Headwaters Incorporated Announces Results for Fiscal 2006 Second Quarter

-- 54% Increase in Diluted EPS to $0.40

-- 84% Increase in Net Income to $18.4 Million

-- 21% Increase in Revenue to $269.7 Million

-- Additional $10 million of license fees not recognized

-- Strong progress on strategic growth initiatives

Headwaters Incorporated (NYSE: HW) today announced results for itsquarter ended March 31, 2006. Total revenue for the quarter endedMarch 31, 2006 was $269.7 million, up 21% from $222.4 million reportedfor the March 2005 quarter. Operating income increased 5%, to $37.7million in the March 2006 quarter compared to $35.9 million in theprior year quarter. Net income for the March 2006 quarter was $18.4million or $0.40 of earnings per diluted share, using 48.9 millionweighted-average shares outstanding. Net income for the March 2005quarter was $10.0 million or $0.26 of earnings per diluted share,using 43.1 million weighted-average shares outstanding.

Due to uncertainty surrounding the phase-out of Section 29 creditsin 2006, no revenues have been recognized in the March quarter forseveral licensees whose payments to Headwaters are based on a portionof the tax credits earned by the licensee. Approximately $10 millionof potential license fees have not been recognized. The followingtable summarizes results of operations that would have been reportedfor the three months ended March 31, 2006, assuming no phase out ofSection 29 credits.
As Adjusted,
(in thousands, except per-share data) As Reported Using 0%
Phase-out
----------------------------------------------------------------------

Revenue $269,683 $280,140

Operating income $37,742 $46,500

Income before income taxes $26,601 $33,859

Income tax provision $(8,200) $(8,170)

Net income $18,401 $25,689

Diluted earnings per share $0.40 $0.55

Total revenue for the six months ended March 31, 2006 was $550.2million, up 25% from $440.8 million reported for the six months endedMarch 31, 2005. Operating income increased 24%, to $88.0 million forthe six months ended March 31, 2006 compared to $71.2 million in theprior year period. Net income for the six months ended March 31, 2006was $46.7 million or $1.00 of earnings per diluted share, using 48.8million weighted-average shares outstanding. Net income for the March2005 period was $21.1 million or $0.55 of earnings per diluted share,using 41.8 million weighted-average shares outstanding.

Headwaters Construction Materials Performance

Revenues from Headwaters' construction materials segment duringthe March 2006 quarter increased $22.5 million or 21%, to $131.7million versus $109.2 million for the prior year quarter. Gross marginpercentage decreased from 32% for the March 2005 quarter to 31% forthe 2006 quarter. Revenue increases occurred across all major productlines due to strong market demand and the introduction of newproducts. The primary reasons for the decline in gross marginpercentage were higher raw material costs and manufacturinginefficiencies related to expansion of capacity and new product linesand restructuring of operations at certain manufacturing facilities.We expect gross margins to improve in our third and fourth fiscalquarters.

During the quarter, Headwaters acquired a new product linedeveloped over the last ten years by a well know architectspecializing in concrete, utilizing recycled materials. Syndecrete(R)is an advanced cement based composite using natural minerals andrecycled materials as its primary ingredients. There are no resins orpolymers. Syndecrete is a solid surfacing material which providesconsistency of color, texture, and aggregate throughout. It is lessthan half the weight with twice the compressive strength of normalconcrete. Headwaters intends to further develop the marketing andimprove the manufacturing of Syndecrete in the areas of customconcrete counter tops and outdoor tiles.

Headwaters Resources Performance

Revenues from Headwaters' coal combustion products ("CCPs")segment during the March 2006 quarter increased $10.0 million or 21%,from $48.5 million to $58.5 million versus the comparable March 2005quarter. Gross margin percentage of 21% was flat compared to the March2005 quarter. The increase in revenue resulted from a combination ofcontinued strong demand for CCPs, upward pricing trends in most cementmarkets, and increased project revenues. In addition, weatherconditions in the south central region of the United States werefavorable.

Sales of high-value coal combustion products for the March 2006quarter totaled approximately 1.6 million tons, compared toapproximately 1.4 million tons for the March 2005 quarter, resultingin a 14% increase in tons of high-value coal combustion products sold.

Headwaters Energy Services Performance

Chemical reagent sales increased $10.0 million, or 25%, in theMarch 2006 quarter to $49.9 million, compared to $39.9 million in theMarch 2005 quarter. Headwaters Energy Services' license fees for theMarch 2006 quarter decreased $8.3 million or 34%, from $24.6 millionin the March 2005 quarter, to $16.3 million in the March 2006 quarter.The decrease in license fee revenues in the March 2006 quarterresulted primarily from no revenues being recognized for severallicensees whose payments to Headwaters are based on a portion of thetax credits earned by the licensee. Certain accounting rules governingrevenue recognition require that the seller's price to the buyer be"fixed or determinable," and the uncertainty surrounding the impact ofhigh oil prices on the potential phase-out of Section 29 precluderevenue recognition. Accordingly, revenues for these licensees willnot be recognized until such time as they become more certain.

Due to raw material cost increases, gross margins on chemicalreagent sales in the March 2006 quarter were 24% compared to 29% inthe March 2005 quarter. Headwaters expects reagent margins tostabilize near the current level during fiscal 2006, depending uponcrude oil prices and the availability of raw material feedstocks.

Headwaters' effective tax rate for the March 2006 quarter was 31%compared to 28% in the March 2005 quarter. Using available informationas of March 31, 2006, Headwaters calculated an estimated phase-outpercentage for Section 29 tax credits for calendar year 2006 of 37%.Headwaters used this estimated phase-out percentage in calculating itsestimated effective tax rate for fiscal 2006.

Section 29 tax credits are subject to phase-out after the averageannual domestic wellhead oil price ("reference price") reaches abeginning phase-out threshold price, and are eliminated entirely ifthe reference price reaches the full phase-out price. Historically,the reference price has trended somewhat lower than published marketprices for oil. For calendar 2005, the reference price was $50.26 perbarrel and the phase-out range began at $53.20 and would have fullyphased out tax credits at $66.78 per barrel. Therefore, there was nophase-out of tax credits for calendar 2005.

For calendar 2006, Headwaters estimates that the phase-out range(computed by increasing the 2005 inflation adjustment factor by 2%)begins at $54.27 and completes phase-out at $68.12 per barrel.Congress is considering legislation to change Section 29 phase-outcalculations to a prospective rather than retrospective application ofthe reference price. As of the date hereof, it is too early toestimate a reference price for calendar 2006. However, Headwatersestimates that if average oil prices for the calendar 2006 period todate are maintained for all of calendar 2006, and absent a change to aprospective application of the reference price, significant phase-outwould occur.

Headwaters Technology Innovation Group and New Product Development

The construction of a Headwaters/Degussa direct synthesis hydrogenperoxide demonstration plant located in Germany continues on scheduleand on budget. The operating results from the demonstration plant willprovide engineering data to enable the joint venture to construct aworld scale direct synthesis hydrogen peroxide manufacturing facility.In addition, Headwaters with its joint venture partner Degussa AG, isacquiring and expanding a hydrogen peroxide plant to be a platform forthe advancement of the joint venture's hydrogen peroxide for propyleneoxide business and the commercialization of Headwater's NxCatnanocatalysts.

Headwaters is continuing the commercialization of its HC3 heavyoil upgrading technology. In addition to the successful completion ofits initial commercial scale test at a European refinery, Headwatersis preparing for commercial operations at two additional ebullated bedfacilities. Pilot plant work is continuing on multiple heavy oilfeedstocks, including Canadian bitumen.

Headwaters has successfully completed pilot plant regeneration ofits reforming catalyst. A necessary step in the development of areforming catalyst is the ability to regenerate the catalyst after ithas reached the end of its activity in the reforming process.Regeneration allows the catalyst to be reused and conserves expensiveprecious metals that form the basis of the catalyst.

Capital Structure / Indebtedness

The components of Headwaters' debt structure as of March 31, 2006are as follows:
(in millions) Amount Interest Maturity
Outstanding Rate
----------------------------------------------------------------------
Senior secured first lien term loan $415.3 LIBOR + April 2011
2.0%
----------------------------------------------------------------------
Industrial Revenue Bond and other $7.7 5.1% to Currently
7.3% Callable
----------------------------------------------------------------------
Senior revolving credit facility $0 Prime + September
($60.0 million available less out- 0.75% 2009
standing letters of credit of
approximately $6.9 million)
----------------------------------------------------------------------
Senior subordinated convertible debt $172.5 2.875% June 2011
----------------------------------------------------------------------
Total $595.5
----------------------------------------------------------------------

In January 2006, Headwaters received the final $70.0 millionpayment due from a litigation settlement reached in 2005. Using theseproceeds, Headwaters repaid all of the $30.0 million that wasoutstanding under the revolving credit facility at December 31, 2005and also repaid an additional $24.0 million of the first lien termloan, effectively pre-paying all scheduled principal payments on theterm-debt until November 2007.

To supplement our condensed consolidated financial statementspresented in accordance with generally accepted accounting principles("GAAP"), we use a non-GAAP measure called EBITDA. EBITDA is netincome adjusted by adding net interest expense, income taxes,depreciation and amortization ("EBITDA"). Management uses EBITDAinternally to measure the amount of cash generated by Headwaters andto make decisions about the amount of capital expenditures Headwaterswill make and where to allocate capital. EBITDA is also provided toenhance the user's overall understanding of our current financialperformance, our ability to service our debt, our compliance withcurrent debt covenants and our ability to fund future growth.Therefore, we believe that EBITDA provides useful information to ourinvestors regarding our performance and overall results of operations.Our EBITDA measure presented here may not be comparable to similarlytitled measures presented by other companies.

The following table highlights certain debt coverage and balancesheet ratios using period end balances and the trailing twelve months("TTM") EBITDA:
Pro forma Actual Actual
9/30/04 9/30/05 3/31/06
----------------------------------------------------------------------
TTM EBITDA (in millions) $233.8 $277.6 $297.2
----------------------------------------------------------------------
Total Indebtedness to TTM EBITDA 4.16 2.36 2.00
----------------------------------------------------------------------
Current Ratio 1.24 1.49 1.81
----------------------------------------------------------------------
Total Debt to Equity 3.16 0.95 0.80
----------------------------------------------------------------------

The pro forma September 2004 calculations assume all of the 2004acquisitions occurred on October 1, 2003. Pro forma EBITDA for thetrailing twelve months ended September 30, 2004 of $233.8 million isderived as follows (in millions): Net income of $72.9 plus netinterest expense of $63.1, income taxes of $45.6, and depreciation andamortization of $52.2. Actual EBITDA for the trailing twelve monthsended September 30, 2005 of $277.6 million is derived as follows (inmillions): Net income of $121.3 plus net interest expense of $57.4,income taxes of $42.5, and depreciation and amortization of $56.4.Actual EBITDA for the trailing twelve months ended March 31, 2006 of$297.2 million is derived as follows (in millions): Net income of$146.8 plus net interest expense of $40.5, income taxes of $50.4, anddepreciation and amortization of $59.5. See "Current Ratio"calculations in financial tables that follow.

Commentary and Outlook

Scott K. Sorensen, Headwaters' Chief Financial Officer, stated,"Our quarterly performance continues to be strong with exceptionalrevenue growth and continues to mark our transition away from Section29. The consolidated operating margins were impacted by the lack ofrecognition of license fees and inefficiencies within our constructionmaterials segment. We remain hopeful that uncertainty surrounding theSection 29 issue will be resolved in the near term. Headwaters'balance sheet continues to improve, reflecting the fundamentalstrength in operating cash flow generated from our core businesses andour commitment to reducing debt."

"The acquisition of mineral leases providing us with access toalmost 150 million tons of waste coal is a major step towards therealization of a waste coal business and achievement of our EBITDAgoal from coal cleaning," said Kirk A. Benson, Chairman and ChiefExecutive Officer. "In addition, our progress on (HC)3, our ethanolfacility construction, and a pending hydrogen peroxide transaction allbode well for the complete replacement of Section 29 earnings."

Management will host a conference call with a simultaneous webcast today at 11:00 a.m. Eastern/9:00 a.m. Mountain to discuss theCompany's financial results and business outlook. The call will beavailable live via the Internet by accessing Headwaters' web site atwww.headwaters.com and clicking on the Investor Relations section. Tolisten to the live broadcast, please go to the web site at leastfifteen minutes early to register, download, and install any necessaryaudio software. For those who cannot listen to the live broadcast, anonline replay will be available for 90 days on www.headwaters.com, ora phone replay will be available through May 15, 2006 by dialing800-642-1687 or 706-645-9291 and entering the passcode 7837926.

About Headwaters Incorporated

Headwaters Incorporated is a world leader in creating valuethrough innovative advancements in the utilization of naturalresources. Headwaters is a diversified growth company providingproducts, technologies and services to the energy, construction andhome improvement industries. Through its alternative energy, coalcombustion products, and building materials businesses, the Companyearns a growing revenue stream that provides the capital needed toexpand and acquire synergistic new business opportunities.

Forward Looking Statements

Certain statements contained in this report are forward-lookingstatements within the meaning of federal securities laws andHeadwaters intends that such forward-looking statements be subject tothe safe-harbor created thereby. Forward-looking statements includeHeadwaters' expectations as to the managing and marketing of coalcombustion products, the production and marketing of buildingmaterials and products, the licensing of technology and chemical salesto alternative fuel facilities, the receipt of product sales, licensefees and royalty revenues, which are subject to tax credit phase outrisks, the development, commercialization, and financing of newtechnologies and other strategic business opportunities andacquisitions, and other information about Headwaters. Such statementsthat are not purely historical by nature, including those statementsregarding Headwaters' future business plans, the operation offacilities, the availability of tax credits in an environment of highoil prices and potential tax credit phase out,, the availability offeedstocks, and the marketability of the coal combustion products,building products, and synthetic fuel, are forward-looking statementswithin the meaning of the Private Securities Litigation Reform Act of1995 regarding future events and our future results that are based oncurrent expectations, estimates, forecasts, and projections about theindustries in which we operate and the beliefs and assumptions of ourmanagement. Actual results may vary materially from such expectations.Words such as "expects," "anticipates," "targets," "goals,""projects," "believes," "seeks," "estimates," variations of suchwords, and similar expressions are intended to identify suchforward-looking statements. Any statements that refer to projectionsof our future financial performance, our anticipated growth and trendsin our businesses, and other characterizations of future events orcircumstances, are forward-looking. In addition to matters affectingthe coal combustion product, alternative fuel, and building productsindustries or the economy generally, factors which could cause actualresults to differ from expectations stated in forward-lookingstatements include, among others, the factors described in thecaptions entitled "Forward-looking Statements" and "Risk Factors" inItem 7 in Headwaters' Annual Report on Form 10-K for the fiscal yearended September 30, 2005, Quarterly Reports on Form 10-Q, and otherperiodic filings and prospectuses.

Although Headwaters believes that its expectations are based onreasonable assumptions within the bounds of its knowledge of itsbusiness and operations, there can be no assurance that our results ofoperations will not be adversely affected by such factors. Unlesslegally required, we undertake no obligation to revise or update anyforward-looking statements for any reason. Readers are cautioned notto place undue reliance on these forward-looking statements, whichspeak only as of the date of this report. Our internet address iswww.headwaters.com. There we make available, free of charge, ourannual report on Form 10-K, quarterly reports on Form 10-Q, currentreports on Form 8-K and any amendments to those reports, as soon asreasonably practicable after we electronically file such materialwith, or furnish it to, the SEC. Our reports can be accessed throughthe investor relations section of our web site.
HEADWATERS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(in thousands, except per-share amounts)

Quarter Ended Six Months Ended
March 31, March 31,
2005 2006 2005 2006
------------------- -------------------
Revenue:
Construction materials $109,157 $131,709 $222,885 $261,678
Coal combustion products 48,467 58,491 101,519 123,656
Alternative energy 64,768 79,483 116,404 164,897
------------------- -------------------
Total revenue 222,392 269,683 440,808 550,231

Operating costs and expenses:
Construction materials 73,817 91,231 150,420 180,936
Coal combustion products 38,393 46,347 79,446 95,309
Alternative energy 28,590 52,590 53,245 100,247
Amortization 6,098 6,105 12,196 12,141
Research and development 2,967 3,355 5,351 6,319
Selling, general and
administrative 36,663 32,313 68,986 67,272
------------------- -------------------
Total operating costs and
expenses 186,528 231,941 369,644 462,224

------------------- -------------------
Operating income 35,864 37,742 71,164 88,007

Net interest expense (18,798) (8,709) (34,603) (17,660)
Other income (expense), net (3,222) (2,432) (5,140) (5,501)

------------------- -------------------
Income before income taxes 13,844 26,601 31,421 64,846

Income tax provision (3,870) (8,200) (10,310) (18,150)

------------------- -------------------
Net income $9,974 $18,401 $21,111 $46,696
=================== ===================

Basic earnings per share $0.28 $0.44 $0.61 $1.12
=================== ===================

Diluted earnings per share $0.26 $0.40 $0.55 $1.00
=================== ===================

Weighted average shares
outstanding -- basic 36,172 41,830 34,806 41,717
=================== ===================

Weighted average shares
outstanding -- diluted 43,068 48,934 41,810 48,780
=================== ===================



Notes: The results for the quarter and six months ended March 31,
2005 have been restated to reflect the early adoption in
fiscal 2005 of the fair value method of accounting for stock-
based compensation required by SFAS No. 123R, effective as of
October 1, 2004.

Total depreciation and amortization was $14,096 and $15,817
for the quarters ended March 31, 2005 and 2006, respectively,
and $27,683 and $30,780 for the six months ended March 31,
2005 and 2006, respectively.



HEADWATERS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(in thousands)

September March
30, 2005 31, 2006
Assets: -----------------------

Current assets:
Cash and cash equivalents $13,666 $56,775
Trade receivables, net 174,127 127,494
Other receivable 70,000 --
Inventories 60,519 68,202
Other 36,762 31,167
-----------------------
Total current assets 355,074 283,638

Property, plant and equipment, net 190,450 198,904
Intangible assets, net 276,248 261,685
Goodwill 811,545 826,258
Other assets 38,339 45,616

-----------------------
Total assets $1,671,656 $1,616,101
=======================

Liabilities and Stockholders' Equity:
Current liabilities:
Accounts payable $43,957 $32,009
Accrued liabilities 141,574 117,084
Current portion of long-term debt 52,207 7,682
-----------------------
Total current liabilities 237,738 156,775

Long-term debt 601,811 587,842
Deferred income taxes 108,449 106,577
Other long-term liabilities 37,345 24,192
-----------------------
Total liabilities 985,343 875,386
-----------------------

Stockholders' equity:
Common stock - par value 42 42
Capital in excess of par value 489,602 496,569
Retained earnings 197,808 244,504
Other (1,139) (400)
-----------------------
Total stockholders' equity 686,313 740,715

-----------------------
Total liabilities and stockholders' equity $1,671,656 $1,616,101
=======================

The current ratio as of September 30, 2005 of 1.49 is derived by
dividing total current assets of $355,074 by total current
liabilities of $237,738. The current ratio as of March 31, 2006 of
1.81 is derived by dividing total current assets of $283,638 by
total current liabilities of $156,775.

Note to editors: In the mention of (HC)3, the 3 should besubscript.