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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 December 31, 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 300South 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 January 31, 2009 was 42,333,332.









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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, 2008 and December 31, 2008                             |  | 3       
|                               |  | Condensed Consolidated Statements of Operations  For the three months ended December 31, 2007 and
2008            |  | 4       
|                               |  | Condensed Consolidated Statement of Changes in Stockholders Equity  For the three months ended December 31, 2008 |  | 5       
|                               |  | Condensed Consolidated Statements of Cash Flows  For the three months ended December 31, 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                              |  | 21      
|ITEM 3.                        |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                         |  | 28      
|ITEM 4.                        |  | CONTROLS AND PROCEDURES                                                                                            |  | 28      
|                               | 
|PART II  OTHER INFORMATION    |  |                                                                                                                   
|                               |  |                                                                                                                   
|ITEM 1.                        |  | LEGAL PROCEEDINGS                                                                                                  |  | 29      
|ITEM 1A.                       |  | RISK FACTORS                                                                                                       |  | 29      
|ITEM 2.                        |  | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                                        |  | 29      
|ITEM 3.                        |  | DEFAULTS UPON SENIOR SECURITIES                                                                                    |  | 29      
|ITEM 4.                        |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                |  | 29      
|ITEM 5.                        |  | OTHER INFORMATION                                                                                                  |  | 29      
|ITEM 6.                        |  | EXHIBITS                                                                                                           |  | 30      
|                               | 
|SIGNATURES                     |  | 31                                                                                                                

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. In some cases, words such as
may, should, intends, plans, expects, anticipates, targets, goals, projects, believes, seeks, estimates,
or variations of such words and similar expressions, or the negative of such terms, may help to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated
growth and trends in our businesses, and other characterizations of future events or circumstances, are forward-looking. For a discussion of the factors that could cause actual results to differ from expectations, please see the risk factors
described in Item 1A of our Annual Report on Form 10-K for the year ended September 30, 2008. 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 30,2008 |           |   | December 31,2008 |  
|ASSETS                                                                                                                                                                                                                                        |  |                   |           |   |                  |   |           |  
|Current assets:                                                                                                                                                                                                                               |  |                   |           |   |                  |   |           |  
|Cash and cash equivalents                                                                                                                                                                                                                     |  | $                 | 21,637    |   |                  | $ | 45,228    |  
|Trade receivables, net                                                                                                                                                                                                                        |  |                   | 117,595   |   |                  |   | 76,513    |  
|Inventories                                                                                                                                                                                                                                   |  |                   | 53,068    |   |                  |   | 54,594    |  
|Current and deferred income taxes                                                                                                                                                                                                             |  |                   | 37,518    |   |                  |   | 28,997    |  
|Other                                                                                                                                                                                                                                         |  |                   | 10,568    |   |                  |   | 12,582    |  
|                                                                                                                                                                                                                                              |  |                   |           |   |                  |   |           |  
|Total current assets                                                                                                                                                                                                                          |  |                   | 240,386   |   |                  |   | 217,914   |  
|                                                                                                                                                                                                                                              |  |                   |           |   |                  |   |           |  
|Property, plant and equipment, net                                                                                                                                                                                                            |  |                   | 304,835   |   |                  |   | 309,079   |  
|                                                                                                                                                                                                                                              |  |                   |           |   |                  |   |           |  
|Other assets:                                                                                                                                                                                                                                 |  |                   |           |   |                  |   |           |  
|Intangible assets, net                                                                                                                                                                                                                        |  |                   | 226,168   |   |                  |   | 220,521   |  
|Goodwill                                                                                                                                                                                                                                      |  |                   | 582,111   |   |                  |   | 582,111   |  
|Other                                                                                                                                                                                                                                         |  |                   | 48,486    |   |                  |   | 42,181    |  
|                                                                                                                                                                                                                                              |  |                   |           |   |                  |   |           |  
|Total other assets                                                                                                                                                                                                                            |  |                   | 856,765   |   |                  |   | 844,813   |  
|                                                                                                                                                                                                                                              |  |                   |           |   |                  |   |           |  
|Total assets                                                                                                                                                                                                                                  |  | $                 | 1,401,986 |   |                  | $ | 1,371,806 |  
|                                                                                                                                                                                                                                              |  |                   |           |   |                  |   |           |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                                                          |  |                   |           |   |                  |   |           |  
|Current liabilities:                                                                                                                                                                                                                          |  |                   |           |   |                  |   |           |  
|Accounts payable                                                                                                                                                                                                                              |  | $                 | 27,688    |   |                  | $ | 24,652    |  
|Accrued personnel costs                                                                                                                                                                                                                       |  |                   | 29,873    |   |                  |   | 25,678    |  
|Other accrued liabilities                                                                                                                                                                                                                     |  |                   | 58,168    |   |                  |   | 53,030    |  
|                                                                                                                                                                                                                                              |  |                   |           |   |                  |   |           |  
|Total current liabilities                                                                                                                                                                                                                     |  |                   | 115,729   |   |                  |   | 103,360   |  
|                                                                                                                                                                                                                                              |  |                   |           |   |                  |   |           |  
|Long-term liabilities:                                                                                                                                                                                                                        |  |                   |           |   |                  |   |           |  
|Long-term debt                                                                                                                                                                                                                                |  |                   | 532,500   |   |                  |   | 514,926   |  
|Deferred income taxes                                                                                                                                                                                                                         |  |                   | 87,026    |   |                  |   | 86,849    |  
|Unrecognized income tax benefits                                                                                                                                                                                                              |  |                   | 18,441    |   |                  |   | 18,441    |  
|Other                                                                                                                                                                                                                                         |  |                   | 16,738    |   |                  |   | 15,367    |  
|                                                                                                                                                                                                                                              |  |                   |           |   |                  |   |           |  
|Total long-term liabilities                                                                                                                                                                                                                   |  |                   | 654,705   |   |                  |   | 635,583   |  
|                                                                                                                                                                                                                                              |  |                   |           |   |                  |   |           |  
|Total liabilities                                                                                                                                                                                                                             |  |                   | 770,434   |   |                  |   | 738,943   |  
|                                                                                                                                                                                                                                              |  |                   |           |   |                  |   |           |  
|Stockholders equity:                                                                                                                                                                                                                         |  |                   |           |   |                  |   |           |  
|Common stock, $0.001 par value; authorized 100,000 shares; issued and outstanding: 42,035 shares at September 30, 2008 (including 564
shares held in treasury) and 42,333 shares at December 31, 2008 (including 476 shares held in treasury) |  |                   | 42        |   |                  |   | 42        |  
|Capital in excess of par value                                                                                                                                                                                                                |  |                   | 509,977   |   |                  |   | 511,320   |  
|Retained earnings                                                                                                                                                                                                                             |  |                   | 130,394   |   |                  |   | 129,515   |  
|Treasury stock and other                                                                                                                                                                                                                      |  |                   | (8,861    | ) |                  |   | (8,014    | )
|                                                                                                                                                                                                                                              |  |                   |           |   |                  |   |           |  
|Total stockholders equity                                                                                                                                                                                                                    |  |                   | 631,552   |   |                  |   | 632,863   |  
|                                                                                                                                                                                                                                              |  |                   |           |   |                  |   |           |  
|Total liabilities and stockholders equity                                                                                                                                                                                                    |  | $                 | 1,401,986 |   |                  | $ | 1,371,806 |  
|                                                                                                                                                                                                                                              |  |                   |           |   |                  |   |           |  

See accompanying notes.



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HEADWATERS INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)



|                                      |  |                                |         |   |      |   |         |  
|------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                      |  | Three Months EndedDecember 31, |        
|(in thousands, except per-share data) |  | 2007                           |         |   | 2008 |  
|Revenue:                              |  |                                |         |   |      |   |         |  
|Building products                     |  | $                              | 114,766 |   |      | $ | 88,227  |  
|Coal combustion products              |  |                                | 77,426  |   |      |   | 67,226  |  
|Energy                                |  |                                | 56,705  |   |      |   | 10,713  |  
|                                      |  |                                |         |   |      |   |         |  
|Total revenue                         |  |                                | 248,897 |   |      |   | 166,166 |  
|Cost of revenue:                      |  |                                |         |   |      |   |         |  
|Building products                     |  |                                | 81,836  |   |      |   | 70,264  |  
|Coal combustion products              |  |                                | 55,908  |   |      |   | 47,060  |  
|Energy                                |  |                                | 48,097  |   |      |   | 17,201  |  
|                                      |  |                                |         |   |      |   |         |  
|Total cost of revenue                 |  |                                | 185,841 |   |      |   | 134,525 |  
|                                      |  |                                |         |   |      |   |         |  
|Gross profit                          |  |                                | 63,056  |   |      |   | 31,641  |  
|Operating expenses:                   |  |                                |         |   |      |   |         |  
|Amortization                          |  |                                | 5,512   |   |      |   | 5,745   |  
|Research and development              |  |                                | 4,141   |   |      |   | 3,461   |  
|Selling, general and administrative   |  |                                | 35,029  |   |      |   | 31,608  |  
|                                      |  |                                |         |   |      |   |         |  
|Total operating expenses              |  |                                | 44,682  |   |      |   | 40,814  |  
|                                      |  |                                |         |   |      |   |         |  
|Operating income (loss)               |  |                                | 18,374  |   |      |   | (9,173  | )
|Other income (expense):               |  |                                |         |   |      |   |         |  
|Net interest expense                  |  |                                | (5,844  | ) |      |   | (8,691  | )
|Other, net                            |  |                                | 3,983   |   |      |   | 17,435  |  
|                                      |  |                                |         |   |      |   |         |  
|Total other income (expense), net     |  |                                | (1,861  | ) |      |   | 8,744   |  
|                                      |  |                                |         |   |      |   |         |  
|Income (loss) before income taxes     |  |                                | 16,513  |   |      |   | (429    | )
|Income tax provision                  |  |                                | (6,600  | ) |      |   | (450    | )
|                                      |  |                                |         |   |      |   |         |  
|Net income (loss)                     |  | $                              | 9,913   |   |      | $ | (879    | )
|                                      |  |                                |         |   |      |   |         |  
|Basic earnings (loss) per share       |  | $                              | 0.24    |   |      | $ | (0.02   | )
|                                      |  |                                |         |   |      |   |         |  
|Diluted earnings (loss) per share     |  | $                              | 0.23    |   |      | $ | (0.02   | )
|                                      |  |                                |         |   |      |   |         |  

See accompanying notes.



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HEADWATERS INCORPORATED

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY

(Unaudited)

For the Three Months Ended December 31, 2008



|                                                                                                               |  |              |  |                              |    |  |                  |         |   |                        |   |         |       |  |   |                          |   |  |   |        |   |  |   |         |  
|-------------------------------------------------------------------------------------------------------------- |  | ------------ |  | ---------------------------- | -- |  | ---------------- | ------- | - | ---------------------- | - | ------- | ----- |  | - | ------------------------ | - |  | - | ------ | - |  | - | ------- | -
|                                                                                                               |  | Common stock |  | Capital inexcessof par value |    |  | Retainedearnings |         |   | Treasury stock,at cost |   |         | Other |  |   | Totalstockholdersequity |  
|(in thousands)                                                                                                 |  | Shares       |  | Amount                       |    |  |                  |         |  
|Balances as of September 30, 2008                                                                              |  | 42,035       |  | $                            | 42 |  | $                | 509,977 |   |                        | $ | 130,394 |       |  | $ | (7,281                   | ) |  | $ | (1,580 | ) |  | $ | 631,552 |  
|Issuance of restricted stock, net of cancellations                                                             |  | 225          |  |                              |   |  |                  |         |   |                        |   |         |       |  |   |                          |   |  |   |        |   |  |   |        |  
|Exercise of stock options                                                                                      |  | 73           |  |                              |   |  |                  | 410     |   |                        |   |         |       |  |   |                          |   |  |   |        |   |  |   | 410     |  
|88 shares of treasury stock transferred to employee stock purchase plan, at cost                               |  |              |  |                              |    |  |                  | (776    | ) |                        |   |         |       |  |   | 1,157                    |   |  |   |        |   |  |   | 381     |  
|Stock-based compensation                                                                                       |  |              |  |                              |    |  |                  | 1,709   |   |                        |   |         |       |  |   |                          |   |  |   |        |   |  |   | 1,709   |  
|Other comprehensive income (loss), net of taxes  cash flow hedge and foreign currency translation adjustments |  |              |  |                              |    |  |                  |         |   |                        |   |         |       |  |   |                          |   |  |   | (310   | ) |  |   | (310    | )
|Net loss for the three months ended December 31, 2008                                                          |  |              |  |                              |    |  |                  |         |   |                        |   | (879    | )     |  |   |                          |   |  |   |        |   |  |   | (879    | )
|                                                                                                               |  |              |  |                              |    |  |                  |         |   |                        |   |         |       |  |   |                          |   |  |   |        |   |  |   |         |  
|Balances as of December 31, 2008                                                                               |  | 42,333       |  | $                            | 42 |  | $                | 511,320 |   |                        | $ | 129,515 |       |  | $ | (6,124                   | ) |  | $ | (1,890 | ) |  | $ | 632,863 |  
|                                                                                                               |  |              |  |                              |    |  |                  |         |   |                        |   |         |       |  |   |                          |   |  |   |        |   |  |   |         |  

See accompanying notes.



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HEADWATERS INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)



|                                                                                         |  |                                |         |   |      |   |         |  
|---------------------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                                         |  | Three Months EndedDecember 31, |        
|(in thousands)                                                                           |  | 2007                           |         |   | 2008 |  
|Cash flows from operating activities:                                                    |  |                                |         |   |      |   |         |  
|Net income (loss)                                                                        |  | $                              | 9,913   |   |      | $ | (879    | )
|Adjustments to reconcile net income (loss) to net cash provided by operating activities: |  |                                |         |   |      |   |         |  
|Depreciation and amortization                                                            |  |                                | 16,953  |   |      |   | 19,462  |  
|Gain on extinguishment of debt                                                           |  |                                |        |   |      |   | (17,574 | )
|Interest expense related to amortization of debt issue costs                             |  |                                | 667     |   |      |   | 2,005   |  
|Stock-based compensation                                                                 |  |                                | 1,208   |   |      |   | 1,709   |  
|Net losses of unconsolidated joint ventures                                              |  |                                | 3,509   |   |      |   | 2,576   |  
|Net loss (gain) on disposition of property, plant and equipment                          |  |                                | (4,421  | ) |      |   | 224     |  
|Amortization of non-refundable license fees                                              |  |                                | (5,517  | ) |      |   |        |  
|Deferred income taxes                                                                    |  |                                | (37     | ) |      |   |        |  
|Decrease in trade receivables                                                            |  |                                | 59,231  |   |      |   | 41,082  |  
|Increase in inventories                                                                  |  |                                | (9,203  | ) |      |   | (1,705  | )
|Decrease in accounts payable and accrued liabilities                                     |  |                                | (12,748 | ) |      |   | (12,369 | )
|Other changes in operating assets and liabilities, net                                   |  |                                | (24,935 | ) |      |   | 7,062   |  
|                                                                                         |  |                                |         |   |      |   |         |  
|Net cash provided by operating activities                                                |  |                                | 34,620  |   |      |   | 41,593  |  
|                                                                                         |  |                                |         |   |      |   |         |  
|Cash flows from investing activities:                                                    |  |                                |         |   |      |   |         |  
|Purchase of property, plant and equipment                                                |  |                                | (25,569 | ) |      |   | (18,094 | )
|Proceeds from disposition of property, plant and equipment                               |  |                                | 7,693   |   |      |   | 120     |  
|Payments for acquisitions                                                                |  |                                | (19,000 | ) |      |   |        |  
|Net increase in other assets                                                             |  |                                | 230     |   |      |   | 361     |  
|                                                                                         |  |                                |         |   |      |   |         |  
|Net cash used in investing activities                                                    |  |                                | (36,646 | ) |      |   | (17,613 | )
|                                                                                         |  |                                |         |   |      |   |         |  
|Cash flows from financing activities:                                                    |  |                                |         |   |      |   |         |  
|Convertible debt issue costs                                                             |  |                                |        |   |      |   | (1,180  | )
|Proceeds from exercise of stock options                                                  |  |                                | 1       |   |      |   | 410     |  
|Employee stock purchases                                                                 |  |                                | 739     |   |      |   | 381     |  
|Treasury stock purchases                                                                 |  |                                | (14,841 | ) |      |   |        |  
|                                                                                         |  |                                |         |   |      |   |         |  
|Net cash used in financing activities                                                    |  |                                | (14,101 | ) |      |   | (389    | )
|                                                                                         |  |                                |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                                     |  |                                | (16,127 | ) |      |   | 23,591  |  
|Cash and cash equivalents, beginning of period                                           |  |                                | 55,787  |   |      |   | 21,637  |  
|                                                                                         |  |                                |         |   |      |   |         |  
|Cash and cash equivalents, end of period                                                 |  | $                              | 39,660  |   |      | $ | 45,228  |  
|                                                                                         |  |                                |         |   |      |   |         |  
|Supplemental schedule of non-cash investing and financing activities:                    |  |                                |         |   |      |   |         |  
|Exchange of convertible senior subordinated notes due 2016                               |  | $                              |        |   |      | $ | 63,286  |  
|Cancellation of treasury stock                                                           |  |                                | 7,335   |   |      |   |        |  
|Decrease in accrued liabilities for acquisition-related commitments                      |  |                                | (3,000  | ) |      |   |        |  

See accompanying notes.



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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2008

(Unaudited)



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

Description of Business and Organization  Headwaters Incorporated (Headwaters) is a diversified company incorporated in Delaware, which provides products, technologies and services in three industries: building products, coal
combustion products (CCPs) and energy. Headwaters vision is to improve sustainability by transforming underutilized resources into valuable products.

The building products segment designs, manufactures, and sells architectural stone, resin-based exterior siding accessories (such as shutters, mounting blocks, and vents), concrete block and other building 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 housing and residential remodeling
markets.

The CCP segment 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.

The energy segment 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 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 low-value residual oil from refining into higher-value distillates that can be further 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 ended December 31, 2007 and
references to 2008 refer to Headwaters fiscal quarter ended December 31, 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 2009 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, 2008 (Form 10-K).

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 adopted SFAS
No. 157 as of October 1, 2008 but this adoption did not have a material effect on reported results for 2008. 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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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 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 financial statements. Headwaters must adopt these standards simultaneously as of October 1, 2009, the beginning of its fiscal 2010 year. The adoption of these standards 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 no derivatives outstanding as of December 31, 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 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 adoption of the FSP, which for Headwaters is required October 1, 2009, will
require different accounting for both Headwaters 2.50% Convertible Senior Subordinated Notes due 2014 issued in January 2007 and the 16% Convertible Senior Subordinated Notes due 2016 issued in December 2008 (see Note 6). The provisions of the
FSP must be applied retrospectively to all periods presented, or all periods subsequent to January 2007 for Headwaters.

The adoption of the
FSP will result in a redetermination of the carrying amounts of Headwaters 2.50% convertible notes and 16% convertible notes, calculated by measuring the fair values of similar debt instruments that do not have the conversion features, and
recording an equity component for the difference between the original proceeds of the debt and the redetermined amounts of debt. Any basis differences that arise from this accounting that represent 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 values 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 currently estimates that the adoption of the FSP will increase reported interest cost by approximately $3.8 million, $6.0 million and $7.8 million in fiscal years 2007, 2008 and 2009,
respectively, and will not have a material affect on interest capitalized in any of these periods.

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 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. Revenues for the CCP segment consist primarily of CCP product sales with a smaller 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
will consist primarily of coal sales.



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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 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 December 31, 2007 |          
|(in thousands)                |  | BuildingProducts                     |           |   | CCPs |   |         | Energy |  |   | Corporate |   |  | Totals |       
|Segment revenue               |  | $                                    | 114,766   |   |      | $ | 77,426  |        |  | $ | 56,705    |   |  | $      |       |   |  | $ | 248,897   |  
|                              |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   |           |  
|Depreciation and amortization |  | $                                    | (11,138   | ) |      | $ | (3,005  | )      |  | $ | (2,715    | ) |  | $      | (95    | ) |  | $ | (16,953   | )
|                              |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   |           |  
|Operating income (loss)       |  | $                                    | 8,715     |   |      | $ | 14,229  |        |  | $ | (194      | ) |  | $      | (4,376 | ) |  | $ | 18,374    |  
|                              |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   |           |  
|Net interest expense          |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   | (5,844    | )
|Other income (expense), net   |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   | 3,983     |  
|Income tax provision          |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   | (6,600    | )
|                              |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   |           |  
|Net income                    |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  | $ | 9,913     |  
|                              |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   |           |  
|Capital expenditures          |  | $                                    | 13,920    |   |      | $ | 832     |        |  | $ | 10,462    |   |  | $      | 355    |   |  | $ | 25,569    |  
|                              |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   |           |  
|Segment assets                |  | $                                    | 1,058,212 |   |      | $ | 288,096 |        |  | $ | 165,022   |   |  | $      | 90,263 |   |  | $ | 1,601,593 |  
|                              |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   |           |  
|                              | 
|                              |  | Three Months Ended December 31, 2008 |          
|(in thousands)                |  | BuildingProducts                     |           |   | CCPs |   |         | Energy |  |   | Corporate |   |  | Totals |       
|Segment revenue               |  | $                                    | 88,227    |   |      | $ | 67,226  |        |  | $ | 10,713    |   |  | $      |       |   |  | $ | 166,166   |  
|                              |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   |           |  
|Depreciation and amortization |  | $                                    | (11,587   | ) |      | $ | (3,122  | )      |  | $ | (4,658    | ) |  | $      | (95    | ) |  | $ | (19,462   | )
|                              |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   |           |  
|Operating income (loss)       |  | $                                    | (3,307    | ) |      | $ | 13,083  |        |  | $ | (14,638   | ) |  | $      | (4,311 | ) |  | $ | (9,173    | )
|                              |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   |           |  
|Net interest expense          |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   | (8,691    | )
|Other income (expense), net   |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   | 17,435    |  
|Income tax provision          |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   | (450      | )
|                              |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   |           |  
|Net income (loss)             |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  | $ | (879      | )
|                              |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   |           |  
|Capital expenditures          |  | $                                    | 283       |   |      | $ | 2,909   |        |  | $ | 14,868    |   |  | $      | 34     |   |  | $ | 18,094    |  
|                              |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   |           |  
|Segment assets                |  | $                                    | 821,543   |   |      | $ | 286,372 |        |  | $ | 173,409   |   |  | $      | 90,482 |   |  | $ | 1,371,806 |  
|                              |  |                                      |           |   |      |   |         |        |  |   |           |   |  |        |        |   |  |   |           |  



|3. | Equity Securities and Stock-Based Compensation
|-- | ----------------------------------------------

Shelf Registrations  Approximately $18.0 million remains available for future offerings of securities under a universal shelf registration statement originally filed with the SEC in 2002. In November 2008, Headwaters filed
another universal shelf registration statement that, when declared effective and when combined with the 2002 shelf registration, will allow for the



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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2008

(Unaudited)



potential sale of a total of $250.0 million of securities. The November 2008 registration statement, however, has not yet been declared effective and a
prospectus supplement describing the terms of any additional securities to be issued is required to be filed before any future offering could commence under either of the registration statements.

Stock-Based Compensation  During 2008, the Compensation Committee of Headwaters Board of Directors granted approximately
1.1 million stock-based awards to officers and employees. All of the awards, consisting of stock appreciation rights and restricted stock, were granted under existing stock incentive plans, and all have an exercise or base price equal to the
fair market value of Headwaters common stock on the date of grant and a contractual term of 10 years.

Subsequent to December 31,
2008, the Compensation Committee granted approximately 0.1 million restricted stock units to the non-affiliated directors of Headwaters. The units were granted subject to the terms of an existing incentive plan and vest during calendar year
2009. Each unit provides for the issuance of one share of Headwaters common stock, to be issued at the time of termination of a directors service on the Board of Directors, provided vesting has occurred.

Total stock-based compensation expense was approximately $1.2 million and $1.7 million for 2007 and 2008, respectively. As of December 31, 2008,
there was approximately $9.8 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, 2008 |        | December 31, 2008
|Raw materials  |  | $                  | 11,239 |                   | $ | 11,863
|Finished goods |  |                    | 41,829 |                   |   | 42,731
|               |  |                    |        |                   |   |       
|               |  | $                  | 53,068 |                   | $ | 54,594
|               |  |                    |        |                   |   |       



|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:



|                                  |  |                       |                     |                    |                         |                   |                     |        |                         |   |         |  |   |        
|--------------------------------- |  | --------------------- | ------------------- | ------------------ | ----------------------- | ----------------- | ------------------- | ------ | ----------------------- | - | ------- |  | - | -------
|                                  |  | Estimateduseful lives |                     | September 30, 2008 |                         | December 31, 2008
|(in thousands)                    |  |                       | GrossCarryingAmount |                    | AccumulatedAmortization |                   | GrossCarryingAmount |        | AccumulatedAmortization
|CCP contracts                     |  | 8 -20 years           |                     | $                  | 117,690                 |                   | $                   | 38,449 |                         | $ | 117,690 |  | $ | 40,132 
|Customer relationships            |  | 71/2-15 years         |                     |                    | 77,403                  |                   |                     | 20,826 |                         |   | 77,403  |  |   | 22,318 
|Trade names                       |  | 5 - 20 years          |                     |                    | 68,412                  |                   |                     | 14,227 |                         |   | 68,412  |  |   | 15,130 
|Patents and patented technologies |  | 6 - 19 years          |                     |                    | 54,635                  |                   |                     | 23,354 |                         |   | 54,734  |  |   | 24,671 
|Other                             |  | 1 - 15 years          |                     |                    | 6,370                   |                   |                     | 1,486  |                         |   | 6,370   |  |   | 1,837  
|                                  |  |                       |                     |                    |                         |                   |                     |        |                         |   |         |  |   |        
|                                  |  |                       |                     | $                  | 324,510                 |                   | $                   | 98,342 |                         | $ | 324,609 |  | $ | 104,088
|                                  |  |                       |                     |                    |                         |                   |                     |        |                         |   |         |  |   |        



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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2008

(Unaudited)



Total amortization expense related to intangible assets was approximately $5.5 million and $5.7
million for 2007 and 2008, respectively. Total estimated annual amortization expense for 2009 through 2014 is shown in the following table.



|                          |  |                |       
|------------------------- |  | -------------- | ------
|Year ending September 30: |  | (in thousands)
|2009                      |  | $              | 22,996
|2010                      |  |                | 22,169
|2011                      |  |                | 21,758
|2012                      |  |                | 19,990
|2013                      |  |                | 19,082
|2014                      |  |                | 18,723

Goodwill  SFAS No. 142 requires Headwaters to periodically test for goodwill
impairment, at least annually, or sooner if indicators of possible impairment arise. Headwaters performs its annual impairment testing as of June 30. As a result of the depressed new housing and residential remodeling market, Headwaters has
determined that the building products reporting units goodwill was impaired as of the June 30 test date in both fiscal 2007 and 2008, and non-cash impairment charges of $98.0 million and $205.0 million were recorded in fiscal 2007 and
2008, respectively. These impairment charges did not affect Headwaters cash position, cash flow from operating activities or senior debt covenant compliance.

Due to the continuing decline in the new housing and residential remodeling markets and the ongoing downward revisions by market analysts of near-term projections in these markets, management believes that indicators
of further impairment in the building products reporting unit exist. Accordingly, Headwaters has commenced a goodwill impairment test for this reporting unit. Upon completion of step 2 of the impairment test, Headwaters could be required to record a
further write-down of the building products reporting unit goodwill. Any resulting non-cash impairment charge is expected to be recorded in the quarter ending March 31, 2009. Because Headwaters is in the early stages of its analysis, Headwaters
does not believe it is currently possible to reasonably estimate the range of the potential goodwill impairment charge, if any.

Headwaters
does not currently believe there are any indicators of impairments of other long-lived assets, including intangible assets and property, plant and equipment, but will perform a formal analysis of these assets in the building products reporting unit
in connection with the goodwill impairment analysis.



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

Long-term debt consisted of
the following at:



|                                      |  |                   |         |                  |   |        
|------------------------------------- |  | ----------------- | ------- | ---------------- | - | -------
|(in thousands)                        |  | September 30,2008 |         | December 31,2008
|Senior secured debt                   |  | $                 | 200,000 |                  | $ | 200,000
|Convertible senior subordinated notes |  |                   | 332,500 |                  |   | 314,926
|                                      |  |                   |         |                  |   |        
|Total long-term debt                  |  | $                 | 532,500 |                  | $ | 514,926
|                                      |  |                   |         |                  |   |        

Senior Secured Credit Agreements  Headwaters senior secured credit facility
currently consists of a first lien term loan in the amount of $200.0 million. The credit facility also provides for up to $60.0 million of borrowings under a revolving credit arrangement. The first lien term loan is senior in priority to all other
debt and, with the exception of joint venture assets, 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 December 31, 2008. However, given the continuing decrease in building products revenues as a result of the depressed new housing and residential remodeling market and the termination of Headwaters Section 45K
business, combined with the high level of capital expenditures during fiscal 2008 and early fiscal 2009, there is increased risk of noncompliance with certain leverage and fixed charge coverage ratios in future periods, particularly during periods
ending on or after June 30, 2009.



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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2008

(Unaudited)



The first lien term loan bears interest, at Headwaters option, at either i) the London
Interbank Offered Rate (LIBOR) plus 3.5%, 4.0%, 4.5% or 5.0%, 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 2.5%, 3.0%, 3.5% or 4.0%, 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%. As of December 31, 2008, the interest rate was LIBOR plus 4.5%. Subsequent to December 31, 2008, a decrease in the credit rating on the debt was announced,
the effect of which was to increase the interest rate to LIBOR plus 5.0%. Headwaters can select new LIBOR rates for the first lien term loan for one, two, three or six month periods. The weighted-average interest rate on the first lien term loan was
approximately 6.0% at December 31, 2008. Interest on the first lien term loan is generally payable on a quarterly or more frequent basis.

The first lien term loan is repayable $74.8 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. Borrowings and reborrowings of
any available portion of the $60.0 million revolver can be made at any time through September 2009, when all revolver 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 December 31, 2008 there were no amounts outstanding under the revolving credit arrangement. The credit agreement also
allows for the issuance of letters of credit, provided there is capacity under the $60.0 million revolver. As of December 31, 2008, stand-by letters of credit totaling approximately $10.1 million were outstanding, with expiration dates ranging
from March 2009 to September 2009.

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, capital expenditures in excess of $100.0 million annually (plus, in certain circumstances, 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 4.75:1 from December 31,
2008 through March 31, 2009, 4.25:1 as of June 30, 2009, 3.75:1 as of September 30, 2009, then 3.5:1 from December 31, 2009 through the maturity date; ii) a maximum ratio of consolidated funded indebtedness minus subordinated
indebtedness to EBITDA of 2.5:1; and iii) a minimum ratio of EBITDA plus rent payments (EBITDAR), less certain capital expenditures and taxes for the four preceding fiscal quarters, to scheduled rent payments and payments of principal and interest
on all indebtedness for the next four fiscal quarters of 1:1 for the periods ending December 31, 2008 through June 30, 2009, then 1.25:1 for periods ending on or after September 30, 2009.

2.875% Convertible Senior Subordinated Notes Due 2016  In 2002, Headwaters issued $172.5 million of 2.875% convertible senior subordinated
notes due June 2016, with interest payable semi-annually. In December 2008, Headwaters entered into separate, privately-negotiated agreements with certain holders of the notes to exchange approximately $80.9 million in aggregate principal amount of
the notes for approximately $63.3 million in aggregate principal amount of new 16% convertible senior subordinated notes due 2016, described below.

Following the extinguishment of $80.9 million principal amount of the 2.875% notes, approximately $91.6 million principal amount of the notes remained outstanding as of December 31, 2008. These notes are subordinate to the senior
secured debt described above and rank equally with both the 16% convertible senior subordinated notes due 2016 and the 2.50% convertible senior subordinated notes due 2014 described below, as well as any future issuances of senior subordinated debt.
Holders of the 2.875% 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 approximately 3.1 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.



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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2008

(Unaudited)



The 2.875% 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 2.875% 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 holders of the notes have 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. When dilutive, 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).

16% Convertible Senior Subordinated Notes Due 2016  As noted above, in December 2008, Headwaters exchanged
approximately $80.9 million of its 2.875% convertible senior subordinated notes due 2016 for $63.3 million of new 16% convertible senior subordinated notes due 2016. In accordance with the provisions of Emerging Issues Task Force Issue
No. 96-19, Debtors Accounting for a Modification or Exchange of Debt Instruments, Headwaters accounted for the exchange of convertible debt securities as an extinguishment of the original debt and an issuance of new debt. A
gain, recorded in other income (expense) in the accompanying consolidated statement of operations for 2008, of approximately $17.6 million was recognized on the extinguishment of debt. Additionally, approximately $1.0 million of unamortized debt
issue costs related to the extinguished $80.9 million of debt was charged to interest expense in 2008.

The 16% notes are subordinate to the
senior secured debt described above and rank equally with both the 2.875% convertible senior subordinated notes due 2016 described above and the 2.50% convertible senior subordinated notes due 2014 described below, as well as any future issuances of
senior subordinated debt. Holders of the notes may convert the notes into shares of Headwaters common stock at a conversion rate of 42.5532 shares per $1,000 principal amount ($23.50 conversion price), or approximately 2.7 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. Upon conversion, Headwaters will pay cash up to the principal amount of the notes, and, at Headwaters option, cash, shares
of common stock, or a combination of cash and shares, 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 APB 14-1 in October 2009.

The 16% 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, 2012, in any calendar quarter the closing price of Headwaters common stock exceeds $30.55 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, 2012 the closing price of Headwaters common stock exceeds $30.55 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; 4) Headwaters calls the notes for redemption; or 5) upon the occurrence of
specified corporate transactions.



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Headwaters may call the 16% notes for redemption at any time prior to June 1, 2012 if the
closing common stock price exceeds 130% of the conversion price for 20 trading days in any consecutive 30-day trading period. Headwaters may redeem any portion of the notes at any time on or after June 1, 2012. In addition, the holders of the
notes have the right to require Headwaters to repurchase all or a portion of the notes on June 1, 2012 or if a fundamental change in common stock has occurred, including termination of trading.

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 and the 16% convertible senior
subordinated notes due 2016 described above, and any future issuances of 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 APB 14-1 in October 2009.

The 2.50% notes are convertible at the option of the holders 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 2.50% 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 and Debt Maturities  During 2007 and 2008, Headwaters incurred total interest costs of approximately $6.8 million and $9.3 million,
respectively, including approximately $0.7 million and $2.0 million, respectively, of non-cash interest expense and approximately $0.2 million and $0.4 million, respectively, of interest costs that were capitalized.

Interest income was approximately $0.8 million and $0.2 million during 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 4.8% at September 30, 2008 and 5.6% at December 31, 2008.

As noted above, the holders of the 2.875% convertible senior subordinated notes due June 2016, totaling $91.6 million, have the right to require Headwaters to repurchase all or a portion of those notes on June 1,
2011. Also, the holders of the 16% convertible senior subordinated notes due June 2016, totaling $63.3 million, have the right to require Headwaters to repurchase all or a portion of those notes on June 1, 2012. Headwaters currently believes it
is likely that the holders of the 2.875% notes will require Headwaters to repurchase those notes on June 1, 2011 and it is possible that the holders of the 16% notes will require Headwaters to repurchase those notes on June 1, 2012.



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December 31, 2008

(Unaudited)



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

Headwaters estimated
effective income tax rate for the fiscal year ending September 30, 2009, exclusive of discrete items, is currently estimated to be less than 20.0%. Headwaters also recognized $0.5 million of net income tax expense in 2008 for discrete items
that did not affect the calculation of the estimated effective income tax rate for the 2009 fiscal year. In 2007, Headwaters used an estimated effective income tax rate of 29.0%, exclusive of discrete items, and recognized $1.8 million of additional
net income tax expense for discrete items that primarily related to Section 45K-related adjustments pertaining to prior periods.

The
estimated effective tax rate for fiscal 2008 and 2009, exclusive of discrete items, is lower than the statutory rate primarily due to estimated Section 45 refined coal tax credits (which are different from the Section 45K tax credits
discussed elsewhere) related to the coal cleaning facilities that Headwaters owns and operates. Headwaters believes it is more likely than not that the refined coal produced at 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 2009 would be
approximately 40%.

As of December 31, 2008, Headwaters had approximately $18.4 million of unrecognized tax benefits, net of an $11.2
million refund claim related to an uncertain tax position. Headwaters has recorded approximately $25.6 million of gross unrecognized income tax benefits which would affect the fiscal 2009 effective tax rate if released into income. Headwaters
recognizes accrued interest and potential penalties related to all income tax liabilities, including unrecognized income tax benefits, in income tax expense. During 2008, Headwaters released approximately $0.1 million of interest and penalties and
as of December 31, 2008, approximately $7.0 million was accrued for the payment of interest and penalties.

The calculation of tax
liabilities involves uncertainties in the application of complex tax regulations in multiple jurisdictions. For example, Headwaters is currently under audit by the IRS for the years 2003 through 2006 and has open tax periods subject to examination
by both federal and state taxing authorities for the years 2003 through 2008. Headwaters recognizes potential liabilities for anticipated tax audit issues in the U.S. and state tax jurisdictions based on estimates of whether, and the extent to
which, additional taxes and interest will be due. If events occur and the payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when it is determined
the liabilities are no longer probable or necessary. If the estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result. 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, beyond amounts currently accrued.



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

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



|                                                                                                                                  |  |                                |        |      |   |        |  
|--------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------ | ------ | ---- | - | ------ | -
|                                                                                                                                  |  | Three Months EndedDecember 31, |       
|(in thousands, except per-share data)                                                                                             |  | 2007                           |        | 2008 |  
|Numerator:                                                                                                                        |  |                                |        |      |   |        |  
|Numerator for basic earnings per share  net Income (loss)                                                                        |  | $                              | 9,913  |      | $ | (879   | )
|Interest expense related to convertible senior subordinated notes, net of taxes                                                   |  |                                | 1,044  |      |   |       |  
|                                                                                                                                  |  |                                |        |      |   |        |  
|Numerator for diluted earnings per share  net income (loss) plus interest expense related to convertible notes, net of
taxes     |  | $                              | 10,957 |      | $ | (879   | )
|                                                                                                                                  |  |                                |        |      |   |        |  
|Denominator:                                                                                                                      |  |                                |        |      |   |        |  
|Denominator for basic earnings per share  weighted-average shares outstanding                                                    |  |                                | 41,888 |      |   | 41,361 |  
|Effect of dilutive securities:                                                                                                    |  |                                |        |      |   |        |  
|Shares issuable upon exercise of options and SARs and vesting of restricted stock                                                 |  |                                | 140    |      |   |       |  
|Shares issuable upon conversion of convertible notes                                                                              |  |                                | 5,750  |      |   |       |  
|                                                                                                                                  |  |                                |        |      |   |        |  
|Total potential dilutive shares                                                                                                   |  |                                | 5,890  |      |   |       |  
|                                                                                                                                  |  |                                |        |      |   |        |  
|Denominator for diluted earnings per share  weighted-average shares outstanding after assumed exercises, vesting and
conversions |  |                                | 47,778 |      |   | 41,361 |  
|                                                                                                                                  |  |                                |        |      |   |        |  
|Basic earnings per share                                                                                                          |  | $                              | 0.24   |      | $ | (0.02  | )
|                                                                                                                                  |  |                                |        |      |   |        |  
|Diluted earnings per share                                                                                                        |  | $                              | 0.23   |      | $ | (0.02  | )
|                                                                                                                                  |  |                                |        |      |   |        |  
|Anti-dilutive securities not considered in diluted EPS calculation:                                                               |  |                                |        |      |   |        |  
|Stock options                                                                                                                     |  |                                | 1,989  |      |   | 2,000  |  
|SARs                                                                                                                              |  |                                | 1,130  |      |   | 2,151  |  
|Restricted stock                                                                                                                  |  |                                |       |      |   | 364    |  
|Weighted-average shares issuable upon conversion of convertible notes                                                             |  |                                |       |      |   | 5,369  |  



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

Significant
new commitments and ongoing contingencies as of December 31, 2008 not disclosed previously, are as follows.

Acquisitions 
In fiscal 2008, Headwaters acquired certain assets and assumed certain liabilities of a privately-held company in the building products industry. Total consideration for this acquisition was approximately $16.1 million, of which $5.0 million was
paid at the date of acquisition. The remaining balance is payable in 2009. Pursuant to contractual terms for some small 2006 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. At the current time, Headwaters does not believe that any such payments will be material. If any future earn-out consideration is paid for any acquisition, goodwill will be increased accordingly.



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Performance Unit Awards  In 2008, Headwaters Compensation Committee approved
grants of performance unit awards to certain officers and employees, to be settled in cash, based on the achievement of goals tied to cumulative divisional free cash flow generated subsequent to September 30, 2008 and prior to
September 30, 2028, at which time the awards expire, if not forfeited earlier. These awards replaced all existing long-term cash-based awards, except for certain awards already earned at the date of grant. For purposes of these awards, free
cash flow is generally defined as operating income plus depreciation and amortization, reduced by capital expenditures. Payments will vest according to a predetermined schedule as free cash flow accumulates over time. The maximum payout under the
performance unit awards if all performance criteria are achieved by all of Headwaters operating divisions is approximately $85.0 million. No amounts have been expensed for these awards through December 31, 2008 because no performance
criteria have yet been achieved.

Property, Plant and Equipment  As of December 31, 2008, Headwaters was committed to
spend approximately $29.7 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 2008,
Headwaters incurred approximately $0.9 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 December 31, 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 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 $45.0 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. The District Court has set a trial date for June 2009. Because the resolution of the litigation is
uncertain, legal counsel cannot express an opinion as to the ultimate amount, if any, of Headwaters liability.



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December 31, 2008

(Unaudited)



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 against Carmelo with AAA
Arbitration in Atlanta, Georgia, 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.

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.

Mainland Laboratory. HRI entered into a license agreement for the use of a fly ash carbon treatment technology with Mainland Laboratory, LTD (Mainland) in April 2000. The agreement grants exclusive rights to the patented carbon
treatment technology owned by Mainland. In 2006, HRI became aware of prior art relating to the Mainland patented technology which Headwaters believes invalidates the Mainland patent and HRI stopped paying royalties under the agreement. In September
2007, Mainland filed suit against HRI in the United States District Court for the Southern District of Texas with a demand for arbitration under the terms of the license agreement, for breach of contract and patent infringement. HRI has requested
that the District Court invalidate the Mainland patent and cancel the license agreement due to Mainlands inability to provide HRI with exclusivity to practice the patented technology. Mainland is seeking approximately $23.0 million in damages,
enhancement of any damages award based on alleged willful infringement of its patent, and recovery of its costs associated with the litigation, including its attorneys fees. Additionally, Mainland is seeking an injunction to stop HRI from
practicing the technology covered by the patent. Because the resolution of the federal court and arbitration actions are uncertain, legal counsel cannot express an opinion concerning the likely outcome of this matter or the liability of HRI, if any.

Coalco Corporation. Beginning in 1996, Headwaters entered into a series of agreements with Coalco Corporation by which Coalco would
assist Headwaters in identifying financing sources for synthetic fuel manufacturing projects. Under these agreements, Headwaters agreed to pay certain fees to Coalco. Beginning in 1997, Pelletco Company, an affiliate of Coalco, entered into license
agreements for the use of Headwaters synthetic fuel technology for which Pelletco agreed to pay certain license fees to Headwaters. As of December 31, 2008, trade receivables include $3.8 million which is due from Pelletco to Headwaters.
The synthetic fuel businesses underlying all of these agreements ended during fiscal 2008. In January 2009, Coalco filed a complaint in the Commonwealth of Massachusetts Suffolk County Superior Court, alleging that Headwaters has breached its
agreements to pay certain fees to Coalco. Coalco seeks damages in the principal amount of approximately $20.8 million, plus approximately $2.7 million in interest, attorneys fees, and other costs. Pelletco joined the complaint with Coalco,
both seeking declaratory judgment as to their rights and obligations under the various agreements. Headwaters intends to vigorously defend against the alleged claims and to assert counterclaims against the plaintiffs. The $3.8 million due to
Headwaters from Pelletco has not been paid. Although the merits of Coalco and Pelletcos claims will be determined in due legal course, management currently believes that the amount due from Pelletco is collectible.



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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2008

(Unaudited)



Headwaters Building Products Matters.There are litigation and pending and threatened claims
made against certain subsidiaries of Headwaters Building Products (HBP), 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 HBP 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 HBP.

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 HBP incur substantial costs, there is no guarantee of insurance coverage or continuing coverage. These and future proceedings may result in substantial costs to HBP, including attorneys fees, managerial time and
other personnel resources and costs. Adverse resolution of these proceedings could have a materially negative effect on HBPs business, financial condition, and results of operation, and its ability to meet its financial obligations. Although
HBP carries general and product liability insurance, HBP cannot assure that such insurance coverage will remain available, that HBPs insurance carrier will remain viable, or that the insured amounts will cover all future claims in excess of
HBPs uninsured retention. Future rate increases may also make such insurance uneconomical for HBP to maintain. In addition, the insurance policies maintained by HBP 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 HBP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 were closed because production
of synthetic fuel was 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.

IRS Audits. The IRS is currently auditing Headwaters tax credits claimed for synthetic fuel sold
from the facilities in which it owned 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 effective tax rate for
fiscal 2008 and 2009 is lower than the statutory rate due to refined coal tax credits related to facilities that Headwaters owns and operates. Headwaters believes the refined coal produced at these facilities and sold to qualified buyers qualifies
for tax credits under Section 45 (which is different from



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(Unaudited)



the Section 45K tax credits 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 its coal cleaning facilities are 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 NOxand either SOxor 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. Through December 31, 2008, Headwaters has recognized a total benefit of approximately $3.4 million related to Section 45 tax credits.

In the Energy Improvement and Extension Act of 2008, Congress extended the benefits of
Section 45 tax credits to refined coal facilities placed in service after December 31, 2008 and before January 1, 2010. For refined coal facilities placed in service in calendar year 2009, Congress also eliminated the Section 45
requirement that there be a 50% increase in market value but increased the emissions reduction required of either SOxor mercury to 40% from 20%.
Headwaters is evaluating the ability of any possible future plants to comply with these revised requirements.



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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 ended December 31, 2007 and references to 2008 refer to our fiscal quarter ended December 31, 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
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), concrete block and other building 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, including fly ash used as a substitute for portland cement. Revenues in the CCP segment consist primarily of product sales with a smaller amount of service revenue. 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 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. During fiscal 2008 and through December 31, 2008, our primary focus was on growing our coal cleaning business and our primary use of cash consisted of capital expenditures, primarily
for coal cleaning facilities 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 were closed because production of synthetic fuel was 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 had reached the full phase-out price. The calendar 2007 reference price and
phase-out range were announced 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 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 through fiscal 2008. At the current time, we do not believe there are any material
residual contingencies related to phase-out.

We own and operate several newly-constructed and recently-renovated coal cleaning facilities
that remove rock, dirt, and other impurities from waste coal, resulting in higher-value, marketable coal. Construction of these facilities was our largest single investment of cash during fiscal 2008 and through December 31, 2008 and currently
we expect construction activities in the energy segment and other segments to be our most significant investment of cash in fiscal 2009. Capital expenditures in fiscal 2008 and through December 31, 2008 were financed primarily with available
cash and with lease financing. In 2008, coal sales were $12.3 million, compared to $1.4 million in 2007. Despite this growth in coal sales from 2007 to 2008, there has been a rapid decline in demand and pricing for coal during 2008, especially
metallurgical coal, which has had a negative effect on our 2008 revenue and which is currently expected to have a negative effect on 2009 revenue and operating income.



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Our CCP segment business strategy is to continue to negotiate long-term contracts with suppliers,
supported by investment in transportation and storage infrastructure for the marketing and sale of CCPs. We are also continuing our efforts to expand the use 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 depressed new housing and residential remodeling market 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. We are also continuing to develop new building products and leverage our robust distribution system which we believe is a competitive advantage for us. Our CCPs and building products businesses are
significantly affected by seasonality, with the highest revenue and profitability produced in the June and September quarters.

Our
acquisition strategy targets businesses that are leading companies in their respective industries and that have strong 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 industry 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. To a smaller degree, 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 fiscal years 2005 through 2008, we made several early repayments
of our long-term debt. In fiscal 2008 and through December 31, 2008, early repayments of long-term debt decreased as compared to earlier periods primarily due to our investments of available cash in developing and growing our coal cleaning
business in the energy segment. Cash needs for capital expenditures will continue in fiscal 2009, so we are focused on liquidity to enable us to continue implementing our growth plans. Although our historical emphasis on the early repayment of
long-term debt has diminished temporarily, a significant amount of our long-term debt is repayable beginning in 2011. Operational improvements and the continued growth in the coal cleaning business are currently expected to increase cash flow from
operations, but this increase, along with the cash flow currently being generated, may not provide sufficient funds to retire all of this maturing debt. Accordingly, management is considering other potential transactions, including asset sales,
asset-based loans, refinancing of debt obligations, and equity and debt securities offerings.

Three Months Ended December 31, 2008 Compared to
Three Months Ended December 31, 2007

The information set forth below compares our operating results for the quarter ended
December 31, 2008 (2008) with operating results for the quarter ended December 31, 2007 (2007).

Summary. Our total
revenue for 2008 was $166.2 million, down 33% from $248.9 million for 2007. Gross profit decreased 50%, from $63.1 million in 2007 to $31.6 million in 2008. Operating income decreased from $18.4 million in 2007 to an operating loss of $(9.2) million
in 2008. Net income decreased from $9.9 million, with diluted earnings per share of $0.23, to a net loss of $(0.9) million, or $(0.02) per diluted share, in 2008.

Our Section 45K business terminated in fiscal 2008 and we sold the mortar/stucco business in our building products segment in fiscal 2008. Removing the effect of these two profitable operations from the numbers
for the 2007 period, our total revenue for 2008 was $166.2 million, down 11% from $186.2 million for 2007. Gross profit decreased 36%, from $49.3 million in 2007 to $31.6 million in 2008. Operating income decreased from $5.3 million in 2007 to an
operating loss of $(9.2) million in 2008, and the net loss increased from $(0.4) million, with diluted earnings (loss) per share of $(0.01), to a net loss of $(0.9) million, or $(0.02) per diluted share, in 2008.

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 $88.2 million with a corresponding gross profit of $18.0 million. Sales of
building products during 2007 were $114.8 million with a corresponding gross profit of $32.9 million. The decrease in our sales of building products in 2008 was due primarily to the continuing effects of the depressed new housing and residential
remodeling market which impacted sales across most of our product lines. Also, in early 2008, we sold certain non-strategic mortar/stucco assets in the building products segment which accounted for approximately $8.3 million of the decrease in
revenue from 2007 to 2008. The gross margin percentage declined from 2007 to 2008 due primarily to fewer fixed costs being absorbed as a result of 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; however, the recession has resulted in higher unemployment, adding to the home foreclosure rate, putting additional homes on the market and further reducing the demand for
new construction.



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New housing starts according to the U.S. National Association of Home Builders (NAHB) were
1.3 million and 0.9 million units in calendar 2007 and 2008, respectively, compared to a 10-year average of 1.6 million units. Our building products business relies on the home improvement and remodeling markets as well as new
construction. The U.S. Census Bureaus Value of Private Residential Construction Spending Put in Place data on home owner improvement activity shows that the four quarter moving average topped out at $147.4 billion in the second calendar
quarter of 2007 and fell to approximately $122.6 billion by the fourth calendar quarter of 2008. The Leading Indicator of Remodeling Activity estimate issued by the Joint Center for Housing Studies at Harvard University has estimated that the four
quarter moving average will be only $109.5 billion in the third calendar quarter of 2009, which would be the lowest level since the second calendar quarter of 2004. Based on the forecasted declines in new housing starts and remodeling activity for
calendar 2009, we expect that our revenues and operating results will also decline in 2009 as compared to fiscal 2008 levels.

CCP
Segment. CCP revenues for 2008 were $67.2 million with a corresponding gross profit of $20.2 million. CCP revenues for 2007 were $77.4 million with a corresponding gross profit of $21.5 million. We believe the decrease in CCP revenues in 2008
compared to 2007 was due primarily to general economic conditions affecting the construction industry. The gross margin percentage increased from 2007 to 2008 primarily due to declines in the costs of rail and truck transportation.

Energy Segment. In 2007, our energy segment revenue consisted almost exclusively of revenues related to our Section 45K business. In 2008,
there was no Section 45K revenue and energy segment revenue consisted substantially of coal sales revenue. Cost of revenue exceeded revenue for this segment due primarily to start-up and ramp-up costs for newly-constructed coal cleaning
facilities that were placed into service in late fiscal 2008 and in the quarter ended December 31, 2008.

Operating Expenses.
The increase in amortization expense of $0.2 million from 2007 to 2008 was due primarily to intangible assets that were acquired in a fiscal 2008 acquisition. Research and development expense decreased by $0.7 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 $3.4 million, or 10%, to $31.6 million in 2008 from $35.0 million in 2007. The decrease in 2008 was due
primarily to reduced incentive pay expenses and to a lesser extent, other personnel-related costs. Incentive pay decreased due to reduced profitability of our operations and other personnel-related costs decreased due to headcount reductions.

Other Income and Expense. During 2008, we reported net other income of $8.7 million compared to net other expense of $1.9 million
during 2007. The change in other income and expense of $10.6 million was comprised of an increase in net interest expense of approximately $2.9 million and an increase in net other income of approximately $13.5 million.

Net interest expense increased from $5.8 million in 2007 to $8.7 million in 2008 due to several factors, most notably approximately $1.0 million of
accelerated amortization of unamortized debt issue costs related to the extinguished $80.9 million of 2.875% convertible notes. In addition, there was more interest expense attributed to our convertible debt as a result of the debt exchange that
resulted in the extinguishment of 2.875% convertible notes and the issuance of 16% convertible notes, higher interest rates on our senior debt as a result of the August 2008 amendment to our senior secured credit agreement, as well as reduced
interest income in 2008. Due to the increased interest rates on our senior debt and convertible debt, we expect interest expense in 2009 to exceed the respective fiscal 2008 levels.

The change in other income/expense items of $13.5 million consisted primarily of the gain of approximately $17.6 million recognized on the extinguishment
of debt in 2008, which increase was partially offset by a decrease in gain on the sale of assets of $4.6 million from 2007 to 2008. In 2007, we sold certain non-strategic mortar/stucco assets in the building products segment on which a gain of
approximately $4.4 million was recognized. 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. Our estimated effective income tax rate for the fiscal year ending September 30, 2009, exclusive of discrete items, is
currently estimated to be less than 20.0%. We also recognized $0.5 million of net income tax expense in 2008 for discrete items that did not affect the calculation of the estimated effective income tax rate for the 2009 fiscal year. In 2007, we used
an estimated effective income tax rate of 29.0%, exclusive of discrete items, and recognized $1.8 million of additional net income tax expense for discrete items that primarily related to Section 45K-related adjustments pertaining to prior
periods.

The estimated effective tax rate for fiscal 2008 and 2009, 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 the coal cleaning facilities that we own and operate. We believe it is more likely than not that the
refined coal produced at 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.



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Excluding the effect of tax credits in both periods, our effective tax rate for 2007 and 2008 would have
been approximately 39% and 40%, respectively.

Impact of Inflation and Related Matters

Some of our operations have been negatively impacted by increased raw materials costs for commodities, such as polypropylene and poly-vinyl chloride in
the building products segment; however, the negative impact has generally been less significant during the quarter ended December 31, 2008 than during the latter part of the 2008 fiscal year. We have been successful in passing on some, but not
all, of the increased materials costs to customers. Additionally, recent decreases in fuel costs have benefited all of our business units during the quarter ended December 31, 2008. 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 three months ended December 31, 2008 (2008) was $41.6
million compared to $34.6 million for the three months ended December 31, 2007 (2007). Profitability decreased in 2008 compared to 2007, primarily due to the absence of Section 45K-related operations in 2008. The termination of our
Section 45K business was also the primary reason for the higher cash flow from collection of trade receivables in 2007 than 2008. Nevertheless, there were other significant changes in operating assets and liabilities, as reflected in the
statements of cash flows, which were a use of cash in 2007, but a source of cash in 2008, which more than offset the decreased profitability and the decreased cash flow from collection of trade receivables in 2008.

In both 2008 and 2007, the primary investing activity consisted of the purchase of property, plant and equipment. In 2007, payments for acquisitions also
comprised a significant investing activity. In 2008, our primary financing activity consisted of the exchange of convertible senior subordinated notes resulting in the extinguishment of approximately $17.6 million of convertible debt. In 2007, our
primary financing activity consisted of the purchase of treasury stock. 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 $18.1 million, a decrease of $7.5 million from 2007. The
largest share of capital expenditures in 2007 was incurred by the building products segment and represented primarily maintenance of operating capacity, rather than expansion of operations. In contrast, in 2008, a substantial majority of total
capital expenditures was incurred by the energy segment, in particular for expanding the coal cleaning business. Most of the remaining fiscal 2009 capital expenditures also represent expansion of operations, but a somewhat smaller proportion will be
for new capacity versus maintenance of operational capacity than that experienced in recent periods. Also, a majority of capital expenditures for the remainder of fiscal 2009 will be in the CCP and building products segments instead of the energy
segment. Our 2009 capital expenditures are currently expected to be less than $75.0 million and could be as low as $60.0 million.

Capital
expenditures are limited by our senior debt covenants to $100.0 million annually. In certain circumstances, the unused amount from a fiscal year can be carried forward and used in the subsequent fiscal year; however, as of September 30, 2008,
we had no unused amount available to be carried forward to future periods. As of December 31, 2008, we were committed to spend approximately $29.7 million on capital projects that were in various stages of completion. In 2007, we realized $7.7
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 fiscal 2007, we
acquired 100% of the ownership interests of Dutch Quality Stone (DQS), a privately-held company in the building products business. Total consideration paid at the date of acquisition was approximately $52.9 million. An additional $19.0 million was
paid in 2007, based on earnings of DQS for the 12-month period ended September 30, 2007 that exceeded an agreed-upon threshold. In fiscal 2008, we acquired certain assets and assumed certain liabilities of a privately-held company in the
building products industry. Total consideration for this acquisition was approximately $16.1 million, of which $5.0 million was paid at the date of acquisition. The remaining balance is payable in 2009. Pursuant to contractual terms for some small
2006 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. At the current time, we do not believe that any such payments will be
material.



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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 as of June 30. As a result of the depressed new housing and residential remodeling market, we determined that the building products reporting units goodwill was impaired
as of the June 30 test date in both fiscal 2007 and 2008, and non-cash impairment charges of $98.0 million and $205.0 million were recorded in fiscal 2007 and 2008, respectively. These impairment charges did not affect our cash position, cash
flow from operating activities or senior debt covenant compliance.

Due to the continuing decline in the new housing and residential
remodeling markets and the ongoing downward revisions by market analysts of near-term projections in these markets, management believes that indicators of further impairment in the building products reporting unit exist. Accordingly, we have
commenced a goodwill impairment test for this reporting unit. Upon completion of step 2 of the impairment test, we could be required to record a further write-down of the building products reporting unit goodwill. Any resulting non-cash impairment
charge is expected to be recorded in the quarter ending March 31, 2009. Because we are in the early stages of our analysis, we do not believe it is currently possible to reasonably estimate the range of the potential goodwill impairment charge,
if any.

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 have routinely reviewed potential
acquisitions, including those in the areas of building products, CCP marketing, and coal and catalyst technologies. It is possible that some portion 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 building products, CCP and energy 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 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. If our total leverage ratio, as defined, is less than or equal to 3.50:1.0, after giving effect to an acquisition, these 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 exchanged approximately $80.9 million of our 2.875% convertible senior subordinated notes due 2016 for $63.3
million of new 16% convertible senior subordinated notes due 2016. A gain, recorded in other income (expense) in the accompanying consolidated statement of operations for 2008, of approximately $17.6 million was recognized on the extinguishment of
debt. Additionally, approximately $1.0 million of unamortized debt issue costs related to the extinguished $80.9 million of debt was charged to interest expense in 2008 and approximately $1.0 million of new debt issue costs were incurred related to
the 16% convertible notes. In 2007, financing activities consisted primarily of treasury stock purchases totaling $14.8 million.

We have
no long-term debt repayments that are due prior to 2011. 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 2009 than it was in fiscal 2008 and recent years due to the termination of our Section 45K business and the continued weakness in
the new housing and residential remodeling market. Also, while we have periodically accessed the debt and equity markets in prior years, affordable and available additional debt and equity may be much 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. Reference is made to the subsequent section titled Potential Liquidity Risks and
Managements Plans for detailed information about our debt covenant ratio calculations and related matters.



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In fiscal 2008, we obtained 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 below and in Note 6 to the consolidated financial statements. We are in
compliance with all debt covenants as of December 31, 2008. However, given the continuing decrease in building products revenues as a result of the depressed new housing and residential remodeling market and the termination of our
Section 45K business, combined with the high level of capital expenditures during fiscal 2008 and early fiscal 2009, there is increased risk of noncompliance with certain leverage and fixed charge coverage ratios in future periods, particularly
during periods ending on or after June 30, 2009.

Approximately $18.0 million remains available for future offerings of securities
under a universal shelf registration statement originally filed with the SEC in 2002. In November 2008, we filed another universal shelf registration statement that, when declared effective and when combined with the 2002 shelf registration, will
allow for the potential sale of a total of $250.0 million of securities. The November 2008 registration statement, however, has not yet been declared effective and a prospectus supplement describing the terms of any additional securities to be
issued is required to be filed before any future offering could commence under either of the registration statements.

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.

Working Capital. As of December 31, 2008, our working capital was $114.6 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 for our seasonal needs, will be sufficient for operating needs for the next 12 months.

Income Taxes.
Historically, there has often been 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 taxable income
based on year-to-date results. We currently expect this pattern to continue. We expect our effective income tax rate for 2009 and future years to be less than the statutory rate due primarily to the availability of Section 45 refined coal tax
credits. These tax credits relate to the coal cleaning facilities that we currently own and operate. The tax credits are expected to reduce required cash payments for estimated taxes during the year they are earned.

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 amounts were 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.

Potential Liquidity Risks and Managements Plans. Operational improvements such as reduced headcount, reduced or eliminated advertising and
marketing programs, reduced plant overhead expenses and reduced fuel costs, along with growth in the coal cleaning business, are currently expected to partially offset the impact of reduced revenues on cash flow from operations. However, the
anticipated increase in cash flow from these actions, along with the cash flow currently being generated, may not provide sufficient funds to retire all of our maturing debt. Accordingly, managements plans to increase liquidity and minimize
the risk of noncompliance with debt covenants also include the following potential actions: the delay, postponement or cancellation of certain planned capital expenditures; the sale of assets; obtaining asset-based loans; refinancing debt
obligations; the sale of equity, the proceeds of which would be used to repay long-term debt; additional amendments to our senior secured credit agreement; or restructuring our credit facilities and capitalization.

Most of our potential debt covenant compliance risk relates to compliance with certain leverage and fixed charge coverage ratios in future periods,
particularly during periods ending on or after June 30, 2009. The potential risk is primarily a result of declining EBITDA, combined with increased levels of planned capital expenditures, as compared to prior periods. EBITDA consists of net
income adjusted for net interest expense, income taxes, depreciation and amortization and goodwill and other impairments, as these items are defined in our senior secured debt agreement. Because our net income declined significantly during fiscal
2008 and through December 31, 2008, EBITDA has also declined significantly. We do not currently expect our trailing twelve months (TTM) EBITDA, which is used to calculate many of the required leverage and fixed coverage ratios, to
significantly improve during 2009, primarily due to the depressed new housing and residential remodeling market and the challenges of ramping up and operating our coal cleaning facilities in a difficult coal market.



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The three primary debt covenant ratios with which we must comply are: i) a total leverage ratio of 4.75:1
from December 31, 2008 through March 31, 2009, 4.25:1 as of June 30, 2009, 3.75:1 as of September 30, 2009, then 3.5:1 from December 31, 2009 through the maturity date (total leverage ratio); ii) a maximum ratio of
consolidated funded indebtedness minus subordinated indebtedness to EBITDA of 2.5:1 (senior leverage ratio); and iii) a minimum ratio of EBITDA plus rent payments (EBITDAR), less certain capital expenditures and taxes for the four preceding fiscal
quarters, to scheduled rent payments and payments of principal and interest on all indebtedness for the next four fiscal quarters of 1:1 for the periods ending December 31, 2008 through June 30, 2009, then 1.25:1 for periods ending on or
after September 30, 2009 (fixed charge coverage ratio). The following table summarizes the calculations of each of these three key ratios for the dates indicated. All components have been calculated based on the definitions of such items in our
senior secured credit facility.



|                                                                                   |  |                   |       |   |                   |   |       |                  |  |   |       |  
|---------------------------------------------------------------------------------- |  | ----------------- | ----- | - | ----------------- | - | ----- | ---------------- |  | - | ----- | -
|(in millions)                                                                      |  | September 30,2007 |       |   | September 30,2008 |   |       | December 31,2008 | 
|Senior debt (A)                                                                    |  | $                 | 210.0 |   |                   | $ | 200.0 |                  |  | $ | 200.0 |  
|Convertible debt (B)                                                               |  |                   | 332.5 |   |                   |   | 332.5 |                  |  |   | 314.9 |  
|                                                                                   |  |                   |       |   |                   |   |       |                  |  |   |       |  
|Total long-term debt                                                               |  |                   | 542.5 |   |                   |   | 532.5 |                  |  |   | 514.9 |  
|Stand-by letters of credit                                                         |  |                   | 6.0   |   |                   |   | 9.7   |                  |  |   | 10.1  |  
|Other long-term obligations                                                        |  |                   |      |   |                   |   | 9.7   |                  |  |   | 9.5   |  
|                                                                                   |  |                   |       |   |                   |   |       |                  |  |   |       |  
|Total indebtedness, as defined (C)                                                 |  | $                 | 548.5 |   |                   | $ | 551.9 |                  |  | $ | 534.5 |  
|                                                                                   |  |                   |       |   |                   |   |       |                  |  |   |       |  
|TTM EBITDA, as defined (D)                                                         |  | $                 | 301.2 |   |                   | $ | 142.1 |                  |  | $ | 133.3 |  
|                                                                                   |  |                   |       |   |                   |   |       |                  |  |   |       |  
|Total leverage ratio (C ÷ D)                                                       |  |                   | 1.82  |   |                   |   | 3.88  |                  |  |   | 4.01  |  
|                                                                                   |  |                   |       |   |                   |   |       |                  |  |   |       |  
|Senior leverage ratio ((C  B) ÷ D)                                                |  |                   | 0.72  |   |                   |   | 1.54  |                  |  |   | 1.65  |  
|                                                                                   |  |                   |       |   |                   |   |       |                  |  |   |       |  
|TTM EBITDA                                                                         |  | $                 | 301.2 |   |                   | $ | 142.1 |                  |  | $ | 133.3 |  
|Rent expense                                                                       |  |                   | 34.2  |   |                   |   | 35.4  |                  |  |   | 35.0  |  
|Less certain capital expenditures                                                  |  |                   | (55.0 | ) |                   |   | (40.1 | )                |  |   | (34.4 | )
|Income taxes                                                                       |  |                   | (60.9 | ) |                   |   | (1.4  | )                |  |   | 0.2   |  
|                                                                                   |  |                   |       |   |                   |   |       |                  |  |   |       |  
|TTM EBITDAR, as defined (E)                                                        |  | $                 | 219.5 |   |                   | $ | 136.0 |                  |  | $ | 134.1 |  
|                                                                                   |  |                   |       |   |                   |   |       |                  |  |   |       |  
|Future twelve months scheduled interest payments                                  |  | $                 | 24.4  |   |                   | $ | 31.7  |                  |  | $ | 34.1  |  
|Future twelve months scheduled repayments of long-term debt and other obligations |  |                   |      |   |                   |   | 1.0   |                  |  |   | 1.0   |  
|Future twelve months scheduled rent payments                                      |  |                   | 38.5  |   |                   |   | 36.0  |                  |  |   | 36.0  |  
|                                                                                   |  |                   |       |   |                   |   |       |                  |  |   |       |  
|Future fixed charges, as defined (F)                                               |  | $                 | 62.9  |   |                   | $ | 68.7  |                  |  | $ | 71.1  |  
|                                                                                   |  |                   |       |   |                   |   |       |                  |  |   |       |  
|Fixed charge coverage ratio (E ÷ F)                                                |  |                   | 3.49  |   |                   |   | 1.98  |                  |  |   | 1.89  |  
|                                                                                   |  |                   |       |   |                   |   |       |                  |  |   |       |  

Trailing twelve months (TTM) EBITDA, as used in the above table, is calculated as follows:



|                                          |  |                   |       |                   |   |        |                  |  |   |        |  
|----------------------------------------- |  | ----------------- | ----- | ----------------- | - | ------ | ---------------- |  | - | ------ | -
|(in thousands)                            |  | September 30,2007 |       | September 30,2008 |   |        | December 31,2008 | 
|Net income (loss)                         |  | $                 | 20.1  |                   | $ | (169.7 | )                |  | $ | (180.5 | )
|Net interest expense                      |  |                   | 31.1  |                   |   | 23.8   |                  |  |   | 26.7   |  
|Income taxes, as defined                  |  |                   | 69.8  |                   |   | 2.2    |                  |  |   | 0.6    |  
|Depreciation and amortization, as defined |  |                   | 82.2  |                   |   | 74.2   |                  |  |   | 77.2   |  
|Impairments, as defined                   |  |                   | 98.0  |                   |   | 211.6  |                  |  |   | 209.3  |  
|                                          |  |                   |       |                   |   |        |                  |  |   |        |  
|TTM EBITDA, as defined (D)                |  | $                 | 301.2 |                   | $ | 142.1  |                  |  | $ | 133.3  |  
|                                          |  |                   |       |                   |   |        |                  |  |   |        |  

Before a potential debt covenant violation becomes imminent, we would take several potential
actions, including all of the steps discussed above, as well as negotiate with the holders of our senior secured debt with a view to obtaining a waiver or an amendment to the debt agreement (such as we did in fiscal 2008). If our efforts to increase
EBITDA were unsuccessful and we failed to obtain a waiver or amendment to our debt agreement, a breach of our covenants could result in a default, in which event our lenders could elect to declare all amounts outstanding to be immediately due and
payable. If we were not able to repay our obligations if they were accelerated, the lenders could foreclose on our assets.



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In addition to the risks of noncompliance with leverage and fixed charge coverage ratios, our $60.0
million revolving credit arrangement expires in September 2009. During fiscal 2008, we used this revolver for short-term working capital needs and for stand-by letters of credit, which at December 31, 2008 totaled $10.1 million. We currently
expect to use the revolver for seasonal working capital needs and for letters of credit during 2009. Our seasonal working capital needs should decline as coal cleaning operations continue to grow because this business is less seasonal than our
building products and CCP businesses. We continue to evaluate our liquidity needs and the potential replacement of the revolving credit facility.

Subsequent to December 31, 2008, a decrease in the credit rating on our debt was announced. The primary result of this action is an increase in the interest rate on our senior secured debt from LIBOR plus 4.5 % to LIBOR plus 5.0%.

Our $200.0 million of senior debt is required to be repaid in February 2011 and April 2011. Our 2.50% convertible senior subordinated
notes are repayable in 2014. The holders of the 2.875% convertible senior subordinated notes due June 2016, totaling $91.6 million, have the right to require us to repurchase all or a portion of those notes on June 1, 2011. Also, the holders of
the 16% convertible senior subordinated notes due June 2016, totaling $63.3 million, have the right to require us to repurchase all or a portion of those notes on June 1, 2012. We currently believe it is likely that the holders of the 2.875%
notes will require us to repurchase those notes on June 1, 2011 and it is possible that the holders of the 16% notes will require us to repurchase those notes on June 1, 2012.

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 December 31, 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 $200.0 million
as of December 31, 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 $2.0 million during the 12 months
ending December 31, 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  25.0 million (approximately $35.0 million at December 31, 2008) of long-term debt along with other obligations denominated in Euros.
Because the debt and other obligations are repayable in a currency different from the Korean Won, the joint ventures functional currency, they must be remeasured into Korean Won at the end of each reporting period based on then current
exchange rates, with the impact recorded in earnings. As a result of this requirement, the joint venture is subject to foreign currency exchange rate movements. During 2008, the joint venture recorded foreign currency exchange gains of which $0.2
million has been included in our results of operations. As of December 31, 2008, a change in the relationship between the Euro and Korean Won of 10% would result in a gain or loss of approximately $1.8 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 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 December 31, 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



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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 December 31, 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 December 31, 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.



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

None.



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

None.



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|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       |  | *
|      |  |                                                                                         
|99.11 |  | Nominating and Corporate Governance Committee Charter, dated December 19, 2008           |  | *
|      |  |                                                                                         
|99.12 |  | Audit Committee Charter, dated December 19, 2008                                         |  | *
|      |  |                                                                                         
|99.13 |  | Compensation Committee Charter, dated December 19, 2008                                  |  | *
|      |  |                                                                                         
|99.25 |  | Form of Performance Unit Award Agreement (October 2008)                                  |  | *
|      |  |                                                                                         
|99.26 |  | Form of Director Restricted Stock Unit Award Agreement (January 2009)                    |  | *



|* | 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: |  | February 6, 2009 |  |                         |  | By: |  | /s/ Kirk A. Benson                        
|      |  |                  |  |                         |  |     |  | Kirk A. Benson, Chief Executive Officer   
|      |  |                  |  |                         |  |     |  | (Principal Executive Officer)             
|      |  |                  |  |                        
|Date: |  | February 6, 2009 |  |                         |  | By: |  | /s/ Steven G. Stewart                     
|      |  |                  |  |                         |  |     |  | Steven G. Stewart, Chief Financial Officer
|      |  |                  |  |                         |  |     |  | (Principal Financial Officer)             



31