UNITED STATES

                       SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549

                                    FORM 10-K

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

                  For the fiscal year ended September 30, 2000,

                                       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
                       (formerly Covol Technologies, Inc.)

             (Exact name of registrant as specified in its charter)

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

         11778 S. Election Drive, Suite 210
                   Draper, Utah                             84020
     (Address of principal executive offices)             (Zip Code)

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

           Securities registered pursuant to Section 12(b) of the Act:
                                      None

           Securities registered pursuant to Section 12(g) of the Act:
                          Common Stock, $.001 par value

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

         Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]

         The aggregate market value of the voting stock held by non-affiliates
of the registrant as of December 1, 2000 was $57,893,307 based upon the closing
price on the Nasdaq National Market(SM) reported for such date. This calculation
does not reflect a determination that persons whose shares are excluded from the
computation are affiliates for any other purpose.

         The number of shares outstanding of the registrant's common stock as of
December 1, 2000 was 23,391,473.

                           ---------------------------

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the following document are incorporated herein by reference:
Portions of the registrant's definitive proxy statement to be issued in
connection with registrant's annual stockholders' meeting to be held in 2001.

<PAGE>

                                TABLE OF CONTENTS

                                                                           Page
PART I

ITEM 1.    BUSINESS..........................................................3
ITEM 2.    PROPERTIES........................................................9
ITEM 3.    LEGAL PROCEEDINGS................................................10
ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..............11

PART II

ITEM 5.    MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
           STOCKHOLDER MATTERS..............................................11
ITEM 6.    SELECTED FINANCIAL DATA..........................................15
ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
           AND RESULTS OF OPERATIONS........................................16
ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK........22
ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......................22
ITEM 9.    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
           ACCOUNTING AND FINANCIAL DISCLOSURE..............................22

PART III

ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT...............22
ITEM 11.   EXECUTIVE COMPENSATION...........................................23
ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT...23
ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...................23

PART IV

ITEM 14.   EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
           FORM 8-K.........................................................23

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


Forward-Looking Statements

Statements in this Form 10-K, 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 Item 7 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.

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<PAGE>

                                     PART I

ITEM 1.  BUSINESS

The Company

         Headwaters has developed an innovative chemical technology wherein
chemical reagents interact with coal based feedstock to produce an alternative
fuel. Through its existing chemical-based fuels business, Headwaters earns a
stable and growing revenue stream that provides the capital needed to develop
synergistic business opportunities.

         Headwaters was incorporated in Delaware in 1995 under the name Covol
Technologies, Inc. In September 2000, the Company's name was changed to
Headwaters Incorporated. Headwaters' stock trades under the Nasdaq symbol HDWR.

Company History

         Headwaters' technologies are being used to transform coal, coal fines,
coal refuse and other coal derivatives into a special qualified fuel. The
technologies molecularly bind coal derivatives into a formed fuel through a
significant chemical reaction. The resulting product has been classified as a
"qualified fuel" within the meaning of Section 29 of the U.S. Internal Revenue
Code. Sales of the fuel therefore qualify for a significant tax credit. By
licensing its technology to owners of production facilities, Headwaters earns
royalties based upon the sale of qualified fuel. Headwaters also earns revenues
from chemical reagent sales to these producers.

         Although not proven commercially, the Headwaters technologies have
broader potential applications. For example, the technologies can also be used
to transform coke dust into formed coke. Coke, which is processed metallurgical
grade coal, is primarily used in the iron making process as a reducing agent and
also as a fuel source. Coke dust, also known as "coke breeze," is a fine residue
by-product resulting from the production, handling and storage of coke. In
tests, Headwaters has successfully aggregated coke dust into briquettes designed
to withstand the weight, heat and other factors inside of metal making furnaces.

         The Headwaters technologies can also be used to convert iron rich
wastes into usable iron. Mill scale, bag-house dust, furnace sludge, blast
furnace dust and other iron rich materials, are all waste by-products created by
steel producers. These by-products present environmental problems for the steel
industry. Because of their high iron content, they also have high potential
value. Within controlled, small scale laboratory settings, the Headwaters
technologies have been demonstrated to be capable of producing briquettes from
such steel production wastes. Such briquettes can be further processed in metal
reducing furnaces to form high grade pig iron, a common form of feed material
used in the steel industry.

         Additional fuel or resource by-products to which the Headwaters
technologies appear applicable after initial testing include: molybdenum,
silicon carbide, grinding swarf, lead dross, zinc oxide, titanium dioxide,
phosphorous, and charcoal. Briquettes containing these by-products appear
potentially marketable to ferrous and non-ferrous metals producers and to other
industrial consumers.

         Except for alternative fuel production, the Headwaters technologies
described above have not been commercially applied. No assurance can be given
that Headwaters will be able to implement these applications profitably or that
the development of these alternative applications will be the most profitable
use of Headwaters' limited financial and managerial resources.

Current and Future Business Strategy

         Headwaters intends to grow its business by increasing chemical reagent
sales and maximizing royalty income. The growth of alternative fuel production
and sales by licensees results in increased royalty payments and increased
chemical sales for Headwaters. Headwaters hopes to diversify its operations in
related businesses, building on its core competencies in specialty chemicals,
energy, and in resource recovery.

                                       3
<PAGE>

         For the past four years, Headwaters' business strategy has been focused
almost exclusively upon alternative fuels from coal derivatives. There are 28
facilities owned by unaffiliated third parties located in nine states that are
licensed to use Headwaters' alternative fuel technology.

         Headwaters and its licensees are in the process of increasing
production levels and product sales. An industry report estimates that the
optimum potential production level for the Headwaters' alternative fuels
technology is 23,000,000 tons per year. Licensees' reports of alternative fuel
sales for the quarter ended September 30, 2000 yield annualized sales of
approximately 9,800,000 tons. Headwaters is working with its licensees to
optimize production levels and quality though laboratory testing and field work.
These efforts result in improved Headwaters products, services and techniques.
Feedstock supply, production, product quality and the marketing of the
alternative fuel all directly affect the amount and timing of royalties to be
received by Headwaters. Accordingly, assisting licensees to optimize the
production from these facilities is one of Headwaters' highest priorities.

         Headwaters has received one-time initial license fees with respect to
most of the facilities. These initial license fees are being amortized into
revenue over the life of the license agreements. Future revenues related to such
facilities are expected to come from royalties earned from Headwaters'
licensees' ongoing production and sale of alternative fuel pursuant to existing
licensing agreements.

          Headwaters also expects to generate significant revenues from future
sales of chemical reagent materials. Headwaters hopes to increase sales of its
chemical materials, first, by increased purchases by licensees as alternative
fuel production increases, and second, by marketing these chemicals to existing
non-licensee facility owners that have not used the Headwaters chemical reagent
materials before.

         Headwaters has a contract to operate one alternative fuel facility
located in Pennsylvania. This operation provides Headwaters with manufacturing
experience to add to its ongoing laboratory experience. Headwaters also receives
a small operating fee for these services.

         Strategic Acquisitions. Headwaters believes that it may have unique
opportunities to pursue acquisitions that are synergistic with Headwaters'
financial and operational objectives. Headwaters intends to pursue possible
acquisitions of complementary businesses aligned to the chemical, mineral, or
energy industries in which Headwaters does business. If suitable candidates are
not found in these industries, Headwaters intends to pursue possible acquisition
candidates in other fragmented, growing industries where promising financial
returns exist.

         Emerging Business Investments. Headwaters has made some limited
investments in emerging businesses. These investments are in the form of secured
loans and equity purchases. As of December 1, 2000, Headwaters and its
wholly-owned subsidiary, Kwai Financial, Inc., have loaned or committed to loan
approximately $4.1 million to nine businesses. Kwai Financial normally
participates with other lenders in bridge loans with terms of approximately 120
to 180 days until equity financing is obtained, at which time the bridge loans
are repaid.

         As of December 1, 2000, Headwaters has also invested approximately $5
million to purchase minority equity interests in five emerging businesses.
Headwaters' goal is to maximize the return on these investments and identify a
liquidity event for the equity investment. Headwaters does not intend to
increase the funds committed to these investment types in the future.

Alternative Fuel Tax Credits

         Headwaters' technology royalties and chemical reagent sales ultimately
derive from each licensee's ability to manufacture and sell qualified fuels that
generate tax credits for the facility owner. Section 29 of the U.S. Internal
Revenue Code provides for a credit against regular federal income tax with
respect to sales of qualified fuel to an unrelated party. The Section 29 credit
equates to approximately $20.00-$28.00 per ton of alternative fuel, depending
upon the recoverable heat content.

         In order to qualify as "solid synthetic fuels produced from coal" for
purposes of the Section 29 credit, the fuel produced must differ significantly
in chemical composition, as opposed to physical composition, from the raw
material used to produce it. In September 1995 Headwaters received a Private
Letter Ruling, or PLR, from the IRS in which the IRS, based on representations
made to it by Headwaters, ruled that the alternative fuel technology produces a
significant chemical change compared to the parent feedstocks and this qualifies
the end product as a solid synthetic fuel.

                                       4
<PAGE>

         Because Headwaters currently does not sell fuel from an alternative
fuel facility, Headwaters does not claim Section 29 tax credits. However,
licensees of Headwaters' alternative fuel technology do claim Section 29 tax
credits. At least 11 PLRs covering 17 alternative fuel facilities have been
obtained by third parties in connection with licenses of Headwaters' alternative
fuel technology. All PLRs are only binding with respect to the specific projects
addressed in the PLR and may only be relied on by the party that obtained the
PLR. Also, in its rulings to licensees the IRS notes that no temporary or final
regulations pertaining to one or more of the issues addressed in the PLRs have
been adopted and that the PLRs would be modified or revoked by the adoption of
temporary or final regulations to the extent the regulations are inconsistent
with any conclusions in the PLRs. The IRS notes, however, that a PLR is not
revoked or modified retroactively, except in rare and unusual circumstances,
provided that:

*        there has been no misstatement or omission of material facts,

*        the facts at the time of the transaction  are not materially  different
         from the facts on which the PLR was based,

*        there has been no change in the applicable law,

*        the PLR was originally issued for a proposed transaction and

*        the  taxpayer  directly  involved  in the PLR  acted  in good  faith in
         relying on the PLR, and revoking the PLR retroactively  would be to the
         taxpayer's detriment.

         The Section 29 credit is subject to a phase out after the unregulated
oil price reaches specified levels under an annually adjusted formula. The
credit would begin to phase out if the reference price for oil exceeds
approximately $48.00 per barrel. The credit is also subject to reduction insofar
as an otherwise qualifying facility benefits from grants or subsidized financing
provided by federal, state or local governments, or from tax-exempt bond
financing.

         Section 29 of the tax code contains no provision for carryback or
carryforward of Section 29 credits. Once earned, the credits are not subject to
subsequent recapture. By virtue of the various limitations and other factors
described above, there can be no assurances that any particular amount of
Section 29 credit will be allowable and usable. The alternative fuel facilities
must have been constructed pursuant to a binding written contract in effect as
of December 31, 1996, and placed in service before July 1, 1998. The Section 29
credit will, under present law, be available for sales of qualified fuels
completed before January 1, 2008.

         Because of the significance of the Section 29 tax credit, constituents
have communicated with their congressional representatives about the benefits
and burdens of the credit. Congress continues to periodically entertain
legislation to further extend Section 29 deadlines particularly in times of
heightened energy dependence awareness. However, the Department of the Treasury
and the IRS have ongoing oversight programs and are currently reviewing taxpayer
use of the credit for possible abuses, including whether there should be
restrictions on the availability of credits.

Licensees

         Headwaters derives most of its revenue from the owners of alternative
fuel facilities who have licensed Headwaters' technology and who purchase
chemical reagent from Headwaters.

         In total, Headwaters has licensed or constructed plants using the
Headwaters technologies at 24 alternative fuel facilities that operate at
various locations in the primary coal supply regions of the United States. For
all facilities, the construction agreements were entered into prior to December
31, 1996. In some instances, Headwaters entered into a construction contract
that was either fulfilled by Headwaters or later assigned to a licensee. In
certain instances, the licensees entered into their own construction contracts.

         License and Chemical Supply Agreements. All entities that have
constructed or own facilities using the Headwaters technologies have entered
into a technology license and chemical reagent supply agreement with Headwaters.
Many license agreements provided for an initial license fee, payable upon
reaching project milestones.

                                       5
<PAGE>

Headwaters has received most of the initial license fees related to these
facilities, which amounts are being amortized into revenue by Headwaters over
the life of the license agreements. In addition, pursuant to many of the license
agreements, the licensee pays a quarterly earned license fee generally at a
prescribed dollar amount or a percentage of the tax credits earned by the
licensee. In some cases, the amount to be paid is subject to adjustment to the
extent that licensees incur operating losses on the production and sale of
alternative fuel, exclusive of the amount licensees pay as a license fee for the
use of the technology. The fees paid to Headwaters under the license agreements
are not based on the sales price of the alternative fuel product but rather the
tax credits earned. The license agreements generally have a term continuing
through the later of January 1, 2008 or the corresponding date after which tax
credits may not be claimed or are not otherwise available under Section 29 of
the tax code.

         Headwaters has also agreed, pursuant to chemical supply agreements, to
provide chemical reagent to licensees for the manufacture and production of
alternative fuel. The price for the chemical sold to the licensees falls into
two categories: a fixed price, or an amount equal to Headwaters' cost plus a
prescribed mark-up.

         The chemical reagent is currently manufactured by Dow Chemical
Corporation for Headwaters utilizing Headwaters' patented and proprietary
technology. Headwaters does not inventory any chemical material but instead
arranges with Dow for shipping of the chemical reagent directly to the
facilities.

         Major Licensees. Approximately 15% of revenues in 1998, 15% of revenues
in 1999 and 34% of revenues in 2000 were from PacifiCorp affiliated licensees;
approximately 21% of revenues in 1998, 40% of revenues in 1999 and 7% of
revenues in 2000 were from a Fluor Corporation affiliated licensee; and 21% of
revenues in 1998, 13% of revenues in 1999 and 6% of revenues in 2000 were from
Pace Carbon Fuels, L.L.C. affiliated licensees. Also, in 2000 approximately 27%
of revenues were from DTE Energy Services, Inc. affiliated licensees and 19% of
revenues were from TECO Coal Corporation affiliated licensees, most of which
related to non-recurring gains on sales of facilities. No other single customer
accounted for over ten percent of total revenues in the years presented.

         Licensees' Coal Feedstock. The alternative fuel facilities use coal,
coal refuse, and coal fines as the primary feedstocks to produce alternative
fuel. Licensees secure their own supply of coal feedstocks. Many licensees that
are also coal producers utilize their own feedstock sources. Nonproducer
licensees purchase coal feedstocks to supply their facilities. While a supply of
coal derivatives is essential to the feasibility of an alternative fuel
facility, such feedstocks are available for purchase by licensees.

         Supply of Chemicals. Headwaters purchases its patented and proprietary
chemical reagent from Dow Chemical Company under an agreement through 2007 under
which Headwaters pays a prescribed price per pound of chemical. Headwaters
arranges with Dow for the delivery of the chemical reagent from Dow's
manufacturing plants directly to each of the alternative fuel facilities
licensed by Headwaters.

Sale of Facilities

         Headwaters has constructed and sold six alternative fuel facilities.
The following summarizes each sale:

         Utah Synfuel #1. In March 1997, Utah Synfuel #1 Ltd., a Delaware
limited partnership in which Headwaters was at the time a 64% owner and general
partner, sold the Utah alternative fuel facility to Coaltech No. 1, L.P. for
$3.5 million payable in 44 quarterly installments, all in accordance with the
Utah Project Purchase Agreement among Headwaters, Utah Synfuel #1 and Coaltech.
In June 2000, Headwaters and Coaltech negotiated a termination of the Utah
Project Purchase Agreement and a new licensee and chemical reagent purchase
agreement calling for payment to Headwaters of a specified percentage of the
ongoing net benefits received by the Coaltech partners.

         Alabama Synfuel #1. Alabama Synfuel #1 Ltd., a Delaware limited
partnership in which Headwaters was at the time a 74% owner and general partner,
sold its facility to Birmingham Syn Fuel, L.L.C., a wholly-owned subsidiary of
PacifiCorp Financial Services, Inc. in March 1998. The purchase price for the
Birmingport facility was $6,500,000 payable in the form of a nonrecourse
promissory note collateralized by certain portions of the Birmingport facility.
In May 2000 Headwaters and Birmingham Syn Fuel negotiated a termination of the
purchase transaction documents and replaced them with a reduced interest but
otherwise substantially similar amended and restated $6,500,000 note. At the
same time, Headwaters, Birmingham Syn Fuel and PacifiCorp negotiated four new
license and chemical reagent purchase agreements calling for payment to
Headwaters of specified ongoing royalties and chemical reagent sales.

                                       6
<PAGE>

         River Hill. Headwaters and its subsidiaries, Commonwealth Synfuel,
L.L.C. and Synfuel Investments, Inc., sold the River Hill facility to DTE River
Hill L.L.C., an affiliate of DTE Energy Services, Inc., in August 1999. The
purchase price for the River Hill facility consisted of a cash payment to
Headwaters of $1,250,000, assumption of $5,000,000 of facility debt, completion
of capital improvements to the facility and an eight-year royalty arrangement
with both Headwaters and the construction lender, plus contingent payments based
upon facility production performance. Headwaters subsequently received all
production performance payments. Headwaters also entered into a license and
chemical reagent supply agreement which calls for ongoing royalties and chemical
reagent sales.

         Carbon Synfuel. Headwaters and its subsidiaries, Carbon Synfuel, L.L.C.
and Synfuel Investments, Inc., sold the Carbon Synfuel facility for $10 million
cash to DTE Kentucky, LLC, an affiliate of DTE Energy Services, Inc., in
December 1999. Headwaters also entered into a license and chemical reagent
supply agreement which calls for ongoing royalties and chemical reagent sales.

         Pocahontas Synfuel. Headwaters and its subsidiaries Pocahontas Synfuel,
L.L.C. and Synfuel Investments, Inc. sold the Pocahontas Synfuel facility for $8
million cash and an additional net payment of $2.5 million contingent upon the
buyer's placing the facility into commercial operation at a new site to Premier
Elkhorn Coal Company, an affiliate of TECO Coal Corporation in January 2000.
Headwaters subsequently received the contingent payment. Headwaters also entered
into a license and chemical reagent supply agreement which calls for ongoing
royalties and chemical reagent sales.

         Mountaineer Fuels. Headwaters and its subsidiaries Mountaineer Fuels,
L.L.C. and Synfuel Investments, Inc. sold the Mountaineer Fuels facility for
$9.7 million cash and an additional $300,000 payment contingent upon successful
reassembly at the owner's new site to DTE Kentucky, LLC, an affiliate of DTE
Energy Services, Inc., in April 2000. Headwaters also entered into a license and
chemical reagent supply agreement which calls for ongoing royalties and chemical
reagent sales.

Proprietary Protection

         Trademarks and Service Marks:

         United States Trademark Registration No. 2,038,742 issued February 18,
         1997 for mark "Covol."

         United States Trademark/Service Mark Application No. 78/018,501 filed
         July 26, 2000 for mark "Headwaters."

         Patents. Headwaters has eight U.S. patents that expire on January 21,
2014 and one U.S. patent that expires on August 9, 2011. There can be no
assurance as to the scope of protection afforded by the patents. In addition,
there are other technologies in use and others may subsequently be developed,
which do not, or will not utilize processes covered by the patents. There can be
no assurance that Headwaters' patents will not be infringed or challenged by
other parties, that Headwaters will not infringe on patents held by other
parties or that Headwaters will have the resources to enforce any proprietary
protection afforded by the patent or defend against an infringement claim.

         In addition to patent protection, Headwaters also relies on trade
secrets, know-how and confidentiality agreements to protect the Headwaters
technologies. However, such methods may not afford complete protection and there
can be no assurance that others will not independently develop such know-how or
obtain access to Headwaters' know-how, concepts, ideas, and documentation.

         Since Headwaters' proprietary information is important to its business,
failure to protect ownership of its proprietary information would likely have a
material adverse effect on Headwaters. Headwaters' current and expected revenues
are dependent upon license agreements by which licensees use the Headwaters
technologies to manufacture alternative fuel and then pay license fees to
Headwaters. Headwaters believes that its patents, trade secrets, know-how and
confidential information are the basis upon which Headwaters is able to obtain
licensing agreements.

                                       7
<PAGE>

Government Regulation

         Headwaters' and its licensees' alternative fuel operations are subject
to federal, state and local environmental regulations that impose limitations on
the discharge of pollutants into the air and water and establish standards for
the treatment, storage and disposal of waste products. In order to establish and
operate the alternative fuel plants, Headwaters and its licensees obtained
various state and local permits. Headwaters believes that it or its licensees
obtained all required permits to construct and operate alternative fuel
facilities, and that they are in substantial compliance with all relevant laws
and regulations governing the alternative fuel operations.

         Compliance with permits, regulations, and the approved processes helps
protect against pollution or contamination. Acid is the only stored raw material
used in the approved process that is classified as hazardous. Still the
possibility exists that regulatory noncompliance or accidental discharges, in
spite of safeguards, could create an environmental liability. Therefore,
Headwaters' and its licensees' alternative fuel operations entail risk of
environmental damage and Headwaters or its licensees may incur liabilities in
the future arising from the discharge of pollutants into the environment or from
waste disposal practices.

         Failure by Headwaters or its licensees to maintain necessary permits to
operate alternative fuel plants and to comply with permit requirements could
have a material adverse effect on Headwaters or its licensees. Other
developments, such as the enactment of more stringent environmental laws and
regulations, could require Headwaters or its licensees to incur significant
capital expenditures. If Headwaters or its licensees do not have the financial
resources or are otherwise unable to comply with such laws and regulations, or
if compliance substantially increases production costs, these results could also
have a material adverse effect on Headwaters.

         Headwaters' goal is to establish itself as the provider of technologies
that will assist others in the processing and reclamation of their wastes and
by-products, and Headwaters seeks for itself and its licensees to avoid creating
waste streams or compounding environmental reclamation problems. However, the
alternative fuel manufacturing process using Headwaters' technologies typically
uses dilute acids. Headwaters and its licensees must comply with hazardous
material handling and storage regulations related to acid solutions and stored
concentrates.

         Headwaters' and its licensees' alternative fuel operations are also
subject to federal and state safety and health standards. Headwaters is
committed to providing effective management of worker safety and health
protection. In addition, Headwaters has developed a safety policy designed to
raise and maintain safety awareness by both management and employees. Failure to
comply with safety and health standards could have a material adverse affect on
Headwaters. For example, a regulatory inspector could close the operation until
a licensee meets the required standards.

Competition

         Alternative fuels made using the Headwaters technologies compete with
other alternative fuel products as well as traditional fuels. Competitive
factors include price, quality, delivery cost and handling costs. Headwaters may
experience competition from other alternative fuel technology companies and
their licensees, particularly those companies with technologies to produce coal
based solid alternative fuels. Competition may come in the form of the licensing
of the competing technologies to process coal derivatives, marketing of
competitive chemical reagents or in the marketing of end products qualifying as
synthetic fuel. Competition includes, for example, Startec in the project
development business and Nalco Chemical Company in the chemical reagent sales
business. Headwaters will also experience competition from traditional coal and
fuel suppliers and natural resource producers in addition to those companies
that specialize in the recycling of waste products generated by coal, coke,
steel and other resource production. Many of these companies have greater
financial, management and other resources than Headwaters. Headwaters believes
that it will be able to compete effectively although there can be no assurance
that it will do so successfully.

                                       8
<PAGE>

Employees

         Headwaters and its subsidiaries currently employ 51 persons full-time.
Of these employees, 35 are in alternative fuel operations and technical support
services and 16 are in corporate administration and miscellaneous operations and
project development. None of these employees are covered by a collective
bargaining agreement.

Forward Looking Statements

         Statements in this Annual Report on Form 10-K 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 tax credits, 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. For a discussion of
the factors that could cause actual results to differ from expectations, please
see the caption entitled "Forward Looking Statements" in Item 7.

ITEM 2.       PROPERTIES

         Headwaters leased in October 2000 for a five year term approximately
7,000 square-feet of office space in Draper, Utah, which houses its executive
offices. The lease provides for a monthly rent of approximately $8,000 with
certain adjustments for inflation plus expenses.

         In October 1997, Headwaters purchased for $150,000 an 8,000 square-foot
site located in Price, Utah, on which Headwaters' prototype plant is located.
Included in the purchase was a 1,400 square-foot office and warehouse building
which houses equipment. The property is subject to a 10-year $100,000 mortgage
held by the seller. Headwaters has been leasing the property and is also
considering selling the property.

         In June 1996, Headwaters entered into a land lease of approximately 12
acres in Price, Utah with a current monthly rental of $600. The lease term
commenced on June 20, 1996 and expires on December 31, 2007 but may be extended.
In 1996, Headwaters constructed a 22,000 square-foot building to house a synfuel
facility. In March 1997, this building was subleased by Headwaters to Coaltech
as part of the sale of the Utah Synfuel #1 facility. Headwaters has also
constructed a 1,650 square-foot chemical mixing plant, on the property.

         In February 1997, Headwaters entered into a lease agreement with
Earthco for two contiguous parcels located in Wellington, Utah. On one 30 acre
parcel, Headwaters constructed a 3,400 square-foot wash plant. The second parcel
covers approximately 357 acres to be used as a fines recovery operation. In
September 2000, Headwaters agreed to terminate the lease agreement with Earthco
which has relinquished its rights in the property to Nevada Electric Investment
Company ("NEICO") as a part of a settlement. At the same time, Headwaters leased
the first parcel from NEICO and entered into a sublease with a third party that
wishes to use the wash plant. The lease and sublease are each for a concurrent
one year term, with the sublessee performing all of Headwaters' lease
obligations to NEICO. The sublessee has an option to purchase the wash plant at
the end of the one year sublease.

         In 1997, Headwaters entered into a five-year, $850 per month sublease
with Combustion Resources, Inc. for approximately 2,400 square feet of office
and laboratory space in Provo, Utah. Headwaters is currently renegotiating this
lease.

         In May 1998, Headwaters purchased approximately 80 acres of undeveloped
property near Sunnyside, Utah for $100,000. In June 1998, Headwaters entered
into a five-year lease with an option to purchase approximately 40 acres of
property with office and warehouse improvements. The lease payments are $2,500
per month, escalating to $3,500 per month over time. The leased property is
adjacent to the purchased property.

         None of Headwaters' subsidiaries have significant interests in real
property.

                                       9
<PAGE>

ITEM 3.  LEGAL PROCEEDINGS

         Headwaters has ongoing litigation that it incurs in the normal course
of business including the items discussed herein. Headwaters intends to
vigorously defend and/or pursue it's rights in these actions. Headwaters does
not currently believe that the outcome of these actions will have a material
adverse effect on the Company's financial position.

         NEICO/Earthco. In February 1997, Headwaters entered into a contract on
a parcel of real property located near Price, Utah, in which Headwaters obtained
certain possessory and related interests, Headwaters' primary purpose being to
obtain a source of coal fines to serve as feedstock for a nearby alternative
fuel facility. In August 1999, Headwaters alleged that Earthco had breached a
material provision of the contract because Earthco did not have title to the
property. Headwaters refused to tender its August 1999 payment because of
Earthco's breach. In addition, Headwaters contended that the quantity and/or
quality of recoverable coal fines was substantially less than what Headwaters
had understood. Earthco subsequently countered with allegations that Headwaters
had breached its obligations under the contract, including failure to make the
August 1999 payment.

         In November 1999, Headwaters was served with a complaint from the
Seventh Judicial District Court of Carbon County, Utah styled Nevada Electric
Investment Company v. Earthco, et al. In the complaint, Nevada Electric
Investment Company ("NEICO") alleged that it is the lawful owner of the property
near Wellington, Utah described in Headwaters' lease from Earthco. NEICO sought
a declaratory judgement that Headwaters is not entitled to possession of the
property due to the lack of ownership by Earthco. The complaint also sought
further relief from Earthco.

         Headwaters received Earthco's answer, counterclaims and cross-claim in
December 1999. Earthco's cross-claim against Headwaters alleged breach of
contract and prayed for substantial damages in an amount to be proven at trial
but alleged to be in excess of $5 million. Headwaters filed its reply and
cross-claim against Earthco in January 2000 denying Earthco's claims and
asserting claims of misrepresentation, breach of lease, unjust enrichment, and
related claims and for general and consequential damages in an amount to be
proven at trial.

         NEICO, Earthco and Headwaters have settled their disputes. Earthco and
Headwaters entered into a mutual release of claims. Earthco confirmed title to
the property in NEICO. In September 2000, Headwaters entered into a one-year
lease for the wash plant parcel directly with NEICO and otherwise confirmed
title to the property in NEICO. The parties are awaiting an order of dismissal
from the court.

         K-Lee Processing. In March 1997, Headwaters entered into an Amended and
Restated Supply Agreement for the purchase of coal fines from K-Lee Processing,
Inc. and Concord Coal Recovery Limited Partnership (together "K-Lee").
Headwaters periodically purchased coal fines from K-Lee throughout 1997. K-Lee
invoiced Headwaters for a total of 108,000 tons of fines and Headwaters paid for
those fines. However, K-Lee failed to deliver 11,059 tons valued at $320,716.
K-Lee has refused to refund the overpayment for non-delivered fines. In July
2000 Headwaters filed a complaint against K-Lee Processing, Inc. and Concord
Coal Recovery Limited Partnership in the United States District Court for the
Northern District of Alabama seeking damages in the amount of $320,716 for the
coal fines purchased but not delivered. 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.

         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. (This technology is distinct from the
technology developed by Headwaters.) 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,
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.

                                       10
<PAGE>

         Levy. 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 the action, a
purported shareholder of Headwaters alleges 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 complaint seeks on behalf of Headwaters from OZ unspecified money damages to
be proven at trial, attorney fees, and other relief. 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.

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

         A special meeting of stockholders was held on September 6, 2000.
Reference is made to Headwaters' Form 8-K filed September 19, 2000 for a
description of the matters voted on and the results of the voting.

                                     PART II

ITEM 5.       MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER

              MATTERS

     The shares of common stock of Headwaters trade on the Nasdaq Stock
Market(SM) under the symbol "HDWR." The following table sets forth, for the
periods presented, the high and low trading prices of Headwaters' common stock
as reported by Nasdaq. The following prices may not be considered valid
indications of market value due to the limited and sporadic trading in the
shares of common stock during certain periods.

                                       11
<PAGE>

Fiscal 1999                                            Low          High
-----------                                            ---          ----
Quarter ended December 31, 1998                       $4.25         $9.38
Quarter ended March 31, 1999                           4.13          8.13
Quarter ended June 30, 1999                            3.25          7.00
Quarter ended September 30, 1999                       2.50          6.06

Fiscal 2000
-----------
Quarter ended December 31, 1999                       $0.50         $3.25
Quarter ended March 31, 2000                           0.78          2.31
Quarter ended June 30, 2000                            1.25          2.13
Quarter ended September 30, 2000                       2.06          4.75


         As of December 1, 2000, there were approximately 547 stockholders of
record of Headwaters' common stock.

         Headwaters has not paid dividends on its common stock to date and does
not intend to pay dividends on its common stock in the foreseeable future.
Headwaters intends to retain earnings to finance the development and expansion
of its business. Payment of common stock dividends in the future will depend,
among other things, upon Headwaters' ability to generate earnings, its need for
capital, investment opportunities and its overall financial condition.

Recent Sales of Unregistered Securities

         The following sets forth all securities issued by Headwaters within the
past three years without registration under the Securities Act of 1933, as
amended. No underwriters were involved in any stock issuances nor were any
commissions paid in connection therewith. However, Headwaters did pay finders
fees in the form of cash, stock or warrants in connection with various
securities issuances.

         Headwaters believes that the following issuances of shares of common
stock, notes, debentures and other securities were exempt from the registration
requirements of the Securities Act of 1933, as amended, pursuant to the
exemption set forth in Section 4(2) thereof. Each security was issued subject to
transfer restrictions. Each certificate for each security bears a restricted
legend. Each investor made representations to Headwaters that it was accredited
as that term is defined in Regulation D and that the security was acquired for
investment purposes. However, Headwaters has effective five registration
statements filed on Form S-3. These registration statements have registered many
of the securities described in this section.

         In 1996, Headwaters formed two limited partnerships, Alabama Synfuel #1
Ltd. and Utah Synfuel #1 Ltd., to assist with the financing of construction at
two alternative fuel facilities. These two facilities have been sold and are now
owned by Birmingham Syn Fuel, L.L.C. and Coaltech No. 1 L.P. On September 9,
1998, Headwaters offered the limited partners in Utah Synfuel #1 and Alabama
Synfuel #1 an exchange of Headwaters' common stock for their limited partnership
interests. The exchange ratio was based in part on an independent valuation of
the limited partnerships' assets and other factors including but not limited to
current and future expected cash flow of the partnerships and current market
values of Headwaters' common stock as quoted on NASDAQ. The exchange ratio for
Utah Synfuel #1 was 112.828 shares of common stock for each limited partnership
unit and for Alabama Synfuel #1 was 125.97 shares for each limited partnership
unit. The limited partnerships' units originally sold for $1,000 per unit.

         As of November 10, 1998, all of the limited partners in Utah Synfuel #1
and all but one of the limited partners in Alabama Synfuel #1 had agreed to
exchange their limited partnership interests for shares of Headwaters' common
stock, and accordingly Utah Synfuel #1 became a wholly-owned subsidiary of
Headwaters. In November 1999, the last limited partner in Alabama Synfuel #1
exchanged its limited partnership interest as a part of a licensing agreement so
that Alabama Synfuel #1 also became a wholly-owned subsidiary of Headwaters.

         During November 1998, Headwaters completed a financing transaction that
consisted of $400,000 of debt and approximately $3,500,000 of equity issued to
28 investors. The debt, which had a twelve-month term, has been

                                       12
<PAGE>

repaid. The equity transaction consisted of the sale of a unit at a price of
$5.00. A unit consisted of one share of restricted common stock of Headwaters
plus a warrant to purchase one additional share of restricted common stock at an
exercise price of $7.50. The warrants expired on June 30, 2000 if not exercised.
However, during 2000 the exercise period for the purchase of approximately
183,000 of these warrant shares was extended for approximately seven months. The
stock and shares issuable pursuant to the related warrants bear "piggyback"
registration rights.

         During January 1999, Headwaters completed a financing transaction with
a major shareholder and lender to Headwaters, that consisted of the sale of
1,000 shares of a new series of non-voting preferred stock, designated as Series
C 7% Convertible Preferred Stock. Headwaters received approximately $900,000 in
net proceeds from the issuance of this preferred stock, which had the following
rights and privileges:

*        Dividends on the preferred stock were cumulative and accrued whether or
         not they had been declared or whether Headwaters had any profits. The
         dividend rate was 7% per year of the liquidation value of $1,000 per
         share.

*        The preferred stock was convertible into common shares in incremental
         stages beginning April 1999 through July 1999, at which time all of the
         outstanding shares became convertible to common stock. The number of
         common shares to be received upon conversion was determined by
         multiplying the number of preferred shares by $1,000 and dividing that
         number by the conversion price (originally $5.50 per share, subject to
         market adjustment). Upon conversion, all accrued and unpaid dividends
         were to be paid or converted into shares of common stock.

*        Headwaters had the option to redeem the outstanding preferred stock
         beginning July 1999 for a redemption price equal to 125% of the
         liquidation value plus any accrued and unpaid dividends thereon.

         Warrants for the purchase of 72,727 shares of common stock were issued
in conjunction with this preferred stock. The warrants are exercisable from
April 1999 through July 2001 at an exercise price of $6.88 per share. The
exercise deadline for certain other warrants with an exercise price of $7.00 per
share held by the shareholder were extended to June 2000 and certain additional
warrants with an exercise price of $30.00 per share were relinquished and
canceled. Headwaters granted registration rights for the restricted common
shares issuable upon conversion of the preferred stock or upon exercise of the
common stock warrants.

         During January 2000, all of the remaining shares of Series C preferred
stock were converted. Approximately 237,000 shares of common stock were issued
on conversion of the preferred stock and related accrued but unpaid dividends.
There are no outstanding shares of Series C preferred stock.

         On March 17, 1999, Headwaters completed a financing transaction with a
large investment fund. The financing consisted of the issuance of $20,000,000
face value of convertible secured debt, issued at a 50% discount, and the
issuance of 60,000 shares of cumulative convertible preferred stock (Series D)
for $6,000,000, for total gross proceeds of $16,000,000. Warrants for the
purchase of common stock were also issued as part of the financing and were
valued at approximately $3,000,000. Net cash proceeds were used to retire
maturing short-term debt and related accrued interest, for working capital and
other general corporate purposes. This transaction is described in detail in the
Form 8-K filed March 24, 1999 and in the Form 10-Q/A for the quarterly period
ended March 31, 1999. Beginning in November 1999 and through March 2000,
Headwaters issued approximately 2,632,000 shares of common stock on conversion
of 24,369 shares of Series D preferred stock. The preferred stock was
convertible at $5.00 or 90% of market, whichever was less. By May 2000,
Headwaters had redeemed all of the investment fund's $20,000,000 face value
convertible debt and incurred early prepayment costs of approximately
$6,037,000. By March 2000, Headwaters had redeemed the investment fund's
35,631remaining Series D preferred shares for $4,454,000 including a redemption
premium of approximately $1,882,000. There are no outstanding shares of Series D
preferred stock.

         In September 1999, Headwaters entered into a transaction with an
affiliate of a major shareholder and lender to Headwaters, to provide financing
of up to $4,000,000 in the form of convertible secured debt. Headwaters received
$850,000 at the time of closing, less a placement fee of 10%, and subsequent to
September 30, 1999 received a total of $1,650,000, less a placement fee of 10%.
The debt was convertible at $3.00 per share, or market, whichever is less, and
was convertible at the rate of 25% every 30 days beginning 30 days from the date
of closing, subject to certain restrictions. Headwaters could redeem all
outstanding debt at a rate of 125% of face value by providing 30 days notice.
Borrowings were due in March 2001, if not converted earlier, and interest
payments were

                                       13
<PAGE>

due quarterly beginning December 1999. Headwaters assigned the royalties to be
received from a licensed alternative fuel facility as collateral for the
financing. In November and December 1999, approximately 2,532,000 shares of
common stock were issued on conversion of $1,280,000 of the convertible debt. In
January 2000, Headwaters redeemed all of the remaining convertible debt for
redemption consideration of approximately $1,300,000 plus 8,565 shares of common
stock.

         The agreement required the issuance of warrants to purchase Headwaters
shares equal to 40% of the shares issuable under any borrowings under this
financing arrangement. The warrants have a three-year exercise period and an
exercise price of $3.60 per share. Warrants for the purchase of a total of
approximately 350,000 shares of common stock were issued.

         In December 1999, Headwaters placed $1,500,000 of financing less a 10%
placement fee with an investor rather than drawing the entire $4,000,000 of
funding as provided under the September financing arrangement. The terms and
conditions of this financing were similar to the September financing. The debt
was convertible at $0.73 per share, the market price at closing, or market price
on the conversion date, whichever was less. In January 2000, Headwaters redeemed
all of this convertible debt for redemption consideration of approximately
1,900,000 plus 205,435 shares of common stock.

         The agreement required the issuance of warrants to purchase Headwaters
shares equal to 40% of the shares issuable under the debt agreement. Warrants
for the purchase of approximately 923,000 shares were issued. The warrants have
a three-year exercise period and an exercise price of $0.88 per share.

         In March 2000, Headwaters completed a private placement financing
transaction by selling to 49 investors approximately 3,629,000 shares of
restricted Headwaters common stock, $0.001 par value, at a price of $1.36 per
share, yielding to Headwaters $4,666,000, net of $270,000 in placement costs.
The investors received registration rights for the stock purchased.

         In April 2000, Headwaters completed a private placement financing
transaction by selling to one of its directors and three officers a total of
approximately 379,000 shares of restricted Headwaters common stock, $0.001 par
value, at a price of $1.56 per share and warrants for the purchase of
approximately 133,000 shares of common stock, for net cash proceeds to
Headwaters of approximately $588,000. The warrants are exercisable through March
2005 at a price of $1.56 per share. The investors received registration rights
for the stock purchased and the warrant shares.

         In April 2000, an investor acquired from a third party a Headwaters'
14% note due in April 2000 with an approximate $3,000,000 balance and at the
same time also acquired from the third party warrants to purchase 100,000 shares
of Headwaters' common stock. Headwaters and the investor agreed to extend for
one year the repayment date for $1,000,000 of the principal amount of the note.
Headwaters and the investor further agreed to the satisfaction of $2,000,000 of
the note in exchange for 1,185,818 shares of Headwaters restricted common stock,
$0.001 par value, and warrants to purchase 296,000 shares of Headwaters' common
stock. The warrants are exercisable through April 2005 at a price of $2.10 per
share. In July 2000, Headwaters repaid the $1,000,000 note balance which was
accruing interest at 14%. A director of Headwaters is a manager and 2.5% owner
of the investor. The director disclaims any beneficial interest in the
investor's securities in Headwaters.

                                       14
<PAGE>

ITEM 6.  SELECTED FINANCIAL DATA

         The following selected financial data are derived from the consolidated
financial statements of Headwaters. This information should be read in
conjunction with the consolidated financial statements, related notes and other
financial information included herein. In 1996, Headwaters sold its construction
subsidiaries. All construction - related operations were reflected as
discontinued operations in the 1996 financial statements. The note receivable
received by Headwaters as consideration for the sale is "marked to market" each
quarter based on the market value of Headwaters' stock held as collateral, and
the resulting adjustments are reflected in Headwaters' statement of operations.
As more fully described in Notes 14 and 15 to the consolidated financial
statements, in 1998, 1999 and 2000, Headwaters recorded approximately $200,000,
$0 and $17,949,000, respectively, of gains on sale of facilities and other
non-recurring transactions, and approximately $218,000, $9,234,000 and
$17,758,000, respectively, of losses on sale of facilities, asset write-offs and
other non-recurring charges. Additionally, as more fully described in Note 5 to
the consolidated financial statements, in 2000 Headwaters recorded an
extraordinary loss on early extinguishment of debt of $7,860,000.

         The selected financial data as of and for the years ended September 30,
1996 and 1997 and as of September 30, 1998 are derived from audited financial
statements not included herein. The selected financial data for the year ended
September 30, 1998, and as of and for the year ended September 30, 1999 were
derived from the financial statements of Headwaters which have been audited by
PricewaterhouseCoopers LLP included elsewhere herein. The selected financial
data as of and for the year ended September 30, 2000 were derived from the
financial statements of Headwaters which have been audited by Arthur Andersen
LLP included elsewhere herein.
<TABLE>
<CAPTION>
                                                                      Year Ended September 30,
                                                 --------------------------------------------------------------------
(thousands of dollars, except per-share data)        1996          1997         1998          1999         2000
------------------------------------------------- ------------ ------------- ------------ ------------- ------------
<S>                                                  <C>           <C>         <C>           <C>           <C>
OPERATING DATA:
     Total revenue                                     $  295        $  147      $ 2,186       $ 6,719       $45,835
     Income (loss) from continuing operations         (12,955)      (10,498)     (11,308)      (28,393)        3,682
     Net income (loss)                                (13,836)      (10,498)     (11,308)      (28,393)        3,682
     Diluted net income (loss) per
        common share:
          Income (loss) per share from
             continuing operations                      (1.86)        (1.32)       (1.17)        (2.39)          .15
          Net income (loss) per share                   (1.99)        (1.32)       (1.17)        (2.39)          .15

                                                                        As of September 30,
                                                 -------------------------------------------------------------------
(thousands of dollars)                               1996          1997         1998          1999         2000
------------------------------------------------ ------------- ------------- ------------ ------------- ------------
BALANCE SHEET DATA:
     Working capital (deficit)                        $(3,482)      $(3,471)     $ 7,497       $(1,799)      $11,225
     Net property, plant and equipment                  7,125        13,619       15,809        14,182           552
     Total assets                                       8,072        26,590       68,061        58,095        33,441
     Long-term obligations:
        Long-term liabilities                             364         3,817       14,879        18,422         5,235
        Deferred revenue                                   --         1,545        8,377         7,501        10,513
        Redeemable convertible preferred
           stock                                           --            --           --         4,332           --
     Total long-term obligations                          364         5,362       23,256        30,255       15,748
     Total stockholders' equity (deficit)                (233)        6,426       14,746       (1,028)       10,747
</TABLE>


                                       15
<PAGE>

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                  RESULTS OF OPERATIONS

         The following discussion and analysis should be read in conjunction
with the information set forth under the caption entitled "ITEM 6. SELECTED
FINANCIAL DATA" and the consolidated financial statements and notes thereto
included elsewhere herein.

Year Ended September 30, 2000 Compared to Year Ended September 30, 1999

         The information set forth below compares Headwaters' operating results
for 2000 with its operating results for 1999.

         Revenues. Total revenue for the year ended September 30, 2000 ("2000")
increased by $39,116,000 to $45,835,000 as compared to $6,719,000 for the year
ended September 30, 1999 ("1999"). The major components of this revenue are
discussed in the sections below.

         License Fees. During 2000, Headwaters recognized license fees totaling
$17,315,000 while $3,526,000 of license fees were recognized during 1999. The
license fees in 2000 consisted of the straight-line amortization of one-time
non-refundable initial and prepaid license fees of $1,003,000, reduced by a
one-time adjustment of $201,000, and recurring earned license fees or royalty
payments of $16,513,000. License fees in 1999 consisted of the straight-line
amortization of one-time non-refundable initial license fees of $875,000 and
recurring license fees or royalty payments of $2,651,000. 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 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 produced and sold as reported to
Headwaters by its licensees. The increase in 2000 earned license fees was due
primarily to a significant increase from a licensee that owns and operates four
alternative fuel facilities in addition to less significant increases from other
licensees.

         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 2000 were $9,757,000 with a
corresponding direct cost of $6,617,000. Chemical sales during 1999 were
$2,140,000 with a corresponding direct cost of $1,695,000. The increase in
chemical sales in 2000 over 1999 was due to increased alternative fuel
production by Headwaters' licensees.

         Gains on Sale of Facilities. In 1999, Headwaters sold a facility
located in Pennsylvania on which a loss of approximately $1,839,000 was
recognized. Headwaters also entered into an agreement under which it operates
this facility on behalf of the owner. In 2000, upon achieving specified
operating performance milestones, Headwaters received additional cash payments
related to the sale of this facility. The cash proceeds from these payments, net
of obligations to third parties, approximated $7,377,000. Of the net amount
received, Headwaters recognized $4,400,000 as revenue because there were no
ongoing obligations associated with those payments. Headwaters deferred the
recognition of $2,977,000 which amount was characterized as prepaid royalties.
This amount is being recognized as revenue on a straight-line basis through
December 2007.

         In 2000, Headwaters sold the three remaining alternative fuel
facilities it owned plus an option to acquire a licensee facility. One of these
sold facilities was located in Utah, two of these facilities were located in
West Virginia, and the facility under option was located in Nevada. Headwaters
reported net gains on these transactions totaling approximately $12,470,000.
Headwaters also entered into its standard supply agreements with the new owners
of the facilities to sell proprietary chemical material used at the facilities.
Headwaters also receives ongoing royalties based upon the sale of alternative
fuel from the facilities.

         Gains on Non-recurring Transactions. In 2000, Headwaters recorded
non-recurring gains of approximately $1,079,000 related to the satisfaction of a
$755,000 contingent contract liability and a $324,000 gain recognized on a note
receivable transaction.

         Cost of Operations decreased by $9,258,000 to $3,821,000 during 2000
from $13,079,000 during 1999. During 2000, Headwaters incurred significantly
lower operating expenses in connection with the continued

                                       16
<PAGE>

refinement and implementation of the briquetting process associated with the 24
facilities placed in service during 1998, and in particular the operating costs
associated with the four facilities owned by Headwaters which have now been
sold. In 1999, cost of operations consisted primarily of labor and operating
expenses at the owned alternative fuel facilities and the wash plant located in
Utah, losses related to the write-down of inventory purchased from Coaltech, and
costs incurred in providing assistance to Headwaters' licensees in resolving
ramp-up issues at their alternative fuel facilities. Headwaters expects future
costs of operations to remain significantly below 1999 levels.

         Selling, General and Administrative Expenses increased $237,000, or 5%,
to $5,361,000 during 2000 from $5,124,000 for 1999. The increase in expenses in
2000 is due to an increase in payroll and other compensation-related costs,
partially offset by decreases in nearly all other cost categories.

         Asset Write-offs and Other Non-recurring Charges. In 2000, Headwaters
recorded an impairment charge of approximately $14,804,000 related to assets
located in Utah and Alabama. This impairment charge consisted of an approximate
$12,615,000 write-down to net realizable value of certain plant and equipment
which remained on the sites when the facilities were sold and was idled, 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
also recorded employee severance and other non-cash charges from incremental
amortization of deferred compensation from stock options (resulting from the
termination of employees whose stock options became fully vested upon
termination) totaling approximately $1,443,000. Other non-recurring settlement
charges ($979,000) and asset write-downs ($532,000) were recorded in 2000. All
of these asset write-offs and non-recurring charges totaled approximately
$17,758,000.

         Other Income and Expense. During 2000, Headwaters reported net other
expenses of $3,636,000 compared to $5,980,000 for 1999. This decrease of
$2,344,000 relates primarily to a decrease of $1,439,000 in interest expense and
a positive variance of $1,275,000 in the mark-to-market adjustment of the
carrying value of a related party note receivable collateralized by Headwaters
common stock, offset by $746,000 of losses recorded in 2000 in the carrying
value of equity investments.

         Interest expense decreased in 2000 primarily due to the lower average
levels of outstanding borrowings which existed in 2000 as compared to 1999, most
notably as a result of the debt repayments during 2000. Interest expense is
expected to significantly decrease in the future as a result of repayment of
debt related to the sale of Company-owned facilities and the complete redemption
of outstanding convertible debt in 2000.

         During 1996, Headwaters sold certain construction companies and
received as consideration a $5,000,000 note receivable ("Note"). The Note is
"marked to market" each quarter based upon the market value of Headwaters'
common stock held as collateral and is reflected in the consolidated balance
sheet at the underlying value of this collateral, $466,000 at September 30,
2000. This adjustment resulted in a write-up of $66,000 during 2000, compared to
a write-down of $1,209,000 during 1999 for a net change of $1,275,000.

         During 2000, Headwaters made investments in several less than 50%-owned
affiliates. Allowances are provided, on a case-by-case basis, when management
determines that the investment or equity in earnings is not realizable. During
2000, the provision for such allowances totaled approximately $646,000. In
addition, Headwaters recognized approximately $100,000 of losses related to its
equity in investments accounted for using the equity method.

         Income Taxes. In 2000, Headwaters reported an income tax benefit of
$2,900,000, consisting of the recognition of $3,000,000 of its deferred tax
asset, reduced by $100,000 of alternative minimum tax. Headwaters believes it is
more likely than not that the portion of the total deferred tax asset recognized
in 2000 will be realized as a result of income to be recognized from the
amortization of deferred revenue in subsequent periods.

         Extraordinary Item. In January 2000, Headwaters redeemed all of the
convertible debt issued from September 1999 through December 1999 not previously
converted into common stock. The redemption consideration given included
approximately $1,000,000 in redemption premiums plus approximately 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 consolidated statements of operations.
Also in 2000, Headwaters redeemed all of the $20,000,000 face value convertible
debt issued in March 1999. Early prepayment costs of approximately $6,037,000
were recognized as an extraordinary item as a result of the redemption
consideration paid plus the acceleration of amortization of the unamortized debt
discount and debt issuance costs in excess of the debt carrying value.

                                       17
<PAGE>

         Net Income. For 2000, net income of $3,682,000 represents an
improvement of $32,075,000 from the net loss of $28,393,000 in 1999. This is
primarily due to substantially increased revenue, including gains on the sale of
facilities, and decreased cost of operations, partially offset by increased
asset write-offs and other non-recurring charges and an extraordinary loss.

Year Ended September 30, 1999 Compared to Year Ended September 30, 1998

         The information set forth below compares Headwaters' operating results
for 1999 with its operating results for 1998.

         Revenues. Total revenue for the year ended September 30, 1999 ("1999")
increased by $4,533,000 to $6,719,000 as compared to $2,186,000 for the year
ended September 30, 1998 ("1998"). The major components of this revenue are
discussed in the sections below.

         License Fees. During 1999, Headwaters recognized license fees totaling
$3,526,000, while $860,000 of license fees were recognized during 1998. The
license fees in 1999 consisted of the straight-line amortization of one-time
non-refundable initial license fees of $875,000 and recurring earned license
fees or royalty payments of $2,651,000. License fees in 1998 consisted of the
straight-line amortization of one-time non-refundable initial license fees of
$654,000 and recurring license fees or royalty payments of $206,000.

         Chemical Sales. Total chemical sales during 1999 were $2,140,000 with a
corresponding direct cost to Headwaters of $1,695,000. Total chemical sales
during 1998 were $994,000 with a corresponding direct cost to Headwaters of
$642,000. Alternative fuel sales were $767,000 in 1999 compared to $32,000 in
1998 and represent the sale of product from Headwaters-owned facilities.
Headwaters sold six chemical mixing plants to licensees during 1998 for
$1,088,000, generating a gross profit of $200,000. There were no sales of
chemical mixing plants during 1999.

         Cost of Operations increased $6,878,000 from $6,201,000 during 1998 to
$13,079,000 during 1999. During 1999, Headwaters incurred significantly higher
operating expenses in connection with the continued refinement and
implementation of the briquetting process in connection with the 24 facilities
placed in service during 1998, and in particular the operating costs of the four
facilities owned by Headwaters which were held for sale. These expenses
primarily related to labor and operating expenses at the four Headwaters-owned
alternative fuel facilities and the wash plant located in Utah, losses related
to the write-down of inventory purchased from Coaltech, and costs incurred in
providing assistance to Headwaters' licensees in resolving ramp-up issues at
their alternative fuel facilities.

         Until October 1999, Headwaters operated one of the alternative fuel
facilities for Coaltech, a partnership for which Headwaters was the general
partner. Under the operating agreement, Headwaters was contractually obligated
to purchase all of the alternative fuel produced at cost plus $1 per ton.
Production of alternative fuel from this facility during 1999 and 1998 was not
significant and accordingly, the cost per ton was significantly in excess of the
current market value. These costs and the corresponding write-down of this
inventory to its market value are included in the cost of operations. The
write-down was approximately $1,815,000 during 1999 and $1,400,000 during 1998.
Headwaters operated the Coaltech Utah facility at a loss because of the need to
gain operating experience (it was the first alternative fuel facility Headwaters
built and operated), test alternative production methods, maintain operational
status for Section 29 qualification, maintain the relationship with AJ
Gallagher, an owner of the Utah facility who is a major licensee and partner of
Headwaters, and other related business reasons.

         Selling, General and Administrative Expenses increased $385,000, or 8%,
to $5,124,000 during 1999 from $4,739,000 for 1998. The largest components of
selling, general and administrative expenses for both 1999 and 1998 were
payroll, professional services and travel expenses. Payroll-related costs
increased approximately $540,000, due primarily to increased headcount, salary
costs and amortization of deferred compensation from stock options; professional
services increased approximately $20,000; and travel decreased approximately
$50,000 from 1998 to 1999. Also, there was approximately $250,000 of commissions
incurred in connection with the placement of alternative fuel license agreements
in 1998 while there were no such commissions in 1999. Changes in the other
categories from year to year were not material.

                                       18
<PAGE>

         Asset Write-offs and Other Non-recurring Charges. In 1999, certain
assets, primarily consisting of leasehold improvements on the property where a
small alternative fuel facility was located, were abandoned. The carrying value
of these assets, totaling approximately $556,000, was written off during 1999.
Based on the uncertainty of recovering certain advances on coal fine inventories
paid from 1997 through May 1999, Headwaters wrote off $3,677,000 of advances on
inventories in 1999. In addition, in 1999 Headwaters wrote off a $660,000 note
receivable and recorded a liability for approximately $469,000 related to a
settlement agreement with a company that had provided Headwaters with advice
with respect to the use of certain alternative fuel technology, certain
financing obtained and the sale of certain alternative fuel manufacturing
facilities. Finally, Headwaters recorded approximately $2,033,000 of non-cash,
incremental amortization of deferred compensation from stock options, resulting
from the termination of employees whose stock options became fully vested upon
termination. All of these 1999 write-offs and provisions total approximately
$7,395,000, which amount is recorded as asset write-offs and other non-recurring
charges in the consolidated statement of operations.

         Loss on Sale of Facility. In March 1998, Headwaters sold an alternative
fuel facility located in Alabama on which a loss of $218,000 was recognized. The
sales price was $6,500,000 payable in the form of a nonrecourse promissory note
collateralized by the facility. In 1999, Headwaters sold a facility located in
Pennsylvania on which a loss of approximately $1,839,000 was recognized. As more
fully described in Note 14 to the consolidated financial statements, Headwaters
received additional cash payments in 2000, some of which were recognized as
revenue in 2000, related to the 1999 facility sale.

         Other Income and Expense. During 1999, Headwaters had net other
expenses of $5,980,000 compared to $1,694,000 for 1998. This increase of
$4,286,000 relates primarily to an increase in interest expense of $3,508,000, a
change between periods of $1,228,000 in the mark-to-market adjustment of the
carrying value of the related party note receivable collateralized by common
stock, and a decrease in minority interest in losses of consolidated
subsidiaries of $401,000, partially offset by an increase in interest income of
$1,006,000.

         A $515,000 payment on the related party note receivable during 1999 was
included in interest income for 1999, while no interest income on the note was
recognized in 1998. Another reason for the increase in interest income in 1999
over 1998 relates to a full year's interest being recognized on the $6,500,000
note receivable from the sale of the Alabama facility in March 1998.

         Interest expense in 1998 of $2,745,000 consisted primarily of
amortization of the discount incurred upon the issuance of convertible debt and
warrants at a discount. Interest expense of $6,253,000 in 1999 consisted of
interest accrued on notes payable used to finance the construction of
alternative fuel facilities held for sale and for operating needs and $2,075,000
of amortization of debt discount and debt issue costs. Interest expense
increased significantly as a result of the debt issued during March 1999.

         During September 1998, Headwaters offered the limited partners of Utah
Synfuel #1 and Alabama Synfuel #1 common stock of Headwaters in exchange for
their limited partnership interests. These exchanges, most of which were
accounted for in September 1998, were substantially completed by November 1998,
at which time Utah Synfuel #1 became a wholly-owned subsidiary of Headwaters and
Alabama Synfuel #1 became a 98%-owned subsidiary of Headwaters. As a result of
these exchanges, minority interest in the losses of consolidated subsidiaries
decreased from approximately $392,000 in 1998 to $0 in 1999.

         Net Loss. For 1999, the net loss of $28,393,000 represents an increase
of $17,085,000 from the net loss of $11,308,000 in 1998. This is primarily due
to the increase in cost of operations, the asset write-offs and other
non-recurring charges, and the increase in interest expense. Headwaters did not
recognize any income tax benefit in 1999 or 1998 since the realization of its
deferred tax asset of approximately $21,800,000, consisting primarily of net
operating loss carryforwards, was dependent on generation of future taxable
income.

Liquidity and Capital Resources

         Liquidity. During 1998, Headwaters and its licensees completed the
construction of and began operations at 24 alternative fuel facilities.
Headwaters owned four facilities which were sold during 1999 and 2000. Proceeds
from the sale of facilities were used primarily to retire debt that was incurred
in connection with the construction and operation of the facilities, and to a
lesser extent, for working capital needs.

                                       19
<PAGE>

         Net cash provided by operating activities during the year ended
September 30, 2000 was $6,608,000 compared to $17,516,000 of cash used during
the year ended September 30, 1999. Most of this change in cash flow from
operating activities is attributable to the 2000 net income of $3,682,000 as
compared to the 1999 net loss of $28,393,000, augmented by the non-cash nature
of some of the material expenses included in results of operations for 2000.
During 2000, proceeds from the sale of facilities were approximately
$42,334,000, net proceeds from the issuance of notes payable and related common
stock warrants totaled approximately $6,980,000, and net proceeds from the
issuance of common stock and related common stock warrants totaled approximately
$5,254,000. Approximately $43,995,000 of notes payable were repaid during 2000
and approximately $4,454,000 of cash was used for preferred stock redemptions.

         Capital Resources. In addition to the sale of facilities in 2000,
Headwaters' investing activities consisted of the purchase of short-term
investments and investments in non-affiliated companies. Headwaters has no
current plans to construct additional synthetic fuel facilities or to incur
significant costs to acquire property, plant and equipment, but may increase its
strategic investments and lending activities as opportunities arise. As of
September 30, 2000, Headwaters owns from 1% to 27% of the voting securities of
five non-public high-risk investee companies. Current investments range from
approximately $130,000 to $1,400,000. Through December 1, 2000, Headwaters made
additional equity investments of approximately $1,558,000 under the same general
terms as the investments made in fiscal 2000. Headwaters also has notes
receivable representing short-term loans to nine private, emerging growth
companies in order to bridge the period between seed funding and the close of
first and second rounds of equity financing. Notes receivable from these
companies range from $200,000 to $500,000 each. From October 1, 2000 to December
1, 2000, Headwaters made additional loans of approximately $1,050,000 under the
same general terms as the loans made in fiscal 2000. Headwaters does not intend
to increase the funds committed to these investment types in the future, but
could incur losses if the loans are not repaid or if the investments are not
recoverable.

         As described in Note 5 to the consolidated financial statements,
Headwaters began acquiring shares of its common stock in connection with a stock
repurchase plan announced during 2000. The program authorizes Headwaters to
purchase stock in the open market or through negotiated transactions referred to
as block trades. Purchases under the plan are at the discretion of Headwaters'
management. Through September 30, 2000, Headwaters purchased approximately
586,000 shares for approximately $1,897,000, and continues to purchase stock
subsequent to September 30, 2000. Headwaters continually evaluates financial
alternatives to the stock repurchase program but currently expects the program
to continue through fiscal 2001 subject to market conditions and available cash.

         Headwaters' working capital improved from a deficit position of
approximately $1,799,000 at September 30, 1999 to a positive working capital
position of approximately $11,225,000 as of September 30, 2000. Several factors
caused this change, most notably an increase in cash from the sale of facilities
and increased revenue. The most significant changes in working capital, in
addition to the increase in cash and short-term investments, were the reduction
of approximately $19,883,000 in facilities and equipment held for sale and the
reduction of approximately $20,418,000 in current notes payable. Both of these
changes resulted primarily from the sales of alternative fuel facilities in
2000.

         Headwaters expects its operations to produce positive cash flows in
future periods. In addition to cash provided by operating activities, Headwaters
has borrowing capability under a revolving line of credit with a bank which was
obtained in October 2000. Borrowings under this line of credit, which expires
January 2002, were used to repay a $3,000,000 note payable to this bank which
was outstanding at September 30, 2000 and to repay a $1,838,000 note payable to
a corporation (see Notes 5 and 6 to the consolidated financial statements).
Subsequently, the line of credit was paid down and at October 31, 2000, there
were no outstanding borrowings under the line of credit. Borrowings under this
revolving line bear interest at prime plus 1% and are limited to the lesser of
$8,000,000 or the "borrowing base," as defined. At October 31, 2000, Headwaters'
notes payable totaled less than $500,000. Headwaters believes it will have
sufficient cash reserves to meet its obligations during the foreseeable future,
and also believes it has the ability to raise additional debt and equity capital
from other sources if necessary.

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

                                       20
<PAGE>

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, 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, 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.
(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.
(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.

Impact of Inflation

         During 2000, cost increases to Headwaters were not materially impacted
by inflation.

Other Items

         Headwaters has reviewed all recently issued, but not yet adopted,
accounting standards in order to determine their effects, if any, on the results
of operations or financial position of Headwaters. Based on that review,
Headwaters believes that none of these pronouncements will have any significant
effects on current or future financial position or results of operations.

                                       21
<PAGE>

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

         None.


ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

         The financial statements and supplementary financial data required by
this Item 8 are set forth in Item 14 of this Form 10-K. All information which
has been omitted is either inapplicable or not required.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

         On July 19, 2000, Headwaters dismissed PricewaterhouseCoopers LLP as
its independent accountants. The Registrant's audit committee participated in
and approved the decision to change independent accountants.

         The reports of PricewaterhouseCoopers LLP on the financial statements
for the two fiscal years ended September 30, 1998 and 1999 contained no adverse
opinion or disclaimer of opinion and were not qualified or modified as to
uncertainty, audit scope or accounting principle.

         In connection with its audits for the two fiscal years ended September
30, 1998 and 1999 and through July 19, 2000, there were no disagreements with
PricewaterhouseCoopers LLP on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure, which
disagreements if not resolved to the satisfaction of PricewaterhouseCoopers LLP
would have caused them to make reference thereto in their reports on the
financial statements for such years.

         During the two fiscal years ended September 30, 1998 and 1999 and
through July 19, 2000, there were no reportable events (as defined in Regulation
S-K Item 304(a)(1)(v)).

         The Registrant requested that PricewaterhouseCoopers LLP furnish it
with a letter addressed to the Securities and Exchange Commission stating
whether or not it agrees with the above statements. A copy of such letter is
filed as Exhibit 16 to this Form 10-K.

         On July 19, 2000, the audit committee appointed Arthur Andersen LLP as
Headwaters' auditors. Headwaters did not consult with Arthur Andersen LLP on any
application of accounting principles or any other matter during the two fiscal
years ended September 30, 1999 or subsequent thereto through July 19, 2000.

         The appointment of Arthur Andersen LLP as independent auditors of
Headwaters for the fiscal year ended September 30, 2000 was ratified by the
stockholders at a special meeting held on September 6, 2000.

         There have been no disagreements with accountants on accounting or
financial statement disclosure subsequent to the appointment of Arthur Andersen
LLP on July 19, 2000.

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         The information to be set forth under the captions "Executive
Officers," "Section 16(a) Beneficial Ownership Reporting Compliance" and
"Proposal No. 1: Election of Directors" in Headwaters' Proxy Statement to be
filed in January 2001 for the Annual Meeting of Stockholders to be held in 2001
(the "Proxy Statement"), are incorporated herein by reference.

                                       22
<PAGE>

ITEM 11. EXECUTIVE COMPENSATION

         The information to be set forth under the caption "Executive
Compensation and Related Information" in the Proxy Statement is incorporated
herein by reference; provided, however, that Headwaters specifically excludes
from such incorporation by reference any information set forth under the
captions "Compensation Committee Report on Executive Compensation" and
"Stockholder Return Performance Graph" in the Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         Security ownership of certain beneficial owners and management to be
set forth under the caption "Security Ownership of Directors, Nominees and
Principal Stockholders" in the Proxy Statement is incorporated herein by
reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         The information to be set forth under the caption "Transactions with
Related Parties" in the Proxy Statement is incorporated herein by reference.

                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)      1.       Financial Statements

Consolidated Financial Statements of Headwaters Incorporated

Reports of Independent Public Accountants                                 F-1
Consolidated Balance Sheets as of September 30, 1999 and 2000             F-2
Consolidated Statements of Operations
  for the years ended September 30, 1998, 1999 and 2000                   F-4
Consolidated Statements of Changes in Stockholders' Equity (Deficit)
  for the years ended September 30, 1998, 1999 and 2000                   F-5
Consolidated Statements of Cash Flows
  for the years ended September 30, 1998, 1999 and 2000                   F-8
Notes to Consolidated Financial Statements                               F-10

         2.       Financial Statement Schedules

         All financial statement schedules for which provision is made in the
applicable accounting regulations of the Securities and Exchange Commission are
not required under the related instructions or are inapplicable, and therefore
have been omitted.

         3.       Listing of Exhibits

         Certain other instruments which would otherwise be required to be
listed below have not been so listed because such instruments do not authorize
securities in an amount which exceeds 10% of the total assets of Headwaters and
its subsidiaries on a consolidated basis and Headwaters agrees to furnish a copy
of any such instrument to the Commission upon request.

         There is included a restated financial data schedule for the years
ended September 30, 1998 and 1999.

         For convenience, the name Headwaters is used throughout this listing
although in some cases the name Covol was used in the original instrument.

                                       23
<PAGE>
<TABLE>
<CAPTION>
Exhibit No.                                        Description                                          Location

<S>              <C>                                                                                      <C>
3.1              Certificate of Incorporation of Headwaters                                                (1)
3.1.1            Certificate of Amendment of the Certificate of Incorporation of Headwaters dated          (1)
                 January 22, 1996
3.1.2            Certificate of Amendment of the Certificate of Incorporation dated June 25, 1997          (3)
3.1.3            Certificate of Designation, Number, Voting Powers, Preferences and Rights of              (4)
                 Headwaters' Series A 6% Convertible Preferred Stock dated August 18, 1997
                 (originally designated as Exhibit No. 3.1.2)
3.1.4            Certificate of Designation, Number, Voting Powers, Preferences and Rights of              (5)
                 Headwaters' Series B Convertible Preferred Stock dated September 18, 1997
                 (originally designated as Exhibit No. 3.1.3)
3.1.7            Certificate of Amendment of the Certificate of Incorporation dated March 1, 2000          (14)
3.1.8            Certificate of Amendment of the Certificate of Incorporation dated September 6,           (19)
                 2000
3.2              By-Laws of Headwaters                                                                     (1)
3.2.1            Certificate of Amendment to Bylaws of Headwaters dated January 31, 1996                   (1)
3.2.2            Certificate of Amendment to the Bylaws dated May 20, 1997 (Originally designated          (3)
                 as Exhibit No. 3.2.1)
3.2.3            Certificate of Amendment to the Bylaws dated June 25, 1997  (Originally                   (3)
                 designated as Exhibit No. 3.2.2)
9.1              Special Powers of Attorney Coupled With an Interest dated February 1, 1996                (1)
                 between Headwaters, Gerald Larson and Michael McEwan
10.8             Lease Agreement, dated May 31, 1994, between Headwaters and Byrleen Hansen                (1)
                 regarding Carbon County, Utah property
10.11.2          License Agreement dated September 10, 1996, between Headwaters and CoBon Energy,          (2)
                 LLC
10.13.1          Promissory Noted dated August 1996 in favor of Headwaters from Michael McEwan and          *
                 Gerald Larson
10.13.2          Unlimited Guaranty of Gerald Larson and release of Michael McEwan dated April 29,          *
                 1998
10.16.1          Stock Option Agreement dated June 1, 1996 with Brent M. Cook                              (2)
10.30            Lease Agreement, dated December 12, 1996, between Headwaters and UPC, Inc.                (2)
                 regarding Price City, Utah property
10.45**          License and Binder Purchase Agreement, dated December 14, 1997, between                   (6)
                 Appalachian Synfuel, LLC and Headwaters
10.47**          License Agreement, dated  August 5, 1997, between Pelletco Corporation and                (6)
                 Headwaters
10.49**          Agreement Concerning Additional Facilities, dated December 27, 1996, between AJG          (6)
                 Financial Services, Inc. and Headwaters
10.50.1**        Form of Amended and Restated License and Binder Purchase Agreement dated February         (7)
                 3, 1998, between PC Virginia Synthetic Fuel #1, PC West Virginia Synthetic Fuel
                 #1, PC West Virginia Synthetic Fuel #2, PC West Virginia Synthetic Fuel #3
                 and Headwaters
10.50.1.1***     Form of First Amendment to Amended and Restated License and Binder Purchase                *
                 Agreement, dated March 31, 1999, between PC
                 Virginia Synthetic Fuel #1; PC Virginia Synthetic Fuel #2; PC
                 West Virginia Synthetic Fuel #3 and Headwaters
10.54            Employment Agreement effective May 1, 1998 with Steven G. Stewart                         (8)
10.56            Employment Agreement effective April 21, 1998 with Brent M. Cook                          (9)
10.58.8          Series E Warrant in favor of Leeds Group dated March 17, 1999                             (10)
10.58.9          Series E Warrant in favor of Howard L. Schwartz dated March 17, 1999                      (10)
10.58.10         Series E Warrant in favor of Jack A. Schwebel dated March 17, 1999                        (10)
10.58.11         Series E Warrant in favor of Brent M. Lockwood dated March 17, 1999                       (10)
10.60            Employment Agreement effective April 20, 1999 with Kirk A. Benson                         (11)
10.61***         Purchase Agreement dated August 27, 1999 relating to the sale of the River Hill           (12)
                 Project
10.61.1***       License and Binder Purchase Agreement dated August 27, 1999 relating to the River         (12)
                 Hill Project
10.61.2***       Modification Agreement dated August 27, 1999 between the Purchaser of the River           (12)
                 Hill Project, Fun Enterprises Pty Limited and Headwaters
10.64***         Utah #2 Asset Purchase Agreement dated December 23, 1999 between Headwaters and           (13)
                 DTE Kentucky, LLC
10.64.1***       License and Binder Purchase Agreement dated December 29, 1999 between Headwaters           *
                 and DTE Kentucky, LLC
10.65***         Asset Purchase Agreement dated January 18, 2000 among Headwaters, Pocahontas              (13)
                 Synfuel, L.L.C., Synfuel Investments, Inc., Premier Elkhorn Coal Company, and
                 TECO Coal Corporation
10.65.1***       License and Binder Purchase Agreement dated January 18, 2000 between Headwaters and        *
                 Premier Elkhorn Coal Company (related to the Pocahontas facility)

                                       24
<PAGE>

10.65.2***       License and Binder Purchase Agreement dated January 21, 2000 between Headwaters and        *
                 Premier Elkhorn Coal Company (related to the Mohave facility)
10.67            Mountaineer Fuels Asset Purchase Agreement dated April 17, 2000 between DTE               (15)
                 Kentucky, LLC and Headwaters
10.67.1***       License and Binder Purchase Agreement dated April 17, 2000 between DTE Kentucky,          (15)
                 LLC and Headwaters
10.69***         Settlement Agreement and Mutual Release dated May 25, 2000 among Headwaters and           (17)
                 Birmingham Syn Fuel, L.L.C., PacifiCorp Syn Fuel, L.L.C., and PacifiCorp
                 Financial Services, Inc.
10.69.1          Amended and Restated Promissory Note dated May 25, 2000 in favor of Headwaters,           (17)
                 executed by Birmingham Syn Fuel, L.L.C. as debtor
10.69.2          Amended and Restated Security Agreement dated May 25, 2000 between Headwaters and         (17)
                 Birmingham Syn Fuel, L.L.C.
10.69.3***       License and Binder Purchase Agreement dated May 25, 2000 between Birmingham Syn           (17)
                 Fuel, L.L.C. and Headwaters
10.69.4***       License and Binder Purchase Agreement dated May 25, 2000 between PacifiCorp Syn           (17)
                 Fuel, L.L.C. and Headwaters (related to the Brookwood facility)
10.69.5***       License and Binder Purchase Agreement dated May 25, 2000 between PacifiCorp Syn           (17)
                 Fuel, L.L.C. and Headwaters (related to the Pumpkin Center #1 facility)
10.69.6***       License and Binder Purchase Agreement dated May 25, 2000 between PacifiCorp Syn           (17)
                 Fuel, L.L.C. and Headwaters (related to the Pumpkin Center #2 facility)
10.70***         Settlement Agreement and Release dated June 26, 2000 among Headwaters, Utah               (17)
                 Synfuel #1, Ltd., Coaltech No. 1, L.P., AJG Financial Services, Inc. and Square D
                 Company
10.70.1***       License and Binder Supply Agreement dated June 26, 2000 among Coaltech No.1 L.P.,         (17)
                 Utah Synfuel #1 Ltd, and Headwaters
10.71            Loan Agreement dated October 18, 2000 between Headwaters and Zions First National          *
                 Bank
10.71.1          Promissory Note dated October 18, 2000 between Headwaters as borrower and Zions            *
                 First National Bank as lender
10.72            Employment Agreement effective as of January 1, 1999 with Kenneth R. Frailey               *
10.73.1          Stock Purchase Agreement dated July 7, 2000 between StyleU4EA.com, Inc. and                *
                 Headwaters
10.73.2          Loan Agreement dated October 6, 2000 between StyleU4EA.com, Inc. and Headwaters            *
10.73.3          Stock Purchase Agreement dated October 16, 2000 between StyleU4EA.com, Inc. and            *
                 Headwaters
10.73.4          Loan Agreement dated November 29, 2000 between NextStep Broadband Corporation and          *
                 Headwaters
10.74            Credit Agreement dated October 20, 2000 between The H.B. Group, Inc. and                   *
                 Headwaters
10.74.1          Amendment to Credit Agreement dated October 20, 2000 between The H.B. Group, Inc.          *
                 and Headwaters
10.74.2          Second Amendment to Credit Agreement dated December 1, 2000 between The H.B.               *
                 Group, Inc. and Headwaters
16               Letter regarding change in certifying accountant                                          (18)
21.1             List of Subsidiaries of Headwaters                                                         *
23.1             Consent of Arthur Andersen LLP                                                             *
23.2             Consent of PricewaterhouseCoopers LLP                                                      *
27.1             Financial Data Schedule for the fiscal year ended September 30, 2000                       *
27.2             Restated Financial Data Schedule for the fiscal years ended September 30, 1998             *
                 and 1999
99.1             2000 Employee Stock Purchase Plan                                                         (16)
99.2             1995 Stock Option Plan (originally designated as Exhibit No. 10.5)                        (1)
99.2.1           First Amendment to the 1995 Stock Option Plan (originally designated as Exhibit           (1)
                 10.5.1)
99.3             Headwaters Incentive Bonus Plan dated May 25, 2000                                         *
</TABLE>
-----------------------
         *        Filed herewith.
         **       Confidential treatment has been granted to certain portions of
                  this exhibit, which portions have been deleted and filed
                  separately with the Securities and Exchange Commission.
         ***      This exhibit contains confidential material that has been
                  omitted pursuant to a Confidential Treatment Request. The
                  omitted information has been filed separately with the
                  Securities and Exchange Commission.

Unless another exhibit number is indicated as the exhibit number for the exhibit
as "originally filed," the exhibit number in the filing in which any exhibit was
originally filed and to which reference is made hereby is the same as the
exhibit number assigned herein to the exhibit.

                                       25
<PAGE>

(1)      Incorporated by reference to the indicated exhibit filed with
         Headwaters' Registration Statement on Form 10, filed February 26, 1996.
(2)      Incorporated by reference to the indicated exhibit filed with
         Headwaters' Annual Report on Form 10-K for the fiscal year ended
         September 30, 1996.
(3)      Incorporated by reference to the indicated exhibit filed with
         Headwaters' Current Report on Form 8-K, dated March 10, 1997.
(4)      Incorporated by reference to the indicated exhibit filed with
         Headwaters' Current Report on Form 8-K, dated August 19, 1997.
(5)      Incorporated by reference to the indicated exhibit filed with
         Headwaters' Current Report on Form 8-K, for event dated September 18,
         1997, filed October 28, 1997.
(6)      Incorporated by reference to the indicated exhibit filed with
         Headwaters' Annual Report on Form 10-K for the fiscal year ended
         September 30, 1997.
(7)      Incorporated by reference to the indicated exhibit filed with
         Headwaters' Quarterly Report on Form 10-Q, for the quarterly period
         ended March 31, 1998.
(8)      Incorporated by reference to the indicated exhibit filed with
         Headwaters' Annual Report on Form 10-K, for the fiscal year ended
         September 30, 1998.
(9)      Incorporated by reference to the indicated exhibit filed with
         Headwaters' Quarterly Report on Form 10-Q, for the quarterly period
         ended December 31, 1998.
(10)     Incorporated by reference to the indicated exhibit filed with
         Headwaters' Current Report on Form 8-K, for the event dated March 17,
         1999, filed March 24, 1999.
(11)     Incorporated by reference to the indicated exhibit filed with
         Headwaters' Quarterly Report on Form 10-Q for the quarter ended June
         30, 1999.
(12)     Incorporated by reference to the indicated exhibit filed with
         Headwaters' Current Report on Form 8-K/A, for event dated August 27,
         1999, filed September 28, 1999.
(13)     Incorporated by reference to the indicated exhibit filed with
         Headwaters' Current Report on Form 8-K/A, for the event dated December
         31, 1999, filed March 16, 2000.
(14)     Incorporated by reference to the indicated exhibit filed with
         Headwaters' Current Report on Form 8-K, for the event dated February
         29, 2000, filed March 2, 2000.
(15)     Incorporated by reference to the indicated exhibit filed with
         Headwaters' Quarterly Report on Form 10-Q for the quarter ended March
         31, 2000.
(16)     Incorporated by reference to the indicated exhibit filed with
         Headwaters' Registration Statement on Form S-8 (SEC file no.
         333-39674), filed June 20, 2000.
(17)     Incorporated by reference to the indicated exhibit filed with
         Headwaters' Quarterly Report on Form 10-Q for the quarter ended June
         30, 2000.
(18)     Incorporated by reference to the indicated exhibit filed with
         Headwaters' Current Report on Form 8-K/A, for the event dated July 19,
         2000, filed July 28, 2000.
(19)     Incorporated by reference to the indicated exhibit filed with
         Headwaters' Current Report on Form 8-K, for the event dated September
         6, 2000, filed September 19, 2000.


Reports on Form 8-K

         The following reports on Form 8-K were filed during the quarter ended
September 30, 2000:

*        Form 8-K filed on July 19, 2000, amended on July 28, 2000, for an event
         dated July 19, 2000 (Change in Certifying Accountant).
*        Form 8-K filed on September 19, 2000 for an event dated September 6,
         2000 (Special Meeting of Stockholders).

Exhibits

         The response to this portion of Item 14 is submitted as a separate
section of this report. See Item 14 (a) 3 above.

Financial Statement Schedules

         The response to this portion of Item 14 is submitted as a separate
section of this report. See Item 14 (a) 2 above.

                                       26
<PAGE>
                                   SIGNATURES

         Pursuant to the requirements of Section 13 or 15(d) 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

                                        By: /s/ Kirk A. Benson
                                            -------------------------------
                                            Kirk A. Benson
                                            Chief Executive Officer and
                                            Principal Executive Officer

                                        By: /s/ Steven G. Stewart
                                            -------------------------------
                                            Steven G. Stewart, Chief Financial
                                            Officer and Principal Financial
                                            Officer

                                        Date: December 20, 2000


Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.

    SIGNATURE                          TITLE                       DATE
    ---------                          -----                       ----

  /s/ Kirk A Benson       Chief Executive Officer             December 20, 2000
---------------------     (Principal Executive Officer) and
  Kirk A. Benson           Director

  /s/ Steven G. Stewart    Chief Financial Officer            December 20, 2000
------------------------   (Principal Financial and
  Steven G. Stewart        Accounting Officer)

  /s/ Brent M. Cook        President and Director             December 20, 2000
-----------------------
  Brent M. Cook

 /s/ DeLance W. Squire     Director                           December 20, 2000
-----------------------
  DeLance W. Squire

 /s/ James A. Herickhoff   Director                           December 20, 2000
-------------------------
 James A. Herickhoff

 /s/ Raymond J. Weller     Director                           December 20, 2000
-----------------------
 Raymond J. Weller

 /s/ John P. Hill, Jr.     Director                           December 20, 2000
-----------------------
 John P. Hill, Jr.


                                       27
<PAGE>

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Headwaters Incorporated:

We have  audited  the  accompanying  consolidated  balance  sheet of  Headwaters
Incorporated  (formerly  Covol  Technologies,   Inc.)  and  subsidiaries  as  of
September  30, 2000,  and the related  consolidated  statements  of  operations,
changes  in  stockholders'  equity  (deficit)  and cash  flows for the year then
ended. The financial  statements of the Company as of September 30, 1999 and for
the years ended September 30, 1999 and 1998 were audited by other auditors whose
report  dated  January  13,  2000,  expressed  an  unqualified  opinion on those
statements.  These financial  statements are the responsibility of the Company's
management.  Our  responsibility  is to express  an  opinion on these  financial
statements based on our audit.

We conducted our audit in accordance with auditing standards  generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable  assurance about whether the financial  statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting  the amounts and  disclosures in the financial  statements.  An audit
also includes assessing the accounting principles used and significant estimates
made by  management,  as well as  evaluating  the  overall  financial  statement
presentation.  We believe  that our audit  provides a  reasonable  basis for our
opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all material  respects,  the financial  position of Headwaters  Incorporated and
subsidiaries  as of September 30, 2000, and the results of their  operations and
their  cash  flows  for the  year  then  ended  in  conformity  with  accounting
principles generally accepted in the United States.

/s/ ARTHUR ANDERSEN LLP

ARTHUR ANDERSEN LLP
Salt Lake City, Utah
November 1, 2000

                        Report of Independent Accountants

To the Board of Directors

Headwaters Incorporated (formerly Covol Technologies, Inc.) and Subsidiaries

In our opinion, the accompanying  consolidated balance sheet as of September 30,
1999 and the related consolidated statements of operations, stockholders' equity
(deficit),  and  cash  flows  for  each of the two  years  in the  period  ended
September 30, 1999, present fairly, in all material  respects,  the consolidated
financial  position,   results  of  operations  and  cash  flows  of  Headwaters
Incorporated  (formerly Covol Technologies,  Inc.) and Subsidiaries at September
30,  1999 and for the two years in the  period  ended  September  30,  1999,  in
conformity with accounting  principles  generally accepted in the United States.
These financial  statements are the responsibility of the Company's  management;
our responsibility is to express an opinion on these financial  statements based
on our audits.  We conducted our audits of these  statements in accordance  with
auditing standards generally accepted in the United States which require that we
plan and  perform the audit to obtain  reasonable  assurance  about  whether the
financial  statements  are free of  material  misstatement.  An  audit  includes
examining,  on a test basis,  evidence supporting the amounts and disclosures in
the  financial   statements,   assessing  the  accounting  principles  used  and
significant  estimates made by management,  and evaluating the overall financial
statement  presentation.  We believe that our audits provide a reasonable  basis
for the opinion expressed above.

/s/ PricewaterhouseCoopers LLP

PricewaterhouseCoopers LLP
Salt Lake City, Utah
January 13, 2000

                                      F-1
<PAGE>
<TABLE>
<CAPTION>
           HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.)
                                AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS

                                                                                         As of September 30,
(thousands of dollars)                                                                   1999              2000
---------------------------------------------------------------------------------- --------------- ----------------
<S>                                                                                 <C>              <C>
ASSETS

Current assets:
     Cash and cash equivalents                                                              $ 461            $ 983
     Short-term investments                                                                    --            6,973
     Trade receivables, net                                                                 3,155            7,298
     Notes receivable                                                                          --            2,530
     Facilities and equipment held for sale                                                20,139              256
     Due from related party                                                                 2,722               --
     Inventories                                                                              573               --
     Other current assets                                                                      19              131
                                                                                   --------------- ----------------
            Total current assets                                                           27,069           18,171
                                                                                   --------------- ----------------
Property, plant and equipment, net of accumulated depreciation                             14,182              552
                                                                                   --------------- ----------------

Other assets:
     Facility-dependent note and accrued interest receivable                                7,879            6,598
     Equity investments, net                                                                   --            3,259
     Deferred income taxes                                                                     --            3,000
     Intangible assets, net of accumulated amortization                                     3,647            1,221
     Facility transferred under note receivable arrangement                                 2,641               --
     Restricted assets                                                                        843               --
     Other assets                                                                           1,834              640
                                                                                   --------------- ----------------
            Total other assets                                                             16,844           14,718
                                                                                   --------------- ----------------
            Total assets                                                                  $58,095          $33,441
                                                                                   =============== ================
</TABLE>

                                   (continued)

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

                                      F-2
<PAGE>
<TABLE>
<CAPTION>
           HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.)
                                AND SUBSIDIARIES

                     CONSOLIDATED BALANCE SHEETS, continued

                                                                                         As of September 30,
(thousands of dollars and shares)                                                         1999             2000
------------------------------------------------------------------------------------ -------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
<S>                                                                                 <C>              <C>
Current liabilities:
     Accounts payable                                                                      $ 1,179            $ 698
     Accrued personnel costs                                                                   356            2,254
     Accrued interest payable                                                                1,452              132
     Other accrued liabilities                                                               2,549            3,654
     Due to related party                                                                    2,706               --
     Notes payable, current                                                                 20,626              208
                                                                                     -------------- ----------------
            Total current liabilities                                                       28,868            6,946
                                                                                     -------------- ----------------
Long-term liabilities:
     Notes payable, non-current                                                             17,887            5,055
     Other long-term liabilities                                                               535              180
     Deferred revenue                                                                        7,501           10,513
                                                                                     -------------- ----------------
            Total long-term liabilities                                                     25,923           15,748
                                                                                     -------------- ----------------
            Total liabilities                                                               54,791           22,694
                                                                                     -------------- ----------------

Commitments and contingencies

Redeemable convertible preferred stock, $0.001 par value, issued and outstanding
   60 shares at September 30, 1999 and 0 shares at September 30, 2000                        4,332               --

Stockholders' equity (deficit):
     Convertible preferred stock, $0.001 par value; authorized 10,000 shares,
      issued and outstanding 17 shares at September 30, 1999 and 2000 (aggregate
      liquidation preference of $3,682 at September 30, 2000)                                    1                1
     Common stock, $0.001 par value; authorized 50,000 shares, issued and
      outstanding 12,766 shares at September 30, 1999 and 23,341 shares,
      including 214 shares held in treasury, at September 30, 2000                              13               23
     Capital in excess of par value                                                         78,457           82,659
     Accumulated deficit                                                                  (71,713)         (70,221)
     Other, including treasury stock                                                       (7,786)          (1,715)
                                                                                     -------------- ----------------
            Total stockholders' equity (deficit)                                           (1,028)           10,747
                                                                                     -------------- ----------------
            Total liabilities and stockholders' equity (deficit)                           $58,095          $33,441
                                                                                     ============== ================
</TABLE>
                     The accompanying notes are an integral
                 part of the consolidated financial statements.

                                      F-3
<PAGE>
<TABLE>
<CAPTION>
           HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.)
                                AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS

                                                                                       Year ended September 30,
(thousands of dollars, except per-share data)                                     1998               1999               2000
--------------------------------------------------------------------- ----------------- ------------------ ------------------
<S>                                                                    <C>              <C>                <C>
Revenue:
     License fees                                                                $ 860            $ 3,526            $17,315
     Chemical sales                                                                994              2,140              9,757
     Gains on sales of facilities                                                   --                 --             16,870
     Gains on non-recurring transactions                                           200                 --              1,079
     Alternative fuel sales                                                         32                767                149
     Other                                                                         100                286                665
                                                                      ----------------- ------------------ ------------------
          Total revenue                                                          2,186              6,719             45,835
                                                                      ----------------- ------------------ ------------------

Operating costs and expenses:
     Cost of chemical                                                              642              1,695              6,617
     Cost of operations                                                          6,201             13,079              3,821
     Selling, general and administrative                                         4,739              5,124              5,361
     Asset write-offs and other non-recurring charges                               --              7,395             17,758
     Loss on sale of facilities                                                    218              1,839                 --
                                                                      ----------------- ------------------ ------------------
        Total operating costs and expenses                                      11,800             29,132             33,557
                                                                      ----------------- ------------------ ------------------
Operating income (loss)                                                         (9,614)           (22,413)            12,278
                                                                      ----------------- ------------------ ------------------

Other income (expense):
     Interest and investment income                                                580              1,586              1,775
     Interest expense                                                           (2,745)            (6,253)            (4,814)
     Other, net                                                                    471             (1,313)              (597)
                                                                      ----------------- ------------------ ------------------
          Total other expense, net                                              (1,694)            (5,980)            (3,636)
                                                                      ----------------- ------------------ ------------------

Income (loss) before income taxes and extraordinary item                       (11,308)           (28,393)             8,642

Income tax benefit                                                                  --                 --              2,900
                                                                      ----------------- ------------------ ------------------

Income (loss) before extraordinary item                                        (11,308)           (28,393)            11,542

Extraordinary loss on early extinguishment of debt                                  --                 --             (7,860)
                                                                      ----------------- ------------------ ------------------

Net income (loss)                                                             $(11,308)          $(28,393)           $ 3,682
                                                                      ================= ================== ==================

Basic net income (loss) per common share                                        $(1.17)            $(2.39)              $.17
                                                                      ================= ================== ==================

Diluted net income (loss) per common share                                      $(1.17)            $(2.39)              $.15
                                                                      ================= ================== ==================
</TABLE>
                     The accompanying notes are an integral
                 part of the consolidated financial statements.

                                      F-4
<PAGE>
<TABLE>
<CAPTION>
                           HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

                                CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)


                                                                                                             Other
                                                                                          ------------------------------------------
                                                                                             Notes and
                                                                                             interest
                                                                                            receivable
                                                                                             -related
                                                                                           parties, from
                                                                                            issuance of,
                          Convertible                                                           or          Deferred
                        Preferred Stock       Common Stock      Capital in                collateralized  compensation  Common stock
(thousands of          --------------------------------------  excess of par  Accumulated    by, common     from stock     held in
dollars and shares)     Shares    Amount    Shares    Amount       value        deficit        stock         options      treasury
------------------------------------------------------------------------------------------------------------------------------------
<S>                     <C>     <C>      <C>        <C>        <C>         <C>              <C>             <C>        <C>
Balances at
 October 1, 1997           303      $1       9,089      $9        $50,203     $(31,694)      $(7,411)        $(4,683)       $--

Common stock issued
 to purchase minority
 interests in
 subsidiaries                                  540       1          5,383

Common stock
 issued for cash,
 including exercise
 of stock options                              533      --          3,257

Preferred stock
 issued for cash,
 net of offering
 costs                      13      --                                 90

Common stock issued
 on conversion of
 notes payable and
 accrued interest
 to common stock                             1,107       1          8,178

Interest expense
 related to
 issuance of
 convertible debt
 at a discount                                                      2,046

Payment received
 on notes
 receivable -
 related parties                                                                                 329

Amortization of
 deferred
 compensation from
 stock options                                                                                                   908

Write-up of
 related party
 note receivable                                                                                 (19)

Compensation expense
 related to issuance
 of stock options for
 services                                        3      --            127

Reclassification of
 notes receivable -
 related parties                                                                                (672)

Net loss for the
 year ended September
 30, 1998                                                                      (11,308)
                      --------------------------------------------------------------------------------------------------------------
Balances at
 September 30, 1998        316       1      11,272      11         69,284      (43,002)       (7,773)         (3,775)        --
                      --------------------------------------------------------------------------------------------------------------

Common stock issued
 to purchase minority
 interests in
 subsidiaries                                   70      --            519

Common stock and
 warrants to purchase
 common stock issued
 for cash, including
 exercise of stock
 options                                       776       1          3,774

Value of common stock
 warrants issued under
 terms of existing
 debt agreement and in
 connection with
 extension of note
 payable due date                               --      --            453

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

                                      F-5
<PAGE>
<CAPTION>
                           HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

                          CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT), continued

                                                                                                             Other
                                                                                          ------------------------------------------
                                                                                             Notes and
                                                                                             interest
                                                                                            receivable
                                                                                             -related
                                                                                           parties, from
                                                                                            issuance of,
                          Convertible                                                           or          Deferred
                        Preferred Stock       Common Stock      Capital in                collateralized  compensation  Common stock
(thousands of          --------------------------------------  excess of par  Accumulated    by, common     from stock     held in
dollars and shares)     Shares    Amount    Shares    Amount       value        deficit        stock         options      treasury
------------------------------------------------------------------------------------------------------------------------------------
<S>                     <C>     <C>      <C>        <C>        <C>         <C>              <C>             <C>        <C>
Common stock issued
 for rights to
 technology                      $              60     $--           $375

Common stock issued
 on conversion of
 preferred stock
 and in payment of
 dividends                (300)     --         602       1            194         (195)

Return of previously
 issued common stock
 by a director                                 (14)     --             --

Value of common stock
 options and warrants
 issued in connection
 with debt financing                            --      --            323

Preferred stock and
 warrants to purchase
 common stock issued
 for cash, net of
 offering costs              1      --                                899

Value of common stock
 warrants issued in
 connection with
 redeemable convertible
 preferred stock and
 convertible debt                                                   2,435

Value of extended and
 repriced warrants
 issued in connection
 with satisfaction of
 notes payable                                  --      --            201

Preferred stock cash
 dividends                                                                        (123)

Write-down of related
 party note receivable                                                                         1,209

Amortization of
 deferred compensation
 from stock options                                                                                            2,553

Net loss for the year
 ended September 30,
 1999                                                                          (28,393)
                      --------------------------------------------------------------------------------------------------------------
Balances at
 September 30, 1999         17       1      12,766      13         78,457      (71,713)       (6,564)         (1,222)        --
                      --------------------------------------------------------------------------------------------------------------
Preferred stock cash
 dividends                                                                        (297)

Reclassification of
 redeemable convertible
 preferred stock to
 convertible preferred
 stock                      38      --                              2,710

Common stock issued on
 conversion of
 convertible preferred
 stock and in payment
 of dividends               (2)     --       2,812       3          1,631          (11)


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

                                      F-6
<PAGE>
<CAPTION>
                           HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

                          CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT), continued

                                                                                                             Other
                                                                                          ------------------------------------------
                                                                                             Notes and
                                                                                             interest
                                                                                            receivable
                                                                                             -related
                                                                                           parties, from
                                                                                            issuance of,
                          Convertible                                                           or          Deferred
                        Preferred Stock       Common Stock      Capital in                collateralized  compensation  Common stock
(thousands of          --------------------------------------  excess of par  Accumulated    by, common     from stock     held in
dollars and shares)     Shares    Amount    Shares    Amount       value        deficit        stock         options      treasury
------------------------------------------------------------------------------------------------------------------------------------
<S>                     <C>     <C>      <C>        <C>        <C>         <C>              <C>             <C>        <C>
Redemption of
 convertible preferred
 stock                    (36)       $--              $           $(2,572)     $(1,882)

Common stock issued
 for cash                                    4,008       4          5,250

Common stock issued on
 conversion of debt                          3,726       3          2,961

Common stock issued in
 connection with
 redemption of debt                            214      --            256

Common stock issued in
 connection with cash
 and cashless exercises
 of warrants and options                       985       1            658

Value of common stock
 warrants and options
 issued in connection
 with convertible debt
 financing and debt
 extension                                      --      --            538

Purchase and
 cancellation of
 warrants                                                            (149)

Cancellation of
 related party notes
 receivable and
 common stock
 collateralizing the
 notes                                        (812)     (1)        (5,944)                     6,164

Write-up of related
 party note receivable                                                                           (66)

Amortization of
 deferred compensation
 from stock options                                                                                              707

Purchase of treasury
 stock, at cost                                                                                                          (1,897)

Treasury stock
 transferred to
 employee stock
 purchase plan                                                                                                               26

Cancellation of
 treasury stock                               (358)     --         (1,137)                                                1,137

Net income for the
 year ended September
 30, 2000                                                                        3,682
                      --------------------------------------------------------------------------------------------------------------
Balances at
 September 30, 2000         17      $1      23,341     $23        $82,659     $(70,221)        $(466)          $(515)     $(734)
                      ==============================================================================================================
</TABLE>
                     The accompanying notes are an integral
                 part of the consolidated financial statements.

                                      F-7
<PAGE>
<TABLE>
<CAPTION>
                     HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

                                         CONSOLIDATED STATEMENTS OF CASH FLOWS

                                                                                                     Year ended September 30,
(thousands of dollars)                                                                          1998          1999         2000
----------------------------------------------------------------------------------------- ----------- ------------- ------------
<S>                                                                                        <C>           <C>            <C>
Cash flows from operating activities:
Net income (loss)                                                                           $(11,308)     $(28,393)     $ 3,682
     Adjustments to reconcile net income (loss) to net cash provided by (used in)
       operating activities:
          Depreciation and amortization                                                          523         2,570        1,021
          Recognition of deferred revenue                                                       (654)         (876)        (801)
          Deferred income tax benefit                                                             --            --       (3,000)
          Equity in losses of investees and provision for unrealizable investments                --            --          746
          Net losses (gains) on sales of facilities and disposition of equipment                 218         1,979      (16,894)
          Gains on non-recurring transactions                                                     --            --       (1,079)
          Non-cash portion of asset write-offs and other non-recurring charges                    --         5,362       15,485
          Amortization of deferred compensation from stock options                             1,035         2,553          707
          Interest expense related to amortization of debt discount and debt
            issuance costs                                                                        --         2,075        3,034
          Extraordinary loss on early extinguishment of debt                                      --            --        7,860
          Write-down (write-up) of related party note receivable                                 (19)        1,209          (66)
          Interest expense related to issuance of convertible debt at a discount               2,046            --           --
          Minority interest in net income (losses) of consolidated subsidiaries                 (392)            9           --
      Other changes in operating assets and liabilities:
          Receivables                                                                         (4,176)       (2,837)      (3,968)
          Other current assets                                                                (1,570)          107          161
          Accounts payable and accrued liabilities                                             1,297          (993)      (1,804)
          Deferred revenue                                                                     7,486            --        1,586
          Other, net                                                                             148          (281)         (62)
                                                                                          ----------- ------------- ------------
                Net cash provided by (used in) operating activities                           (5,366)      (17,516)       6,608
                                                                                          ----------- ------------- ------------

     Cash flows from investing activities:
          Proceeds from sale of facilities and equipment                                          --         1,433       42,334
          Purchase of property, plant and equipment and facilities held for sale             (36,963)         (861)        (403)
          Net purchase of short-term investments                                                  --            --       (6,973)
          Investments in non-affiliated companies                                               (340)           --       (4,005)
          Decrease (increase) in restricted assets                                              (748)          (95)         843
          Proceeds from facility transferred under note receivable arrangement                   647           525           --
          Issuance of note receivable                                                          (660)            --           --
          Other                                                                                   --          (127)          (9)
                                                                                          ----------- ------------- ------------
               Net cash provided by (used in) investing activities                           (38,064)          875       31,787
                                                                                          ----------- ------------- ------------

     Cash flows from financing activities:
        Net proceeds from issuance of notes payable and warrants                              35,454        11,193        6,980
        Payments on notes payable, including redemption premiums                                (330)       (4,690)     (43,995)
        Net proceeds from issuance of common stock and warrants                                3,257         3,775        5,254
        Net proceeds from issuance of preferred stock and warrants                                90         6,367           --
        Preferred stock redemptions                                                               --            --       (4,454)
        Preferred stock dividends                                                                 --          (123)        (297)
        Purchase of common stock for the treasury                                                 --            --       (1,871)
        Proceeds from exercise of warrants and options                                            --            --          659
        Proceeds from stock subscription and related party receivables                           906            --           --
        Other                                                                                     --          (147)        (149)
                                                                                          ----------- ------------- ------------
         Net cash provided by (used in) financing activities                                  39,377        16,375      (37,873)
                                                                                          ----------- ------------- ------------
     Net increase (decrease) in cash and cash equivalents                                     (4,053)         (266)         522

     Cash and cash equivalents, beginning of year                                              4,780           727          461
                                                                                          ----------- ------------- ------------
     Cash and cash equivalents, end of year                                                    $ 727         $ 461        $ 983
                                                                                         ============ ============= ============

                                   (continued)

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

                                      F-8
<PAGE>
<CAPTION>
                   HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

                                 CONSOLIDATED STATEMENTS OF CASH FLOWS, continued



                                                                                                     Year ended September 30,
(thousands of dollars)                                                                          1998        1999          2000
----------------------------------------------------------------------------------------- ----------- ----------- -------------
<S>                                                                                        <C>           <C>            <C>
     Supplemental schedule of non-cash investing and financing activities:
        Cancellation of notes receivable - related parties and common stock
          collateralizing the notes                                                            $  --         $  --       $6,164
        Common stock issued on conversion of convertible debt, debt and related
          accrued interest                                                                     8,179            --        2,964
        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                                                                    --         2,761        1,634
        Cancellation of treasury stock                                                            --            --       (1,137)
        Reduction of note payable upon sale of facility held for sale                             --         5,800           --
        Notes payable issued for equipment and rights to technology                               --           850           --
        Common stock issued to purchase minority interests in subsidiaries                     5,384           519           --
        Common stock issued for rights to technology                                              --           375           --
        Property, plant and equipment acquired through reduction of accounts receivable           --           413           --
        Facility-dependent note receivable issued for sale of facility                         6,500            --           --
        Accounts payable for facilities held for sale                                            588            --           --

     Supplemental disclosure of cash flow information - cash paid for interest, net of
       amount capitalized in 1998                                                                $49        $3,646      $10,458

</TABLE>
                     The accompanying notes are an integral
                 part of the consolidated financial statements.

                                      F-9
<PAGE>

  HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   -----------


1. Organization and Nature of Operations

   Headwaters Incorporated (formerly Covol Technologies,  Inc.) was incorporated
   in Delaware in 1995. The name change to Headwaters  Incorporated  occurred in
   September  2000.  Headwaters  owns 100% of Kwai  Financial,  Inc.,  which was
   incorporated in fiscal 2000 ("2000"), and is the general partner and the sole
   limited partner in two limited partnerships, Utah Synfuel #1 Ltd. and Alabama
   Synfuel #1 Ltd., which were formed in 1996 (see Note 13).

   Headwaters'  primary business is to commercialize  its chemical  technologies
   used to  recycle  otherwise  unusable  materials  from  the  coal  and  other
   industries  into  marketable  fuel and resources.  Currently,  Headwaters has
   licensed its  technology to the owners of 28 alternative  fuel  facilities at
   various  levels of production in  approximately  ten states.  During 1999 and
   2000,  Headwaters  consummated  the sale of its  four  owned  facilities  and
   licensed its  technology  to the owners.  One of the  facilities  was sold in
   August  1999 and  three of the  facilities  were  sold in 2000 (see Note 14).
   Headwaters  has no  current  plans to  construct  or acquire  any  additional
   alternative  fuel  facilities.  During 2000,  Headwaters began evaluating and
   pursuing  investment  alternatives  for the cash generated  from  operations.
   Headwaters  has  invested  a major  portion  of this  available  cash flow in
   high-grade   government  secured  securities  and  has  made  several  equity
   investments in and loans to unrelated entities.

2. Summary of Significant Accounting Policies

   Principles of Consolidation - The consolidated  financial  statements include
   the accounts of Headwaters and three subsidiaries, Kwai Financial, Inc., Utah
   Synfuel #1 and Alabama Synfuel #1. All significant intercompany  transactions
   and accounts are eliminated in consolidation.  During 1997, Headwaters became
   a 1%  general  partner  of  Coaltech  No.  1  L.P.,  a  limited  partnership.
   Headwaters  abandoned  its interest in Coaltech in October  1999.  Based upon
   Headwaters' lack of effective control over Coaltech and the limited partners'
   financial  responsibility  for  its  operations,  Headwaters'  investment  in
   Coaltech  was  accounted  for using the  equity  method  of  accounting  with
   proportional elimination of intercompany revenues and expenses.

   Revenue Recognition - There are 28 alternative fuel facilities that currently
   utilize  Headwaters'  patented  technology  and from which  Headwaters  earns
   license fees and/or profits from the sale of chemical reagent. Non-refundable
   advance  license fees and royalty  payments have been received from licensees
   under various terms and  conditions.  These  non-refundable  license fees and
   royalties  have been  deferred and are being  recognized  on a  straight-line
   basis over the period covered by the related license and royalty  agreements,
   generally  through  2007.  Recurring  license  fees or royalty  payments  are
   recognized  in the  period  when  earned  which  coincides  with the sale and
   reporting of alternative fuel by Headwaters' licensees.

   Segment  Reporting,  Major Customers and  Concentrations of Risk - Headwaters
   operates and reports as a single industry segment.  Approximately $325,000 of
   revenue in 1998, $1,032,000 in 1999 and $15,511,000 in 2000 was from a single
   licensee;  $469,000 of revenue in 1998,  $2,673,000 in 1999 and $3,138,000 in
   2000 was from a second licensee; and $463,000 of revenue in 1998, $849,000 in
   1999 and $2,558,000 in 2000 was from a third  licensee.  Also,  approximately
   $12,296,000  and $8,509,000 of revenue in 2000 was from two other  licensees,
   most of which related to non-recurring gains on sales of facilities. No other
   single  customer  accounted  for  over  10% of  total  revenue  in  any  year
   presented.  All of the above customers are energy companies  operating in the
   United  States.  Headwaters  had trade  receivable  balances  from these five
   customers totaling $6,906,000 at September 30, 2000. Headwaters purchases all
   of the  chemical  reagent  that is  sold to  licensees  from a  single  large
   international  chemical  company.  If necessary,  the chemical  reagent could
   easily be obtained  from other  suppliers.  Headwaters  has no other  unusual
   credit risks or concentrations.

   Cash and Cash  Equivalents  -  Headwaters  considers  all highly  liquid debt
   instruments  with an  original  maturity  of three  months or less to be cash
   equivalents.   Cash  and  cash   equivalents  are  deposited  with  financial
   institutions and at times may exceed insured depository limits.

   Short-term   Investments  -  Short-term   investments  consist  primarily  of
   mortgage-  and  other  asset-backed  securities,  corporate  bonds,  and U.S.
   government securities.  By policy, Headwaters invests primarily in high-grade
   marketable securities.  All investments are defined as trading securities and
   are stated at market value as determined by the most recently traded price of
   each  security at the balance  sheet  date.  Unrealized  gains and losses are
   included in earnings.  Approximately  $100,000 of  investment  income in 2000
   related to securities held at September 30, 2000.

   Receivables  -  Allowances  are  provided  for  uncollectible  accounts  when
   appropriate. Such allowances are based on a receivable-by-receivable analysis
   of  collectibility  or  impairment  and  totaled  approximately  $121,000  at
   September  30, 2000 ($0 at September 30, 1999) for trade  receivables  and $0
   for notes  receivable.  Collateral  is not  required  for trade  receivables.
   Collateral,  generally  consisting  of most or all assets of the  debtor,  is
   required for notes receivable, which consist of short-term notes and interest
   receivable.  Due from / to related  party  consisted of amounts due from / to
   Coaltech for operating  expenses or purchases  from  Coaltech of  alternative
   fuel.

                                      F-10
<PAGE>

  HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

                                   -----------

2. Summary of Significant Accounting Policies, continued

   Facilities  and Equipment  Held for Sale - At September 30, 1999,  facilities
   and equipment held for sale consisted of three  alternative  fuel  facilities
   which were sold in 2000 (see Note 14). The  facilities and equipment held for
   sale at September  30, 2000 are stated at the lower of cost or estimated  net
   realizable  value.  Headwaters  recognizes a gain or loss on  facilities  and
   equipment  held for  sale  when  the  sale is  consummated.  The gain or loss
   represents the difference  between the sales price and the carrying value and
   is reflected as a component of revenue or expenses.

   Inventories  -  Inventories  are stated at the lower of cost or market,  with
   cost determined using an average cost method, and consisted primarily of coal
   fines and alternative fuel available for sale.

   Property, Plant and Equipment - Property, plant and equipment are recorded at
   cost,  including  where  applicable  interest  on funds  borrowed  during the
   construction  period (see Note 6), and is depreciated using the straight-line
   method over the estimated  useful lives of the assets.  Maintenance,  repairs
   and minor  replacements are charged to expense as incurred.  Upon the sale or
   retirement of property,  plant and equipment, any gain or loss on disposition
   is reflected in the statement of  operations,  and the related asset cost and
   accumulated depreciation are removed from the respective accounts.

   Equity Investments - Equity investments in less-than-50% owned affiliates are
   accounted for at cost when  Headwaters  does not have the ability to exercise
   significant  influence over operating and financial  policies of an investee.
   When  Headwaters  does have the  ability to exercise  significant  influence,
   either through its ownership of voting  securities or contractually  provided
   rights to board seats,  the equity method of accounting is used,  whereby the
   investment  is carried at cost,  plus  Headwaters'  portion of  undistributed
   earnings or losses subsequent to the date of acquisition. As of September 30,
   2000,  Headwaters  owns  from  1% to 27% of the  voting  securities  of  five
   non-public  high-risk  investee  companies.  Current  investments  range from
   approximately   $130,000  to  $1,400,000.   Allowances  are  provided,  on  a
   case-by-case basis, when management determines that the carrying value of the
   investment is not realizable.  At September 30, 2000, such allowances totaled
   approximately   $646,000.   In  addition,   in  2000  Headwaters   recognized
   approximately  $100,000  of losses  related to its equity in the  investments
   accounted for using the equity method.

   Intangible  Assets - Intangible assets consist of (i) the excess of the value
   of the  consideration  paid for the  purchase  of certain  limited  partners'
   interests in subsidiaries  over the fair values of the related assets,  which
   fair values  approximated  their carrying cost (see Note 13); and (ii) rights
   to technology,  consisting of a coal-based  alternative  fuel  technology and
   related  licensing  and  patent  rights.  These  intangible  assets are being
   amortized on the straight-line  method over  approximately ten- and nine-year
   periods,  respectively.  Accumulated  amortization  of intangible  assets was
   $410,000 as of September  30, 1999 and $302,000 as of September  30, 2000. As
   described  in more  detail in Note 15,  Headwaters  wrote  off  approximately
   $2,189,000 of intangible assets during 2000.

   Restricted  Assets - Restricted  assets consisted  primarily of highly liquid
   interest  bearing   deposits  held  as  collateral  for  certain   Headwaters
   obligations   and  cash  restricted  by  agreement  for  payment  to  one  of
   Headwaters' major vendors.

   Valuation  of  Long-Lived  Assets -  Headwaters  periodically  evaluates  the
   carrying value of long-lived assets, including intangible assets, when events
   and circumstances  warrant such a review.  The carrying value of a long-lived
   asset is considered  impaired when the  anticipated  cumulative  undiscounted
   cash flow from that asset is less than its carrying  value.  In that event, a
   loss is  recognized  based on the amount by which the carrying  value exceeds
   the fair market  value of the  long-lived  asset.  Impairment-related  losses
   recognized in Headwaters' consolidated financial statements for 1999 and 2000
   are more fully described in Note 15.

   Income  Taxes -  Headwaters  accounts  for income  taxes  using the asset and
   liability  approach in  accordance  with  Statement of  Financial  Accounting
   Standards (SFAS) No. 109,  "Accounting for Income Taxes."  Headwaters files a
   consolidated  tax return  with its 100% owned  subsidiary.  The  wholly-owned
   limited partnerships file separate tax returns, as required.

   Common  Stock,  Options and  Warrants - Common  stock  issued for services is
   accounted for using the fair value of the shares of common stock,  determined
   at the time the  services are  provided  and the  liability is incurred.  The
   measurement date used to value non-employee option grants is the option grant
   date.  Such options,  as well as warrants  issued in connection with debt and
   equity financings,  including repricings and extensions of option and warrant
   expiration dates, are valued using the Black-Scholes  model. If modifications
   to  existing  options or  warrants  relating to debt  securities  occur,  the
   incremental  value of the  modified  options or warrants is  capitalized  and
   amortized to interest expense over the remaining life of the related debt.

                                      F-11
<PAGE>

  HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

                                   -----------


2. Summary of Significant Accounting Policies, continued

   Income Per Share  Calculation - Income per share has been  computed  based on
   the weighted-average number of common shares outstanding.  Diluted income per
   share  computations  reflect the increase in  weighted-average  common shares
   outstanding that would result from the assumed exercise of outstanding  stock
   options and warrants,  calculated  using the treasury  stock method,  and the
   assumed conversion of convertible securities,  using the if-converted method,
   where such options, warrants, and convertible securities are dilutive.

   Use of Estimates - The preparation of financial statements in conformity with
   accounting  principles  generally  accepted  in the  United  States  requires
   management to make estimates and assumptions that affect the reported amounts
   of assets  and  liabilities  and the  disclosure  of  contingent  assets  and
   liabilities at the date of the financial statements, and the reported amounts
   of revenue and expenses  during the reporting  period.  Actual  results could
   differ from those estimates.

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

3. Property, Plant and Equipment

   Property, plant and equipment consisted of the following at September 30:
<TABLE>
<CAPTION>
  (thousands of dollars)                                          Range of estimated useful lives          1999           2000
  --------------------------------------------------------------- ------------------------------- -------------- --------------
<S>                                                                      <C>                            <C>           <C>
  Land                                                                                                    $ 204           $224
  Buildings and improvements                                                 15 years                    12,235             96
  Machinery and equipment                                                  5 - 7 years                    4,757            370
                                                                                                  -------------- --------------
                                                                                                         17,196            690
   Less accumulated depreciation                                                                         (3,014)          (138)
                                                                                                  -------------- --------------
   Net property, plant and equipment                                                                    $14,182           $552
                                                                                                  ============== ==============
</TABLE>
   As described in more detail in Note 15, Headwaters recorded approximately
   $12,615,000 of expense related to impaired assets during 2000. Depreciation
   expense was $474,000 in 1998, $1,988,000 in 1999, and $784,000 in 2000.

4. Notes Receivable

   Notes receivable,  all of which were recorded  initially at their fair value,
   consist of the following at September 30:
<TABLE>
<CAPTION>
   (thousands of dollars)                                                                                  1999           2000
   ---------------------------------------------------------------------------------------------- -------------- --------------
   <S>                                                                                                  <C>         <C>
   Notes Receivable

   Notes receivable  representing  bridge loans to nine companies,  primarily in
   the start-up  phase,  for amounts ranging from $200 to $500 each and with due
   dates  of  120  days  or  less  from  note   origination.   These  notes  are
   collateralized by most or all assets of the debtors.                                                     $--         $2,530
                                                                                                  ============== ==============

   Facility-dependent Note and Accrued Interest Receivable

   Note  receivable  from a corporation,  bearing  interest at 6%,  interest due
   quarterly and principal due February 2003,  collateralized  by an alternative
   fuel facility in Alabama sold by Headwaters in 1998.  This note receivable is
   recorded at an amount which does not exceed its fair value.                                           $6,500         $6,500

   Accrued interest receivable from the above corporation                                                 1,379             98
                                                                                                  -------------- --------------
                                                                                                         $7,879         $6,598
                                                                                                  ============== ==============
   Facility Transferred under Note Receivable Arrangement

   Facility  transferred  under note receivable  arrangement  with Coaltech.  In
   2000,  this  receivable was accepted by a creditor as partial payment on debt
   owed by Headwaters to the  creditor.  This creditor was a limited  partner in
   Coaltech (see Note 5).                                                                                $2,641            $--
                                                                                                  ============== ==============
</TABLE>

                                      F-12
<PAGE>

  HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

                                   -----------


5. Financing Transactions

   During  and  subsequent  to fiscal  2000,  Headwaters  entered  into  several
   financing transactions, including the following:

   Convertible Debt - In 2000,  Headwaters issued  convertible  secured debt and
   warrants to purchase  approximately  1,172,000 shares of common stock, in two
   unrelated transactions,  for total net proceeds of approximately  $2,800,000.
   The warrants had exercise  prices ranging from $.88 to $3.60 per share,  with
   expiration  dates  ranging  from  September  2002 to  December  2002 and were
   assigned  a value  of  approximately  $562,000.  This  debt,  along  with the
   convertible  debt issued to one of the same debt holders in  September  1999,
   was convertible into common stock at market rates.  During 2000,  convertible
   debt with a face amount of  approximately  $1,280,000 and a carrying value of
   approximately  $970,000 was converted into approximately  2,540,000 shares of
   common  stock.  In January  2000,  Headwaters  redeemed all of the  remaining
   convertible debt. The redemption  consideration given included  approximately
   $1,000,000 in redemption premiums plus approximately 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 consolidated statement of operations.

   Also  in  2000,  Headwaters  redeemed  all  of  the  $20,000,000  face  value
   convertible  debt. Early  prepayment  costs of approximately  $6,037,000 were
   recognized  as  an   extraordinary   item  as  a  result  of  the  redemption
   consideration  paid plus the  acceleration of amortization of the unamortized
   debt discount and debt issuance  costs in excess of the debt carrying  value.
   Also,  Headwaters redeemed,  concurrent with the debt redemption,  all of the
   preferred stock held by this entity (see Preferred Stock below).

   Note Payable to a Bank - During 2000,  Headwaters entered into a note payable
   arrangement with a bank under which Headwaters borrowed $4,000,000.  Prior to
   September 30, 2000,  $1,000,000  of this amount was repaid.  In October 2000,
   the remaining  $3,000,000  was repaid with proceeds from a revolving  line of
   credit  with the same  bank,  which line of credit  expires in January  2002.
   Funds from this line of credit  were also used to repay the  $1,838,000  note
   payable  described  in Note 6.  Borrowings  under  the  line of  credit  bear
   interest  at prime plus 1%, are  limited to the lesser of  $8,000,000  or the
   "borrowing base," as defined,  and are collateralized by license fees payable
   to Headwaters from the sale of alternative  fuel from four  alternative  fuel
   facilities and by a $6,500,000 note receivable due to Headwaters. The line of
   credit agreement contains certain operating covenants and restrictions common
   for such loans,  including  minimum  monthly  royalty revenue of $850,000 and
   quarterly earnings, as defined, of $2,000,000.

   Other Notes Payable - In February 2000, Headwaters  restructured  outstanding
   debt  associated  with the  construction  of a wash  plant  (see Note 6). The
   creditor,  which  is  a  limited  partner  of  Coaltech,   agreed  to  accept
   Headwaters'   note   receivable   from  Coaltech   (classified  as  "Facility
   transferred  under note receivable  arrangement" in the consolidated  balance
   sheet) as partial payment on the debt. The outstanding  principal and accrued
   interest,  totaling  approximately  $4,927,000,  was  reduced to a  remaining
   balance of  approximately  $1,962,000  ($1,838,000 at September 30, 2000) and
   the due date of the  restructured  note was  extended to October 31,  2000. A
   gain of  approximately  $324,000 was  recognized on this  transaction,  which
   amount  represents  the  interest  on the note  receivable  that had not been
   previously  recognized.  In October  2000,  the debt was repaid with proceeds
   from the revolving line of credit.

   In April  2000,  the  holder  of the 14%  note  payable  described  in Note 6
   converted  $2,000,000 of principal  into  approximately  1,186,000  shares of
   common stock and warrants for the purchase of approximately 296,000 shares of
   common stock.  The warrants are exercisable  through April 2005 at a price of
   $2.10 per share.

   Preferred Stock - During 2000, 200 shares of Series C preferred stock,  along
   with related  accumulated  but  undeclared  dividends,  were  converted  into
   approximately  180,000 shares of common stock,  and 24,369 shares of Series D
   convertible  preferred stock (classified as redeemable  convertible preferred
   stock  until the  provisions  allowing  the holder to require  Headwaters  to
   redeem the preferred stock were eliminated) were converted into approximately
   2,632,000  shares of common  stock.  Also in 2000,  Headwaters  redeemed  the
   remaining 35,631 shares of Series D preferred stock. The total amount paid to
   redeem  the  preferred  stock  was  approximately  $4,454,000,   including  a
   redemption premium of approximately $1,882,000, which was charged directly to
   stockholders'  equity.  As of September 30, 2000,  there were no  outstanding
   shares of Series C and Series D preferred stock.

   Common Stock - In 2000,  Headwaters issued approximately  3,629,000 shares of
   common  stock in a  private  placement  for cash  proceeds  of  approximately
   $4,666,000,  net of costs of approximately  $270,000. In another transaction,
   Headwaters issued  approximately  379,000 shares of common stock and warrants
   for the purchase of  approximately  133,000 shares of common stock to certain
   officers and directors for net cash proceeds of approximately  $588,000.  The
   warrants are exercisable through March 2005 at a price of $1.56 per share.

                                      F-13
<PAGE>

  HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

                                   -----------

5. Financing Transactions, continued

   Treasury Stock - During 2000, Headwaters began acquiring shares of its common
   stock in connection with a stock  repurchase plan announced  during the year.
   The program  authorizes  Headwaters  to purchase  stock in the open market or
   through negotiated block transactions. Through September 30, 2000, Headwaters
   purchased approximately 586,000 shares for approximately $1,897,000, of which
   approximately  358,000 shares were cancelled and approximately  14,000 shares
   were transferred to Headwaters'  employee stock purchase plan.  Subsequent to
   September   30,  2000  through   November  9,  2000,   Headwaters   purchased
   approximately 100,000 additional shares for approximately $278,000.

   Warrants  and  Options - In addition  to the  issuance of warrants  described
   previously,  the terms of existing warrants for the purchase of approximately
   183,000  shares of common stock at an exercise  price of $7.50 per share were
   amended  in 2000 to extend  the  exercise  periods  for  approximately  seven
   months.  Also the terms of existing options for the purchase of approximately
   60,000 shares of common stock were amended to reduce the exercise  price from
   $8.58 per share to $2.93 per share.  These  extended  warrants  and  repriced
   options were valued at  approximately  $70,000,  which value was amortized as
   interest over the term of the related debt.

   Also  during  2000,  existing  warrants  for the  purchase  of  approximately
   2,750,000  shares of common  stock at exercise  prices  ranging from $3.50 to
   $12.00  per  share  were   exchanged   for   warrants  for  the  purchase  of
   approximately  620,000  shares of common stock with exercise  prices of $1.32
   per share.  In 2000,  Headwaters  purchased  and  cancelled  warrants for the
   purchase of approximately 79,000 shares of common stock for a cash payment of
   approximately $149,000.

6. Liabilities

   Other  Accrued  Liabilities  -  Other  accrued  liabilities  consist  of  the
   following at September 30:
<TABLE>
<CAPTION>
   (thousands of dollars)                                                                                  1999           2000
   ---------------------------------------------------------------------------------------------- -------------- --------------
<S>                                                                                                    <C>            <C>
   Contingent liability arising from the sale of an alternative fuel facility                              $800           $800
   Commitment to a feed stock supplier for a licensee's alternative fuel facility                            --            784
   Chemical costs not yet invoiced                                                                           --            552
   Estimated costs to settle long-term contractual obligations                                              755            407
   Other                                                                                                    994          1,111
                                                                                                  -------------- --------------
                                                                                                         $2,549         $3,654
                                                                                                  ============== ==============
</TABLE>

   Notes Payable - Notes payable consist of the following at September 30:
<TABLE>
<CAPTION>
   (thousands of dollars)                                                                                   1999          2000
  --------------------------------------------------------------------------------------------------- ----------- -------------
  <S>                                                                                                  <C>         <C>
   Note payable to a bank, bearing interest at prime plus 2% (11.5% at September
   30, 2000), collateralized by license fees payable to Headwaters from the sale
   of alternative  fuel from four  alternative  fuel  facilities and by a $6,500
   note receivable due to Headwaters, repaid with proceeds from a long-term line
   of credit with this bank obtained in October 2000 (see Note 5).                                          $ --        $3,000

   Note payable to a corporation,  bearing interest at 6%,  collateralized  by a
   coal wash  plant  with a carrying  value of $0,  repaid in October  2000 with
   funds obtained from a long-term bank line of credit  obtained in October 2000
   (see Note 5).                                                                                           4,313         1,838

   Note payable to the same corporation  referred to in the preceding paragraph,
   bearing interest at prime, repaid in December 1999.                                                     2,900            --

   Note  payable  to the  same  corporation  referred  to in the  preceding  two
   paragraphs, bearing interest at 6%, repaid in January 2000.                                             6,500            --

   Note payable to a limited liability company,  bearing interest at 10%, repaid
   in April 2000.                                                                                          9,191            --

   Convertible  secured  note payable with an  investment  company,  issued at a
   discount,  bearing a stated interest rate of 2.5% on the $20,000 face amount,
   redeemed in May 2000 (see Note 5).                                                                     10,265            --

                                      F-14
<PAGE>

  HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

                                   -----------

6. Liabilities, continued

   Convertible  secured note payable to a  Headwaters  shareholder,  issued at a
   discount, bearing a stated interest rate of 8%. This note, which increased in
   amount in October  1999,  along with another  convertible  note payable to an
   unrelated  entity  issued in December  1999,  were  redeemed by Headwaters in
   January 2000.                                                                                             622            --

   Note payable to a  corporation  bearing  interest at 14%. In 2000, a total of
   $2,000 of principal  was repaid and $2,000 of principal  was  converted  into
   shares of common  stock and  warrants  for the  purchase of common  stock.  A
   member of Headwaters' Board of Directors is affiliated with this corporation.                           4,000            --

   Other                                                                                                     722           425
                                                                                                      ----------- -------------
                                                                                                          38,513         5,263
       Less: current portion                                                                             (20,626)         (208)
                                                                                                      ----------- -------------
       Total non-current                                                                                 $17,887        $5,055
                                                                                                      =========== =============
</TABLE>

   Interest Rates and Debt  Maturities - The  weighted-average  interest rate on
   notes payable,  excluding note discounts,  was 7.9% at September 30, 1999 and
   9.7% at  September  30,  2000.  Future  maturities  of  notes  payable  as of
   September 30, 2000 are as follows:

              Year ending September 30,   (thousands of dollars)
              --------------------------- ---------------------
                          2001                            $208
                          2002                           4,921
                          2003                              63
                          2004                              30
                          2005                              12
                       Thereafter                           29
                                          ---------------------
                          Total                         $5,263
                                          =====================

   Interest  Costs - During 1998,  Headwaters  incurred  total interest costs of
   approximately  $4,135,000  (including  approximately  $2,046,000  of non-cash
   interest expense  resulting from issuance of convertible debt at a discount),
   of which approximately  $1,390,000 was capitalized.  During 1999,  Headwaters
   incurred  total  interest  costs  of  approximately   $6,253,000   (including
   approximately   $2,075,000  of  non-cash   interest  expense  resulting  from
   amortization  of  debt  discount  and  debt  issuance  costs).  During  2000,
   Headwaters   incurred  total  interest  costs  of  approximately   $4,814,000
   (including  approximately  $3,034,000 of non-cash  interest expense resulting
   from  amortization  of debt  discount and debt issuance  costs).  No interest
   costs were capitalized in 1999 or 2000.

   Deferred  Compensation  - In 1993,  Headwaters  assumed a liability  to pay a
   stockholder of Headwaters $40,000 per year for seven years beginning February
   1999. The present value of the unpaid portion of this liability  ($180,000 at
   September 30, 2000),  discounted  at  approximately  5%, is included in other
   long-term liabilities in the consolidated balance sheet.

7. Preferred Stock

   As of September 30, 2000,  Headwaters had shares outstanding under two series
   of non-voting  preferred stock. There were 3,000 shares of Series A preferred
   stock issued and  outstanding  and 14,310 shares of Series B preferred  stock
   issued and outstanding.  Holders are entitled to cumulative  dividends at the
   rate of 6% per year of the liquidation value of $1,000 per share for Series A
   and  approximately  7% per year of the liquidation  value of $7 per share for
   Series B. These dividends  accumulate  whether or not they have been declared
   or whether  Headwaters has any profits.  Additional shares of preferred stock
   may be issued in lieu of cash to pay  accumulated  dividends  on both series.
   Accumulated  dividends on the Series B shares may be converted by  Headwaters
   into common stock at a conversion price of $7.00 per share.

   Upon the  liquidation of  Headwaters,  holders are entitled to receive $1,000
   per share  for  Series A and $7 per share  for  Series B,  together  with all
   accumulated  and unpaid  dividends,  if any.  Holders are entitled to convert
   their  preferred  shares to common  shares at any time.  The number of common
   shares to be received upon conversion of the Series A shares is determined by
   multiplying  the number of  preferred  shares by $1,000 and  dividing  by the
   conversion  price of $7.00 per  share.  The  number  of  common  shares to be
   received  upon  conversion  of the  Series B shares is equal to the number of
   preferred shares converted. Headwaters has the right to require any holder of
   the Series A preferred  shares to convert their shares into common stock.  No
   dividends  have been  declared on either series  through  September 30, 2000.
   Dividends in arrears at September 30, 2000 totaled approximately $561,000, or
   $187 per share for Series A, and  approximately  $21,000,  or $1.50 per share
   for Series B.

                                      F-15
<PAGE>

  HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

                                   -----------


8. Notes and Interest  Receivable - Related  Parties,  Collateralized  by Common
   Stock

   Notes and interest  receivable - related  parties,  collateralized  by common
   stock, consist of the following at September 30:
<TABLE>
<CAPTION>
   (thousands of dollars and shares)                                                                      1999           2000
   ---------------------------------------------------------------------------------------------- ------------- --------------
   <S>                                                                                                <C>            <C>
   Note receivable from a stockholder, $5,000 face amount, bearing interest at
   6%, renegotiated in November 1997, principal and interest of $515 due in
   annual installments beginning January 1999 through January 2004, with
   remaining balances due January 2005. The note is collateralized by 150 shares
   of Headwaters' common stock and options expiring in January 2006 to acquire
   25 shares of Headwaters' common stock and is personally guaranteed by the
   stockholder. The carrying value is equal to the fair value of the 150 shares
   and options and is net of an unamortized discount of $1,281 based upon an
   imputed rate of 10.25%, and an allowance for impairment of $3,319 in 1999 and
   $3,253 in 2000. No interest income was recognized in 1998. Interest income of
   $515 was recognized in both 1999 and 2000 based on cash payments received.                             $400           $466

   Notes and interest receivable from 16 current and former officers and
   employees, issued upon exercise of options to purchase common stock of
   Headwaters and collateralized by the shares of Headwaters' common stock
   purchased. These notes were cancelled in 2000, as described below. No
   interest income was recognized during 1998, 1999 or 2000.                                             5,492             --

   Notes receivable from seven former officers of Headwaters, originally
   collateralized by partnership interests which were subsequently exchanged for
   shares of Headwaters' common stock (see Note 13). These notes were cancelled
   in 2000, as described below. No interest income was recognized during 1998,
   1999 or 2000.                                                                                           672             --
                                                                                                  ------------- --------------
                                                                                                        $6,564           $466
                                                                                                  ============= ==============
</TABLE>

   In 2000, Headwaters entered into termination  agreements with the current and
   former officers and employees having notes and interest payable to Headwaters
   totaling approximately $6,164,000. The agreements called for the cancellation
   of the outstanding balances under the notes,  including interest, in exchange
   for the surrender and cancellation of the outstanding  shares of common stock
   collateralizing the notes. These transactions resulted in the cancellation of
   approximately 812,000 shares of common stock and the recognition of a loss of
   approximately  $219,000 (see Note 15),  which amount  represents the interest
   recognized on the notes in prior periods.

9. Fair Value of Financial Instruments

   SFAS No.  107  requires  that  the fair  market  value of  certain  financial
   instruments  be disclosed in the  financial  statements.  Headwaters  has the
   following  financial  instruments  that are subject to the provisions of SFAS
   No. 107:

     *     Cash and cash  equivalents
     *     Short-term investments
     *     Trade and notes receivable
     *     Facility-dependent note receivable
     *     Notes payable
     *     Note receivable - related party, collateralized by common stock

   Substantially all of Headwaters'  financial instruments are either carried at
   fair  value  as of the  balance  sheet  date or are of a  short-term  nature.
   Accordingly,  while  the  fair  values  of some of the  individual  financial
   instruments vary somewhat from their carrying values,  the aggregate carrying
   values as reflected in the  consolidated  financial  statements  for 1999 and
   2000 approximated fair value, with the exception of the notes payable in 1999
   totaling  approximately  $38,500,000  for which the  aggregate  market  value
   approximated $42,300,000 at September 30, 1999.

                                      F-16
<PAGE>

  HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

                                   -----------

10. Stock Options and Warrants

   Stock Options - At September 30, 2000,  Headwaters  had one stock option plan
   (the "Option Plan") under which 2,400,000 shares of common stock are reserved
   for ultimate issuance.  A committee of Headwaters' Board of Directors,  or in
   its absence  the Board (the  "Committee"),  administers  and  interprets  the
   Option Plan.  This  Committee is authorized to grant options and other awards
   both  under the terms of the  Option  Plan and  outside  the  Option  Plan to
   eligible employees,  officers,  directors, and consultants of Headwaters. The
   Option Plan  provides for the granting of both  incentive  stock  options and
   non-statutory stock options.  Terms of options granted under the Option Plan,
   including  vesting  requirements,  are determined by the  Committee.  Options
   granted  under the  Option  Plan vest over  periods  ranging up to ten years,
   expire ten years from the date of grant and are not  transferable  other than
   by will or by the laws of descent and  distribution.  Incentive  stock option
   grants must meet the requirements of the Internal Revenue Code.

   Headwaters  has  elected to  continue to apply  Accounting  Principles  Board
   Opinion No. 25,  "Accounting  for Stock Issued to Employees"  ("APB 25"), and
   related interpretations in accounting for options. The alternative fair value
   method of accounting  prescribed by SFAS No. 123, "Accounting for Stock-Based
   Compensation" ("SFAS 123"),  requires the use of option valuation models that
   were not developed for use in valuing  employee stock  options,  as discussed
   below. Accordingly, under APB 25, no compensation expense has been recognized
   for stock  option  grants  to  employees,  officers  and  directors  when the
   exercise  price of stock  options  equals  or  exceeds  the  market  price of
   Headwaters' common stock on the date of grant.

   When  options  are issued  with terms  considered  compensatory,  the related
   compensation  expense is  amortized  to expense  over the  specified  vesting
   period on a straight-line  basis. There was no deferred  compensation related
   to options granted in 1998, 1999 and 2000. The amortized compensation expense
   related to  compensatory  options  granted in prior  years was  approximately
   $908,000,  $2,553,000  and  $707,000 for 1998,  1999 and 2000,  respectively.
   Compensation   expense  related  to  options  that  vested   immediately  was
   approximately $127,000 for 1998 and $0 for 1999 and 2000.

   If Headwaters had elected to account for options  granted based on their fair
   value,  as  prescribed  by SFAS 123, net income  (loss) and income (loss) per
   share  would have been  changed to the pro forma  amounts  shown in the table
   below.
<TABLE>
<CAPTION>
  (thousands of dollars, except per-share data)                                          1998            1999            2000
  --------------------------------------------------------------------------- ---------------- --------------- ---------------
<S>                                                                                 <C>             <C>                <C>
  Net income (loss) attributed to common stockholders -- reported                   $(11,645)       $(29,704)          $3,246
                                                      -- pro forma                   (14,567)        (32,969)           1,532
  Basic income (loss) per share -- reported                                            (1.17)          (2.39)             .17
                                -- pro forma                                           (1.46)          (2.65)             .08
  Diluted income (loss) per share -- reported                                          (1.17)          (2.39)             .15
                                  -- pro forma                                         (1.46)          (2.65)             .08
</TABLE>

   The  fair  value  of  each  stock  option  grant  was  determined  using  the
   Black-Scholes  option pricing model and the following  assumptions:  expected
   stock price volatility of .50 to .70,  risk-free  interest rates ranging from
   4.4% to 7.8%,  weighted average expected option lives of 4 to 10 years and no
   dividends.  The Black-Scholes option valuation model was developed for use in
   estimating   the  fair  value  of  traded   options  which  have  no  vesting
   restrictions and are fully transferable. In addition, option valuation models
   require the input of highly subjective  assumptions  including expected stock
   price  volatility.  Because  Headwaters'  stock options have  characteristics
   significantly  different from those of traded options, and because changes in
   the subjective  input  assumptions  can materially  affect the fair value, in
   management's  opinion,  the  existing  models  do not  necessarily  provide a
   reliable single measure of the fair value of stock options.

                                      F-17
<PAGE>

  HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

                                   -----------

10. Stock Options and Warrants, continued

   The  following  table is a summary of activity for all of  Headwaters'  stock
   options,  including  options not granted under the Option Plan, for the years
   ended September 30:
<TABLE>
<CAPTION>
                                                         1998                       1999                      2000
                                              --------------------------- ------------------------- --------------------------
                                                              Weighted                  Weighted                   Weighted
                                                              Average                    Average                   Average
                                                              Exercise                  Exercise                   Exercise
  (thousands of shares)                          Shares        Price        Shares        Price        Shares       Price
  ------------------------------------------- ------------- ------------- ------------ ------------ ------------ -------------
<S>                                                  <C>          <C>           <C>          <C>          <C>           <C>
  Outstanding at beginning of year                   1,614        $ 2.85        2,370        $6.29        2,971         $6.18
     Granted                                           850         12.34          667         5.40        1,112          3.31
     Exercised                                        (94)          1.93         (30)         1.50         (42)          1.50
     Canceled                                           --            --         (36)         2.34        (219)         10.37
                                              ------------- ------------- ------------ ------------ ------------ -------------
  Outstanding at end of the year                     2,370        $ 6.29        2,971        $6.18        3,822         $5.16
                                              ============= ============= ============ ============ ============ =============
  Exercisable at end of year                         1,038         $5.23        1,801        $5.23        2,201         $5.29
                                              ============= ============= ============ ============ ============ =============

  Weighted average fair value of options
  granted during the year below market                            $10.21                      none                       none

  Weighted average fair value of options
  granted during the year at market                                $9.91                     $2.93                      $1.92

  Weighted average fair value of options
  granted during the year above market                              none                     $2.92                      $3.98

<CAPTION>

   The  following  table   summarizes   information   about  all  stock  options
   outstanding at September 30, 2000:

   (thousands of shares)                        Options Outstanding                               Options Exercisable
   ------------------------ ------------------------------------------------------------- ------------------------------------
                                                       Weighted
                                   Number               Average            Weighted            Number            Weighted
                               Outstanding at          Remaining            Average        Exercisable at        Average
      Range of Exercise         September 30,       Contractual Life       Exercise         September 30,        Exercise
           Prices                   2000                in Years             Price              2000              Price
   ------------------------ ---------------------- ------------------- ------------------ ------------------ -----------------
         <S>                               <C>                   <C>             <C>                 <C>              <C>
            $1.50 to $3.00                  1,728                 4.9             $ 1.85              1,136            $ 1.68
            $4.00 to $9.00                  1,441                 6.6               5.62                652              6.73
          $11.00 to $13.56                    653                 7.2              12.92                413             12.96
                            ----------------------                                        ------------------
                                            3,822                                                     2,201
                            ======================                                        ==================
</TABLE>

   Common  Stock  Warrants - As of  September  30,  2000,  there  were  warrants
   outstanding for the purchase of approximately  724,000 shares of common stock
   at prices  ranging  from $1.32 to $3.84 per share and with  expiration  dates
   ranging from October 2001 to April 2005. All of these warrants were issued in
   connection  with private  placements of common and  preferred  stock or notes
   payable during 1999 and 2000 (see Note 5).

                                      F-18
<PAGE>

  HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

                                   -----------


11. Basic and Diluted Income Per Share
<TABLE>
<CAPTION>
  (thousands of dollars and shares, except per-share data)                            1998            1999            2000
  ---------------------------------------------------------- -------------- --------------- --------------- ---------------
<S>                                                                               <C>             <C>               <C>
  Numerator:
       Income (loss) before extraordinary item                                    $(11,308)       $(28,393)         $11,542
       Extraordinary item                                                               --              --           (7,860)
                                                                            --------------- --------------- ---------------
       Net income (loss)                                                           (11,308)        (28,393)           3,682
       Preferred stock dividends (undeclared)                                         (337)           (466)            (378)
       Imputed preferred stock dividends                                                --            (845)             (58)
                                                                            --------------- --------------- ---------------
  Numerator for basic earnings per share -- net income
    (loss) attributable to common stockholders                                     (11,645)        (29,704)           3,246
  Effect of dilutive securities - preferred stock dividends                             --              --              139
                                                                            --------------- --------------- ---------------
  Numerator for diluted earnings per share -- net income
    (loss) attributable to common stockholders after assumed
    conversions                                                                   $(11,645)       $(29,704)         $ 3,385
                                                                            =============== =============== ===============
  Denominator:
  Denominator for basic earnings per share --
    weighted-average shares outstanding                                              9,969          12,418           19,468
  Effect of dilutive securities:
    Shares issuable upon exercise of options and warrants                               --              --              391
    Shares issuable upon conversion of preferred stock                                  --              --            2,376
                                                                            --------------- --------------- ---------------
  Total dilutive potential shares                                                       --              --            2,767
                                                                            --------------- --------------- ---------------
  Denominator for diluted earnings per share -- weighted- average shares
    outstanding after assumed exercises and conversions                              9,969          12,418           22,235
                                                                            =============== =============== ===============

  Basic earnings per share:
  Income (loss) before extraordinary item                                           $(1.17)         $(2.39)            $.57
  Extraordinary item                                                                    --              --             (.40)
                                                                            --------------- --------------- ---------------
  Net income (loss) per common share                                                $(1.17)         $(2.39)            $.17
                                                                            =============== =============== ===============

  Diluted earnings per share:
  Income (loss) before extraordinary item                                           $(1.17)         $(2.39)            $.50
  Extraordinary item                                                                    --              --             (.35)
                                                                            --------------- --------------- ---------------
  Net income (loss) per common share                                                $(1.17)         $(2.39)            $.15
                                                                            =============== =============== ===============
</TABLE>

   During the periods presented,  Headwaters'  potentially  dilutive  securities
   consisted  of  options  and  warrants  for  the  purchase  of  common  stock,
   convertible debt and convertible preferred stock. For both 1998 and 1999, all
   potentially dilutive securities were anti-dilutive and were not considered in
   the  calculation of diluted  earnings per share.  For 2000,  some options and
   warrants and certain convertible  preferred stock, most of which was redeemed
   in April and May 2000  (see Note 5),  were  dilutive;  all other  potentially
   dilutive  securities  (for  the  purchase  of or  conversion  into a total of
   approximately  5,000,000 shares of common stock) were anti-dilutive (exercise
   price  exceeded  market price) and were not  considered  in the  calculation.
   Imputed  preferred stock  dividends were calculated  based upon the amount by
   which the price of Headwaters'  common stock exceeded the conversion price at
   the date convertible preferred shares were issued.

12. Income Taxes

   Headwaters  had no income tax provision or benefit in 1998 or 1999 because of
   its net operating loss position.  In 2000,  Headwaters reported an income tax
   benefit of  $2,900,000,  consisting of the  recognition  of $3,000,000 of its
   deferred  tax  asset,   reduced  by  $100,000  of  alternative  minimum  tax.
   Headwaters  believes it is more likely than not that the portion of the total
   deferred tax asset  recognized in 2000 will be realized as a result of income
   to be  recognized  from the  amortization  of deferred  revenue in subsequent
   periods.

                                      F-19
<PAGE>

  HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

                                   -----------

12. Income Taxes, continued

   As of September 30, 2000,  Headwaters has net operating loss carryforwards of
   approximately  $39,700,000 which can be used to offset future taxable income.
   The net operating  loss  carryforwards  expire from 2010 to 2019.  Headwaters
   also has  approximately  $200,000  in  research  and  development  tax credit
   carryforwards  which can be used to offset  future tax  liabilities.  The tax
   credit  carryforwards  expire  from 2007 to 2011.  The  utilization  of these
   carryforwards  against  future taxable income may become subject to an annual
   limitation due to changes in ownership of Headwaters' common stock.

   The provision for income taxes for the years ended  September 30, 1998,  1999
   and  2000  differs  from the  statutory  federal  income  tax rate due to the
   following:
<TABLE>
<CAPTION>
  (thousands of dollars)                                                              1998            1999           2000
  --------------------------------------------------------------------------- ------------- --------------- --------------
<S>                                                                               <C>             <C>              <C>
  Tax provision (benefit) at statutory rate                                        $(3,844)        $(9,653)          $1,252
  Alternative minimum tax                                                               --              --              100
  Change in valuation allowance                                                      4,200          10,600           (3,600)
  State income taxes, net of federal tax effect                                       (373)           (936)             122
  Net operating loss carryforwards                                                      --              --           (1,100)
  Other, including redetermination of prior years' tax estimates                        17             (11)             326
                                                                              ----------------------------------------------
     Federal income tax provision (credit)                                         $     0         $     0          $(2,900)
                                                                              =============== =============== ==============
<CAPTION>

   The  components  of the net deferred  tax asset as of September  30, 1999 and
   2000 are as follows:

  (thousands of dollars )                                                                             1999             2000
  ------------------------------------------------------------------------------------------- -------------- ---------------
  Net operating loss carryforwards                                                                 $16,300          $14,800
  Research and development tax credit carryforwards                                                    200              200
  License fee revenue recognition                                                                    3,200            3,900
  Compensation expense related to common stock options                                               3,000            3,300
  Write-down of related party note receivable                                                        1,200            1,100
  Estimated liabilities                                                                                300              300
  Depreciation                                                                                         400               --
  Other                                                                                                 --              400
                                                                                              ------------------------------
       Total deferred tax assets                                                                    24,600           24,000
  Valuation allowance                                                                              (24,600)         (21,000)
                                                                                              ------------------------------
       Net deferred tax asset                                                                     $      0         $  3,000
                                                                                              ==============================
</TABLE>

   The  valuation   allowance   increased  by  $4,200,000  during  1998  and  by
   $10,600,000  during 1999.  The  valuation  allowance  decreased by $3,600,000
   during  2000,  representing  the  decreased  amount of deferred tax assets at
   September 30, 2000 not considered recoverable through the reversal of taxable
   temporary  differences or the generation of future taxable  income.  SFAS No.
   109 requires that a valuation allowance be provided if it is more likely than
   not that some  portion or all of a deferred  tax asset will not be  realized.
   Headwaters'  ability to realize the benefit of its  deferred  tax assets will
   depend on the  generation of future  taxable  income  through its  continuing
   operations. Because Headwaters has not generated significant operating income
   to date, Headwaters believes that a valuation allowance of $21,000,000 should
   be provided as of September  30, 2000.  This  estimate may change in the near
   term depending on the level of earned license fees received in 2001.

13. Purchase of Limited Partners' Interests in Subsidiaries

   In September 1998,  Headwaters  formally  offered the limited partners in its
   two  consolidated  subsidiaries,  Utah Synfuel #1 and Alabama  Synfuel #1, an
   exchange of Headwaters' common stock for their limited partnership interests.
   During  September  through November 1998, all but one of the limited partners
   exchanged   their  interests  and  Utah  Synfuel  #1  became  a  wholly-owned
   subsidiary of Headwaters and Alabama Synfuel #1 became a 98%-owned subsidiary
   of  Headwaters.  Approximately  610,000 shares of common stock were issued in
   these transactions. In 2000, Headwaters reached an agreement settling several
   outstanding  issues with the remaining  limited partner of Alabama Synfuel #1
   following  which  Alabama  Synfuel  #1 became a  wholly-owned  subsidiary  of
   Headwaters.  The  carrying  value of the  intangible  assets  recorded in the
   exchange  transactions,  net of accumulated  amortization,  was approximately
   $2,786,000 at September 30, 1999 and approximately  $464,000 at September 30,
   2000 (see Note 15).

                                      F-20
<PAGE>

  HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

                                   -----------

14. Sale of Facilities

   Headwaters' business plan called for the construction and sale of alternative
   fuel manufacturing  facilities and the licensing of Headwaters' technology to
   facility purchasers to generate ongoing royalties.  In 1998,  Headwaters sold
   an alternative  fuel facility  located in Alabama on which a loss of $218,000
   was  recognized.  The sales  price was  $6,500,000  payable  in the form of a
   nonrecourse   promissory  note  collateralized  by  the  facility.  In  1999,
   Headwaters  sold a  facility  located  in  Pennsylvania  on  which  a loss of
   approximately  $1,839,000 was recognized.  Headwaters  remained  contingently
   liable for $800,000 of the facility debt which liability has been recorded in
   other  accrued  liabilities  (see Note 6).  Headwaters  also  entered into an
   agreement  under which it operates this  facility on behalf of the owner.  In
   2000, upon achieving specified operating performance  milestones,  Headwaters
   received  additional cash payments related to the sale of this facility.  The
   cash proceeds  from these  payments,  net of  obligations  to third  parties,
   approximated  $7,377,000.  Of the net amount received,  Headwaters recognized
   $4,400,000 as revenue  because there were no ongoing  obligations  associated
   with those payments. Headwaters deferred the recognition of $2,977,000, which
   amount  was  characterized  as  prepaid  royalties.   This  amount  is  being
   recognized as revenue on a straight-line basis through December 2007.

   In 2000,  Headwaters sold the three remaining  alternative fuel facilities it
   owned  plus an  option to  acquire a  licensee  facility.  One of these  sold
   facilities was located in Utah, two of these  facilities were located in West
   Virginia,  and the facility  under  option was located in Nevada.  Headwaters
   reported net gains on these transactions totaling approximately  $12,470,000.
   Headwaters  also  entered into its standard  supply  agreements  with the new
   owners of the facilities to sell  proprietary  chemical  material used at the
   facilities. Headwaters also receives ongoing royalties based upon the sale of
   alternative fuel from the facilities.

15. Gains  on  Non-recurring   Transactions  and  Asset  Write-offs  and   Other
    Non-recurring Charges

   Gains on Non-recurring Transactions - In fiscal 1998, Headwaters recorded net
   gains on sales of  chemical  plants  of  $200,000.  During  2000,  Headwaters
   recorded  non-recurring  gains of  approximately  $1,079,000  related  to the
   satisfaction  of a  contingent  contract  liability  ($755,000)  and the gain
   recognized on the Coaltech note receivable transaction described in Note 5.

   1999  Asset  Write-offs  and Other  Non-recurring  Charges - In fiscal  1999,
   certain  assets,  primarily  consisting  of  leasehold  improvements  on  the
   property where a small alternative fuel facility was located, were abandoned.
   The carrying  value of these assets,  totaling  approximately  $556,000,  was
   written off during  1999.  Based on the  uncertainty  of  recovering  certain
   advances on coal fine inventories paid from 1997 through May 1999, Headwaters
   wrote off $3,677,000 of advances on inventories in 1999. In addition, in 1999
   Headwaters  wrote off a $660,000 note receivable and recorded a liability for
   approximately  $469,000 related to a settlement agreement with a company that
   had  provided  Headwaters  with  advice  with  respect  to the use of certain
   alternative  fuel  technology,  certain  financing  obtained  and the sale of
   certain  alternative  fuel  manufacturing  facilities.   Finally,  Headwaters
   recorded approximately  $2,033,000 of non-cash,  incremental  amortization of
   deferred  compensation from stock options,  resulting from the termination of
   employees  whose stock options became fully vested upon  termination.  All of
   these 1999 write-offs and provisions total  approximately  $7,395,000,  which
   amount is recorded as asset write-offs and other non-recurring charges in the
   consolidated   statement  of  operations.   Of  this  amount,   approximately
   $5,362,000 represented non-cash expenses.

   2000  Asset  Write-offs  and Other  Non-recurring  Charges - In fiscal  2000,
   Headwaters recorded an impairment charge of approximately $14,804,000 related
   to assets located in Utah and Alabama. This impairment charge consisted of an
   approximate  $12,615,000  write-down to net realizable value of certain plant
   and equipment  which remained on the sites when the facilities  were sold and
   was idled,  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  also recorded  employee  severance and other
   non-cash charges from incremental  amortization of deferred compensation from
   stock  options  (resulting  from the  termination  of  employees  whose stock
   options  became  fully  vested  upon  termination)   totaling   approximately
   $1,443,000.  Other  non-recurring  settlement  charges  ($979,000)  and asset
   write-downs  ($532,000) were recorded in 2000. All of these asset  write-offs
   and non-recurring charges totaled approximately $17,758,000.  Of this amount,
   approximately $15,485,000 represented non-cash expenses.

16. Commitments and Contingencies

   Commitments  and  contingencies  as  of  September  30,  2000  not  disclosed
   elsewhere, are as follows:

   Leases - Rental  expense was  approximately  $480,000 in 1998,  $1,309,000 in
   1999 and $255,000 in 2000. Headwaters has noncancellable operating leases for
   equipment and for real estate. At September 30, 2000, minimum rental payments
   due under these leases are as follows:

                                      F-21
<PAGE>

  HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

                                   -----------

16.  Commitments and Contingencies, continued

             Year ending September 30:    (thousands of dollars)
            ----------------------------- -----------------------
                        2001                       $143
                        2002                        170
                        2003                        147
                        2004                        116
                        2005                        119
                     Thereafter                      44
                                          -----------------------
                                                   $739
                                          =======================

   Employee  Benefit Plans - In 2000,  Headwaters'  Board of Directors  approved
   three employee  benefit  plans,  the  Headwaters  Technologies  401(k) Profit
   Sharing Plan,  the 2000 Employee  Stock  Purchase  Plan,  and the  Headwaters
   Incorporated  Incentive  Bonus  Plan.  Under  the terms of the  401(k)  Plan,
   employees may elect to make  tax-deferred  contributions to the Plan of up to
   15% of their compensation,  subject to statutory limitations.  Headwaters may
   elect to match employee  contributions up to a specified  maximum rate, which
   matching contributions,  if made, vest over a four-year period. Headwaters is
   not required to have net income in order to make a matching contribution.

   The 2000 Employee  Stock  Purchase Plan provides  eligible  employees with an
   opportunity  to  increase  their  proprietary  interest  in  the  success  of
   Headwaters  by purchasing  stock in Headwaters on favorable  terms and to pay
   for such purchases through payroll  deductions.  A total of 500,000 shares of
   common  stock are  reserved  for  issuance  under  the Plan.  Under the Plan,
   employees purchase shares of stock directly from Headwaters, which shares are
   made available  primarily from treasury shares repurchased on the open market
   or from authorized but unissued  shares,  if necessary.  Headwaters'  current
   intent is to use  shares  being  purchased  on the open  market to meet these
   requirements. The Plan is intended to comply with Section 423 of the Internal
   Revenue  Code,  but is not subject to the  requirements  of ERISA.  Employees
   purchase  stock  through  payroll  deductions  of  from  1% to  10%  of  cash
   compensation,  subject to certain  limitations.  The stock is  purchased in a
   series of calendar-month offerings. The cost per share to the employee is 85%
   of the  lesser of the fair  market  value at the  beginning  of the  offering
   period or the end of the offering period.

   The Incentive Bonus Plan, approved annually by the compensation  committee of
   the board of  directors,  provides  for  annual  cash  bonuses  to be paid if
   Headwaters  accomplishes  certain  financial  goals  and  if  employees  meet
   individual goals. A participant's cash bonus is based on Headwaters'  success
   in exceeding  specified  financial  performance  targets  established  by the
   compensation  committee,  the employee's base pay, and individual performance
   during the year. Headwaters' financial goals are based upon an economic value
   added concept  ("EVA") which  purports to more closely align with a company's
   share price than other measurements of performance.

   Substantially  all employees of Headwaters are eligible to participate in the
   401(k) and Stock  Purchase  plans  after  meeting  certain  age and length of
   employment requirements. All employees, except those directly involved in the
   operation of an alternative  fuel facility owned by a licensee,  are eligible
   to  participate  in the  Incentive  Bonus Plan.  The total amount  charged to
   operations in 2000 for all of the above plans was approximately $1,768,000.

   Legal or Contractual  Matters - NEICO/Earthco.  In February 1997,  Headwaters
   entered  into a contract  on a parcel of real  property  located  near Price,
   Utah, in which Headwaters  obtained certain possessory and related interests,
   Headwaters'  primary  purpose being to obtain a source of coal fines to serve
   as  feedstock  for a  nearby  alternative  fuel  facility.  In  August  1999,
   Headwaters  alleged  that  Earthco had  breached a material  provision of the
   contract  because  Earthco  did not have  title to the  property.  Headwaters
   refused to tender its August 1999  payment  because of Earthco's  breach.  In
   addition,   Headwaters   contended  that  the  quantity   and/or  quality  of
   recoverable  coal  fines was  substantially  less than  what  Headwaters  had
   understood.  Earthco subsequently  countered with allegations that Headwaters
   had breached its obligations  under the contract,  including  failure to make
   the August 1999 payment.

   In November  1999,  Headwaters  was served with a complaint  from the Seventh
   Judicial  District  Court of  Carbon  County,  Utah  styled  Nevada  Electric
   Investment  Company v.  Earthco,  et al. In the  complaint,  Nevada  Electric
   Investment  Company  ("NEICO")  alleged  that it is the  lawful  owner of the
   property near Wellington,  Utah described in Headwaters'  lease from Earthco.
   NEICO  sought a  declaratory  judgement  that  Headwaters  is not entitled to
   possession  of the  property  due to the lack of  ownership  by Earthco.  The
   complaint also sought further relief from Earthco.

                                      F-22
<PAGE>

  HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

                                   -----------

16. Commitments and Contingencies, continued

   Headwaters  received  Earthco's  answer,  counterclaims  and  cross-claim  in
   December 1999.  Earthco's  cross-claim  against  Headwaters alleged breach of
   contract  and  prayed  for  substantial  damages in an amount to be proven at
   trial but alleged to be in excess of $5 million.  Headwaters  filed its reply
   and cross-claim  against Earthco in January 2000 denying Earthco's claims and
   asserting claims of  misrepresentation,  breach of lease,  unjust enrichment,
   and related claims and for general and consequential  damages in an amount to
   be proven at trial.

   NEICO,  Earthco and  Headwaters  have  settled  their  disputes.  Earthco and
   Headwaters  entered into a mutual release of claims.  Earthco confirmed title
   to the property in NEICO.  In September  2000  Headwaters  entered into a one
   year  lease for the wash  plant  parcel  directly  with  NEICO and  otherwise
   confirmed  title to the property in NEICO.  The parties are awaiting an order
   of dismissal from the court.

   K-Lee  Processing.  In March  1997,  Headwaters  entered  into an Amended and
   Restated  Supply  Agreement  for  the  purchase  of  coal  fines  from  K-Lee
   Processing,  Inc. and Concord Coal  Recovery  Limited  Partnership  (together
   "K-Lee").  Headwaters periodically purchased coal fines from K-Lee throughout
   1997.  K-Lee  invoiced  Headwaters  for a total of 108,000  tons of fines and
   Headwaters paid for those fines. However, K-Lee failed to deliver 11,059 tons
   valued  at  $320,716.  K-Lee  has  refused  to  refund  the  overpayment  for
   non-delivered  fines. In July 2000 Headwaters filed a complaint against K-Lee
   Processing,  Inc. and Concord Coal Recovery Limited Partnership in the United
   States District Court for the Northern District of Alabama seeking damages in
   the  amount of  $320,716  for the coal  fines  purchased  but not  delivered.
   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.

   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,  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. 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 the action,  a
   purported shareholder of Headwaters alleges 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 complaint seeks on behalf of Headwaters from OZ unspecified  money
   damages to be proven at trial,  attorney fees, and other relief.  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.

                                      F-23
<PAGE>

  HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

                                   -----------

16. Commitments and Contingencies, continued

   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 out
   of 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.

   Employment Contracts - Headwaters has entered into employment agreements with
   the Chief Executive Officer,  President,  Chief Financial Officer and others.
   The agreements generally are renewable by Headwaters and have terms of one to
   three  years.  They provide for annual  salaries  and  benefits  ranging from
   approximately   $132,000  to  $250,000  annually  per  officer  or  employee,
   currently  totaling  approximately  $1,142,000 for all officers and employees
   combined.   All  agreements  provide  for  termination  benefits,   generally
   consisting of at least one-year's salary.

17. Events Subsequent to September 30, 2000

   Events subsequent to September 30, 2000, not disclosed elsewhere, include the
   following.

   From October 1, 2000 through  December 1, 2000,  Headwaters  made  additional
   finance loans of approximately  $1,050,000 and additional equity  investments
   of  approximately  $1,558,000  under the same general  terms as the loans and
   investments made in fiscal 2000.


18. Quarterly Financial Data (Unaudited)

    Summarized quarterly financial data for 1999 and 2000 is as follows:
<TABLE>
<CAPTION>
                                                                                1999
                                                  ------------------------------------------------------------------
                                                     First        Second        Third        Fourth
(thousands of dollars)                              Quarter      Quarter       Quarter      Quarter      Full Year
------------------------------------------------- ------------ ------------- ------------ ------------- ------------
<S>                                                   <C>           <C>          <C>            <C>          <C>
     Net revenue                                      $ 1,382       $ 1,143      $ 1,577        $2,617       $6,719
     Gross loss                                        (2,640)       (1,684)      (1,741)       (1,990)      (8,055)
     Net loss                                          (4,558)       (5,057)      (5,527)      (13,251)     (28,393)
       Non-recurring asset write-offs and
         other non-recurring charges included in
         net loss (1)                                      --          (556)          --        (6,839)      (7,395)
       Non-recurring loss on sale of facility
         included in net loss (1)                          --            --           --        (1,839)      (1,839)

     Basic net loss per common share (2)                 (.39)         (.41)        (.48)        (1.09)       (2.39)
     Diluted net loss per common share (2)               (.39)         (.41)        (.48)        (1.09)       (2.39)

                                      F-24
<PAGE>

  HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

                                   -----------

18. Quarterly Financial Data (Unaudited), continued
<CAPTION>
                                                                                2000
                                                  ------------------------------------------------------------------
                                                     First        Second        Third        Fourth
(thousands of dollars)                              Quarter      Quarter       Quarter       Quarter     Full Year
------------------------------------------------- ------------ ------------- ------------ -------------- -----------
<S>                                                   <C>            <C>         <C>           <C>          <C>
     Net revenue                                      $11,049        $7,899      $15,000       $11,887      $45,835
       Non-recurring gains (losses) on sales
         of facilities included in net revenue(1)       5,341          (598)       8,527         3,600       16,870
       Other non-recurring gains included in
         net revenue (1)                                   --         1,079           --            --        1,079
     Gross profit                                       8,600         5,832       12,363         8,602       35,397
     Income (loss) before extraordinary item           (1,926)        2,137        8,259         3,072       11,542
     Net income (loss)                                 (1,926)          314        2,222         3,072        3,682
       Non-recurring asset write-offs and
         other non-recurring charges included in
         net income (loss) (1)                        (11,021)         (841)      (1,559)       (4,337)     (17,758)
     Basic net income (loss) per common share(2)         (.16)          .01          .09           .13          .17
     Diluted net income (loss) per common share(2)       (.16)          .01          .09           .12          .15
</TABLE>


(1)  The non-recurring gains and losses on sales of facilities, other
     non-recurring gains, and asset write-offs and other non-recurring charges
     are more fully described in Notes 14 and 15.

(2)  In accordance with SFAS No. 128, "Earnings Per Share," net income (loss)
     per common share is computed independently for each of the quarters
     presented and the sum of the quarterly computations does not equal the
     total computed for the year.

                                      F-25