Headwaters 10-Q 2009 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2009

or

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

For the transition period from              to             

Commission file number: 1-32459

HEADWATERS INCORPORATED

(Exact name of registrant as specified in its charter)

Delaware	87-0547337
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
10653 South River Front Parkway, Suite 300 South Jordan, Utah	84095
(Address of principal executive offices)	(Zip Code)

(801) 984-9400

(Registrant’s telephone number, including area code)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).

Large accelerated filer	x	Accelerated filer	¨
Non-accelerated filer	¨	Smaller reporting company	¨

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

The number of shares outstanding of the Registrant’s common stock as of July 31, 2009 was 50,645,207.

HEADWATERS INCORPORATED

TABLE OF CONTENTS

		Page No.
PART I – FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS (Unaudited):
	Condensed Consolidated Balance Sheets – As of September 30, 2008 and June 30, 2009	3
	Condensed Consolidated Statements of Operations – For the three and nine months ended June 30, 2008 and 2009	4
	Condensed Consolidated Statement of Changes in Stockholders’ Equity – For the nine months ended June 30, 2009	5
	Condensed Consolidated Statements of Cash Flows – For the nine months ended June 30, 2008 and 2009	6
	Notes to Condensed Consolidated Financial Statements	7
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	24
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	37
ITEM 4.	CONTROLS AND PROCEDURES	37
PART II – OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	38
ITEM 1A.	RISK FACTORS	38
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	39
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	39
ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	39
ITEM 5.	OTHER INFORMATION	39
ITEM 6.	EXHIBITS	40
SIGNATURES		41

Forward-looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 regarding future events and our future results that are based on current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of our management. Actual results may vary materially from such expectations. In some cases, words such as “may,” “should,” “intends,” “plans,” “expects,” “anticipates,” “targets,” “goals,” “projects,” “believes,” “seeks,” “estimates,” or variations of such words and similar expressions, or the negative of such terms, may help to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances, are forward-looking. For a discussion of the factors that could cause actual results to differ from expectations, please see the risk factors described in Item 1A of our Annual Report on Form 10-K for the year ended September 30, 2008 and in Item 1A of this Form 10-Q. There can be no assurance that our results of operations will not be adversely affected by such factors. Unless legally required, we undertake no obligation to revise or update any forward-looking statements for any reason. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report.

Our internet address iswww.headwaters.com. There we make available, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (SEC). Our reports can be accessed through the investor relations section of our web site. The information found on our web site is not part of this or any report we file with or furnish to the SEC.

2

ITEM 1. FINANCIAL STATEMENTS

HEADWATERS INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands, except par value)	September 30, 2008			June 30, 2009
ASSETS
Current assets:
Cash and cash equivalents	$	21,637		$	14,016
Trade receivables, net		117,595			97,566
Inventories		53,068			46,602
Current and deferred income taxes		37,518			31,049
Other		10,568			13,497
Total current assets		240,386			202,730
Property, plant and equipment, net		304,835			324,483
Other assets:
Intangible assets, net		226,168			209,106
Goodwill		582,111			115,999
Other		48,486			50,254
Total other assets		856,765			375,359
Total assets	$	1,401,986		$	902,572
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	27,688		$	23,875
Accrued personnel costs		29,873			20,616
Other accrued liabilities		58,168			48,183
Current portion of long-term debt		—			30,000
Total current liabilities		115,729			122,674
Long-term liabilities:
Long-term debt		532,500			500,696
Deferred income taxes		87,026			12,696
Unrecognized income tax benefits		18,441			10,002
Other		16,738			15,167
Total long-term liabilities		654,705			538,561
Total liabilities		770,434			661,235
Stockholders’ equity:
Common stock, $0.001 par value; authorized 100,000 shares; issued and outstanding: 42,035 shares at September 30, 2008 (including 564 shares held in treasury) and 42,294 shares at June 30, 2009 (including 228 shares held in treasury)		42			42
Capital in excess of par value		509,977			511,291
Retained earnings (accumulated deficit)		130,394			(265,462	)
Treasury stock and other		(8,861	)		(4,534	)
Total stockholders’ equity		631,552			241,337
Total liabilities and stockholders’ equity	$	1,401,986		$	902,572

See accompanying notes.

3

HEADWATERS INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	Three Months Ended June 30,						Nine Months Ended June 30,
(in thousands, except per-share data)	2008			2009			2008			2009
Revenue:
Building products	$	129,283		$	92,577		$	337,609		$	249,205
Coal combustion products		82,640			64,412			221,048			179,721
Energy		18,533			18,242			92,675			50,139
Total revenue		230,456			175,231			651,332			479,065
Cost of revenue:
Building products		93,960			66,975			248,639			193,321
Coal combustion products		58,117			46,458			161,676			129,998
Energy		14,087			19,666			72,334			59,331
Total cost of revenue		166,164			133,099			482,649			382,650
Gross profit		64,292			42,132			168,683			96,415
Operating expenses:
Amortization		5,469			5,719			16,412			17,674
Research and development		3,480			2,171			11,448			7,466
Selling, general and administrative		34,290			28,881			110,278			87,773
Goodwill impairment		—			—			—			465,656
Total operating expenses		43,239			36,771			138,138			578,569
Operating income (loss)		21,053			5,361			30,545			(482,154	)
Other income (expense):
Net interest expense		(5,556	)		(10,066	)		(17,607	)		(27,224	)
Other, net		(280	)		9,237			7,498			29,922
Total other income (expense), net		(5,836	)		(829	)		(10,109	)		2,698
Income (loss) before income taxes		15,217			4,532			20,436			(479,456	)
Income tax benefit (provision)		(1,520	)		6,760			(6,030	)		83,600
Net income (loss)	$	13,697		$	11,292		$	14,406		$	(395,856	)
Basic earnings (loss) per share	$	0.33		$	0.27		$	0.35		$	(9.53	)
Diluted earnings (loss) per share	$	0.31		$	0.27		$	0.35		$	(9.53	)

See accompanying notes.

4

HEADWATERS INCORPORATED

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

For the Nine Months Ended June 30, 2009

	Common stock			Capital in excess of par value			Retained earnings (accumulated deficit)			Treasury stock, at cost			Other			Total stockholders’ equity
(in thousands)	Shares	Amount
Balances as of September 30, 2008	42,035	$	42	$	509,977		$	130,394		$	(7,281	)	$	(1,580	)	$	631,552
Issuance of restricted stock, net of cancellations	186		—														—
Exercise of stock options	73		—		410												410
Income tax benefit from exercise of stock options					93												93
336 shares of treasury stock transferred to employee stock purchase plan, at cost					(3,542	)					4,424						882
Stock-based compensation					4,353												4,353
Other comprehensive income (loss), net of taxes – cash flow hedge and foreign currency translation adjustments														(97	)		(97	)
Net loss for the nine months ended June 30, 2009								(395,856	)								(395,856	)
Balances as of June 30, 2009	42,294	$	42	$	511,291		$	(265,462	)	$	(2,857	)	$	(1,677	)	$	241,337

See accompanying notes.

5

HEADWATERS INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine Months Ended June 30,
(in thousands)	2008			2009
Cash flows from operating activities:
Net income (loss)	$	14,406		$	(395,856	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Goodwill impairment		—			465,656
Depreciation and amortization		50,791			51,853
Stock-based compensation		3,957			4,353
Interest expense related to amortization of debt issue costs		1,996			4,436
Deferred income taxes		9,000			(74,236	)
Gain on extinguishment of debt		—			(29,304	)
Net losses (gains) of unconsolidated joint ventures		6,199			(162	)
Net gain on disposition of property, plant and equipment		(7,750	)		(478	)
Amortization of non-refundable license fees		(5,517	)		—
Decrease in trade receivables		50,912			20,029
Decrease (increase) in inventories		(6,994	)		5,324
Decrease in accounts payable and accrued liabilities		(26,036	)		(12,263	)
Other changes in operating assets and liabilities, net		(37,212	)		(4,635	)
Net cash provided by operating activities		53,752			34,717
Cash flows from investing activities:
Purchase of property, plant and equipment		(86,052	)		(55,255	)
Proceeds from disposition of property, plant and equipment		13,135			3,081
Payments for acquisitions		(19,000	)		(10,792	)
Net increase in other assets		(5,537	)		(4,960	)
Net cash used in investing activities		(97,454	)		(67,926	)
Cash flows from financing activities:
Net proceeds from issuance of long-term debt		35,000			35,000
Payments on long-term debt		—			(7,500	)
Convertible debt and other debt issue costs		—			(3,297	)
Employee stock purchases		1,286			882
Proceeds from exercise of stock options		1			410
Income tax benefit from exercise of stock options		5			93
Treasury stock purchases		(14,841	)		—
Net cash provided by financing activities		21,451			25,588
Net decrease in cash and cash equivalents		(22,251	)		(7,621	)
Cash and cash equivalents, beginning of period		55,787			21,637
Cash and cash equivalents, end of period	$	33,536		$	14,016
Supplemental schedule of non-cash investing and financing activities:
Exchanges of convertible senior subordinated notes	$	—		$	90,656
Purchase of assets in exchange for future obligations		9,967			—
Cancellation of treasury stock		7,335			—
Decrease in accrued liabilities for acquisition-related commitments		(3,000	)		—

See accompanying notes.

6

HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

1. Nature of Operations and Basis of Presentation

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

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

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

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

Basis of Presentation – Headwaters’ fiscal year ends on September 30 and unless otherwise noted, references to 2008 refer to Headwaters’ fiscal quarter and/or nine-month period ended June 30, 2008 and references to 2009 refer to Headwaters’ fiscal quarter and/or nine-month period ended June 30, 2009. Other references to years refer to Headwaters’ fiscal year rather than a calendar year.

The consolidated financial statements include the accounts of Headwaters, all of its subsidiaries and other entities in which Headwaters has a controlling interest. All significant intercompany transactions and accounts are eliminated in consolidation. Due to the seasonality of most of Headwaters’ operations and other factors, the consolidated results of operations for 2009 are not indicative of the results to be expected for the full fiscal 2009 year.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (SEC) for quarterly reports on Form 10-Q. In the opinion of management, all adjustments considered necessary for a fair presentation have been included, and consist of normal recurring adjustments, except for the adjustments related to goodwill impairment and the debt exchange transactions. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Headwaters’ Annual Report on Form 10-K for the year ended September 30, 2008 (Form 10-K) and in Headwaters’ Quarterly Reports on Form 10-Q for the quarters ended December 31, 2008 and March 31, 2009.

Recent Accounting Pronouncements –SFAS No. 157. In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157, “Fair Value Measurements,” which addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles. Headwaters adopted SFAS No. 157 as of October 1, 2008 but this adoption did not have a material effect on reported results for 2009. Headwaters uses fair value measurements to determine the reported amounts of assets acquired and liabilities assumed in purchase transactions, in testing for potential goodwill impairment, for disclosure of the fair value of financial instruments, and elsewhere. It is therefore possible that the implementation of SFAS No. 157 could have a material effect on the reported amounts or disclosures in Headwaters’ consolidated financial statements in future periods.

7

HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

FSP FAS 157-4. In April 2009, the FASB issued FASB Staff Position FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (FSP FAS 157-4), which provides guidance for estimating fair value in accordance with SFAS No. 157 in certain circumstances. Headwaters adopted FSP FAS 157-4 in 2009 and considered the relevant guidance in determining the fair value of long-term debt disclosed in Note 7.

EITF 07-5. The Emerging Issues Task Force (EITF) of the FASB has published EITF Issue No. 07-5, “Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock,” which could affect Headwaters’ accounting for the fiscal 2007 convertible note hedge and warrant transactions described in Note 6. Headwaters must apply the provisions of EITF 07-5 in its financial statements issued for periods beginning on or after October 1, 2009. At the current time, Headwaters has not determined what impact, if any, EITF 07-5 will have on the accounting and future financial statement disclosures for the convertible note hedge and warrant transactions.

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

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

FSP APB 14-1. In May 2008, the FASB issued FASB Staff Position APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (the FSP). The FSP specifies that issuers of convertible debt that can be settled in cash should separately account for the liability (debt) and equity (conversion option) components in a manner that reflects the entity’s nonconvertible debt borrowing rate when interest cost is recognized. The adoption of the FSP, which for Headwaters is required October 1, 2009, will require different accounting for Headwaters’ 2.50% Convertible Senior Subordinated Notes due 2014 issued in January 2007, the 16% Convertible Senior Subordinated Notes due 2016 issued in December 2008, and the 14.75% Convertible Senior Subordinated Notes due 2014 issued in March and April 2009 (see Note 6). The provisions of the FSP must be applied retrospectively to all periods presented, or all periods subsequent to January 2007 for Headwaters.

The adoption of the FSP will result in a redetermination of the carrying amounts of Headwaters’ 2.50% convertible notes, 16% convertible notes and 14.75% convertible notes, calculated by measuring the fair values of similar debt instruments that do not have the conversion features, and recording an equity component for the difference between the original proceeds of the debt and the redetermined amounts of debt. Any basis differences that arise from this accounting that represent a temporary difference will also require the recording of deferred taxes. The original debt issuance costs will be allocated pro-rata between debt and equity issuance costs and accounted for accordingly. Debt discount recorded as a result of the redetermination of the debt carrying values will be amortized using the interest method and will result in recognition of additional interest cost for all periods subsequent to January 2007. If material, a portion of the increased interest cost will be capitalized, as required by SFAS No. 34, “Capitalization of Interest Cost.” Headwaters currently estimates that the adoption of the FSP will increase reported interest cost by approximately $3.8 million, $6.0 million and $7.2 million in fiscal years 2007, 2008 and 2009, respectively; will decrease the reported fiscal 2009 gain on extinguishment of debt by approximately $8.9 million; and will not have a material affect on interest capitalized for any period.

8

HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

FSP FAS 107-1 and APB 28-1. In April 2009, the FASB issued FASB Staff Positions FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (FSPs). These FSPs require disclosures about fair value of financial instruments for interim reporting periods as well as in annual financial statements. Headwaters has adopted these FSPs and provided the required fair value disclosures of its financial instruments in Note 7.

SFAS No. 165. In May 2009, the FASB issued SFAS No. 165, “Subsequent Events,” which sets forth principles and requirements for evaluating, recognizing and disclosing events or transactions that occur subsequent to the balance sheet date in financial statements. With the exception of disclosing the date through which subsequent events are evaluated for potential recognition or disclosure in the consolidated financial statements, SFAS No. 165 is not expected to have a significant effect on Headwaters. Because Headwaters’ financial statements are considered issued when filed with the SEC, it has evaluated subsequent events to August 5, 2009, the filing date of this Form 10-Q with the SEC.

Other. Headwaters has reviewed all other recently issued accounting standards which have not yet been adopted in order to determine their potential effect, if any, on the results of operations or financial position of Headwaters. Based on that review, Headwaters does not currently believe that any of these other recent accounting pronouncements will have a significant effect on its current or future financial position, results of operations, cash flows or disclosures.

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

2. Segment Reporting

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

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

Segment costs and expenses considered in deriving segment operating income (loss) include cost of revenue, amortization, research and development, and segment-specific selling, general and administrative expenses. Amounts included in the “Corporate” column represent expenses not specifically attributable to any segment and include administrative departmental costs and general corporate overhead. Segment assets reflect those specifically attributable to individual segments and primarily include accounts receivable, inventories, property, plant and equipment, intangible assets and goodwill. Cash and cash equivalents and certain other assets are included in the “Corporate” column.

9

HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

	Three Months Ended June 30, 2008
(in thousands)	Building Products			CCPs			Energy			Corporate			Totals
Segment revenue	$	129,283		$	82,640		$	18,533		$	—		$	230,456
Depreciation and amortization	$	(11,585	)	$	(3,114	)	$	(2,359	)	$	(100	)	$	(17,158	)
Operating income (loss)	$	10,816		$	17,341		$	(2,747	)	$	(4,357	)	$	21,053
Net interest expense														(5,556	)
Other income (expense), net														(280	)
Income tax provision														(1,520	)
Net income													$	13,697
Capital expenditures	$	9,283		$	3,108		$	22,001		$	168		$	34,560
	Three Months Ended June 30, 2009
(in thousands)	Building Products			CCPs			Energy			Corporate			Totals
Segment revenue	$	92,577		$	64,412		$	18,242		$	—		$	175,231
Depreciation and amortization	$	(8,854	)	$	(3,143	)	$	(2,520	)	$	(81	)	$	(14,598	)
Operating income (loss)	$	7,172		$	11,213		$	(8,620	)	$	(4,404	)	$	5,361
Net interest expense														(10,066	)
Other income (expense), net														9,237
Income tax benefit														6,760
Net income													$	11,292
Capital expenditures	$	1,693		$	9,448		$	6,191		$	—		$	17,332
	Nine Months Ended June 30, 2008
(in thousands)	Building Products			CCPs			Energy			Corporate			Totals
Segment revenue	$	337,609		$	221,048		$	92,675		$	—		$	651,332
Depreciation and amortization	$	(34,741	)	$	(9,146	)	$	(6,619	)	$	(285	)	$	(50,791	)
Operating income (loss)	$	11,417		$	37,845		$	(4,405	)	$	(14,312	)	$	30,545
Net interest expense														(17,607	)
Other income (expense), net														7,498
Income tax provision														(6,030	)
Net income													$	14,406
Capital expenditures	$	34,530		$	3,997		$	46,907		$	618		$	86,052
Segment Assets as of June 30, 2008	$	1,072,324		$	303,191		$	173,062		$	87,553		$	1,636,130

10

HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

	Nine Months Ended June 30, 2009
(in thousands)	Building Products			CCPs			Energy			Corporate			Totals
Segment revenue	$	249,205		$	179,721		$	50,139		$	—		$	479,065
Depreciation and amortization	$	(31,807	)	$	(9,412	)	$	(10,370	)	$	(264	)	$	(51,853	)
Operating income (loss)	$	(464,950	)	$	29,100		$	(35,386	)	$	(10,918	)	$	(482,154	)
Net interest expense														(27,224	)
Other income (expense), net														29,922
Income tax benefit														83,600
Net loss													$	(395,856	)
Capital expenditures	$	4,204		$	17,212		$	33,803		$	36		$	55,255
Segment assets as of June 30, 2009	$	348,492		$	301,861		$	189,892		$	62,327		$	902,572

3. Equity Securities and Stock-Based Compensation

Shelf Registration – Headwaters filed with the SEC a universal shelf registration statement for the potential sale of a total of $250.0 million of debt or equity securities. This registration statement was declared effective in April 2009. A prospectus supplement describing the terms of any additional securities to be issued is required to be filed before any future offering could commence under the registration statement.

Stock-Based Compensation – During the quarter ended June 30, 2009, the Compensation Committee granted approximately 1.2 million performance-based stock appreciation rights (SARs) to certain officers and employees under the terms of an existing stock incentive plan. If the performance criteria underlying the SARs are not met, all recognized expense for the SARs up to the time that determination is made will be reversed.

Total stock-based compensation expense was approximately $1.5 million and $1.4 million for the three months ended June 30, 2008 and 2009, respectively, and approximately $4.0 million and $4.4 million for the nine months ended June 30, 2008 and 2009, respectively. As of June 30, 2009, there was approximately $7.3 million of total compensation cost related to unvested awards not yet recognized, which will be recognized in future periods subject to applicable vesting terms.

4. Inventories

Inventories consisted of the following at:

(in thousands)	September 30, 2008		June 30, 2009
Raw materials	$	11,239	$	11,464
Finished goods		41,829		35,138
	$	53,068	$	46,602

11

HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

5. Long-Lived Assets

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

	Estimated useful lives	September 30, 2008				June 30, 2009
(in thousands)		Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
CCP contracts	8 - 20 years	$	117,690	$	38,449	$	117,690	$	43,498
Customer relationships	7 1/2 - 5 years		77,403		20,826		77,603		25,217
Trade names	5 - 20 years		68,412		14,227		67,425		15,846
Patents and patented technologies	6  - 19 years		54,635		23,354		55,047		27,455
Other	1 - 15 years		6,370		1,486		5,690		2,333
		$	324,510	$	98,342	$	323,455	$	114,349

Total amortization expense related to intangible assets was approximately $5.5 million and $5.7 million for the three months ended June 30, 2008 and 2009, respectively, and approximately $16.4 million and $17.7 million for the nine months ended June 30, 2008 and 2009, respectively. Total estimated annual amortization expense for fiscal years 2009 through 2014 is shown in the following table.

Year ending September 30:	(in thousands)
2009	$	23,357
2010		22,052
2011		21,641
2012		19,874
2013		18,965
2014		18,587

Goodwill – SFAS No. 142 requires Headwaters to periodically test for goodwill impairment, at least annually, or sooner if indicators of possible impairment arise. Headwaters performs its annual impairment testing as of June 30. As a result of the depressed new housing and residential remodeling markets, Headwaters determined that the building products reporting unit’s goodwill was impaired as of the June 30 test date in both fiscal 2007 and 2008, and non-cash impairment charges of $98.0 million and $205.0 million were recorded in fiscal 2007 and 2008, respectively.

Due to the continuing decline in the new housing and residential remodeling markets, the ongoing downward revisions by market analysts of near-term projections in these markets, and the significant decline in Headwaters’ stock price during the six months ended March 31, 2009, management determined that indicators of further goodwill impairment in the building products reporting unit existed. In addition, the significant declines in coal and oil prices and in Headwaters’ stock price indicated potential goodwill impairment in the energy reporting unit. Accordingly, Headwaters performed goodwill impairment tests for both the building products and energy reporting units during the quarter ended March 31, 2009. Upon completion of the impairment tests, Headwaters wrote off all remaining goodwill in the building products and energy reporting units, totaling approximately $465.7 million. None of the impairment charges in fiscal 2007, 2008 or 2009 affected Headwaters’ cash position, cash flow from operating activities or debt covenant compliance.

Headwaters has not yet completed the June 30, 2009 goodwill impairment test for the CCPs reporting unit, but does not currently expect there will be any impairment.

Other Long-Lived Assets – In connection with the goodwill impairment testing for the building products and energy reporting units in 2009, Headwaters also performed a formal analysis for potential impairments of other long-lived assets in those reporting units, including all intangible assets and property, plant and equipment. The results of this analysis did not result in any significant impairment of any other long-lived assets.

12

HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

6. Long-term Debt

Long-term debt consisted of the following at:

(in thousands)	September 30, 2008		June 30, 2009
Senior secured debt	$	200,000	$	227,500
Convertible senior subordinated notes:
2.875%, due 2016 with put date of June 2011		172,500		91,640
16%, due 2016 with put date of June 2012		—		63,286
2.50%, due 2014		160,000		120,900
14.75%, due 2014		—		27,370
Total convertible notes		332,500		303,196
Total long-term debt, including current portion		532,500		530,696
Less current portion		—		(30,000	)
Long-term debt	$	532,500	$	500,696

Senior Secured Credit Agreements – Headwaters’ senior secured credit facility currently consists of a first lien term loan in the amount of $197.5 million, plus $30.0 million outstanding under the revolving credit arrangement. The credit facility provides for up to $60.0 million of borrowings under the revolving credit arrangement. The first lien term loan is senior in priority to all other debt and, with the exception of joint venture assets, is secured by all assets of Headwaters. The terms of the credit facility, as currently amended, are described in more detail in the following paragraphs.

Headwaters is in compliance with all debt covenants as of June 30, 2009. However, there is risk of noncompliance with certain leverage and fixed charge coverage ratios in future periods given the continuing decrease in building products and CCPs revenues as a result of current economic conditions, especially the depressed new housing and residential remodeling markets; the termination of Headwaters’ Section 45K business in fiscal 2008; and the high level of capital expenditures during fiscal 2008 and fiscal 2009. The risk of noncompliance will be reduced if Headwaters completes a new asset based revolver (ABL facility) to replace the revolving credit facility that matures in September 2009, as explained in more detail hereafter.

The first lien term loan bears interest, at Headwaters’ option, at either i) the London Interbank Offered Rate (LIBOR) plus 5.25%, 5.75%, 6.25% or 6.75%, depending on the credit ratings that have been most recently announced for the loans by Standard & Poor’s Ratings Services (S&P) and Moody’s Investors Service, Inc. (Moody’s); or ii) the “Base Rate” plus 4.25%, 4.75%, 5.25% or 5.75%, again depending on the credit ratings announced by S&P and Moody’s. Base rate is defined as the higher of the rate announced by Morgan Stanley Senior Funding and the overnight rate charged by the Federal Reserve Bank of New York plus 0.5%. Headwaters can select new LIBOR rates for the first lien term loan for one, two, three or six month periods; however, pursuant to the terms of the credit agreement, LIBOR has a minimum floor of 3.0% and the Base Rate has a minimum floor of 4.0%. As of June 30, 2009, the interest rate was LIBOR plus 6.75%, or 9.75%. Interest on the first lien term loan is generally payable on a quarterly or more frequent basis.

The first lien term loan is repayable $73.5 million in February 2011 and $124.0 million in April 2011, the maturity date of the credit facility. There are mandatory prepayments of the first lien term loan in the event of certain asset sales and debt and equity issuances and from “excess cash flow,” as defined in the agreement. A mandatory prepayment of $2.5 million was made during the quarter ended March 31, 2009 as a result of an asset sale. Optional prepayments of the first lien term loan are permitted without penalty or premium. Once repaid in full or in part, no reborrowings can be made.

Borrowings under the revolving credit arrangement are generally subject to the terms of the first lien term loan agreement. Borrowings and reborrowings of any available portion of the $60.0 million revolver can be made at any time through September 2009, when all revolver loans must be repaid and the revolving credit arrangement terminates. The fees for the

13

HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

unused portion of the revolving credit arrangement range from 0.5% to 0.75% (depending on Headwaters’ “total leverage ratio,” as defined). As of June 30, 2009, there was $30.0 million outstanding under the revolving credit arrangement, which amount was reduced to $25.0 million subsequent to June 30, 2009. The credit agreement also allows for the issuance of letters of credit, provided there is capacity under the $60.0 million revolver. As of June 30, 2009, stand-by letters of credit totaling approximately $9.4 million were outstanding, with expiration dates ranging from July 2009 to September 2009.

The credit facility contains restrictions and covenants common to such agreements, including limitations on the incurrence of additional debt, investments, merger and acquisition activity, asset sales and liens, capital expenditures in excess of $67.5 million in fiscal 2009, $60.0 million in fiscal 2010 and $55.0 million in fiscal 2011 (plus, in certain circumstances, the unused amount from the prior fiscal year), and the payment of dividends, among others. In addition, Headwaters must maintain certain leverage and fixed charge coverage ratios, as those terms are defined in the agreements, as follows: i) a total leverage ratio of 3.75:1 as of September 30, 2009, then 3.5:1 from December 31, 2009 through the maturity date; ii) a maximum ratio of consolidated funded indebtedness minus subordinated indebtedness to EBITDA of 2.5:1; and iii) a minimum ratio of EBITDA plus rent payments (EBITDAR), less certain capital expenditures and taxes for the four preceding fiscal quarters, to scheduled rent payments and payments of principal and interest on all indebtedness for the next four fiscal quarters of 1:1 as of June 30, 2009, 1.25:1 for September 30, 2009 and December 31, 2009, then 1:1 for periods ending through September 30, 2010, and 1.25:1 for periods ending after September 30, 2010.

In connection with the most recent amendment to the credit facility in June 2009, the lenders agreed to waive the total leverage ratio requirement as of June 30, 2009. They also agreed to allow Headwaters to establish a new ABL facility to replace the revolving credit facility that matures in September 2009. Headwaters currently expects to finalize an ABL facility during August 2009. If an ABL facility is finalized, it will have a first lien security interest in certain receivables and inventory, and any outstanding balances under the current revolving credit facility will be repaid. At the time an ABL facility is finalized, Headwaters is required to pay a fee to the senior lenders of approximately $0.5 million, the interest rate on the term loan will increase by 1.0%, and Headwaters will be required to repay $25.0 million of the term loan prior to December 31, 2009. Beginning January 1, 2010, the term loan interest rate will increase by 0.25% each quarter until Headwaters repays at least $50.0 million of the term loan. Finally, the total leverage ratio requirements noted above will change to 5.25:1 as of September 30, 2009, 5.50:1 as of December 31, 2009, 5.75:1 as of March 31, 2010 and June 30, 2010, 5.25:1 as of September 30, 2010, 5:1 as of December 31, 2010, and 4.75:1 as of March 31, 2011. There can be no assurance that Headwaters will be able to secure an ABL facility.

2.875% Convertible Senior Subordinated Notes Due 2016 – In 2004, Headwaters issued $172.5 million of 2.875% convertible senior subordinated notes due June 2016, with interest payable semi-annually. In December 2008, Headwaters entered into separate, privately-negotiated agreements with certain holders of the notes to exchange approximately $80.9 million in aggregate principal amount of the notes for approximately $63.3 million in aggregate principal amount of new 16% convertible senior subordinated notes due 2016, described below.

Following the extinguishment of $80.9 million principal amount of the 2.875% notes, approximately $91.6 million principal amount of the notes remain outstanding as of June 30, 2009. These notes are subordinate to the senior secured debt described above and rank equally with the 16% convertible senior subordinated notes due 2016 and the 2.50% and 14.75% convertible senior subordinated notes due 2014 described below, as well as any future issuances of senior subordinated debt. Holders of the 2.875% notes may convert the notes into shares of Headwaters’ common stock at a conversion rate of 33.3333 shares per $1,000 principal amount ($30 conversion price), or approximately 3.1 million aggregate shares of common stock, contingent upon certain events. The conversion rate adjusts for events related to Headwaters’ common stock, including common stock issued as a dividend, rights or warrants to purchase common stock issued to all holders of Headwaters’ common stock, and other similar rights or events that apply to all holders of common stock.

The 2.875% notes are convertible if any of the following five criteria are met: 1) satisfaction of a market price condition which becomes operative if, prior to June 1, 2011, in any calendar quarter the closing price of Headwaters’ common stock exceeds $39 per share for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of the calendar quarter, or, at any time on or after June 1, 2011 the closing price of Headwaters’ common stock exceeds

14

HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

$39 per share; 2) a credit rating, if any, assigned to the notes is three or more rating subcategories below the initial rating; 3) the notes trade at less than 98% of the product of the common stock trading price and the number of shares of common stock issuable upon conversion of $1,000 principal amount of the notes, except this provision is not available if the closing common stock price is between 100% and 120% of the current conversion price of the notes; 4) Headwaters calls the notes for redemption; or 5) upon the occurrence of specified corporate transactions.

Headwaters may call the 2.875% notes for redemption at any time prior to June 4, 2011 if the closing common stock price exceeds 130% of the conversion price for 20 trading days in any consecutive 30-day trading period (in which case Headwaters must provide a “make whole” payment of the present value of all remaining interest payments on the redeemed notes through June 1, 2011). Headwaters may redeem any portion of the notes at any time on or after June 4, 2011. In addition, the holders of the notes have the right to require Headwaters to repurchase all or a portion of the notes on June 1, 2011 or if a fundamental change in common stock has occurred, including termination of trading. Subsequent to June 1, 2011, the notes require an additional interest payment equal to 0.40% of the average trading price of the notes if the trading price equals 120% or more of the principal amount of the notes. When dilutive, Headwaters includes the additional shares of common stock contingently issuable under the convertible notes in its diluted EPS calculations on an if-converted basis (see Note 9).

Subsequent to June 30, 2009, Headwaters exchanged approximately $19.8 million of the 2.875% convertible senior subordinated notes plus related accrued interest for approximately 4.8 million shares of common stock. In accordance with the provisions of SFAS No. 84, “Induced Conversions of Convertible Debt,” Headwaters will record a non-cash expense of approximately $13.6 million in connection with this transaction, which amount represents the fair value of the shares issued in excess of the shares required to be issued pursuant to the original terms of conversion described above.

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

The 16% notes are subordinate to the senior secured debt described above and rank equally with the 2.875% convertible senior subordinated notes due 2016 described above and the 2.50% and 14.75% convertible senior subordinated notes due 2014 described below, as well as any future issuances of senior subordinated debt. Holders of the notes may convert the notes into shares of Headwaters’ common stock at a conversion rate of 42.5532 shares per $1,000 principal amount ($23.50 conversion price), or approximately 2.7 million aggregate shares of common stock, contingent upon certain events. The conversion rate adjusts for events related to Headwaters’ common stock, including common stock issued as a dividend, rights or warrants to purchase common stock issued to all holders of Headwaters’ common stock, and other similar rights or events that apply to all holders of common stock. Upon conversion, Headwaters will pay cash up to the principal amount of the notes, and, at Headwaters’ option, cash, shares of common stock, or a combination of cash and shares, to the extent the price of Headwaters’ common stock exceeds the conversion price during a 20-trading-day observation period. The conversion rate is adjusted for certain corporate transactions referred to as “fundamental changes.” As described in more detail in Note 1, the accounting for these notes will change upon adoption of FSP APB 14-1 in October 2009.

The 16% notes are convertible if any of the following five criteria are met: 1) satisfaction of a market price condition which becomes operative if, prior to June 1, 2012, in any calendar quarter the closing price of Headwaters’ common stock exceeds $30.55 per share for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of the calendar quarter, or, at any time on or after June 1, 2012 the closing price of Headwaters’ common stock exceeds $30.55 per share; 2) a credit rating, if any, assigned to the notes is three or more rating subcategories below the initial rating; 3) the notes trade at less than 98% of the product of the common stock trading price and the number of shares of common stock issuable upon conversion of $1,000 principal amount of the notes; 4) Headwaters calls the notes for redemption; or 5) upon the occurrence of specified corporate transactions.

15

HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

Headwaters may redeem any portion of the notes at any time on or after June 4, 2012. In addition, the holders of the notes have the right to require Headwaters to repurchase all or a portion of the notes on June 1, 2012 or if a fundamental change in common stock has occurred, including termination of trading.

Subsequent to June 30, 2009, Headwaters exchanged approximately $15.0 million of the 16% convertible senior subordinated notes plus related accrued interest for approximately 3.5 million shares of common stock. In accordance with the provisions of SFAS No. 84, Headwaters will record a non-cash expense of approximately $8.9 million in connection with this transaction, which amount represents the fair value of the shares issued in excess of the shares required to be issued pursuant to the original terms of conversion described above.

2.50% Convertible Senior Subordinated Notes Due 2014 – In fiscal 2007, Headwaters issued $160.0 million of 2.50% convertible senior subordinated notes due February 2014, with interest payable semi-annually. In March and April 2009, Headwaters entered into separate, privately-negotiated agreements with certain holders of the notes to exchange approximately $39.1 million in aggregate principal amount of the notes for approximately $27.4 million in aggregate principal amount of new 14.75% convertible senior subordinated notes due 2014, described below.

Following the March and April 2009 extinguishment of $39.1 million principal amount of the 2.50% notes, approximately $120.9 million principal amount of the notes remained outstanding as of June 30, 2009. These notes are subordinate to the senior secured debt and rank equally with the 2.875% and 16% convertible senior subordinated notes due 2016 described above, the 14.75% convertible senior subordinated notes due 2014 described below, and any future issuances of senior subordinated debt. The conversion rate for the notes is 33.9236 shares per $1,000 principal amount ($29.48 conversion price), subject to adjustment. Upon conversion, Headwaters will pay cash up to the principal amount of the notes, and shares of common stock to the extent the price of Headwaters’ common stock exceeds the conversion price during a 20-trading-day observation period. The conversion rate is adjusted for certain corporate transactions referred to as “fundamental changes.” As described in more detail in Note 1, the accounting for these notes will change upon adoption of FSP APB 14-1 in October 2009.

The 2.50% notes are convertible at the option of the holders prior to December 1, 2013 if any of the following criteria are met: 1) during any fiscal quarter the closing price of Headwaters’ common stock exceeds $38.32 per share for at least 20 trading days during a period of 30 consecutive trading days ending on the last trading day of the preceding fiscal quarter; 2) during the five-business-day period after any ten-consecutive-trading-day period, the notes trade at less than 98% of the product of the common stock trading price and the number of shares of common stock issuable upon conversion of $1,000 principal amount of the notes; or 3) upon the occurrence of specified corporate transactions. The notes are convertible on or after December 1, 2013 regardless of the foregoing circumstances. Headwaters may not redeem the notes. If Headwaters has a “fundamental change,” holders may require Headwaters to repurchase the notes at a price equal to the principal amount plus any accrued interest.

In connection with the issuance of the 2.50% notes, Headwaters entered into convertible note hedge and warrant transactions for the purpose of effectively increasing the common stock conversion price for the notes from $29.48 per share to $35.00 per share. The convertible note hedge terminates upon the maturity of the notes or when none of the notes remain outstanding due to conversion or otherwise.

14.75% Convertible Senior Subordinated Notes Due 2014 – As noted above, in March and April 2009, Headwaters exchanged approximately $39.1 million of its 2.50% convertible senior subordinated notes due 2014 for approximately $27.4 million of new 14.75% convertible senior subordinated notes due 2014. In accordance with the provisions of EITF 96-19, Headwaters accounted for the exchange of convertible debt securities as an extinguishment of the original debt and an issuance of new debt. A gain, recorded in other income (expense) in the accompanying consolidated statements of operations of approximately $11.7 million was recognized on the extinguishment of debt, and approximately $0.9 million of unamortized debt issue costs related to the extinguished $39.1 million of debt was charged to interest expense.

16

HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

The conversion rate for the 14.75% notes is 48.4623 shares per $1,000 principal amount ($20.63 conversion price), subject to adjustment. The conversion rate and the interest rate are the primary differences in terms between the 2.50% notes and the 14.75% notes. As described in more detail in Note 1, the accounting for these notes will also change upon adoption of FSP APB 14-1 in October 2009.

Interest and Debt Maturities – During the three months ended June 30, 2008 and 2009, Headwaters incurred total interest costs of approximately $5.8 million and $10.4 million, respectively, including approximately $0.7 million and $1.5 million, respectively, of non-cash interest expense and approximately $0.2 million and $0.3 million, respectively, of interest costs that were capitalized. During the nine months ended June 30, 2008 and 2009, Headwaters incurred total interest costs of approximately $19.2 million and $28.5 million, respectively, including approximately $2.0 million and $4.4 million, respectively, of non-cash interest expense and approximately $0.5 million and $0.9 million, respectively, of interest costs that were capitalized.

Interest income was approximately $0.1 million during each of the three-month periods ended June 30, 2008 and 2009, and approximately $1.0 million and $0.4 million during the nine months ended June 30, 2008 and 2009, respectively. The weighted-average interest rate on the face amount of outstanding long-term debt, disregarding amortization of debt issue costs, was approximately 4.8% at September 30, 2008 and 7.9% at June 30, 2009.

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

7. Fair Value of Financial Instruments

Headwaters’ financial instruments consist primarily of cash and cash equivalents, trade receivables, accounts payable and long-term debt. All of these financial instruments except long-term debt are either carried at fair value in the balance sheets or are short-term in nature. Accordingly, the carrying values for those financial instruments as reflected in the consolidated balance sheets closely approximate their fair values.

Headwaters’ outstanding debt as of September 30, 2008 and June 30, 2009 consisted of both fixed-rate debt and variable-rate debt. The fixed-rate debt consisted of all issues of convertible senior subordinated notes. Using fair values for this debt, the fair value of all outstanding long-term debt as of September 30, 2008 and June 30, 2009 would have been approximately $465.0 million and $390.0 million, respectively, compared to carrying values of $532.5 million and $530.7 million, respectively.

Fair value estimates for the convertible senior subordinated notes were based on several factors including market prices and discounted future cash flows using estimated current risk-adjusted borrowing rates for similar instruments. The fair values for the convertible senior subordinated notes differ substantially from the carrying values primarily due to below-market coupon interest rates and the significant differences between Headwaters’ common stock price at the balance sheet measurement dates and the convertible note conversion prices.

8. Income Taxes

Headwaters’ estimated effective income tax rate for the fiscal year ending September 30, 2009, exclusive of discrete items, is currently estimated to be less than 20.0%. During the nine months ended June 30, 2009, Headwaters also recognized $0.3 million of income tax expense for discrete items that did not affect the calculation of the estimated effective income tax rate for the 2009 fiscal year. For the nine months ended June 30, 2008, Headwaters used an estimated effective income tax rate of 29.0%, exclusive of discrete items, and recognized $0.1 million of additional income tax expense for discrete items.

17

HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

The estimated effective tax rate for fiscal 2009, exclusive of discrete items, is lower than the statutory rate because a significant portion of the goodwill impairment recorded in 2009 is not tax deductible. Accordingly, the tax benefit expected to be recorded for fiscal 2009 will be significantly less than the statutory rate. The fiscal 2009 estimated effective tax rate was also affected by estimated Section 45 refined coal tax credits (which are different from the Section 45K tax credits discussed elsewhere) related to the coal cleaning facilities that Headwaters owns and operates, but to a far lesser extent than by the portion of the goodwill impairment representing a permanent difference. The estimated effective tax rate for fiscal 2008, exclusive of discrete items, was lower than the statutory rate primarily due to estimated Section 45 refined coal tax credits. Headwaters believes it is more likely than not that the refined coal produced at its coal cleaning facilities qualifies for tax credits pursuant to Section 45 of the Internal Revenue Code, notwithstanding the uncertainties and risks associated with the tax credits, as more fully described in Note 10. Excluding the effect of Section 45 tax credits and goodwill impairment, Headwaters’ estimated effective tax rate for fiscal 2009 would also be less than 20%, due primarily to the effect of valuation allowances and permanent differences unrelated to goodwill impairment, combined with an expected pre-tax loss for the year.

As of June 30, 2009, Headwaters had approximately $10.0 million of unrecognized tax benefits, net of an $11.1 million refund claim related to an uncertain tax position. Headwaters has recorded approximately $22.7 million of gross unrecognized income tax benefits which would affect the fiscal 2009 effective tax rate if released into income. Headwaters recognizes accrued interest and potential penalties related to all income tax liabilities, including unrecognized income tax benefits, in income tax expense. During the nine months ended June 30, 2009, Headwaters released approximately $2.8 million of interest and penalties and as of June 30, 2009, approximately $4.2 million was accrued for the payment of interest and penalties. Changes to the estimated liability for unrecognized income tax benefits during 2009 were primarily the result of settlement of the IRS audit for the years 2003 and 2004.

The calculation of tax liabilities involves uncertainties in the application of complex tax regulations in multiple jurisdictions. For example, Headwaters is currently under audit by the IRS for the years 2005 and 2006 and has open tax periods subject to examination by both federal and state taxing authorities for the years 2005 through 2008. Headwaters recognizes potential liabilities for anticipated tax audit issues in the U.S. and state tax jurisdictions based on estimates of whether, and the extent to which, additional taxes and interest will be due. If events occur and the payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when it is determined the liabilities are no longer probable or necessary. If the estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result. It is reasonably possible that the amount of Headwaters’ unrecognized income tax benefits will change significantly within the next 12 months. These changes could be the result of Headwaters’ ongoing tax audits or the settlement of outstanding audit issues. However, due to the number of years under audit and the matters being examined, at the current time, an estimate of the range of reasonably possible outcomes cannot be made, beyond amounts currently accrued.

18

HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

9. Earnings per Share

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

	Three Months Ended June 30,				Nine Months Ended June 30,
(in thousands, except per-share data)	2008		2009		2008		2009
Numerator:
Numerator for basic earnings per share – net income (loss)	$	13,697	$	11,292	$	14,406	$	(395,856	)
Interest expense related to convertible senior subordinated notes, net of taxes		1,044		645		—		—
Numerator for diluted earnings per share – net income (loss) plus interest expense related to convertible notes, net of taxes	$	14,741	$	11,937	$	14,406	$	(395,856	)
Denominator:
Denominator for basic earnings per share – weighted-average shares outstanding		41,156		41,704		41,387		41,540
Effect of dilutive securities:
Shares issuable upon exercise of options and SARs and vesting of restricted stock		121		24		129		—
Shares issuable upon conversion of convertible notes		5,750		3,054		—		—
Total potential dilutive shares		5,871		3,078		129		—
Denominator for diluted earnings per share – weighted-average shares outstanding after assumed exercises, vesting and conversions		47,027		44,782		41,516		41,540
Basic earnings (loss) per share	$	0.33	$	0.27	$	0.35	$	(9.53	)
Diluted earnings (loss) per share	$	0.31	$	0.27	$	0.35	$	(9.53	)
Anti-dilutive securities not considered in diluted EPS calculation:
Stock options		1,988		1,917		2,095		1,968
SARs		1,312		1,967		1,210		2,070
Restricted stock		—		327		—		348
Weighted-average shares issuable upon conversion of convertible notes		—		—		5,750		2,808

10. Commitments and Contingencies

Significant new commitments and ongoing contingencies as of June 30, 2009 not disclosed elsewhere, are as follows.

Acquisitions – In fiscal 2008, Headwaters acquired certain assets and assumed certain liabilities of a privately-held company in the building products industry. Total consideration for this acquisition was approximately $16.1 million, of which approximately $5.0 million was paid at the date of acquisition and approximately $10.8 million was paid in 2009, with approximately $0.3 million of assumed liabilities. Pursuant to contractual terms for some small 2006 acquisitions in the building products segment, additional amounts may be payable in the future, based on the achievement of stipulated revenue or earnings targets for periods ending no later than March 2010. At the current time, Headwaters does not believe that any such payments will be material. If any future earn-out consideration is paid for any acquisition, the amounts will be charged to income because all goodwill in the building products reporting unit has been written off.

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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

Performance Unit Awards – In October 2008, Headwaters’ Compensation Committee approved grants of performance unit awards to certain officers and employees, to be settled in cash, based on the achievement of goals tied to cumulative divisional free cash flow generated subsequent to September 30, 2008 and prior to September 30, 2028, at which time the awards expire, if not forfeited earlier. These awards replaced all existing long-term cash-based awards, except for certain awards already earned at the date of grant. For purposes of these awards, free cash flow is generally defined as operating income plus depreciation, amortization and goodwill impairment, reduced by capital expenditures. Payments will vest according to a predetermined schedule as free cash flow accumulates over time. The maximum payout under the performance unit awards if all performance criteria were to be achieved by all of Headwaters’ operating divisions would be approximately $78.3 million. Approximately $0.4 million has been expensed for these awards through June 30, 2009.

Property, Plant and Equipment – As of June 30, 2009, Headwaters was committed to spend approximately $7.6 million on capital projects that were in various stages of completion.

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

Historically, costs paid to outside legal counsel for litigation have comprised a majority of Headwaters’ litigation-related costs. During the nine months ended June 30, 2009, Headwaters incurred approximately $3.3 million of expense for legal matters, which consisted primarily of costs for outside legal counsel. Headwaters currently believes the range of potential loss for all unresolved matters, excluding costs for outside counsel, is from $1.0 million up to the amounts sought by claimants and has recorded a total liability as of June 30, 2009 of $1.0 million. Claims and damages sought by claimants in excess of this amount are not deemed to be probable. Headwaters and its outside counsel currently believe that unfavorable outcomes of outstanding litigation are neither probable nor remote and declined to express opinions concerning the likely outcomes or liability to Headwaters. It is not possible to estimate what litigation-related costs will be in future periods.

The matters discussed below raise difficult and complex legal and factual issues, and the resolution of these issues is subject to many uncertainties, including the facts and circumstances of each case, the jurisdiction in which each case is brought, and the future decisions of juries, judges, and arbitrators. Therefore, although management believes that the claims asserted against Headwaters in the named cases lack merit, there is a possibility of material losses in excess of the amounts accrued if one or more of the cases were to be determined adversely against Headwaters for a substantial amount of the damages asserted. It is possible that a change in the estimates of probable liability could occur, and the changes could be material. Additionally, as with any litigation, these proceedings require that Headwaters incur substantial costs, including attorneys’ fees, managerial time and other personnel resources, in pursuing resolution.

Boynton. In October 1998, Headwaters entered into a technology purchase agreement with James G. Davidson and Adtech, Inc. The transaction transferred certain patent and royalty rights to Headwaters related to a synthetic fuel technology invented by Davidson. In June 2002, Headwaters received a summons and complaint from the United States District Court for the Western District of Tennessee filed by former stockholders of Adtech alleging, among other things, fraud, conspiracy, constructive trust, conversion, patent infringement and interference with contract arising out of the 1998 technology purchase agreement entered into between Davidson and Adtech on the one hand, and Headwaters on the other. All claims against Headwaters were dismissed in pretrial proceedings except claims of conspiracy and constructive trust. The District Court certified a class comprised of substantially all purported stockholders of Adtech, Inc. At trial, the plaintiffs sought compensatory damages from Headwaters in the approximate amount of $43.0 million plus prejudgment interest and punitive damages. On June 22, 2009, a jury reached a verdict in a trial in the amount of $8.7 million for eight named plaintiffs representing a portion of the class members. The jury also reached a verdict on certain legal liability issues and an advisory verdict on damages of up to $12.7 million on behalf of the balance of the class members. Headwaters expects that there will be further trial court proceedings to resolve the constructive trust claim as to all members of the class and the remaining legal issues as to the unnamed class members. It is not expected that a final judgment will be entered by the trial court until all issues are concluded. Once entered, the parties may seek

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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

relief from judgment by motion to the trial court and by appeal from the final judgment. Because the resolution of the litigation is uncertain, legal counsel and management cannot express an opinion as to the ultimate amount, if any, of Headwaters’ liability.

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

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

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

Coalco Corporation. Beginning in 1996, Headwaters entered into a series of agreements with Coalco Corporation by which Coalco would assist Headwaters in identifying financing sources for synthetic fuel manufacturing projects. Under these agreements, Headwaters agreed to pay certain fees to Coalco. Beginning in 1997, Pelletco Company, an affiliate of Coalco, entered into license agreements for the use of Headwaters’ synthetic fuel technology for which Pelletco agreed to pay certain license fees to Headwaters. As of December 31, 2008, trade receivables include $3.8 million which is due from Pelletco to Headwaters. The synthetic fuel businesses underlying all of these agreements ended during fiscal 2008. In January 2009, Coalco filed a complaint in the Commonwealth of Massachusetts Suffolk County Superior Court, which has been removed to the United States District Court for the District of Massachusetts, alleging that Headwaters has breached its agreements to pay certain fees to Coalco. Coalco seeks damages in the principal amount of approximately $20.8 million, plus approximately $2.7 million in interest, plus attorneys’ fees, and other costs. Pelletco joined the complaint with Coalco, both seeking declaratory judgment as to their rights and obligations under the various agreements. Headwaters filed an answer denying the allegations of the complaint. Headwaters also filed a counterclaim against the plaintiffs and their principals claiming breach of contract and related claims for failure to pay the $3.8 million due from Pelletco to Headwaters. Because the resolution of the litigation is uncertain, legal counsel and management cannot express an opinion as to the ultimate amount, if any, of Headwaters’ liability. Although the merits of Coalco and Pelletco’s claims against Headwaters will be determined in due legal course, management currently believes that the $3.8 million owed to Headwaters from Pelletco is due and collectible.

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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

J. Hall Inc. In June 2009, J. Hall, Inc. (Hall) and RC Trucking, Inc. (RC) filed a complaint against Covol Fuels No. 3, LLC (Covol) (a subsidiary of Headwaters), Yukon Coal Company, LLC, Suburban Coal Sales, LLC, and Century Coal, LLC (collectively, Yukon) in Bell County Circuit Court in the Commonwealth of Kentucky. The complaint alleges that Hall and RC obtained or brokered coal on behalf of Yukon which was then sold by Yukon to Covol. Allegedly, Yukon never paid Hall and RC for the coal. Hall and RC named Covol as a party to the suit claiming that Covol is an alter ego of Yukon and that Covol and Yukon are engaged in a joint venture or partnership in the operation of Covol’s coal cleaning facility located near Beverly, Kentucky. Hall and RC have asserted claims against Covol for breach of contract, unjust enrichment, and right of offset against Covol for monies owed by Hall and RC to Covol. Hall and RC are seeking damages of $0.7 million. In July 2009, Covol filed a motion to remove the case to the United States District Court for the Eastern District of Kentucky and also filed counterclaims against Hall and RC for breach of contract, or in the alternative, unjust enrichment for plaintiffs’ failure to pay for cleaned coal sold by Covol to Hall and RC in separate transactions. Covol seeks damages against Hall in the amount of $0.6 million. Covol also seeks monetary damages against RC for amounts less than $0.1 million. Although the merits of Hall’s and RC’s claims against Covol will be determined in due legal course, management currently believes that the $0.6 million owed to Covol from Hall and RC is due and collectible.

Fentress Families Trust. VFL Technology Corporation (VFL), a subsidiary acquired by HRI in 2004, provided fly ash management and disposal services to Virginia Electric and Power Company. A large group of homeowners living in the City of Chesapeake, Virginia, have prepared a complaint filed in the State of Virginia Circuit Court naming as defendants Dominion Energy and certain of its affiliates, including Virginia Electric and Power Company, certain persons associated with the Battlefield Golf Course, including the owner, developer, and contractors, and others, including VFL and Headwaters. The complaint alleges that fly ash used to construct the golf course has contaminated area ground water. The complaint alleges multiple causes of action and seeks unspecified damages and injunctive relief. Neither VFL nor Headwaters has been served with the complaint and the matter is still at an early stage of assessment. Because resolution of the anticipated litigation is uncertain, legal counsel cannot express an opinion as to the ultimate amount, if any, of Headwaters’ liability.

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

Typically, the claims cite damages for alleged personal injuries and punitive damages for alleged unfair business practices in addition to asserting more conventional damage claims for alleged economic loss and damage to property. To date, claims made against such subsidiaries have been paid by their insurers, with the exception of minor deductibles or self-insured retentions, although such insurance carriers typically have issued “reservation of rights” letters. While, to date, none of these proceedings have required that HBP incur substantial costs, there is no guarantee of insurance coverage or continuing coverage. These and future proceedings may result in substantial costs to HBP, including attorneys’ fees, managerial time and other personnel resources and costs. Adverse resolution of these proceedings could have a materially negative effect on HBP’s business, financial condition, and results of operation, and its ability to meet its financial obligations. Although HBP carries general and product liability insurance, HBP cannot assure that such insurance coverage will remain available, that HBP’s insurance carrier will remain viable, or that the insured amounts will cover all future claims in excess of HBP’s uninsured retention. Future rate increases may also make such insurance

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HEADWATERS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2009

(Unaudited)

uneconomical for HBP to maintain. In addition, the insurance policies maintained by HBP exclude claims for damages resulting from exterior insulating finish systems, or EIFS, that have manifested after March 2003. Because resolution of the litigation and claims is uncertain, legal counsel cannot express an opinion as to the ultimate amount, if any, of HBP’s liability.

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

Section 45K Matters – A material amount of Headwaters’ consolidated revenue and net income through December 31, 2007 was derived from license fees and sales of chemical reagents, both of which were dependent on the ability of licensees and other customers to manufacture and sell qualified synthetic fuel that generated tax credits under Section 45K (formerly Section 29) of the Internal Revenue Code. Headwaters has also claimed Section 45K tax credits for synthetic fuel sales from facilities in which it owned an interest (see Note 8). The following issues exist related to Section 45K tax credits.

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

IRS Audits. The IRS is currently auditing Headwaters’ tax credits claimed for synthetic fuel sold from the facilities in which it owned an interest. The tax credits which are under audit that Headwaters believes are more likely than not to be sustained, and are therefore not included in unrecognized income tax benefits in the balance sheet, total approximately $30.0 million.

Section 45 Matters – As explained in Note 8, Headwaters’ effective tax rates for fiscal 2008 and 2009 are lower than the statutory rate in part due to refined coal tax credits related to facilities that Headwaters owns and operates. Headwaters believes the refined coal produced at these facilities and sold to qualified buyers qualifies for tax credits under Section 45 (which is different from the Section 45K tax credits discussed in preceding paragraphs) of the Internal Revenue Code. To date, the IRS has issued limited guidance about how this tax credit program will be administered and the restrictions on the availability of such credits. Based on the language of Section 45, Headwaters believes that its coal cleaning facilities are eligible for Section 45 refined coal tax credits, and as a result, has recognized a benefit for such credits in its fiscal 2008 and 2009 tax provisions. The ability to claim tax credits is dependent upon a number of conditions, including, but not limited to:

• Placing facilities in service on or before December 31, 2008;

• Producing a fuel from coal that is lower in NO_x and either SO_x or mercury emissions by the specified amount as compared to the emissions of the feedstock;

• Producing a fuel at least 50% more valuable than the feedstock; and

• Sale of the fuel to a third party for the purpose of producing steam.

The IRS may challenge Section 45 tax credits claimed by Headwaters on any one of these or other conditions. In addition, Congress may modify or repeal Section 45 so that these tax credits may not be available in the future. From fiscal 2007 through June 30, 2009, Headwaters has recognized a total benefit of approximately $8.2 million related to Section 45 tax credits.

In the Energy Improvement and Extension Act of 2008, Congress extended the benefits of Section 45 tax credits to refined coal facilities placed in service after December 31, 2008 and before January 1, 2010. For refined coal facilities placed in service in calendar year 2009, Congress also eliminated the Section 45 requirement that there be a 50% increase in market value but increased the emissions reduction required of either SO_x or mercury to 40% from 20%. Headwaters does not believe that these revised requirements apply to its existing coal cleaning facilities.

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

The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes included in this Form 10-Q. Our fiscal year ends on September 30 and unless otherwise noted, references to 2008 refer to our fiscal quarter and/or nine-month period ended June 30, 2008 and references to 2009 refer to our fiscal quarter and/or nine-month period ended June 30, 2009. Other references to years refer to our fiscal year rather than a calendar year.

Overview

Consolidation and Segments. The consolidated financial statements include the accounts of Headwaters, all of our subsidiaries, and other entities in which we have a controlling interest. All significant intercompany transactions and accounts are eliminated in consolidation.

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

Operations and Strategy. During the past several years, we have executed our two-fold plan of maximizing cash flow from our existing operating business units and diversifying from significant reliance on the legacy energy segment Section 45K (formerly Section 29) business. With the addition and expansion of our CCP management and marketing business through acquisitions beginning in 2002, and the growth of our building products business through several acquisitions beginning in 2004, we have achieved revenue growth and diversification in three business segments. Because we also incurred increased indebtedness to make strategic acquisitions, one of our historical financial objectives has been to focus on increasing cash flows to reduce debt levels. During fiscal 2008 and 2009, our primary focus has been on the development of our coal cleaning business and our primary use of cash consisted of maintenance and growth capital expenditures, a major portion of which related to our coal cleaning facilities in the energy segment.

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

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

Section 45K tax credits were subject to phase-out after the average annual U.S. wellhead oil price (reference price) reached a beginning phase-out threshold price, and would have been eliminated entirely if the reference price had reached the full phase-out price. The calendar 2007 reference price and phase-out range were announced in calendar 2008 and accordingly, in the March and June 2008 quarters we adjusted previously recognized revenue and tax credits as required to reflect the finalized phase-out. The existence and unpredictability of phase-out had a material adverse effect on both the amount and timing of recognition of our revenue, net income and cash flow beginning in fiscal 2006 and continuing into fiscal 2008. At the current time, we do not believe there are any material residual contingencies related to phase-out.

We own and operate several newly-constructed and recently-renovated coal cleaning facilities that remove rock, dirt, and other impurities from waste coal, resulting in higher-value, marketable coal. Construction of these facilities was our largest single investment of cash during fiscal 2008 and through June 30, 2009 and currently we expect construction activities in the energy segment and other business segments will be our most significant investment of cash in fiscal 2009. Capital expenditures in fiscal 2008 and through June 30, 2009 were financed primarily with available cash and with lease financing.

24

For the nine months ended June 30, 2009, coal sales were $46.6 million, compared to $20.8 million for the nine months ended June 30, 2008. Despite this growth in coal sales from 2008 to 2009, there has been a rapid decline in demand and pricing for coal from 2008 to 2009, especially metallurgical grade coal. In addition, we have experienced high start-up costs and operational challenges as we have finished construction and renovation activities and commenced operations at many facilities in a short period of time. Finally, as of June 30, 2009, we have temporarily shut down four of our coal cleaning facilities, due primarily to industry market conditions, and reduced staffing at other facilities to better match coal production with current demand. The site lessor and feedstock coal supplier for one of these facilities located in Kentucky has filed for bankruptcy. The disruption caused by this bankruptcy and lack of primary coal supply may cause reduced or curtailed production at this facility for an extended period of time. These circumstances have had a negative effect on our 2009 revenue and are currently expected to have a negative effect on the fiscal 2009 year’s revenue and operating income.

Our CCP segment business strategy is to continue to negotiate long-term contracts with suppliers, supported by investment in transportation and storage infrastructure for the marketing and sale of CCPs. We are also continuing our efforts to expand the use of high-value CCPs, develop more uses for lower-value CCPs such as in blending, and expand our CCP disposal services. While all of our businesses have been affected by the current recession, the impact on our CCP segment has been less severe than on our other segments.

Our building products segment has been significantly affected by the depressed new housing and residential remodeling markets and our current strategy is to reduce operating costs as much as possible and be positively positioned to take advantage of an industry turnaround at some point in the future. We are also continuing to develop new building products and to leverage our robust distribution system which we believe is a competitive advantage for us.

The building products industry is experiencing a severe downturn that may continue for an indefinite period into the future. Because the markets for our building products are heavily dependent on the residential construction and remodeling markets, our revenues could decrease as a result of events outside our control that impact home construction and home improvement activity, including economic factors specific to the building products industry.

There has been a severe slowing in fiscal 2007 through 2009 of new housing starts and in home sales generally. Bank foreclosures have put a large number of homes into the market for sale, effectively limiting some of the incentives to build new homes. The homebuilding industry continues to experience a significant and sustained decrease in demand for new homes and an oversupply of new and existing homes available for sale. While our residential building products business relies upon the home improvement and remodeling markets as well as new construction, we have experienced a further slowdown in sales activity in fiscal 2009. Interest rate increases, limits on credit availability, further foreclosures, home price depreciation, and an oversupply of homes for sale in the market may adversely affect homeowners’ ability or desire to engage in construction or remodeling, resulting in a continued or further slowdown in new construction or remodeling and repair activities.

We, like many others in the building products industry, experienced a large drop in orders and a reduction in our margins in fiscal 2008 and continuing into 2009 relative to prior years. For the past two years and in fiscal 2009, we have recorded significant goodwill impairments associated with our building products business. We can provide no assurances that the building products market will improve in the near future. We expect weakness to continue through fiscal 2009 and into 2010 and to have an adverse effect on our business and our results of operations.

In addition, the ongoing financial crisis could negatively affect our business, results of operations, and financial condition. Market conditions in the mortgage lending and mortgage finance industries deteriorated significantly in fiscal 2008 and remain poor in fiscal 2009, which adversely affects the availability of credit for home purchasers and remodelers.

The financial crisis affecting the banking system and financial markets and the going concern threats to banks and other financial institutions have resulted in a tightening in the credit markets, a low level of liquidity in many financial markets, including mortgages and home equity loans, and extreme volatility in credit and equity markets. Continued tightness of mortgage lending or mortgage financing requirements could adversely affect the availability of credit for purchasers of our products and thereby reduce our sales. There could be a number of follow-on effects from the credit crisis on our business, including the inability of prospective homebuyers or remodelers to obtain credit for financing the purchase of our building products. These and other similar factors could cause decisions to delay or forego new home construction or improvement projects, cause our customers to delay or decide not to purchase our building products, or lead to a decline in customer transactions and our financial performance.

As a result of the above circumstances, we determined that the building products reporting unit’s goodwill was impaired in both fiscal 2007 and 2008, and non-cash impairment charges of $98.0 million and $205.0 million were recorded in fiscal 2007 and 2008, respectively. Due to the continuing decline in the new housing and residential remodeling markets, the ongoing downward revisions by market analysts of near-term projections in these markets, and the significant decline in our

25

stock price during the six months ended March 31, 2009, management determined that indicators of further goodwill impairment in the building products reporting unit existed. In addition, the significant declines in coal and oil prices and in our stock price indicated potential goodwill impairment in the energy reporting unit. Accordingly, we performed goodwill impairment tests for both the building products and energy reporting units, and upon completion of the impairment tests, we wrote off all remaining goodwill in the building products and energy reporting units in the quarter ended March 31, 2009, totaling approximately $465.7 million. None of the impairment charges in fiscal 2007, 2008 or 2009 affected our cash position, cash flow from operating activities or debt covenant compliance. Changes in the credit markets have increased our borrowing rate, which borrowing rate directly affects the discount rate used in the goodwill impairment calculations. The increase in the discount rate led to the majority of the goodwill impairment in fiscal 2009.

Our CCPs and building products businesses are significantly affected by seasonality, with the highest revenue and profitability produced in the June and September quarters.

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

In 2005 and subsequent years, we focused on the integration of our large 2004 acquisitions, including the marketing of diverse kinds of building products through our national distribution network. We became highly leveraged as a result of those acquisitions, but reduced our outstanding debt significantly since that time through cash generated from operations, from an underwritten public offering of common stock and from proceeds from settlement of litigation. During fiscal years 2005 through 2008, we made several early repayments of our long-term debt. In fiscal 2008 and through June 30, 2009, early repayments of long-term debt decreased as compared to earlier periods primarily due to our investments of available cash in the development of our coal cleaning business in the energy segment. Cash needs for capital expenditures have continued in fiscal 2009, so we are highly focused on liquidity to enable us to continue implementing our overall operational strategy. In addition, outstanding borrowings under the $60.0 million revolver must be repaid in September 2009. We currently expect to finalize a new replacement asset based revolver (ABL facility) during August 2009; however, an agreement has not yet been consummated.

Although our historical emphasis on the early repayment of long-term debt has diminished temporarily, a significant amount of our long-term debt is repayable beginning in 2011. Current and planned operational improvements are currently expected to partially offset the impact of reduced revenues on our cash flow from operations. However, the anticipated increase in cash flow from these actions, along with the cash flow currently being generated, may not provide sufficient funds for operations and for the retirement of all of our maturing debt, including the outstanding September 2009 revolving credit obligations. Accordingly, management’s plans to increase liquidity and minimize the risk of noncompliance with debt covenants also include additional actions, all as described in the section“Potential Liquidity Risks and Management’s Plans” near the end of this Management’s Discussion.

Critical Accounting Policies and Estimates

Our significant accounting policies are identified and described in Note 2 to the consolidated financial statements in our Form 10-K. In addition, there is a discussion of critical accounting policies and estimates in“Management’s Discussion and Analysis of Financial Condition and Results of Operations” in that Form 10-K. The following is an update of the Form 10-K discussion of one of our critical accounting policies.

Valuation of Long-Lived Assets, including Intangible Assets and Goodwill. Long-lived assets consist primarily of property, plant and equipment, intangible assets and goodwill. Intangible assets consist primarily of identifiable intangible assets obtained in connection with acquisitions. These intangible assets are being amortized using the straight-line method, our best estimate of the pattern of economic benefit, over their estimated useful lives.

Goodwill consists of the excess of the purchase price for businesses acquired over the fair value of identified assets acquired, net of liabilities assumed. In accordance with the requirements of SFAS No. 142, we do not amortize goodwill, all of which relates to acquisitions. SFAS No. 142 requires us to periodically test for goodwill impairment, at least annually, or sooner if indicators of possible impairment arise. We perform our annual goodwill impairment testing as of June 30, using the two-step process described in Note 7 to the consolidated financial statements in our Form 10-K. As a result of the depressed new housing and residential remodeling markets, we determined that the building products reporting unit’s goodwill was impaired as of the June 30 test date in both fiscal 2007 and 2008, and non-cash impairment charges of $98.0 million and $205.0 million were recorded in fiscal 2007 and 2008, respectively.

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Due to the continuing decline in the new housing and residential remodeling markets, the ongoing downward revisions by market analysts of near-term projections in these markets, and the significant decline in our stock price during 2009, management determined that indicators of further goodwill impairment in the building products reporting unit existed. In addition, the significant declines in coal and oil prices and in our stock price indicated potential goodwill impairment in the energy reporting unit. Accordingly, we performed goodwill impairment tests for both the building products and energy reporting units during the quarter ended March 31, 2009. Upon completion of the impairment tests in 2009, we wrote off all remaining goodwill in the building products and energy reporting units, totaling approximately $465.7 million. None of the impairment charges in fiscal 2007, 2008 or 2009 affected our cash position, cash flow from operating activities or debt covenant compliance and will not have any impact on future operations. Changes in the credit markets have increased our borrowing rate, which borrowing rate directly affects the discount rate used in the goodwill impairment calculations. The increase in the discount rate led to the majority of the goodwill impairment in fiscal 2009.

As disclosed in Note 7 to the consolidated financial statements in the Form 10-K, through fiscal 2007, we had five reporting units with allocated goodwill, three of which were in the building products segment. There has been one reporting unit with goodwill in each of the CCPs and energy segments. As a result of changes in the operations and management of the businesses in the building products segment, and in accordance with the requirements contained in SFAS No. 142, SFAS No. 131 and EITF Topic D-101, “Clarification of Reporting Unit Guidance in Paragraph 30 of SFAS No. 142,” commencing with our 2008 fiscal year we aggregated the three reporting units in the building products segment into one reporting unit for the purpose of goodwill impairment testing.

The changes in the building products segment resulting in aggregation of the reporting units included, among other things, consolidation under a single management team, consolidation of incentive compensation programs to be dependent upon combined segment operating results, consolidation of some sales chains such that these chains sell many of the segment’s products, and cross selling into other sales chains, collaboration on new products, and cash flow/resource allocation decisions being made on a combined basis. If these three reporting units had not been aggregated into a single reporting unit, the recorded goodwill impairment charge for fiscal 2008 would have been lower by approximately $6.0 million. As of September 30, 2008, there was approximately $461.9 million of goodwill remaining in the building products reporting unit.

The CCP reporting unit had recorded goodwill of approximately $116.0 million as of September 30, 2008 and June 30, 2009. The estimated fair value of the CCP reporting unit exceeded its carrying value as of the June 30, 2008 test date by approximately $194.0 million. Despite the current economic downturn, the demand for CCPs has declined significantly less than many other types of construction materials and thus continues to generate strong operating results. Revenue for this reporting unit increased by approximately $7.0 million in fiscal 2008 compared to fiscal 2007; meanwhile, the gross margin decreased by only approximately 1% during the same time period. The anticipated future cash flows for this reporting unit are not currently expected to change significantly from 2008 levels. The energy segment reporting unit had recorded goodwill of approximately $4.3 million as of September 30, 2008 and there was a difference of approximately $8.0 million between the estimated fair value of the reporting unit and its carrying value as of the June 30, 2008 test date.

The Tapco reporting unit failed step 1 of the goodwill impairment test in 2007 and the aggregated building products reporting unit failed step 1 in 2008 and in 2009. In addition, the energy reporting unit failed step 1 in 2009. These step 1 results required completion of step 2, which resulted in a determination that Tapco’s goodwill was impaired in 2007, the building products segment goodwill was impaired in 2008 and in 2009, and the energy segment goodwill was impaired in 2009. Accordingly, non-cash impairment charges of $98.0 million, $205.0 million and $465.7 million were recorded in fiscal 2007, 2008 and 2009, respectively.

In determining the fair values of the reporting units, all three of the traditional valuation approaches, the income approach, the market approach and the asset-based approach, were considered. The fair values of the reporting units were calculated using the income approach, determined by discounting expected future cash flows. This method was chosen because it specifically considers the operations, opportunities and risks applicable to the reporting units. The market approach, specifically the guideline public company method, was also considered. However, the reporting units’ direct competitors are either subsets of large corporate entities or are privately held. Therefore, there is limited comparability between the reporting units and the potential guideline public companies. Accordingly, the guideline public company method was utilized only as a reasonableness test of the results from the income approach. Finally, the asset-based approach was also considered; however, it was not utilized because it does not consider the income producing/going concern nature of the reporting units’ assets.

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As discussed above, the fair values of the reporting units are calculated primarily using discounted expected future cash flows. There are many estimates and assumptions involved in preparing these expected future cash flows, including most significantly the weighted average cost of capital used to discount future cash flows, anticipated long-term growth rates, future profit margins, working capital requirements and required capital expenditures. Management uses its best efforts to reasonably estimate all of these and other inputs in the cash flow models utilized; however, it is certain that actual results will differ from these estimates and the differences could be material. Materially different input estimates and assumptions would necessarily result in materially different calculations of discounted expected future cash flows and reporting unit fair values and materially different goodwill impairment estimates.

The most sensitive assumptions for the income approach were the discount rates (based on weighted average cost of capital), the expected long-term growth rate and expected future gross profit margins. For the building products reporting unit, discount rates of 11.8% and 19.0% were used in fiscal 2008 and 2009, respectively. Each 1% change in the discount rate would have changed the fair value of the reporting unit by approximately $100.0 million in 2008 and $18.0 million in 2009. The long-term growth rate used was 3.2% in both fiscal 2008 and 2009. Each 1% change in the long-term growth rate would have changed the fair value by approximately $70.0 million in 2008 and $8.0 million in 2009. The expected future gross profit margins used ranged from 28%-34% in fiscal 2008 and 27%-32% in fiscal 2009. Each 1% change in the gross profit margins would have changed the fair value by approximately $47.0 million in 2008 and $19.0 million in 2009. The sensitivity to a 1% change in these assumptions was much less pronounced in 2009 because of the high discount rate used, thereby lessening the impact of other variables on the fair value calculation.

Our building products segment gross margin percentage for fiscal years 2005 through 2008 was 33%, 31%, 30% and 26%, respectively. The year-over-year revenue growth (decrease) was 10%, (5)%, and (16)% over the same period. The results for fiscal years 2007 and 2008 reflect the recent dramatic slowing of the building products industry; however, we did not believe that recent conditions were indicative of the long-term future of the housing market. The housing market is extremely cyclical and the cycles can vary materially in length and scope. Average housing starts reported by the U.S. National Association of Home Builders (NAHB) for the last seventeen years, including 2008, were 1.6 million units per year. While the estimated housing starts for 2009 were 0.6 million, the five-year average that included current estimates for 2009 and 2010 indicated estimated average housing starts of more than 1.1 million units, which is nearly 20% higher than the 2008 actual starts. We believe that the gross profit margins used in the cash flow forecast of 28%-34% in fiscal 2008 and 27%-32% in fiscal 2009, which are consistent with our actual 2005-2007 levels, were reasonable in the long term, especially given productivity improvements being implemented through application of lean manufacturing techniques. We also believe that the long-term revenue growth rate of 3.2% will be achieved as the housing market rebounds.

In addition to the annual review, we evaluate, based on current events and circumstances, the carrying value of all long-lived assets, including intangible assets and goodwill, as well as the related amortization periods, to determine whether adjustments to these amounts or to the estimated useful lives are required. Changes in circumstances such as technological advances, or changes in our business model or capital strategy could result in the actual useful lives differing from our current estimates. In those cases where we determine that the useful lives of property, plant and equipment or intangible assets should be changed, we amortize the net book value in excess of salvage value over the revised remaining useful lives, thereby prospectively adjusting depreciation or amortization expense as necessary. In connection with the goodwill impairment testing for the building products and energy reporting units in 2009, we also performed a formal analysis for potential impairments of other long-lived assets in those reporting units, including all intangible assets and property, plant and equipment. The results of this analysis did not result in any significant impairment of any other long-lived assets.

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. Indicators of impairment include such things as a significant adverse change in legal factors or in the general business climate, a decline in operating performance indicators, a significant change in competition, or an expectation that significant assets will be sold or otherwise disposed of. No significant changes have been made to estimated useful lives during the periods presented.

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

Three Months Ended June 30, 2009 Compared to Three Months Ended June 30, 2008

The information set forth below compares our operating results for the quarter ended June 30, 2009 (2009) with operating results for the quarter ended June 30, 2008 (2008).

Summary. Our total revenue for 2009 was $175.2 million, down 24% from $230.5 million for 2008. Gross profit decreased 35%, from $64.3 million in 2008 to $42.1 million in 2009. Operating income decreased from $21.1 million in 2008 to $5.4 million in 2009. Net income decreased from $13.7 million, with diluted earnings per share of $0.31, in 2008, to $11.3 million, or $0.27 per diluted share, in 2009.

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

Building Products Segment. Sales of building products during 2009 were $92.6 million with a corresponding gross profit of $25.6 million. Sales of building products during 2008 were $129.3 million with a corresponding gross profit of $35.3 million. The decrease in our sales of building products in 2009 was due primarily to the continuing effects of the depressed new housing and residential remodeling markets which impacted sales across most of our product lines. The gross margin percentage did not change significantly from 2008 to 2009 despite the decrease in revenues. We believe our niche strategy and our focus in 2009 on productivity improvements and cost reductions tempered somewhat the impact of the severe slowdown in new residential construction; however, the recession has resulted in higher unemployment, adding to the high level of home foreclosures, putting additional homes on the market and further reducing the demand for new construction.

New housing starts according to the National Association of Home Builders were 1.3 million and 0.9 million units in calendar 2007 and 2008, respectively, compared to a 10-year average of 1.6 million units. Our building products business relies on the home improvement and remodeling markets as well as new construction. The U.S. Census Bureau’s Value of Private Residential Construction Spending Put in Place data (as revised) on homeowner improvement activity shows that the four quarter moving average peaked at $146.2 billion in the second quarter of calendar 2007 and fell to approximately $118.2 billion by the first quarter of calendar 2009. The Leading Indicator of Remodeling Activity estimate issued by the Joint Center for Housing Studies at Harvard University has estimated that the four-quarter moving average will be only $105.2 billion in the first quarter of calendar 2010, which would be the lowest level since the first quarter of calendar 2004. Based on the forecasted declines in new housing starts and remodeling activity for calendar 2009, we expect that our revenues and operating results will continue to decline for the remainder of fiscal 2009 and into fiscal 2010, when compared to fiscal 2008 levels.

CCP Segment. CCP revenues for 2009 were $64.4 million with a corresponding gross profit of $18.0 million. CCP revenues for 2008 were $82.6 million with a corresponding gross profit of $24.5 million. The decrease in CCP revenues in 2009 compared to 2008 was due primarily to significant reductions in concrete consumption, partially offset by increased revenue from service contracts. The gross margin percentage decreased from 2008 to 2009 primarily due to the change in sales mix and lower fixed cost coverage resulting from decreased sales.

Energy Segment. In both 2009 and 2008, our energy segment revenue consisted primarily of coal sales. Cost of revenue exceeded revenue for this segment in 2009 due primarily to low coal prices and ongoing start-up and ramp-up costs for newly-constructed and renovated coal cleaning facilities that were placed into service in late fiscal 2008 and in the quarter ended December 31, 2008. As of June 30, 2009, we have temporarily shut down four of our coal cleaning facilities, due primarily to industry market conditions, and reduced staffing at other facilities to better match coal production with current demand. The site lessor and feedstock coal supplier for one of these facilities located in Kentucky has filed for bankruptcy. The disruption caused by this bankruptcy and lack of primary coal supply may cause reduced or curtailed production at this facility for an extended period of time.

Operating Expenses. The increase in amortization expense of $0.3 million from 2008 to 2009 was due primarily to amortization of intangible assets that were acquired in a late fiscal year 2008 acquisition. Research and development expense decreased by $1.3 million from 2008 to 2009, primarily because of decreased spending on our coal-to-liquids and hydrogen peroxide technologies. Selling, general and administrative expenses decreased $5.4 million, or 16%, to $28.9 million in 2009 from $34.3 million in 2008. The decrease in 2009 was due to cost reductions in most categories of expense, with the largest contributor being reduced personnel-related costs totaling $4.8 million. Personnel-related costs decreased primarily due to headcount reductions. Because of ongoing cost-cutting activities, we expect selling, general and administrative expenses for the remainder of fiscal 2009 to be below comparable fiscal 2008 levels.

Other Income and Expense. During 2009, we reported net other expense of $0.8 million, compared to net other expense of $5.8 million during 2008. The decrease in net other expense of $5.0 million was comprised of an increase in net interest expense of approximately $4.5 million and an increase in net other income of approximately $9.5 million.

Net interest expense increased from $5.6 million in 2008 to $10.1 million in 2009 due to several factors, most notably increased interest expense attributed to our convertible debt exchanges that occurred in December 2008 and March and April 2009 that resulted in the extinguishment of $80.9 million of 2.875% convertible notes and the issuance of $63.3 million of 16% convertible notes, and the extinguishment of $39.1 million of 2.50% convertible notes and the issuance of $27.4 million of 14.75% convertible notes (see Note 6 to the consolidated financial statements). In connection with the April 2009 convertible debt exchange, approximately $0.8 million of accelerated debt issue costs were amortized related to the extinguished 2.50% convertible notes. In addition, we experienced higher interest rates on our senior debt as a result of the August 2008 amendment to our senior secured credit agreement. Due to the increased interest rates on our convertible debt and senior debt, we expect interest expense for the remainder of fiscal 2009 and for fiscal 2010 to significantly exceed the respective fiscal 2008 levels.

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The increase in net other income of approximately $9.5 million consisted primarily of the gain related to the April 2009 extinguishment of debt of $10.1 million, partially offset by an increase of $0.6 million in loss on sale of assets in 2009 as compared to 2008.

Income Tax Provision. The recorded income tax rates for 2008 and 2009 were 10% and (149)%, respectively, including discrete items. Our estimated effective income tax rate for the fiscal year ending September 30, 2009, exclusive of discrete items, is currently estimated to be less than 20.0%. During 2009, we also recognized $0.3 million of income tax benefit for discrete items that did not affect the calculation of the estimated effective income tax rate for the 2009 fiscal year. For 2008, we used an estimated effective income tax rate of 29.0%, exclusive of discrete items, and recognized $2.9 million of income tax benefit for discrete items. The 2009 discrete items primarily related to the reversal of estimated tax liabilities, penalties and interest recorded when we adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income taxes – an Interpretation of FASB Statement No. 109.”

The “negative” income tax rate for 2009 resulted primarily from relatively low pre-tax income for the quarter ended June 30, 2009, combined with a small adjustment of the 2009 estimated effective income tax rate calculated as of June 30, 2009 when compared with the estimated rate calculated as of March 31, 2009. The adjustment in the effective income tax rate estimate was applied to the entire pre-tax loss for the year-to-date period, which was relatively large due to the goodwill impairment of approximately $465.7 million recorded in the quarter ended March 31, 2009.

The estimated effective tax rate for fiscal 2009, exclusive of discrete items, is lower than the statutory rate because a significant portion of the goodwill impairment recorded in 2009 is not tax deductible. Accordingly, the tax benefit expected to be recorded for fiscal 2009 will be significantly less than the statutory rate. The fiscal 2009 estimated effective tax rate was also affected by estimated Section 45 refined coal tax credits (which are different from the Section 45K tax credits discussed elsewhere) related to the coal cleaning facilities that we own and operate, but to a far lesser extent than by the portion of the goodwill impairment representing a permanent difference. The estimated effective tax rate for fiscal 2008, exclusive of discrete items, was lower than the statutory rate primarily due to estimated Section 45 refined coal tax credits. We believe it is more likely than not that the refined coal produced at our coal cleaning facilities qualifies for tax credits pursuant to Section 45 of the Internal Revenue Code, notwithstanding the uncertainties and risks associated with the tax credits, as more fully described in Note 10 to the consolidated financial statements.

Excluding the effect of expected tax credits in both fiscal 2008 and 2009 and goodwill impairment in fiscal 2009, our effective tax rate for fiscal 2008 and 2009 would have been approximately 40% and less than 20%, respectively. The low rate for 2009 is due primarily to the effect of valuation allowances and permanent differences unrelated to goodwill impairment, combined with a relatively small expected pre-tax loss for the year.

The calculation of our income tax provision involves uncertainties in the application of complex tax regulations in multiple jurisdictions. For example, we are currently under audit by the IRS for the years 2005 and 2006 and have open tax periods subject to examination by both federal and state taxing authorities for the years 2005 through 2008. We recognize potential liabilities for anticipated tax audit issues in the U.S. and state tax jurisdictions based on estimates of whether, and the extent to which, additional taxes and interest will be due. If events occur and the payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when it is determined the liabilities are no longer probable or necessary. If the estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result. It is reasonably possible that the amount of our unrecognized income tax benefits will change significantly within the next 12 months. These changes could be the result of the ongoing tax audits or the settlement of outstanding audit issues. However, due to the number of years under audit and the matters being examined, at the current time, an estimate of the range of reasonably possible outcomes cannot be made, beyond amounts currently accrued.

Nine Months Ended June 30, 2009 Compared to Nine Months Ended June 30, 2008

The information set forth below compares our operating results for the nine months ended June 30, 2009 (2009) with operating results for the nine months ended June 30, 2008 (2008).

Summary. Our total revenue for 2009 was $479.1 million, down 26% from $651.3 million for 2008. Gross profit decreased 43%, from $168.7 million in 2008 to $96.4 million in 2009. Operating income decreased from $30.5 million in 2008 to an operating loss of $(482.2) million in 2009. Net income decreased from $14.4 million, with diluted earnings per share of $0.35, in 2008, to a net loss of $(395.9) million, or $(9.53) per diluted share, in 2009. The most significant reason for the change in results from 2008 to 2009 was the goodwill impairment charge totaling approximately $465.7 million in 2009.

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In addition to the goodwill impairment charge in 2009, our Section 45K business terminated in fiscal 2008 and we sold the mortar/stucco business in our building products segment in fiscal 2008. Removing the effect of these two profitable operations from the numbers for 2008 and the effect of the goodwill impairment charge for 2009, our total revenue for 2009 was $479.1 million, down 17% from $579.0 million for 2008. Gross profit decreased 34%, from $146.7 million in 2008 to $96.4 million in 2009. Operating income decreased from $9.4 million in 2008 to an operating loss of $(16.5) million in 2009, and net income (loss) decreased from a net loss of $(2.9) million, with diluted earnings (loss) per share of $(0.06), in 2008, to net income of $0.9 million, or $0.02 per diluted share, in 2009.

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

Building Products Segment. Sales of building products during 2009 were $249.2 million with a corresponding gross profit of $55.9 million. Sales of building products during 2008 were $337.6 million with a corresponding gross profit of $89.0 million. The decrease in our sales of building products in 2009 was due primarily to the continuing effects of the depressed new housing and residential remodeling markets which impacted sales across most of our product lines. Also, in early fiscal 2008, we sold certain non-strategic mortar/stucco assets in the building products segment which accounted for approximately $9.7 million of the decrease in revenue from 2008 to 2009. The gross margin percentage declined from 2008 to 2009 due primarily to fewer fixed costs being absorbed as a result of lower sales.

CCP Segment. CCP revenues for 2009 were $179.7 million with a corresponding gross profit of $49.7 million. CCP revenues for 2008 were $221.0 million with a corresponding gross profit of $59.4 million. The decrease in CCP revenues in 2009 compared to 2008 was due primarily to significant reductions in concrete consumption, partially offset by increased revenue from service contracts. The gross margin percentage increased from 2008 to 2009 primarily due to declines in the costs of rail and truck transportation and improved productivity.

Energy Segment. In 2008, our energy segment revenue consisted primarily of residual revenues related to our Section 45K business. In 2009, there was no Section 45K revenue and energy segment revenue consisted almost exclusively of coal sales. Cost of revenue exceeded revenue for this segment in 2009 due primarily to low coal prices and ongoing start-up and ramp-up costs for newly-constructed and renovated coal cleaning facilities that were placed into service in late fiscal 2008 and in the quarter ended December 31, 2008.

Operating Expenses. The increase in amortization expense of $1.3 million from 2008 to 2009 was due primarily to accelerated amortization of certain intangible assets and amortization of intangible assets that were acquired in a late fiscal year 2008 acquisition. Research and development expense decreased by $4.0 million from 2008 to 2009, primarily because of decreased spending on our coal-to-liquids and hydrogen peroxide technologies. Selling, general and administrative expenses decreased $22.5 million, or 20%, to $87.8 million in 2009 from $110.3 million in 2008. The decrease in 2009 was due to reduced expenses in every significant category of expense, with the largest contributor being personnel-related costs, including incentive pay expenses, totaling $13.9 million. Incentive pay decreased due to reduced profitability of our operations and other personnel-related costs decreased primarily because of headcount reductions. In addition, in 2008, $3.8 million of restructuring costs related to plant consolidations and other cost improvement projects undertaken in our building products segment were recorded, and such costs in 2009 were minimal.

Other Income and Expense. During 2009, we reported net other income of $2.7 million, compared to net other expense of $10.1 million during 2008. The change in other income and expense of $12.8 million was comprised of an increase in net interest expense of approximately $9.6 million and an increase in net other income of approximately $22.4 million.

Net interest expense increased from $17.6 million in 2008 to $27.2 million in 2009 due to several factors, most notably increased interest expense attributed to our convertible debt exchanges that occurred in December 2008 and March and April 2009 that resulted in the extinguishment of $80.9 million of 2.875% convertible notes and the issuance of $63.3 million of 16% convertible notes, and the extinguishment of $39.1 million of 2.50% convertible notes and the issuance of $27.4 million of 14.75% convertible notes (see Note 6 to the consolidated financial statements). In connection with the convertible debt exchanges, approximately $1.9 million of accelerated debt issue costs were amortized related to the extinguished convertible notes. In addition, we experienced higher interest rates on our senior debt as a result of the August 2008 amendment to our senior secured credit agreement.

The increase in net other income of $22.4 million consisted primarily of the gains related to the 2009 extinguishments of debt of $29.3 million, partially offset by a decrease of $7.3 million in gain on sale of assets in 2009 as compared to 2008. In 2008, we sold certain non-strategic mortar/stucco assets in the building products segment on which a gain of approximately $7.6 million was recognized. A portion of the proceeds from this sale were used to acquire assets that have increased the capacity of our Texas-based concrete block business, which contributed to higher operating income of this business in 2009.

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Income Tax Provision. The recorded income tax rates for 2008 and 2009 were 30% and 17%, respectively, including discrete items. During 2009, we recognized $0.3 million of income tax expense for discrete items that did not affect the calculation of the estimated effective income tax rate for the 2009 fiscal year. For 2008, we recognized $0.1 million of additional income tax expense for discrete items.

Impact of Inflation and Related Matters

Some of our operations have been negatively impacted by increased raw materials costs for commodities, such as polypropylene and poly-vinyl chloride in the building products segment; however, the negative impact has generally been less significant during 2009 than during the latter part of the 2008 fiscal year. We have been successful in passing on some, but not all, of the increased materials costs to customers. Additionally, recent decreases in fuel costs have benefited all of our business units during 2009. It is not possible to predict the future trends of these costs, nor our ability to pass on any future price increases to customers.

Liquidity and Capital Resources

Summary of Cash Flow Activities. Net cash provided by operating activities for the nine months ended June 30, 2009 (2009) was $34.7 million compared to $53.8 million for the nine months ended June 30, 2008 (2008). The 2009 net loss would have been approximately $(4.4) million instead of $(395.9) million if adjusted for the goodwill impairment and the decrease in deferred taxes, nearly all of which related to the goodwill impairment. The 2009 net loss would have been $29.3 million higher absent the gain on extinguishment of debt. After adjusting for the effects of goodwill impairment and the gain on extinguishment of debt, profitability decreased in 2009 compared to 2008 primarily due to the effects on our building products business of the depressed new housing and residential remodeling markets, losses sustained by our coal cleaning business, and the absence of Section 45K-related operations in 2009. The termination of our Section 45K business was also one of the reasons for the higher cash flow from collection of trade receivables in 2008 than 2009 and was the cause of some of the other changes in operating assets and liabilities reflected in the statements of cash flows.

In both 2009 and 2008, the primary investing activities consisted of the purchase of property, plant and equipment and payments for acquisitions. In 2009, our primary financing activities consisted of the exchange of convertible senior subordinated notes resulting in the extinguishment of approximately $29.3 million of convertible debt, and borrowings under our revolving credit arrangement. (As described below, subsequent to June 30, 2009, we exchanged approximately $15.0 million of our 16% convertible senior subordinated notes plus related accrued interest for approximately 3.5 million shares of common stock and approximately $19.8 million of our 2.875% convertible senior subordinated notes plus accrued interest for approximately 4.8 million shares of common stock.) In 2008, our primary financing activities consisted of borrowings under our revolving credit arrangement and the purchase of treasury stock. More details about our investing and financing activities are provided in the following paragraphs.

Investing Activities. Total expenditures for property, plant and equipment in 2009 were $55.3 million, a decrease of $30.8 million from 2008. In 2008, a large majority of capital expenditures were for projects in the energy and building products segments. The energy segment expenditures were for the construction and renovation of coal cleaning facilities and the building products segment expenditures were for both expansion of operations (primarily our Texas block business) and maintenance of operating capacity. In 2009, a substantial majority of total capital expenditures related to our coal cleaning facilities in the energy segment. Spending on coal cleaning facilities will comprise a smaller portion of total expenditures for the remainder of fiscal 2009 and in future years as compared to fiscal 2008 and 2009. Total fiscal 2009 capital expenditures are currently expected to be between $60.0 million and $65.0 million.

Capital expenditures are limited by our senior debt covenants to $67.5 million in fiscal 2009, $60.0 million in fiscal 2010 and $55.0 million in fiscal 2011. In certain circumstances, the unused amount from a fiscal year can be carried forward and used in the subsequent fiscal year; however, as of September 30, 2008, we had no unused amount available to be carried forward to future periods. As of June 30, 2009, we were committed to spend approximately $7.6 million on capital projects that were in various stages of completion. In 2008, we realized $13.1 million of proceeds from the sale of property, plant and equipment, most of which represented non-strategic assets in our building products segment. A portion of the proceeds from this sale was used to acquire assets that increased the capacity of our Texas-based concrete block business, enabling us to meet current and projected demand in this line of business. In 2009, proceeds from disposition of property, plant and equipment of $3.1 million were closer to normal historical levels.

In fiscal 2007, we acquired 100% of the ownership interests of Dutch Quality Stone (DQS), a privately-held company in the building products business. Total consideration paid at the date of acquisition was approximately $52.9 million. An additional $19.0 million was paid in 2008, based on earnings of DQS for the 12-month period ended September 30, 2007

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that exceeded an agreed-upon threshold. In fiscal 2008, we acquired certain assets and assumed certain liabilities of a privately-held company in the building products industry. Total consideration for this acquisition was approximately $16.1 million, of which approximately $5.0 million was paid at the date of acquisition and approximately $10.8 million was paid in 2009, with approximately $0.3 million of assumed liabilities.

Pursuant to contractual terms for some small 2006 acquisitions in the building products segment, additional amounts may be payable in the future, based on the achievement of stipulated revenue or earnings targets for periods ending no later than March 2010. At the current time, we do not believe that any such payments will be material. If any future earn-out consideration is paid for any acquisition, the amounts will be charged to income because all goodwill in the building products reporting unit has been written off.

We intend to continue to expand our business through growth of existing operations, commercialization of technologies currently being developed, and possible strategic acquisitions of products or entities that expand our current operating platform. Acquisitions have historically been an important part of our long-term business strategy. We have routinely reviewed potential acquisitions, including those in the areas of building products, CCP marketing, and coal and catalyst technologies. It is possible that some portion of future cash and cash equivalents and/or proceeds from the issuance of stock or debt could be used to fund acquisitions of complementary businesses in the building products, CCP and energy industries; however, because of cash flow considerations and current events affecting the debt and equity markets, we do not currently anticipate any significant acquisitions in fiscal 2009 or fiscal 2010. Our senior secured credit agreement limits acquisitions in the aggregate to $50.0 million of cash consideration and $20.0 million of non-cash consideration annually, with no more than $30.0 million of cash consideration for any one acquisition. If our “total leverage ratio,” as defined, is less than or equal to 3.50:1.0, after giving effect to an acquisition, these limitations do not apply.

The senior secured credit agreement also limits the amount we can invest in joint ventures and other less than 100%-owned entities. We have invested in several joint ventures, which are accounted for using the equity method of accounting, but we do not currently have plans to significantly increase our investments in those entities.

Financing Activities. In December 2008, we exchanged approximately $80.9 million of our 2.875% convertible senior subordinated notes due 2016 for $63.3 million of new 16% convertible senior subordinated notes due 2016. In March and April 2009, we exchanged approximately $39.1 million of our 2.50% convertible senior subordinated notes due 2014 for approximately $27.4 million of new 14.75% convertible senior subordinated notes due 2014. Gains of approximately $29.3 million, recorded in other income (expense) in the accompanying consolidated statement of operations for 2009, were recognized on the extinguishments of debt. Additionally, approximately $1.9 million of unamortized debt issue costs related to the extinguished debt was charged to interest expense. New debt issue costs of approximately $1.3 million were incurred related to the new 16% and 14.75% convertible notes.

Subsequent to June 30, 2009, we exchanged approximately $15.0 million of our 16% convertible senior subordinated notes plus related accrued interest for approximately 3.5 million shares of common stock and approximately $19.8 million of our 2.875% convertible senior subordinated notes plus accrued interest for approximately 4.8 million shares of common stock. In accordance with the provisions of SFAS No. 84, “Induced Conversions of Convertible Debt,” we will record a non-cash expense of approximately $22.5 million in connection with these transactions, which amount represents the fair value of the shares issued in excess of the shares required to be issued pursuant to the original terms of conversion described in Note 6 to the Consolidated Financial Statements.

In both 2008 and 2009, we had borrowings under our revolving credit arrangement of $35.0 million, primarily related to seasonal financing needs. In 2009, $5.0 million of the seasonal borrowings were repaid prior to June 30, 2009 and an additional $5.0 million was repaid subsequent to June 30, 2009. In 2008, financing activities also included treasury stock purchases totaling $14.8 million.

With the exception of amounts outstanding under our revolving credit arrangement, which are repayable not later than September 2009, we have no long-term debt repayments that are due prior to 2011. There are mandatory prepayments of the first lien term loan in the event of certain asset sales and debt and equity issuances and from “excess cash flow,” as defined in the agreement. A mandatory prepayment of $2.5 million was made in 2009 as a result of an asset sale. Optional prepayments of the first lien term loan are permitted without penalty or premium. Once repaid in full or in part, no reborrowings can be made. We may, in the future, make optional prepayments of senior debt depending on actual cash flows, our current and expected cash requirements and other applicable factors we deem to be significant.

In June 2009, we obtained an amendment to our senior secured credit agreement to modify certain of the leverage and fixed charge coverage ratios described in more detail below and in Note 6 to the consolidated financial statements. In connection with the amendment to the credit facility, the lenders agreed to allow us to establish a new ABL facility to replace the revolving credit facility that matures in September 2009. We currently expect to finalize an ABL facility during August 2009. If an ABL

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facility is finalized, it will have a first lien security interest in certain receivables and inventory, and any outstanding balances under the current revolving credit facility will be repaid. At the time an ABL facility is finalized, we are required to pay a fee to the senior lenders of approximately $0.5 million, the interest rate on the term loan will increase by 1.0%, and we will be required to repay $25.0 million of the term loan prior to December 31, 2009. Finally, the total leverage ratio requirements currently in place will change to 5.25:1 as of September 30, 2009, 5.50:1 as of December 31, 2009, 5.75:1 as of March 31, 2010 and June 30, 2010, 5.25:1 as of September 30, 2010, 5:1 as of December 31, 2010, and 4.75:1 as of March 31, 2011. There can be no assurance that we will be able to secure an ABL facility.

We are in compliance with all debt covenants as of June 30, 2009. However, there is risk of noncompliance with certain leverage and fixed charge coverage ratios in future periods given the continuing decrease in building products and CCPs revenues as a result of current economic conditions, especially the depressed new housing and residential remodeling markets; the termination of our Section 45K business in fiscal 2008; and the high level of capital expenditures during fiscal 2008 and fiscal 2009.

Due to covenants associated with our senior debt, we currently have restrictions on our ability to obtain significant additional amounts of long-term debt. However, we have historically experienced strong positive cash flow from operations which has enabled us to repay a substantial amount of our long-term debt prior to scheduled maturities. While we expect our positive cash flow to continue in the future, our positive cash flow from operations is expected to be lower in fiscal 2009 than it was in fiscal 2008 and in recent years due to the termination of our Section 45K business and the continued weakness in the new housing and residential remodeling markets and other business operations. Also, while we have periodically accessed the debt and equity markets in prior years, affordable and available additional debt and equity may be much more difficult for us to obtain in future periods than in the past, due to less favorable market conditions as well as changes in our business model.

We filed with the SEC a universal shelf registration statement for the potential sale of a total of $250.0 million of debt or equity securities. This registration statement was declared effective in April 2009. A prospectus supplement describing the terms of any additional securities to be issued is required to be filed before any future offering could commence under the registration statement.

Reference is made to Note 6 to the consolidated financial statements for detailed information about our outstanding long-term debt and compliance with debt covenants, as well as the available $60.0 million revolving credit arrangement, which terminates in September 2009. The senior credit facility contains restrictions and covenants common to such agreements, including limitations on the incurrence of additional debt, investments, merger and acquisition activity, asset sales and liens, annual capital expenditures in excess of $67.5 million in fiscal 2009, $60.0 million in fiscal 2010 and $55.0 million in fiscal 2011, and the payment of dividends, among others. In addition, we must maintain certain leverage and fixed charge coverage ratios. Reference is made to the subsequent section titled “Potential Liquidity Risks and Management’s Plans” for detailed information about our debt covenant ratio calculations and related matters.

In both 2008 and 2009, cash proceeds from the exercise of options and employee stock purchases were not material. Option exercise activity is primarily dependent on our stock price and is not predictable. To the extent non-qualified stock options are exercised, or there are disqualifying dispositions of shares obtained upon the exercise of incentive stock options, we receive an income tax deduction generally equal to the income recognized by the optionee. Such amounts were not material in either 2008 or 2009.

Working Capital. As of June 30, 2009, our working capital was $80.1 million. Notwithstanding the termination of our Section 45K business as of December 31, 2007 and the continuing decrease in building products and CCPs revenues as a result of existing economic conditions, we currently expect operations to produce positive cash flow in future periods. We believe working capital, along with available borrowings under the revolving credit arrangement or an ABL facility for our temporary seasonal needs, will be sufficient for operating needs for the next 12 months.

Income Taxes. Historically, there has often been some lag in paying estimated taxes during a fiscal year due to the seasonality of our operations and because estimated income tax payments are typically based on annualizing a fiscal year’s taxable income based on year-to-date results. We currently expect this pattern to continue, but to have a less significant effect on our cash flow in future periods due to expected results of operations that are closer to break-even than what we have historically experienced. We currently expect our effective income tax rate in future years to be less than the statutory rate due primarily to the availability of Section 45 refined coal tax credits. These tax credits relate to the coal cleaning facilities that we currently own and operate. The tax credits are expected to reduce required cash payments for estimated taxes during the year they are earned.

As of June 30, 2009, we had approximately $10.0 million of unrecognized tax benefits, net of an $11.1 million refund claim related to an uncertain tax position. We have recorded approximately $22.7 million of gross unrecognized income tax benefits which would affect the fiscal 2009 effective tax rate if released into income. We recognize accrued

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interest and potential penalties related to all income tax liabilities, including unrecognized income tax benefits, in income tax expense. During 2009, we released approximately $2.8 million of interest and penalties and as of June 30, 2009, approximately $4.2 million was accrued for the payment of interest and penalties. Changes to the estimated liability for unrecognized income tax benefits during 2009 were primarily the result of settlement of the IRS audit for the years 2003 and 2004.

The calculation of tax liabilities involves uncertainties in the application of complex tax regulations in multiple jurisdictions. For example, we are currently under audit by the IRS for the years 2005 and 2006 and have open tax periods subject to examination by both federal and state taxing authorities for the years 2005 through 2008. We recognize potential liabilities for anticipated tax audit issues in the U.S. and state tax jurisdictions based on estimates of whether, and the extent to which, additional taxes and interest will be due. If events occur and the payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when it is determined the liabilities are no longer probable or necessary. If the estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result. It is reasonably possible that the amount of our unrecognized income tax benefits will change significantly within the next 12 months. These changes could be the result of ongoing tax audits or the settlement of outstanding audit issues. However, due to the number of years under audit and the matters being examined, at the current time, an estimate of the range of reasonably possible outcomes cannot be made, beyond amounts currently accrued.

As discussed previously, cash payments for income taxes are reduced for tax deductions resulting from disqualifying dispositions of incentive stock options and from the exercise of non-qualified stock options, which amounts were not material in 2008 or 2009. Option exercise activity is primarily dependent on our stock price which is not predictable, and likewise, it is not possible to estimate what tax benefits may be realized from future option exercises.

Summary of Future Cash Requirements. Significant future cash needs, beyond operational working capital requirements, including interest payments on long-term debt and income tax payments, are currently expected to consist primarily of capital expenditures and repayment of amounts outstanding under our revolving credit arrangement.

Potential Liquidity Risks and Management’s Plans. Operational improvements, including reduced headcount, reduced or eliminated advertising and marketing programs, the ongoing realignment of manufacturing capacity with projections of future requirements, reduced plant overhead expenses and reduced fuel costs, are currently expected to partially offset the impact of reduced revenues on our cash flow from operations. However, the anticipated increase in cash flow from these actions, along with the cash flow currently being generated, may not provide sufficient funds for operations and for the retirement of all of our maturing debt, including the September 2009 revolving credit obligations. Accordingly, management’s plans to increase liquidity and minimize the risk of noncompliance with debt covenants also include the following potential actions: the delay, postponement or cancellation of certain planned capital expenditures; the sale of assets; obtaining an ABL facility; refinancing debt obligations or exchanging debt; the sale of equity, the proceeds of which would be used to repay long-term debt; additional amendments to our senior secured credit agreement; and the restructuring of our capitalization.

Our $60.0 million revolving credit arrangement expires in September 2009. During fiscal 2008 and through the current time, we have used this revolver for short-term working capital needs and for stand-by letters of credit, which at June 30, 2009 totaled $9.4 million. We currently expect to continue to use the revolver for seasonal working capital needs and for letters of credit until September 2009. A current high-priority action for us is to obtain an ABL facility, which will allow us to repay any remaining obligations under the revolving credit facility and to have accessible funds to meet seasonal and temporary financing requirements in future periods. We currently expect to finalize an ABL facility during August 2009; however, an agreement has not yet been consummated.

Most of our potential debt covenant compliance risk relates to compliance with certain leverage and fixed charge coverage ratios in future periods. The potential risk is primarily a result of declining EBITDA combined with increased levels of capital expenditures. EBITDA consists of net income adjusted for net interest expense, income taxes, depreciation and amortization and goodwill and other impairments, as these items are defined in our senior secured debt agreement. Because our net income declined significantly during fiscal 2008 and through June 30, 2009, EBITDA has also declined significantly. Our trailing twelve months’ (TTM) EBITDA, which is used to calculate many of the required leverage and fixed charge coverage ratios, is not expected to significantly improve during the remainder of fiscal 2009 and early fiscal 2010, primarily due to the depressed new housing and residential remodeling markets, decreased CCP revenues and the challenges of operating our coal cleaning facilities in a difficult coal market.

The three primary debt covenant ratios with which we must comply are: i) a total leverage ratio of 3.75:1 as of September 30, 2009, then 3.5:1 from December 31, 2009 through the maturity date (total leverage ratio); ii) a maximum ratio of consolidated funded indebtedness minus subordinated indebtedness to EBITDA of 2.5:1 (senior leverage ratio); and iii) a minimum ratio of EBITDA plus rent payments (EBITDAR), less certain capital expenditures and taxes for the four preceding

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fiscal quarters, to scheduled rent payments and payments of principal and interest on all indebtedness for the next four fiscal quarters of 1:1 as of June 30, 2009, 1.25:1 for September 30, 2009 and December 31, 2009, then 1:1 for periods ending through September 30, 2010, and 1.25:1 for periods ending after September 30, 2010 (fixed charge coverage ratio). At the time an ABL facility is finalized, the total leverage ratio requirements noted above will change to 5.25:1 as of September 30, 2009, 5.50:1 as of December 31, 2009, 5.75:1 as of March 31, 2010 and June 30, 2010, 5.25:1 as of September 30, 2010, 5:1 as of December 31, 2010, and 4.75:1 as of March 31, 2011. In connection with the most recent amendment to the credit facility in June 2009, the lenders agreed to waive the total leverage ratio requirement as of June 30, 2009.

The following table summarizes the calculations of each of these three key ratios for the dates indicated. All components have been calculated based on the definitions of such items in our senior secured credit facility.

(in millions)	September 30, 2007			September 30, 2008			June 30, 2009
Senior debt, including revolver (A)	$	210.0		$	200.0		$	227.5
Convertible debt (B)		332.5			332.5			303.2
Total long-term debt, including current portion		542.5			532.5			530.7
Stand-by letters of credit		6.0			9.7			9.4
Other long-term obligations		—			9.7			9.0
Total indebtedness, as defined (C)	$	548.5		$	551.9		$	549.1
TTM EBITDA, as defined (D)	$	301.2		$	142.1		$	118.3
Total leverage ratio (C ÷ D)		1.82			3.88			4.64
Senior leverage ratio ((C – B) ÷ D)		0.72			1.54			2.08
TTM EBITDA	$	301.2		$	142.1		$	118.3
Rent expense		34.2			35.4			36.7
Less certain capital expenditures		(55.0	)		(40.1	)		(27.7	)
Income taxes		(60.9	)		(1.4	)		82.3
TTM EBITDAR, as defined (E)	$	219.5		$	136.0		$	209.6
Future twelve months’ scheduled interest Payments	$	24.4		$	31.7		$	44.8
Future twelve months’ scheduled repayments of long-term debt and other obligations		—			1.0			31.0
Future twelve months’ scheduled rent Payments		38.5			36.0			37.7
Future fixed charges, as defined (F)	$	62.9		$	68.7		$	113.5
Fixed charge coverage ratio (E ÷ F)		3.49			1.98			1.85

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

(in thousands)	September 30, 2007		September 30, 2008			June 30, 2009
Net income (loss)	$	20.1	$	(169.7	)	$	(579.9	)
Net interest expense		31.1		23.8			33.4
Income taxes, as defined		69.8		2.2			(82.3	)
Depreciation and amortization, as defined		82.2		74.2			75.7
Impairments, as defined		98.0		211.6			671.4
TTM EBITDA, as defined (D)	$	301.2	$	142.1		$	118.3

Before a potential debt covenant violation becomes imminent, we would take several potential actions, including all of the steps discussed above, as well as negotiate with the holders of our senior secured debt with a view to obtaining a waiver or an amendment to the debt agreement (such as we did in June 2009). If our efforts to increase EBITDA were unsuccessful and we failed to obtain a waiver or amendment to our debt agreement, a breach of our covenants could result in a default, in which event our lenders could elect to declare all amounts outstanding to be immediately due and payable. If we were not able to repay our obligations if they were accelerated, the lenders could foreclose on our assets.

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As noted previously, any amount outstanding under our revolving credit arrangement (currently $25.0 million) is required to be repaid in September 2009. Our first lien term loan in the amount of $197.5 million is required to be repaid in February 2011 and April 2011, unless an ABL facility is finalized, which will require us to repay $25.0 million of the term loan prior to December 31, 2009. Our 2.50% and 14.75% convertible senior subordinated notes totaling $148.3 million as of June 30, 2009 are repayable in 2014. The holders of the 2.875% convertible senior subordinated notes due June 2016, totaling $91.6 million (reduced to $71.8 million subsequent to June 30, 2009), have the right to require us to repurchase all or a portion of those notes on June 1, 2011. Also, the holders of the 16% convertible senior subordinated notes due June 2016, totaling $63.3 million (reduced to $48.3 million subsequent to June 30, 2009), have the right to require us to repurchase all or a portion of those notes on June 1, 2012. We currently believe it is likely that the holders of the 2.875% notes will require us to repurchase those notes on June 1, 2011 and it is possible that the holders of the 16% notes will require us to repurchase those notes on June 1, 2012.

During 2009, a decrease in the credit rating on our debt was announced; however, there was no direct effect of this action on the variable interest rate applicable to our senior secured credit facility or on our debt covenant compliance.

Legal Matters

We have ongoing litigation and asserted claims which have been incurred during the normal course of business. Reference is made to Note 10 to the consolidated financial statements for a description of our accounting for legal costs and for other information about legal matters.

Recent Accounting Pronouncements

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to financial market risks, primarily related to changes in interest rates and certain foreign currencies. We do not use derivative financial instruments for speculative or trading purposes. We have entered into certain hedge transactions in the past, primarily to limit our variable interest rate exposure, but there are no such hedges outstanding as of June 30, 2009. The Blue Flint joint venture has derivatives in place related to variable interest rates and commodities.

As described in more detail in Note 6 to the consolidated financial statements, our senior debt, which totaled $227.5 million as of June 30, 2009, bears interest at a variable rate. Accordingly, assuming no change in the amount of senior debt outstanding except for repayment of outstanding amounts under the revolving credit arrangement prior to the end of fiscal 2009, a change in the interest rate of 1% would change our interest expense by approximately $2.0 million during the 12 months ending June 30, 2010.

We have limited operations in foreign jurisdictions. However, one of our joint ventures with Evonik Industries AG owns a hydrogen peroxide business located in South Korea. This joint venture has € 25.0 million (approximately $35.1 million at June 30, 2009) of long-term debt along with other obligations denominated in Euros. Because the debt and other obligations are repayable in a currency different from the Korean Won, the joint venture’s functional currency, they must be remeasured into Korean Won at the end of each reporting period based on period end exchange rates, with the impact recorded in earnings. As a result, the joint venture is subject to foreign currency exchange rate movements. During the nine months ended June 30, 2009, the joint venture recorded foreign currency exchange gains of which $0.2 million has been included in our results of operations. As of June 30, 2009, a change in the relationship between the Euro and Korean Won of 10% would result in a gain or loss of approximately $1.8 million for us.

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures – We maintain disclosure controls and procedures that are designed to ensure that information we are required to disclose in the reports that we file or submit under the Securities Exchange Act of 1934 (the Exchange Act), such as this Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified by SEC rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including the Chief Executive Officer (CEO) and the Chief Financial Officer (CFO), to allow timely decisions regarding required disclosure.

Our management evaluated, with the participation of our CEO and CFO, the effectiveness of our disclosure controls and procedures as of June 30, 2009, pursuant to paragraph (b) of Rules 13a-15 and 15d-15 under the Exchange Act. This

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evaluation included a review of the controls’ objectives and design, the operation of the controls, and the effect of the controls on the information presented in this Quarterly Report. Our management, including the CEO and CFO, do not expect that disclosure controls can or will prevent or detect all errors and all fraud, if any. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Our disclosure controls and procedures are designed to provide such reasonable assurance of achieving their objectives. Also, the projection of any evaluation of the disclosure controls and procedures to future periods is subject to the risk that the disclosure controls and procedures may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Based on their review and evaluation, and subject to the inherent limitations described above, our CEO and CFO have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were effective as of June 30, 2009 at the above-described reasonable assurance level.

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

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

There has been no change in our internal control over financial reporting during the quarter ended June 30, 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

See “Legal Matters”in Note 10 to the consolidated financial statements for a description of current legal proceedings.

ITEM 1A. RISK FACTORS

Risks relating to our business and our common stock are described in Item 1A of our Form 10-K. The following information supplements the information contained therein.

The profitability of Headwaters Energy Service Corp. (HES) depends upon the operational success of a new business.

Because of the end of HES’s legacy alternative fuel licensing and chemical reagent sales business as of December 31, 2007, HES began development of its new coal cleaning business. By December 2008, HES had acquired or completed construction on eleven coal cleaning facilities. To successfully operate its facilities, HES must produce and market a quality fuel, addressing operational issues including feedstock availability and cost, construction and operability of equipment, successful separation of minerals including ash, sulfur, and mercury, product moisture and Btu content, overall costs of operations, as well as marketing and sales of the finished product, which is generally of smaller particle size (called fines) and which may be more difficult to sell than run-of-mine coal. This is a new business for HES, and we have experienced difficulty in receiving or extracting our full requirements of feedstock at some facilities and softness in the price of our products. The profitability of HES depends on the ability of HES to increase production and sales of cleaned coal. If these facilities operate at low production levels or cannot produce fuel satisfactory to customers, revenues will be materially adversely affected.

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We are involved in litigation and claims for which we incur significant costs and are exposed to significant liability.

We are a party to some significant legal proceedings and are subject to potential claims regarding operation of our business. These proceedings will require that we incur substantial costs, including attorneys’ fees, managerial time and other personnel resources and costs in pursuing resolution, and adverse resolution of these proceedings could hurt our reputation. With respect to the cases referred to in Note 10 to the consolidated financial statements, the following amount of damages is being sought by the counter parties:

Boynton: Boynton has been an ongoing litigation since 2000 with both trial court and appellate court proceedings. Boynton originally sought declaratory relief as well as compensatory damages in the approximate amount of $43.0 million plus prejudgment interest and punitive damages. On June 22, 2009, a jury reached a verdict in a trial in the amount of $8.7 million for eight named plaintiffs representing a portion of the class members. The jury also reached a verdict on certain liability issues and an advisory verdict on damages of up to $12.7 million on behalf of the balance of the class members. We expect that there will be further trial court proceedings to resolve an equitable claim as to all members of the class and the remaining legal issues as to the unnamed class members. It is not expected that a final judgment will be entered by the trial court until all issues are concluded in the coming months. Once entered, the parties may seek relief from judgment by motion to the trial court and by appeal from the final judgment.

Ecologica Carmelo: Carmelo seeks compensatory damages in the approximate amount of $12.3 million.

Mainland Laboratory: Mainland seeks compensatory damages in the approximate amount of $23.0 million, as well as an enhancement of any damages award based on the alleged willful infringement by HRI of its patent.

Coalco Corporation: Coalco seeks compensatory damages in the approximate amount of $23.5 million.

J. Hall Inc.: Plaintiffs seek compensatory damages in the approximate amount of $0.7 million.

Fentress Families Trust: VFL Technology Corporation (VFL), a subsidiary acquired by HRI in 2004, provided fly ash management and disposal services to Virginia Electric and Power Company. A large group of homeowners living in the City of Chesapeake, Virginia, have prepared a complaint filed in the State of Virginia Circuit Court naming as defendants Dominion Energy and certain of its affiliates, including Virginia Electric and Power Company, certain persons associated with the Battlefield Golf Course, including the owner, developer, and contractors, and others, including VFL and Headwaters. The complaint alleges that fly ash used to construct the golf course has contaminated area ground water. The complaint alleges multiple causes of action and seeks unspecified damages and injunctive relief. Neither VFL nor Headwaters has been served with the complaint. The matter is still at an early stage of assessment.

We have ongoing litigation and claims incurred during the normal course of business, including the items referred to above. We intend to vigorously defend and/or pursue our rights in these actions. We do not currently believe that the outcome of these actions will have a material adverse effect on our operations, cash flows or financial position; however, it is possible that a change in the estimates of probable liability could occur, and the change could be significant.

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

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

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

None.

ITEM 5. OTHER INFORMATION

None.

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ITEM 6. EXHIBITS

The following exhibits are included herein:

12	Computation of ratio of earnings to combined fixed charges and preferred stock dividends	*
31.1	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer	*
31.2	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer	*
32	Section 1350 Certifications of Chief Executive Officer and Chief Financial Officer	*

* Filed herewith.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	HEADWATERS INCORPORATED
Date: August 5, 2009	By:	/s/    Kirk A. Benson
		Kirk A. Benson, Chief Executive Officer
		(Principal Executive Officer)
Date: August 5, 2009	By:	/s/    Steven G. Stewart
		Steven G. Stewart, Chief Financial Officer
		(Principal Financial Officer)

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