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


                                   FORM 10-K/A


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

                  For the fiscal year ended September 30, 2001,

                                       or

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

                  For the transition period from _____ to _____

                         Commission file number 0-27808

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

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

         11778 South Election Road, Suite 210
                     Draper, Utah                            84020
       (Address of principal executive offices)            (Zip Code)

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

           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. [X]

         The aggregate market value of the voting stock held by non-affiliates
of the registrant as of November 30, 2001 was $265,687,832 based upon the
closing price on the Nasdaq Stock 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
November 30, 2001 was 24,342,384.

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

                       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 2002.

<PAGE>

This Form 10-K/A is the result of a re-audit of Headwaters' financials
statements as of and for the fiscal years ended September 30, 2000 and 2001 due
to a change in Headwaters' independent accountants. The information contained in
this Form 10-K/A generally has not been updated to reflect events and
circumstances occurring since its original filing. Such matters have been or
will be addressed in subsequent reports filed with the SEC.


                                TABLE OF CONTENTS
                                                                            Page
PART I

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

PART II

ITEM 5.      MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
             STOCKHOLDER MATTERS..............................................10
ITEM 6.      SELECTED FINANCIAL DATA..........................................12
ITEM 7.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
             AND RESULTS OF OPERATIONS........................................13

ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES 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...............23
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......................................................24

SIGNATURES....................................................................28


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 Incorporated is a world leader in developing and deploying
alternative energy and related technologies to the marketplace. Headwaters is
focused on converting fossil fuels such as gas, coal and heavy oils into
alternative energy products.

         Company History. 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. Except where the context requires otherwise, references to
"Headwaters" includes Headwaters' subsidiaries.

         Business Strategy. The future of fossil fuels is at the molecular
level. Converting natural gas and refinery off-gas to liquid fuels, coal to gas
and clean transportation fuels, and heavy oils to light fuels are all examples
of changing the physical nature of the fossil fuel at the molecular level.
Broadly speaking, this is the technology that Headwaters has developed.
Headwaters has the ability to adjust the composition of the fossil fuel
molecules, converting the low value fossil fuel into a higher value product. The
conversion from low to high value products also allows Headwaters to extract
troublesome elements, like sulfur, nitrogen, and heavy metals, out of the fuel.
The result is a high value clean product.

         Through its operating division, Covol Fuels, Headwaters has developed,
patented and commercialized an innovative chemical technology that interacts
with carbon based feedstock to produce a solid alternative fuel that is eligible
for federal tax credits. Since 1996, Headwaters has licensed this technology for
royalty payments and also sells its chemical reagent products to its licensees
and other customers. To date, this technology has provided Headwaters with most
of its revenue.

         Additionally, Headwaters' subsidiary acquired in August 2001,
Hydrocarbon Technologies, Inc. ("HTI"), has developed catalyst and nano-catalyst
technologies to convert coal to liquid fuels, gas to liquid fuels, and
heavy/waste oils to clean light fuels. The development of nano-catalyst
technology by HTI places Headwaters at the forefront of applying advanced
molecular science to multiple energy and chemical processes.

Covol Fuels

         Covol Fuels earns royalty fees from licensing its patented technology
to produce solid alternative fuel from coal. In addition, Covol Fuels earns
revenues from the sale of the chemical reagents used in producing the
alternative fuel. The chemical reagent reacts on the surface of the coal-based
feedstock to bind the materials together. The ultimate end-users of this
alternative fuel are electric utilities and steel companies.

         Covol Fuels' proprietary, organic reagents are the most widely used
reagents for coal-based alternative fuel. They are competitively priced, safe,
odorless, and easy to handle. They improve combustion properties and do not
damage material handling, pulverizing or combustion equipment. They do not
increase HAP, VOC, SOx, or NOx emissions and they do not fall under any SARA,
CONEG or TCLP regulations.

         Covol Fuels' hands-on field engineers are available to assist
customers. They have years of experience operating mixers, extruders, pellet
mills, briquetters, dryers and material handling equipment. They are experts in
applying Covol Fuels' reagents on multiple types of coal feedstocks. Covol Fuels
has been successful in operating facilities above minimum rated design capacity
while running multiple types of coal feedstocks. As an operator, Covol Fuels can
develop process improvements and demonstrate them in commercial facilities.
Covol Fuels designs and constructs reagent mixing and application systems and
can retrofit existing plants to use the Covol Fuels reagents. For new customers,
Covol Fuels has a mobile, skid-mounted, reagent delivery system to allow on-site
demonstration testing.

         Covol Fuels has fully-equipped production and analytical laboratories.
The production laboratory includes bench-scale equipment for mixing, extruding,
pelletizing, briquetting and drying. The analytical laboratory has all of the
equipment necessary for testing chemical change, including Fourier transform
infrared spectroscopy (FTIR), thermogravimetric analysis (TGA) and full

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<PAGE>

proximate analysis equipment. Covol Fuels has a staff of engineers with field
and laboratory experience available to analyze test results. Covol Fuels has an
agreement with Dow Chemical Company for technical support services. In addition,
Covol Fuels has a technical advisory board, made up of experts in the fields of
coal combustion and polymer chemistry, to assist in developing new reagent
technologies, analytical procedures, and combustion improvements for alternative
fuels.

         Licensees. Covol Fuels derives most of its revenue from the owners of
alternative fuel facilities that have licensed Covol Fuels' technology and that
purchase chemical reagent from Covol Fuels. Covol Fuels has royalty agreements
with 28 out of the approximate 75 total solid alternative fuel facilities in the
industry. Licensees include large electrical utility companies, coal companies,
and financial institutions that pay Covol Fuels licensing fees for its
technology. An industry report estimates that Covol Fuels' licensee facilities
have total production capacity in excess of 23 million tons per year.

         License and Chemical Supply Agreements. All entities that have
constructed or own facilities using the Covol Fuels technologies have entered
into a technology license and chemical reagent supply agreement with Covol
Fuels. Many license agreements provided for an initial license fee, payable upon
reaching project milestones. Covol Fuels has received most of the initial
license fees related to these facilities, which amounts are being amortized to
revenue by Covol Fuels over the life of the license agreements. In addition,
pursuant to many of the license agreements, the licensee pays a quarterly
royalty generally at a prescribed dollar amount per ton of alternative fuel sold
or a percentage of the tax credits earned by the licensee. In some cases, the
amount 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.
However, the fees paid to Covol Fuels under license agreements are not based on
the sales price of the alternative fuel product but rather on 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 otherwise not available under Section 29 of the tax code.

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


         Major Licensees. Approximately $2,607,000 of revenue in 2000 and
$1,328,000 in 2001 was from TECO Coal Corporation affiliated licensees;
$12,296,000 of revenue in 2000 and $5,111,000 in 2001 was from DTE Energy
Services, Inc. affiliated licensees; $1,032,000 of revenue in 1999, $15,511,000
in 2000 and $4,978,000 in 2001 was from licensees formerly affiliated with
PacifiCorp; $849,000 of revenue in 1999, $2,558,000 in 2000 and $4,675,000 in
2001 was from Pace Carbon Fuels, L.L.C. affiliated licensees; and $2,673,000 of
revenue in 1999 was from a licensee formerly affiliated with Flour Corporation.
No other single customer accounted for over 10% of total revenue in 1999, 2000
or 2001.


         Licensees' Coal Feedstock. The alternative fuel facilities use coal 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. Covol Fuels purchases its patented and proprietary
chemical reagent from Dow Chemical Company pursuant to an agreement under which
Covol Fuels pays a prescribed price per pound of chemicals. Covol Fuels arranges
with Dow for the delivery of the chemical reagent from Dow's manufacturing
plants directly to each Covol Fuels customer. The reagents are manufactured in
six Dow plants throughout North America, assuring short lead-time deliveries.
Covol Fuels does not inventory any chemical material but instead arranges with
Dow for shipping of the chemical reagent directly to the facilities.

         Construction and Sale of Facilities. Covol Fuels designed, constructed,
and commissioned six alternative fuel facilities between 1996 and 1998. In
transactions that closed between March 1997 and April 2000, Headwaters sold its
six alternative fuel facilities. There are no outstanding purchase payments for
Headwaters to receive in connection with these transactions. However, Headwaters
entered into technology license and chemical reagent supply agreements with the
buyers for ongoing royalties and chemical reagent sales.

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<PAGE>

         Alternative Fuel Tax Credits. The alternative fuel produced by Covol
Fuels' technology qualifies for tax credits under Section 29 of the Internal
Revenue Code. Section 29 was originally developed in 1979 to encourage the
creation of additional domestic production of fuels to decrease the United
States' dependency on foreign oil. The credit encourages the production of oil,
gas and synthetic fuels from non-conventional sources such as shale, tar sands
and coal. The Section 29 tax credit is scheduled to expire on December 31, 2007.
Congress has extended the tax credit three times in the past.

         Covol Fuels' technology royalties and chemical reagent sales ultimately
derive from each customer's ability to manufacture and sell qualified fuels that
generate tax credits for the facility owner. Section 29 of the 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, Covol Fuels received a Private
Letter Ruling, or PLR, from the IRS in which the IRS, based on representations
made to it by Covol Fuels, ruled that Covol Fuels' alternative fuel technology
produces a significant chemical change compared to the parent feedstocks and
thus qualifies the end product for the Section 29 credit.

         Because Covol Fuels currently does not sell fuel from an alternative
fuel facility, Covol Fuels does not itself claim Section 29 tax credits.
However, licensees of Covol Fuels' alternative fuel technology do claim Section
29 tax credits. At least 14 PLRs covering 19 alternative fuel facilities have
been obtained by third parties in connection with licenses of Covol Fuels'
alternative fuel technology. PLRs are only binding with respect to the specific
facts and circumstances 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:

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

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

   o     there has been no change in the applicable law,

   o     the PLR was originally issued for a proposed transaction, and

   o     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 phaseout after unregulated oil
prices reach 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. To qualify for the tax credit,
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 from time-to-time communicated with their congressional representatives
about the benefits and burdens of the credit. Congress periodically entertains

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<PAGE>

legislation to further extend Section 29 deadlines, particularly in times of
heightened energy dependence awareness. The Department of the Treasury and the
IRS have ongoing oversight programs and review taxpayer use of the credit for
possible abuses, including whether there should be restrictions on the
availability of credits.

         Covol Fuels pioneered work with the IRS in defining the criteria for
chemical change in coal-based synthetic fuel. Covol obtained one of the first
PLR's from the IRS for a coal-based synthetic fuel facility and assisted in
establishing record keeping and compliance procedures. Covol Fuels' reagents
have demonstrated significant chemical change as verified through independent
laboratories. Covol Fuels can tailor the reagents to maintain chemical change
across the full FTIR spectrum while enhancing chemical change on specific
absorption peaks on high rank coals. Covol Fuel's in-house personnel work
hand-in-hand with customers to achieve compliance with IRS guidelines.

Hydrocarbon Technologies, Inc. (HTI)

         HTI Acquisition. On May 2, 2001, Headwaters entered into an Agreement
and Plan of Reorganization and a Share Exchange Agreement with HTI and its
shareholders, pursuant to which Headwaters has now acquired all of the stock of
HTI, in exchange for $1,394,920 and 592,952 shares of Headwaters common stock at
the closing, which occurred in August 2001 (with 10% of the cash and shares
being placed in escrow to protect Headwaters from any breaches or
misrepresentations in the representations, warranties, and covenants in the
agreements), plus the conversion of HTI options into options to purchase up to
144,285 shares of Headwaters stock. The HTI shareholders tendering their shares
under the Share Exchange Agreement are also eligible to obtain up to
approximately $1,395,000 of additional cash and approximately 593,000 additional
shares of Headwaters common stock, in the aggregate, if HTI achieves certain
business and financial milestones specified in the Share Exchange Agreement. HTI
will continue to conduct its business as a wholly-owned subsidiary of
Headwaters.

         HTI is a company focused on developing and commercializing catalysts
and catalytic processes for producing chemicals and converting low-value fossil
fuels into high-value alternative fuels while improving energy efficiency and
reducing environmental risks. Initially formed in 1943 as Hydrocarbon Research,
Inc., the Company and its predecessor have a long history of developing and
commercializing leading edge chemical and energy technologies.

         One of the core competencies developed by HTI is working at the
molecular level to control how atoms of precious metals catalysts are fixed on
substrate materials. Nanotechnology is one of the most significant advancements
in catalysis technology during the past 20 years, and HTI is currently
positioned to be a major player within this market through its research
expertise and increasing portfolio of patents.

         HTI offers technology for producing ultra-clean liquid fuels directly
from coal. In this process, coal molecules are changed into diesel, gasoline and
other fuel molecules, and sulfur, nitrogen, ash and other impurities are
removed, leaving a very high grade of liquid fuel.

         HTI has developed a patented technology to change complex heavy oil
molecules into lighter molecules. The HTI process is a novel hydrocracking
process using HTI's proprietary slurry catalyst and close-coupled hydrotreating
to produce ultra-clean diesel fuel, jet fuel, gasoline or fuel oil. The
technology can be applied in new or existing hydrocrackers.

         Many used motor oils and bottom-of-the-barrel refinery residual oils
are difficult to process in existing refineries because they contain high
percentages of sulfur, ash, carbon residues and heavy metals. HTI holds the
patents to an innovative environmentally-clean process that upgrades these oils
using the carbon in scrap tires to remove impurities. All of the feed materials
are fully utilized and converted into value added products.

         Commercialization of slurry-phase Fischer-Tropsch (F-T) technology is a
major objective of both government and industry to provide the nation with
adequate clean diesel fuels from indigenous fossil fuel resources. HTI has
developed a novel skeletal-iron F-T catalyst specifically designed for
slurry-phase reactors. It is stronger than conventional F-T catalysts and
delivers improved economics, making F-T technology more competitive in the
marketplace.

         HTI maintains a staff of engineers, scientists and technicians with
expertise in the design and operation of high-pressure and temperature process

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<PAGE>

plants. The Company has invested $30 million in pilot plant and laboratory
facilities in Lawrenceville, New Jersey. The facilities meet all of the latest
environmental and safety standards and are used for providing outside services
for other companies and government agencies.

Proprietary Protection

         Trademarks and Service Marks. Headwaters and its subsidiaries have
three registered trademarks issued between 1997 and 2000 and one pending
trademark application filed in 2000.

         Patents. Headwaters and its subsidiaries have 23 U.S. patents that
expire between 2011 and 2020 and seven U.S. patent applications pending.

         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 or that Headwaters will not infringe on
patents held by other parties. Because many of these patents represent new
technology, the importance of the patents to Headwaters' business will depend on
its ability to commercialize these technologies successfully, as well as its
ability to protect its technology from infringement or challenge by other
parties.

         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 revenues are
dependent upon license agreements by which licensees use the Headwaters
technologies to manufacture alternative fuel and then pay license fees, and
purchase chemical reagent products from 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.

Other Strategic Acquisitions

         Headwaters believes that it may have unique opportunities to pursue
additional acquisitions that are synergistic with Headwaters' financial and
operational objectives. Headwaters will evaluate 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 growing industries where promising financial returns exist.

Government Regulation

         Covol Fuels and Licensees. Covol Fuels' 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,
Covol Fuels and its licensees have obtained various state and local permits.
Covol Fuels believes that it or its licensees have 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
alternative fuel operations.

         Compliance with permits, regulations, and the approved processes and
procedures help protect against pollution or contamination. Acid is the only
stored raw material used in the approved alternative fuel from coal 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, Covol Fuels' and its licensees' alternative
fuel operations entail risk of environmental damage and Covol Fuels or its
licensees could incur liabilities in the future arising from the discharge of
pollutants into the environment or from waste disposal practices.

         Failure by Covol Fuels 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 Covol Fuels or its licensees. Other

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developments, such as the enactment of more stringent environmental laws and
regulations, could require Covol Fuels or its licensees to incur significant
capital expenditures. If Covol Fuels or its licensees are unable to comply with
such laws and regulations, or if compliance substantially increases production
costs, such developments could also have a material adverse effect on Covol
Fuels.

         HTI. HTI's operations are also subject to federal, state, and local
environmental regulation. HTI believes that it has obtained all required permits
pertaining to its business and operations, and that it is in substantial
compliance with all applicable laws.

         HTI's ordinary course of business involves using its facilities to
perform R&D activities, process and recycle oil and to research and develop
technologies involving waste coal, oil chemicals, and energy technologies,
including liquefaction of coal. As a result, petroleum and other hazardous
materials have been and are present on its property. HTI hires independent
contractors to transport and dispose of any hazardous materials generated and
sends any hazardous wastes only to federally approved, large scale, and
reputable off-site waste facilities. HTI's wholly owned subsidiary Chemsampco's
ordinary course of business involves distillation to purify products, analysis,
packaging of chemicals, and the selling, warehousing, and manufacturing of
organic chemicals in small research volumes (generally from 1 gram to 1
kilogram). As a result, hazardous materials have been and are present on
Chemsampco's leased property. HTI believes that appropriate handling and
training procedures are in effect for HTI's and Chemsampco's properties and
operations. However, the possibility still exists that regulatory noncompliance
or accidental discharges, in spite of safeguards, could create an environmental
liability. Therefore, HTI's and Chemsampco's operations entail risk of
environmental damage and HTI could incur liabilities in the future arising from
the discharge of pollutants into the environment or from waste disposal
practices.

         Safety. Covol Fuels, its licensees, and HTI are also subject to federal
and state safety and health standards. Covol Fuels is committed to providing
effective management of worker safety and health protection. In addition, Covol
Fuels has developed a safety policy designed to raise and maintain safety
awareness by both management and employees. Covol Fuels has a positive,
well-established, working relationship with MSHA and has coordinated and hosted
meetings between MSHA and synthetic fuel industry participants. Failure by Covol
Fuels or its licensees to comply with safety and health standards could have a
material adverse affect on Covol Fuels. For example, a regulatory inspector
could close an alternative fuel facility until the 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, the
marketing of competitive chemical reagents, the marketing of end products
qualifying as synthetic fuel, and the development of alternative fuel projects.
Competition includes, for example, Nalco Chemical Company in the chemical
reagent sales business. Headwaters also experiences competition from traditional
coal and fuel suppliers and natural resource producers, in addition to those
companies that specialize in the recycling and upgrading of industrial waste
products. Many of these companies have greater financial, management, and other
resources than Headwaters. Headwaters believes that it will be able to compete
effectively, but there can be no assurance that it will be able to do so
successfully.

Employees

         Headwaters and its subsidiaries currently employ approximately 110
persons full-time. Of these employees, approximately 50 are in alternative fuel
operations and technical support services, 14 are in corporate administration,
miscellaneous operations and project development, and 45 are employed by HTI.
None of these employees are covered by a collective bargaining agreement.

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ITEM 2.  PROPERTIES

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

         In 1995, HTI purchased approximately six acres in Lawrenceville, New
Jersey, where its headquarters and research facilities are now located. HTI's
subsidiary Chemsampco leases real property located in Lawrence Township, New
Jersey, for $3,800 per month. The lease was entered into on July 28, 1998 and
expires on August 31, 2002.

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


ITEM 3.  LEGAL PROCEEDINGS

         Headwaters has ongoing litigation that it has incurred in the normal
course of business, including the items discussed herein. Headwaters intends to
vigorously defend and/or pursue its 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.

         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 alleged that the
technology purchase transaction was an unauthorized corporate action and that
Davidson and Headwaters conspired together to effect the transfer. The complaint
asserted related causes of action and sought unspecified money damages and other
relief. In August 2001, the trial court granted Headwaters' motion to dismiss
the complaint. It is not known whether the plaintiffs will appeal. Because
resolution of the litigation is uncertain, legal counsel cannot express an
opinion as to the ultimate amount, if any, of Headwaters' liability.

         AJG. In December 1996, Headwaters entered into a technology license and
proprietary chemical 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 had
failed to make payments and to perform other obligations under the agreement.
Headwaters asserts claims including breach of contract, declaratory judgment,
unjust enrichment, and accounting and seeks money damages in the amount of
$750,000 plus other damages to be proven at trial, as well as other relief.
AJG's answer to the complaint denied Headwaters' claims and asserted
counter-claims based upon allegations of misrepresentation and breach of
contract. AJG seeks unspecified compensatory damages as well as punitive
damages. Headwaters has denied 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. 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.


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

         None.

                                       9
<PAGE>

                                     PART II

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

         The shares of Headwaters' common stock trade on the Nasdaq Stock
Market(SM) under the symbol "HDWR." Options on Headwaters' common stock are
traded on the Chicago Board Options Exchange under the symbol "HQK." 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.

         Fiscal 2000                                    Low          High
         -----------                                    ---          ----
         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

         Fiscal 2001
         -----------
         Quarter ended December 31, 2000               $2.13        $ 3.25
         Quarter ended March 31, 2001                   2.25          6.53
         Quarter ended June 30, 2001                    6.44         16.00
         Quarter ended September 30, 2001               7.11         14.19

         As of November 30, 2001, there were approximately 453 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. 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 by 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.

                                       10
<PAGE>

         As of November 10, 1999, all of the limited partners in Utah Synfuel #1
and all 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 and Alabama Synfuel #1 became wholly-owned
subsidiaries 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 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, 7% dividend, convertible 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.

         Warrants for the purchase of 72,727 shares of common stock were issued
in conjunction with this preferred stock. The warrants were exercisable 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 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.

                                       11
<PAGE>

         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 former director of Headwaters was also a manager and
2.5% owner of the investor. The director disclaims any beneficial interest in
the investor's securities in Headwaters.

         In August 2001, Headwaters completed a 100% acquisition of HTI for
total costs at closing of approximately $11,774,000, including the issuance of
approximately 593,000 shares of Headwaters restricted common stock. Former HTI
shareholders are also eligible to receive up to 593,000 additional shares of
Headwaters restricted common stock in future periods if HTI achieves certain
operating targets and other milestones. Headwaters is obligated to file a
registration statement on Form S-3 to register the restricted stock issued and
issuable to the former HTI shareholders.

         During the fiscal year ended September 30, 2001, options for the
exercise of approximately 116,000 shares of Headwaters common stock were
exercised, resulting in the issuance of restricted shares of common stock.


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. As more fully described in Notes 13 and
14 to the consolidated financial statements, in 1999 and 2000 Headwaters
recorded approximately $(1,839,000) and $16,870,000, respectively, of gains
(losses) on sale of facilities, and approximately $7,395,000 and $17,758,000,
respectively, of asset write-offs and other charges. Headwaters believes these
items are not directly related to its core business and does not expect similar
items in the future. As more fully described in Note 14 to the consolidated
financial statements, in 2000 Headwaters recorded an extraordinary loss on early
extinguishment of debt of $7,860,000. Additionally, as more fully described in
Note 11 to the consolidated financial statements, in 2000 and 2001, Headwaters
recorded approximately $3,000,000 and $7,470,000, respectively, of income tax
benefit from the reduction of its deferred tax asset valuation allowance. Also,
as more fully described in Notes 2 and 3 to the consolidated financial
statements, in August 2001, Headwaters acquired HTI, the financial statements of
which are consolidated with Headwaters' financial statements using a one-month
lag. Accordingly, HTI's August 2001 acquisition date balance sheet has been

                                       12
<PAGE>

consolidated with Headwaters' September 30, 2001 balance sheet but no results of
operations of HTI have been included in Headwaters' consolidated results for any
period.

         The selected financial data as of and for the years ended September 30,
1997 and 1998 and as of September 30, 1999 are derived from audited financial
statements not included herein. The selected financial data as of September 30,
2000 and 2001 and for the years ended September 30, 1999, 2000, and 2001 were
derived from the financial statements of Headwaters which have been audited by
PricewaterhouseCoopers LLP included elsewhere herein.

<TABLE>
<CAPTION>
                                                                      Year Ended September 30,
                                                  -----------------------------------------------------------------
(thousands of dollars, except per-share data)        1997         1998         1999         2000          2001
------------------------------------------------- ------------ ------------ ------------ ------------ -------------
<S>                                                  <C>           <C>          <C>           <C>           <C>
OPERATING DATA:
     Total revenue                                   $    147      $ 2,186      $ 6,719       $27,886       $45,464
     Net income (loss)                                (10,498)     (11,308)     (28,393)        3,682        21,517
     Diluted net income (loss) per
        common share                                    (1.32)       (1.17)       (2.39)         0.07          0.87

<CAPTION>
                                                                        As of September 30,
                                                  -----------------------------------------------------------------
(thousands of dollars)                               1997         1998         1999         2000          2001
------------------------------------------------- ------------ ------------ ------------ ------------ -------------
<S>                                                   <C>          <C>          <C>          <C>           <C>
BALANCE SHEET DATA:
     Working capital (deficit)                       $ (3,826)     $ 6,575      $(2,721)     $ 8,393       $ 8,619
     Net property, plant and equipment                 13,619       15,809       14,182          552         2,680
     Total assets                                      26,590       68,061       58,095       33,441        55,375
     Long-term obligations:
        Long-term liabilities                           3,817       14,879       18,422        5,235         3,055
        Unamortized portion of non-refundable
          license fees                                  1,190        7,455        6,579        7,681         5,805
        Redeemable convertible preferred
           stock                                           --           --        4,332           --            --
     Total long-term obligations                        5,362       23,256       30,255       12,916         8,860
     Total stockholders' equity (deficit)               6,426       14,746       (1,028)      10,747        31,086
</TABLE>


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. Headwaters' fiscal year ends on September 30 and
unless otherwise noted, all future references to years shall mean Headwaters'
fiscal year rather than a calendar year.

Year Ended September 30, 2001 Compared to Year Ended September 30, 2000

         The information set forth below compares Headwaters' operating results
for 2001 with its operating results for 2000.


         Revenue. Total revenue for 2001 increased by $17,578,000 to $45,464,000
as compared to $27,886,000 for 2000. The major components of revenue are
discussed in the sections below.


         License Fees. During 2001, Headwaters recognized license fee revenue
totaling $20,765,000, an increase of $3,450,000 over $17,315,000 of license fee
revenue recognized during 2000. License fees in 2001 consisted of recurring
license fees or royalty payments of $18,750,000 and deferred revenue
amortization of $2,015,000. License fees in 2000 consisted of recurring license
fees of $16,513,000 and deferred revenue amortization of $802,000.

                                       13
<PAGE>

         Recurring license fees in 2000 included $11,680,000 related to a single
licensee that owned four facilities. This licensee did not report and pay
certain prior period royalty obligations to Headwaters timely, resulting in some
"catch-up" revenue recognition in 2000 for royalties related to periods other
than the year ended September 30, 2000. Moreover, this licensee significantly
reduced its production and sale of alternative fuel in early 2001 and did not
operate the four facilities for most of 2001. These two factors combined
resulted in a decline in recurring license fees from the licensee of
approximately $7,982,000 in 2001 as compared to 2000. This licensee sold the
facilities in October 2001 and Headwaters expects to receive license fees from
the new owner in 2002. Due to increased alternative fuel sales, there was an
increase of approximately $10,219,000 in recurring license fees from all other
licensees in 2001 over 2000. In 2001, the largest single licensee accounted for
$6,228,000 of earned license fees.

         Chemical Sales. Chemical sales during 2001 were $22,407,000 with a
corresponding direct cost of $14,524,000. Chemical sales during 2000 were
$9,757,000 with a corresponding direct cost of $6,617,000. The increase in
chemical sales in 2001 over 2000 was due to increased alternative fuel
production by Headwaters' licensees, as well as sales of chemicals to new
customers. There were no similar sales of chemicals to new customers in 2000.
Currently, Headwaters expects its future chemical sales revenue from all
licensees and other customers to be higher than the amounts reported for 2001
due to anticipated increases in alternative fuel production by licensees and
increased sales of chemicals to new customers. Headwaters currently expects
future gross profit margins to be somewhat less than the record margin
percentage for 2001 due to differing chemical formula requirements of certain
licensees and new customers.



         Cost of Operations. These costs decreased by $1,284,000 to $3,071,000
in 2001 from $4,355,000 in 2000. The decrease was primarily attributable to
elimination of operating costs associated with the three facilities owned by
Headwaters which were sold in December 1999 through April 2000. In 2000, cost of
operations included labor and other operating expenses at the owned alternative
fuel facilities and the wash plant located in Utah. There were no such costs in
2001.

         Selling, General and Administrative Expenses. These expenses increased
$1,011,000 to $5,838,000 during 2001 from $4,827,000 for 2000. The increase in
2001 was due primarily to an increase in professional services expenses of
approximately $1,273,000 and an increase in compensation-related costs of
approximately $257,000. These increases were partially offset by the resolution
of certain liabilities for $175,000 less than previously recorded and a net
decrease in other cost categories of approximately $344,000. The increase in
professional services expenses was due primarily to legal costs associated with
the current legal actions Headwaters is pursuing. The increase in
compensation-related costs related primarily to an increase in marketing
department headcount.

         Asset Write-offs and Other 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 ancillary 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 settlement charges
($979,000) and asset write-downs ($532,000) were recorded in 2000. All of these
asset write-offs and other charges totaled approximately $17,758,000. There were
no similar charges recorded in 2001.

         Acquired In-process Research and Development. Approximately $2,400,000
of the HTI purchase price was allocated to purchased in-process research and
development, all of which was expensed in 2001(see "Acquisition of HTI," below).


         Other Income and Expense. During 2001, Headwaters reported net other
expenses of $5,163,000 compared to net other income of $14,313,000 during 2000.
The change of $19,476,000 is primarily attributable to a decrease in gains on
sale of facilities of $16,870,000, a decrease in interest and investment income
of approximately $1,049,000 and an increase in equity and debt
investment-related losses of approximately $5,519,000, partially offset by a
decrease of approximately $4,590,000 in interest expense, an increase in the
mark-to-market adjustment of the carrying value of a related party note
receivable of approximately $475,000, and a decrease of $1,079,000 from gains on
other transactions, related to the satisfaction of a $755,000 contingent
contract liability and a $324,000 gain recognized on a note receivable
transaction in 2000.

                                       14
<PAGE>

         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. These payments,
net of obligations to third parties, approximated $7,377,000. Of the net amount
received, Headwaters recognized $4,400,000 as a gain in 2000 because there were
no ongoing obligations associated with those payments. Headwaters deferred the
recognition of $2,977,000, which amount was characterized in the sales agreement
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
and receives ongoing royalties based upon the sale of alternative fuel from the
facilities.


         The decrease in interest income from 2000 to 2001 primarily related to
a decrease in interest from the related party note receivable discussed below
from $515,000 in 2000 to $0 in 2001 and a decrease in the interest rate on a
$6,500,000 note receivable from a licensee. During 2000, Headwaters made several
equity investments in and loans to unrelated high-risk entities and in 2000,
Headwaters recognized approximately $746,000 of losses related to its equity
investments. During 2001, Headwaters recorded additional losses totaling
approximately $6,265,000 related to write-offs of notes receivable and losses on
equity investments, for an increase of $5,519,000 in the 2001 losses compared to
2000.


         Interest expense decreased in 2001 primarily due to the significantly
lower average levels of outstanding borrowings that existed in 2001 as compared
to 2000. During 1996, Headwaters sold certain construction companies and
received as consideration a $5,000,000 note receivable. The note was "marked to
market" each period based upon the market value of Headwaters' common stock held
as collateral and was reflected in the consolidated balance sheet at the
underlying value of this collateral, $466,000 at September 30, 2000. In 2001,
Headwaters accepted as full satisfaction of the note receivable the shares of
Headwaters' stock collateralizing the note and a new note receivable which was
recorded at $0 due to substantial uncertainty of both the collectibility of the
new note and the value of the new collateral. This transaction resulted in
recognition of a gain in 2001 of approximately $541,000, representing the
increase in value of the collateral from September 30, 2000 to the date the
collateral was surrendered in payment of the note. The corresponding adjustment
in 2000 resulted in a write-up of $66,000 for a net increase in the adjustment
of $475,000 in 2001 compared to 2000.


         Income Taxes. In 2000, Headwaters reported a net 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 federal alternative minimum tax. In 2001,
Headwaters reported a net income tax benefit of $7,049,000, consisting of the
recognition of $7,470,000 of its deferred tax asset, reduced by $100,000 of
federal alternative minimum tax and $321,000 of current state income tax
expense.

         Headwaters' valuation allowance decreased by $14,200,000 during 2001. A
valuation allowance is provided if it is more likely than not that some portion
or all of a deferred tax asset will not be realized. Based primarily on results
of operations in 2001 and expected future results of operations, Headwaters
determined that as of September 30, 2001, it is more likely than not that its
deferred tax assets will be realized and the valuation allowance was reduced. In
order to realize the entire amount of its deferred tax asset, Headwaters may
need to report in excess of $25,000,000 of pretax earnings.

         Extraordinary Item. In 2000, Headwaters redeemed all of its remaining
convertible debt. The redemption consideration and early prepayment costs
included approximately $7,037,000 in cash plus the issuance of approximately
214,000 shares of common stock. The loss recognized as a result of the total
redemption consideration paid plus the acceleration of amortization of the
unamortized debt discount and debt issuance costs in excess of the debt carrying
value totaled approximately $7,860,000.

                                       15
<PAGE>

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.


         Revenue. Total revenue for 2000 increased by $22,246,000 to $27,886,000
as compared to $5,640,000 for 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 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. The increase in 2000 recurring
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. 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.



         Cost of Operations. These costs decreased by $8,967,000 to $4,355,000
during 2000 from $13,322,000 during 1999. During 2000, Headwaters incurred
significantly lower operating expenses in connection with the continued
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 were 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.

         Until October 1999, Headwaters operated an alternative fuel facility
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 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 cost of operations. The 1999 write-down was
approximately $1,815,000. 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 facility and a
major licensee and partner of Headwaters, and other related business reasons.

         Selling, General and Administrative Expenses. These expenses decreased
$54,000, or 1%, to $4,827,000 during 2000 from $4,881,000 for 1999.

         Asset Write-offs and Other Charges. In 2000, Headwaters recorded
impairment charges of approximately $14,804,000 related to assets located in
Utah and Alabama. Headwaters also recorded employee severance and other non-cash
charges from incremental amortization of deferred compensation from stock
options totaling approximately $1,443,000. Other settlement charges ($979,000)
and asset write-downs ($532,000) were recorded in 2000. All of these asset
write-offs and other charges totaled approximately $17,758,000.

         In 1999, Headwaters sold a facility located in Pennsylvania on which a
loss of approximately $1,839,000 was recognized. Also 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, 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 facilities. Finally,

                                       16
<PAGE>

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 losses, write-offs and provisions totaled
approximately $9,234,000, which amount is recorded as asset write-offs and other
charges in the consolidated statement of operations.


         Other Income and Expense. During 2000, Headwaters reported net other
income of $14,313,000 compared to net other expenses of $7,819,000 for 1999.
This change of $22,132,000 relates primarily to an increase of $18,709,000 in
net gains on sale of facilities, a decrease of $1,439,000 in interest expense, 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, and an increase of $1,079,000 from gains on other transactions, related
to the satisfaction of a $755,000 contingent contract liability and a $324,000
gain recognized on a note receivable transaction in 2000, offset by $746,000 of
losses recorded in 2000 in the carrying value of equity investments.

         In 2000, Headwaters recognized net gains on the sale of its owned
alternative fuel facilities totaling approximately $16,870,000. There was one
facility sale in 1999 on which a loss of $1,839,000 was recognized.


         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. The adjustment to the
carrying amount of the related party note receivable (which was "marked to
market" each period based upon the market value of Headwaters' common stock held
as collateral) 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.
During 2000, the provision for 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 a net 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 federal alternative minimum tax. Headwaters had no
income tax provision or benefit in 1999 because of its net operating loss
position.

Liquidity and Capital Resources

         Net cash provided by operating activities during 2001 was $18,884,000
compared to $6,608,000 during 2000. Most of the cash flow from operating
activities in 2001was attributable to net income of $21,517,000. During 2001,
investing activities consisted primarily of investments in and loans to
non-affiliated companies of approximately $4,636,000 and the acquisition of HTI
for cash of approximately $4,845,000 and the issuance of stock and stock options
valued at approximately $6,810,000. Financing activities in 2001 consisted
primarily of proceeds from borrowings of approximately $8,991,000, repayments of
borrowings of approximately $9,941,000, the purchase of treasury stock, net of
transfers to Headwaters' Employee Stock Purchase Plan, for approximately
$10,409,000, and proceeds from the exercise of stock options and warrants of
approximately $1,926,000.


         In 2001, Headwaters' primary investing activity consisted of
investments in and loans to unrelated high-risk companies. During 2001,
Headwaters collected, wrote off, or sold all of the loans to such entities and
wrote off or sold all of the equity investments. Total losses recorded in 2001
were approximately $6,265,000. In September 2001, Headwaters sold all of its
remaining high-risk investments in exchange for a $4,000,000 note receivable
from a limited liability corporation. This note is due no later than September
2004, is collateralized by the bridge loans and equity investments sold and is
being accounted for on the cost recovery method. Following payment of the note
principal, Headwaters has the right to receive the first $1,000,000 plus 20% of
any additional cash received by the limited liability corporation related to the
assets sold by Headwaters. Headwaters does not currently intend to make any
significant additional equity investments in or loans to any new unrelated
entities, but could incur additional losses if the $4,000,000 loan is not
repaid. In addition to the $4,000,000 note receivable, at September 30, 2001
Headwaters had outstanding one other note receivable in the amount of
$6,500,000. This note and the related accrued interest was collected in October
2001. Headwaters has no current plans to construct any additional alternative
fuel facilities, but is interested in possible strategic acquisitions of
entities that operate in adjacent industries and that would be synergistic with
Headwaters' current operations. Any future acquisitions could be funded using
Headwaters' common stock, available cash, debt, or some combination thereof.


         As described in Note 6 to the consolidated financial statements,
Headwaters acquired shares of its common stock during 2001 in connection with
its stock repurchase program. The program authorizes Headwaters to purchase

                                       17
<PAGE>

stock in the open market or through negotiated block transactions. Purchases
under the plan are at the discretion of Headwaters' management. During 2001,
Headwaters purchased approximately 1,648,000 shares for approximately
$10,510,000. Headwaters continually evaluates financial alternatives to the
stock repurchase program and future purchases are subject to market conditions
and available cash. Headwaters currently expects repurchases during 2002 to be
below 2001 levels.


         Headwaters' working capital increased from approximately $8,400,000 at
September 30, 2000, to approximately $8,600,000 at September 30, 2001.
Headwaters expects its operations to produce positive cash flows in future
periods. In addition to cash provided by operating activities, Headwaters has an
arrangement with an investment company under which Headwaters can borrow up to
90% of the value of the portfolio of Headwaters' short-term investments with the
investment company. These investments consist primarily of government-backed
securities and collateralize any outstanding borrowings. Maximum borrowings
under this arrangement during 2001 were approximately $4,095,000, which amount
was outstanding at September 30, 2001. Borrowings under this arrangement were
used for short-term working capital needs, primarily for stock repurchases,
rather than liquidating the securities held as collateral. Maximum borrowing
capacity under this arrangement at November 30, 2001 approximated $8,600,000.


         Headwaters also has borrowing capability under an unsecured revolving
line of credit with a bank which currently has an expiration date in October
2002. Borrowings under the line of credit are limited to a maximum amount of
$10,000,000 and bear interest at prime plus .75% (6.75% at September 30, 2001).
Maximum borrowings under the line of credit during 2001 were approximately
$4,896,000, but there were no borrowings outstanding under the line at September
30, 2001. Headwaters believes it will have sufficient cash reserves to meet its
obligations during 2002, and also believes it has the ability to raise
additional debt and equity capital from other sources if necessary.

         Income Taxes. As of September 30, 2001, Headwaters had net operating
loss carryforwards of approximately $24,000,000 which can be used to offset
future taxable income. The net operating loss carryforwards expire from 2017 to
2021. Headwaters also has approximately $220,000 in research and development tax
credit carryforwards which can be used to offset future tax liabilities. The tax
credit carryforwards expire from 2007 to 2016. The utilization of HTI's
acquisition date operating loss carryforwards (totaling approximately
$2,800,000) against future taxable income is subject to an annual limitation of
approximately $800,000 due to the change in ownership of HTI. Headwaters'
valuation allowance decreased by $14,200,000 during 2001. A valuation allowance
is provided if it is more likely than not that some portion or all of a deferred
tax asset will not be realized. Based primarily on results of operations in 2001
and expected future results of operations, Headwaters determined that as of
September 30, 2001 it is more likely than not that its deferred tax assets will
be realized and the valuation allowance was reduced.

         During 2002, Headwaters expects to pay some alternative minimum taxes
and some state income taxes in certain states where net operating loss
carryforwards aren't available. However, because of existing net operating loss
carryforwards for regular federal tax purposes and in many states where
Headwaters does business, and due to anticipated tax benefits from exercise of
stock options, Headwaters does not currently expect to pay significant amounts
of regular income taxes until late 2002 or early 2003.

Acquisition of HTI

         In August 2001, Headwaters completed a 100% acquisition of HTI, a New
Jersey-based company that has significant intellectual property including
technologies to transform coal and heavy oil into ultra-clean diesel fuel and to
recycle waste oil into higher value carbon products, and nano-catalyst
technology. Total consideration paid at closing, including the direct costs
incurred by Headwaters to consummate the acquisition, was approximately
$11,774,000. Additional contingent consideration can be earned by the former HTI
stockholders in future periods based on operating targets and other milestones.
As required by generally accepted accounting principles, a contingent liability
of $2,714,000 was recorded, representing the contingent incremental
consideration for identified purchased assets in excess of the consideration
paid at closing. A contingent liability was not recognized for the contingent
incremental consideration that, if paid in the future, would be recorded as
goodwill. This amount will be adjusted in the future when the actual contingent
consideration is paid. If some or all of the recorded contingent consideration
is not paid in the future, some of the recorded asset values will be adjusted
accordingly.

         If all operating targets and other milestones are achieved, the total
additional consideration that could be issued to the former HTI stockholders
would consist of approximately $1,395,000 in cash and approximately 593,000
shares of Headwaters common stock. The value of the common shares issued, if
any, will be determined at the time the shares are issued, based on the fair
value of the shares at that time.

                                       18
<PAGE>

         Assets acquired and liabilities assumed were recorded at their
estimated fair values as of the acquisition date. Approximately $9,700,000 of
the purchase price was allocated to identifiable intangible assets consisting of
existing patented technology with an estimated useful life of 15 years.
Management currently plans to commercialize HTI's existing technology
domestically and in certain other countries and is currently planning to
emphasize catalytic processes and technologies to change coal and heavy oils
into other high-grade fuels.

         Approximately $2,400,000 of HTI's purchase price was allocated to
purchased in-process research and development, consisting primarily of efforts
focused on developing catalysts and catalytic processes to lower the cost of
producing alternative fuels and chemicals while improving energy efficiency and
reducing environmental risks. This amount represents the estimated purchased
in-process technology for projects that have not yet reached technological
feasibility and currently have no alternative use. The valuation of the
in-process research and development included, but was not limited to, an
analysis of the market for the acquired products and technologies, the
completion costs for the projects, the expected cash flows attributed to the
projects and the risks associated with achieving such cash flows. The estimated
value of these projects was determined by estimating the costs to develop the
purchased in-process technology into commercially viable products, estimating
the resulting net cash flows from the sale of those products, and discounting
the net cash flows back to their present value. As required by generally
accepted accounting principles, Headwaters recorded a charge for this purchased
in-process research and development as of the date of acquisition, which is
included in operating costs and expenses in the consolidated statement of
operations.

         Due to the time required to obtain accurate financial information
related to HTI's significant foreign operations, for financial reporting
purposes HTI's financial statements are consolidated with Headwaters' financial
statements using a one-month lag. Accordingly, HTI's August 2001 acquisition
date balance sheet has been consolidated with Headwaters' September 30, 2001
balance sheet, but no results of operations of HTI have been included in
Headwaters' consolidated statements of operations for any period. HTI's November
30, 2001 balance sheet will be consolidated with Headwaters' December 31, 2001
balance sheet and HTI's results of operations for the period from date of
acquisition to November 30, 2001 will be consolidated with Headwaters' results
for the quarter ending December 31, 2001. As of September 30, 2001, Headwaters
had loaned HTI approximately $1,060,000, of which $259,000 was not eliminated in
consolidation.


Critical Accounting Policies and Estimates

         Headwaters' significant accounting policies are identified and
described in Note 2 to the consolidated financial statements. 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 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.

         Headwaters continually evaluates its policies and estimation
procedures. Estimates are often based on historical experience and on
assumptions that it believes to be reasonable under the circumstances, but which
could change in the future. Some of Headwaters' accounting policies and
estimation procedures require the use of substantial judgment and actual results
could differ materially from the estimates underlying the amounts reported in
the consolidated financial statements. The following is a discussion of these
critical accounting policies and estimates.

         License Fee Revenue Recognition. There are 28 alternative fuel
facilities that are currently licensed to use Headwaters' patented technology
and from which Headwaters can earn recurring license fees. These recurring
license fees or royalty payments are recognized in the period when earned which
generally coincides with the sale of the solid alternative fuel produced and
sold by Headwaters' licensees. In most instances, Headwaters receives timely
regular written reports from licensees notifying Headwaters of the amount of
solid alternative fuel sold and the royalty due Headwaters under the terms of
the respective license fee agreements. Moreover, in most instances, Headwaters
has observed a pattern of payment by the licensees of these reported amounts
due.

         Generally, estimates of license fee revenue earned, where required, can
be reliably made based upon historical experience and / or verbal communications
from licensees for whom an established pattern exists. In some cases, however,
such as when a licensee is beginning to produce and sell alternative fuel or
when an alternative fuel facility is sold by a licensee to another entity, and

                                       19
<PAGE>

for which there is no pattern or knowledge of past or current production and
sales activity, there may be more limited information upon which to determine an
estimate of license fee revenue earned. In these situations, Headwaters uses
such information as is available and where possible, attempts are made to
substantiate the information, such as observing the levels of chemical reagents
purchased by the licensee and used in the production of the solid alternative
fuel. In limited situations, Headwaters is unable to reliably estimate the
license fee revenues earned during a period, and therefore revenue recognition
is delayed until a future date when sufficient information is known from which
to make a reasonable estimation.

         Realizability of Receivables. Allowances are provided for uncollectible
accounts and notes receivable when appropriate. Such allowances are based on a
receivable-by-receivable analysis of collectibility or the occurrence of an
impairment and totaled approximately $121,000 at September 30, 2000 and $0 at
September 30, 2001 for trade receivables and $0 at September 30, 2000 and 2001
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. Total losses recognized on notes receivable were
$0 in 1999 and 2000 and approximately $3,658,000 in 2001. These losses are
included in other expense in the consolidated statement of operations.

         The losses on receivables in 2001 consisted entirely of write-offs or
impairments of notes receivable from unrelated high-risk entities which
Headwaters loaned funds to in late fiscal 2000 and early fiscal 2001, which
amounts were determined to be uncollectible or worthless. Headwaters no longer
makes these loans; however, in September 2001, Headwaters sold all its remaining
loans and equity investments in these entities to a limited liability
corporation, in exchange for a $4,000,000 note receivable, due no later than
September 2004. Headwaters intends to review collectibility of this note
receivable at the end of each reporting period. This collectibility review will
consist of consideration of payments of required interest and principal and the
sufficiency of the collateral to support the outstanding note receivable
balance. To the extent impairment is indicated, Headwaters will write down the
note receivable to its estimated net realizable value at that time, giving
consideration primarily to the estimated value of the collateral.

         With regard to Headwaters trade receivables from its core business,
past allowances have been minimal as have any required write-offs. Nevertheless,
Headwaters reviews the collectibility of its trade receivables as of the end of
each reporting period.

         Valuation of Long-Lived Assets, including Intangible 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, an impairment calculation is made and 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 14. Indicators of impairment include such things as a significant adverse
change in legal factors or in the general business climate or an expectation
that significant assets will be sold or otherwise disposed of.

         Beginning in fiscal 2002, Headwaters will, in accordance with SFAS No.
142, "Accounting for Goodwill and Intangible Assets," perform periodic
impairment tests of its intangible assets, most of which were acquired when HTI
was purchased in August 2001. Intangible assets consist of (i) identifiable
intangible assets, comprised of existing patented technology obtained in
connection with the acquisition of HTI (see Note 3 to the consolidated financial
statements); (ii) rights to technology, consisting of a coal-based alternative
fuel technology and related licensing and patent rights; and (iii) the excess of
the value of the consideration paid for the purchase of certain assets or equity
securities over the fair values of the related assets, which fair values
approximated their carrying cost. As described in more detail in Note 14 to the
consolidated financial statements, Headwaters wrote off approximately $2,189,000
of intangible assets during 2000.

         It is possible that some of Headwaters' tangible or intangible
long-lived assets could be impaired in the future and that the resulting
write-downs could be material.

         Legal Matters. Headwaters is involved in several legal proceedings that
have arisen out of the normal course of business, all as explained in more
detail in Note 15 to the consolidated financial statements. Of the three primary
legal matters described in Note 15, Headwaters is plaintiff in one case,
defendant in a second case, and both a plaintiff and defendant in a third case.
Management in all cases intends to vigorously defend its position. Management
does not currently 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.

                                       20
<PAGE>

Impact of Inflation

         During 2001, Headwaters' operations 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 potential effects, if any, on
the future results of operations or financial position of Headwaters. Based on
that review, Headwaters believes that full implementation of SFAS No. 142,
"Accounting for Goodwill and Intangible Assets," which pursuant to its
provisions can not be early implemented, will require certain additional
disclosures; however, Headwaters believes that neither SFAS No. 142 nor any of
the other pronouncements reviewed will have any significant effects on its
current or future financial position or results of operations.

Forward Looking Statements

         Statements in this Annual Report on Form 10-K regarding Headwaters'
expectations as to the operation of facilities utilizing Headwaters' alternative
fuel technologies, the marketing of products, the receipt of licensing fees,
royalties, and product sales revenues, the development, commercialization and
financing of new technologies and other strategic business opportunities and
acquisitions and other information about Headwaters that is not purely
historical by nature, including those statements regarding Headwaters' future
business plans, the operation of facilities, the availability of tax credits,
the availability of feedstocks, 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)  Operating issues for licensed facilities including feedstock availability,
     moisture content, Btu content, correct application of chemical reagent,
     achieving significant chemical change, operability of equipment, production
     capacity, product durability, resistance to water absorption, overall costs
     of operations and other commercial factors surrounding the use of
     Headwaters' technologies.
(2)  Marketing issues relating to market acceptance and regulatory permitting of
     products manufactured using Headwaters' technologies.
(3)  Securing of suitable facility sites, including permits and raw materials,
     for relocation and operation of facilities and product sales.
(4)  The market acceptance of products manufactured with Headwaters'
     technologies in the face of competition from traditional products.
(5)  Dependence on licensees to successfully implement Headwaters' chemical
     technologies and to make license and other payments to Headwaters.
(6)  Maintenance of placed-in-service and other requirements under Section 29 of
     the tax code by alternative fuel manufacturing facilities.
(7)  Changes in governmental regulations or failure to comply with existing
     regulations that could result in reduction or shutdown of operations of
     licensee facilities.
(8)  The continued availability of tax credits to licensees under the tax code
     and each licensee's ability to use tax credits.
(9)  The commercial feasibility of Headwaters' alternative fuel technologies
     upon the expiration of tax credits.
(10) Ability to meet financial commitments under existing contractual
     arrangements.
(11) Ability to meet non-financial commitments under existing contractual
     arrangements.
(12) Ability to commercialize new technologies which have only been tested in
     the laboratory and not in full-scale operations.
(13) Ability to commercialize the technology of HTI and to implement new
     business plans which are at an early stage of investigation and investment
     and which will require significant time, management, and capital
     investment.

                                       21
<PAGE>

(14) Success in the face of competition by others producing alternative chemical
     reagent products and other competing alternative fuel.
(15) Sufficiency of intellectual property protections.
(16) Satisfactory resolution of disputes in litigation.


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 that has
been omitted is either inapplicable or not required.


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


         Due to recent events involving the Registrant's auditors, Arthur
Andersen LLP, on May 10, 2002, Headwaters Incorporated dismissed Arthur Andersen
LLP as its independent accountants. The Registrant's Audit Committee
participated in and approved the decision to change independent accountants.

         The reports of Arthur Andersen LLP on the financial statements for the
past two fiscal years 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 most recent fiscal years and
through May 10, 2002, there were no disagreements with Arthur Andersen 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 Arthur Andersen LLP would have caused them to make
reference thereto in their reports on the financial statements for such years.

         During the two most recent fiscal years and through May 10, 2002, there
were no reportable events (as defined in Regulation S-K Item 304(a)(1)(v)).

         The Registrant requested that Arthur Andersen 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 May 10, 2002, the audit committee appointed PricewaterhouseCoopers
LLP as Headwaters' independent accountants. Headwaters has not consulted with
PricewaterhouseCoopers LLP on any application of accounting principles or any
other matter during the two fiscal years ended September 30, 2001 or subsequent
thereto, except for consultations in the capacity as Headwaters' independent
accountants up to July 19, 2000.


         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)).

                                       22
<PAGE>

         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 were 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"
and "Proposal No. 1: Election of Directors" in Headwaters' Proxy Statement to be
filed in January 2002 for the Annual Meeting of Stockholders to be held in 2002
(the "Proxy Statement"), is incorporated herein by reference.


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.

                                       23
<PAGE>

                                     PART IV

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

(a)  1.  Financial Statements

Consolidated Financial Statements of Headwaters Incorporated              Page


Report of Independent Accountants                                          F-1
Consolidated Balance Sheets as of September 30, 2000 and 2001              F-2
Consolidated Statements of Operations
  for the years ended September 30, 1999, 2000 and 2001                    F-4
Consolidated Statements of Changes in Stockholders' Equity
  for the years ended September 30, 1999, 2000 and 2001                    F-5
Consolidated Statements of Cash Flows
  for the years ended September 30, 1999, 2000 and 2001                    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.

         For convenience, the name Headwaters is used throughout this listing
although in some cases the name Covol was used in the original instrument.
<TABLE>
<CAPTION>
 Exhibit No.                                        Description                                          Location
 -----------                                        -----------                                          --------
<S>              <C>                                                                                     <C>
3.1.9            Restated Certificate of Incorporation of Headwaters dated August 14, 2001                 (17)
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)
10.11.2          License Agreement dated September 10, 1996, between Headwaters and CoBon Energy,          (2)
                 LLC


10.13.7          Note Restructure and Assumption Agreement among Gerald Larson, et. al. and                (18)
                 Headwaters dated October 24, 2001
10.13.8          $250,000 Promissory Note from The Murdock Group Holding Corporation in favor of           (18)
                 Headwaters dated October 24, 2001
10.13.9          $200,000 Promissory Note from The Murdock Group Holding Corporation in favor of           (18)


                 Headwaters dated October 24, 2001
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                   (4)
                 Appalachian Synfuel, LLC and Headwaters
10.47**          License Agreement, dated  August 5, 1997, between Pelletco Corporation and                (4)
                 Headwaters
10.49**          Agreement Concerning Additional Facilities, dated December 27, 1996, between AJG          (4)
                 Financial Services, Inc. and Headwaters
10.50.1**        Form of Amended and Restated License and Binder Purchase Agreement dated                  (5)
                 February 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

                                       24
<PAGE>
<CAPTION>
<S>              <C>                                                                                     <C>
10.50.1.1***     Form of First Amendment to Amended and Restated License and Binder Purchase               (13)
                 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                         (6)
10.56            Employment Agreement effective April 21, 1998 with Brent M. Cook                          (7)
10.60            Employment Agreement effective April 20, 1999 with Kirk A. Benson                         (8)
10.61            River Hill Project Purchase Agreement between DTE River Hill, L.L.C. and                  (16)
                 Headwaters dated August 27, 1999
10.61.1**        License and Binder Purchase Agreement between DTE River Hill, L.L.C. and                  (16)
                 Headwaters dated August 27, 1999
10.61.2          Modification Agreement between DTE River Hill L.L.C., Fun Enterprises Pty Limited         (16)
                 and Headwaters dated August 27, 1999
10.64***         Utah #2 Asset Purchase Agreement dated December 23, 1999 between Headwaters and           (9)
                 DTE Kentucky, LLC
10.64.1***       License and Binder Purchase Agreement dated December 29, 1999 between Headwaters          (13)
                 and DTE Kentucky, LLC
10.65***         Asset Purchase Agreement dated January 18, 2000 among Headwaters, Pocahontas              (9)
                 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           (13)
                 and Premier Elkhorn Coal Company (related to the Pocahontas facility)
10.65.2***       License and Binder Purchase Agreement dated January 21, 2000 between Headwaters           (13)
                 and Premier Elkhorn Coal Company (related to the Mohave facility)
10.67            Mountaineer Fuels Asset Purchase Agreement dated April 17, 2000 between DTE               (10)
                 Kentucky, LLC and Headwaters
10.67.1***       License and Binder Purchase Agreement dated April 17, 2000 between DTE Kentucky,          (10)
                 LLC and Headwaters
10.69***         Settlement Agreement and Mutual Release dated May 25, 2000 among Headwaters and           (11)
                 Birmingham Syn Fuel, L.L.C., PacifiCorp Syn Fuel, L.L.C., and PacifiCorp
                 Financial Services, Inc.
10.69.3***       License and Binder Purchase Agreement dated May 25, 2000 between Birmingham Syn           (11)
                 Fuel, L.L.C. and Headwaters
10.69.4***       License and Binder Purchase Agreement dated May 25, 2000 between PacifiCorp Syn           (11)
                 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           (11)
                 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           (11)
                 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               (11)
                 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.,         (11)
                 Utah Synfuel #1 Ltd, and Headwaters
10.71            Loan Agreement dated October 18, 2000 between Headwaters and Zions First National         (13)
                 Bank
10.71.2          First Amendment to Loan Agreement dated February 1, 2001 between Headwaters and           (14)
                 Zions First National Bank
10.71.3          Promissory Note dated February 1, 2001 between Headwaters as borrower and Zions           (14)
                 First National Bank as lender


10.71.4          Second Amendment to Loan Agreement dated September 26, 2001 between Headwaters            (18)
                 and Zions First National Bank


10.72            Agreement and Plan of Reorganization between Headwaters and Hydrocarbon                   (15)
                 Technologies, Inc. dated May 2, 2001
10.72.1          Share Exchange Agreement between Headwaters and Hydrocarbon Technologies, Inc.            (15)
                 dated May 2, 2001
10.72.2          Amendment No. 1 to Agreement and Plan of Reorganization between Headwaters and            (17)
                 Hydrocarbon Technologies, Inc. dated August 21, 2001
10.72.3          Amendment No. 1 to Share Exchange Agreement between Headwaters and Hydrocarbon            (17)
                 Technologies, Inc. dated August 21, 2001
10.72.4          Certificate of Merger between Headwaters and Hydrocarbon Technologies, Inc. dated         (17)
                 August 29, 2001


10.73            Contribution and Subscription Agreement among Headwaters and Avintaquin Capital,          (18)
                 LLC dated September 24, 2001
10.73.1          Promissory Note from Avintaquin Capital, LLC in favor of Headwaters dated                 (18)
                 September 24, 2001


16               Letter regarding change in certifying accountant                                          (12)

                                       25
<PAGE>
<CAPTION>
<S>              <C>                                                                                     <C>

16               Letter regarding change in certifying accountant                                          (19)
21.1             List of Subsidiaries of Headwaters                                                        (18)
23.1             Consent of PricewaterhouseCoopers LLP                                                      *

99.1             Amended 2000 Employee Stock Purchase Plan (originally designated as Exhibit No.           (15)
                 99.2)
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                                        (13)
       -----------------------
         *        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.
</TABLE>

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.

(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'
     Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997.
(4)  Incorporated by reference to the indicated exhibit filed with Headwaters'
     Annual Report on Form 10-K for the fiscal year ended September 30, 1997.
(5)  Incorporated by reference to the indicated exhibit filed with Headwaters'
     Quarterly Report on Form 10-Q, for the quarterly period ended March 31,
     1998.
(6)  Incorporated by reference to the indicated exhibit filed with Headwaters'
     Annual Report on Form 10-K, for the fiscal year ended September 30, 1998.
(7)  Incorporated by reference to the indicated exhibit filed with Headwaters'
     Quarterly Report on Form 10-Q, for the quarterly period ended December 31,
     1998.
(8)  Incorporated by reference to the indicated exhibit filed with Headwaters'
     Quarterly Report on Form 10-Q for the quarter ended June 30, 1999.
(9)  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.
(10) Incorporated by reference to the indicated exhibit filed with Headwaters'
     Quarterly Report on Form 10-Q for the quarter ended March 31, 2000.
(11) Incorporated by reference to the indicated exhibit filed with Headwaters'
     Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.
(12) 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.
(13) Incorporated by reference to the indicated exhibit filed with Headwaters'
     Annual Report on Form 10-K for the fiscal year ended September 30, 2000.
(14) Incorporated by reference to the indicated exhibit filed with Headwaters'
     Quarterly Report on Form 10-Q, for the quarter ended March 31, 2001.
(15) Incorporated by reference to the indicated exhibit filed with Headwaters'
     Quarterly Report on Form 10-Q, for the quarter ended June 30, 2001.
(16) Incorporated by reference to the indicated exhibit filed with Headwaters'
     Current Report on Form 8-K/A, for an event dated August 27, 1999, filed
     August 15, 2001.
(17) Incorporated by reference to the indicated exhibit filed with Headwaters'
     Current Report on Form 8-K, for events dated August 14, 2001 and August 28,
     2001, filed September 12, 2001.


(18) Incorporated by reference to the indicated exhibit filed with Headwaters'
     Annual Report on Form 10-K, for the fiscal year ended September 30, 2001.
(19) Incorporated by reference to the indicated exhibit filed with Headwaters'
     Current Report on Form 8-K, for the event dated May 10, 2002, filed
     May 10, 2002.


                                       26
<PAGE>

Reports on Form 8-K

         The following reports on Form 8-K were filed during the quarter ended
September 30, 2001:

o        Form 8-K/A filed on August 15, 2001, for an event dated August 27, 1999
         (Sale of alternative fuel facility).

o        Form 8-K filed on September 12, 2001 for events dated August 14, 2001
         (Restatement of Certificate of Incorporation) and August 28, 2001
         (Acquisition of Hydrocarbon Technologies, Inc.). The following
         financial statements of Hydrocarbon Technologies, Inc. and subsidiaries
         and unaudited pro forma financial information were filed with this Form
         8-K:

                  Audited Financial Statements of HTI:
                  ------------------------------------
                  Independent Auditors' Report
                  Consolidated Balance Sheets as of December 31, 2000 and 1999
                  Consolidated Statements of Operations for the Years Ended
                    December 31, 2000 and 1999
                  Consolidated Statements of Stockholders' Equity (Deficit) for
                    the Years Ended December 31, 2000 and 1999
                  Consolidated Statements of Cash Flows for the Years Ended
                    December 31, 2000 and 1999
                  Notes to Consolidated Financial Statements

                  Unaudited Financial Statements of HTI:
                  --------------------------------------
                  Accountants' Review Report
                  Consolidated Balance Sheets as of June 30, 2001 and
                    December 31, 2000
                  Consolidated Statements of Operations for the Six Months Ended
                    June 30, 2001 and 2000
                  Consolidated Statements of Stockholders' Equity (Deficit) for
                    the Six Months Ended June 30, 2001 and 2000
                  Consolidated Statements of Cash Flows for the Six Months Ended
                  June 30, 2001 and 2000
                  Notes to Consolidated Financial Statements

                  Unaudited pro forma financial information:
                  ------------------------------------------
                  Introduction to Pro Forma Financial Information
                  Pro Forma Condensed Combined Balance Sheet as of June 30, 2001
                  Pro Forma Condensed Combined Statement of Income for the Year
                    Ended September 30, 2000
                  Pro Forma Condensed Combined Statement of Income for the Nine
                    Months Ended June 30, 2001
                  Notes to Pro Forma Condensed Combined Financial Information


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.

                                       27
<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: July 15, 2002


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             July 15, 2002
-------------------------     (Principal Executive Officer)
 Kirk A. Benson               and Director

 /s/ Steven G. Stewart        Chief Financial Officer             July 15, 2002
-------------------------     (Principal Financial and
 Steven G. Stewart            Accounting Officer)

 /s/ Brent M. Cook            President and Director              July 15, 2002
-------------------------
 Brent M. Cook


 /s/ James A. Herickhoff      Director                            July 15, 2002
-------------------------
James A. Herickhoff


 /s/ Raymond J. Weller        Director                            July 15, 2002
-------------------------
Raymond J. Weller


 /s/ Ronald  S. Tanner        Director                            July 15, 2002
-------------------------
 Ronald S. Tanner


 /s/ E. J. "Jake Garn         Director                            July 15, 2002
-------------------------
 E. J. "Jake" Garn


 /s/ Alfred G. Comolli        Director                            July 15, 2002
-------------------------
  Alfred G. Comolli


 /s/ L.K. (Theo) Lee          Director                            July 15, 2002
-------------------------
  L.K. (Theo) Lee


                                       28
<PAGE>

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Stockholders
 of Headwaters Incorporated:

In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, changes in stockholders' equity, and cash
flows present fairly, in all material respects, the financial position of
Headwaters Incorporated and its subsidiaries at September 30, 2001 and 2000, and
the results of their operations and their cash flows for each of the three years
in the period ended September 30, 2001 in conformity with accounting principles
generally accepted in the United States of America. 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 of America, 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 our opinion.

/s/ PricewaterhouseCoopers LLP

PricewaterhouseCoopers LLP

Salt Lake City, Utah
July 15, 2002


                                       F-1
<PAGE>
<TABLE>
<CAPTION>
                             HEADWATERS INCORPORATED AND SUBSIDIARIES

                                    CONSOLIDATED BALANCE SHEETS


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

Current assets:
     Cash and cash equivalents                                                     $          983  $           999
     Short-term investments                                                                 6,973            6,048
     Trade receivables, net                                                                 7,298            8,887
     Short-term notes and accrued interest receivable                                       2,530            6,857
     Other current assets                                                                     387            1,257
                                                                                   --------------- ----------------
            Total current assets                                                           18,171           24,048
                                                                                   --------------- ----------------

Property, plant and equipment, net                                                            552            2,680
                                                                                   --------------- ----------------

Other assets:
     Notes and accrued interest receivable                                                  6,598            4,000
     Equity investments, net                                                                3,259               --
     Deferred income taxes                                                                  3,000           13,090
     Intangible assets, net                                                                 1,221           10,752
     Other assets                                                                             640              805
                                                                                   --------------- ----------------
            Total other assets                                                             14,718           28,647
                                                                                   --------------- ----------------

            Total assets                                                           $       33,441  $        55,375
                                                                                   =============== ================

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

                                      F-2
<PAGE>
<CAPTION>
                           HEADWATERS INCORPORATED AND SUBSIDIARIES

                            CONSOLIDATED BALANCE SHEETS, continued

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

Current liabilities:
     Accounts payable                                                                $         698  $         2,203
     Accrued personnel costs                                                                 2,254            2,777
     Other accrued liabilities                                                               3,786            4,987
     Unamortized portion of non-refundable license fees                                      2,832            1,106
     Short-term borrowings                                                                     208            4,356
                                                                                     -------------- ----------------
            Total current liabilities                                                        9,778           15,429
                                                                                     -------------- ----------------

Long-term liabilities:
     Notes payable, non-current                                                              5,055              149
     Other long-term liabilities                                                               180            2,906
     Unamortized portion of non-refundable license fees                                      7,681            5,805
                                                                                     -------------- ----------------
            Total long-term liabilities                                                     12,916            8,860
                                                                                     -------------- ----------------
            Total liabilities                                                               22,694           24,289
                                                                                     -------------- ----------------

Commitments and contingencies

Stockholders' equity:
     Convertible preferred stock, $0.001 par value; authorized 10,000 shares,
       issued and outstanding 17 shares at September 30, 2000 and 0 shares at
       September 30, 2001                                                                        1               --
     Common stock, $0.001 par value; authorized 50,000 shares, issued and
       outstanding 23,341 shares at September 30, 2000 (including 214 shares
       held in treasury) and 23,807 shares at September 30, 2001 (including 548
       shares held in treasury)                                                                 23               24
     Capital in excess of par value                                                         82,659           83,226
     Accumulated deficit                                                                   (70,221)         (48,704)
     Treasury stock                                                                           (734)          (3,038)
     Other                                                                                    (981)            (422)
                                                                                     -------------- ----------------
            Total stockholders' equity                                                      10,747           31,086
                                                                                     -------------- ----------------

            Total liabilities and stockholders' equity                               $      33,441  $        55,375
                                                                                     ============== ================
</TABLE>

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

                                      F-3
<PAGE>
<TABLE>
<CAPTION>
                                          HEADWATERS INCORPORATED AND SUBSIDIARIES

                                           CONSOLIDATED STATEMENTS OF OPERATIONS

                                                                                            Year ended September 30,
(thousands of dollars, except per-share data)                                     1999               2000               2001
--------------------------------------------------------------------- ----------------- ------------------ ------------------
<S>                                                                   <C>               <C>                <C>
Revenue:
     License fees                                                     $          3,526  $          17,315  $          20,765
     Chemical sales                                                              2,140              9,757             22,407
     Alternative fuel sales                                                        767                149                 --
     Other                                                                         286                665              2,292
                                                                      ----------------- ------------------ ------------------
          Total revenue                                                          6,719             27,886             45,464
                                                                      ----------------- ------------------ ------------------

Operating costs and expenses:
     Cost of chemical                                                            1,695              6,617             14,524
     Cost of operations                                                         13,322              4,355              3,071
     Selling, general and administrative                                         4,881              4,827              5,838
     Acquired in-process research and development                                   --                 --              2,400
     Asset write-offs and other charges                                          7,395             17,758                 --
                                                                      ----------------- ------------------ ------------------
        Total operating costs and expenses                                      27,293             33,557             25,833
                                                                      ----------------- ------------------ ------------------
Operating income (loss)                                                        (20,574)            (5,671)            19,631
                                                                      ----------------- ------------------ ------------------

Other income (expense):
     Interest and net investment income                                          1,586              1,775                726
     Interest expense                                                           (6,253)            (4,814)              (224)
     Losses on notes receivable and equity investments                              --               (746)            (6,265)
     Net gains (losses) on sale of facilities                                   (1,839)            16,870                 --
     Other, net                                                                 (1,313)             1,228                600
                                                                      ----------------- ------------------ ------------------
          Total other income (expense), net                                     (7,819)            14,313             (5,163)
                                                                      ----------------- ------------------ ------------------

Income (loss) before income taxes and extraordinary item                       (28,393)             8,642             14,468

Income tax benefit                                                                  --              2,900              7,049
                                                                      ----------------- ------------------ ------------------

Income (loss) before extraordinary item                                        (28,393)            11,542             21,517

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

Net income (loss)                                                     $        (28,393) $           3,682  $          21,517
                                                                      ================= ================== ==================


Basic net income (loss) per common share                              $          (2.39) $            0.07  $            0.94
                                                                      ================= ================== ==================

Diluted net income (loss) per common share                            $          (2.39) $            0.07  $            0.87
                                                                      ================= ================== ==================
</TABLE>


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

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

                                   CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

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

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 as of September 30, 1999    17      1  12,766       13       78,457      (71,713)      (6,564)        (1,222)         --
                                 ---------------------------------------------------------------------------------------------------

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

                                      F-5
<PAGE>
<CAPTION>
                                            HEADWATERS INCORPORATED AND SUBSIDIARIES

                              CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY, continued

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

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 586 shares of
 treasury stock, at cost                                                                                                  $(1,897)

14 shares of treasury stock
 transferred to employee stock
 purchase plan                                                                                                                 26

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

Net income for the year ended
 September 30, 2000                                                                 3,682
                                 ---------------------------------------------------------------------------------------------------
Balances as of September 30, 2000    17      1  23,341       23       82,659      (70,221)        (466)          (515)       (734)
                                 ---------------------------------------------------------------------------------------------------

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

                                      F-6
<PAGE>
<CAPTION>
                                            HEADWATERS INCORPORATED AND SUBSIDIARIES

                              CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY, continued

                                                                                                            Other
                                                                                           -----------------------------------------
                                                                                              Notes and
                                                                                              interest
                                                                                              receivable
                                                                                              - related
                                                                                             parties, from
                                   Convertible                                               issuance of,
                                   Preferred                                                      or          Deferred
                                     Stock        Common Stock      Capital in              collateralized compensation Common stock
(thousands of dollars            -------------------------------- excess of par Accumulated  by, common     from stock    held in
and shares)                      Shares Amount  Shares    Amount      value       deficit       stock         options     treasury
------------------------------------------------------------------------------------------------------------------------------------
<S>                               <C>    <C>    <C>     <C>         <C>          <C>          <C>           <C>         <C>
Common stock issued on conversion
 of convertible preferred stock     (17)   $(1)    443      $--        $  --

Preferred stock cash dividends                                          (695)

Exercise of stock options and
 warrants                                          860        1        1,925

Common stock issued in connection
 with purchase of Hydrocarbon
 Technologies, Inc., net of
 estimated registration costs                      593        1        5,434

Common stock options issued in
 connection with purchase of
 Hydrocarbon Technologies, Inc.                                        1,325

Tax benefit from exercise of
 stock options                                                         1,690

Write-up of related party note
 receivable to collateral value                                                                  $(541)

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

Amortization of deferred
 compensation from stock options                                                                                  $93

Purchase of 1,648 shares of
 treasury stock, at cost                                                                                                  (10,510)

34 shares of treasury stock
 transferred to employee stock
 purchase plan                                                                                                                101

Cancellation of 1,430 shares of
 treasury stock                                 (1,430)      (1)      (9,112)                                               9,112

Net income for the year ended
 September 30, 2001                                                                21,517
                                 ---------------------------------------------------------------------------------------------------
Balances as of September 30, 2001    --    $--  23,807      $24      $83,226     $(48,704)        $ --          $(422)    $(3,038)
                                 ===================================================================================================
</TABLE>

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

                                      F-7
<PAGE>
<TABLE>
<CAPTION>
                                    HEADWATERS INCORPORATED AND SUBSIDIARIES

                                      CONSOLIDATED STATEMENTS OF CASH FLOWS


                                                                                                     Year ended September 30,
(thousands of dollars)                                                                          1999          2000         2001
----------------------------------------------------------------------------------------- ----------- ------------- ------------
<S>                                                                                         <C>           <C>          <C>
Cash flows from operating activities:
Net income (loss)                                                                           $(28,393)     $  3,682     $ 21,517
     Adjustments to reconcile net income (loss) to net cash provided by (used in)
      operating activities:
          Deferred income tax benefit                                                             --        (3,000)      (7,470)
          Amortization of non-refundable license fees                                           (875)         (802)      (2,015)
          Depreciation and amortization                                                        2,570         1,021          263
          Amortization of deferred compensation from stock options                             2,553           707           93
          Interest expense related to amortization of debt discount and debt
           issuance costs                                                                      2,075         3,034           79
          Net losses (gains) on sale of facilities, property, plant and equipment              1,979       (16,894)         (42)
          Losses in equity investments, write-offs and provisions for unrealizable
           investments                                                                            --           746        3,018
          Write-down of notes receivable and related accrued interest                             --            --        3,200
          Write-down (write-up) of related party note receivable                               1,209           (66)        (541)
          Acquired in-process research and development                                            --            --        2,400
          Gains on other transactions                                                             --        (1,079)          --
          Non-cash portion of asset write-offs and other charges                               5,362        15,485           --
          Extraordinary loss on early extinguishment of debt                                      --         7,860           --
          Other changes in operating assets and liabilities, net of effect of
           acquisition of Hydrocarbon Technologies, Inc.:
                 Receivables                                                                  (2,837)       (3,968)        (987)
                 Other current assets                                                            107           161           26
                 Accounts payable and accrued liabilities                                       (993)       (1,804)         958
                 Unamortized portion of non-refundable license fees                               --         1,587       (1,587)
                 Other, net                                                                     (273)          (62)         (28)
                                                                                          ----------- ------------- ------------
                      Net cash provided by (used in) operating activities                    (17,516)        6,608       18,884
                                                                                          ----------- ------------- ------------

     Cash flows from investing activities:
          Payments for acquisition of Hydrocarbon Technologies, Inc., net of cash
           acquired                                                                               --            --       (4,845)
          Net proceeds from sale of short-term investments                                        --            --          925
          Net purchases of short-term investments                                                 --        (6,973)          --
          Investments in and loans to non-affiliated companies                                    --        (4,005)      (4,636)
          Purchase of facilities held for sale and equipment                                    (861)         (403)        (170)
          Proceeds from sale of facilities, property, plant and equipment                      1,433        42,334          168
          Net decrease (increase) in restricted assets                                           (95)          843          (85)
          Proceeds from facility transferred under note receivable arrangement                   525            --           --
          Other, net                                                                            (127)           (9)         (95)
                                                                                          ----------- ------------- ------------
               Net cash provided by (used in) investing activities                               875        31,787       (8,738)
                                                                                          ----------- ------------- ------------

     Cash flows from financing activities:
        Net proceeds from issuance of notes payable, warrants and other borrowings            11,193         6,980        8,991
        Payments on notes payable, including redemption premiums, and other borrowings        (4,690)      (43,995)      (9,941)
        Purchase of common stock for the treasury, net of employee stock purchases                --        (1,871)     (10,409)
        Proceeds from exercise of options and warrants                                            --           659        1,926
        Preferred stock dividends                                                               (123)         (297)        (695)
        Net proceeds from issuance of common stock and warrants                                3,775         5,254           --
        Net proceeds from issuance of preferred stock and warrants                             6,367            --           --
        Preferred stock redemptions                                                               --        (4,454)          --
        Other, net                                                                              (147)         (149)          (2)
                                                                                          ----------- ------------- ------------
         Net cash provided by (used in) financing activities                                  16,375       (37,873)     (10,130)
                                                                                          ----------- ------------- ------------

     Net increase (decrease) in cash and cash equivalents                                       (266)          522           16

     Cash and cash equivalents, beginning of year                                                727           461          983
                                                                                          ----------- ------------- ------------

     Cash and cash equivalents, end of year                                                 $    461      $    983     $    999
                                                                                         ============ ============= ============

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

                                      F-8
<PAGE>
<CAPTION>

                                    HEADWATERS INCORPORATED AND SUBSIDIARIES

                                CONSOLIDATED STATEMENTS OF CASH FLOWS, continued



                                                                                                     Year ended September 30,
(thousands of dollars)                                                                          1999        2000          2001
----------------------------------------------------------------------------------------- ----------- ----------- -------------
<S>                                                                                         <C>           <C>          <C>
     Supplemental schedule of non-cash investing and financing activities:
        Common stock issued in connection with purchase of Hydrocarbon Technologies, Inc.   $     --      $     --     $  5,435
        Common stock options issued in connection with purchase of Hydrocarbon
         Technologies, Inc.                                                                       --            --        1,325
        Exchange of equity investments in and loans to non-affiliated companies for
         long-term note receivable from non-affiliate                                             --            --        4,000
        Common stock issued on conversion of convertible preferred  stock and in
         payment of dividends                                                                  2,761         1,634        3,100
        Cancellation of treasury stock                                                            --        (1,137)      (9,112)
        Tax benefit from exercise of stock options                                                --            --        1,690
        Cancellation of related party note receivable and transfer of collateral shares
         to treasury stock                                                                        --            --        1,007
        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                                                                                 --         2,964           --
        Reclassification of redeemable convertible preferred stock to convertible
          preferred stock                                                                         --         2,710           --
        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                       519            --           --
        Common stock issued for rights to technology                                             375            --           --
        Property, plant and equipment acquired through reduction of accounts receivable          413            --           --


     Supplemental disclosure of cash flow information:
         Cash paid for interest                                                             $  3,646      $ 10,458     $    269
         Cash paid for income taxes                                                               --            --          283
</TABLE>

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

                                      F-9
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   Organization and Description of Business


     Headwaters Incorporated was incorporated in Delaware in 1995. Headwaters
     owns 100% of Hydrocarbon Technologies, Inc. ("HTI"), a New Jersey company
     formed in 1995 and acquired by Headwaters in August 2001. In September
     2001, Headwaters disposed of its 100% interest in Kwai Financial, Inc.
     ("Kwai"), a Delaware company formed in 2000. Headwaters is also 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.
     Headwaters' fiscal year ends on September 30 and unless otherwise noted,
     all future references to years shall mean Headwaters' fiscal year rather
     than a calendar year.

     Headwaters Incorporated and its subsidiaries' primary business is
     commercializing its chemical technologies used to produce alternative fuel
     from coal derivatives and to develop and deploy alternative energy
     technologies. Currently, Headwaters has licensed its technology to the
     owners of 28 alternative fuel facilities which are operating at various
     levels of production in ten states. During 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 1999 and three
     of the facilities were sold in 2000 (see Note 13). Headwaters has no
     current plans to construct any additional alternative fuel facilities.
     During 2000, Headwaters began evaluating and pursuing investment
     alternatives. Headwaters invested excess cash in high-grade
     government-backed securities and made several equity investments in and
     loans to unrelated high-risk entities. Headwaters continues to invest in
     government-backed securities, but does not currently intend to make any
     additional equity investments in or loans to any new unrelated entities.
     Headwaters is interested in possible strategic acquisitions of entities
     that operate in adjacent industries and that would be synergistic with its
     current operations.

2.   Summary of Significant Accounting Policies

     Principles of Consolidation - The consolidated financial statements include
     the accounts of Headwaters and its four subsidiaries, HTI, Kwai, Utah
     Synfuel #1 and Alabama Synfuel #1. All significant intercompany
     transactions and accounts are eliminated in consolidation. Due to the time
     required to obtain accurate financial information related to HTI's
     significant foreign contracts, for financial reporting purposes HTI's
     financial statements are consolidated with Headwaters' financial statements
     using a one-month lag. Accordingly, HTI's August 2001 acquisition date
     balance sheet has been consolidated with Headwaters' September 30, 2001
     balance sheet, but no results of operations of HTI have been included in
     the accompanying consolidated statements of operations for any period.
     HTI's November 30, 2001 balance sheet will be consolidated with Headwaters'
     December 31, 2001 balance sheet and HTI's results of operations for the
     period from date of acquisition to November 30, 2001 will be consolidated
     with Headwaters' results for the quarter ending December 31, 2001.

     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 certain 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 calendar 2007. Recurring
     license fees or royalty payments are recognized in the period when earned
     which generally coincides with the sale of alternative fuel by Headwaters'
     licensees. Revenues from the sale of chemical reagent are recognized upon
     delivery of product to the licensee or non-licensee customer. In certain
     instances, Headwaters is required to pay to third parties a portion of
     license fees received or cash proceeds from the sale of chemical reagent.
     In such cases, Headwaters records the net proceeds as revenue.

     Segment Reporting, Major Customers and Concentrations of Risk - Headwaters
     operates in the alternative energy industry and reports as a single
     industry segment. Approximately $2,607,000 of revenue in 2000 and
     $1,328,000 in 2001 was from a single licensee; $12,296,000 of revenue in
     2000 and $5,111,000 in 2001 was from a second licensee; $1,032,000 of
     revenue in 1999, $15,511,000 in 2000 and $4,978,000 in 2001 was from a
     third licensee; $849,000 of revenue in 1999, $2,558,000 in 2000 and
     $4,675,000 in 2001 was from a fourth licensee; and $2,673,000 of revenue in
     1999 was from a fifth licensee. 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 approximately
     $5,275,000 at September 30, 2001. Headwaters purchases all of the chemical
     reagent that is sold to licensees and other customers from a single large
     international chemical company. Management believes that if necessary, the
     chemical reagent could 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.

                                      F-10
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued


2.   Summary of Significant Accounting Policies, continued

     Short-term Investments - Short-term investments consist primarily of
     mortgage- and other asset-backed securities, corporate bonds, U.S.
     government securities, and equity 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 and $16,000 of investment losses in
     2001 related to securities held at September 30, 2000 and 2001,
     respectively.


     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 and $0 at September 30, 2001 for trade receivables
     and $0 at September 30, 2000 and 2001 for notes receivable. The increase to
     the trade receivable allowance for 2000 was $479,000 with a write-off of
     $358,000. The increase to the trade receivable allowance for 2001 was $0
     with a write-off of $121,000. Collateral is not required for trade
     receivables. Collateral, generally consisting of most or all assets of the
     debtor, is required for notes receivable. Total losses recognized on notes
     receivable were $0 in 1999 and 2000 and approximately $3,658,000 in 2001.
     These losses are included in other expense in the consolidated statement of
     operations.


     Property, Plant and Equipment - Property, plant and equipment are recorded
     at cost and 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
     results 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 owned from 1% to
     27% of the voting securities of five non-public high-risk investee
     companies. There were no equity investments at September 30, 2001.
     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 investments accounted for using the equity method.
     In 2001, Headwaters recognized approximately $2,607,000 of total losses
     related to its investments accounted for using the equity method. These
     losses are included in other expense in the consolidated statements of
     operations.


     Intangible Assets - Intangible assets consist of (i) identifiable
     intangible assets, comprised of existing patented technology, obtained in
     connection with the acquisition of HTI (see Note 3); (ii) rights to
     technology, consisting of a coal-based alternative fuel technology and
     related licensing and patent rights; and (iii) 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. These intangible assets are
     being amortized on the straight-line method over their estimated useful
     lives, which range from nine to fifteen years. Accumulated amortization of
     intangible assets was $302,000 as of September 30, 2000 and $470,000 as of
     September 30, 2001. As described in more detail in Note 14, Headwaters
     wrote off approximately $2,189,000 of intangible assets during 2000.
     Headwaters has implemented SFAS No. 142, "Accounting for Goodwill and
     Intangible Assets," with the exception of certain additional disclosures
     which can not be early implemented.

     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 14.


     Income Taxes - Headwaters accounts for income taxes using the asset and
     liability approach. Headwaters recognizes deferred income tax assets or
     liabilities for the expected future tax consequences of events that have
     been recognized in the financial statements or income tax returns. Deferred
     income tax assets or liabilities are determined based upon the differences
     between the financial statement and tax bases of assets and liabilities
     using enacted tax rates expected to apply when the differences are expected
     to be settled or realized. Deferred income tax assets are reviewed
     periodically for recoverability and valuation allowances are provided as
     necessary. Headwaters files a consolidated tax return with its
     subsidiaries.

                                      F-11
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued

2.   Summary of Significant Accounting Policies, continued

     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 earlier of the option grant date or the date at which the recipient's
     performance is complete. 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.

     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 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 materially 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 income (loss) or total assets.

3.   Acquisition of HTI

     In August 2001, Headwaters completed a 100% acquisition of HTI, a New
     Jersey-based company that has significant intellectual property including
     technologies to transform coal and heavy oil into ultra-clean diesel fuel
     and to recycle waste oil into higher value carbon products, and
     nano-catalyst technology. Total consideration at closing, including the
     direct costs incurred by Headwaters to consummate the acquisition, was
     approximately $11,774,000. The following table sets forth the consideration
     paid:

     (thousands of dollars and shares, except per-share amount)
     -------------------------------------------------------------- ------------

     Fair value of Headwaters stock (593 shares at $9.25 per
       share)                                                          $ 5,485
     Fair value of options to purchase 144 shares of Headwaters'
       common stock issued in exchange for 152 outstanding vested
       HTI options                                                       1,325
     Cash paid to HTI stockholders                                       1,395
     Cash paid to retire HTI note payable to a bank, plus
       pre-acquisition loans by Headwaters to HTI                        2,560
     Costs directly related to acquisition                               1,009
                                                                    ------------
                 Total consideration                                   $11,774
                                                                    ============

     The value of the 593,000 shares of Headwaters common stock issued to the
     former HTI stockholders was determined using the average market price of
     Headwaters' stock over a three-day period, consisting of the day the terms
     of acquisition were agreed to and one day prior to and one day subsequent
     to that day ($9.25). For purposes of computing the estimated fair value of
     the Headwaters stock options issued in exchange for outstanding HTI
     options, the Black-Scholes model was used with the following assumptions:
     expected stock price volatility of 90%, risk free interest rates of 3.5% to
     4.0%, weighted average expected option lives of one to three years, no
     dividend yield, and a fair value of Headwaters' stock of $9.25 per share.

     Additional contingent consideration can be earned by the former HTI
     stockholders during calendar 2001 and calendar 2002 based on certain
     operating targets and other milestones. As required by generally accepted
     accounting principles, a contingent liability of $2,714,000 was recorded,
     representing the contingent incremental consideration for identified
     purchased assets in excess of the consideration paid at closing. A
     contingent liability was not recognized for the contingent incremental
     consideration that, if paid in the future, would be recorded as goodwill.
     This amount will be adjusted in the future if and when the actual
     contingent consideration is paid. If some or all of the recorded contingent
     consideration is not paid, some of the recorded asset values, as shown in
     the following table, will be adjusted accordingly. If all operating targets
     and other milestones are achieved, the total additional consideration that
     could be issued to the former HTI stockholders would consist of
     approximately $1,395,000 in cash and approximately 593,000 shares of
     Headwaters common stock. The value of the common shares issued in the
     future, if any, will be determined at the time the shares are issued, based
     on the fair value of the shares at that time.

                                      F-12
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued


3.   Acquisition of HTI, continued


     The following table sets forth the preliminary allocation to the tangible
     and intangible assets acquired and liabilities assumed, of the total
     consideration at closing. Headwaters is in the process of obtaining
     third-party valuations of assets acquired and is refining the income
     tax-related consequences of the acquisition; therefore, the allocation of
     the purchase price is subject to adjustment.


     (thousands of dollars)
     -------------------------------------------------------------- ------------
     Tangible assets acquired, net of liabilities assumed              $ 1,388
     Intangible assets acquired:
          Existing patented technology                                   9,700
          Acquired in-process research and development                   2,400
     Deferred income taxes related to HTI acquisition date tax
       net operating losses which can be utilized in future
       periods                                                           1,000
     Contingent liability for purchased assets in excess of
       consideration paid at closing                                    (2,714)

                                                                    ------------
                 Net assets acquired                                   $11,774
                                                                    ============

     The HTI acquisition has been accounted for using the purchase method of
     accounting as required by SFAS No. 141, "Business Combinations." Assets
     acquired and liabilities assumed have been recorded at their estimated fair
     values as of the acquisition date. Approximately $9,700,000 of the purchase
     price was allocated to identifiable intangible assets consisting of
     existing patented technology with an estimated useful life of 15 years.

     Approximately $2,400,000 of the purchase price was allocated to purchased
     in-process research and development, consisting primarily of efforts
     focused on developing catalysts and catalytic processes to lower the cost
     of producing alternative fuels and chemicals while improving energy
     efficiency and reducing environmental risks. This amount represents the
     estimated purchased in-process technology for projects that have not yet
     reached technological feasibility and currently have no alternative use.
     Further development of the in-process technology is currently expected to
     take at least three years and to cost approximately $5,000,000. The
     valuation of the in-process research and development included, but was not
     limited to, an analysis of the market for the acquired products and
     technologies, the completion costs for the projects, the expected cash
     flows attributed to the projects and the risks associated with achieving
     such cash flows. The estimated value of these projects was determined by
     estimating the costs to develop the purchased in-process technology into
     commercially viable products, estimating the resulting net cash flows from
     the sale of those products, and discounting the net cash flows back to
     their present value. As required by generally accepted accounting
     principles, Headwaters recorded a charge for this purchased in-process
     research and development as of the date of acquisition, which is included
     in operating costs and expenses in the 2001 consolidated statement of
     operations.

     The following unaudited pro forma financial information for 2000 and 2001
     assumes the HTI acquisition occurred as of the beginning of the respective
     years. The pro forma combined results for 2000 combine Headwaters'
     historical results for the year ended September 30, 2000 with HTI's
     historical results for the twelve months ended June 30, 2000, after giving
     effect to certain adjustments, including the amortization of acquired
     intangible assets. The pro forma combined results for 2001 combine
     Headwaters' historical results for the year ended September 30, 2001 with
     HTI's historical results for the twelve months ended June 30, 2001, after
     giving effect to necessary adjustments. The pro forma results have been
     prepared for illustrative purposes only. Such information does not purport
     to be indicative of the results of operations which actually would have
     resulted had the acquisition occurred on the dates indicated, nor is it
     indicative of the results that may be expected in future periods.

                                                          Unaudited Pro Forma
                                                               Results
                                                    ---------------------------
     (thousands of dollars, except per-share data)          2000          2001
     ---------------------------------------------- ------------- -------------

     Total revenue                                       $36,555       $49,961

     Income before extraordinary item                     11,058        17,802

     Net income                                            3,198        17,802

     Basic income per common share before
       extraordinary item                                   0.44          0.78

     Diluted income per common share before
       extraordinary item                                   0.39          0.72

     Basic net income per common share                      0.04          0.78

     Diluted net income per common share                    0.04          0.72


                                      F-13
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued


4.   Property, Plant and Equipment

     Property, plant and equipment consisted of the following at September 30:

                                        Estimated useful
     (thousands of dollars)                  lives         2000       2001
     ---------------------------------- ---------------- --------- ----------
     Land                                                   $ 224     $  379
     Buildings and improvements            15 years            96        624
     Machinery and equipment             3 - 8 years          370      1,885
                                                         --------- ----------
                                                              690      2,888
      Less accumulated depreciation                          (138)      (208)
                                                         --------- ----------
      Net property, plant and equipment                     $ 552     $2,680
                                                         ========= ==========


     Depreciation expense was approximately $1,988,000 in 1999, $784,000 in 2000
     and $93,000 in 2001. As described in more detail in Note 14, Headwaters
     recorded approximately $12,615,000 of expense related to impaired assets
     during 2000.


5.   Notes Receivable

     Notes receivable consisted of the following at September 30:

     (thousands of dollars)                                      2000     2001
     --------------------------------------------------------- -------- --------
     Short-term Notes and Accrued Interest Receivable

     Facility-dependent note receivable from a corporation,
       bearing interest at 6% paid quarterly, collateralized
       by an alternative fuel facility in Alabama sold by
       Headwaters in 1998. This note receivable was
       collected in October 2001.                               $   --   $6,500

     Accrued interest receivable from the above corporation,
       collected in October 2001                                    --       98

     Portion of intercompany note receivable and accrued
       interest due from HTI not eliminated in consolidation
       (see Note 3)                                                 --      259

     Notes receivable representing bridge loans to nine
       companies, primarily in the start-up phase, for
       amounts ranging from $200 to $500 each, with due
       dates of 120 days or less from note origination.
       These notes were collateralized by most or all assets
       of the debtors and were collected, written off or
       sold in 2001.                                             2,530       --
                                                             -------------------
     Total                                                      $2,530   $6,857
                                                             ===================

     Notes and Accrued Interest Receivable


     Note receivable from a limited liability corporation,
       bearing interest at LIBOR plus 0.9% interest (3.7% at
       September 30, 2001) payable quarterly, with principal
       due no later than September 2004. This note is
       collateralized by certain bridge loans and equity
       investments sold by Headwaters to this entity in
       September 2001. Following payment of the note
       principal, Headwaters has the right to receive the
       first $1,000 plus 20% of any additional cash received
       by the limited liability corporation related to the
       assets sold by Headwaters. This note is being
       accounted for on the cost recovery basis.                $   --   $4,000


     Facility-dependent note receivable described above,
       collected in October 2001.                                6,500       --

     Accrued interest receivable from the above corporation         98       --
                                                             -------------------
     Total                                                      $6,598   $4,000
                                                             ===================

                                      F-14
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued


6.   Financing and Other Equity Transactions

     During 2000 and 2001 and subsequent to 2001, Headwaters entered into
     several transactions, including the following:

     Unsecured Bank Line of Credit - In October 2000, the remaining balance of
     $3,000,000 due under a note payable to a bank (see Note 7) was repaid with
     proceeds from a revolving line of credit with the same bank, which line of
     credit has an expiration date in October 2002. Funds from this line of
     credit were also used to repay the $1,838,000 note payable described in
     Note 7. Borrowings under the unsecured line of credit are limited to a
     maximum amount of $10,000,000 and bear interest at prime plus .75% (6.75%
     at September 30, 2001). Maximum borrowings under the line of credit during
     2001 were approximately $4,896,000, but there were no borrowings
     outstanding under the line as of September 30, 2001. The line of credit
     agreement contains certain covenants and restrictions common for such
     loans, including minimum required stockholders' equity and quarterly
     earnings. Headwaters was in compliance with the covenants and restrictions
     at September 30, 2001.

     Short-term Borrowings with an Investment Company - Headwaters has an
     arrangement with an investment company under which Headwaters can borrow up
     to 90% of the value of the portfolio of Headwaters' short-term investments
     with the investment company (see Note 7). These investments consist
     primarily of government-backed securities and collateralize any outstanding
     borrowings. Maximum borrowings under this arrangement during 2001 were
     approximately $4,095,000, which amount was outstanding at September 30,
     2001. Borrowings under this arrangement were used for short-term working
     capital needs, primarily for stock repurchases, rather than liquidating the
     securities held as collateral.

     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.

     In April 2000, the holder of a $4,000,000 note payable 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.

     Convertible 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 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. In 2001, all of the outstanding
     shares of preferred stock, consisting of 3,000 shares of Series A and
     14,310 shares of Series B, were converted into a total of approximately
     443,000 shares of common stock, representing a conversion price of $7.00
     per common share. Headwaters paid the accrued but undeclared dividends of
     approximately $695,000 in cash rather than allowing conversion into common
     stock at a price below market.

     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.

     Treasury Stock - During 2001, Headwaters acquired shares of its common
     stock in connection with the stock repurchase program announced in May 2000
     and expanded in June 2001. The program, as revised, authorizes Headwaters
     to purchase stock in the open market or through negotiated block
     transactions up to an aggregate of 20% of the outstanding common stock, or
     $15,000,000, whichever is greater. During 2001, Headwaters purchased
     approximately 1,648,000 shares for approximately $10,510,000. Also during
     2001, approximately 1,430,000 shares of treasury stock were cancelled.

                                      F-15
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued


6.   Financing and Other Equity Transactions, continued


     Related Party Note Receivable Collateralized by Common Stock - In January
     2001, Headwaters accepted from a stockholder as full satisfaction of a
     collateral-based note receivable, i) 150,000 shares of Headwaters stock and
     options to acquire 25,000 shares of Headwaters common stock for $1.50 per
     share that collateralized the note, both of which were cancelled, and ii) a
     new 6% collateralized promissory note receivable in the principal amount of
     $1,750,000. Prior to this transaction, the original note receivable was
     being carried at the value of the underlying collateral. Headwaters
     recognized a gain of approximately $541,000 representing the increase in
     value of that collateral from September 30, 2000 to the date the collateral
     was surrendered by the stockholder in payment of the note. Headwaters
     recorded the new note receivable at $0 due to substantial uncertainty of
     both the collectibility of the new note and the value of the new
     collateral. In October 2001, a $750,000 payment was received on the new
     promissory note, which amount, along with certain other assets, was
     accepted as full satisfaction of the new promissory note. The $750,000 gain
     on this transaction will be recognized in the December 2001 quarter. Due to
     substantial uncertainty regarding both value and realization, Headwaters
     recorded the other assets obtained in that transaction at $0.


7.   Liabilities

     Other Accrued Liabilities - Other accrued liabilities consisted of the
     following at September 30:
<TABLE>
<CAPTION>
              (thousands of dollars)                                                                2000        2001
              -------------------------------------------------------------------------------------------------------
              <S>                                                                                 <C>        <C>
              Chemical costs not yet invoiced                                                     $  552     $   877
              Accrued costs related to HTI acquisition                                                --         777
              Accrued royalties due to third parties                                                 215         725
              Commitment to a feed stock supplier for a licensee's alternative fuel
               facility                                                                              784         576
              Contingent liability arising from the 1999 sale of an alternative fuel
               facility                                                                              800          --
              Estimated costs to settle long-term contractual obligations                            407          --
              Other                                                                                1,028       2,032
                                                                                            -------------------------
                                                                                                  $3,786     $ 4,987
                                                                                            =========================

     Notes Payable and Other Short-term Borrowings - Notes payable and other
     borrowings consist of the following at September 30:
<CAPTION>
               (thousands of dollars)                                                               2000        2001
              -------------------------------------------------------------------------------------------------------
              <S>                                                                                 <C>        <C>
              Short-term borrowings from an investment company, bearing interest
               at a floating rate (4.1% at September 30, 2001), collateralized by
               investments with the investment company with a carrying value of
               approximately $5,700.                                                              $   --     $ 4,095

              Note payable to a bank, bearing interest at prime plus 2%, repaid with
               proceeds from a line of credit with this bank obtained in October 2000
               (see Note 6).                                                                       3,000          --

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

              Other                                                                                  425         410
                                                                                            -------------------------
                                                                                                   5,263       4,505
                   Less: current portion                                                            (208)     (4,356)
                                                                                            -------------------------
                   Total non-current                                                              $5,055     $   149
                                                                                            =========================
</TABLE>
                                      F-16
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued


7.   Liabilities, continued

     Interest Rates and Debt Maturities - The weighted-average interest rate on
     notes payable and other short-term borrowings was 9.7% at September 30,
     2000 and 4.7% at September 30, 2001. Future maturities of notes payable and
     short-term borrowings as of September 30, 2001 are as follows:

                                                  (thousands of
                Year ending September 30,              dollars)
                -------------------------- ---------------------
                          2002                           $4,356
                          2003                               78
                          2004                               30
                          2005                               12
                          2006                               13
                       Thereafter                            16
                                           ---------------------
                         Total                           $4,505
                                           =====================

     Interest Costs - 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. During 2001, Headwaters incurred total interest costs of
     approximately $224,000, including approximately $79,000 of non-cash
     interest expense resulting from amortization of debt discount and debt
     issuance costs. No interest costs were capitalized in any of these years.

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

     As of September 30, 2000, notes and interest receivable - related parties,
     collateralized by common stock, consisted of a collateral-based note
     receivable from a stockholder with a carrying value of approximately
     $466,000 and a $5,000,000 face amount, bearing interest at 6%. The note was
     collateralized by 150,000 shares of Headwaters' common stock and options to
     acquire 25,000 shares of Headwaters' common stock, which collateral, along
     with a new note receivable, was accepted as satisfaction of the note in
     2001, all as described in more detail in Note 6. Interest income of
     approximately $515,000 was recognized in both 1999 and 2000 based on cash
     payments received. No interest income was recognized in 2001.

     In 2000, Headwaters entered into termination agreements with certain then
     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, which amount
     represents the interest recognized on the notes in prior periods.

9.   Stock Options and Warrants

     Stock Options - As of September 30, 2001, Headwaters had one stock option
     plan (the "Option Plan") under which 2,400,000 shares of common stock are
     reserved for ultimate issuance. As of September 30, 2001 options for
     approximately 150,000 shares of common stock can be granted under the Plan.
     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 granted to employees and
     directors. 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. Under APB 25, no
     compensation expense is recognized for stock option grants to employees,
     officers and directors when the exercise price of stock options equals or
     exceeds the market price of Headwaters' common stock on the date of grant.

                                      F-17
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued


9.   Stock Options and Warrants, continued

     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 1999, 2000 or 2001. The amortized compensation
     expense related to compensatory options granted in prior years was
     approximately $2,553,000, $707,000 and $93,000 for 1999, 2000 and 2001,
     respectively.

     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)          1999     2000      2001
             -------------------------------------------------- --------- -------- ---------
             <S>                                                <C>        <C>      <C>
             Net income (loss) attributable to
              common stockholders -- reported                   (29,704)   $1,364   $21,404
                                  --  pro forma                 (32,969)     (350)   18,944
             Basic income (loss) per share -- reported            (2.39)     0.07      0.94
                                           -- pro forma           (2.65)    (0.02)     0.83
             Diluted income (loss) per share -- reported          (2.39)     0.07      0.87
                                             -- pro forma         (2.65)    (0.02)     0.77
</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 85%, risk-free interest rates ranging from
     3.8% to 7.8%, weighted average expected option lives of 2 to 10 years and
     no dividend yield. 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 measure of the fair value of
     stock options.

     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>
                                                 ----------------------- ---------------------- -----------------------
                                                          1999                   2000                    2001
                                                 ----------------------- ---------------------- -----------------------
                                                              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              2,370       $6.29      2,971       $6.18       3,822       $5.16
           Granted                                      667        5.40      1,112        3.31         251        9.15
           Granted in exchange for HTI options           --          --         --          --         144        0.07
           Exercised                                    (30)       1.50        (42)       1.50        (822)       2.42
           Canceled                                     (36)       2.34       (219)      10.37        (112)       8.42
                                                 ----------- ----------- ---------- ----------- ----------- -----------
        Outstanding at end of the year                2,971       $6.18      3,822       $5.16       3,283       $5.80
                                                 =========== =========== ========== =========== =========== ===========

        Exercisable at end of year                    1,801       $5.23      2,201       $5.29       2,171       $5.70
                                                 =========== =========== ========== =========== =========== ===========

        Weighted average fair value of
         options granted during the year
         below market                                              none                   none                   $9.18

        Weighted average fair value of options
         granted during the year at market                        $2.94                  $1.09                   $5.20

        Weighted average fair value of options
         granted during the year above market                     $0.67                  $1.19                    none
</TABLE>

                                      F-18
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued


9.   Stock Options and Warrants, continued

     The following table summarizes information about all stock options
     outstanding at September 30, 2001:
<TABLE>
<CAPTION>
          (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                2001            in Years        Price          2001          Price
          ---------------------- ----------------- ----------------- ----------- --------------- -------------
              <S>                        <C>                 <C>        <C>         <C>               <C>
                 $0.01 to $1.50               779               4.3      $ 1.23             568        $ 1.14
                 $2.00 to $5.88             1,435               5.2        4.28             930          4.28
                 $8.00 to $9.09               442               6.6        8.71             200          8.25
               $11.00 to $13.56               627               6.3       12.89             473         12.93
                                 -----------------                               ---------------
                                            3,283                                         2,171
                                 =================                               ===============
</TABLE>

     Common Stock Warrants - As of September 30, 2001, there were warrants
     outstanding for the purchase of approximately 684,000 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 debt during 1999 and 2000.

10.  Fair Value of Financial Instruments

     Substantially all of Headwaters' financial instruments (consisting of cash
     and cash equivalents, short-term investments, trade and notes receivable,
     accounts payable, and notes payable) 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 2000 and 2001
     approximated fair value.

11.  Income Taxes

     Headwaters had no income tax provision or benefit in 1999 because of its
     net operating loss position. In 2000, Headwaters reported a net 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 federal alternative minimum tax.
     In 2001, Headwaters reported a net income tax benefit of $7,049,000,
     consisting of the recognition of $7,470,000 of its deferred tax asset,
     reduced by $100,000 of federal alternative minimum tax and $321,000 of
     current state income tax expense.

     As of September 30, 2001, Headwaters had net operating loss carryforwards
     of approximately $24,000,000 which can be used to offset future taxable
     income. The net operating loss carryforwards expire from 2017 to 2021.
     Headwaters also has approximately $220,000 in research and development tax
     credit carryforwards which can be used to offset future tax liabilities.
     The tax credit carryforwards expire from 2007 to 2016. The utilization of
     HTI's acquisition date operating loss carryforwards (totaling approximately
     $2,800,000) against future taxable income is subject to an annual
     limitation of approximately $800,000 due to the change in ownership of HTI.

     The provision for income taxes differs from the statutory federal income
     tax rate due to the following:
<TABLE>
<CAPTION>
              (thousands of dollars)                                            1999          2000          2001
              --------------------------------------------------------- ------------- ------------- -------------
              <S>                                                            <C>          <C>           <C>
              Tax provision (benefit) at statutory rate                      $(9,653)     $    274      $  5,064
              Change in valuation allowance                                   10,600       (10,400)      (14,200)
              Alternative minimum tax                                             --           100           100
              State income taxes, net of federal tax effect                     (936)           25           470
              Acquired in-process research and development                        --            --           918
              Other, primarily redetermination of prior years' tax estimates     (11)        7,101           599
                                                                        ------------- ------------- -------------
                 Income tax provision (benefit)                              $     0      $(2,900)      $(7,049)
                                                                        ============= ============= =============
</TABLE>

                                      F-19
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued


11.  Income Taxes, continued

     The components of the net deferred tax assets were as follows as of
     September 30:
<TABLE>
<CAPTION>
              (thousands of dollars )                                                        2000           2001
              ----------------------------------------------------------------------- ------------ --------------
              <S>                                                                        <C>             <C>
              Net operating loss carryforwards                                           $ 11,300        $ 9,120
              Research and development tax credit carryforwards                               200            220
              License fee revenue recognition                                               3,900          2,640
              Write-down of related party note receivable                                   1,100            720
              Estimated liabilities                                                           300            410
              Other, net                                                                      400             50
                                                                                      ------------ --------------
                   Total deferred tax assets                                               17,200         13,160
              Valuation allowance                                                         (14,200)            --
                                                                                      ------------ --------------
                   Net deferred tax assets                                               $  3,000        $13,160
                                                                                      ============ ==============
</TABLE>

     The valuation allowance increased by $10,600,000 during 1999, decreased by
     $10,400,000 during 2000, and decreased by $14,200,000 during 2001. A
     valuation allowance is provided if it is more likely than not that some
     portion or all of a deferred tax asset will not be realized. Based
     primarily on results of operations in 2001 and expected future results of
     operations, Headwaters determined that as of September 30, 2001, it is more
     likely than not that its deferred tax assets will be realized and the
     valuation allowance was reduced.

12.  Basic and Diluted Income Per Share

     The following table sets forth the computation of basic and diluted income
     (loss) per share.
<TABLE>
<CAPTION>

          (thousands of dollars and shares, except per-share data)               1999         2000         2001
          ----------------------------------------------------------     ------------- ------------ ------------
          <S>                                                                <C>           <C>          <C>
          Numerator:
               Income (loss) before extraordinary item                       $(28,393)     $11,542      $21,517
               Extraordinary item                                                  --       (7,860)          --
                                                                         ------------- ------------ ------------
               Net income (loss)                                              (28,393)       3,682       21,517
               Preferred stock dividends (undeclared) and redemption
                 premium                                                         (466)      (2,260)        (113)
               Imputed preferred stock dividends                                 (845)         (58)          --
                                                                         ------------- ------------ ------------
          Numerator for basic earnings per share -- net income
          (loss) attributable to common stockholders                          (29,704)       1,364       21,404
          Effect of dilutive securities - preferred stock dividends                --          119          113
                                                                         ------------- ------------ ------------
          Numerator for diluted earnings per share - net income
          (loss) attributable to common stockholders after assumed
          conversions                                                        $(29,704)     $ 1,483      $21,517
                                                                         ============= ============ ============

          Denominator:
          Denominator for basic earnings per share -
          weighted-average shares outstanding                                  12,418       19,468       22,787
          Effect of dilutive securities:
               Shares issuable upon exercise of options and warrants               --          391        1,582
               Shares issuable upon conversion of preferred stock                  --        2,113          268
                                                                         ------------- ------------ ------------
          Total dilutive potential shares                                          --        2,504        1,850
                                                                         ------------- ------------ ------------

          Denominator for diluted earnings per share -- weighted
          - average shares outstanding after assumed exercises
          and conversions                                                      12,418       21,972       24,637
                                                                         ============= ============ ============
          Basic earnings per share:
          Income (loss) before extraordinary item                            $  (2.39)     $  0.47      $  0.94
          Extraordinary item                                                       --        (0.40)          --
                                                                         ------------- ------------ ------------
          Net income (loss) per common share                                 $  (2.39)     $  0.07      $  0.94
                                                                         ============= ============ ============

          Diluted earnings per share:
          Income (loss) before extraordinary item                            $  (2.39)     $  0.43      $  0.87
          Extraordinary item                                                       --        (0.36)          --
                                                                          ------------- ------------ ------------
          Net income (loss) per common share                                 $  (2.39)     $  0.07      $  0.87
                                                                         ============= ============ ============
</TABLE>


                                      F-20
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued


12.  Basic and Diluted Income Per Share, continued


     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 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 were dilutive, but all
     other potentially dilutive securities were anti-dilutive and were not
     considered in the calculation. For 2001, most options and warrants and all
     of the then outstanding preferred stock were dilutive and were considered
     in the calculation. Anti-dilutive securities not considered in the diluted
     earnings per share calculation totaled approximately 7,000,000 shares in
     2000 and approximately 1,375,000 shares in 2001. 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.

13.  Sale of Facilities

     Headwaters' business plan through 2000 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 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
     contingent liability was originally recorded in other accrued liabilities
     (see Note 7), but which was recognized as income in 2001 due to the
     elimination of the contingency. 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 a gain 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 and receives ongoing royalties based upon the sale
     of alternative fuel from the facilities.


14.  Gains on Other Transactions, Asset Write-offs and Other Charges, and
     Extraordinary Item

     Gains on Other Transactions - During 2000, Headwaters recorded other income
     of approximately $1,079,000 related to the satisfaction of a contingent
     contract liability ($755,000) and the gain recognized on a note receivable
     transaction.

     1999 Asset Write-offs and Other 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, 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 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 totaled approximately $7,395,000, which amount is recorded
     as asset write-offs and other charges in the consolidated statement of
     operations. Of this amount, approximately $5,362,000 represented non-cash
     expenses.

     2000 Asset Write-offs and Other 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 settlement charges ($979,000) and asset write-downs
     ($532,000) were recorded in 2000. All of these asset write-offs and other
     charges totaled approximately $17,758,000. Of this amount, approximately
     $15,485,000 represented non-cash expenses.


                                      F-21
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued



14.  Gains on Other Transactions, Asset Write-offs and Other Charges, and
     Extraordinary Item, continued

     Extraordinary Loss - In 2000, Headwaters redeemed all of its remaining
     convertible debt. The redemption consideration and early prepayment costs
     included approximately $7,037,000 in cash plus the issuance of
     approximately 214,000 shares of common stock. The loss recognized as a
     result of the total redemption consideration paid plus the acceleration of
     amortization of the unamortized debt discount and debt issuance costs in
     excess of the debt carrying value totaled approximately $7,860,000. This
     loss is reflected as an extraordinary item in the consolidated statement of
     operations.

15.  Commitments and Contingencies


     Commitments and contingencies as of September 30, 2001 not disclosed
     elsewhere, are as follows:

     Leases - Rental expense was approximately $1,309,000 in 1999, $255,000 in
     2000 and $204,000 in 2001. Headwaters has noncancellable operating leases
     for equipment and for real estate. At September 30, 2001, minimum rental
     payments due under these leases are as follows:

               Year ending September 30:    (thousands of dollars)
              ----------------------------- -----------------------
                          2002                       $221
                          2003                        179
                          2004                        139
                          2005                        137
                          2006                         44
                       Thereafter                      12
                                            -----------------------
                                                     $732
                                            =======================

     Employee Benefit Plans - In 2000, Headwaters' Board of Directors approved
     three employee benefit plans, the Headwaters Incorporated 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 of up to 15% of
     their compensation, subject to statutory limitations. Headwaters matches
     employee contributions up to a specified maximum rate, which matching
     contributions vest over a three-year period. Headwaters is not required to
     be profitable in order to make matching contributions.

     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 quarterly 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 meeting or 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 performance 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 operations of alternative fuel facilities owned by a licensee, are
     eligible to participate in the Incentive Bonus Plan. Total expense for all
     of the above plans was approximately $1,768,000 in 2000 and $2,082,000 in
     2001.

                                      F-22
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued



 15. Commitments and Contingencies, continued


     Legal or Contractual Matters - 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 alleged that the technology
     purchase transaction was an unauthorized corporate action and that Davidson
     and Headwaters conspired together to effect the transfer. The complaint
     asserted related causes of action and sought unspecified money damages and
     other relief. In August 2001, the trial court granted Headwaters' motion to
     dismiss the complaint. It is not known whether the plaintiffs will appeal.
     Because resolution of the litigation is uncertain, legal counsel cannot
     express an opinion as to the ultimate amount, if any, of Headwaters'
     liability.

     AJG. In December 1996, Headwaters entered into a technology license and
     proprietary chemical 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 had failed to make payments and to perform other
     obligations under the agreement. Headwaters asserts claims including breach
     of contract, declaratory judgment, unjust enrichment, and accounting and
     seeks money damages in the amount of $750,000 plus other damages to be
     proven at trial, as well as other relief. AJG's answer to the complaint
     denied Headwaters' claims and asserted counter-claims based upon
     allegations of misrepresentation and breach of contract. AJG seeks
     unspecified compensatory damages as well as punitive damages. Headwaters
     has denied 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.


     Headwaters has an agreement with an entity that provides for payments to be
     made to that entity of a portion of the amounts due from AJG now or in the
     future. This contingent liability has not been recorded in the accompanying
     consolidated balance sheet.


     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. 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.

     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 and Severance Agreements - Headwaters has entered into
     employment agreements with its Chief Executive Officer and six other
     officers, including three HTI officers. The agreements generally are
     renewable by Headwaters and have original terms ranging from three to five
     years. They provide for annual salaries and benefits ranging from
     approximately $143,000 to $257,000 annually per officer. The annual
     commitment under all Headwaters and HTI agreements combined is currently
     approximately $1,278,000. All agreements provide for termination benefits,
     ranging from at least six-month's salary, up to a maximum period equal to
     the remaining term of the agreement. In addition to these employment
     agreements, in connection with the acquisition of HTI and in accordance
     with HTI's Change in Control Severance Plan, substantially all of HTI's
     employees could potentially be eligible to receive continuation of salary
     for certain periods of time following termination without cause, if such
     termination occurs within six months after a change in control. Headwaters
     does not currently expect to make any material payments under the terms of
     this HTI plan.


16.  Related Party Transactions


     In addition to related party transactions disclosed elsewhere, Headwaters
     purchases certain insurance benefits for its employees from various
     companies for which a director of Headwaters acts as a broker or agent.
     Gross payments to those insurance companies totaled approximately $374,000
     in 1999, $361,000 in 2000 and $381,000 in 2001.

                                      F-23
<PAGE>

                    HEADWATERS INCORPORATED AND SUBSIDIARIES

              NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued



17.  Quarterly Financial Data (Unaudited)

     Summarized quarterly financial data for 2000 and 2001 is as follows:
<TABLE>
<CAPTION>
                                                                                   2000
                                                      ----------------------------------------------------------------
                                                        First       Second        Third        Fourth
       (thousands of dollars, except per-share data)   Quarter      Quarter      Quarter       Quarter     Full Year
       ---------------------------------------------- ----------- ------------ ------------ -------------- -----------
         <S>                                             <C>           <C>         <C>            <C>         <C>
         Net revenue                                     $ 5,708       $7,418      $ 6,473        $ 8,287     $27,886
         Gross profit                                      3,192        5,280        3,630          4,812      16,914
         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

              Net gains (losses) on sale of
                facilities included in net income
                (loss) (1)                                 5,341        (598)        8,527          3,600      16,870
              Asset write-offs and other charges
                included in net income (loss) (1)        (11,021)        (841)      (1,559)        (4,337)    (17,758)
         Basic net income (loss) per common share (2)      (0.16)        0.01         0.01           0.13        0.07
         Diluted net income (loss) per common share (2)    (0.16)        0.01         0.01           0.12        0.07

<CAPTION>
                                                                                   2001
                                                      ----------------------------------------------------------------
                                                      First         Second        Third        Fourth
       (thousands of dollars, except per-share data)   Quarter      Quarter      Quarter     Quarter (3)   Full Year
       ---------------------------------------------- ----------- ------------ ------------ -------------- -----------
         <S>                                             <C>           <C>         <C>            <C>         <C>
         Net revenue                                     $12,316       $9,754      $10,699        $12,695     $45,464
         Gross profit                                      7,590        6,245        6,600          7,434      27,869
         Net income (3)                                    5,406        4,576        4,956          6,579      21,517
         Basic net income per common share                  0.23         0.20         0.22           0.29        0.94
         Diluted net income per common share                0.22         0.19         0.20           0.26        0.87
</TABLE>


(1)  Net gains (losses) on sale of facilities and asset write-offs and other
     charges are more fully described in Notes 13 and 14.

(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.
(3)  In the fourth quarter of 2001, Headwaters recognized approximately
     $7,470,000 of its deferred tax asset (see Note 11), recorded losses
     totaling approximately $3,812,000 related to write-offs of notes receivable
     and losses on equity investments (see Note 2), and recorded $2,400,000 of
     expense related to in-process research and development purchased in the HTI
     acquisition (see Note 3).


     In order to conform with the presentation of the financial information in
     this Form 10-K/A, certain reclassifications, none of which affected net
     income, total assets, total liabilities, or total stockholders' equity,
     resulted in the following balances as of December 31, 2001 and March 31,
     2002:

                                                           Fiscal 2002
     (thousands of dollars)                       First Quarter  Second Quarter
     -------------------------------------------- -------------- ---------------
       Unamortized portion of non-refundable
         license fees-current                       $  1,179        $  1,179
       Unamortized portion of non-refundable
         license fees-long-term                        5,539           6,001
       Accumulated deficit                           (43,977)        (38,518)
       Capital in excess of par value                 85,113          87,158


18.  Event Subsequent to September 30, 2001

     In July 2002, Headwaters reached a settlement agreement with a third-party
     entity with which Headwaters had a dispute regarding an ongoing commitment
     to pay a portion of the license fees Headwaters receives from a licensee.
     Under the terms of the agreement, in recognition of full settlement of
     amounts due, Headwaters agreed to pay this entity approximately 30% of the
     amount Headwaters had received from the licensee. Of the total amount paid
     of approximately $1,100,000, approximately $350,000 related to license fees
     applicable to the year ended September 30, 2001, for which a liability of
     approximately $100,000 already had been recorded as of September 30, 2001
     in accordance with SFAS No. 5, "Accounting for Contingencies." The balance
     of the amount paid represents the settlement of liabilities arising
     subsequent to September 30, 2001.


                                      F-24