DEAR FELLOW SHAREHOLDERS:

Fiscal year 2009 proved to be an eventful year for Headwaters. Negative market conditions in the residential construction, remodeling, and commercial markets resulted in the most difficult operating environment building products companies have faced in decades. However, we successfully adapted to the changing environment and we believe we have laid the ground work for future success. We reduced our cost structure by over $50 million, reduced capital expenditures and conserved cash. The efficiencies and expense reductions we implemented during fiscal 2009 are working, and are providing us with operating leverage as the economy starts to recover. We recapitalized our balance sheet, created up to $140 million of liquidity and extended our debt maturities. In completing our recapitalization, Headwaters substantially reduced its financial risk and improved its overall operating flexibility. We now have a sound capital structure and are positioned to focus our resources on profitable growth initiatives.

During fiscal 2009 Headwaters’ light building products segment continued to feel the effects of the weak construction markets. Because of the recession and down cycle in new residential construction, fiscal 2009 revenues decreased by $116 million. Our response was to become more efficient, reducing manufacturing and administrative costs, improving working capital management, and right sizing our business. As a result of our employees’ efforts, and in spite of the loss in revenue, our gross margins actually improved year over year in the September quarter by 270 basis points. We introduced some new products, maintained our market share and pricing in existing products, and positioned ourselves for the anticipated improvement in the economy.

Our heavy construction materials segment is the largest domestic manager and marketer of coal combustion products (CCPs), including fly ash. The majority of the segment’s revenue is generated from sales of fly ash which is used as a substitute for portland cement in major infrastructure projects, as well as residential and commercial construction. Revenue of the heavy construction materials business declined by $52 million due to the recession. However, we identified over $12 million of annualized cost savings, and realized over $6 million of the savings in 2009. As a result, our fourth quarter EBITDA margins actually improved by 40 basis points. We believe that the 2010 outlook for our heavy construction materials business should improve due to the Federal stimulus bill that was passed in 2009 and our heavy emphasis on infrastructure markets. As we move into the 2010 construction season, stimulus spending should significantly increase, leading to incremental demand for fly ash. In addition, we recently announced three new contracts that should provide $14 million of incremental revenue for Headwaters in 2010.

Our energy operations continue to create value while helping to protect the environment by upgrading waste coal feedstocks into a marketable product, converting coal to liquid fuels, and utilizing waste heat from a coal-fired power plant in the production of ethanol. Headwaters processes waste coal by removing impurities, reclaiming waste ponds and improving the environment. The coal cleaning process reduces the ash content of the treated coal, and at the same time reduces mercury and sulfur, producing a cleaner coal product with improved fuel combustion characteristics.

Revenue from Headwater’s coal cleaning business for fiscal 2009 was $58.1 million, up from $38.7 million reported for fiscal 2008. Although total revenue increased, the business was challenged by declining coal prices, and soft demand for coal during the year. In response to these market conditions, the Company temporarily idled four of its eleven plants to align production to sales, and to concentrate production in fewer facilities. We also merged our coal cleaning and fly ash businesses and focused on reducing fixed costs. These steps resulted in substantially reducing SG&A and total fixed costs during fiscal 2009.

Despite the current economic environment we will continue to make improvements that will position us for the years ahead. Headwaters’ management remains committed to delivering sustainable growth and value for our shareholders.


Sincerely,
Kirk A. Benson

Chairman and CEO