DEAR FELLOW SHAREHOLDERS:

We entered fiscal 2008 knowing that we faced tremendous challenges. Our Section 45K business was ending, and the most dramatic slowdown in residential construction in 50 years was just getting started. In response to the end of Section 45K, we have built a coal cleaning business that has the potential of completely replacing the revenues and operating income lost when Section 45K ended. In building products, we have right sized the business, reducing employment by over 40%, consolidating facilities, and increasing productivity.

We began fiscal 2008 with three coal cleaning facilities in service, and ended with eight facilities ramping up production. We have three additional coal cleaning facilities that will be completed and placed in service by calendar 2008 year end. Our coal cleaning employees delivered on Headwaters’ promise to realize between $30 and $40 million of revenue in 2008, finishing the year at $38.7 million, up from $2.2 million in 2007. As our clean coal business gains mass in 2009, we anticipate more than $100 million in revenue, with strong operating margins and a potential ROIC in the top quartile of mining companies. The potential ROIC performance in our clean coal business is truly outstanding and places us with a small number of elite firms.

Today, Headwaters Resources remains the largest marketer of coal combustion products (“CCPs”) in the United States, controlling roughly 50% of the market. CCPs may be used as a partial replacement for portland cement; typically, 20% to 30% replacement is possible. Over the last four years we have almost doubled operating income, expanding a business that consistently generates an ROIC above 12%, a top quartile performance. In 2009, ready mix production is projected to be down more than 10%, but we have the possibility of exceeding market expectations by growing revenue in the face of the recession through increased levels of portland cement substitution. Substitution of fly ash for portland cement also reduces CO2 emissions, helping to combat global warming. California has recognized fly ash’s environmental benefit by proposing mandated portland cement substitution for all construction in California.

In 2008, home builders struggled with tighter credit markets, higher mortgage default rates, and higher inventory numbers for new and existing homes, resulting in a dramatic reduction in construction. We responded by right sizing the business and emphasizing our expanding portfolio of new products. Sales of new products and brands have increased by 13.5% to a total of $92.2 million in fiscal 2008. These new products and brands currently represent 20% of our total building products sales. As a result, our revenue only declined by 16% in 2008, compared to a 30% decline in new residential construction. And even with margin pressure, our Building Products division continues to generate substantial positive cash flow, with an EBITDA of $73.6 million. 2009 promises to be just as challenging as 2008, and we will face the challenge with continued cost control measures combined with growth in new products. It is notable that Headwaters’ return on invested capital compares favorably to some of American’s most recognized companies. For fiscal year 2009, we are projecting a strong return on invested capital for the Company overall. Our Energy Services and Resources groups are expected to generate return on invested capital of more than 12%. This compares favorably with the performance of stellar brands such as Tyco (6.8%), Berkshire Hathaway (6.6%), and General Electric (6.5%).

Our high ROIC businesses are linked by a commitment to improving the sustainability of the world in which we live. Our vision statement succinctly identifies Headwaters with a future world of sustainable operations:

Headwaters improves sustainability by transforming underutilized resources into valuable products.”

During these challenging times, we have often reminded ourselves of the old aphorism: “Life isn’t about waiting for the storm to pass, it’s about learning how to dance in the rain.”

We are proud of the effort Headwaters employees have made to work through the transition away from Section 45K and the building products down cycle. In every case, our employees have responded by continuing to innovate and deploy our Company’s assets with care.

We invite you to review the remainder of this Annual Report. More than just a window to our past, it offers a view of how we can create value in the future by making the world a better place.


Sincerely,
Kirk A. Benson

Chairman and CEO