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Article by DailyStocks_admin    (01-29-08 04:54 AM)

The Daily Magic Formula Stock for 01/28/2008 is Headwaters Inc. According to the Magic Formula Investing Web Site, the ebit yield is 21% and the EBIT ROIC is 50-75 %.

Dailystocks.com only deals with facts, not biased journalism. What is a better way than to go to the SEC Filings? It's not exciting reading, but it makes you money. We cut and paste the important information from SEC filings for you to get started on your research on a specific company.


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BUSINESS OVERVIEW

General Development of Business

Headwaters Incorporated (“Headwaters”) is a diversified company providing products, technologies and services in three industries: construction materials, coal combustion products (“CCPs”) and alternative energy. Headwaters uses technology to differentiate itself from competitors and to create value in its businesses.

In the construction materials segment, Headwaters designs, manufactures, and sells architectural stone and resin-based exterior siding accessories (such as window shutters) and other products. Headwaters believes that many of its branded products have a leading market position. Revenue from Headwaters’ construction materials businesses are diversified geographically and also by market, including the new construction, remodeling and home improvement markets.

In the CCP segment, Headwaters is a nationwide leader in the management and marketing of CCPs, including fly ash used as a substitute for portland cement. Headwaters believes it is uniquely positioned to manufacture an array of building materials that use fly ash, such as block, stucco, and mortar. Headwaters’ CCP business is comprised of a nationwide storage and distribution network and revenue is diversified geographically and by market.

In the alternative energy segment, Headwaters is focused on reducing waste and increasing the value of energy feedstocks, primarily in the areas of low-value coal and oil. In coal, Headwaters owns and operates several coal cleaning facilities that remove rock, dirt, and other impurities from waste or other low-value coal, resulting in higher-value, marketable coal. Headwaters also licenses technology and sells reagents to the coal-based solid alternative fuel industry. 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 residual oil feedstocks into higher-value distillates that can be refined into gasoline, diesel and other products.

Headwaters’ Company History. Headwaters is incorporated in Delaware. Headwaters’ stock trades under the New York Stock Exchange symbol “HW.”

As used herein, “Headwaters,” “combined company,” “we,” “our” and “us” refer to Headwaters Incorporated and its consolidated subsidiaries, including Headwaters Energy Services Corp. and its subsidiaries; Headwaters Resources, Inc. and its subsidiaries; Headwaters Construction Materials, Inc. and its subsidiaries (including Eldorado Stone LLC and Tapco International Corporation and their subsidiaries and affiliates); Headwaters Heavy Oil, LLC; and Headwaters Technology Innovation, LLC; unless the context otherwise requires. As used in this report, “HES” refers to Headwaters Energy Services Corp., together with its consolidated subsidiaries and affiliates; “HRI” refers to Headwaters Resources, Inc. and its consolidated subsidiaries; “HCM” refers to Headwaters Construction Materials, Inc., together with its consolidated subsidiaries and affiliates (including “Eldorado”, which refers to Eldorado Stone LLC and its subsidiaries and affiliates; and “Tapco,” which refers to Tapco International Corporation and its subsidiaries); and “HTI” refers to Headwaters Technology Innovation Group, Inc. unless the context otherwise requires.

Construction Materials

Headwaters Construction Materials (“HCM”) produces construction materials that minimize waste, conserve natural resources, and/or use less energy in manufacturing or application. We operate leading businesses in manufactured architectural stone products and siding accessories (such as window shutters, gable vents, mounting blocks, simulated wood shake siding and composite roofing) and professional tools used in exterior residential remodeling and construction. We plan to expand the business organically and through small strategic acquisitions. Our manufactured stone and building accessories products have a national presence in commercial, residential and remodeling markets. HCM is also a leading supplier of concrete blocks and specialty blocks in Texas. We believe our traditional building products and new product offerings position HCM to participate in significant growth after the end of the current downturn in residential construction. We participate in two segments within the siding industry, manufactured stone and specialty siding, both of which we believe have growth potential in periods when the residential construction market improves. The construction markets are seasonal and the majority of our construction materials sales are in the residential construction market, which tends to slow down in the winter months.

Principal Products and their Markets

Manufactured Stone . Under the Eldorado Stone ® , StoneCraft, and Dutch Quality Stone brands, we offer a wide variety of high-quality, hand-made manufactured stone products to meet a variety of design needs. Our manufactured architectural stone siding incorporates several key features important to a successful siding product, including: high aesthetic quality, ease of installation, durability, low maintenance, reasonable cost and widespread availability. The Eldorado Stone product line has been designed and is manufactured to be one of the most realistic architectural stone products in the world. Headwaters’ architectural stone siding is a lightweight, adhered siding product used by national, regional and local architectural firms, real estate developers, contractors, builders and homeowners. Our stone products are used in construction projects ranging from large-scale residential housing developments and commercial projects to do-it-yourself home improvement jobs. In addition to its use as a primary siding material, the Eldorado Stone product line is used in a variety of external and internal home applications such as walls, archways, fireplaces and landscaping. In 2006, we introduced an architectural brick veneer product. Headwaters believes that our focus on product quality, breadth and innovation, combined with a geographically diversified manufacturing platform, provides us with significant marketing advantages over traditional materials such as natural stone, brick or stucco.

Exterior Siding Accessories. We are a leading designer, manufacturer and marketer of resin-based siding accessories and professional tools used in exterior residential home improvement and construction under the Tapco brands. These products, which are either injection-molded or extruded, enhance the appearance of homes and include decorative window shutters, gable vents, and mounting blocks for exterior fixtures, roof ventilation, window and door trim products, specialty siding products, synthetic roofing tiles, and window well systems. Professional tools include portable cutting and shaping tools used by contractors, on-site, to fabricate customized aluminum shapes that complement the installation of exterior siding.

Brands include “Tapco Integrated Tool Systems,” “Mid-America Siding Components,” “Builders Edge,” “Atlantic Premium Shutters,” “Vantage,” “The Foundry,” “InSpire,” and “WellCraft.” We market our injection-molded building product accessories to retailers and mass merchandisers through our Builders Edge and Vantage brands and to the manufactured housing market through the MHP brand. In addition, we market tools through the Tapco brand, functional shutters and storm protection systems through the Atlantic Premium Shutters brand, specialty siding product through the Foundry brand, specialty roofing products through the InSpire brand, and window wells under the WellCraft brand.

These building products serve the needs of the siding, roofing, and window and door installation industries. Our injection-molded products are designed to enhance the exterior appearance of the home while delivering durability at a lower cost compared to similar aluminum, wood and plastic products while the functional shutters enhance the exterior appearance of the home and can be manufactured to meet certain hurricane codes.

Concrete Block. We are one of the largest manufacturers and sellers of concrete block in the Texas market, one of America’s largest block markets. Fly ash is used in the manufacturing process for concrete block, brick and foundation blocks. We also market mortar and stucco under the Best Masonry and Magna Wall ® brands.

Flexcrete . HCM, in conjunction with the CCP group, is commercializing a new commercial and residential building product called Flexcrete™. FlexCrete is an aerated concrete product with approximately 50% fly ash content. We expect FlexCrete will offer advantages for construction, including ease of use, physical strength, durability, energy efficiency, fire resistance and environmental sensitivity.

Manufacturing

Headwaters’ architectural stone brands are currently manufactured through a network of eight plants strategically situated in proximity to customers. These locations allow for a high level of customer service, shorter lead times and lower freight costs. We also have a production contract with a facility in Tijuana, Mexico.

We conduct manufacturing, distribution and sales operations for resin-based accessories and ancillary products through eight facilities, which total approximately 985,000 square feet. Manufacturing assets include more than 100 injection molding presses, almost all of which are automated through robotics or conveyor systems which has reduced cycle times and helped reduce waste. Any nonconforming plastic parts are reused as raw material, further minimizing waste.

We operate three of the most modern concrete block and brick manufacturing facilities in the industry. Our block and brick operations are located to provide coverage of all the key metropolitan areas in Texas.

Distribution

Architectural stone is distributed throughout the United States and Canada primarily on a wholesale basis through a network of distributors, including masonry and stone suppliers, roofing and siding materials distributors, fireplace suppliers and other contractor specialty stores. Distribution for Eldorado Stone branded products is conducted at its manufacturing facilities and at three distribution centers.

Resin-based accessories and our ancillary products are distributed throughout the United States and Canada through four primary distribution channels: one-step distributors that sell directly to contractors, two-step distributors that sell our products to lumberyards and one-step distributors, retail home centers/mass merchandisers, and manufactured housing.

We seek to be a leader in each meaningful distribution channel for our products by providing the broadest selection coupled with high levels of customer service.

Sales and Marketing

We have a small direct sales force for architectural stone products. This sales force works closely with architects and contractors to provide information concerning the attributes and ease of installation of its manufactured product and to promote market acceptance over traditional building materials.

Our resin-based products’ sales and marketing organization supports the one-step, two-step distribution, and retail channels through various networks of sales support that include almost 180 independent sales representatives and a small group of business development managers, regional sales managers and sales executives.

We maintain relationships with local contractors, professional builders, and other end-users by participating in over 2,000 local shows and seven national shows annually. Local shows, sponsored by local distributors, enable us to promote our products through hands-on comparisons to competing products. These shows enable us to receive useful feedback from local contractors, which leads to new product ideas, as well as significant goodwill within the trade.

Major Customers

We have a large customer base for our construction products. Because primarily all of the one-and two-step distributors have multiple locations and each individual location generally has autonomy to stock various products from different suppliers, the number of ship-to locations is a better measure of the breadth of sales than is the total number of customers. In the residential home improvement and building products market, we have approximately 6,900 non-retail ship-to locations and approximately 8,900 retail ship-to locations for our products. Sales are broadly diversified across customers and ship-to locations. For fiscal 2007, three large customers together represented approximately 29% of total sales of our resin-based accessory products. None of our other construction materials lines had a customer representing over 10% of its product sales.

Sources of Available Raw Materials

We purchase cement, sand and aggregates as primary raw materials for our concrete-based products. We do not have long-term contracts for the supply of these materials. Worldwide demand for these materials has risen in recent years, as well as our costs to purchase raw materials. However, we have not suffered from any long-term shortages and believe that supplies will be adequate in the future.

The raw materials purchased for resin-based products include polypropylene and styrene pellets, and PVC. Polypropylene and styrene are purchased primarily from single (separate) suppliers. From time to time, prices for some of the raw materials used in production/assembly processes fluctuate significantly. Although we do not have any contracts with suppliers and purchase supplies on a purchase order basis, we occasionally make volume purchases of materials to lock in pricing.

Coal Combustion Products

Principal Products and their Markets

We sell coal combustion products (“CCPs”), such as fly ash and bottom ash, which are created when coal is burned. CCPs have traditionally been an environmental and economic burden for power generators but, when properly managed, can be valuable products. We supply CCPs as a replacement for portland cement in a variety of concrete infrastructure projects and building products. We are currently the largest manager and marketer of CCPs in the United States and also manage and market CCPs in Canada and Puerto Rico. We have a number of long-term exclusive management contracts with coal-fueled electric generating utilities throughout the United States and provide CCP management services at more than 110 locations.

Utilities produce CCPs year-round, including in the winter when demand for electricity increases in many regions. In comparison, sales of CCPs and construction materials produced using CCPs are keyed to construction market demands that tend to follow national trends in construction with predictable increases during temperate seasons. CCPs must be stored, usually in terminals, during the off-peak sales periods as well as transported to where they are needed for use in construction. In part because of the cost of transportation, the market for CCPs used in construction is generally regional, although we ship products significant distances to states such as California and Florida that have limited coal-fueled electric utilities producing high quality CCPs. We enjoy advantages in both logistics and sales from our status as the largest manager and marketer of CCPs in the United States. We maintain 26 stand-alone CCP distribution terminals across North America, as well as approximately 100 plant-site supply facilities. We own or lease approximately 1,670 rail cars and more than 200 trucks, and also contract with other carriers so that we can meet our transportation needs for the marketing and disposal of CCPs. In addition, we have more than 50 area managers and technical sales representatives nationwide to manage CCP customer relations.

The benefits of CCP use in construction applications include improved product performance, cost savings and positive environmental impact. Fly ash improves both the chemical and physical performance of concrete, decreasing permeability and enhancing durability. When fly ash is used in concrete it also provides environmental benefits. In addition to conserving landfill space, fly ash usage conserves energy and reduces green house gas emissions. According to the U.S. Environmental Protection Agency (EPA), one ton of fly ash used as a replacement for portland cement eliminates approximately one ton of carbon dioxide emissions associated with cement production. The value of utilizing fly ash in concrete has been recognized by numerous federal agencies, including the United States Department of Energy (DOE) and the EPA, which has issued comprehensive procurement guidelines directing federal agencies to utilize fly ash. The EPA has also created the Coal Combustion Products Partnership (“C2P2”) to promote national CCP utilization. Almost all states specify or recommend the use of fly ash in state and federal transportation projects.

Higher-quality fly ash and other high-value CCPs have the greatest value because of the wide variety of higher-margin commercial uses. The quality of fly ash produced by the combustion process at coal-fueled facilities varies widely and is affected by the type of coal feedstock used and the boilers maintained by the utilities. We assist our utility clients in their efforts to improve the production of high-value CCPs at their facilities. A quality control system ensures that customers have a specific quality of CCPs for various applications while our investment in transportation equipment and terminal facilities provides reliability of supply.

Sales and Marketing

We support our CCP marketing and sales program by focusing on customer desires for quality and reliability. Marketing efforts emphasize the performance value of CCPs, as well as the attendant environmental benefits. We undertake a variety of marketing activities to increase fly ash sales. These activities include professional outreach, technical publications, relationships with industry organizations, and involvement in legislative initiatives leading to greater use of CCPs. In addition, we have developed several specialty products that increase market penetration of CCPs and name recognition for our products for road bases, structural fills, industrial fillers and agricultural applications.

New Technologies for CCP Utilization . In an effort to maximize the percentage of CCPs marketed to end users and to minimize the amount of materials disposed of in landfills, our research and development activities focus on expanding the use of CCPs by developing new products that utilize high volumes of CCPs. For example, through these research and development activities, we developed two products to utilize the fly ash generated at fluidized bed combustion (FBC) power plants, which is generally unsuitable for use in traditional concrete applications. Stabil-Mix, a mixture of fly ash and lime used primarily for roadbed stabilization, can be custom blended for optimum results in varying soil conditions. Pozzalime takes advantage of the lower SO3 and free lime content of some sources of FBC ash to create a product ideally suited for use as a cement replacement in the manufacture of concrete masonry units.

Technologies to Improve Fly Ash Quality . We have also developed technologies that maintain or improve the quality of CCPs, further expanding and enhancing their marketability. Utilities are switching fuel sources, changing boiler operations and introducing activated carbon and ammonia into the exhaust gas stream in an effort to decrease costs and/or to meet increasingly stringent emissions control regulations. All of these factors can have a negative effect on fly ash quality, including an increase in the amount of unburned carbon in fly ash and the presence of ammonia slip. We are attempting to address these challenges with the development and/or commercialization of two technologies: carbon fixation, which pre-treats unburned carbon particles in fly ash in order to minimize the particles’ adverse effects, and ammonia slip mitigation, which counteracts the impact of ammonia contaminants in fly ash.

Sources of Available Raw Materials

Coal is the largest indigenous fossil fuel resource in the United States. The DOE estimates that in 2006 annual coal production was in excess of 1.11 billion tons. About 92% of all coal consumed in the United States was for electrical power generation. The DOE further estimates that 2006 U.S. coal consumption for electrical power generation was slightly more than one billion tons. Coal serves as a primary resource for baseline electricity production in the United States and is used to produce approximately half of the electricity generated in the United States. The combustion of coal results in a high percentage of residual materials which serve as the “raw material” for the CCP industry. According to the American Coal Ash Association, in 2006, about 54.2 million tons of CCPs were beneficially used in the United States of the approximately 124.8 million tons generated. This provides for opportunities for continuing increases in CCP utilization. As long as a significant amount of electricity in this country is generated from coal-fueled generation, we believe that there will be significant supplies of CCP raw materials. However, as Clean Air Act rules are implemented, the efforts of coal-fueled electric power producers to comply with tighter emissions requirements may have an adverse effect on supplies of fly ash suitable for use as a substitute for portland cement (see “Regulation”).

Alternative Energy

In alternative energy, Headwaters is focused on reducing waste and increasing the value of energy feedstocks, primarily in the areas of low-value coal and oil. Headwaters Energy Services Corp. (“HES”) uses coal cleaning processes that upgrade low value or waste coal by separating ash from the carbon. The resultant coal product is lower in ash, including sulfur, mercury and other impurities, and higher in Btu value. We also develop and commercialize technologies to convert or upgrade fossil fuels into higher-value products, including direct coal liquefaction, the conversion of gas-to-liquid fuels, and heavy oil upgrading. Additionally, HES owns 51% and operates a 50 million gallon per year corn-to-ethanol facility near Underwood, North Dakota.

The legacy business of HES, ending as of January 2008, has been, we believe, the market leader in enhancing the value of coal used in power generation through licensing technologies and selling chemical reagents that convert coal into a solid alternative fuel. This solid alternative fuel has qualified for tax credits under Section 45K of the Internal Revenue Code based upon the Btu content of the alternative fuel produced and sold. The sale of qualified alternative fuel has enabled facility owners who comply with certain statutory and regulatory requirements to claim federal tax credits under Section 45K, which expires on December 31, 2007.

Principal Products and their Markets

We own and develop coal cleaning facilities. We are currently operating three coal cleaning facilities and nine additional coal cleaning facilities are in various stages of acquisition, planning, development, and construction. We estimate that we have access to 240 million tons of waste and low value coal material which we have access to under contract in various coal regions around the country. We are actively negotiating for the rights to process another 335 million tons. These facilities will provide HES with an opportunity to reduce sulfur oxides (SOx), nitrogen oxides (NOx) and mercury emissions from coal, greatly increasing coal’s cleanliness and usability. The cleaned coal product is comparable to high value run of mine coal products. The cleaned coal is expected to be sold primarily to electric power plants, but can also be sold to other industrial users of coal, and in certain cases, as a metallurgical grade coal to coke producers. We anticipate that the sale of the cleaned coal product will generate a refined coal tax credit for Headwaters under section 45 of the Internal Revenue Code in circumstances where the requirements of section 45 can be met. To date, sales of the cleaned coal product have been modest, but are expected to increase substantially in 2008 as additional production facilities begin operation.

In 2006 Headwaters entered into a joint venture with Great River Energy (“GRE”) of Elk River, Minnesota to develop and construct a 50 million gallon-per-year ethanol production facility. The joint venture is named Blue Flint Ethanol, LLC and is owned 51% by HES and 49% by GRE (however both partners have equal voting rights and control over the joint venture). The Blue Flint production facility is located at the GRE Coal Creek pulverized coal electric power station near Underwood, North Dakota. Coal Creek station supplies steam, water and other services to Blue Flint. HES operates the facility. The facility began ethanol production in February 2007. Blue Flint purchases corn as the primary feedstock for the operation and sells ethanol and distiller’s grain products. Blue Flint customers use ethanol as a blending feedstock for gasoline and distiller’s grain as feed for livestock.

HES began its business with the development and commercialization of technologies that interact with coal-based feedstocks to produce a solid alternative fuel intended to be eligible for Section 45K (formerly Section 29) tax credits. Since the tax credits will expire at the end of 2007 and have been subject to phase out as a result of higher oil prices (see “Risk Factors”), our strategy has been to develop new alternative fuel business by taking advantage of our expertise.

New Business Opportunities

As part of our alternative energy strategy, we are developing the following businesses and technologies:

Heavy Oil Upgrading Technology . We hold an exclusive, worldwide license to develop, market and sublicense a unique heavy oil upgrading technology for the catalytic hydrocracking of heavy residual oils such as petroleum vacuum residue (so-called “bottom of the barrel”) and tar sand bitumen into lighter, more valuable petroleum materials. The proprietary HCAT™ process uses a highly active, molecular-scale catalyst to efficiently convert heavy oils, including the asphaltenic components, which are generally considered the most difficult to process. In early 2006, we announced the completion of the first commercial scale demonstration of the heavy oil upgrading technology at a large commercial refinery. Later in 2006, we completed a second refinery test of this technology. In 2007 we signed an agreement to sell the HCAT catalyst precursor material and license the associated process to a petroleum refiner, subject to the successful completion of its own commercial trial. In 2008, we plan to continue discussions with operators of several heavy oil upgrading facilities (in the U.S. and overseas) to explore how the addition of this technology to their existing refineries could increase product yields and reduce downtime caused by equipment fouling with minimal modifications to the existing facilities.

Hydrogen Peroxide . In September 2004, we entered into a joint venture with Evonik Industries (formerly Degussa AG), located in Essen, Germany, to develop and commercialize a process for the direct synthesis of hydrogen peroxide, or H 2 O 2 . The venture aims to develop or invest in large facilities to produce low-cost hydrogen peroxide for chemical intermediates. High-volume producers will be able to use the H 2 O 2 from these facilities to produce intermediates such as propylene oxide (PO). Subject to terms and conditions of the agreement, the joint venture is responsible for development of manufacturing facilities. In October 2005, the joint venture announced the success of pilot plant operations. In October 2007, a demonstration plant in Germany was completed and began startup operations. Demonstration plant operations are anticipated to be completed in early 2008. This demonstration plant is intended to provide performance data relative to large scale operations, a prerequisite for engineering a commercial scale H 2 O 2 project. In September 2006, we and Evonik acquired a hydrogen peroxide plant in Korea to provide hydrogen peroxide to SKC Chemicals for use in the manufacture of PO. The joint venture plans to expand the Korea facility to ultimately demonstrate the direct synthesis of hydrogen peroxide technology on a commercial scale. The joint venture is developing plans and exploring markets to build additional hydrogen peroxide production facilities in other strategic locations to help meet the expected world-wide growth in demand for H 2 O 2 as a chemical intermediate.

Coal Liquefaction . We have technologies for producing liquid fuels from coal. One of these technologies was evaluated during 2005 in a commercial pre-feasibility study commissioned by Oil India Limited, a Government of India enterprise. In October 2007 Headwaters announced that Oil India has begun a 16 month second phase of its feasibility analysis. Oil India is a public sector company engaged in energy services in the Assam Region of northeastern India, an area rich in natural resources but distant from established oil refining operations. HES believes that its direct coal liquefaction (“DCL”) technology may assist Oil India in converting the Assam region’s abundant and soluble coal into transportation fuels. The technology involved encompasses some of the same elements that the Shenhua Group, China’s largest coal company, licensed from an HES affiliate in 2004 for a DCL project in Majiata, China. We have entered into agreements with the government of the Philippines and with a private company in China, for feasibility and pilot plant studies related to site-specific applications of our coal-to-liquids technologies.

In 2007 HES announced a joint venture with Great River Energy (GRE) and The North American Coal Corporation (NAC) to investigate the potential and to perform a pre-feasibility study for a coal-to-liquid plant located at the NAC Falkirk Coal Company near Underwood, North Dakota. The partners have formed American Lignite Energy (ALE) to pursue this project. Matching funds from the state of North Dakota in the amount of $10 million dollars have been secured by ALE. Up to $1.7 million may be used by ALE in the performance of the pre-feasibility work for the project. The remaining funds may be used to pursue project engineering should a decision be made to continue work following a positive economic evaluation in the first quarter of 2008 calendar year.

CEO BACKGROUND

Steven G. Stewart was our Chief Financial Officer from 1998 through 2005. Since 2005, Mr. Stewart has acted in several advisory roles for Headwaters. Effective September 4, 2007, Mr. Stewart was reappointed as our Chief Financial Officer. From May 1973 through July 1998, Mr. Stewart worked for several “Big Eight” international accounting firms in numerous management capacities, including 13 years as a partner, with the firms of Ernst & Young, Touche Ross and PricewaterhouseCoopers. During this time, Mr. Stewart also served as the Salt Lake City office Director of High Technology and Entrepreneurial Services, the office Director of Recruiting and the office Director of Accounting and Auditing Services. Mr. Stewart is a board member and chairman of the audit committee of BSD Medical Corporation. Mr. Stewart is a Certified Public Accountant and received his B.S. degree from Brigham Young University.



Harlan M. Hatfield has served as Corporate Counsel since October 1996, as Vice President and General Counsel since July 1998 and as Secretary since July 1999. His activities with us have included the development of energy projects, intellectual property, licensing, strategic business acquisitions, and debt and equity financings. As General Counsel he oversees the legal staff and outside legal counsel, litigation, regulatory issues, contracts and other legal matters. Prior to his employment with us, he was in private practice at the Seattle law firm of Oles, Morrison and Rinker for more than nine years where he was a partner. Mr. Hatfield obtained a B.A. degree in Public Policy from Brigham Young University in 1984 and a Juris Doctorate from the University of Minnesota in 1987.



Kenneth R. Frailey joined us in August 1998 as Vice President of Operations, after having been employed by Kennecott Corporation and General Electric for a total of 20 years. In February 2003, Mr. Frailey was appointed President of Headwaters Energy Services. Mr. Frailey’s responsibilities include all aspects of the Headwaters Energy Services business, including coal cleaning, Section 45 refined coal tax credits, bio-fuels, coal-to-liquids and synthetic fuels, along with any associated technology development and intellectual property protection and management. Mr. Frailey has experience and expertise in mining, electrical power generation and energy fuels covering a wide variety of managerial assignments in a plant operating environment, business development and engineering. Mr. Frailey has leadership experience in plant technological improvements, plant optimization and profitability of existing operations as well as bringing start-up projects to full capacity. Mr. Frailey received his B.S. degree in Electrical Engineering from the University of Utah in 1979.

William H. Gehrmann, III was appointed President of Headwaters Resources, Inc. in October 2004. Mr. Gehrmann has been with Headwaters Resources and its predecessors for more than 20 years and was appointed Senior Vice President, Operations in 2004 and was Senior Vice President, Southern Region for the previous five years. During his time with Headwaters Resources, Mr. Gehrmann has been responsible for the development of new products utilizing coal combustion products, the construction and operation of hazardous and non-hazardous waste landfills, and the design and operation of material handling systems. Mr. Gehrmann has worked in the coal combustion product industry since 1985 where he has received a patent, authored numerous technical papers, and developed new products utilizing CCPs. Mr. Gehrmann graduated from the University of Texas at Austin in 1984 with a B.S. degree in Architectural Engineering, with specializations in structural engineering and construction management.



John N. Lawless, III currently serves as President of Headwaters’ Construction Materials, Inc. (HCM), a position he assumed in 2007. Previously, Mr. Lawless was the President and Chief Executive Officer of Tapco International Corporation (Tapco), the position he held when we acquired Tapco in September 2004. Mr. Lawless joined Tapco in 1989 and served as Vice President, Marketing and Operations, and Executive Vice President, before being appointed President in 1998. Prior to 1989, Mr. Lawless was employed by Comerica Bank in Detroit as a Commercial Lender. Mr. Lawless received his B.S. degree in Economics from Kalamazoo College in 1983 and his MBA from the University of Notre Dame in 1985.

SHARE OWNERSHIP


(1) The address of each director and officer is c/o Headwaters Incorporated, 10653 South River Front Parkway, Suite 300, South Jordan, Utah 84095.


(2) The persons named in this table have sole voting and investment power with respect to all shares of common stock reflected as beneficially owned by them. A person is deemed to be the beneficial owner of securities that can be acquired by such person within sixty (60) days from January 2, 2008, and the total

outstanding shares used to calculate each beneficial owner’s percentage includes such shares. Beneficial ownership as reported does not include shares subject to option or conversion that are not exercisable within 60 days of January 2, 2008.


(3) Based on the statements on Schedule 13G filed with the SEC on February 2, 2007, EARNEST Partners has sole voting power over 1,376,108 shares and sole dispositive power over 5,150,942 shares.


(4) Based on the statements on Schedule 13G filed with the SEC on January 23, 2007, Barclays Global Investors has sole voting power over 2,153,571 shares and sole dispositive power over 2,314,037 shares.


(5) Consists of 968,453 shares owned by Mr. Benson and options to purchase 347,249 shares held by Mr. Benson exercisable within 60 days of January 2, 2008.


(6) Consists of 214,124 shares owned by Mr. Weller and options to purchase 36,000 shares held by Mr. Weller exercisable within 60 days of January 2, 2008.


(7) Consists of 11,800 shares owned by Mr. Herickhoff and options to purchase 95,500 shares held by Mr. Herickhoff exercisable within 60 days of January 2, 2008.


(8) Consists of options to purchase 72,000 shares held by Mr. Garn exercisable within 60 days of January 2, 2008.


(9) Consists of 10,000 shares owned by a partnership of which Mr. Christensen is a Trustee of the General Partner and options to purchase 60,000 shares held by Mr. Christensen exercisable within 60 days of January 2, 2008.


(10) Consists of 6,000 shares owned by Mr. Malquist and options to purchase 60,000 shares held by Mr. Malquist exercisable within 60 days of January 2, 2008.


(11) Consists of 2,700 shares owned by Mr. Dickinson and options to purchase 60,000 shares held by Mr. Dickinson exercisable within 60 days of January 2, 2008.


(12) Consists of 4,000 shares owned by Mr. Fisher and options to purchase 36,000 shares held by Mr. Fisher exercisable within 60 days of January 2, 2008.


(13) Consists of 13,503 shares owned by Mr. Frailey and options to purchase 149,133 shares held by Mr. Frailey exercisable within 60 days of January 2, 2008.


(14) Consists of 7,669 shares owned by Mr. Lawless and options to purchase 125,000 shares held by Mr. Lawless exercisable within 60 days of January 2, 2008.


(15) Consists of 2,588 shares owned by Mr. Hickman and options to purchase 71,338 shares held by Mr. Hickman exercisable within 60 days of January 2, 2008.


(16) Consists of 32,353 shares owned by Mr. Stewart and options to purchase 20,000 shares held by Mr. Stewart exercisable within 60 days of January 2, 2008.


(17) Consists of 4,771 shares owned by Mr. Lewis.


(18) Consists of 2,500 shares owned by Mr. Sorensen.


(19) Consists of 1,330,002 shares issued and outstanding and options to purchase 1,344,783 shares exercisable within 60 days of January 2, 2008.

COMPENSATION

(1) Mr. Stewart was appointed Chief Financial Officer effective September 4, 2007. He was employed in a non-executive position for the period from October 1, 2006 to September 4, 2007.


(2) Mr. Sorensen was Chief Financial Officer for the period from October 1, 2006 to August 31, 2007.


(3) Mr. Hickman was an executive officer for the period from October 1, 2006 through April 30, 2007. Since May 1, 2007, Mr. Hickman has been employed in a non-executive position.


(4) Mr. Lewis was an executive officer during all of fiscal 2007 continuing into November 2007, at which time his employment terminated.

(5) The bonuses shown in this column represent discretionary payments. Bonuses paid under terms of Headwaters’ Short Term Incentive Bonus Plan, approved by stockholders in 2005, are shown in the column titled “Non-equity incentive plan compensation.”


(6) Stock-based compensation represents the amounts recognized for financial reporting purposes, calculated in accordance with the requirements of SFAS No. 123R, except that estimated forfeitures were disregarded. A significant portion of the stock-based compensation shown above arose from the voluntary cancellation of certain stock-based awards granted in 2005. The amounts of accelerated compensation cost related to cancelled awards were as follows: Mr. Benson - $1,032,078; Mr. Hickman - $103,069; Mr. Lawless - $142,784; Mr. Lewis - $136,045; and Mr. Frailey - $136,600. No named executive received any actual compensation benefit from any of the cancelled awards, either in fiscal 2007 or in any prior fiscal year. Upon his separation from Headwaters, Mr. Sorensen forfeited stock-based awards consisting of 100,000 SARs and 30,000 shares of restricted stock. Reference is made to Note 11 to the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year 2007 for a detailed description of the assumptions used in valuing stock-based awards under SFAS No. 123R.


(7) Represents bonuses paid under terms of our Short Term Incentive Bonus Plan, including banked amounts from prior years that were earned and paid in fiscal 2007.


(8) Represents a payment to Mr. Stewart upon his appointment as Chief Financial Officer in September 2007.


(9) Represents $7,239 of vehicle-related perquisites and $502,518 paid to Mr. Hickman upon his change in employment responsibilities in April 2007.


(10) Represents $12,295 of insurance premiums, $7,760 for a club membership and $1,140 of vehicle-related perquisites.

MANAGEMENT DISCUSSION FROM LATEST 10K

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. As described in more detail in Note 13 to the consolidated financial statements, we made one acquisition in 2007 and several insignificant acquisitions in 2006. These entities’ results of operations for the periods from the acquisition dates through September 30, 2007 have been consolidated with our results; their operations up to the dates of acquisition have not been included in the consolidated results for any period.

We currently operate in three industries: construction materials, coal combustion products (“CCPs”) and alternative energy. In the construction materials segment, we design, manufacture, and sell architectural stone and resin-based exterior siding accessories (such as shutters, mounting blocks, and vents) and other 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. Revenues in the CCP segment consist primarily of fly ash and other product sales. In the alternative energy segment, we are focused on reducing waste and increasing the value of energy feedstocks, primarily in the areas of low-value coal and oil. Revenues for the alternative energy segment consist primarily of sales of chemical reagents and license fees.

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 over-reliance on the legacy alternative energy segment Section 45K (formerly Section 29) business. With the addition and expansion of our CCP management and marketing business through acquisitions in 2002 and in 2004, and the growth of our construction materials business, through several large and small acquisitions in 2004, 2006 and 2007, we have achieved revenue growth and diversification in three business segments. Because we also incurred increased indebtedness to make strategic acquisitions, one of our ongoing financial objectives is to continue to focus on increased cash flows to reduce debt.

A material amount of our 2007 and prior fiscal year consolidated revenue and net income has been derived from license fees and sales of chemical reagents, both of which depend on the ability of licensees and other customers to manufacture and sell qualified synthetic fuel that generates 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 own an interest. The following issues exist related to tax credits.

By law, Section 45K tax credits for synthetic fuel produced from coal expire for synthetic fuel sold after December 31, 2007. When Section 45K expires, we expect our licensees’ synthetic fuel facilities to close because we do not believe that production of synthetic fuel will be profitable absent the tax credits. When our licensees close their facilities or significantly reduce production activities, it will have a material adverse effect on our revenue, net income and cash flow, in addition to the current material adverse effect caused by phase-out concerns.

Section 45K tax credits are subject to phase-out after the average annual U.S. wellhead oil price (“reference price”) reaches a beginning phase-out threshold price, and are eliminated entirely if the reference price reaches the full phase-out price. There was a partial phase-out of tax credits for calendar 2006 of approximately 33% and we currently expect a significant phase-out of tax credits for calendar 2007. Most of our licensees stopped production for a period of time in calendar 2006. As of September 30, 2007, all of our licensees were producing synthetic fuel, but some have indicated intent to stop production prior to December 31, 2007. These events have materially adversely affected both the amount and timing of recognition of our revenue, net income and cash flow in 2006 and 2007, and will likely have a material adverse effect in 2008, until Section 45K expires at the end of calendar 2007 and the calendar 2007 reference price and phase-out range are published in the quarter ending June 30, 2008. Reference is made to Notes 10 and 14 to the consolidated financial statements where there is more information on phase-out and other uncertainties related to Section 45K tax credits that have affected our business historically and that will continue to affect our business in 2008.

Our acquisition strategy targets businesses that are leading players in their respective industries and that enjoy healthy operating margins, thus providing additional cash flow that complements the financial performance of our existing businesses. In addition, in 2006, we began to acquire small companies 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 which operate an ethanol plant located in North Dakota and a hydrogen peroxide plant in South Korea. We are also investing in other alternative energy projects such as coal cleaning and the use of nanocatalysts to engineer coal for emissions reduction and to enhance the refining of heavy crude oils into lighter transportation fuels.

Our CCPs and construction materials businesses are affected by seasonality, with the highest revenue and profitability produced in the June and September quarters. With CCPs, our strategy is to continue to negotiate long-term contracts so that we can invest in transportation and storage infrastructure for the marketing and sale of CCPs. We also intend to continue our efforts to expand usage of high-value CCPs, develop more uses for lower-value CCPs, such as blending, and expand the use of CCPs in our construction materials businesses.

In 2005 and 2006, we focused on the integration of our large 2004 acquisitions, including the marketing of diverse construction materials products through our national distribution network. We became highly leveraged as a result of those acquisitions, but have reduced our outstanding debt since that time through cash generated from operations, from an underwritten public offering of common stock and from proceeds from settlement of litigation. We intend to continue to focus on repaying long-term debt while continuing to look for diversification opportunities.

Critical Accounting Policies and Estimates

Our significant accounting policies are identified and described in Note 2 to the consolidated financial statements. The preparation of consolidated financial statements in conformity with U. S. generally accepted accounting principles requires us to make estimates and assumptions that affect i) the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and ii) the reported amounts of revenue and expenses during the reporting period. Actual results could differ materially from those estimates.

We continually evaluate our policies and estimation procedures. Estimates are often based on historical experience and on assumptions that are believed to be reasonable under the circumstances, but which could change in the future. Some of our accounting policies and estimation procedures require the use of substantial judgment, and actual results could differ materially from the estimates underlying the amounts reported in the consolidated financial statements. Such policies and estimation procedures have been reviewed with our Audit Committee. The following is a discussion of critical accounting policies and estimates.

License Fee Revenue Recognition . We currently license our technologies to the owners of 28 coal-based solid alternative fuel facilities in the U.S. License agreements contain a quarterly earned royalty fee generally set at a prescribed dollar amount per ton or a percentage of the tax credits earned by the licensee. Recurring license fees or royalty payments are recognized in the period when earned, which coincides with the sale of alternative fuel by our licensees, provided standard revenue recognition criteria such as amounts being “fixed or determinable” are met. In most instances, we receive timely reports from licensees notifying us of the amount of solid synthetic fuel sold and the royalty due us under the terms of the respective license fee agreements. Additionally, we have experienced a regular pattern of payment by these licensees of the reported amounts.

Estimates of license fee revenue earned, where required, can be reliably made based upon historical experience and/or communications from licensees with whom an established pattern exists. In some cases, however, such as when a licensee is beginning to produce and sell synthetic fuel or when a synthetic fuel facility is sold by a licensee to another entity, and for which there is no pattern or knowledge of past or current production and sales activity, there may be more limited information available to estimate the license fee revenue earned. In these situations, we use such information as is available and where possible, substantiate the information through such procedures as observing the levels of chemical reagents purchased by the licensee and used in the production of the solid synthetic fuel. In certain limited situations, we are unable to reliably estimate the license fee revenues earned during a period, and revenue recognition is delayed until a future date when sufficient information is known from which to make a reasonable estimation.

In 1996, we entered into an agreement with AJG Financial Services, Inc. The agreement provided for AJG to pay royalties and allowed AJG to purchase proprietary chemical reagent material from us. In October 2000, we filed a complaint in the Fourth District Court for the State of Utah against AJG alleging that it had failed to make payments and to perform other obligations under the agreement. We asserted claims including breach of contract and sought money damages as well as other relief. AJG’s answer to the complaint denied our claims and asserted counter-claims based upon allegations of misrepresentation and breach of contract.

This litigation came to the trial phase in January 2005. The jury reached a verdict substantially in our favor and the court entered a judgment for us against AJG in the amount of approximately $175.0 million which included approximately $32.0 million in prejudgment interest. In May 2005, we entered into a settlement agreement with AJG which provided for payments to us in the amount of $50.0 million at the time of settlement (which payment was received in May 2005), $70.0 million (related to a contract modification for use of technology) in January 2006, and certain quarterly payments based upon tax credits associated with AJG’s facilities for calendar years 2005 through 2007. Payments based upon tax credits associated with AJG’s facilities for the first three quarters of calendar year 2005 were received in January 2006, with all other quarterly payments for 2005 through 2007 payable 45 days after the end of each quarter. Payments based upon tax credits for 2005 through 2007 are subject to downward adjustment or elimination if a phase-out of section 29 tax credits occurs due to high oil prices.

We recognized the $50.0 million contract litigation settlement gain, net of payments due to a third party, as a reduction in operating costs and expenses in 2005. The $70.0 million, net of payments due to a third party, is being recognized as revenue over calendar years 2005 through 2007. The ongoing quarterly payments based upon tax credits are being recognized as revenue in accordance with our revenue recognition policy for license fee revenue.

In connection with the settlement of the AJG litigation, we also recognized approximately $8.2 million of revenue from a licensee with an indirect interest in that litigation, all of which related to periods prior to January 1, 2005. Ongoing revenue from this licensee is also being recognized in accordance with our revenue recognition policy for license fee revenue.

The amount of license fee revenue recognized during 2006 and 2007 was negatively affected by reduced revenues being recognized for certain licensees whose license agreements call for us to be paid a portion of the tax credits earned by the licensee. Certain accounting rules limit revenue recognition to amounts that are “fixed or determinable.” Therefore, due to uncertainties related to phase-out of Section 45K tax credits and other licensee-specific factors, the timing of revenue recognition was delayed for certain licensees during fiscal 2006 and 2007.

Due to publication of the Section 45K calendar 2006 reference price and the phase-out range, finalization of calendar 2006 phase-out was made possible during the quarter ended June 30, 2007. As a result of the availability of this information and the clarification of other licensee-specific factors, certain calendar 2006 and prior year license fee revenue totaling approximately $31.5 million was recognized in 2007. This amount related to periods ending on or prior to December 31, 2006 and was recognized in 2007 when it met the “fixed or determinable” recognition criterion and it was remote that any negative adjustment would be required in the future. We have applied the same policy in 2007 with regard to the recognition of revenue for calendar 2007 tax credit-based license fees. The final determination of revenue to be collected pertaining to fiscal and calendar year 2007 will not occur until the calendar 2007 reference price and phase-out range are published in the quarter ending June 30, 2008.

Income Taxes . Significant estimates and judgments were required in the calculation of our income tax provisions for the years presented, most particularly in 2006 and 2007. One of the key estimates affecting our 2006 and 2007 tax provisions is the amount of Section 45K (formerly Section 29) tax credits that will ultimately be available related to our 19% interest in an entity that owns and operates a coal-based solid alternative fuel production facility, plus two other smaller alternative fuel facilities that we own and operate (see Note 10 to the consolidated financial statements).

The calendar 2006 Section 45K tax credit phase-out percentage was not finalized until the quarter ended June 30, 2007. The calendar 2007 phase-out percentage will not be finalized until the quarter ending June 30, 2008. As of September 30, 2007, an estimated phase-out percentage of 54% is our best estimate of what the phase-out percentage for calendar 2007 would be, using available information as of that date. It is certain that the phase-out percentage for calendar 2007 will be different from this estimate. As of October 31, 2007, the estimated phase-out percentage for calendar 2007 would be 70%. We estimate that NYMEX average oil prices would need to exceed $110 for the period October 1, 2007 through December 31, 2007 for full phase-out to occur in calendar 2007. The effect of the finalization of the calendar 2006 phase-out percentage, which was published in 2007, was a decrease in income tax expense of approximately $1.5 million which amount was included in the 2007 tax provision. Likewise, the effect on income taxes of the change in the calendar 2007 phase-out percentage from 54% to the actual percentage for the year will be recorded to income tax expense in fiscal 2008, when the calendar 2007 actual oil prices and the phase-out range are known. The effect of this adjustment could be material to our 2008 income tax expense.

As described in more detail in Note 7 to the consolidated financial statements, we recorded a goodwill impairment charge of $98.0 million in 2007. The impairment charge is not deductible for tax purposes and therefore had a significant negative effect on our reported effective tax rate for 2007.

As described in Note 11 to the consolidated financial statements, approximately $3.9 million of stock-based compensation in 2007 resulted from the early voluntary cancellation of SARs and other stock-based awards, requiring an acceleration of expense recognition for the grant-date fair value that had not been recognized as of the cancellation dates. As a result of the cancellation of the stock-based awards, approximately $10.0 million of deferred tax assets were written off.

As described in more detail in Note 2 to the consolidated financial statements, we are required to adopt Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109 (“FIN 48”) at the beginning of our fiscal 2008 year, or October 1, 2007, with a transition adjustment to retained earnings as of October 1, 2007, if material. Based upon our evaluation as of September 30, 2007, the cumulative effect of adopting FIN 48 could be a decrease in retained earnings and an increase in income tax liabilities for uncertain tax positions of approximately $18.0 million; however, this amount is subject to revision when we complete our evaluation.

The calculation of our tax liabilities involves uncertainties in the application of complex tax regulations in multiple jurisdictions. We recognize potential liabilities for anticipated tax audit issues in the U.S. and state tax

jurisdictions based on our estimate 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 we determine the liabilities are no longer probable or necessary. If our estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result.

In evaluating our ability to recover our recorded deferred tax assets, in full or in part, all available positive and negative evidence, including our past operating results and our forecast of future taxable income on a jurisdiction by jurisdiction basis, is considered and evaluated. In determining future taxable income, we are responsible for assumptions utilized including the amount of federal, state and international pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage our underlying businesses.

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 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 that occurred from 2001 through 2007. SFAS No. 142 requires us to periodically test for goodwill impairment at least annually, or more frequently if evidence of possible impairment arises. We perform our annual impairment testing as of June 30, using the two-step process described in Note 7 to the consolidated financial statements. As of June 30, 2007, there were five distinguishable reporting units with goodwill, three of which were in the construction materials segment. There was one reporting unit with goodwill in each of the CCPs and alternative energy segments. As a result of ongoing changes in the operations and management of the businesses in the construction materials segment, and in accordance with the requirements contained in SFAS No. 142, SFAS No. 131 and EITF Abstract Topic D-101, “Clarification of Reporting Unit guidance in Paragraph 30 of SFAS No. 142,” we expect goodwill in the three historical reporting units in this segment will be aggregated and tested for impairment as one reporting unit for goodwill impairment testing in 2008.

With the exception of the Tapco reporting unit for 2007, all of the step 1 tests indicated that the fair values of the reporting units, calculated primarily using discounted expected future cash flows, exceeded their carrying values. Accordingly, step 2 of the impairment tests was not required to be performed for those reporting units, and no impairment charges were necessary. As a result of the depressed residential housing and remodeling market and changes in cost of capital, the Tapco reporting unit failed step 1, requiring completion of step 2, which resulted in a determination that Tapco’s goodwill was impaired. Accordingly, a non-cash impairment charge of $98.0 million was recorded in 2007. The impairment did not affect our cash position, cash flow from operating activities or senior debt covenants, and will not have any impact on future operations.

In addition to the annual review, we evaluate, based on current events and circumstances, the carrying value of 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 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.

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. In 2006, the construction materials segment revised downward the estimated useful lives of certain assets resulting in accelerated depreciation charges in order to fully depreciate the assets over shorter periods. This is the primary reason for the increased depreciation expense in 2006 as compared to 2005 and in 2007 as compared to 2006.

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.

Stock-Based Compensation . As described in more detail in Note 11 to the consolidated financial statements, we early adopted the fair value method of accounting for stock-based compensation required by SFAS No. 123R, effective as of October 1, 2004, the beginning of our 2005 fiscal year. Most of the 2005 stock-based compensation resulted from the expense associated with grants of immediate-vested SARs and from the acceleration of vesting of certain stock options. Approximately $3.9 million of the 2007 stock-based compensation resulted from the early voluntary cancellation of SARs and other stock-based awards, requiring an acceleration of expense recognition for the grant-date fair value that had not been recognized as of the cancellation dates.

We recognize compensation expense equal to the grant-date fair value of stock-based awards for all awards expected to vest, over the period during which the related service is rendered by grantees. The fair value of stock-based awards is determined primarily using the Black-Scholes-Merton option pricing model (“B-S-M model”), developed for use in estimating the fair value of traded options that have no vesting restrictions and that are fully transferable. Option valuation models require the input of certain subjective assumptions, including expected stock price volatility. For stock-based awards, we use the “graded vesting” or accelerated method to allocate compensation expense over the requisite service periods. Our estimated forfeiture rates are based largely on historical data and ranged from 0% to 5% from 2005 to 2007, depending on the type of award and the award recipients. As of September 30, 2007, the estimated forfeiture rate for most unvested awards was 1% per year.

The fair values of stock options and SARs were estimated using the B-S-M model, adjusted where necessary to account for specific terms of awards that the B-S-M model does not have the capability to consider. We used the services of an independent valuation firm to validate our fair value estimates and assumptions and also to determine certain necessary adjustments to the B-S-M model output. One such adjustment was used in determining the fair value of SARs which had a cap on allowed appreciation. For those SARs, the output determined by the B-S-M model was reduced by an amount determined by a Quasi-Monte Carlo simulation to reflect the reduction in fair value associated with the appreciation cap.

Expected stock price volatility was estimated using primarily historical volatilities of our common stock. Implied volatilities of traded options on our stock, volatility predicted by a “Generalized AutoRegressive Conditional Heteroskedasticity” model, and an analysis of volatilities used by other public companies in comparable lines of business were also considered. Risk-free interest rates used were the US Treasury bond yields with terms corresponding to the expected terms of the awards being valued. In estimating expected lives, we considered the contractual and vesting terms of awards, along with historical experience; however, due to insufficient historical data from which to reliably estimate expected lives, we used estimates based on the “simplified method” set forth by the SEC in Staff Accounting Bulletin No. 107, where expected life is estimated by summing the award’s vesting term and the contractual term and dividing that result by two. The reduction in value related to grantee payment for certain immediate-vested SARs was estimated by management based on the terms of the payment requirements and other factors.

As of September 30, 2007, there was approximately $2.9 million of total compensation cost related to nonvested awards not yet recognized. This unrecognized compensation cost is expected to be recognized over a weighted-average period of approximately 1.9 years. Due to the grant of stock-based awards subsequent to September 30, 2007, the amount of total compensation cost related to nonvested awards has increased, and the weighted-average period over which compensation cost will be recognized has changed.

The adoption of SFAS No. 123R, combined with the settlement of the AJG litigation described above, was a contributing factor in our decision to grant employee incentive awards in 2005, in particular to grant fewer options and more SARs, including many that vested immediately, the granting of performance-based awards, and the acceleration of vesting of stock options. The early voluntary cancellation of SARs and other stock-based awards in 2007 was a direct result of the low stock price as compared to the exercise prices of the cancelled SARs.

Year Ended September 30, 2007 Compared to Year Ended September 30, 2006

The information set forth below compares our operating results for the year ended September 30, 2007 (“2007”) with operating results for the year ended September 30, 2006 (“2006”).

Revenue . Total revenue for 2007 increased by approximately 8% to $1.21 billion as compared to $1.12 billion for 2006. The major components of revenue are discussed in the sections below.

Construction Materials Segment . Sales of construction materials during 2007 were $544.1 million with a corresponding direct cost of $383.5 million. Sales of construction materials during 2006 were $573.4 million with a corresponding direct cost of $394.1 million. The decrease in sales of construction materials during 2007 was due primarily to the effects of a depressed residential housing and remodeling market which impacted sales across most of our product lines. The housing market slowdown also was the primary reason for the decline in gross margin percentage from 2006 to 2007. Because a substantial amount of our revenues in this segment are dependent on the housing market, we anticipate continuing impact in 2008 from the current slowdown in the housing industry.

CCP Segment . CCP revenues for 2007 were $306.4 million with a corresponding direct cost of $217.6 million. CCP revenues for 2006 were $281.2 million with a corresponding direct cost of $206.4 million. The increase in CCP revenues and in the gross margin percentage during 2007 were due primarily to a combination of continued strong demand for CCPs and upward pricing trends in most concrete markets. The growth in demand for CCPs is due in part to certain regional shortages of portland cement for which CCPs are a substitute. The cement shortages also resulted in increased prices for CCPs in several markets.

Alternative Energy Segment . Our alternative energy segment revenue consists primarily of chemical reagent sales, license fee revenue related to our solid alternative fuel technologies, and to a lesser extent, sales of synthetic fuel from two solid alternative fuel production facilities that we own. The major components of revenue for the alternative energy segment are discussed in the sections below.

As described previously and in Note 14 to the consolidated financial statements, a material amount of our 2007 and prior fiscal year consolidated revenue has been derived from license fees and sales of chemical reagents, both of which depend on the ability of licensees and other customers to manufacture and sell qualified synthetic fuel that generates tax credits under Section 45K of the Internal Revenue Code. By law, Section 45K tax credits for synthetic fuel produced from coal expire for synthetic fuel sold after December 31, 2007. When Section 45K expires, we expect our licensees’ synthetic fuel facilities to close because we do not believe that production of synthetic fuel will be profitable absent the tax credits. When our licensees close their facilities or significantly reduce production activities, it will have a material adverse effect on our revenue, in addition to the current material adverse effect caused by phase-out concerns.

Sales of Chemical Reagents . Chemical reagent sales during 2007 were $190.1 million with a corresponding direct cost of $151.6 million. Chemical reagent sales during 2006 were $143.0 million with a corresponding direct cost of $108.1 million. Chemical reagent sales in 2007 were higher than in 2006 primarily due to increased synthetic fuel production by most of our licensees (resulting in increased sales of $32.6 million) and other customers with whom we do not have a license agreement (resulting in increased sales of $14.5 million). We believe there has been less concern in 2007 over phase-out of Section 45K tax credits than existed in 2006, due partly to mitigation efforts such as hedging, which has resulted in increased synthetic fuel production. The gross margin percentage for 2007 of 20% was lower than the 2006 gross margin percentage of 24% due primarily to increases in the cost of product, which in turn was related to increases in the costs of petroleum-based materials.

License Fees . During 2007, we recognized license fee revenue totaling $112.6 million, an increase of $37.9 million from $74.7 million of license fee revenue recognized during 2006. The amount of license fee revenue recognized during 2006 and 2007 was negatively affected by reduced revenues being recognized for certain licensees whose license agreements call for us to be paid a portion of the tax credits earned by the licensee. Due to uncertainties related to phase-out and other licensee-specific factors, revenue recognition was deferred for certain licensees during fiscal 2006 and 2007.

Due to publication of the calendar 2006 reference price and the phase-out range for that year, finalization of calendar 2006 phase-out was made possible during the quarter ended June 30, 2007. As a result of the availability of this information and the clarification of other licensee-specific factors, certain calendar 2006 and prior year license fee revenue totaling approximately $31.5 million was recognized in 2007. This amount related to periods ending on or prior to December 31, 2006 and was recognized in 2007 when it met the “fixed or determinable” recognition criterion and it was remote that any negative adjustment would be required in the future. We have applied the same policy in 2007 with regard to the recognition of revenue for calendar 2007 tax credit-based license fees. The final determination of revenue to be collected pertaining to fiscal and calendar year 2007 will not occur until the calendar 2007 reference price and phase-out range are published in the quarter ending June 30, 2008. Reference is made to our policy disclosures discussed previously.

Other Alternative Energy Segment Revenues. The majority of other alternative energy segment revenue is comprised of sales of synthetic fuel, which during 2007 were $45.5 million with a corresponding direct cost of $52.5 million. Sales of synthetic fuel during 2006 were $42.5 million with a corresponding direct cost of $49.2 million. Revenue from the sale of synthetic fuel has a negative gross margin, which is more than compensated for by the income tax credits expected to be earned from the sales of the synthetic fuel.

Amortization and Research and Development Expenses . The decrease in amortization expense of $1.4 million from 2006 to 2007 was due primarily to intangible assets that have been fully amortized. Research and development expense increased by $4.3 million from 2006 to 2007 primarily because of increased spending in our joint research efforts with Evonik Industries AG (formally Degussa AG) related to hydrogen peroxide and in developmental efforts related to our nanotechnologies. Both amortization and research and development expenses are currently expected to decrease somewhat in 2008 from the reported 2007 amounts.

Selling, General and Administrative Expenses . These expenses increased $17.6 million, or 13%, to $155.6 million for 2007 from $138.0 million for 2006. The increase in 2007 was due primarily to a $10.9 million increase in payroll and incentive pay at the operating business unit level, a $3.3 million increase in litigation-related costs, and a $2.4 million increase in stock-based compensation. A majority of the increase in payroll costs relates to growth initiatives at the operating business unit level, and increased incentive pay related to improved performance at certain operating business units. The increase in litigation costs was due to a net credit recorded in 2006 because of positive developments in certain legal matters. Those developments resulted in reduced likelihood of ultimate legal liability and the reversal of previously expensed litigation costs. The higher stock-based compensation was due to the cancellation of SARs and other stock-based awards in 2007 and the resultant acceleration of expense recognition for unrecognized compensation cost that remained as of the cancellation dates.

Other Income and Expense . During 2007, we reported net other expense of $42.0 million compared to net other expense of $44.0 million during 2006. The change of $2.0 million was comprised of a decrease in net interest expense of $2.9 million and an increase in other expenses of $0.9 million. Net interest expense decreased from $34.0 million in 2006 to $31.1 million in 2007, due primarily to the lower interest rate (2.50%) on the $160.0 million of convertible senior subordinated notes issued in 2007, and lower average levels of long-term debt in 2007 as compared to 2006. The decrease in interest expense caused by those factors was partially offset by $2.6 million of accelerated amortization of debt issue costs related to early repayments of senior debt in 2007, a majority of which were funded by net proceeds from the new lower-rate convertible notes. We currently expect interest expense in 2008 to be somewhat less than the 2007 amount.

The increase in other expenses of $0.9 million consisted primarily of an increase in costs related to our investment in the coal-based solid alternative fuel production facility described in Note 10 to the consolidated financial statements.

Income Tax Provision . We recorded income tax provisions with an effective tax rate of approximately 26% in 2006 and 66% in 2007 (24%, exclusive of the $98.0 million goodwill impairment charge, which is not tax-deductible). The effective tax rates are lower than statutory rates primarily due to tax credits related to the two coal-based solid alternative fuel facilities that we own and operate, plus our 19% interest in an entity that owns and operates another alternative fuel facility (see Note 10 to the consolidated financial statements). The alternative fuel produced at these three facilities through December 2007 qualifies for tax credits pursuant to Section 45K (formerly Section 29) of the Internal Revenue Code, subject to the uncertainties of phase-out, IRS audit and other risks associated with the tax credits, all as more fully described in Note 14 to the consolidated financial statements. Excluding the effect of the tax credits in both years and the goodwill impairment charge in 2007, our effective tax rate for 2006 and 2007 would have been approximately 40% and 39%, respectively.

As discussed in Note 10, the Section 45K tax credits used in calculating the income tax provision are estimated as of September 30, 2007. While the calendar 2007 phase-out percentage can not be finalized at the current time, as of September 30, 2007, the estimated phase-out percentage of 54% represents our best estimate of what the phase-out percentage would be, using available information as of that date. The effect on income taxes of any change in the calendar 2007 phase-out percentage from 54% to the actual percentage for the year will be recorded to income tax expense in subsequent periods, when the calendar 2007 actual oil prices and the phase-out range are known. Any such effect could be material to our 2008 income tax expense.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

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. As described in more detail in our December 31, 2006 Form 10-Q, during that quarter, we acquired 100% of the ownership interests of a privately-held company in the construction materials business. Operating results for the acquired business subsequent to the acquisition date have been included in our consolidated results for 2007 and were not material.

We currently operate in two industries and report three business segments, the construction materials and CCPs segments in the building materials industry, and the alternative energy segment in the energy industry. In the construction materials segment, we design, manufacture, and sell architectural stone and resin-based exterior siding accessories (such as shutters, mounting blocks, and vents) and related products. Revenues consist of sales to wholesale and retail distributors, contractors and other users of building products. We are also a nationwide leader in the management and marketing of CCPs. Revenues in the CCP segment consist primarily of fly ash and other product sales. In the alternative energy segment, we are focused on reducing waste and increasing the value of energy feedstocks, primarily in the areas of low-value coal and oil. Revenue for the alternative energy segment consists primarily of sales of chemical reagents and license fees.

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 over-reliance on the legacy alternative energy segment Section 45K (formerly Section 29) business. With the addition and expansion of our CCP management and marketing business through acquisitions in 2002 and in 2004, and the growth of our construction materials business, through several large and small acquisitions in 2004, 2006 and 2007, we have achieved revenue growth and diversification in three business segments. Because we also incurred increased indebtedness to make strategic acquisitions, one of our ongoing financial objectives is to continue to focus on increased cash flows to reduce debt.

A material amount of our 2007 and prior fiscal year consolidated revenue and net income has been derived from license fees and sales of chemical reagents, both of which depend on the ability of licensees and other customers to manufacture and sell qualified synthetic fuel that generates tax credits under Section 45K (formerly Section 29) of the Internal Revenue Code. We have also claimed Section 45K tax credits for synthetic fuel sales from facilities in which we own an interest. From time to time, issues arise as to the availability of tax credits and, with the increased price of oil, the phase-out of credits.

By law, Section 45K tax credits for synthetic fuel produced from coal expire on December 31, 2007. In addition, Section 45K tax credits are subject to phase-out after the average annual U.S. wellhead oil price (“reference price”) reaches a beginning phase-out threshold price, and are eliminated entirely if the reference price reaches the full phase-out price. There was no phase-out of tax credits for calendar 2005; however, as a result of high oil prices in calendar 2006, there was a partial phase-out of tax credits for calendar 2006 of approximately 33%. In addition, phase-out of Section 45K for calendar 2007 is also possible. As of June 30, 2007, all of our licensees are producing synthetic fuel, but most licensees stopped production for a period of time in calendar 2006. These events have materially adversely affected both the amount and timing of recognition of our revenue, net income and cash flow, and will likely have a material adverse effect in future periods as well. Reference is made to notes 7 and 9 to the consolidated financial statements where there is more information on phase-out and other uncertainties related to Section 45K tax credits that have affected our business in 2007 and that will continue to affect our business for the remainder of calendar 2007.

Our acquisition strategy targets businesses that are leading players in their respective industries and that enjoy healthy operating margins, thus providing additional cash flow that complements the financial performance of our existing businesses. In addition, in fiscal 2006, we began to acquire small companies 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 a joint venture which operates an ethanol plant located in North Dakota, and we are also investing in other alternative energy projects such as coal cleaning and the use of nanocatalysts to engineer coal for emissions reduction and to enhance the refining of heavy crude oils into lighter transportation fuels.

As a result of our CCPs and construction materials businesses, we are affected by seasonality, with the highest revenue and profitability produced in the June and September quarters. With CCPs, our strategy is to continue to negotiate long-term contracts so that we can invest in transportation and storage infrastructure for the marketing and sale of CCPs. We also intend to continue our efforts to expand usage of high-value CCPs and develop uses for lower-value CCPs, including the expanded use of CCPs in our construction materials businesses and the industry in general.

In fiscal 2005 and 2006, we focused on the integration of our large 2004 acquisitions, including the marketing of diverse construction materials products through our national distribution network. We became highly leveraged as a result of those acquisitions, but have reduced our outstanding debt since that time through cash generated from operations, from an underwritten public offering of common stock and from proceeds from settlement of litigation. We intend to continue to focus on repaying long-term debt while continuing to look for diversification opportunities within prescribed parameters.

Three Months Ended June 30, 2007 Compared to Three Months Ended June 30, 2006

The information set forth below compares our operating results for the quarter ended June 30, 2007 (“2007”) with operating results for the quarter ended June 30, 2006 (“2006”).

Revenue . Total revenue for 2007 increased by $40.4 million or 14% to $336.3 million as compared to $295.9 million for 2006. The major components of revenue are discussed in the sections below.

Construction Materials Segment . Sales of construction materials during 2007 were $155.6 million with a corresponding direct cost of $103.3 million. Sales of construction materials during 2006 were $162.1 million with a corresponding direct cost of $107.3 million. The decrease in sales of construction materials during 2007 was due primarily to the effects of a depressed residential housing and remodeling market which impacted sales across most of our product lines. We believe that the impact of the general industry slowdown has been significantly mitigated by our product categories, geographic diversification, product diversification and the introduction of new products. Despite the depressed market, gross margin percentage did not change significantly from 2006 to 2007, due primarily to operational efficiencies that have been achieved during the past year. Nevertheless, because a substantial amount of our revenues in this segment are dependent on the housing market, we anticipate some impact from market conditions in future periods until the cycle reverses.

CCP Segment . CCP revenues for 2007 were $83.2 million with a corresponding direct cost of $58.4 million. CCP revenues for 2006 were $74.1 million with a corresponding direct cost of $53.7 million. The increase in CCP revenues and in the gross margin percentage during 2007 were due primarily to a combination of continued strong demand for CCPs and upward pricing trends in most concrete markets. The growth in demand for CCPs is due in part to certain regional shortages of portland cement for which CCPs are a substitute, which can result in an increased percentage of CCPs being used in concrete. The cement shortages also resulted in increased prices for CCPs in several markets.

Alternative Energy Segment . Our alternative energy segment revenue consists primarily of chemical reagent sales, license fee revenue related to our solid alternative fuel technologies, and to a lesser extent, sales of synthetic fuel from two solid alternative fuel production facilities that we own. The major components of revenue for the alternative energy segment are discussed in the sections below.

Sales of Chemical Reagents . Chemical reagent sales during 2007 were $50.6 million with a corresponding direct cost of $39.3 million. Chemical reagent sales during 2006 were $34.9 million with a corresponding direct cost of $26.5 million. Chemical reagent sales in 2007 were higher than in 2006 primarily due to increased synthetic fuel production by nearly all of our licensees and other customers. We believe there has been less concern in 2007 over phase-out of Section 45K tax credits than existed in 2006, which has resulted in increased synthetic fuel production. Nevertheless, it is not possible to predict the trend for sales of chemical reagents in future periods because synfuel production by our licensees and other customers is subject to decisions based on future oil prices and other customer-specific factors. The gross margin percentage for 2007 of 22% was lower than the 2006 gross margin percentage of 24% due primarily to increases in the cost of product, which in turn was related to increases in the costs of petroleum-based materials. Subject to crude oil prices and other factors, we currently believe reagent margins in fiscal 2007 will be lower than in 2006.

License Fees . During 2007, we recognized license fee revenue totaling $33.6 million, an increase of $21.2 million from $12.4 million of license fee revenue recognized during 2006. Certain accounting rules limit revenue recognition to amounts that are “fixed or determinable.” The amount of license fee revenue recognized in 2006 and 2007 was negatively affected for certain licensees whose license agreements call for us to be paid a portion of the tax credits earned by the licensee. Due to uncertainties related to phase-out for calendar 2006 and 2007 and other licensee-specific factors, revenue recognition was deferred for certain licensees during 2006. A portion of such revenue is also currently being deferred for certain licensees in fiscal 2007.

Due to the publication of the calendar 2006 reference price and the phase-out range for that year, finalization of calendar 2006 phase-out was made possible during the quarter ended June 30, 2007. As a result of the availability of this information and the clarification of other licensee-specific factors, certain calendar 2006 and prior year license fee revenue totaling approximately $26.5 million and $3.3 million was recognized during the quarters ended March 31 and June 30, 2007, respectively. These amounts related to periods ending on or prior to December 31, 2006 and were recognized in 2007 when they met the “fixed or determinable” recognition criterion and it was remote that any negative adjustment would be required in the future. Additionally, applying the same policy, approximately $19.4 million of license fee revenue was recognized during the quarter ended June 30, 2007 for calendar 2007 tax credit-based license fees, approximately $9.7 million of which related to the quarter ended March 31, 2007. As of June 30, 2007, most license fee revenue that has not been recognized relates to the quarters ended March 31 and June 30, 2007. This unrecognized revenue, which as of June 30, 2007 could total approximately $5.5 million (calculated based on licensee-reported data and assuming 25% phase-out of Section 45K tax credits for calendar 2007), will not be recognized until such time as the amounts become “fixed or determinable.” Reference is made to our policy disclosures contained in Note 2 to the consolidated financial statements and in “ Management’s Discussion and Analysis ” in our Form 10-K, as well as information in Note 9 to the consolidated financial statements in this Form 10-Q and in the overview above.

Other Alternative Energy Segment Revenues. The majority of other alternative energy segment revenue is comprised of sales of synthetic fuel, which during 2007 were $10.7 million with a corresponding direct cost of $14.6 million. Sales of synthetic fuel during 2006 were $10.5 million with a corresponding direct cost of $12.3 million. Revenue from the sale of synthetic fuel has a negative gross margin, which is more than compensated for by the income tax credits expected to be earned from the sales of the synthetic fuel.

Amortization and Research and Development Expenses . The decrease in amortization expense ($0.5 million) from 2006 to 2007 was due primarily to intangible assets that have been fully amortized. Research and development expense increased by $1.0 million from 2006 to 2007 primarily because of increased spending in our joint research efforts with Degussa related to hydrogen peroxide (see Note 9) and in developmental efforts related to our nanotechnologies.

Selling, General and Administrative Expenses . These expenses increased $2.8 million, or 8% to $38.7 million for 2007 from $35.9 million for 2006. Most of the increase represented payroll costs related to growth initiatives at the operating business unit level.

Other Income and Expense . During 2007, we reported net other expense of $9.5 million compared to net other expense of $7.6 million during 2006. The change of $1.9 million was comprised of a decrease in net interest expense of $1.5 million and an increase in other expenses of $3.4 million. Net interest expense decreased from $8.2 million in 2006 to $6.7 million in 2007, due primarily to a lower interest rate (2.50%) on the $160.0 million of convertible senior subordinated notes issued in January 2007, the proceeds of which were used primarily to make early repayments of higher-rate debt.

The increase in other expenses of $3.4 million consisted primarily of a $3.0 million increase in costs related to our investment in the coal-based solid alternative fuel production facility described in Note 7 to the consolidated financial statements.

Income Tax Provision . Our estimated effective income tax rate for the fiscal year ending September 30, 2007, exclusive of discrete items (none of which affected the quarter ended June 30, 2007), is 23.0%, which rate was applied to income before income taxes for the nine months ended June 30, 2007. The income tax rates for the three months ended June 30, 2006 and 2007 were 34.2% and 23.0%, respectively. The effective tax rates for 2006 and 2007 are lower than statutory rates primarily due to tax credits related to the alternative fuel facilities that we own or have an interest in, all as described in Note 7 to the consolidated financial statements. Excluding the effect of the tax credits, our estimated effective tax rate for 2007 would be approximately 37.5%.

Also, as described in Notes 7 and 9 to the consolidated financial statements, while we have estimated a phase-out percentage for Section 45K tax credits for calendar 2007 using available information as of June 30, 2007, it is certain that our estimated phase-out percentage will change during the year. The effect on income taxes of changes in the estimated phase-out percentage for calendar 2007 will be recorded to income tax expense in subsequent periods, when the calendar 2007 actual oil prices are known. Any such effect could be material to our 2007 and 2008 income tax expense.

The calculation of tax liabilities involves uncertainties in the application of complex tax regulations in multiple jurisdictions. For example, we are currently under IRS audit for the years 2003 through 2006. 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.

Nine Months Ended June 30, 2007 Compared to Nine Months Ended June 30, 2006

The information set forth below compares our operating results for the nine months ended June 30, 2007 (“2007”) with operating results for the nine months ended June 30, 2006 (“2006”).

Revenue . Total revenue for 2007 increased by $39.2 million or 5% to $885.4 million as compared to $846.2 million for 2006. The major components of revenue are discussed in the sections below.

Construction Materials Segment . Sales of construction materials during 2007 were $393.9 million with a corresponding direct cost of $281.1 million. Sales of construction materials during 2006 were $423.7 million with a corresponding direct cost of $288.2 million. The decrease in sales of construction materials during 2007 was due primarily to the effects of a depressed residential housing and remodeling market which impacted sales across most of our product lines. The housing market slowdown also was the primary reason for the decline in gross margin percentage from 2006 to 2007.

CCP Segment . CCP revenues for 2007 were $214.5 million with a corresponding direct cost of $154.6 million. CCP revenues for 2006 were $197.7 million with a corresponding direct cost of $149.0 million. The increase in CCP revenues and in the gross margin percentage during 2007 were due primarily to a combination of continued strong demand for CCPs and upward pricing trends in most concrete markets. The growth in demand for CCPs is due in part to certain regional shortages of portland cement for which CCPs are a substitute. The cement shortages also resulted in increased prices for CCPs in several markets.

Alternative Energy Segment . Our alternative energy segment revenue consists primarily of chemical reagent sales, license fee revenue related to our solid alternative fuel technologies, and to a lesser extent, sales of synthetic fuel from two solid alternative fuel production facilities that we own. The major components of revenue for the alternative energy segment are discussed in the sections below.

Sales of Chemical Reagents . Chemical reagent sales during 2007 were $141.1 million with a corresponding direct cost of $112.1 million. Chemical reagent sales during 2006 were $129.4 million with a corresponding direct cost of $97.5 million. Chemical reagent sales in 2007 were higher than in 2006 primarily due to increased synthetic fuel production by most of our licensees and other customers. We believe there has been less concern in 2007 over phase-out of Section 45K tax credits than existed in 2006, which has resulted in increased synthetic fuel production. The gross margin percentage for 2007 of 21% was lower than the 2006 gross margin percentage of 25% due primarily to increases in the cost of product, which in turn was related to increases in the costs of petroleum-based materials.

License Fees . During 2007, we recognized license fee revenue totaling $98.1 million, an increase of $41.2 million from $56.9 million of license fee revenue recognized during 2006. The amount of license fee revenue recognized in 2006 and 2007 was negatively affected for certain licensees whose license agreements call for us to be paid a portion of the tax credits earned by the licensee. Due to uncertainties related to phase-out for calendar 2006 and 2007 and other licensee-specific factors, revenue recognition was deferred for certain licensees during 2006. A portion of such revenue is also currently being deferred for certain licensees in fiscal 2007.

Due to the publication of the calendar 2006 reference price and the phase-out range for that year, finalization of calendar 2006 phase-out was made possible during the quarter ended June 30, 2007. As a result of the availability of this information and the clarification of other licensee-specific factors, certain calendar 2006 and prior year license fee revenue totaling approximately $26.5 million and $3.3 million was recognized during the quarters ended March 31 and June 30, 2007, respectively. These amounts related to periods ending on or prior to December 31, 2006 and were recognized in 2007 when they met the “fixed or determinable” recognition criterion and it was remote that any negative adjustment would be required in the future. Additionally, applying this same policy, approximately $19.4 million of license fee revenue was recognized during 2007 for calendar 2007 tax credit-based license fees.

Other Alternative Energy Segment Revenues. The majority of other alternative energy segment revenue is comprised of sales of synthetic fuel, which during 2007 were $32.2 million with a corresponding direct cost of $39.2 million. Sales of synthetic fuel during 2006 were $33.9 million with a corresponding direct cost of $39.3 million. Revenue from the sale of synthetic fuel has a negative gross margin, which is more than compensated for by the income tax credits expected to be earned from the sales of the synthetic fuel.

Amortization and Research and Development Expenses . The decrease in amortization expense ($1.0 million) from 2006 to 2007 was due primarily to intangible assets that have been fully amortized. Research and development expense increased by $3.8 million from 2006 to 2007 primarily because of increased spending in our joint research efforts with Degussa related to hydrogen peroxide and in developmental efforts related to our nanotechnologies.

Selling, General and Administrative Expenses . These expenses increased $9.9 million, or 10% to $113.1 million for 2007 from $103.2 million for 2006. The increase in 2007 was due primarily to an $8.6 million increase in payroll and long-term incentive pay at the operating business unit level, a $3.4 million increase in litigation-related costs, and a $2.0 million decrease in marketing and sales-related expenses. A majority of the increase in payroll costs relates to growth initiatives at the operating business unit level, and the increased long-term incentive pay relates to improved performance at certain operating business units. The increase in litigation costs was due to a net credit recorded in 2006 because of positive developments in certain legal matters. Those developments resulted in reduced likelihood of ultimate legal liability and the reversal of previously expensed litigation costs. The lower marketing and sales-related expenses were a result of lower sales at certain operating business units.

Other Income and Expense . During 2007, we reported net other expense of $33.0 million compared to net other expense of $30.8 million during 2006. The change of $2.2 million was comprised of a decrease in net interest expense of $1.8 million and an increase in other expenses of $4.0 million. Net interest expense decreased from $25.8 million in 2006 to $24.0 million in 2007, due primarily to the lower interest rate (2.50%) on the $160.0 million of convertible senior subordinated notes issued in January 2007, and lower average levels of long-term debt in 2007 as compared to 2006. The decrease in interest expense caused by those factors was partially offset by $2.0 million of accelerated amortization of debt issue costs related to early repayments of senior debt in 2007, which early repayments were funded primarily by net proceeds from the new lower-rate convertible notes.

The increase in other expenses of $4.0 million consisted primarily of a $4.2 million increase in costs related to our investment in the coal-based solid alternative fuel production facility described in Note 7 to the consolidated financial statements.

Income Tax Provision . Our estimated effective income tax rate for the fiscal year ending September 30, 2007 is 23.0%, which rate was applied to income before income taxes for the nine months ended June 30, 2007. We also recognized a net $1.2 million income tax benefit in 2007 for discrete items that did not affect the calculation of the estimated effective income tax rate for the fiscal year. The discrete items primarily consisted of additional tax credits for fiscal 2006 and changes in estimated tax liabilities and in reserves related to an IRS examination. The additional tax credits for fiscal 2006 resulted from actual phase-out of Section 45K tax credits for calendar 2006 being lower than previously estimated. After consideration of the effect of the discrete items, income tax expense totaled approximately 22.0% of income before income taxes for 2007, compared to 30.4% for 2006. The effective tax rates for 2006 and 2007 are lower than statutory rates primarily due to tax credits related to the alternative fuel facilities that we own or have an interest in, all as described in Note 7 to the consolidated financial statements.

Impact of Inflation and Related Matters

Our operations have been impacted by i) increased cement, polypropylene and poly-vinyl chloride costs in the construction materials segment; ii) rising costs for chemical reagents in the alternative energy segment; iii) increased fuel costs that have affected transportation costs in most of our business units; and iv) certain regional shortages of cement and aggregate materials. The increased costs of polypropylene, poly-vinyl chloride, chemical reagents and fuel are directly related to the increase in prices of natural gas, oil and other petroleum-based materials. The increased costs of cement are caused primarily by a lack of adequate supplies in some regions of the U.S.

We have been successful in passing on some, but not all, of the increased material and transportation costs to customers. It is not possible to predict the future trend of material and transportation costs, nor our ability to pass on any future price increases to customers. It is also not possible to predict the impact of potential future cement supply shortages on our ability to procure needed supplies in our construction materials business.

Liquidity and Capital Resources

Summary of Cash Flow Activities . Net cash provided by operating activities during the nine months ended June 30, 2007 (“2007”) was $75.8 million compared to $172.7 million during the nine months ended June 30, 2006 (“2006”) . The primary reason for the change in cash provided by operations from 2006 to 2007 was the collection in 2006 of a $70.0 million receivable related to the litigation settlement reached with AJG in 2005, along with other changes in working capital. In 2006 and 2007, the primary investing activities consisted of payments for acquisitions and the purchase of property, plant and equipment. In 2007 financing activities consisted primarily of the issuance of a new series of convertible senior subordinated notes and the early repayment of a portion of our senior debt. In 2006, the primary financing activity consisted of repayments of long-term debt. More details about our investing and financing activities are provided in the following paragraphs.

Investing Activities . Total expenditures for property, plant and equipment in 2007 were not materially different from 2006. Most of the capital expenditures in both periods were incurred by the construction materials segment; however, in 2007, a higher proportion of total capital expenditures were incurred by the alternative energy segment as compared to 2006. A significant portion of our planned future capital expenditures represent expansion of operations, rather than maintenance of operating capacity, primarily due to growth initiatives in the alternative energy segment . Capital expenditures in fiscal 2007 are currently expected to exceed the fiscal 2006 amount. Capital expenditures are limited by our senior debt covenants to $100.0 million annually; however, the cumulative unused amounts of annual capital expenditures limits can be carried forward and used in subsequent years. As of September 30, 2006, we had approximately $25.4 million of unused amounts of capital expenditures from prior years and as of June 30, 2007, we were committed to spend approximately $27.8 million on capital projects that were in various stages of completion, primarily in the alternative energy segment.

We intend to continue to expand our business through growth of existing operations, commercialization of technologies currently being developed, and strategic acquisitions of products or entities that expand our current operating platform. Acquisitions are an important part of our business strategy and to that end, we routinely review potential complementary acquisitions, including those in the areas of construction materials, 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 will be used to fund acquisitions of complementary businesses in the chemical, energy, building products and related industries. The 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, unless our “total leverage ratio,” as defined, is less than or equal to 3.50:1.0, after giving effect to an acquisition, in which case the foregoing 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.

In 2007, we acquired 100% of the ownership interests of a privately-held company in the construction materials business. Total consideration paid of approximately $53.0 million consisted primarily of cash. During fiscal 2006, we acquired certain assets and assumed certain liabilities of several privately-held companies in the construction materials industry. Pursuant to contractual terms for some of the acquisitions, additional amounts may be payable in the future, based on the achievement of stipulated revenue or earnings targets for periods ending no later than March 2010. One such period for the 2007 acquisition ends September 30, 2007 and it is currently expected that the additional payment could be in excess of $20 million, which amount would be payable in fiscal 2008. If it is determined that future earn-out consideration is payable, goodwill will be increased accordingly.

As described in more detail in Note 5 to the consolidated financial statements and in our Form 10-K, we periodically test for goodwill impairment. We perform our annual impairment testing using a test date of June 30. Due primarily to the depressed residential housing and remodeling market, there is risk that one or more of our reporting units may fail the goodwill impairment test, requiring a write-down of goodwill. The goodwill impairment testing is expected to be completed in the quarter ending September 30, 2007, with any necessary non-cash impairment charges recorded in that quarter.

Reference is made to Note 9 to the consolidated financial statements for a discussion of our investments in joint ventures which are accounted for using the equity method of accounting.

Financing Activities . In 2006, financing activities consisted primarily of the repayment of long-term debt. In 2007, as described in more detail in Note 6 to the consolidated financial statements, we issued $160.0 million of 2.50% convertible senior subordinated notes due February 2014. Substantially all of the net proceeds of approximately $154.6 million, along with $5.2 million of available cash, were used to repay $152.8 million of senior debt and the remaining balance (approximately $7.0 million) of notes payable to a bank. As of June 30, 2007, we have no long-term debt repayments that are due prior to fiscal 2011. We may, in the future, make optional prepayments of the senior debt depending on actual cash flows, our current and expected cash requirements and other applicable factors we deem to be significant.

Due to covenants associated with our senior debt, we currently have restrictions on our ability to obtain significant additional amounts of long-term debt. However, we have historically experienced strong positive cash flow from operations and in fiscal 2005 issued common stock which together has enabled us to repay a substantial amount of our long-term debt prior to scheduled maturities. We expect our positive cash flow to continue in the future and also have the ability to access the equity markets if necessary.

In January 2007, we announced that we were planning an exchange offer for our 2.875% convertible senior subordinated notes due 2016, whereby new notes with similar, but not identical, terms, along with an exchange fee, would be issued upon tender of the existing notes. The commencement of an exchange offer has been indefinitely postponed.

Reference is made to Note 6 to the consolidated financial statements for detailed information about our outstanding long-term debt, interest rate hedges, and compliance with debt covenants, as well as the available $60.0 million revolving redit arrangement. Subject to obtaining additional revolving loan commitments, we can increase the revolving credit limit to $100.0 million . The senior credit facility contains restrictions and covenants common to such agreements, including limitations on the incurrence of additional debt, investments, merger and acquisition activity, asset sales and liens, annual capital expenditures in excess of $100.0 million annually, and the payment of dividends, among others. In addition, we must maintain certain leverage and fixed charge coverage ratios. We are in compliance with all debt covenants as of June 30, 2007.

In 2007, cash proceeds from the exercise of options and employee stock purchases totaled $2.1 million, compared to $8.3 million in 2006. 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, reflected in cash flows from financing activities in the consolidated statements of cash flows, were not material in 2006 or 2007.

Working Capital . As of June 30, 2007, our working capital was $184.5 million. Notwithstanding the expiration of Section 45K tax credits as of December 31, 2007 and the resulting impact on cash flow, we expect operations to produce positive cash flow in future periods and believe working capital, along with available borrowings under the revolving credit arrangement, will be sufficient for operating needs for the next 12 months.

Income Taxes . Our cash requirements for income taxes generally approximate the income tax provision; however, there is usually some lag in paying estimated taxes during a fiscal year due to the seasonality of our operations and because estimated income tax payments are typically based on annualizing the fiscal year’s income based on year-to-date results. There is also some lag in realizing the cash benefits from the utilization of tax credits due to the interaction of our September 30 fiscal year end and the different fiscal year ends of the entities through which we receive the tax credits. In 2007, there may be more variability in the relationship between the income tax provision and income tax payments because the tax provision calculation is materially dependent upon the estimated phase-out percentage of Section 45K tax credits (see Notes 7 and 9 to the consolidated financial statements). The calendar 2007 phase-out percentage is subject to material change because it is dependent on oil prices for all of calendar 2007, which are not predictable.

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 amount was not material in 2007. Option exercise activity is primarily dependent on our stock price which is not predictable, and likewise, it is not possible to estimate what tax benefits may be realized from future option exercises.

Summary of Future Cash Requirements . Significant future cash uses, in addition to operational working capital requirements, including income tax payments, are currently expected to consist primarily of capital expenditures, acquisitions and investments in joint ventures, and debt service payments on outstanding long-term debt. The board of directors recently authorized management to develop a stock repurchase program, subject to legal and financial review, which if carried out, could also result in a future use of cash.

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