, 2013 if any of the
following criteria are met: 1) during any fiscal quarter the closing price of Headwaters common stock exceeds $38.32 per share for at least 20 trading days during a period of 30 consecutive trading days ending on the last trading day of the
preceding fiscal quarter; 2) during the five-business-day period after any ten-consecutive-trading-day period, the notes trade at less than 98% of the product of the common stock trading price and the number of shares of common stock issuable upon
conversion of $1,000 principal amount of the notes; or 3) upon the occurrence of specified corporate transactions. The notes are convertible on or after December 1, 2013 regardless of the foregoing circumstances. Headwaters may not redeem the
notes. If Headwaters has a fundamental change, holders may require Headwaters to repurchase the notes at a price equal to the principal amount plus any accrued interest.

In connection with the issuance of the notes, Headwaters entered into convertible note hedge and warrant transactions for the purpose of effectively
increasing the common stock conversion price for the notes from $29.48 per share to $35.00 per share. The convertible note hedge terminates upon the maturity of the notes or when none of the notes remain outstanding due to conversion or otherwise.

Interest  During the three months ended June 30, 2007 and 2008, Headwaters incurred total interest costs of approximately
$7.4 million and $5.8 million, respectively, including approximately $0.7 million in both periods of non-cash interest expense and approximately $0.2 million in both periods of interest costs that were capitalized. During the nine months ended
June 30, 2007 and 2008, Headwaters incurred total interest costs of approximately $26.7 million and $19.2 million, respectively, including approximately $4.0 million and $2.0 million, respectively, of non-cash interest expense and approximately
$0.7 million and $0.5 million, respectively, of interest costs that were capitalized.

Interest income was approximately $0.5 million and
$0.1 million during the three months ended June 30, 2007 and 2008, respectively, and $2.0 million and $1.0 million during the nine months ended June 30, 2007 and 2008, respectively. The weighted-average interest rate on the face amount of
outstanding long-term debt, disregarding amortization of debt issue costs, was approximately 4.5% at September 30, 2007 and 3.4% at June 30, 2008.



|7. | Income Taxes
|-- | ------------

Headwaters estimated
effective income tax rate for the fiscal year ending September 30, 2008, exclusive of discrete items, is 29.0%, which rate was applied to income before income taxes for the nine months ended June 30, 2008. Headwaters also recognized $2.9
million of net income tax benefit in the three months ended June 30, 2008 for discrete items that did not affect the calculation of the estimated effective income tax rate for the 2008 fiscal year. The discrete items recognized in the June 2008
quarter consisted primarily of the reversal of estimated tax liabilities, penalties and interest recorded when Headwaters adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes  an Interpretation of FASB
Statement No. 109 (FIN 48) and substantially offset the $3.0 million of discrete items that were expensed in the six months ended March 31, 2008. Those discrete items primarily represented Section 45K-related changes in
estimates pertaining to the nine-month period ended September 30, 2007, which in turn resulted from the phase-out of Section 45K tax credits for calendar 2007 being different than previously estimated.

In the nine months ended June 30, 2007, Headwaters recognized a net $1.2 million income tax benefit for discrete items that did not affect the
calculation of the estimated effective income tax rate for the 2007 fiscal year. After consideration of the effect of the discrete items, income tax expense totaled approximately 29.5% of income before income taxes for the nine months ended
June 30, 2008, compared to 22.0% for the nine months ended June 30, 2007. The resulting reported income tax rates for the three months ended June 30, 2007 and 2008 were 23.0% and 10.0%, respectively.

The estimated effective tax rate for fiscal 2008, exclusive of the discrete items, is lower than the statutory rate primarily due to Section 45
refined coal tax credits (which are different from the Section 45K tax credits discussed elsewhere) related to several coal cleaning facilities that Headwaters currently owns and operates as well as additional facilities that Headwaters expects
to be operating later in fiscal 2008. Headwaters believes it is more likely than not the refined coal produced at many of these facilities qualifies for tax credits pursuant to Section 45 of the Internal Revenue Code, notwithstanding the
uncertainties and risks associated with the tax credits, as more fully described in Note 9. Excluding the effect of all tax credits, Headwaters estimated effective tax rate for 2008 would be approximately 40%.



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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(Unaudited)



The estimated effective tax rate for fiscal 2007 was lower than the statutory rate primarily due to
Section 45K tax credits related to two coal-based solid alternative fuel facilities that Headwaters owned and operated, plus Headwaters 19% interest in an entity that owned and operated another alternative fuel facility. The alternative
fuel produced at these three facilities through December 2007 qualified for tax credits pursuant to Section 45K (formerly Section 29) of the Internal Revenue Code, subject to the uncertainties and other risks associated with the tax
credits, all as more fully described in Note 9.

The FASB issued FIN 48 in July 2006. This interpretation prescribes a consistent financial
reporting recognition threshold and measurement standard, as well as criteria for subsequently recognizing, derecognizing and measuring tax positions taken or expected to be taken in a tax return. FIN 48 also requires expanded disclosures with
respect to the uncertainty in income taxes. Headwaters adopted FIN 48 effective as of October 1, 2007, the beginning of the 2008 fiscal year, with a cumulative adjustment to decrease retained earnings and increase income tax liabilities for
unrecognized income tax benefits by $19.8 million, which included $2.9 million for interest and penalties. Certain reclassifications of deferred income taxes as of September 30, 2007 were also made to conform to the presentation requirements of
FIN 48, but these were not material. Headwaters recognizes accrued interest and potential penalties related to all income tax liabilities, including unrecognized income tax benefits, in income tax expense. During the nine months ended June 30,
2008, Headwaters recognized the reversal of approximately $0.2 million of interest and penalties and as of June 30, 2008, there was approximately $6.5 million accrued for the payment of interest and penalties.

As of June 30, 2008, Headwaters had approximately $16.9 million of net unrecognized tax benefits, most of which are classified as a long-term
liability. Prior to the adoption of FIN 48, most unrecognized income tax benefits were classified as a current liability. The change in unrecognized tax benefits during the three months ended June 30, 2008 included approximately $1.6 million
relating to a favorable settlement with the taxing authorities. Approximately $24.6 million of gross unrecognized income tax benefits would affect the 2008 effective tax rate if released into income.

Headwaters is currently under audit by the IRS for fiscal years 2003 through 2006 and has open tax periods subject to examination by both federal and
state taxing authorities for fiscal years 2003 through 2007. It is reasonably possible that the amount of Headwaters unrecognized income tax benefits will significantly change within the next 12 months. These changes could be the result of
Headwaters ongoing tax audits or the settlement of outstanding audit issues. However, due to the number of years under audit and the matters being examined, at the current time, an estimate of the range of reasonably possible outcomes cannot
be made.



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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(Unaudited)



|8. | Earnings per Share
|-- | ------------------

The following table sets
forth the computation of basic and diluted EPS for the periods indicated.



|                                                                                                                                  |  |                            |        |                           |   |        |  |      |        |  |   |       
|--------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------- | ------ | ------------------------- | - | ------ |  | ---- | ------ |  | - | ------
|                                                                                                                                  |  | Three Months EndedJune 30, |        | Nine Months EndedJune 30,
|(in thousands, except per-share data)                                                                                             |  | 2007                       |        | 2008                      |   | 2007   |  | 2008
|Numerator:                                                                                                                        |  |                            |        |                           |   |        |  |      |        |  |   |       
|Numerator for basic earnings per share  net income                                                                               |  | $                          | 46,397 |                           | $ | 13,697 |  | $    | 90,592 |  | $ | 14,406
|Interest expense related to convertible senior subordinated notes, net of taxes                                                   |  |                            | 1,132  |                           |   | 1,044  |  |      | 3,386  |  |   |      
|                                                                                                                                  |  |                            |        |                           |   |        |  |      |        |  |   |       
|Numerator for diluted earnings per share  net income plus interest expense related to convertible notes, net of taxes            |  | $                          | 47,529 |                           | $ | 14,741 |  | $    | 93,978 |  | $ | 14,406
|                                                                                                                                  |  |                            |        |                           |   |        |  |      |        |  |   |       
|Denominator:                                                                                                                      |  |                            |        |                           |   |        |  |      |        |  |   |       
|Denominator for basic earnings per share  weighted-average shares outstanding                                                    |  |                            | 42,196 |                           |   | 41,156 |  |      | 42,148 |  |   | 41,387
|Effect of dilutive securities:                                                                                                    |  |                            |        |                           |   |        |  |      |        |  |   |       
|Shares issuable upon exercise of options and SARs and vesting of restricted stock                                                 |  |                            | 411    |                           |   | 121    |  |      | 481    |  |   | 129   
|Shares issuable upon conversion of convertible notes                                                                              |  |                            | 5,750  |                           |   | 5,750  |  |      | 5,750  |  |   |      
|                                                                                                                                  |  |                            |        |                           |   |        |  |      |        |  |   |       
|Total potential dilutive shares                                                                                                   |  |                            | 6,161  |                           |   | 5,871  |  |      | 6,231  |  |   | 129   
|                                                                                                                                  |  |                            |        |                           |   |        |  |      |        |  |   |       
|Denominator for diluted earnings per share  weighted-average shares outstanding after assumed exercises, vesting and
conversions |  |                            | 48,357 |                           |   | 47,027 |  |      | 48,379 |  |   | 41,516
|                                                                                                                                  |  |                            |        |                           |   |        |  |      |        |  |   |       
|Basic earnings per share                                                                                                          |  | $                          | 1.10   |                           | $ | 0.33   |  | $    | 2.15   |  | $ | 0.35  
|                                                                                                                                  |  |                            |        |                           |   |        |  |      |        |  |   |       
|Diluted earnings per share                                                                                                        |  | $                          | 0.98   |                           | $ | 0.31   |  | $    | 1.94   |  | $ | 0.35  
|                                                                                                                                  |  |                            |        |                           |   |        |  |      |        |  |   |       
|Anti-dilutive securities not considered in diluted EPS calculation:                                                               |  |                            |        |                           |   |        |  |      |        |  |   |       
|Stock options                                                                                                                     |  |                            | 1,156  |                           |   | 1,998  |  |      | 1,023  |  |   | 2,095 
|SARs                                                                                                                              |  |                            | 3,365  |                           |   | 1,312  |  |      | 3,212  |  |   | 1,210 
|Shares issuable upon conversion of convertible notes                                                                              |  |                            |       |                           |   |       |  |      |       |  |   | 5,750 



|9. | Commitments and Contingencies
|-- | -----------------------------

Significant
new commitments and ongoing contingencies as of June 30, 2008 not disclosed previously, are as follows.

Acquisitions 
During fiscal 2006, Headwaters acquired certain assets and assumed certain liabilities of several privately-held companies in the building products industry. Pursuant to contractual terms for some of the acquisitions, additional amounts may be
payable in the future, based on the achievement of stipulated revenue or earnings targets for periods ending no later than March 2010.

For
all acquisition transactions, assets acquired and liabilities assumed were recorded at their estimated fair values as of the acquisition dates. If any future earn-out consideration is paid for any acquisition, goodwill will be increased accordingly.



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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(Unaudited)



Property, Plant and Equipment  As of June 30, 2008, Headwaters was committed to
spend approximately $45.6 million on capital projects that were in various stages of completion.

Legal Matters  Headwaters has
ongoing litigation and asserted claims which have been incurred during the normal course of business, including the specific matters discussed below. Headwaters intends to vigorously defend or resolve these matters by settlement, as appropriate.
Management does not currently believe that the outcome of these matters will have a material adverse effect on Headwaters operations, cash flow or financial position.

Historically, costs paid to outside legal counsel for litigation have comprised a majority of Headwaters litigation-related costs. During the nine
months ended June 30, 2008, Headwaters incurred approximately $1.5 million of expense for legal matters, which consisted primarily of costs for outside legal counsel. Headwaters currently believes the range of potential loss for all unresolved
matters, excluding costs for outside counsel, is from $1.0 million up to the amounts sought by claimants and has recorded a total liability as of June 30, 2008 of $1.0 million. Claims and damages sought by claimants in excess of this amount are
not deemed to be probable. Headwaters outside counsel currently believe that unfavorable outcomes of outstanding litigation are neither probable nor remote and declined to express opinions concerning the likely outcomes or liability to
Headwaters. It is not possible to estimate what litigation-related costs will be in future periods.

The matters discussed below raise
difficult and complex legal and factual issues, and the resolution of these issues is subject to many uncertainties, including the facts and circumstances of each case, the jurisdiction in which each case is brought, and the future decisions of
juries, judges, and arbitrators. Therefore, although management believes that the claims asserted against Headwaters in the named cases lack merit, there is a possibility of material losses in excess of the amounts accrued if one or more of the
cases were to be determined adversely against Headwaters for a substantial amount of the damages asserted. It is possible that a change in the estimates of probable liability could occur, and the changes could be material. Additionally, as with any
litigation, these proceedings require that Headwaters incur substantial costs, including attorneys fees, managerial time and other personnel resources, 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 plaintiffs seek declaratory relief and compensatory damages in the approximate amount of $40.0 million and punitive damages. In February 2006, the District Court dismissed all claims against
Headwaters. Also in February 2006, plaintiffs filed an appeal. In July 2007, the United States Court of Appeals for the Federal Circuit vacated the dismissal in favor of Headwaters as to the civil conspiracy and constructive trust claims and
remanded the case to the District Court for further proceedings. Because the resolution of the litigation is uncertain, legal counsel cannot express an opinion as to the ultimate amount, if any, of Headwaters liability.

Ecologica Carmelo. Headwaters Resources, Inc. (HRI), a subsidiary through which Headwaters conducts its CCP business, entered into a fly ash supply
agreement with Ecologica Carmelo, Inc. (Carmelo) in February 2002 to supply fly ash to Carmelo for sale and use in the Caribbean basin region. The agreement guarantees first availability of fly ash to Carmelo from specific power generating plants
and Carmelo agreed to purchase exclusively from HRI and to purchase a minimum tonnage of fly ash annually. In April 2008, HRI filed an arbitration demand with AAA Arbitration in Atlanta, Georgia, against Carmelo alleging that Carmelo
breached the fly ash supply agreement by failing to purchase the minimum annual volume of fly ash it was obligated to purchase under that agreement and for violation of Carmelos obligation to exclusively purchase fly ash from
HRI. HRI is seeking approximately $3.9 million for lost profits on minimum fly ash purchases, plus other direct, incidental, and consequential damages relating to Carmelos failure to purchase from HRI exclusively.



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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(Unaudited)



In June 2008, Carmelo filed its response to HRIs arbitration demand. Carmelo denied
that it breached the fly ash supply agreement, alleged that it properly terminated the agreement, and filed a counterclaim against HRI. Carmelo has alleged that HRI failed to secure a cost-effective source of fly
ash for Carmelo in violation of the fly ash supply agreement. Carmelo has asserted claims for breach of contract, breach of Puerto Rico Law No. 75, and breach of the covenant of good faith and fair dealing. Carmelo is
seeking damages of at least $12.3 million which allegedly represents the lost value of its investment in a facility designed for the intake and storage of fly ash from HRI. Because the resolution of the arbitration
action is uncertain, legal counsel cannot express an opinion concerning the likely outcome of this matter or the liability of HRI, if any.

Headwaters Building Products Matters.There are litigation and pending and threatened claims made against certain subsidiaries of Headwaters Construction Materials (HCM), a division within Headwaters building products segment,
with respect to several types of exterior finish systems manufactured and sold by its subsidiaries for application by contractors on residential and commercial buildings. Typically, litigation and these claims are defended by such subsidiaries
insurance carriers. The plaintiffs or claimants in these matters have alleged that the structures have suffered damage from latent or progressive water penetration due to some alleged failure of the building product or wall system. Some claims
involve alleged defects associated with components of an Exterior Insulating and Finish System (EIFS) which was produced for a limited time (through 1997) by the HCM subsidiaries. There is a 10-year projected claim period following discontinuation
of the product. Other claims involve alleged liabilities associated with certain stucco and architectural stone veneer products which are produced and sold by certain subsidiaries of HCM.

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 damage to property. To date, claims made against such subsidiaries have been paid by their insurers, with the exception of minor deductibles or self-insured retentions, although such insurance
carriers typically have issued reservation of rights letters. None of the cases has gone to trial. While, to date, none of these proceedings have required that HCM incur substantial costs, there is no guarantee of insurance coverage or
continuing coverage. These and future proceedings may result in substantial costs to HCM, including attorneys fees, managerial time and other personnel resources and costs. Adverse resolution of these proceedings could have a materially
negative effect on HCMs business, financial condition, and results of operation, and its ability to meet its financial obligations. Although HCM carries general and product liability insurance, HCM cannot assure that such insurance coverage
will remain available, that HCMs insurance carrier will remain viable, or that the insured amounts will cover all future claims in excess of HCMs uninsured retention. Future rate increases may also make such insurance uneconomical for
HCM to maintain. In addition, the insurance policies maintained by HCM 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 HCMs liability.

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

Section 45K
Matters  A material amount of Headwaters consolidated revenue and net income through December 31, 2007 was derived from license fees and sales of chemical reagents, both of which were dependent on the ability of licensees and
other customers to manufacture and sell qualified synthetic fuel that generated tax credits under Section 45K (formerly Section 29) of the Internal Revenue Code. Headwaters has also claimed Section 45K tax credits for synthetic fuel
sales from facilities in which it owned an interest (see Note 7). The following issues exist related to Section 45K tax credits.

Termination of Section 45K. By law, Section 45K tax credits for synthetic fuel produced from coal expired for synthetic fuel sold after December 31, 2007. With the expiration of Section 45K at the end of calendar
2007, Headwaters licensees synthetic fuel facilities and the facilities owned by Headwaters have closed because production of synthetic fuel is not profitable absent the tax credits. The closure of these synfuel facilities has had and will
continue to have a material adverse effect on the current and future revenue, net income and cash flow of Headwaters, when compared to prior periods.



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Phase-Out. Section 45K tax credits were subject to phase-out after the average annual U.S.
wellhead oil price (reference price) reached a beginning phase-out threshold price, and would have been eliminated entirely if the reference price reached the full phase-out price. The calendar 2007 reference price and phase-out range were announced
earlier in calendar 2008 and accordingly, in the March and June 2008 quarters Headwaters adjusted previously recognized revenue and tax credits as required to reflect the finalized phase-out. The adjustments resulted in an increase of approximately
$5.6 million to the license fee revenue that was recognized through December 31, 2007. The existence and unpredictability of phase-out has materially adversely affected both the amount and timing of recognition of Headwaters revenue, net
income and cash flow beginning in fiscal 2006 and continuing into 2008. At the current time, Headwaters does not believe there are any material residual contingencies related to phase-out.

IRS Audits. Licensees are subject to audit by the IRS. The IRS may challenge whether Headwaters licensees have satisfied the requirements of
Section 45K or applicable Private Letter Rulings, including placed-in-service requirements, or may attempt to disallow Section 45K tax credits for some other reason. The IRS has initiated audits of certain licensee-taxpayers who claimed
Section 45K tax credits and will continue the audit process in the future. To the extent not already paid to Headwaters, the inability of a licensee to claim Section 45K tax credits could reduce amounts to be received by Headwaters from
licensees for license fee revenue recognized prior to June 30, 2008. In addition, the IRS is currently auditing Headwaters tax credits claimed for synthetic fuel sold from the facilities in which it owns an interest. The tax credits which
are under audit that Headwaters believes are more likely than not to be sustained, and are therefore not included in unrecognized income tax benefits in the balance sheet, total approximately $30.0 million.

Section 45 Matters  As explained in Note 7, Headwaters estimated effective tax rate for fiscal 2008 is lower than the statutory
rate due to refined coal tax credits related to several facilities that Headwaters currently owns and operates as well as additional facilities that Headwaters expects to be operating later in fiscal 2008. Headwaters believes the refined coal
produced or to be produced at many of these facilities and sold to qualified buyers will qualify for tax credits under Section 45 (which is different from the Section 45K tax credit discussed in preceding paragraphs) of the Internal
Revenue Code. To date, the IRS has issued limited guidance about how this tax credit program will be administered and the restrictions on the availability of such credits. Based on the language of Section 45, Headwaters believes that many of
its coal cleaning facilities will be eligible for Section 45 refined coal tax credits, and as a result, has recognized a benefit for such credits in its 2008 tax provision. The ability to claim tax credits is dependent upon a number of
conditions, including, but not limited to:



| |  |  | Placing facilities in service on or before December 31, 2008;
| | - |  | -------------------------------------------------------------



| |  |  | Producing a fuel from coal that is lower in NOx and either SOx or mercury emissions by the specified amount as compared to the emissions of the feedstock;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Producing a fuel at least 50% more valuable than the feedstock; and
| | - |  | -------------------------------------------------------------------



| |  |  | Sale of the fuel to a third party for the purpose of producing steam.
| | - |  | ---------------------------------------------------------------------

The IRS may challenge Section 45 tax credits claimed by Headwaters on any one of these or other conditions. In addition, Congress may modify or
repeal Section 45 so that these tax credits may not be available in the future. If Headwaters is not able to claim Section 45 tax credits for fiscal 2008, this will materially adversely affect income tax expense and income taxes paid in
future periods.



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|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 consolidated financial statements and related notes included in this Form
10-Q. Our fiscal year ends on September 30 and unless otherwise noted, references to 2007 refer to our fiscal quarter and/or nine-month period ended June 30, 2007 and references to 2008 refer to our fiscal quarter and/or nine-month period
ended June 30, 2008. Other references to years refer to our fiscal year rather than a calendar year.

Overview

Consolidation and Segments. The consolidated financial statements include the accounts of Headwaters, all of our subsidiaries, and other entities
in which we have a controlling interest. All significant intercompany transactions and accounts are eliminated in consolidation. We made one acquisition in 2007. This entitys results of operations for the period from the acquisition date
through June 30, 2008 have been consolidated with our results; its operations up to the date of acquisition have not been included in the consolidated results for any period.

We currently operate in three industries: building products, coal combustion products (CCPs) and energy. In the building products segment, we design,
manufacture, and sell architectural stone and resin-based exterior siding accessories (such as shutters, mounting blocks, and vents) and other products. Revenues consist of product sales to wholesale and retail distributors, contractors and other
users of building products. We are a nationwide leader in the management and marketing of CCPs. Revenues in the CCP segment consist primarily of fly ash, used as a substitute for portland cement, and other product sales. In the energy segment, we
are focused on reducing waste and increasing the value of energy-related feedstocks, primarily in the areas of low-value coal and oil. Revenues for the energy segment through December 31, 2007 consisted primarily of sales of chemical reagents
and license fees related to our former Section 45K business. Beginning January 1, 2008, and for the foreseeable future, revenues for this segment consist primarily of coal sales.

Operations and Strategy. During the past several years, we have executed our two-fold plan of maximizing cash flow from our existing operating
business units and diversifying from significant reliance on the legacy energy segment Section 45K (formerly Section 29) business. With the addition and expansion of our CCP management and marketing business through acquisitions beginning
in 2002, and the growth of our building products business through several acquisitions beginning in fiscal 2004, we have achieved revenue growth and diversification in three business segments. Because we also incurred increased indebtedness to make
strategic acquisitions, one of our historical financial objectives has been to focus on increasing cash flows to reduce debt levels. In fiscal 2008, our primary focus has been on growing our coal cleaning business and our current primary use of cash
consists of capital expenditures, primarily in the energy segment.

A material amount of our consolidated revenue and net income through
December 31, 2007 was derived from license fees and sales of chemical reagents, both of which were dependent on the ability of licensees and other customers to manufacture and sell qualified synthetic fuel that generated tax credits under
Section 45K of the Internal Revenue Code. We have also claimed Section 45K tax credits for synthetic fuel sales from facilities in which we owned an interest.

By law, Section 45K tax credits for synthetic fuel produced from coal expired for synthetic fuel sold after December 31, 2007. With the expiration of Section 45K at the end of calendar 2007, our
licensees synthetic fuel facilities and the facilities we owned have closed because production of synthetic fuel is not profitable absent the tax credits. The closure of these synfuel facilities has had and will continue to have a material
adverse effect on our current and future revenue, net income and cash flow, when compared to prior periods.

Section 45K tax credits
were subject to phase-out after the average annual U.S. wellhead oil price (reference price) reached a beginning phase-out threshold price, and would have been eliminated entirely if the reference price reached the full phase-out price. The calendar
2007 reference price and phase-out range were announced earlier in calendar 2008 and accordingly, in the March and June 2008 quarters we adjusted previously recognized revenue and tax credits as required to reflect the finalized phase-out. The
adjustments resulted in an increase of approximately $5.6 million to the license fee revenue that was recognized through December 31, 2007. The existence and unpredictability of phase-out has materially adversely affected both the amount and
timing of recognition of our revenue, net income and cash flow beginning in fiscal 2006 and continuing into 2008. At the current time, we do not believe there are any material residual contingencies related to phase-out.

We own and operate several new and recently-renovated coal cleaning facilities that remove rock, dirt, and other impurities from waste coal, resulting in
higher-value, marketable coal. In addition, we are currently constructing several additional coal cleaning facilities, which construction is currently expected to be our largest single investment of cash during fiscal 2008 and fiscal 2009. The coal
cleaning facilities are being financed primarily with available cash and with lease financing. During the quarter ended June 30, 2008, coal sales were $13.1 million, compared to $6.2 million in the March 2008 quarter and $1.4 million in the
December 2007 quarter.



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Our CCP segment business strategy is to continue to negotiate long-term contracts supported by investment
in transportation and storage infrastructure for the marketing and sale of CCPs. We are also continuing our efforts to expand usage of high-value CCPs and to develop more uses for lower-value CCPs, such as blending. Our building products segment has
been significantly affected by the substantial downturn in residential construction and our current strategy is to reduce operating costs as much as possible and be positively positioned to take advantage of an industry turnaround at some point in
the future. Our CCPs and building products businesses are affected by seasonality, with the highest revenue and profitability produced in the June and September quarters. In fiscal 2008, we believe substantially all of our operating income will be
generated in these two quarters.

Our acquisition strategy targets businesses that are leading companies in their respective industries and
that enjoy healthy operating margins, thus providing additional cash flow that complements the financial performance of our existing businesses. In 2006, we began to acquire small companies in the building products segment with innovative products
that can be marketed using our existing distribution channels. We are also committed to continuing to invest in research and development activities that are focused on energy-related technologies and nanotechnology. We participate in joint ventures
that operate an ethanol plant located in North Dakota and a hydrogen peroxide plant in South Korea. We are also investing in other energy projects such as the refining of heavy crude oils into lighter transportation fuels.

In 2005 and subsequent years, we focused on the integration of our large 2004 acquisitions, including the marketing of diverse kinds of building products
through our national distribution network. We became highly leveraged as a result of those acquisitions, but reduced our outstanding debt significantly since that time through cash generated from operations, from an underwritten public offering of
common stock and from proceeds from settlement of litigation. During 2005 through 2007, we made several early repayments of our long-term debt. In 2008, we have not made any early repayments of long-term debt, primarily due to our investments of
available cash in developing and growing our coal cleaning business in the energy segment. Significant cash needs for capital expenditures will continue into 2009, so we are focused on liquidity to enable us to continue implementing our growth
plans. Accordingly, at least temporarily, our historical emphasis on the early repayment of long-term debt has diminished.

Three Months Ended
June 30, 2008 Compared to Three Months Ended June 30, 2007

The information set forth below compares our operating results for
the quarter ended June 30, 2008 (2008) with operating results for the quarter ended June 30, 2007 (2007).

Summary.
Our total revenue for 2008 was $230.5 million, down 31% from $336.3 million for 2007. Gross profit decreased 46%, from $118.6 million in 2007 to $64.3 million in 2008. Operating income decreased from $69.8 million to $21.1 million, and net income
decreased from $46.4 million, with diluted earnings per share of $0.98, to $13.7 million, or $0.31 per diluted share, in 2008.

Excluding
our Section 45K business (for both 2007 and 2008) and results related to certain non-strategic assets in our building products segment which were sold in early fiscal 2008 (for 2007), total revenue for 2008 was $230.1 million, down less than 1%
from $230.9 million for 2007. Gross profit excluding these businesses was $64.0 million in 2008, down 15% from $74.9 million in 2007. Operating income decreased from $27.5 million to $20.8 million in 2008. Net income was $13.5 million with diluted
earnings per share of $0.31, compared to net income of $12.7 million, or $0.27 per diluted share, in 2007.

Revenue and Gross
Margins. The major components of revenue, along with gross margins, are discussed in the sections below.

Building Products
Segment. Sales of building products during 2008 were $129.3 million with a corresponding direct cost of $94.0 million. Sales of building products during 2007 were $155.6 million with a corresponding direct cost of $103.3 million ($145.5 million
and $95.4 million, respectively, excluding results from the non-strategic assets sold in early fiscal 2008). The decrease in sales of building products during 2008 was due primarily to the effects of the depressed new housing and residential
remodeling market which impacted sales across most of our product lines. The gross margin percentage declined from 2007 to 2008 due primarily to fixed costs being absorbed by lower sales. We believe our niche strategy and our focus on productivity
improvements tempered somewhat the impact of the severe slowdown in new residential construction. Because a substantial amount of our revenues in this segment are dependent on the housing industry, we anticipate continuing impact in fiscal 2008 and
beyond from the current industry slowdown.



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CCP Segment. CCP revenues for 2008 were $82.6 million with a corresponding direct cost of $58.1
million. CCP revenues for 2007 were $83.2 million with a corresponding direct cost of $58.4 million. The performance of the CCP segment was affected by the economic slowdown and by variations in sales mix among regions and products.

Energy Segment. In 2007, our energy segment revenue consisted almost exclusively of chemical reagent sales, license fee revenue related to our
solid alternative fuel technologies and sales of synthetic fuel, all of which related to our Section 45K business. In 2008, our energy segment revenue consisted primarily of $13.1 million of coal sales, other energy revenues of $5.0 million and
$0.4 million of residual Section 45K revenue. Coal sales revenue in 2007 was less than $0.5 million. Future energy segment revenues are currently expected to consist primarily of coal sales.

Operating Expenses. The decrease in amortization expense of $0.2 million from 2007 to 2008 was due primarily to intangible assets that have been
fully amortized. Research and development expense decreased by $0.9 million from 2007 to 2008 primarily because of decreased spending on our coal-to-liquids and hydrogen peroxide technologies. Selling, general and administrative expenses decreased
$4.4 million, or 11%, to $34.3 million for 2008 from $38.7 million for 2007. The decrease in 2008 was due primarily to reduced incentive pay expenses and the initial results of our plant consolidations and other cost improvement projects undertaken
in our building products segment earlier in fiscal 2008, partially offset by increased spending in our energy segment on coal cleaning growth initiatives.

Other Income and Expense. During 2008, we reported net other expense of $5.8 million compared to net other expense of $9.5 million during 2007. The decrease in net other expense of $3.7 million was comprised of
a decrease in net interest expense of approximately $1.1 million and a net decrease in other expense items of approximately $2.6 million.

Net interest expense decreased from $6.7 million in 2007 to $5.6 million in 2008 due to lower variable interest rates and lower average levels of long-term debt in 2008 as compared to 2007. For the same reasons, we currently expect interest
expense for the remainder of fiscal 2008 to be less than the corresponding fiscal 2007 amount.

The change in other expense items of $2.6
million consisted primarily of a reduction of $2.7 million in costs related to our investment in the coal-based solid alternative fuel production facility described in Note 7 to the consolidated financial statements. There were no costs related to
this facility in 2008.

Income Tax Provision. The recorded income tax rates for 2008 and 2007 were 10% and 23%, respectively. There
were no discrete items in 2007, but income tax expense in 2008 reflects discrete items totaling $2.9 million of benefit. The discrete items consisted primarily of the reversal of estimated tax liabilities, penalties and interest recorded when we
adopted FIN 48. The estimated effective tax rates, excluding discrete items, were 29% for fiscal 2008 and 23% for fiscal 2007, which rates were applied to fiscal year-to-date income before income taxes, prior to adjusting for discrete items.

The estimated effective tax rate for fiscal 2008, exclusive of discrete items, is lower than the statutory rate primarily due to
Section 45 refined coal tax credits (which are different from the Section 45K tax credits discussed elsewhere) related to several coal cleaning facilities that we currently own and operate as well as additional facilities that we expect to
be operating later in fiscal 2008. We believe it is more likely than not the refined coal produced at many of these facilities qualifies for tax credits pursuant to Section 45 of the Internal Revenue Code, notwithstanding the uncertainties and
risks associated with the tax credits, as more fully described in Note 9 to the consolidated financial statements. Excluding the effect of all tax credits, our estimated effective tax rate for 2008 would be approximately 40%.

The estimated effective tax rate for fiscal 2007 was lower than the statutory rate primarily due to Section 45K tax credits related to two
coal-based solid alternative fuel facilities that we owned and operated, plus our 19% interest in an entity that owned and operated another alternative fuel facility. The alternative fuel produced at these three facilities through December 2007
qualified for tax credits pursuant to Section 45K (formerly Section 29) of the Internal Revenue Code, subject to the uncertainties and other risks associated with the tax credits, all as more fully described in Note 9.

Future changes to our estimates of fiscal 2008 Section 45 refined coal tax credits could be material to our future 2008 income tax expense. Also, we
are currently under audit by the IRS for fiscal years 2003 through 2006 and have open tax periods subject to examination by both federal and state taxing authorities for fiscal years 2003 through 2007. It is reasonably possible that the amount of
unrecognized income tax benefits will significantly change within the next 12 months. These changes could be the result of the ongoing tax audits or the settlement of outstanding audit issues. However, due to the number of years under audit and the
matters being examined, at the current time, an estimate of the range of reasonably possible outcomes cannot be made.

Nine Months Ended June 30,
2008 Compared to Nine Months Ended June 30, 2007

The information set forth below compares our operating results for the nine
months ended June 30, 2008 (2008) with operating results for the nine months ended June 30, 2007 (2007).



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Summary. Our total revenue for 2008 was $651.3 million, down 26% from $885.4 million for 2007.
Gross profit decreased 42%, from $293.0 million in 2007 to $168.7 million in 2008. Operating income decreased from $149.1 million to $30.5 million. Net income decreased from $90.6 million, with diluted earnings per share of $1.94, to $14.4 million,
or $0.35 per diluted share, in 2008.

Excluding our Section 45K business (for both 2007 and 2008) and results related to certain
non-strategic assets in our building products segment which were sold in early fiscal 2008 (for both 2007 and 2008), total revenue for 2008 was $579.0 million, down less than 1% from $584.5 million for 2007. Gross profit excluding these businesses
was $146.7 million in 2008, down 12% from $166.0 million in 2007. Operating income decreased from $26.3 million to $9.4 million in 2008. Net income (loss) was $(2.9) million with diluted earnings (loss) per share of $(0.06), compared to net income
of $1.9 million, or $0.05 per diluted share, in 2007.

Revenue and Gross Margins. The major components of revenue, along with gross
margins, are discussed in the sections below.

Building Products Segment. Sales of building products during 2008 were $337.6 million
with a corresponding direct cost of $248.6 million ($327.9 million and $241.3 million, respectively, excluding results from the non-strategic assets sold in early fiscal 2008). Sales of building products during 2007 were $393.9 million with a
corresponding direct cost of $281.1 million ($366.0 million and $258.5 million, respectively, excluding results from the non-strategic assets sold in early fiscal 2008). The decrease in sales of building products during 2008 was due primarily to the
effects of the depressed new housing and residential remodeling market which impacted sales across most of our product lines. The gross margin percentage declined from 2007 to 2008 due primarily to fixed costs being absorbed by lower sales. We
believe our niche strategy and our focus on productivity improvements tempered somewhat the impact of the severe slowdown in new residential construction.

CCP Segment. CCP revenues for 2008 were $221.0 million with a corresponding direct cost of $161.7 million. CCP revenues for 2007 were $214.5 million with a corresponding direct cost of $154.6 million. The
increase in CCP revenues was due primarily to upward pricing trends in several markets during the early part of fiscal 2008. The gross margin percentage decreased from 2007 to 2008 primarily due to increased costs for material and higher fuel and
transportation costs.

Energy Segment. In 2007, our energy segment revenue consisted almost exclusively of chemical reagent sales,
license fee revenue related to our solid alternative fuel technologies and sales of synthetic fuel, all of which related to our Section 45K business. In 2008, approximately 67% of our energy segment revenue consisted of Section 45K
revenue, the substantial majority of which was recognized in the quarter ended December 31, 2007, when our Section 45K business terminated. Coal sales revenue was $20.8 million in 2008, compared to less than $0.7 million in 2007. Other
energy revenues were $10.2 million in 2008.

Operating Expenses. The decrease in amortization expense of $1.0 million from 2007 to
2008 was due primarily to intangible assets that have been fully amortized. Research and development expense decreased by $2.0 million from 2007 to 2008 primarily because of decreased spending on our coal-to-liquids and hydrogen peroxide
technologies. Selling, general and administrative expenses decreased $2.8 million, or 2%, to $110.3 million for 2008 from $113.1 million for 2007. The decrease in 2008 was due primarily to reduced incentive pay expenses, partially offset by
increased spending in our energy segment on coal cleaning growth initiatives.

Other Income and Expense. During 2008, we reported
net other expense of $10.1 million compared to net other expense of $33.0 million during 2007. The decrease in net other expense of $22.9 million was comprised of a decrease in net interest expense of approximately $6.4 million and a net change in
other income/expense items of approximately $16.5 million.

Net interest expense decreased from $24.0 million in 2007 to $17.6 million in
2008 due to lower variable interest rates and lower average levels of long-term debt in 2008 as compared to 2007.

The change in other
income/expense items of $16.5 million consisted primarily of a $9.0 million decrease in costs related to our investment in the coal-based solid alternative fuel production facility described in Note 7 to the consolidated financial statements, plus
$7.8 million of gain on the sale of property, plant and equipment in 2008 compared to a gain of $0.4 million in 2007. The majority of the property, plant and equipment sold in 2008 represented non-strategic assets in our building products segment. A
portion of the proceeds from this sale were used to acquire assets that have increased the capacity of our Texas-based concrete block business.

Income Tax Provision. The recorded income tax rates for 2008 and 2007 were 30% and 22%, respectively, including discrete items of $0.1 million (expense) in 2008 and $1.2 million (benefit) in 2007. The 2008 discrete items consisted
primarily of Section 45K-related adjustments pertaining to periods prior to the beginning of the fiscal year, net of the reversal of estimated tax



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liabilities, penalties and interest recorded when we adopted FIN 48. The 2007 discrete items consisted primarily of Section 45K-related adjustments
pertaining to periods prior to the beginning of the fiscal year. The estimated effective tax rates, excluding discrete items, were 29% for fiscal 2008 and 23% for fiscal 2007, which rates were applied to income before income taxes, prior to
adjusting for discrete items.

Impact of Inflation and Related Matters

Our operations have been negatively impacted by increased raw materials costs for commodities such as cement, polypropylene and poly-vinyl chloride in the building products segment and by increased fuel costs that
have affected all of our business units. The increased costs of polypropylene, poly-vinyl chloride and fuel have been caused in part by the increase in prices of petroleum-based materials and by supply and demand. The increased costs of cement
appear to be caused by supply and demand and by higher fuel and transportation costs.

We have been successful in passing on some, but not
all, of the increased material, fuel and transportation costs to customers. It is not possible to predict the future trends of these costs, nor our ability to pass on any future price increases to customers.

Liquidity and Capital Resources

Summary of Cash
Flow Activities. Net cash provided by operating activities for the nine months ended June 30, 2008 (2008) was $53.8 million compared to $75.8 million for the nine months ended June 30, 2007 (2007). In both 2008 and 2007, the
primary investing activities consisted of the purchase of property, plant and equipment and payments for acquisitions. In 2008, financing activities consisted primarily of an increase in long-term debt, primarily as a result of capital expenditures.
In 2007, our primary financing activities consisted of the issuance of convertible debt and the repayment of senior debt with those proceeds. More details about our investing and financing activities are provided in the following paragraphs.

Investing Activities. Total expenditures for property, plant and equipment in 2008 were $86.1 million, an increase of $48.3 million
over 2007. The largest share of capital expenditures in 2007 was incurred by the building products segment; however, in 2008, a majority of total capital expenditures was incurred by the energy segment, in particular for growing the coal cleaning
business. Most of our 2008 and planned future capital expenditures represent expansion of operations, rather than maintenance of operating capacity, primarily due to growth initiatives in the energy segment, particularly the construction of coal
cleaning facilities.

Capital expenditures are limited by our senior debt covenants to $100.0 million annually; however, the prior fiscal
year unused amount of annual capital expenditures limit can be carried forward and used in the subsequent fiscal year. As of June 30, 2008, we had approximately $45.0 million of unused amounts of capital expenditures from the prior fiscal year
and we were committed to spend approximately $45.6 million on capital projects that were in various stages of completion, primarily in the energy segment. In 2008, we realized $13.1 million of proceeds from the sale of property, plant and equipment,
most of which represented non-strategic assets in our building products segment. A portion of the proceeds from this sale was used to acquire assets that increased the capacity of our Texas-based concrete block business, enabling us to meet current
and projected demand in this line of business.

In 2007, we acquired 100% of the ownership interests of a privately-held company in the
building products business. Total consideration paid at the date of acquisition of approximately $53.0 million consisted primarily of cash. An additional amount, $19.0 million, was paid in 2008, based on the earnings of the acquired entity for the
12-month period ended September 30, 2007 that exceeded an agreed-upon threshold. Pursuant to contractual terms for some of the acquisitions made in 2006, additional amounts may be payable in the future, based on the achievement of stipulated
revenue or earnings targets for periods ending no later than March 2010. If future earn-out consideration is paid in excess of amounts accrued for any acquisition, goodwill will be increased accordingly.

We are required to periodically test for goodwill impairment, at least annually, or sooner if evidence of possible impairment arises. We perform our
annual impairment testing using a test date of June 30. Due primarily to the depressed new housing and residential remodeling market, there is risk that our building products reporting unit may fail the SFAS No. 142 goodwill impairment
test, requiring a write-down of goodwill. The goodwill impairment testing is expected to be completed in the quarter ending September 30, 2008, with any necessary non-cash impairment charges recorded in that quarter.

We intend to continue to expand our business through growth of existing operations, commercialization of technologies currently being developed, and
possible strategic acquisitions of products or entities that expand our current operating platform. Acquisitions have historically been an important part of our long-term business strategy. We routinely review potential acquisitions, including those
in the areas of building products, CCP marketing, and coal and catalyst technologies. It is possible that some portion



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of future cash and cash equivalents and/or proceeds from the issuance of stock or debt could be used to fund acquisitions of complementary businesses in the
CCP, energy, building products and related industries; however, because of cash flow considerations and current events affecting the debt and equity markets, we do not currently anticipate any significant acquisitions in fiscal 2008 or early 2009.
Our senior secured credit agreement limits acquisitions in the aggregate to $50.0 million of cash consideration and $20.0 million of non-cash consideration annually, with no more than $30.0 million of cash consideration for any one acquisition,
unless our total leverage ratio, as defined, is less than or equal to 3.50:1.0, after giving effect to an acquisition, in which case the foregoing limitations do not apply. The senior secured credit agreement also limits the amount we
can invest in joint ventures and other less than 100%-owned entities.

We have invested in several joint ventures which are accounted for
using the equity method of accounting, but do not currently have plans to significantly increase our investments in those entities.

Financing Activities. In 2008, we had net proceeds of $35.0 million from the issuance of long-term debt, representing borrowings from our senior revolving credit facility. With the exception of borrowings of the revolving credit
facility, we have no long-term debt repayments that are due prior to 2011. In 2008, we made treasury stock purchases totaling $14.8 million, near the limit established by our senior secured credit agreement.

In 2007, financing activities consisted of the repayment of long-term debt and, as described in more detail in Note 6 to the consolidated financial
statements, the issuance of $160.0 million of 2.50% convertible senior subordinated notes due February 2014. The net proceeds from the issuance of the convertible notes and additional cash on hand were used to repay senior debt and the remaining
balance of outstanding notes payable to a bank. We may, in the future, make optional prepayments of senior debt depending on actual cash flows, our current and expected cash requirements and other applicable factors we deem to be significant.

Due to covenants associated with our senior debt, we currently have restrictions on our ability to obtain significant additional amounts
of long-term debt. However, we have historically experienced strong positive cash flow from operations which has enabled us to repay a substantial amount of our long-term debt prior to scheduled maturities. While we expect our positive cash flow to
continue in the future, our positive cash flow from operations is expected to be lower in fiscal 2008 and subsequent years due to the termination of our Section 45K business, as described previously and in Note 9 to the consolidated financial
statements. Also, while we have periodically accessed the debt and equity markets in prior years, affordable and available additional debt and equity will be more difficult for us to obtain in future periods than in the past, due to less favorable
market conditions as well as changes in our business model.

Reference is made to Note 6 to the consolidated financial statements for
detailed information about our outstanding long-term debt and compliance with debt covenants, as well as the available $60.0 million revolving credit arrangement, which terminates in September 2009. The senior credit facility contains restrictions
and covenants common to such agreements, including limitations on the incurrence of additional debt, investments, merger and acquisition activity, asset sales and liens, annual capital expenditures in excess of $100.0 million annually, and the
payment of dividends, among others. In addition, we must maintain certain leverage and fixed charge coverage ratios. We are in compliance with all debt covenants as of June 30, 2008. However, given the decrease in building products revenues
during the continued downturn in the new housing and residential remodeling market and the planned level of capital expenditures in coal cleaning facilities during calendar year 2008, there is a possibility of noncompliance with certain covenants in
the September 30, 2008 quarter. Therefore, we are seeking an amendment to our senior secured credit agreement to provide additional flexibility for capital leases and sale-leaseback transactions and to temporarily modify certain of the leverage
and fixed charge coverage ratios described in more detail in Note 6. The proposed amendment will require consents from a majority of the debt holders and we expect to pay a fee to the consenting lenders. In addition, we expect an amended senior
credit facility will carry higher interest rates than the current facility stipulates. In late July, our credit rating agencies modified downward their ratings and / or outlook. We do not currently believe these changes will significantly affect our
ability to obtain the desired amendments to the senior credit facility.

In January 2007, we announced that we were planning an exchange
offer for our 2.875% convertible senior subordinated notes due 2016, whereby new notes with similar, but not identical, terms, along with an exchange fee, would be issued upon tender of the existing notes. In April 2007, we announced that the
commencement of an exchange offer had been indefinitely postponed. We continue to evaluate the merits and timing of an exchange offer.

In
both 2007 and 2008, cash proceeds from the exercise of options and employee stock purchases were not material. Option exercise activity is primarily dependent on our 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, we receive an income tax deduction generally equal to the income recognized by the optionee. Such amounts were not material in either
2007 or 2008.



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Working Capital. As of June 30, 2008, our working capital was $139.7 million. Notwithstanding
the termination of our Section 45K business as of December 31, 2007 and the resulting impact on cash flow, we currently expect operations to produce positive cash flow in future periods and believe working capital, along with available
borrowings under the revolving credit arrangement, will be sufficient for operating needs for the next 12 months.

Income Taxes.
Historically, our cash requirements for income taxes generally approximated the income tax provision; however, there is usually some lag in paying estimated taxes during a fiscal year due to the seasonality of our operations and because estimated
income tax payments are typically based on annualizing the fiscal years income based on year-to-date results. There has also been some lag in realizing cash benefits from the utilization of tax credits due to the interaction of our
September 30 fiscal year end and the different fiscal year ends of the entities through which we have received the tax credits. Since fiscal 2006 and continuing through June 30, 2008, there has been more variability in the relationship
between the income tax provision and income tax payments because the tax provision calculation has been materially dependent upon estimating the phase-out percentage of Section 45K tax credits (see Notes 7 and 9 to the consolidated financial
statements).

As discussed previously, cash payments for income taxes are reduced for tax deductions resulting from disqualifying
dispositions of incentive stock options and from the exercise of non-qualified stock options, which amount was not material in 2007 or 2008. Option exercise activity is primarily dependent on our stock price which is not predictable, and likewise,
it is not possible to estimate what tax benefits may be realized from future option exercises.

Summary of Future Cash Requirements.
Significant future cash uses, beyond operational working capital requirements, including income tax payments and interest payments on long-term debt, are currently expected to consist primarily of capital expenditures and the repayment of draw-downs
of our senior revolving credit facility.

Legal Matters

We have ongoing litigation and asserted claims which have been incurred during the normal course of business. Reference is made to Note 9 to the consolidated financial statements for a description of our accounting
for legal costs and for other information about legal matters.

Recent Accounting Pronouncements

Reference is made to Note 1 to the consolidated financial statements for a discussion of accounting pronouncements that have been recently issued which we
have not yet adopted.



|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------

We are exposed to financial market risks, primarily related to changes in interest rates and certain foreign currencies. We do not use derivative financial instruments for speculative or trading purposes. We have entered into certain hedge
transactions in the past, primarily to limit our variable interest rate exposure, but there are no such hedges outstanding as of June 30, 2008. The Blue Flint joint venture has derivatives in place related to variable interest rates and
commodities.

As described in more detail in Note 6 to the consolidated financial statements, our senior debt, which totaled $245.0 million
as of June 30, 2008, bears interest at a variable-rate. Accordingly, assuming no change in the amount of senior debt outstanding, a change in the interest rate of 1% would change our interest expense by approximately $2.5 million during the 12
months ending June 30, 2009.

We have limited operations in foreign jurisdictions. However, one of our joint ventures with Evonik
Industries AG owns a hydrogen peroxide business located in South Korea. This joint venture has over  25.0 million of long-term debt and other obligations denominated in Euros. Because the debt and other obligations are payable in a
currency different from the Korean Won, the joint ventures functional currency, it must be translated into Korean Won at the end of each reporting period based on current exchange rates. As a result of this requirement, the joint venture is
subject to foreign currency exchange rate movements. During the nine months ended June 30, 2008 the joint venture recorded foreign currency exchange losses of which $5.7 million has been included in our results of operations. As of
June 30, 2008, a change in the relationship between the Euro and Korean Won of 10% would result in a gain or loss of approximately $2.0 million for us.



|ITEM 4. | CONTROLS AND PROCEDURES
|------- | -----------------------

Disclosure Controls and
Procedures  We maintain disclosure controls and procedures that are designed to ensure that information we are required to disclose in the reports that we file or submit under the Securities Exchange Act of 1934 (the Exchange Act), such as
this Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified



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by SEC rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information we are
required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including the Chief Executive Officer (CEO) and the Chief Financial Officer (CFO), to allow timely decisions
regarding required disclosure.

Our management evaluated, with the participation of our CEO and CFO, the effectiveness of our disclosure
controls and procedures as of June 30, 2008, pursuant to paragraph (b) of Rules 13a-15 and 15d-15 under the Exchange Act. This evaluation 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. Our management, including the CEO and CFO, do 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. Our disclosure controls and procedures are designed to provide such reasonable assurance of achieving
their objectives. Also, the projection of any evaluation of the disclosure controls and procedures to future periods is 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, and subject to the
inherent limitations described above, our CEO and CFO have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were effective as of June 30, 2008 at the above-described
reasonable assurance level.

Internal Control over Financial Reporting  Management is responsible for establishing and
maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even internal controls
determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. The effectiveness of our internal control over financial reporting is subject to various inherent limitations,
including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the possibility of human error, and the risk of fraud. The projection of any evaluation of effectiveness to future periods is subject
to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies may deteriorate. Because of these limitations, there can be no assurance that any system of internal control over
financial reporting will be successful in preventing all errors or fraud or in making all material information known in a timely manner to the appropriate levels of management.

There has been no change in our internal control over financial reporting during the quarter ended June 30, 2008 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial reporting.

PART II  OTHER INFORMATION



|ITEM 1. | LEGAL PROCEEDINGS
|------- | -----------------

See Legal Mattersin Note 9 to the consolidated financial statements for a description of current legal proceedings.



|ITEM 1A. | RISK FACTORS
|-------- | ------------

Risks relating to our business and
our common stock are described in Item 1A of our Form 10-K.



|ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
|------- | -----------------------------------------------------------

None.



|ITEM 3. | DEFAULTS UPON SENIOR SECURITIES
|------- | -------------------------------

None.



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

None.



|ITEM 5. | OTHER INFORMATION
|------- | -----------------

None.



|ITEM 6. | EXHIBITS
|------- | --------

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.
|- | ---------------



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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: August 5, 2008 |  |  |  | By:                     |  | /s/ Kirk A. Benson                                                      
|                     |  |  |  |                         |  | Kirk A. Benson, Chief Executive Officer (Principal
Executive Officer)   
|                     |  |  | 
|Date: August 5, 2008 |  |  |  | By:                     |  | /s/ Steven G. Stewart                                                   
|                     |  |  |  |                         |  | Steven G. Stewart, Chief Financial Officer (Principal
Financial Officer)



29