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

                                    FORM 10-Q

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

                     For the quarterly period ended March 31, 2001

                                       or

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

                    For the transition period from ______ to ______

                         Commission file number 0-27808

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


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

       11778 South Election Road, Suite 210
                   Draper, Utah                          84020
                   ------------                          -----
     (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 [ ]

The number of shares  outstanding of the  Registrant's  common stock as of April
20, 2001 was 22,934,073.

<PAGE>

                             HEADWATERS INCORPORATED

                                TABLE OF CONTENTS

                                                                      Page No.
PART I - FINANCIAL INFORMATION

     ITEM 1.      FINANCIAL STATEMENTS (Unaudited):
                  Condensed Consolidated Balance Sheets - As of
                    September 30, 2000 and March 31, 2001..............     3

                  Condensed Consolidated Statements of Operations
                    - For the three and six months ended March
                    31, 2000 and 2001..................................     5

                  Condensed Consolidated Statement of Changes in
                    Stockholders' Equity - For the six months
                    ended March 31, 2001...............................     6

                  Condensed Consolidated Statements of Cash Flows
                    - For the six months ended March 31, 2000 and
                    2001...............................................     7

                  Notes to Condensed Consolidated Financial Statements.     8

     ITEM 2.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                  CONDITION AND RESULTS OF OPERATIONS..................    13

PART II - OTHER INFORMATION

     ITEM 1.      LEGAL PROCEEDINGS....................................    18

     ITEM 2.      CHANGES IN SECURITIES AND USE OF PROCEEDS............    18

     ITEM 3.      DEFAULTS UPON SENIOR SECURITIES......................    18

     ITEM 4.      SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..    18

     ITEM 5.      OTHER INFORMATION....................................    19

     ITEM 6.      EXHIBITS AND REPORTS ON FORM 8-K.....................    19


SIGNATURES.............................................................    19


Forward Looking Statements

Statements  in this Form  10-Q,  including  those  concerning  the  Registrant's
expectations regarding its business, and certain of the information presented in
this report,  constitute  forward looking  statements  within the meaning of the
Private  Securities  Litigation  Reform Act of 1995. As such, actual results may
vary  materially  from such  expectations.  For a discussion of the factors that
could cause actual results to differ from  expectations,  please see the caption
entitled "Forward Looking Statements" in Part I, Item 2 hereof.  There can be no
assurance  that the  Registrant's  results of  operations  will not be adversely
affected by such  factors.  Registrant  undertakes  no  obligation  to revise or
publicly   release  the  results  of  any  revision  to  these  forward  looking
statements.  Readers are cautioned not to place undue  reliance on these forward
looking  statements,  which  reflect  management's  opinion  only as of the date
hereof.

                                       2
<PAGE>
<TABLE>
<CAPTION>

ITEM 1.  FINANCIAL STATEMENTS (Unaudited)

                                          HEADWATERS INCORPORATED AND SUBSIDIARIES

                                            CONDENSED CONSOLIDATED BALANCE SHEETS
                                                         (Unaudited)

                                                                                              September 30,         March 31,
(thousands of dollars)                                                                                 2000              2001
------------------------------------------------------------------------------------------- ---------------- -----------------
<S>                                                                                         <C>               <C>
ASSETS

Current assets:
     Cash and cash equivalents                                                                        $ 983             $ 293
     Short-term investments                                                                           6,973             5,782
     Trade receivables, net                                                                           7,298             5,603
     Notes receivable                                                                                 2,530             1,811
     Other current assets                                                                               387               108
                                                                                            ---------------- -----------------
            Total current assets                                                                     18,171            13,597
                                                                                            ---------------- -----------------

Property, plant and equipment, net of accumulated depreciation                                          552               658
                                                                                            ---------------- -----------------

Other assets:

     Notes and accrued interest receivable                                                            6,598             8,621
     Equity investments, net                                                                          3,259             4,388
     Deferred income taxes                                                                            3,000             3,000
     Intangible assets, net of accumulated amortization                                               1,221             1,136
     Other assets                                                                                       640               721
                                                                                            ---------------- -----------------
            Total other assets                                                                       14,718            17,866
                                                                                            ---------------- -----------------

            Total assets                                                                            $33,441           $32,121
                                                                                            ================ =================
                                   (continued)

               The accompanying notes are an integral part of the
                       consolidated financial statements.

                                       3
<PAGE>
<CAPTION>
                                          HEADWATERS INCORPORATED AND SUBSIDIARIES

                                      CONDENSED CONSOLIDATED BALANCE SHEETS, continued
                                                        (Unaudited)


                                                                                              September 30,        March 31,
(thousands of dollars and shares)                                                                      2000             2001
-------------------------------------------------------------------------------------------- --------------- ----------------
<S>                                                                                         <C>               <C>
LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
     Accounts payable                                                                                 $ 698            $ 785
     Accrued personnel costs                                                                          2,254            1,397
     Other accrued liabilities                                                                        3,786            3,383
     Short-term borrowings                                                                              208            1,065
                                                                                             --------------- ----------------
            Total current liabilities                                                                 6,946            6,630
                                                                                             --------------- ----------------

Long-term liabilities:
     Notes payable, non-current                                                                       5,055              162
     Other long-term liabilities                                                                        180              146
     Deferred revenue                                                                                10,513            7,464
                                                                                             --------------- ----------------
            Total long-term liabilities                                                              15,748            7,772
                                                                                             --------------- ----------------
            Total liabilities                                                                        22,694           14,402
                                                                                             --------------- ----------------
Commitments and contingencies

Stockholders' equity:
     Convertible  preferred stock,  $0.001 par value;  authorized 10,000 shares,
      issued and  outstanding 17 shares at September 30, 2000 and March 31, 2001
      (aggregate liquidation preference of $3,776 at March 31, 2001)                                      1                1
     Common stock,  $0.001  par  value;  authorized  50,000  shares,  issued and
       outstanding  23,341 shares at September 30, 2000  (including 214 shares
       held in treasury) and 22,834 shares at March 31, 2001 (including 470
       shares held in treasury)                                                                          23               23
     Capital in excess of par value                                                                  82,659           80,289
     Accumulated deficit                                                                            (70,221)         (60,239)
     Other, primarily treasury stock                                                                 (1,715)          (2,355)
                                                                                             --------------- ----------------
            Total stockholders' equity                                                               10,747           17,719
                                                                                             --------------- ----------------
            Total liabilities and stockholders' equity                                              $33,441          $32,121
                                                                                             =============== ================
</TABLE>
               The accompanying notes are an integral part of the
                       consolidated financial statements.

                                       4
<PAGE>
<TABLE>
<CAPTION>
                                            HEADWATERS INCORPORATED AND SUBSIDIARIES

                                         CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                                           (Unaudited)

                                                                   Three Months Ended March 31,        Six Months Ended March 31,
(thousands of dollars, except per-share data)                             2000             2001           2000               2001
-------------------------------------------------------------- ---------------- ---------------- -------------- ------------------
<S>                                                             <C>               <C>           <C>                <C>
Revenue:
     License fees                                                      $ 4,798           $5,168        $ 8,833            $11,434
     Chemical sales                                                      1,883            4,134          3,236              9,656
     Gain on sale of facility                                               --               --          5,341                 --
     Gains on non-recurring transactions                                 1,079               --          1,079                 --
     Other                                                                 139              452            459                979
                                                               ---------------- ---------------- -------------- ------------------
          Total revenue                                                  7,899            9,754         18,948             22,069
                                                               ---------------- ---------------- -------------- ------------------

Operating costs and expenses:
     Cost of chemical                                                    1,367            2,652          2,228              6,278
     Cost of operations                                                    798              857          2,482              1,958
     Selling, general and administrative                                 1,033            1,628          1,895              3,097
     Asset write-offs and other non-recurring charges                      841               --         11,862                 --
     Loss on sale of facilities, net                                       598               --            598                 --
                                                               ---------------- ---------------- -------------- ------------------
        Total operating costs and expenses                               4,637            5,137         19,065             11,333
                                                               ---------------- ---------------- -------------- ------------------
Operating income (loss)                                                  3,262            4,617           (117)            10,736
                                                               ---------------- ---------------- -------------- ------------------

Other income (expense):
     Interest and investment income                                        310              119          1,110                341
     Interest expense                                                   (1,711)             (61)        (3,766)              (146)
     Other, net                                                            276              (77)           (16)              (827)
                                                               ---------------- ---------------- -------------- ------------------
          Total other income (expense), net                             (1,125)             (19)        (2,672)              (632)
                                                               ---------------- ---------------- -------------- ------------------

Income (loss) before income taxes and extraordinary item                 2,137            4,598         (2,789)            10,104

Income tax benefit (expense)                                                --              (22)         3,000               (122)
                                                               ---------------- ---------------- -------------- ------------------

Income before extraordinary item                                         2,137            4,576            211              9,982

Extraordinary loss on early extinguishment of debt                      (1,823)              --         (1,823)                --
                                                               ---------------- ---------------- -------------- ------------------

Net income (loss)                                                        $ 314           $4,576        $(1,612)           $ 9,982
                                                               ================ ================ ============== ==================

Basic net income (loss) per common share                                  $.01             $.20          $(.12)              $.44
                                                               ================ ================ ============== ==================

Diluted net income (loss) per common share                                $.01             $.19          $(.12)              $.41
                                                               ================ ================ ============== ==================
</TABLE>
               The accompanying notes are an integral part of the
                       consolidated financial statements.

                                       5
<PAGE>
<TABLE>
<CAPTION>
                    HEADWATERS INCORPORATED AND SUBSIDIARIES

       CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
                     For the Six Months Ended March 31, 2001
                                (Unaudited)

                                                                                                              Other
                                                                                             ------------ ------------- ------------
                                                                                               Related
                                                                                              party note
                           Convertible                                                        receivable    Deferred
                         Preferred Stock     Common Stock        Capital in                    collater-  compensation  Common stock
(thousands of          ------------------- -------------------     excess      Accumulated    alized by    from stock      held in
dollars and shares)      Shares    Amount    Shares    Amount    of par value    deficit     common stock    options       treasury
------------------------------------------------------------------------------------------------------------------------------------
<S>                      <C>       <C>    <C>         <C>         <C>         <C>             <C>          <C>            <C>
Balances at
 September 30, 2000         17        $1     23,341     $23         $82,659     $(70,221)       $(466)       $(515)         $(734)

Exercise of
 stock options                                   50      --              75

Write-down of
 related party note
 receivable to                                                                                     88
 collateral value

Amortization of
 deferred compensation
 from stock options                                                                                             23

Purchase of treasury
 stock, at cost                                                                                                            (1,610)

Treasury stock
 transferred to
 employee stock
 purchase plan                                                                                                                 42

Cancellation of
 treasury stock                                (497)     --          (1,285)                                                1,285

Net income                                                                         5,406
                       -------------------------------------------------------------------------------------------------------------
Balances at
 December 31, 2000          17         1     22,894      23          81,449      (64,815)        (378)        (492)        (1,017)

Exercise of
 stock options                                  205      --             308

Write-up of related
 party note receivable
 to collateral value                                                                             (629)

Cancellation of related
 party note receivable
 and transfer of
 collateral shares to
 treasury stock                                                                                 1,007                      (1,007)

Amortization of
 deferred compensation
 from stock options                                                                                             23

Purchase of treasury
 stock, at cost                                                                                                            (1,358)

Treasury stock
 transferred to
 employee stock
 purchase plan                                                                                                                 28

Cancellation of
 treasury stock                                (265)     --          (1,468)                                                1,468

Net income                                                                         4,576
                       -------------------------------------------------------------------------------------------------------------
Balances at
 March 31, 2001             17        $1     22,834     $23         $80,289     $(60,239)        $ --        $(469)       $(1,886)
                       =============================================================================================================
</TABLE>
               The accompanying notes are an integral part of the
                       consolidated financial statements.

                                        6
<PAGE>
<TABLE>
<CAPTION>
                    HEADWATERS INCORPORATED AND SUBSIDIARIES

                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)

                                                                                                      Six Months Ended March 31,
     (thousands of dollars)                                                                                   2000          2001
----------------------------------------------------------------------------------------------- ------------------- -------------
<S>                                                                                                     <C>           <C>
     Cash flows from operating activities:
     Net income (loss)                                                                                      $(1,612)      $ 9,982
     Adjustments to reconcile net income (loss) to net cash provided by
       (used in) operating activities:
         Recognition of deferred revenue                                                                       (461)       (1,462)
         Depreciation and amortization                                                                          749           129
         Deferred income tax benefit                                                                         (3,000)           --
         Net gain on sale of facilities and disposition of equipment                                         (4,800)          (42)
         Equity in losses of investees, write-offs and provisions for
           unrealizable investments                                                                              --         1,047
         Write-down of note receivable and related accrued interest                                              --           365
         Amortization of deferred compensation from stock options                                                92            46
         Interest expense related to amortization of debt discount and debt
           issuance costs                                                                                     2,272            43
         Write-down (write-up) of related party note receivable                                                 131          (541)
         Extraordinary loss on early extinguishment of debt                                                   1,823            --
         Gains on non-recurring transactions                                                                 (1,079)           --
         Asset write-offs and other non-recurring charges                                                    10,631            --
         Other changes in operating assets and liabilities                                                   (6,860)         (466)
                                                                                                ------------------- -------------
   Net cash provided by (used in) operating activities                                                       (2,114)        9,101
                                                                                                ------------------- -------------

   Cash flows from investing activities:
        Proceeds from sale of facilities and equipment                                                       18,089            42
        Purchase of equipment and facilities held for sale                                                     (551)         (150)
        Net proceeds from sale of short-term investments                                                         --         1,191
        Investments in and loans to non-affiliated companies                                                     --        (4,201)
        Increase in other assets                                                                                (78)         (122)
                                                                                                ------------------- -------------
   Net cash provided by (used in) investing activities                                                       17,460        (3,240)
                                                                                                ------------------- -------------

   Cash flows from financing activities:
        Net proceeds from issuance of notes payable and warrants and other borrowings                         2,980         8,148
        Payments on notes payable, including redemption premiums, and other borrowings                      (14,279)      (12,184)
        Purchase of common stock for the treasury                                                                --        (2,898)
        Proceeds from exercise of options and warrants                                                          203           383
        Net proceeds from issuance of common stock and warrants                                               4,666            --
        Preferred stock dividends                                                                              (205)           --
                                                                                                ------------------- -------------
   Net cash used in financing activities                                                                     (6,635)       (6,551)
                                                                                                ------------------- -------------

   Net increase (decrease) in cash and cash equivalents                                                       8,711         (690)

   Cash and cash equivalents, beginning of period                                                               461           983
                                                                                                ------------------- -------------

   Cash and cash equivalents, end of period                                                                 $ 9,172         $ 293
                                                                                                =================== =============

   Supplemental schedule of non-cash investing and financing activities:
        Cancellation of treasury stock                                                                      $    --       $(2,753)
        Cancellation of related party notes receivable and the common stock
          collateralizing the notes                                                                           6,164            --
        Reclassification of redeemable convertible preferred stock to convertible
          preferred stock                                                                                     2,710            --
        Common stock issued on conversion of convertible preferred stock and in
          payment of dividends                                                                                1,634            --
        Common stock issued on conversion of convertible debt and related accrued interest                    1,116            --
</TABLE>
               The accompanying notes are an integral part of the
                       consolidated financial statements.

                                       7
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)
                                   ----------

1.       Nature of Operations and Basis of Presentation

         Headwaters  Incorporated and its  Subsidiaries'  primary business is to
         commercialize  its chemical  technologies  used to produce  alternative
         fuel from coal derivatives and to recycle otherwise  unusable materials
         from other industries into marketable resources.  Currently, Headwaters
         has  licensed  its  technology  to the  owners of 28  alternative  fuel
         facilities  which are operating at various  levels of production in ten
         states.  During the fiscal year ended  September  30, 2000,  Headwaters
         began  evaluating  and pursuing  investment  alternatives  for the cash
         generated  from  operations.  Headwaters  has  invested  some  of  this
         available cash in high-grade  government backed securities and has made
         several  equity  investments  in  and  loans  to  unrelated   entities.
         Headwaters  does not  currently  intend to make any  additional  equity
         investments  or  loans,   but  is  interested  in  possible   strategic
         acquisitions  of  entities  that would be  synergistic  to  Headwaters'
         current operations.

         The accompanying  unaudited condensed consolidated financial statements
         have been prepared in accordance  with the rules and regulations of the
         Securities and Exchange  Commission for quarterly reports on Form 10-Q.
         In the opinion of management,  all adjustments considered necessary for
         a fair  presentation  have been included.  All  adjustments  except the
         items described in Note 5 consist of normal recurring adjustments.  The
         results of operations for the three- and six-month  periods ended March
         31, 2001 are not  necessarily  indicative of the results to be expected
         for the  full  fiscal  2001  year.  Certain  information  and  footnote
         disclosures  normally  included  in  financial  statements  prepared in
         accordance  with generally  accepted  accounting  principles  have been
         condensed or omitted.  It is suggested that these financial  statements
         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, 2000 and in Headwaters'  Quarterly  Report
         on Form 10-Q for the quarter  ended  December 31, 2000.  Certain  prior
         period  amounts  have been  reclassified  to conform  with the  current
         periods'  presentation.  The  reclassifications  had no  effect  on net
         income (loss) or total assets.

2.       Financing and Equity Transactions

         During and  subsequent to the quarter ended March 31, 2001,  Headwaters
         completed several transactions, including the following.

         Bank  Line of  Credit - In  January  2001,  the  terms  of  Headwaters'
         revolving line of credit with a bank were  modified.  Under the revised
         terms, i) the line of credit  expiration date was extended from January
         2002 to October 2002, ii) the interest rate was reduced from prime plus
         1% to prime plus .75%,  iii) the maximum  amount which can be borrowed,
         subject  to the  "borrowing  base,"  as  defined,  was  increased  from
         $8,000,000 to $10,000,000,  and iv) certain of the operating  covenants
         and  restrictions  were changed.  Maximum  borrowings under the line of
         credit  during the  quarter  ended  March 31,  2001 were  approximately
         $446,000. The borrowing base was approximately  $6,100,000 at March 31,
         2001 and there were no borrowings under the line at March 31, 2001.

         Short-term  Borrowings  with an Investment  Company - Headwaters has an
         arrangement  with an  investment  company  under which  Headwaters  can
         borrow  up to 90% of the value of the total  portfolio  of  Headwaters'
         short-term  investments with the investment company,  which investments
         collateralize any outstanding borrowings. Maximum borrowings under this
         arrangement  during the quarter ended March 31, 2001 were approximately
         $3,252,000  and  approximately  $944,000 was  outstanding  at March 31,
         2001. The borrowings  were used for short-term  working  capital needs,
         primarily for stock repurchases, rather than liquidating the securities
         held as collateral.

         Treasury  Stock - During the quarter  ended March 31, 2001,  Headwaters
         continued  acquiring  shares of its common stock in connection with the
         stock purchase  program  announced in May 2000. The program  authorizes
         Headwaters to purchase  stock in the open market or through  negotiated
         block transactions. During the quarter ended March 31, 2001, Headwaters
         purchased  approximately  281,000 shares for approximately  $1,358,000.
         Also during the quarter, approximately 265,000 shares of treasury stock
         were cancelled.
                                       8
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)
                                   ----------

         Common Stock Options - During the quarter ended March 31, 2001, options
         for the purchase of 205,000  shares of common stock were  exercised for
         cash proceeds of approximately $308,000. From April 1 through April 20,
         2001,  options for the  purchase  of  approximately  134,000  shares of
         common  stock  were  exercised  for  cash  proceeds  of   approximately
         $244,000.  In April  2001,  options for the  purchase of  approximately
         244,000 shares were granted to officers and employees.

         Related  Party  Note  Receivable  Collateralized  by Common  Stock - In
         January  2001,   Headwaters   accepted  from  a  stockholder   as  full
         satisfaction  of a  collateral-based  note  receivable,  i) the 150,000
         shares of  Headwaters  stock and  options to acquire  25,000  shares of
         Headwaters  common stock that  collateralized  the note,  both of which
         were  cancelled,  and  ii) a new  promissory  note  receivable  in  the
         principal amount of $1,750,000. Prior to this transaction, the original
         note  receivable  was  being  carried  at the  value of the  underlying
         collateral.  Headwaters recognized a gain in the March 31, 2001 quarter
         of  approximately  $629,000  representing  the increase in value of the
         collateral  from  December  31,  2000 to the  date the  collateral  was
         surrendered  by the  stockholder in payment of the note. The $1,750,000
         note  receivable  bears  interest at 6% and both principal and interest
         are due no  later  than  December  2003.  The new  note  receivable  is
         collateralized  by certain assets of the former  stockholder;  however,
         Headwaters  has  recorded an  allowance  against the full amount of the
         note due to substantial  uncertainty of both the  collectibility of the
         note and the value of the collateral.

         Convertible  Preferred Stock - In April 2001,  Headwaters exercised its
         right to require  the  holders of the  Series A  Convertible  Preferred
         Stock to convert  their  preferred  shares into common  stock within 30
         days of the date notice was provided.  Such  conversion  will result in
         the  issuance  of  428,572  shares  of  common  stock  (representing  a
         conversion  price of $7.00 per common share) and the payment in cash of
         accrued but undeclared dividends of approximately $670,000.

3.       Notes Payable and Other Borrowings

         Notes payable and other borrowings consist of the following:
<TABLE>
<CAPTION>


                                                                                                 September 30,       March 31,
  (thousands of dollars)                                                                                  2000            2001
  ---------------------------------------------------------------------------------------------- -------------- ---------------
         <S>                                                                                       <C>              <C>
         Short-term borrowings from an investment company, bearing interest at a
         floating rate (7.25% as of March 31, 2001), collateralized by
         investments with the investment company with a carrying value of
         approximately $5,782,000.                                                                        $ --           $ 944

         Note payable to a bank, bearing interest at prime plus 2%, repaid with
         proceeds from a long-term line of credit with this bank obtained in
         October 2000 (see Note 2).                                                                      3,000              --

         Note payable to a corporation bearing interest at 6%, repaid in October
         2000 with funds obtained from a long-term bank line of credit obtained
         in October 2000 (see Note 2).                                                                   1,838              --

         Other                                                                                             425             283
                                                                                                 -------------- ---------------
                                                                                                         5,263           1,227
         Less: current portion                                                                            (208)         (1,065)
                                                                                                 -------------- ---------------
         Total non-current                                                                              $5,055           $ 162
                                                                                                 ============== ===============
</TABLE>

         The weighted-average interest rate on the above obligations was 9.7% at
         September 30, 2000 and 8.7% at March 31, 2001.

                                       9
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)
                                   ----------

<TABLE>
<CAPTION>

4.       Basic and Diluted Earnings per Share

    (thousands  of dollars  and  shares,                     Three  Months Ended March 31,     Six  Months Ended March 31,
     except  per-share data)                                       2000             2001            2000            2001
    -------------------------------------------------------- ------------- ---------------- --------------- ---------------
    <S>                                                      <C>               <C>              <C>             <C>
    Numerator:
         Income before extraordinary item                         $ 2,137           $4,576           $ 211           $9,982
         Extraordinary item                                        (1,823)              --          (1,823)              --
                                                             ------------- ---------------- --------------- ---------------
         Net income (loss)                                            314            4,576          (1,612)           9,982
         Preferred stock dividends                                   (119)             (47)           (265)             (94)
         Imputed preferred stock dividends                             --               --             (58)              --
                                                             ------------- ---------------- --------------- ---------------

    Numerator for basic earnings per share -- net income
     (loss) attributable to common stockholders                       195            4,529          (1,935)           9,888

    Effect of dilutive securities - preferred stock dividends          72               47              --               94
                                                             ------------- ---------------- --------------- ---------------

    Numerator for diluted earnings per share -- net income
     (loss) attributable to common stockholders after
     assumed conversions                                            $ 267           $4,576         $(1,935)          $9,982
                                                             ============= ================ =============== ===============

    Denominator:
    Denominator for basic earnings per share -- weighted-
      average shares outstanding                                   18,025           22,458          15,818           22,719
    Effect of dilutive securities:
      Shares issuable upon exercise of options and warrants           337            1,416              --            1,057

      Shares issuable upon conversion of preferred stock            8,009              443              --              443
                                                             ------------- ---------------- --------------- ---------------
    Total dilutive potential shares                                 8,346            1,859              --            1,500
                                                             ------------- ---------------- --------------- ---------------

    Denominator for diluted earnings per share -- weighted-
      average shares outstanding after assumed
      exercises and conversions                                    26,371           24,317          15,818           24,219
                                                             ============= ================ =============== ===============

    Basic net income (loss) per share:
    Income (loss) before extraordinary item                          $.11             $.20           $(.01)            $.44
    Extraordinary item                                               (.10)              --            (.11)              --
                                                             ------------- ---------------- --------------- ---------------
    Net income (loss) per common share                               $.01             $.20           $(.12)            $.44
                                                             ============= ================ =============== ===============

    Diluted net income (loss) per share:
    Income (loss) before extraordinary item                          $.08             $.19           $(.01)            $.41
    Extraordinary item                                               (.07)              --            (.11)              --
                                                             ------------- ---------------- --------------- ---------------
    Net income (loss) per common share                               $.01             $.19           $(.12)            $.41
                                                             ============= ================ =============== ===============
</TABLE>

         During the six months ended March 31, 2000, Headwaters' potentially
         dilutive securities consisted of options and warrants for the purchase
         of common stock, convertible debt and convertible preferred stock, all
         of which were anti-dilutive and were therefore omitted in the
         calculation of diluted earnings per share. For all other periods
         presented, certain potentially dilutive securities, primarily options
         and warrants, were anti-dilutive and were also omitted in the
         calculation of diluted earnings per share. The amount of anti-dilutive
         securities not considered in the diluted earnings per share calculation
         totaled approximately 7,300,000 shares and 1,400,000 shares for the
         three months ended March 31, 2000 and 2001, respectively, and
         approximately 9,700,000 shares and 2,100,000 shares for the six months
         ended March 31, 2000 and 2001, respectively.

                                       10
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)
                                   ----------

5.       Non-recurring Items

         In December 1999, Headwaters sold one of the three remaining synthetic
         fuel facilities it owned at that time. Headwaters reported a gain on
         this transaction of approximately $5,341,000. In the March 2000
         quarter, Headwaters sold another synthetic fuel facility and an option
         to acquire a licensee facility. Headwaters reported a combined loss on
         these transactions of approximately $598,000. Both facilities were
         subsequently relocated at which time additional payments were received
         and revenue recognized. Also during the quarter ended March 31, 2000,
         Headwaters recorded non-recurring gains of approximately $1,079,000
         related to the satisfaction of a contingent contract liability and a
         gain recognized on a note receivable transaction.

         In the December 1999 quarter, Headwaters recorded an impairment charge
         of approximately $10,271,000 related to assets located at the Price,
         Utah site. This impairment charge consisted of an approximate
         $8,082,000 write-down to net realizable value of certain plant and
         equipment which remained on the site and became idle when the facility
         was sold, plus an approximate $2,189,000 write-off of an intangible
         asset which was no longer considered recoverable due to the relocation
         of a licensee facility. Headwaters recorded other asset write-offs and
         non-recurring charges in the quarter ended December 31, 1999 which,
         when added to the impairment charges, totaled approximately
         $11,021,000. Of this amount, approximately $10,412,000 did not involve
         the use of cash. In the March 2000 quarter, Headwaters recorded
         additional non-recurring employee severance and other settlement
         charges totaling approximately $841,000, of which $219,000 represented
         a non-cash charge.

         There were no non-recurring gains or losses recorded during the quarter
         or six months ended March 31, 2001.

6.       Income Taxes

         In the quarter ended March 31, 2001, Headwaters incurred $22,000 of
         state income tax expense. In addition, in the quarter ended December
         31, 2000, Headwaters reported $100,000 of alternative minimum tax
         expense. There was no income tax expense recognized in the quarter
         ended March 31, 2000, however Headwaters reported an income tax benefit
         of $3,000,000, consisting of the recognition of a portion of its
         deferred tax asset, in the quarter ended December 31, 1999. Headwaters
         believes it is more likely than not that this portion of the total
         deferred tax asset will be realized as a result of income to be
         recognized from the amortization in subsequent periods of deferred
         revenue currently recorded in the consolidated balance sheet.

         As of March 31, 2001, Headwaters has net operating loss carryforwards
         of approximately $29,000,000 which can be used to offset future taxable
         income. Headwaters has not recognized any portion of the deferred tax
         asset related to these net operating loss carryforwards due to various
         factors, including its short history of profitability, the significant
         variability of licensee production levels, the significant amount of
         existing debt and equity investments in high-risk investee companies,
         and the current political uncertainty that exists with regard to
         Section 29 income tax credits and the potential impact on Headwaters'
         future operations and revenues.

7.       Commitments and Contingencies

         Commitments and contingencies, consisting of legal and contractual
         matters, as of March 31, 2001 not disclosed elsewhere, are as follows:

         Adtech. 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
         an alternative fuel technology invented by Davidson. In September 2000,
         Headwaters received a summons and complaint from the United States
         District Court for the Western District of Tennessee filed by Adtech,
         Inc. against Davidson and Headwaters. In the action certain purported
         officers and directors of Adtech allege that the technology purchase
         transaction was an unauthorized corporate action and that Davidson and
         Headwaters conspired together to effect the transfer. The complaint
         asserts related causes of action in fraud, conversion, patent
         infringement, conspiracy and unfair competition seeking unspecified
         money damages to be proven at trial, accounting, disgorgement,
         recission of contracts, punitive damages,

                                       11
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)
                                   ----------

         and other relief. Headwaters denies these allegations and is asking the
         court to dismiss the action. Because the litigation is at an early
         stage and resolution is uncertain, legal counsel cannot express an
         opinion as to the ultimate amount, if any, of Headwaters' liability.

         Levy and Klein. In March 1999, Headwaters sold convertible preferred
         stock, warrants, and a convertible promissory note to OZ Master Fund,
         Ltd. In September 2000, Headwaters received a summons and complaint
         from the United States District Court for the Southern District of New
         York filed by Mark Levy against OZ Master Fund and related entities
         ("OZ") and Headwaters. In January 2001, Headwaters received a summons
         and complaint from the same court filed by Terry Klein against OZ and
         Headwaters making the same claims. The parties in the two cases have
         agreed to consolidate. In the actions, purported shareholders of
         Headwaters allege that OZ violated section 16(b) of the Securities
         Exchange Act of 1934 by converting preferred stock into Headwaters
         common stock and then selling the same within a six month period, and
         further, that Headwaters' redemption of the preferred stock and the
         note constituted a sale of common stock for which OZ is liable under
         section 16(b). The complaints seek on behalf of Headwaters from OZ
         unspecified money damages to be proven at trial, attorney fees, and
         other relief. OZ has moved for an order of dismissal which the court
         has not yet ruled upon. Because the litigation is at an early stage and
         resolution is uncertain, legal counsel cannot express an opinion as to
         the ultimate amount, if any, that might be recovered.

         AJG. In December 1996, Headwaters entered into a technology license and
         proprietary chemical sale agreement with AJG Financial Services, Inc.
         The agreement called for AJG to pay royalties and to purchase
         proprietary chemical material from Headwaters. In October 2000,
         Headwaters filed a complaint in the Fourth District Court for the State
         of Utah against AJG alleging that it has failed to make payments and to
         perform other obligations under the agreement. Headwaters asserts
         claims including breach of contract, declaratory judgment, unjust
         enrichment, and accounting and seeks money damages in the amount of
         $750,000 plus other damages to be proven at trial, as well as other
         relief. AJG has answered the complaint denying Headwaters' claims and
         asserting counter-claims based upon allegations of misrepresentation
         and breach. AJG seeks unspecified compensatory damages as well as
         punitive damages. Headwaters denies the allegations of AJG's
         counter-claims. Because the litigation is at an early stage and
         resolution is uncertain, legal counsel cannot express an opinion as to
         the ultimate amount of recovery or liability.

         Nalco. In October 2000, Headwaters filed a complaint in the United
         States District Court for the District of Utah against Nalco Chemical
         Company ("Nalco"). Headwaters alleges that Nalco, by its sale and
         marketing of materials for use in creating alternative fuel, breached a
         non-disclosure agreement, misappropriated trade secrets, and violated
         patent rights of Headwaters. Headwaters seeks by its complaint
         injunctive relief and damages to be proven at trial. Nalco filed an
         answer denying the allegations in the complaint and asserting
         counter-claims alleging patent invalidity. Headwaters denies the
         counter-claims; however, if Nalco prevails on its counter-claims, the
         result could have a material adverse effect on Headwaters' business.
         Because the litigation is at an early stage and resolution is
         uncertain, legal counsel cannot express an opinion as to the ultimate
         amount, if any, that might be recovered by Headwaters.

         Headwaters is also involved in other legal proceedings that have arisen
         in the normal course of business. Management believes that many of
         these other claims are without merit and in all cases intends to
         vigorously defend its position. Management does not believe that the
         outcome of these activities will have a significant effect upon the
         operations or the financial position of Headwaters; however, it is
         possible that a change in management's estimates of probable liability
         could occur and the change could be significant.

                                       12
<PAGE>

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

The following  discussion and analysis  should be read in  conjunction  with the
accompanying unaudited consolidated financial statements and notes thereto.

Three Months Ended March 31, 2001 Compared to Three Months Ended March 31, 2000

The information set forth below compares  Headwaters'  operating results for the
three months ended March 31, 2001 ("2001") with operating  results for the three
months ended March 31, 2000 ("2000").

Revenue.  Total  revenue for 2001  increased  by  $1,855,000  to  $9,754,000  as
compared  to  $7,899,000  for 2000.  The major  components  of this  revenue are
discussed in the sections below.

License  Fees.  During  2001,   Headwaters   recognized  license  fees  totaling
$5,168,000  while  $4,798,000 of license fees were  recognized  during 2000. The
license fees in 2001 consisted of the  amortization  of one-time  non-refundable
initial and prepaid license fees of $1,188,000 and recurring earned license fees
or  royalty  payments  of  $3,980,000.  License  fees in 2000  consisted  of the
amortization  of one-time  non-refundable  initial  license fees of $231,000 and
recurring  license fees or royalty payments of $4,567,000.  Initial license fees
were  normally  received  when  construction  of the  related  alternative  fuel
facility began,  when construction was completed,  or when certain  construction
milestones  or other  conditions  were met.  These  license  fees are  generally
recognized  on a  straight-line  basis  over the period  covered by  Headwaters'
license agreements with licensees.

Recurring  earned license fees or royalty  payments are due quarterly based upon
alternative  fuel sold as  reported to  Headwaters  by its  licensees.  The 2000
earned license fees included  significant  amounts  related to a single licensee
that owns four  facilities.  This  licensee did not report and pay certain prior
period royalty  obligations to Headwaters  timely,  resulting in some "catch-up"
revenue  recognition  in 2000 for royalties  relating to periods other than only
the quarter ended March 31, 2000. This same licensee  significantly  reduced its
production and sale of alternative fuel in 2001 resulting in a decline in earned
license fees from the licensee of  approximately  $3,237,000 in 2001 as compared
to 2000.  There was an increase of  approximately  $2,650,000 in earned  license
fees  from all other  licensees  in 2001 over  2000.  This was due to  increased
alternative fuel sales by those licensees.  Headwaters  expects  fluctuations in
future periods in individual licensee  alternative fuel sales with corresponding
fluctuations in Headwaters' license fees due to feedstock availability and other
licensee  operational  issues,  marketing  issues,  the ability of  licensees to
utilize the income tax  credits  earned  from the sale of  alternative  fuel and
other  factors,  many of which are  beyond the  direct  control  of  Headwaters.
Headwaters also expects fluctuations in aggregate license fee revenue.  However,
at the current  time,  Headwaters  expects its license fee revenue in the fiscal
year  ending  September  30,  2001 from all  licensees  to be higher  than total
license fees reported for the fiscal year ended September 30, 2000.

Chemical Sales.  Headwaters provides chemical reagent to its licensees either at
a fixed  price or at  Headwaters'  cost  plus a  contracted  markup.  Headwaters
purchases  the  chemical  materials  under  a  long-term  contract  with a large
chemical   company.   Chemical  sales  during  2001  were   $4,134,000   with  a
corresponding  direct  cost of  $2,652,000.  Chemical  sales  during  2000  were
$1,883,000  with a  corresponding  direct cost of  $1,367,000.  The  increase in
chemical  sales  in  2001  over  2000  was  due to  increased  alternative  fuel
production by Headwaters' licensees.  Currently, Headwaters expects its chemical
sales revenue from all licensees in the fiscal year ending September 30, 2001 to
be  significantly  higher  than the amounts  reported  for the fiscal year ended
September  30, 2000.  Headwaters  expects the gross profit margin for the fiscal
2001 year to be  comparable  to the  profit  margin  reported  in the March 2001
quarter.

Gains on Non-recurring Transactions.  In 2000, Headwaters recorded non-recurring
gains of  approximately  $1,079,000  related to the satisfaction of a contingent
contract liability and a gain recognized on a note receivable transaction. There
were no non-recurring gains recorded in 2001.

Cost of  Operations  increased  by $59,000 to $857,000 in 2001 from  $798,000 in
2000, primarily as a result of increased personnel costs.

Selling,  General and  Administrative  Expenses increased $595,000 to $1,628,000
during 2001 from $1,033,000 for 2000. The increase in expenses in 2001 is due to
an  increase in payroll and other  compensation-related  costs of  approximately
$294,000  and an increase in  professional  services  expenses of  approximately
$340,000,  with a net  decrease in all other cost  categories

                                       13
<PAGE>

of approximately  $39,000. The increase in professional services expenses is due
primarily  to  legal  costs  associated  with the  current  legal  actions  that
Headwaters is involved in.

Asset Write-offs and Other  Non-recurring  Charges.  In 2000,  Headwaters sold a
synthetic fuel facility and an option to acquire a licensee facility. Headwaters
reported a combined loss on these  transactions of  approximately  $598,000.  In
2000,  Headwaters  also  recorded  non-recurring  employee  severance  and other
settlement  charges  totaling  approximately   $841,000.   There  were  no  such
non-recurring charges recorded in 2001.

Other Income and Expense. During 2001, Headwaters reported net other expenses of
$19,000  compared  to net  expenses of  $1,125,000  for 2000.  This  decrease of
$1,106,000 relates primarily to a decrease of $1,650,000 in interest expense and
an increase of $468,000 in the  mark-to-market  adjustment of the carrying value
of a related party note receivable,  offset by an increase of $721,000 in equity
and debt  investment-related  losses  and a decrease  of  $191,000  in  interest
income.

Interest  expense  decreased in 2001  primarily due to the  substantially  lower
average  levels of outstanding  borrowings  which existed in 2001 as compared to
2000.  There has also  been a  substantial  reduction  in the  weighted  average
effective interest rate on outstanding borrowings between 2000 and 2001.

During 1996,  Headwaters  sold certain  construction  companies  and received as
consideration a $5,000,000 note receivable. The note was "marked to market" each
quarter  based  upon  the  market  value of  Headwaters'  common  stock  held as
collateral and was reflected in the consolidated balance sheet at the underlying
value of this  collateral,  $378,000  at December  31,  2000.  In January  2001,
Headwaters  accepted as full  satisfaction  of the note receivable the shares of
Headwaters' stock  collateralizing  the note and a new note receivable which has
been  fully  reserved.  This  resulted  in  recognition  of a gain  in  2001  of
approximately $629,000 representing the increase in value of the collateral from
December 31, 2000 to the date the collateral  was  surrendered in payment of the
note.  The  corresponding  adjustment in 2000 resulted in a write-up of $161,000
for a net change in the adjustment of $468,000 in 2001 compared to 2000.

Beginning in June 2000,  Headwaters made debt and equity  investments in several
less than 50%-owned affiliates.  Allowances are provided on a case-by-case basis
when management first determines that the investment is not realizable. Gains on
these same  investments  cannot be recognized  until  realized,  which  normally
occurs at a much later date.  During 2001,  the  provision  for  allowances  and
related  write-offs  totaled  approximately  $646,000.  In addition,  Headwaters
recognized  approximately  $75,000  related to its equity in losses of investees
accounted for using the equity method.

The  decrease  in  interest  income  from 2000 to 2001  primarily  related  to a
decrease in the  interest  rate,  effective in May 2000,  on a  $6,500,000  note
receivable from a licensee.

Income Taxes. In 2001,  Headwaters incurred $22,000 of state income tax expense.
There  was no income  tax  expense  recognized  in 2000.  As of March 31,  2001,
Headwaters has net operating loss  carryforwards  of  approximately  $29,000,000
which can be used to offset future taxable income. Headwaters has not recognized
any  portion  of the  deferred  tax asset  related to these net  operating  loss
carryforwards   due  to  various   factors,   including  its  short  history  of
profitability,  the significant  variability of licensee  production levels, the
significant amount of existing debt and equity investments in high-risk investee
companies,  and the  current  political  uncertainty  that exists with regard to
Section 29 income tax credits and the  potential  impact on  Headwaters'  future
operations and revenues.

Extraordinary Item. In January 2000,  Headwaters redeemed convertible debt which
had  been  issued  beginning  in  September  1999  through  December  1999.  The
redemption  consideration given included approximately  $1,000,000 in redemption
premiums plus 214,000 shares of common stock. The loss recognized as a result of
the redemption  consideration  paid plus the acceleration of amortization of the
unamortized  debt  discount  and  debt  issuance  costs  totaled   approximately
$1,823,000.  This  loss  is  reflected  as an  extraordinary  item  in the  2000
consolidated statement of operations.

Net Income.  For 2001,  net income of $4,576,000  represents an  improvement  of
$4,262,000  from net  income  of  $314,000  in 2000.  This is  primarily  due to
increased revenue,  decreased  expenses,  a decrease in interest expense and the
extraordinary item recognized in 2000.

Six Months Ended March 31, 2001 Compared to Six Months Ended March 31, 2000

The information set forth below compares  Headwaters'  operating results for the
six months  ended March 31, 2001  ("2001")  with  operating  results for the six
months ended March 31, 2000 ("2000").

                                       14
<PAGE>

Revenue.  Total  revenue for 2001  increased by  $3,121,000  to  $22,069,000  as
compared to  $18,948,000  for 2000.  The major  components  of this  revenue are
discussed in the sections below.

License  Fees.  During  2001,   Headwaters   recognized  license  fees  totaling
$11,434,000  while  $8,833,000 of license fees were recognized  during 2000. The
license fees in 2001 consisted of the  amortization  of one-time  non-refundable
initial and prepaid license fees of $1,463,000 and recurring earned license fees
or  royalty  payments  of  $9,971,000.  License  fees in 2000  consisted  of the
amortization  of one-time  non-refundable  initial  license fees of $461,000 and
recurring license fees or royalty payments of $8,372,000.

The 2000 earned license fees included  significant  amounts  related to a single
licensee that owns four facilities. This licensee did not report and pay certain
prior  period  royalty  obligations  to  Headwaters  timely,  resulting  in some
"catch-up"  revenue  recognition in 2000 for royalties relating to periods other
than the six-month period ended March 31, 2000. This same licensee significantly
reduced its  production  and sale of  alternative  fuel in 2001  resulting  in a
decline in earned license fees from the licensee of approximately  $3,262,000 in
2001 as compared to 2000. There was an increase of  approximately  $4,861,000 in
earned license fees from all other  licensees in 2001 over 2000. This was due to
increased alternative fuel sales by those licensees.

Chemical Sales.  Chemical sales during 2001 were $9,656,000 with a corresponding
direct cost of  $6,278,000.  Chemical sales during 2000 were  $3,236,000  with a
corresponding direct cost of $2,228,000.  The increase in chemical sales in 2001
over  2000 was due to  increased  alternative  fuel  production  by  Headwaters'
licensees.

Gain on Sale of Facility.  In December  1999,  Headwaters  sold one of the three
remaining synthetic fuel facilities it owned at that time. Headwaters reported a
gain on this transaction of approximately  $5,341,000.  There were no such gains
in 2001.

Gains on Non-recurring Transactions.  In 2000, Headwaters recorded non-recurring
gains of  approximately  $1,079,000  related to the satisfaction of a contingent
contract liability and a gain recognized on a note receivable transaction. There
were no non-recurring gains recorded in 2001.

Cost of Operations  decreased by $524,000 to $1,958,000 in 2001 from  $2,482,000
in 2000. During 2001, Headwaters incurred lower operating expenses in connection
with the continued refinement and implementation of the alternative fuel process
associated with licensee-owned facilities. Also, in 2001 there were no operating
costs  associated with the three  facilities owned by Headwaters which were sold
in December 1999 through April 2000. In 2000, cost of operations  included labor
and operating  expenses at the owned  alternative  fuel  facilities and the wash
plant located in Utah. There were no such costs in 2001.

Selling,  General and Administrative Expenses increased $1,202,000 to $3,097,000
during 2001 from $1,895,000 for 2000. The increase in expenses in 2001 is due to
an  increase in payroll and other  compensation-related  costs of  approximately
$570,000  and an increase in  professional  services  expenses of  approximately
$722,000,  with a net  decrease in all other cost  categories  of  approximately
$90,000.  The increase in  professional  services  expenses is due  primarily to
legal costs  associated  with the  current  legal  actions  that  Headwaters  is
involved in.

Asset Write-offs and Other  Non-recurring  Charges.  In 2000,  Headwaters sold a
synthetic fuel facility and an option to acquire a licensee facility. Headwaters
reported a combined loss on these  transactions of  approximately  $598,000.  In
2000,  Headwaters  recorded an impairment  charge of  approximately  $10,271,000
related to assets  located  at the Price,  Utah  site.  This  impairment  charge
consisted of an approximate  $8,082,000  write-down to net  realizable  value of
certain plant and equipment  which remained on the site and became idle when the
facility was sold,  plus an  approximate  $2,189,000  write-off of an intangible
asset which was no longer  considered  recoverable  due to the  relocation  of a
licensee facility.  Headwaters recorded other asset write-offs and non-recurring
charges including  employee  severance and other settlement  charges which, when
added to the impairment charges, totaled approximately  $11,862,000.  There were
no such non-recurring charges recorded in 2001.

Other Income and Expense. During 2001, Headwaters reported net other expenses of
$632,000  compared to net  expenses of  $2,672,000  for 2000.  This  decrease of
$2,040,000 relates primarily to a decrease of $3,620,000 in interest expense and
an increase of $673,000 in the  mark-to-market  adjustment of the carrying value
of a related  party note  receivable,  offset by an  increase of  $1,413,000  in
equity and debt investment-related losses and a decrease of $769,000 in interest
income.

Interest  expense  decreased in 2001  primarily due to the  substantially  lower
average  levels of outstanding  borrowings  which existed in 2001 as compared to
2000.  There has also  been a  substantial  reduction  in the  weighted  average
effective interest rate on outstanding borrowings between 2000 and 2001.

                                       15
<PAGE>

In January 2001,  Headwaters  accepted as full satisfaction of the related party
note receivable the shares of Headwaters' stock  collateralizing  the note and a
new note receivable which has been fully reserved.  This resulted in recognition
of a gain in 2001 of approximately  $541,000  representing the increase in value
of the  collateral  from  September  30,  2000 to the  date the  collateral  was
surrendered  in  payment  of the  note.  The  corresponding  adjustment  in 2000
resulted in a write-down of $131,000 for a change in the  adjustment of $672,000
in 2001 compared to 2000.

During 2001,  the provision for  allowances  and related  write-offs of debt and
equity investments totaled  approximately  $1,238,000.  In addition,  Headwaters
recognized  approximately  $175,000 related to its equity in losses of investees
accounted for using the equity method.

The  decrease  in  interest  income  from 2000 to 2001  primarily  related  to a
decrease in interest from the related party note receivable discussed above from
$515,000 in 2000 to $0 in 2001 and a decrease in the interest rate, effective in
May 2000, on a $6,500,000 note receivable from a licensee.

Income Taxes. In 2001,  Headwaters  incurred $22,000 of state income tax expense
and $100,000 of alternative minimum tax expense. In 2000, Headwaters reported an
income tax benefit of $3,000,000,  consisting of the recognition of a portion of
its deferred tax asset. Headwaters believes it is more likely than not that this
portion of the total  deferred  tax asset will be realized as a result of income
to be recognized from the amortization in subsequent periods of deferred revenue
currently recorded in the consolidated balance sheet.

Extraordinary Item. In January 2000,  Headwaters redeemed convertible debt which
had  been  issued  beginning  in  September  1999  through  December  1999.  The
redemption  consideration given included approximately  $1,000,000 in redemption
premiums plus 214,000 shares of common stock. The loss recognized as a result of
the redemption  consideration  paid plus the acceleration of amortization of the
unamortized  debt  discount  and  debt  issuance  costs  totaled   approximately
$1,823,000.  This  loss  is  reflected  as an  extraordinary  item  in the  2000
consolidated statement of operations.

Net Income.  For 2001,  net income of $9,982,000  represents an  improvement  of
$11,594,000  from a net loss of  $1,612,000  in 2000.  This is primarily  due to
increased revenue,  decreased  expenses,  a decrease in interest expense and the
extraordinary  item  recognized in 2000,  offset in part by the  recognition  of
$3,000,000 of income tax benefit in 2000.

Liquidity and Capital Resources

Liquidity.  Net cash provided by operating activities during 2001 was $9,101,000
compared to  $2,114,000  of cash used during  2000.  Most of this change in cash
flow  from  operating  activities  is  attributable  to the 2001 net  income  of
$9,982,000  as  compared  to the  2000  net  loss of  $1,612,000.  During  2001,
investing  activities  consisted  primarily  of  investments  in  and  loans  to
non-affiliated  companies  of  approximately  $4,201,000  and  net  proceeds  of
approximately  $1,191,000 from the sale of short-term investments.  During 2001,
financing   activities  consisted  primarily  of  proceeds  from  borrowings  of
approximately $8,148,000,  repayments of borrowings of approximately $12,184,000
and the purchase of treasury  stock,  net of transfers to  Headwaters'  Employee
Stock Purchase Plan for approximately $2,898,000.

Capital Resources.  In 2001, Headwaters' primary investing activity consisted of
investments  in and loans to  non-affiliated  companies.  As of March 31,  2001,
Headwaters  owns  from 1% to 33% of the  voting  securities  of four  non-public
high-risk investee  companies.  The carrying value of current investments ranges
from $130,000 to $1,933,000 each.  Headwaters has no future commitments and does
not currently  expect to make any  significant  additional  investments in these
entities.  As of March 31, 2001,  Headwaters  also had notes  receivable  with a
total net carrying  value of  approximately  $3,836,000,  representing  loans to
eight private,  emerging  growth  companies.  These loans  generally  bridge the
period  between seed funding and the close of first and second  rounds of equity
financing.  Seven of these notes receivable range from $200,000 to $350,000 each
and have  original  terms of three to four months,  although many of these loans
have been extended for successive three- to four-month periods.  Headwaters also
has one additional long-term loan for $2,000,000 to a longer-established private
company.  Headwaters  does not currently  intend to make any  additional  equity
investments  or  loans,  but  could  incur  losses  if the  investments  are not
recoverable  or the loans are not  repaid.  Headwaters  has no current  plans to
construct  additional synthetic fuel facilities or to incur significant costs to
acquire property,  plant and equipment,  but is interested in possible strategic
acquisitions  of  entities  that would be  synergistic  to  Headwaters'  current
operations. Any future acquisitions could be funded using Headwaters stock, cash
or a combination of stock and cash.

As  described in Note 2 to the  consolidated  financial  statements,  Headwaters
continued  acquiring  shares of its common stock during 2001, in connection with
the stock  purchase  program  announced  in May  2000.  The  program  authorizes
Headwaters  to  purchase  stock in the open market or through  negotiated  block
transactions.  Purchases  under the plan are at the  discretion  of

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<PAGE>

Headwaters' management.  During 2001, Headwaters purchased approximately 895,000
shares for approximately $2,967,000.  Headwaters continually evaluates financial
alternatives to the stock repurchase  program but currently  expects the program
to selectively  continue  through  fiscal 2001 subject to market  conditions and
available cash.

Headwaters'   working  capital  decreased  from  approximately   $11,225,000  at
September 30, 2000 to approximately $6,967,000 as of March 31, 2001. The primary
reasons for this change were the use of cash for the repayment of  approximately
$4,980,000 of long-term  debt, for  investments  in and loans to  non-affiliated
companies and for purchases of treasury  stock.  Cash from  operations  funded a
majority of these cash  requirements.  Headwaters also expects its operations to
produce  positive cash flows in future periods.  In addition to cash provided by
operating  activities,  Headwaters has an arrangement with an investment company
under which  Headwaters can borrow up to 90% of the value of the total portfolio
of  Headwaters'  short-term  investments  with that  investment  company,  which
investments  collateralize any outstanding  borrowings.  Under this arrangement,
maximum   borrowings  during  2001  were   approximately   $3,252,000  of  which
approximately $944,000 was outstanding as of March 31, 2001.

Headwaters also has borrowing capability under a revolving line of credit with a
bank which  expires in October  2002.  Borrowings  under the line of credit bear
interest  at prime plus .75%  (8.75% at March 31,  2001) and are  limited to the
lesser of $10,000,000 or the "borrowing  base," as defined.  Maximum  borrowings
under  the  line of  credit  during  2001  were  approximately  $4,896,000.  The
borrowing base was approximately  $6,100,000 at March 31, 2001 and there were no
borrowings  under the line at March 31, 2001.  Headwaters  believes it will have
sufficient  cash reserves to meet its  obligations  during fiscal 2001, and also
believes it has the ability to raise  additional  debt and equity  capital  from
other sources if necessary.

Income  Taxes.  As  of  March  31,  2001,  Headwaters  has  net  operating  loss
carryforwards  of approximately  $29,000,000  which can be used to offset future
taxable  income.  Headwaters  has not recognized any portion of the deferred tax
asset related to these net operating loss  carryforwards due to various factors,
including its short history of  profitability,  the  significant  variability of
licensee  production  levels, the significant amount of existing debt and equity
investments  in  high-risk  investee   companies,   and  the  current  political
uncertainty  that  exists  with  regard to Section 29 income tax credits and the
potential  impact on  Headwaters'  future  operations  and revenues.  During the
remainder  of fiscal  2001 and in fiscal  2002,  Headwaters  expects to pay some
level of alternative minimum taxes and a minimal amount of state income taxes in
certain states where net operating loss carryforwards aren't available. However,
because of existing net operating loss carryforwards for federal purposes and in
most states where Headwaters does business, Headwaters does not currently expect
to pay significant  amounts of regular income taxes during fiscal 2001 or fiscal
2002.

Forward Looking Statements

Statements in this Management's  Discussion and Analysis  regarding  Headwaters'
expectations   as  to  the   operation  of  facilities   utilizing   Headwaters'
technologies,  the  marketing  of  products,  the  receipt  of  licensing  fees,
royalties,  and product sales revenues,  the development,  commercialization and
financing of  non-alternative  fuel  technologies  and other strategic  business
opportunities  and acquisitions and other  information  about Headwaters that is
not  purely   historical  by  nature,   including  those  statements   regarding
Headwaters' future business plans, the operation of facilities, the availability
of  feedstocks,  the  marketability  of the  alternative  fuel and the financial
viability of the facilities,  constitute  forward looking  statements within the
meaning  of the  Private  Securities  Litigation  Reform  Act of 1995.  Although
Headwaters  believes that its expectations  are based on reasonable  assumptions
within the bounds of its knowledge of its business and operations,  there can be
no  assurance  that  actual  results  will  not  differ   materially   from  its
expectations.  In addition to matters affecting the alternative fuel industry or
the economy  generally,  factors which could cause actual results to differ from
expectations stated in these forward looking statements  include,  among others,
the following:

(1)      The commercial success of Headwaters' technologies.
(2)      Operating   issues  for   licensed   facilities   including   feedstock
         availability,  moisture content,  Btu content,  correct  application of
         chemical reagent, achieving significant chemical change, operability of
         equipment, production capacity, product durability, resistance to water
         absorption and overall costs of operations.
(3)      Marketing issues relating to market acceptance of products manufactured
         using Headwaters' technologies,  including control of moisture content,
         hardness,  any special handling  requirements and other characteristics
         of the alternative fuel product which affect its  marketability and its
         sales price.
(4)      Securing  of  suitable  facility  sites,   including  permits  and  raw
         materials,  for  relocation  and  operation of  facilities  and product
         sales.
(5)      The  market  acceptance  of  products   manufactured  with  Headwaters'
         technologies in the face of competition from traditional products.

                                       17
<PAGE>

(6)      Dependence on licensees to successfully  implement Headwaters' chemical
         technologies and making license and other payments to Headwaters.
(7)      Maintenance of  placed-in-service  requirements under Section 29 of the
         tax code by alternative fuel manufacturing facilities.
(8)      Changes in governmental  regulations or failure to comply with existing
         regulations  that may  result  in  operational  shutdowns  of  licensee
         facilities.
(9)      The continued  availability  of tax credits to licensees  under the tax
         code and each licensee's ability to use tax credits.
(10)     The commercial feasibility of Headwaters' alternative fuel technologies
         upon the expiration of tax credits.
(11)     Ability  to  meet  financial  commitments  under  existing  contractual
         arrangements.
(12)     Ability to meet  non-financial  commitments under existing  contractual
         arrangements.
(13)     Ability to commercialize the non-alternative fuel chemical technologies
         which have only been  tested in the  laboratory  and not in  full-scale
         operations.
(14)     Ability to  commercialize  the  technology  of others and to  implement
         non-technology  based  business  plans  which are at an early  stage of
         investigation  and investment and which will require  significant time,
         management, and capital investment.
(15)     Success in the face of competition by others producing alternative fuel
         and other products.
(16)     Sufficiency of intellectual property protections.
(17)     Satisfactory resolution of disputes in litigation.

                          PART II -- OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

See "ITEM 3: LEGAL  PROCEEDINGS"  in Headwaters'  Annual Report on Form 10-K for
the year ended September 30, 2000 for descriptions of current legal proceedings.
With respect to all of those matters except  NEICO/Earthco  and Levy, there have
been no  material  changes  since  that  report was filed.  NEICO,  Earthco  and
Headwaters  have  settled  their  disputes and on November 30, 2000 the District
Court  entered an order of dismissal  with  prejudice  as to all  parties.  With
respect to Levy, an additional claimant has been added to the case, as described
in Note 7 to the consolidated financial statements.

ITEM 2.     CHANGES IN SECURITIES AND USE OF PROCEEDS

Recent Sales of Unregistered Securities

Other than the issuance of 5,485 shares of  restricted  common stock issued upon
exercise of options,  there have been no securities  issued by Headwaters within
the past fiscal quarter without  registration  under the Securities Act of 1933,
as amended.  Headwaters has five effective registration statements filed on Form
S-3 and three effective  registration  statements filed on Form S-8. One or more
of these  registration  statements have  registered all of the other  securities
issued  during the  quarter,  which  consisted  solely of the issuance of common
stock upon  exercise  of options,  as  described  in Note 2 to the  consolidated
financial statements.

ITEM 3.     DEFAULTS UPON SENIOR SECURITIES

None.

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

An annual meeting of  stockholders  of Headwaters was held on March 23, 2001 for
the following purposes:

1.       To elect two Class I directors  of  Headwaters  to serve until the 2004
         annual meeting of stockholders; and
2.       To ratify the  selection by the board of  directors of Arthur  Andersen
         LLP as  independent  auditors of Headwaters  for the fiscal year ending
         September 30, 2001.

A total of 18,052,453 shares were voted on both proposals. The results of voting
on these matters were as follows:

1.       To  elect  Mr.  James  A.  Herickhoff  as a  Class  I  director:  for -
         17,644,553; withheld authority - 407,900.
         To elect Mr. John P. Hill, Jr. as a Class I director: for - 15,871,371;
         withheld authority - 2,181,082.
2.       To ratify the  selection of Arthur  Andersen LLP as auditors for fiscal
         2001: for - 18,002,285; against - 30,030; abstain - 20,138.

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<PAGE>

ITEM 5.     OTHER INFORMATION

None.

ITEM 6.     EXHIBITS AND REPORTS ON FORM 8-K

         (a)      The following exhibits are included herein:

         10.13.3  Note Restructure Agreement dated January 26, 2001 among Gerald
                  M. Larson, Larson Holdings, Inc. and Headwaters

         10.13.4  Promissory  Note dated  January  26,  2001  between  Gerald M.
                  Larson as borrower and Headwaters as lender

         10.13.5  Pledge and Security  Agreement  dated January 26, 2001 between
                  Larson  Holdings,  Inc. as pledgor and  Headwaters  as secured
                  party

         10.13.6  Pledge and Security  Agreement  dated January 26, 2001 between
                  Gerald M. Larson as pledgor and Headwaters as secured party

         10.71.2  First  Amendment  to Loan  Agreement  dated  February  1, 2001
                  between Headwaters and Zions First National Bank

         10.71.3  Promissory  Note dated February 1, 2001 between  Headwaters as
                  borrower and Zions First National Bank as lender

         (b)      There  were no reports  filed on Form 8-K  during the  quarter
                  ended March 31, 2001.


                                   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:  April 26, 2001                       By: /s/ Kirk A. Benson
                                                --------------------
                                                Kirk A. Benson, Chief
                                                Executive Officer
                                                and Principal Executive
                                                Officer

Date:  April 26, 2001                       By: /s/ Steven G. Stewart
                                                ---------------------
                                                Steven G. Stewart, Chief
                                                Financial Officer
                                                and Principal Financial
                                                Officer

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