**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D. C. 20549**

**FORM 10-Q**
| **x**                                                  | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**   |
|--------------------------------------------------------|------------------------------------------------------------------------------------------------|
| **For the quarterly period ended September 30,  2006** |
| **or**                                                 |
| **o**                                                  | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission File Number 001-13711**

**WALTER INDUSTRIES, INC.**

| Incorporated in **Delaware** |   | IRS Employer  Identification No. **13-3429953** |
|------------------------------|--------|-------------------------------------------------|

 

**4211 W. Boy Scout Boulevard,Tampa, Florida  33607**

Telephone Number **(813) 871-4811**

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months, and (2) has been subject to such filing requirements for the past 90days.   Yes x   No o.

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of the ExchangeAct. (Check one):  Large acceleratedfiler x   Acceleratedfiler o   Non-acceleratedfiler o

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act.  (Check one):   Yes o   No x.

There were 43,672,440shares of common stock of the registrant outstanding at October 31, 2006.

 

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**PART I - FINANCIALINFORMATION**

**ITEM 1.**                FINANCIALSTATEMENTS

**WALTER INDUSTRIES, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS(UNAUDITED)**

| ** **                                                                          | ** ** | **   September 30,   **   | ** ** | **   December 31,   ** | ** ** |
|-------------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                          | ** ** | **2006**                                                     | ** ** | **2005**                                                  | ** ** |
| ** **                                                                          | ** ** | **(in thousands, except share amounts)** | ** ** |
| ASSETS                                                                              |       |                                                         |       |                                                      |       |   |   |   |   |
| Cash and cash  equivalents                                                          |       |                                                         | $          | 160,644                                                   |       |   |   | $ | 137,396 |   |   |
| Short-term investments,  restricted                                                 |       |                                                         | 86,296     |                                                      |       |   | 124,573 |   |   |
| Instalment notes  receivable, net of allowance of $12,945 and $12,489, respectively |       |                                                         | 1,765,794  |                                                      |       |   | 1,693,922 |   |   |
| Receivables, net                                                                    |       |                                                         | 436,954    |                                                      |       |   | 351,115 |   |   |
| Inventories                                                                         |       |                                                         | 557,183    |                                                      |       |   | 551,293 |   |   |
| Prepaid expenses                                                                    |       |                                                         | 63,987     |                                                      |       |   | 31,320 |   |   |
| Property, plant and  equipment, net                                                 |       |                                                         | 637,272    |                                                      |       |   | 603,350 |   |   |
| Other long-term assets                                                              |       |                                                         | 159,061    |                                                      |       |   | 154,365 |   |   |
| Identifiable  intangibles, net                                                      |       |                                                         | 842,271    |                                                      |       |   | 858,122 |   |   |
| Goodwill                                                                            |       |                                                         | 876,370    |                                                      |       |   | 867,556 |   |   |
|                                                                                |       |                                                         | $          | 5,585,832                                                 |       |   |   | $ | 5,373,012 |   |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                           |       |                                                         |       |                                                      |       |   |   |   |   |
| Accounts payable                                                                    |       |                                                         | $          | 197,457                                                   |       |   |   | $ | 161,215 |   |   |
| Accrued expenses                                                                    |       |                                                         | 215,772    |                                                      |       |   | 213,596 |   |   |
| Deferred income taxes                                                               |       |                                                         | 252,464    |                                                      |       |   | 215,874 |   |   |
| Debt:                                                                               |       |                                                         |       |                                                      |       |   |   |   |   |
| Mortgage-backed/asset-backed  notes                                                 |       |                                                         | 1,687,968  |                                                      |       |   | 1,727,329 |   |   |
| Other debt                                                                          |       |                                                         | 1,549,992  |                                                      |       |   | 2,172,453 |   |   |
| Accrued interest                                                                    |       |                                                         | 32,143     |                                                      |       |   | 32,619 |   |   |
| Accumulated  postretirement benefits obligation                                     |       |                                                         | 271,634    |                                                      |       |   | 275,336 |   |   |
| Other long-term liabilities                                                         |       |                                                         | 271,346    |                                                      |       |   | 285,974 |   |   |
| Total liabilities                                                                   |       |                                                         | 4,478,776  |                                                      |       |   | 5,084,396 |   |   |
| Minority interest                                                                   |       |                                                         | 304,733    |                                                      |       |   | — |   |   |
| Commitments and contingencies (Note 15)                                             |       |                                                         |       |                                                      |       |   |   |   |   |
| Stockholders’ equity                                                           |       |                                                         |       |                                                      |       |   |   |   |   |
| Common stock, $.01 par value per share:                                             |       |                                                         |       |                                                      |       |   |   |   |   |
| Authorized—200,000,000  shares Issued—64,442,771 and 59,818,401 shares    |       |                                                         | 645        |                                                      |       |   | 598 |   |   |
| Capital in excess of par  value                                                     |       |                                                         | 1,545,852  |                                                      |       |   | 1,210,751 |   |   |
| Accumulated deficit                                                                 |       |                                                         | (439,497)  |                                                      |       |   | (602,002) |   |   |
| Treasury stock—20,771,902  shares, at cost                                     |       |                                                         | (259,317)  |                                                      |       |   | (259,317) |   |   |
| Accumulated other  comprehensive loss                                               |       |                                                         | (45,360)   |                                                      |       |   | (61,414) |   |   |
| Total stockholders’  equity                                                    |       |                                                         | 802,323    |                                                      |       |   | 288,616 |   |   |
|                                                                                |       |                                                         | $5,585,832 |                                                      |       |   | $ | 5,373,012 |   |   |

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

2

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**WALTER INDUSTRIES, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(UNAUDITED)**

| ** **                                                                         | ** ** | **For the three months ended September 30,**                                                                                                       | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **              2006              ** | ** ** | **              2005              ** | ** ** |
| ** **                                                                         | ** ** | **(in thousands, except per share amounts)**                                                                                                            | ** ** |
| Net sales and revenues:                                                            |       |                                                                                                                                                                             |       |   |   |   |   |   |   |
| Net sales                                                                          |       |                                                                                                                                                                             | $          | 795,555 |   |   |   | $ | 362,046 |   |   |
| Interest income on instalment notes                                                |       |                                                                                                                                                                             | 49,434     |   |   |   | 50,977 |   |   |
| Miscellaneous                                                                      |       |                                                                                                                                                                             | 12,036     |   |   |   | 5,672 |   |   |
|                                                                               |       |                                                                                                                                                                             | 857,025    |   |   |   | 418,695 |   |   |
| Cost and  expenses:                                                                |       |                                                                                                                                                                             |       |   |   |   |   |   |   |
| Cost of sales (exclusive of depreciation)                                          |       |                                                                                                                                                                             | 555,975    |   |   |   | 280,327 |   |   |
| Depreciation                                                                       |       |                                                                                                                                                                             | 27,612     |   |   |   | 14,238 |   |   |
| Selling, general and administrative                                                |       |                                                                                                                                                                             | 92,121     |   |   |   | 48,328 |   |   |
| Provision for losses on instalment notes                                           |       |                                                                                                                                                                             | 1,946      |   |   |   | 3,076 |   |   |
| Postretirement benefits                                                            |       |                                                                                                                                                                             | 4,017      |   |   |   | 3,240 |   |   |
| Interest expense—mortgage-backed/asset-backed notes                           |       |                                                                                                                                                                             | 29,465     |   |   |   | 30,046 |   |   |
| Interest expense—other debt                                                   |       |                                                                                                                                                                             | 36,390     |   |   |   | 3,595 |   |   |
| Amortization of intangibles                                                        |       |                                                                                                                                                                             | 7,684      |   |   |   | 837 |   |   |
| Provision for estimated hurricane insurance losses                                 |       |                                                                                                                                                                             | —     |   |   |   | 12,200 |   |   |
| Restructuring and impairment charges (credits)                                     |       |                                                                                                                                                                             | —     |   |   |   | (1,243 | ) |   |
|                                                                               |       |                                                                                                                                                                             | 755,210    |   |   |   | 394,644 |   |   |
| Income from continuing operations before income tax  expense and minority interest |       |                                                                                                                                                                             | 101,815    |   |   |   | 24,051 |   |   |
| Income tax  expense                                                                |       |                                                                                                                                                                             | (29,744    | ) |   |   | (3,681 | ) |   |
| Income from  continuing operations before minority interest                        |       |                                                                                                                                                                             | 72,071     |   |   |   | 20,370 |   |   |
| Minority interest  in net income of affiliates                                     |       |                                                                                                                                                                             | (6,889     | ) |   |   | — |   |   |
| Income from  continuing operations                                                 |       |                                                                                                                                                                             | 65,182     |   |   |   | 20,370 |   |   |
| Discontinued  operations, net of income taxes                                      |       |                                                                                                                                                                             | (1,937     | ) |   |   | (173 | ) |   |
| Net income                                                                         |       |                                                                                                                                                                             | $          | 63,245 |   |   |   | $ | 20,197 |   |   |
| Basic income per  share:                                                           |       |                                                                                                                                                                             |       |   |   |   |   |   |   |
| Income from continuing operations                                                  |       |                                                                                                                                                                             | $          | 1.49 |   |   |   | $ | 0.53 |   |   |
| Discontinued operations                                                            |       |                                                                                                                                                                             | (0.04      | ) |   |   | (0.01 | ) |   |
| Net income                                                                         |       |                                                                                                                                                                             | $          | 1.45 |   |   |   | $ | 0.52 |   |   |
| Diluted income  per share:                                                         |       |                                                                                                                                                                             |       |   |   |   |   |   |   |
| Income from continuing operations                                                  |       |                                                                                                                                                                             | $          | 1.27 |   |   |   | $ | 0.44 |   |   |
| Discontinued operations                                                            |       |                                                                                                                                                                             | (0.04      | ) |   |   | (0.01 | ) |   |
| Net income                                                                         |       |                                                                                                                                                                             | $          | 1.23 |   |   |   | $ | 0.43 |   |   |

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

3

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**WALTER INDUSTRIES, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(UNAUDITED)**

| ** **                                                                         | ** ** | **For the nine months ended September 30,**                                                                                            | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **             2006             ** | ** ** | **             2005             ** | ** ** |
| ** **                                                                         | ** ** | **(in thousands, except per share amounts)**                                                                                                | ** ** |
| Net sales and revenues:                                                            |       |                                                                                                                                                                 |       |   |   |   |   |   |   |
| Net sales                                                                          |       |                                                                                                                                                                 | $          | 2,255,361 |   |   |   | $ | 1,079,287 |   |   |
| Interest income on instalment notes                                                |       |                                                                                                                                                                 | 150,901    |   |   |   | 157,580 |   |   |
| Miscellaneous                                                                      |       |                                                                                                                                                                 | 29,765     |   |   |   | 16,063 |   |   |
|                                                                               |       |                                                                                                                                                                 | 2,436,027  |   |   |   | 1,252,930 |   |   |
| Cost and expenses:                                                                 |       |                                                                                                                                                                 |       |   |   |   |   |   |   |
| Cost of sales (exclusive of depreciation)                                          |       |                                                                                                                                                                 | 1,573,801  |   |   |   | 816,050 |   |   |
| Depreciation                                                                       |       |                                                                                                                                                                 | 79,932     |   |   |   | 43,063 |   |   |
| Selling, general and administrative                                                |       |                                                                                                                                                                 | 274,302    |   |   |   | 144,913 |   |   |
| Provision for losses on instalment notes                                           |       |                                                                                                                                                                 | 6,761      |   |   |   | 8,210 |   |   |
| Postretirement benefits                                                            |       |                                                                                                                                                                 | 12,052     |   |   |   | 9,712 |   |   |
| Interest expense—mortgage-backed/asset-backed notes                           |       |                                                                                                                                                                 | 88,399     |   |   |   | 92,583 |   |   |
| Interest expense—other debt                                                   |       |                                                                                                                                                                 | 121,045    |   |   |   | 11,304 |   |   |
| Amortization of intangibles                                                        |       |                                                                                                                                                                 | 23,413     |   |   |   | 2,823 |   |   |
| Provision (credit) for estimated hurricane insurance  losses                       |       |                                                                                                                                                                 | (1,046     | ) |   |   | 11,644 |   |   |
| Restructuring and impairment charges (credits)                                     |       |                                                                                                                                                                 | 5,622      |   |   |   | (633 | ) |   |
|                                                                               |       |                                                                                                                                                                 | 2,184,281  |   |   |   | 1,139,669 |   |   |
| Income from  continuing operations before income tax expense and minority interest |       |                                                                                                                                                                 | 251,746    |   |   |   | 113,261 |   |   |
| Income tax  expense                                                                |       |                                                                                                                                                                 | (79,856    | ) |   |   | (32,228 | ) |   |
| Income from  continuing operations before minority interest                        |       |                                                                                                                                                                 | 171,890    |   |   |   | 81,033 |   |   |
| Minority interest  in net income of affiliates                                     |       |                                                                                                                                                                 | (7,176     | ) |   |   | — |   |   |
| Income from  continuing operations                                                 |       |                                                                                                                                                                 | 164,714    |   |   |   | 81,033 |   |   |
| Discontinued  operations, net of income taxes                                      |       |                                                                                                                                                                 | (2,209     | ) |   |   | (590 | ) |   |
| Net income                                                                         |       |                                                                                                                                                                 | $          | 162,505 |   |   |   | $ | 80,443 |   |   |
| Basic income per  share:                                                           |       |                                                                                                                                                                 |       |   |   |   |   |   |   |
| Income from continuing operations                                                  |       |                                                                                                                                                                 | $          | 3.87 |   |   |   | $ | 2.11 |   |   |
| Discontinued operations                                                            |       |                                                                                                                                                                 | (0.05      | ) |   |   | (0.01 | ) |   |
| Net income                                                                         |       |                                                                                                                                                                 | $          | 3.82 |   |   |   | $ | 2.10 |   |   |
| Diluted income per  share:                                                         |       |                                                                                                                                                                 |       |   |   |   |   |   |   |
| Income from continuing operations                                                  |       |                                                                                                                                                                 | $          | 3.25 |   |   |   | $ | 1.72 |   |   |
| Discontinued operations                                                            |       |                                                                                                                                                                 | (0.05      | ) |   |   | (0.01 | ) |   |
| Net income                                                                         |       |                                                                                                                                                                 | $          | 3.20 |   |   |   | $ | 1.71 |   |   |

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

4

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**WALTER INDUSTRIES,INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY**FOR THE NINE MONTHSENDED SEPTEMBER 30, 2006(UNAUDITED)(in thousands)

| ** **                                                                | ** ** | **Total** | ** ** | **Comprehensive  Income** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Common  Stock** | ** ** | **Capital in  Excess of  Par Value** | ** ** | **Treasury  Stock** | ** ** |
|---------------------------------------------------------------------------|------------|-----------|------------|---------------------------|------------|--------------------------|------------|-----------------------------------------------------------|------------|-------------------|------------|-----------------------------------------------------|------------|---------------------|------------|
| Balance at December 31,  2005                                        |       | $         | 288,616    |                      |       |                     |       |                                                      |       | $                 | (602,002   | )                                                   |       |                | $          | (61,414 | ) |   |   | $ | 598 |   |   | $ | 1,210,751 |   | $ | (259,317 | ) |
| Comprehensive income:                                                     |       |      |       |                      |       |                     |       |                                                      |       |              |       |                                                |       |                |       |   |   |   |   |   |   |   |   |
| Net income                                                                |       | 162,505   |       |                      | $          | 162,505                  |       |                                                      |       | 162,505           |       |                                                |       |                |       |   |   |   |   |   |   |   |   |   |
| Other  comprehensive income, net of tax                                   |       |      |       |                      |       |                     |       |                                                      |       |              |       |                                                |       |                |       |   |   |   |   |   |   |   |   |
| Cumulative foreign currency translation adjustment                        |       | 2,182     |       |                      | 2,182      |                     |       |                                                      |       |              |       |                                                | 2,182      |                |       |   |   |   |   |   |   |   |   |
| Net unrealized gain on hedges                                             |       | 6,912     |       |                      | 6,912      |                     |       |                                                      |       |              |       |                                                | 6,912      |                |       |   |   |   |   |   |   |   |   |
| Comprehensive income                                                      |       |      |       |                      | $          | 171,599                  |       |                                                      |       |              |       |                                                |       |                |       |   |   |   |   |   |   |   |   |   |
| Sale of common stock                                                      |       | 168,680   |       |                      |       |                     |       |                                                      |       |              |       |                                                |       |                |       |   | 26 |   |   | 168,654 |   |   |   |
| Stock issued upon conversion of convertible notes                         |       | 25,862    |       |                      |       |                     |       |                                                      |       |              |       |                                                |       |                |       |   | 15 |   |   | 25,847 |   |   |   |
| Gain on sale of investment in subsidiary through  initial public offering |       | 132,353   |       |                      |       |                     |       |                                                      |       |              |       |                                                | 6,960      |                |       |   |   |   |   | 125,393 |   |   |   |
| Stock issued upon exercise of stock options                               |       | 4,558     |       |                      |       |                     |       |                                                      |       |              |       |                                                |       |                |       |   | 6 |   |   | 4,552 |   |   |   |
| Tax benefit on the exercise of stock options                              |       | 7,150     |       |                      |       |                     |       |                                                      |       |              |       |                                                |       |                |       |   |   |   |   | 7,150 |   |   |   |
| Dividends paid, $.12 per share                                            |       | (5,053    | )          |                      |       |                     |       |                                                      |       |              |       |                                                |       |                |       |   |   |   |   | (5,053 | ) |   |   |
| Stock-based compensation                                                  |       | 8,558     |       |                      |       |                     |       |                                                      |       |              |       |                                                |       |                |       |   |   |   |   | 8,558 |   |   |   |
| Balance at  September 30, 2006                                       |       | $         | 802,323    |                      |       |                     |       |                                                      |       | $                 | (439,497   | )                                                   |       |                | $          | (45,360 | ) |   |   | $ | 645 |   |   | $ | 1,545,852 |   | $ | (259,317 | ) |

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

** **

5

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**WALTER INDUSTRIES,INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)**

| ** **                                                                      | ** ** | **For the nine months ended**                                | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                                                                      | ** ** | **September 30,**                                                           | ** ** |
| ** **                                                                      | ** ** | **      2006      ** | ** ** | **      2005      ** | ** ** |
| ** **                                                                      | ** ** | **(in thousands)**                                                          | ** ** |
| OPERATING ACTIVITIES                                                            |       |                                                                             |       |   |   |   |   |   |   |
| Net income                                                                      |       |                                                                             | $          | 162,505 |   |   |   | $ | 80,443 |   |   |
| Adjustments  to reconcile income to net cash provided by continuing operations: |       |                                                                             |       |   |   |   |   |   |   |
| Minority interest in net income of affiliates, net of  tax                      |       |                                                                             | 7,176      |   |   |   | — |   |   |
| Discontinued operations, net of tax                                             |       |                                                                             | 2,209      |   |   |   | 590 |   |   |
| Provision for losses on instalment notes receivable                             |       |                                                                             | 6,761      |   |   |   | 8,210 |   |   |
| Depreciation                                                                    |       |                                                                             | 79,932     |   |   |   | 43,063 |   |   |
| Restructuring and impairment charges                                            |       |                                                                             | 1,135      |   |   |   | - |   |   |
| Provision for deferred income taxes                                             |       |                                                                             | 36,053     |   |   |   | 15,827 |   |   |
| Tax benefit on the exercise of employee stock options                           |       |                                                                             | (7,150     | ) |   |   | 15,645 |   |   |
| Amortization of intangibles                                                     |       |                                                                             | 23,413     |   |   |   | 2,823 |   |   |
| Amortization of debt expense                                                    |       |                                                                             | 13,115     |   |   |   | 4,760 |   |   |
| Other                                                                           |       |                                                                             | (4,384     | ) |   |   | 4,544 |   |   |
| Decrease  (increase) in assets:                                                 |       |                                                                             |       |   |   |   |   |   |   |
| Receivables                                                                     |       |                                                                             | (92,859    | ) |   |   | (37,934 | ) |   |
| Inventories                                                                     |       |                                                                             | (1,510     | ) |   |   | (57,012 | ) |   |
| Prepaid expenses                                                                |       |                                                                             | (32,127    | ) |   |   | (2,771 | ) |   |
| Instalment notes receivable, net                                                |       |                                                                             | (14,808    | ) |   |   | 46,760 |   |   |
| Increase  (decrease) in liabilities:                                            |       |                                                                             |       |   |   |   |   |   |   |
| Accounts payable                                                                |       |                                                                             | 19,603     |   |   |   | 20,447 |   |   |
| Accrued expenses                                                                |       |                                                                             | (11,072    | ) |   |   | 16,169 |   |   |
| Accrued interest                                                                |       |                                                                             | (476       | ) |   |   | 119 |   |   |
| Cash flows provided by continuing operations                                    |       |                                                                             | 187,516    |   |   |   | 161,683 |   |   |
| Cash flows used in discontinued operations                                      |       |                                                                             | (377       | ) |   |   | (590 | ) |   |
| Cash flows provided by operating activities                                     |       |                                                                             | 187,139    |   |   |   | 161,093 |   |   |
| INVESTING ACTIVITIES                                                            |       |                                                                             |       |   |   |   |   |   |   |
| Acquisitions, net of cash acquired                                              |       |                                                                             | (5,095     | ) |   |   | — |   |   |
| Purchases of loans                                                              |       |                                                                             | (96,083    | ) |   |   | (41,444 | ) |   |
| Principal payments received on purchased loans                                  |       |                                                                             | 32,258     |   |   |   | 15,599 |   |   |
| Decrease in short-term investments, restricted                                  |       |                                                                             | 38,277     |   |   |   | 6,616 |   |   |
| Additions to property, plant and equipment                                      |       |                                                                             | (131,523   | ) |   |   | (94,847 | ) |   |
| Cash proceeds from sale of property, plant and  equipment                       |       |                                                                             | 10,432     |   |   |   | 7,278 |   |   |
| Decrease in investments                                                         |       |                                                                             | (86        | ) |   |   | (2,728 | ) |   |
| Cash flows used in investing activities                                         |       |                                                                             | (151,820   | ) |   |   | (109,526 | ) |   |
| FINANCING  ACTIVITIES                                                           |       |                                                                             |       |   |   |   |   |   |   |
| Issuance of mortgage-backed/asset-backed notes                                  |       |                                                                             | 145,000    |   |   |   | 104,532 |   |   |
| Retirement of mortgage-backed/asset-backed notes                                |       |                                                                             | (184,478   | ) |   |   | (204,096 | ) |   |
| Proceeds from issuance of other debt                                            |       |                                                                             | -          |   |   |   | 93,500 |   |   |
| Retirement of debt                                                              |       |                                                                             | (590,916   | ) |   |   | (83,500 | ) |   |
| Sale of common stock                                                            |       |                                                                             | 168,680    |   |   |   | — |   |   |
| Proceeds from subsidiary’s initial public offering                         |       |                                                                             | 428,924    |   |   |   | — |   |   |
| Tax benefit on the exercise of employee stock options                           |       |                                                                             | 7,150      |   |   |   | — |   |   |
| Other                                                                           |       |                                                                             | 15,656     |   |   |   | 11,620 |   |   |
| Cash flows used in financing activities                                         |       |                                                                             | (9,984     | ) |   |   | (77,944 | ) |   |
| Effect of exchange rate changes on cash                                         |       |                                                                             | (2,087     | ) |   |   | — |   |   |
| Net increase (decrease) in cash and cash equivalents                            |       |                                                                             | 23,248     |   |   |   | (26,377 | ) |   |
| Cash and cash equivalents at beginning of period                                |       |                                                                             | 137,396    |   |   |   | 46,924 |   |   |
| Cash and cash  equivalents at end of period                                     |       |                                                                             | $          | 160,644 |   |   |   | $ | 20,547 |   |   |

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

6

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**SUPPLEMENTALDISCLOSURES:**

(a)           The Company recordedrestructuring and impairment charges of $5.6 million for the nine months ended September 30,2006. The non-cash portion of these charges primarily consists of an assetimpairment charge for Sloss Industries’, included in the “Other” segment. Areconciliation of non-cash restructuring and impairment charges is providedbelow:

| ** **                                  | ** ** | **For the**                 | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|
| ** **                                  | ** ** | **nine months ended**  | ** ** |
| ** **                                  | ** ** | **September 30, 2006** | ** ** |
| Accrued expenses                            |       |                             | $          | 4,487 |   |   |
| Non-cash                                    |       |                             | 1,135      |   |   |
| Total restructuring and  impairment charges |       |                             | $          | 5,622 |   |   |

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

7

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**WALTER INDUSTRIES,INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSAS OF AND FOR THE THREE AND NINE MONTHS ENDED**SEPTEMBER 30, 2006(Unaudited)

**Note 1—Basis ofPresentation**

Walter Industries, Inc. (“Walter”), together withits consolidated subsidiaries (“the Company”), is a diversified company whichoperates in seven reportable segments: Mueller (“Mueller Co.”), Anvil, U.S. Pipe, Natural Resources,Homebuilding, Financing and Other, see Note 13. Through these operatingsegments, the Company offers a diversified line of products and servicesincluding water infrastructure and flow control products, coal, natural gas,home construction and mortgage financing, furnace and foundry coke and slagfiber.

The accompanying unaudited condensed consolidatedfinancial statements of the Company have been prepared in accordance withaccounting principles generally accepted in the United States for interimfinancial information and with the instructions to Form 10-Q and Article 10of Regulation S-X. Accordingly, they do not include all of the information andfootnotes required by accounting principles generally accepted in the UnitedStates for complete financial statements. In the opinion of management, alladjustments (consisting of normal recurring accruals) considered necessary fora fair presentation have been included. Operating results for the three andnine month periods ended September 30, 2006 are not necessarily indicativeof the results that may be expected for the year ending December 31, 2006.

The balance sheet at December 31,2005 has been derived from the audited financial statements at that date butdoes not include all of the information and footnotes required by accountingprinciples generally accepted in the United States for complete financialstatements.

**Note 2—InitialPublic Offering of Mueller Water Products, Inc.**

In June 2006, Mueller Water Products, Inc. (“MuellerWater”) completed its initial public offering (“IPO”) of 28.8 million shares ofSeries A common stock, at $16.00 per share (NYSE: MWA). The gross proceedsof $460.0 million were reduced by $27.6 million in underwriter fees and $3.5million of other costs. The net proceeds were used to repay a portion ofMueller Water’s existing debt, see Note 10.

In connection with theissuance of the Series A common stock, Mueller Water issued 85.8 millionshares of Series B common stock to the Company in exchange for the Company’sone share held prior to the IPO. Following the completion of the IPO, theCompany owns 74.9% of Mueller Water’s common stock outstanding in the form of100% ownership of the Series B common stock outstanding, which provideseight votes per share. As a result, the Company has an effective votinginterest of 96.3% of the combined voting power of all of Mueller Water’soutstanding common stock. The Company recognized a gain of $132.4 million onthe sale of the 25.1% ownership interest which has been included instockholders’ equity.

**Note 3—Share-BasedCompensation Plans**

*Share-basedCompensation—Walter Industries Stock*

As of January 1, 2006, the Company adoptedStatement of Financial Accounting Standards No. 123 (revised 2004), “Share-BasedPayment” (“SFAS 123(R)”) which requires the Company to value and record, ascompensation expense, stock awards granted to employees under a fair valuebased method. Prior to January 1, 2006, the Company accounted for stockawards granted to employees under the recognition and measurement principles ofAccounting Principles Board Opinion No. 25, “Accounting for 

8

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Stock Issued to Employees,”and related interpretations. As a result, no compensation expense waspreviously recognized for stock options granted to employees because all stockoptions granted had exercise prices equal to the market value of the Company’sstock at the date of the grant, while compensation expense associated withrestricted stock unit grants was being recognized over the vesting period ofthe grant.

SFAS 123(R) applies to new awards and to awardsmodified, repurchased or canceled after January 1, 2006. The Company hasadopted SFAS 123(R) utilizing the modified prospective application methodfor stock options and restricted stock units granted prior to January 1,2006, which requires the Company to record compensation expense beginning January 1,2006 for only the unvested portion of those stock awards. This compensation expense is charged to thestatement of operations with a corresponding credit to capital in excess of parvalue. In addition, the Company is required, upon adoption, toreflect the benefits of tax deductions in excess of recognized compensationcost as an operating cash outflow and a financing cash inflow. Consistent withthe requirement of SFAS 123(R), the Company uses the Black-Scholes optionpricing model to value its stock option grants and estimates forfeitures incalculating the expense related to stock-based compensation.

Theeffect of accounting for stock options in accordance with SFAS 123(R) onthe financial performance of the Company for the three and nine months ended September 30,2006 was as follows (in thousands, except per share data):

| ** **                                                         | ** ** | **For the three months  ended September 30,  2006** | ** ** | **For the nine months  ended September 30,  2006** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| Decrease in  income from continuing operations before income taxes |       |                                                                         | $          | 1,739                                                                       |       |   |   | $ | 4,010 |   |   |
| Decrease in net  income                                            |       |                                                                         | $          | 1,131                                                                       |       |   |   | $ | 2,607 |   |   |
| Cash outflow from  operating activities                            |       |                                                                         | $          | 994                                                                         |       |   |   | $ | 7,150 |   |   |
| Cash inflow from  financing activities                             |       |                                                                         | $          | 994                                                                         |       |   |   | $ | 7,150 |   |   |
| Decrease in basic  earnings per share                              |       |                                                                         | $          | 0.03                                                                        |       |   |   | $ | 0.06 |   |   |
| Decrease in diluted  earnings per share                            |       |                                                                         | $          | 0.02                                                                        |       |   |   | $ | 0.05 |   |   |

 

In accordance with the modified prospective transitionmethod, the Company’s Consolidated Financial Statements for periods ended priorto January 1, 2006 have not been restated to reflect, and do not include,the impact of SFAS 123(R). Had compensation cost for the Company’s option plansfor the three and nine months ended September 30, 2005 been determinedbased on the fair value at the grant dates as prescribed by SFAS 123(R), theCompany’s net income and net income per share on a pro forma basis would havebeen (in thousands, except per share data):

| ** **                                                                                                                                    | ** ** | **For the three months**     | ** ** | **For the nine months**      | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **ended September 30, 2005** | ** ** | **ended September 30, 2005** | ** ** |
| Net income, as  reported                                                                                                                      |       |                                        | $          | 20,197                                      |       |   |   | $ | 80,443 |   |   |
| Add: Stock-based  compensation expense included in reported net income, net of related tax  effects                                           |       |                                        | 236        |                                        |       |   | 708 |   |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based method  for all awards, net of related tax effects |       |                                        | (510       | )                                           |       |   | (1,933 | ) |   |
| Pro forma net income                                                                                                                          |       |                                        | $          | 19,923                                      |       |   |   | $ | 79,218 |   |   |

 

9

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| ** **               | ** ** | **For the three months**     | ** ** | **For the nine months**      | ** ** |
|--------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **               | ** ** | **ended September 30, 2005** | ** ** | **ended September 30, 2005** | ** ** |
| Net income per share:    |       |                                        |       |                                        |       |   |   |   |   |
| Basic—as reported   |       |                                        | $          | 0.52                                        |       |   |   | $ | 2.10 |   |   |
| Basic—pro forma     |       |                                        | 0.51       |                                        |       |   | 2.07 |   |   |
| Diluted—as reported |       |                                        | 0.43       |                                        |       |   | 1.71 |   |   |
| Diluted—pro forma   |       |                                        | 0.43       |                                        |       |   | 1.68 |   |   |
|                          |            |                                             |            |                                             |            |  |  |  |  |  |  |

Thepreceding pro forma results were calculated using the Black Scholesoption-pricing model. Weighted average assumptions used for stock compensationawards granted in the following prior year periods were:

| ** **               | ** ** | **For the three months**     | ** ** | **For the nine months**      | ** ** |
|--------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **               | ** ** | **ended September 30, 2005** | ** ** | **ended September 30, 2005** | ** ** |
| Risk free  interest rate |       |                                        | 3.95       | %                                           |       |   | 4.10 | % |   |
| Dividend yield           |       |                                        | 0.40       | %                                           |       |   | 0.40 | % |   |
| Expected life  (years)   |       |                                        | 5.3        |                                        |       |   | 5.8 |   |   |
| Volatility               |       |                                        | 42.34      | %                                           |       |   | 40.36 | % |   |

 

**EquityAward Plans**

The stockholders of the Company approved the 2002Long-Term Incentive Award Plan (the “2002 Plan”),  under which an aggregate of 3.0 millionshares of the Company’s common stock have been reserved for grant and issuanceof incentive and non-qualified stock options, stock appreciation rights (“SARs”)and stock awards.

Under the Long-Term Incentive Stock Plan approved bystockholders in October 1995 (the “1995 Plan”) and amended in September 1997,an aggregate of 6.0 million shares of the Company’s common stock have beenreserved for the grant and issuance of incentive and non-qualified stockoptions, stock appreciation rights and stock awards.  However, the 1995 Plan expired in 2005 and,therefore, no further grants will be issued under this plan.

Under both plans (collectively, the “Equity AwardPlans”), an option becomes exercisable at such times and in such installmentsas set by the Compensation Committee of the Board of Directors (generally, vestingoccurs over three or five years in equal annual increments), but no option willbe exercisable after the tenth anniversary of the date on which it is granted.

Under both plans, the Company may issue restrictedstock units, which fully vest after seven years of continuous employment withthe Company. The restricted units are subject to accelerated vesting if thestock price of the Company reaches certain pre-established targets withincertain time periods after issuance.

For the three months and nine months ended September 30,2006, the Company recorded stock-based compensation expense of approximately$3.0 million and $6.9 million, respectively, and $0.4 million and $1.1 millionfor the three and nine months ended September 30, 2005, respectively. Theseamounts are included in selling, general and administrative expenses and havebeen allocated to the reportable segments. The total income tax benefitsrecognized in the statements of operations for share-based compensationarrangements were $1.1 million and $2.4 million for the three and nine monthsended September 30, 2006, respectively, and $0.1 million and $0.4 millionfor the three and nine months ended September 30, 2005, respectively.

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Asummary of activity related to stock options under the Equity Award Plans as ofSeptember 30, 2006 is presented below:

| ** **                              | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in years)** | ** ** | **Aggregate  Intrinsic Value  ($000)** | ** ** |
|-----------------------------------------|------------|------------|------------|--------------------------------------------|------------|--------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| Outstanding at  December 31, 2005  |       | 879,568    |       |                                       | $          | 15.80                                                                    |       |                                        |       |   |   |   |   |   |   |   |
| Granted                                 |       | 411,703    |       |                                       | 60.75      |                                                                     |       |                                        |       |   |   |   |   |   |   |
| Exercised                               |       | (430,819   | )          |                                       | 11.14      |                                                                     |       |                                        |       |   |   |   |   |   |   |
| Cancelled                               |       | (6,113     | )          |                                       | 25.83      |                                                                     |       |                                        |       |   |   |   |   |   |   |
| Outstanding at  September 30, 2006 |       | 854,339    |       |                                       | $          | 39.74                                                                    |       |                                        |       | 8.11 |   |   |   | $ | 2,509 |   |   |
| Exercisable at  September 30, 2006 |       | 248,075    |       |                                       | $          | 15.46                                                                    |       |                                        |       | 5.85 |   |   |   | $ | 6,753 |   |   |

 

Weighted average assumptions used to determine thegrant-date fair value of options granted during the three and nine months endedSeptember 30, 2006 were:

| ** **               | ** ** | **For the three**      | ** ** | **For the nine**       | ** ** |
|--------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **               | ** ** | **months ended**            | ** ** | **months ended**            | ** ** |
| ** **               | ** ** | **September 30, 2006** | ** ** | **September 30, 2006** | ** ** |
| Risk free  interest rate |       |                             | 4.82       | %                                |       |   | 4.65 | % |   |
| Dividend yield           |       |                             | 0.30       | %                                |       |   | 0.30 | % |   |
| Expected life  (years)   |       |                             | 4.85       |                             |       |   | 5.33 |   |   |
| Volatility               |       |                             | 36.15      | %                                |       |   | 37.74 | % |   |
| Forfeiture rate          |       |                             | 4.66       | %                                |       |   | 3.55 | % |   |

 

The risk-free interest rate is based on the U.S.Treasury yield in effect at the time of grant with a term equal to the expectedlife. The expected dividend yield is based on the Company’s estimated annualdividend payout at grant date. The expected term of the options represents theperiod of time the options are expected to be outstanding. Expected volatilityis based on historical volatility of the Company’s share price for the expectedterm of the options.

Approximately 125,000 and 58,000 restricted stockunits were granted and vested, respectively, during the nine months ended September 30,2006. Approximately 309,000 and 245,000 restricted stock units were outstandingat September 30, 2006 and December 31, 2005, respectively. At September 30,2006, the weighted-average remaining contractual term on the Company’soutstanding restricted stock units was 2.9 years.

The weighted-averagegrant-date fair value of stock options and restricted stock units grantedduring the nine months ended September 30, 2006 was $24.90 and $63.72,respectively. The total amount of cash received from exercise of stock optionswas $0.9 million and $4.8 million for the three months and nine months ended September 30,2006, respectively. The total intrinsic value of stock awards exercised orconverted during the nine months ended September 30, 2006 wasapproximately $26.0 million. As of September 30, 2006, there wasapproximately $15.5 million of unrecognized compensation cost related tonon-vested share-based compensation arrangements granted under the Equity AwardPlans; that cost is to be recognized over a weighted average period of 2.6years.

*Share-basedCompensation—Mueller Water Products Stock*

The stockholders of Mueller Water approved the 2006Stock Incentive Plan (the “2006 Plan”), under which an aggregate of 8.0 millionshares of Mueller Water’s common stock have been reserved for grant andissuance of awards of incentive stock options, non-statutory stock options,restricted stock bonuses, restricted stock purchase rights, stock appreciationrights, phantom stock units, restricted stock units, 

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performance share bonusesand performance share units. Generally, all of the employees (includingexecutive officers), members of the Board of Directors and consultants ofMueller Water, its designated subsidiaries and its affiliates are eligible toparticipate in the 2006 Plan.

Under the 2006 Plan, an award becomes exercisable atsuch times and in such installments as set by the Compensation Committee of theBoard of Directors (generally, vesting occurs over three years in equal annualincrements), but no award will be exercisable after the tenth anniversary ofthe date on which it is granted.

Mueller Water records compensation costs for stockoptions and restricted stock units granted to employees based on the fair valueat the grant dates as prescribed by SFAS No. 123(R) *Share-Based Payment*, which requires that compensation costsrelated to share-based payment transactions be recognized in the financialstatements over the period that an employee provides service in exchange for theaward. Compensation cost for new and modified awards is recorded over therelated vesting period of such awards.

Theeffect of Mueller Water’s stock-based compensation on the financial performanceof the Company for the three and nine months ended September 30, 2006 wasas follows (in millions, except per share data):

| ** **                                                         | ** ** | **For the  three months ended  September 30, 2006** | ** ** | **For the  nine months ended  September 30, 2006** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| Decrease in  income from continuing operations before income taxes |       |                                                                         | $          | 1.6                                                                         |       |   |   | $ | 2.1 |   |   |
| Decrease in net  income                                            |       |                                                                         | $          | 1.1                                                                         |       |   |   | $ | 1.3 |   |   |
| Cash outflow from  operating activities                            |       |                                                                         | $          | —                                                                      |       |   |   | $ | — |   |   |
| Cash inflow from  financing activities                             |       |                                                                         | $          | —                                                                      |       |   |   | $ | — |   |   |
| Decrease in basic and  diluted earnings per share                  |       |                                                                         | $          | 0.01                                                                        |       |   |   | $ | 0.01 |   |   |

 

During the nine months ended September 30, 2006,Mueller Water recorded share-based compensation expense associated with the2006 Plan of approximately $2.1 million. These amounts were reflected inselling, general and administrative expenses of the Mueller Co. segment.

In addition to the share-based compensation expenseassociated with the 2006 Plan, certain of the Mueller Water’s employees havebeen granted Walter restricted stock units and stock options under Walter’sshare-based compensation plans. Mueller Water has expensed $1.0 million relatedto the share-based compensation costs allocated from Walter for the nine monthsended September 30, 2006.

Asummary of activity related to Mueller Water’s stock options under the 2006Plan as of September 30, 2006 is presented below:

| ** **                              | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in years)** | ** ** | **Aggregate  Intrinsic Value  ($ millions)** | ** ** |
|-----------------------------------------|------------|------------|------------|--------------------------------------------|------------|--------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| Granted                                 |       | 112,694    |       |                                       | $          | 16.11                                                                    |       |                                                   |       |   |   |   |   |   |   |   |
| Exercised                               |       | —     |       |                                       | —     |                                                                     |       |                                                   |       |   |   |   |   |   |   |
| Cancelled                               |       | —     |       |                                       | —     |                                                                     |       |                                                   |       |   |   |   |   |   |   |
| Outstanding at  September 30, 2006 |       | 112,694    |       |                                       | $          | 16.11                                                                    |       |                                                   |       | 9.7 |   |   |   | $ | — |   |   |
| Exercisable at  September 30, 2006 |       | —     |       |                                       | $          | —                                                                   |       |                                                   |       | — |   |   |   | $ | — |   |   |

 

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Weightedaverage assumptions used to determine the grant-date fair value of optionsgranted during the nine months ended September 30, 2006 under theBlack-Scholes method were:

| Risk free  interest rate |   | 4.97  | %      |
|--------------------------|--------|-------|--------|
| Dividend yield           |   | 0.44  | %      |
| Expected life  (years)   |   | 6.38  |   |
| Volatility               |   | 32.28 | %      |
| Forfeiture rate          |   | 5.00  | %      |

 

The risk-free interest rate is based on the U.S.Treasury yield in effect at the time of grant with a term equal to the expectedlife. The expected dividend yield is based on Mueller Water’s estimated annualdividend payout at grant date. The expected term of the options represents theperiod of time the options are expected to be outstanding. Expected volatilityis based on management’s best estimate using the most recent disclosed datafrom a group of comparable companies. Mueller Water incorporated the volatilitydata from comparable companies because of its limited historical share priceinformation since Mueller Water’s IPO on June 1, 2006. Since the 2006 Plan’sinception, Mueller Water does not have a sufficient history to estimate theexpected pre-vesting forfeiture rate. Since the structure and terms of the planare very similar to Walter’s plan, Mueller Water has decided it would bereasonable to use a pre-vesting forfeiture rate similar to Walter’s currenthistorical rate of approximately 5% as an initial estimate. This initialestimate will be re-evaluated as Mueller Water accumulates actual experiencewith the passage of time.

Approximately 1.1 million restricted stock units weregranted during the nine months ended September 30, 2006 and wereoutstanding at September 30, 2006. Restricted stock units fall into one oftwo vesting provisions; a 3-year cliff vesting provision or a provisionwith 7-year cliff vesting with early vesting possible if certainfinancial performance targets are met. At September 30, 2006, theweighted-average remaining contractual term on Mueller Water’s restricted stockunits was 2.8 years.

The weighted-averagegrant-date fair value of stock options and of restricted stock units grantedduring nine months ended September 30, 2006 was $6.54 for stock optionsand $16.02 for restricted stock units. As of September 30, 2006, there wasapproximately $17.2 million of unrecognized compensation cost related tonon-vested share-based compensation arrangements granted under the 2006 Plan;that cost is to be recognized over the periods during which they vest.

**Employee StockPurchase Plan**

The Mueller Water Products, Inc. 2006 EmployeeStock Purchase Plan (the “ESPP Plan”) authorizes the sale of 4,000,000 sharesof the Mueller Water’s common stock to employees. Employees may designate up tothe lesser of $25,000 or 20% of their annual compensation for the purchase ofstock. The price for shares purchased under the plan is the lower of 85% ormarket value on the first day or the last day of the quarterly purchase period.Generally, all of the employees (including executive officers) and employees ofits designated subsidiaries and its affiliates are eligible to participate inthe ESPP Plan.

In connection with employee elections made during thenine months ended September 30, 2006, Mueller Water will issue 31,235shares under this plan, with 3,968,765 shares reserved for future issuance. MuellerWater recognizes compensation expense for these shares over the lives of thequarterly purchase periods, which approximated $0.1 million for the nine monthsended September 30, 2006, with an immaterial amount in unamortizedcompensation expense remaining as of September 30, 2006.

The weighted-average grant-date fair value of eachdesignated share purchased under this plan in the nine months ended September 30,2006 under the Employee Stock Purchase Plan is $4.20. The fair value of eachdesignated share purchased under the Employee Stock Purchase Plan is estimatedon the date of grant using the Black-Scholes option-pricing model using thefollowing assumptions:

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| Risk free  interest rate |   | 5.20  | %      |
|--------------------------|--------|-------|--------|
| Dividend yield           |   | 0.43  | %      |
| Expected life  (years)   |   | 3     |   |
| Volatility               |   | 60.33 | %      |
| Forfeiture rate          |   | 0     | %      |

 

The risk-free interestrate is based on the U.S. Treasury yield in effect at the time of grant with aterm equal to the expected life. The expected dividend yield is based onMueller Water’s estimated annual dividend payout at grant date. The expectedterm of the options represents the period of time the options are expected tobe outstanding. The expected volatility is deemed to be equal to the historicalvolatility over a 3-month period ending on the date of grant.

**Note 4—Restructuringand Impairments**

On October 24, 2006, Mueller Water announced theclosure of the James Jones manufacturing facility in El Monte, California. JamesJones will transfer the production of its brass products and hydrants to theDecatur, Illinois and Albertville, Alabama plants by June 2007. Approximately155 employees will be affected by the closure. Total estimated costs related tothis closure are $2.5 million, of which $0.2 million, consisting of terminationbenefits, and $0.5 million, consisting of fixed asset impairments, wererecorded as adjustments to goodwill in the nine months ended September 30,2006. Other estimated costs of $1.8 million, associated with relocating the ElMonte warehouse and equipment, will be expensed as incurred. The restructuringcosts are recorded to goodwill as the overall plan to close the facility wasidentified prior to the acquisition.

On April 20, 2006, Mueller Water announced theclosure of the Mueller Canada valve and hydrant manufacturing facility inMilton, Ontario, Canada. The facility closed during the quarter ended September 30,2006, resulting in the termination of approximately 130 employees. Total costsrelated to this closure were $4.5 million, of which $2.5 million, consisting oftermination benefits, and $0.8 million, consisting of fixed asset impairmentsand contractual future lease obligation costs, were recorded as adjustments togoodwill in the nine months ended September 30, 2006. Other estimatedcosts of $1.2 million, associated with relocating the Milton warehouse andequipment, were expensed during 2006. The restructuring costs are recorded togoodwill as the overall plan to close the facility was identified prior to theacquisition.

On January 26, 2006, Mueller Water announced theclosure of the Henry Pratt valve manufacturing facility in Dixon, Illinois. Theeventual closure of the facility is expected to occur in 2007, resulting in thetermination of approximately 100 employees. Total estimated costs related tothis closure are $3.7 million, of which $1.0 million for termination benefitsand $1.7 million for fixed asset impairment charges were recorded asadjustments to goodwill. The remaining other estimated costs of $1.0 million,which include costs to transfer and install equipment and temporary outsourcingof manufacturing, will be expensed when incurred. The restructuring costs arerecorded to goodwill as the overall plan to close the facility was identifiedprior to the acquisition.

On October 26, 2005, the Company announced plansto close U.S. Pipe’s Chattanooga, Tennessee plant and transfer the valve andhydrant production of that plant to Mueller Water’s Chattanooga, Tennessee andAlbertville, Alabama plants, resulting in the termination of approximately 340employees. The U.S. Pipe Chattanooga plant was closed in June 2006. Totalexit costs have accumulated to $49.9 million of which approximately $28.6million qualified as restructuring and impairment charges. The remaining exitcosts of $21.3 million are comprised of an $11.5 million inventory write-downand a $9.8 million write-off of unabsorbed overhead costs. Of these costs, $5.4million were recognized in cost of sales during 2006.

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Totalrestructuring and impairment charges and the amounts recorded to restructuringexpenses for the Chattanooga plant closure are as follows (in thousands):

| ** **                                   | ** ** | ** **                       | ** ** | **Restructuring**                | ** ** | **Restructuring**                | ** ** | ** **                        | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|----------------------------------|------------|-----------------------------------|------------|
| ** **                                   | ** ** | **Restructuring**                | ** ** | **charges expensed**        | ** ** | **charges expensed**        | ** ** | ** **                        | ** ** |
| ** **                                   | ** ** | **charges expensed**        | ** ** | **for the nine**       | ** ** | **for the three**      | ** ** | **Restructuring**                 | ** ** |
| ** **                                   | ** ** | **from inception to**  | ** ** | **months ended**            | ** ** | **months ended**            | ** ** | **charges expensed in** | ** ** |
| ** **                                   | ** ** | **September 30, 2006** | ** ** | **September 30, 2006** | ** ** | **September 30, 2006** | ** ** | **2005**                          | ** ** |
| Termination  benefits                        |       |                             | $          | 3,816                            |       |                             |       | $                                 | 820        |   |   |   | $ | — |   |   |   | $ | 2,996 |   |   |
| Other employee-related costs                 |       |                             | 3,312      |                             |       |                             | 3,312      |                              |       |   | — |   |   |   | — |   |   |
| Other associated  costs                      |       |                             | 2,094      |                             |       |                             | —     |                              |       |   | — |   |   |   | 2,094 |   |   |
| Impairment of  property, plant and equipment |       |                             | 19,403     |                             |       |                             | 355        |                              |       |   |   |   |   |   | 19,048   |   |   |
| Total                                        |       |                             | $          | 28,625                           |       |                             |       | $                                 | 4,487      |   |   |   | $ | — |   |   |   | $ | 24,138 |   |   |

 

Termination benefits relating to the U.S. PipeChattanooga plant closure totaling $0.8 million in the nine months ended September 30,2006, consist primarily of severance for staff reductions of hourly personnel. Inaddition, the Company recognized $3.3 million of other employee-related costsfor the nine months ended September 30, 2006, consisting primarily ofpension and other postretirement curtailments and termination benefits. TheCompany does not expect to recognize any additional charges or benefits relatedto this plant closure. On August 31, 2006, the Company completed the saleof the Chattanooga facility. The proceeds received approximated the book valueof the assets sold.

In June 2006, the Company recorded an impairmentcharge of $1.1 million relating to Sloss Industries’ chemical division. On November 1,2006, the Company sold these assets. The fair value used to determine theimpairment charge was based on a good faith quote from a willing buyer.

In 2003, the Companyannounced that it expected to close Mine No. 5 in 2004. Later in 2003,the Company modified its coal production plans for Mine No. 5 by extendingmining activity to a revised scheduled shutdown of late 2006or early 2007, due to an improvement in the metallurgicalcoal market. However, in May 2005 a water ingress problemidled Mine No. 5 for approximately five months. This would haveextended production into the second quarter of 2007 had it not been for ageological fault in a planned longwall panel that shortened mining to itscurrent estimated shutdown of December 2006. Total expected costs to close the mine decreased from $11.8 million to$8.5 million due to a decrease in the expected costs of employee benefits andworkers’ compensation. Approximately $6.6 million of the expected closure costsqualify as restructuring costs and have been recorded by the Company. Therewere no costs incurred related to Mine No. 5 closure during the ninemonths ended September 30, 2006. Other costs, primarily representingestimated workers’ compensation and other incremental costs related to theclosure of the mine, will be charged to expense when incurred.

The Company’s activity in accrued restructuring was asfollows (in thousands):

| ** **                           | ** ** | ** **                                         | ** ** | ** **                  | ** ** | ** **                   | ** ** | **For the**                | ** ** |
|--------------------------------------|------------|----------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **For the three months ended** | ** ** | **year ended**         | ** ** |
| ** **                           | ** ** | **September 30, 2006**                   | ** ** | **June 30, 2006** | ** ** | **March 31, 2006** | ** ** | **December 31, 2005** | ** ** |
| Beginning balance                    |       |                                               | $          | 6,732                       |       |                         |       | $                               | 4,251      |   |   |   | $ | 4,460 |   |   |   | $ | 1,588 |   |   |
| Restructuring  expenses accrued      |       |                                               | —     |                        |       |                         | 748        |                            |       |   | 775 |   |   |   | 6,568 |   |   |
| Restructuring accruals  allocated to |       |                                               |       |                        |       |                         |       |                            |       |   |   |   |   |   |   |   |   |
| goodwill for plant closures          |       |                                               | 5,117      |                        |       |                         | 3,836      |                            |       |   | — |   |   |   | — |   |   |
| Restructuring  payments              |       |                                               | (3,848     | )                           |       |                         | (2,103     | )                               |       |   | (984 | ) |   |   | (2,248 | ) |   |
| Reversal of prior  accruals          |       |                                               | (2,094     | )                           |       |                         | —     |                            |       |   | — |   |   |   | (1,448 | ) |   |
| Ending balance                       |       |                                               | $          | 5,907                       |       |                         |       | $                               | 6,732      |   |   |   | $ | 4,251 |   |   |   | $ | 4,460 |   |   |

 

15

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**Note 5—ConsolidatedStatements of Cash Flows**

The Company has revised its consolidated statement ofcash flows for the nine months ended September 30, 2005 to reflect the netincrease or decrease in Financing’s instalment note receivable balance relatingto the portfolio of assets originated by Homebuilding as an element indetermining cash flows from operating activities. Previously, this item wasreported in investing activities. The previous cash flow treatment followed theCompany’s principal lines of business reporting; however, on a consolidatedbasis, there is no cash flow resulting from Financing’s purchase of instalmentnotes from Homebuilding. Financing’s purchase of loans from third parties, aswell as the principal cash collections on those loans, remains in investingactivities.

Prioramounts reported have been revised as follows:

| ** **                                           | ** ** | **For the nine months ended** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                           | ** ** | **September 30, 2005**                  | ** ** |
| ** **                                           | ** ** | **Previous**                                      | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                           | ** ** | **Presentation**                                  | ** ** | **Change** | ** ** | **Revised** | ** ** |
| Instalment notes  receivable, net                    |       |                                              | $          | — |   |   | $ | 46,760 |   | $ | 46,760 |   |
| Net cash provided  by operating activities           |       |                                              | $          | 114,333 |   |   | $ | 46,760 |   | $ | 161,093 |   |
| Purchases of  loans                                  |       |                                              | $          | (322,681 | ) |   | $ | 281,237 |   | $ | (41,444 | ) |
| Principal  payments received on purchased loans      |       |                                              | $          | 343,596 |   |   | $ | (327,997 | ) | $ | 15,599 |   |
| Net cash provided by  (used in) investing activities |       |                                              | $          | (62,766 | ) |   | $ | (46,760 | ) | $ | (109,526 | ) |

 

**Note 6—RestrictedShort-Term Investments**

Restricted short-terminvestments at September 30, 2006 and December 31, 2005 include (i) temporaryinvestments primarily in commercial paper or money market accounts withmaturities less than 90 days from collections on instalment notes receivableowned by various Mid-State Trusts (the “Trusts”) ($78.8 million and $118.2million, respectively) which are available only to pay expenses of the Trustsand principal and interest on indebtedness of the Trusts, and (ii) miscellaneousother segregated accounts restricted to specific uses ($7.5 million and $6.4million, respectively).

**Note 7—InstalmentNotes Receivable**

Theinstalment notes receivable are summarized as follows (in thousands):

| ** **                   | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                   | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Instalment notes  receivable |       |                   | $          | 1,563,281             |       |   |   | $ | 1,558,383 |   |   |
| Mortgage loans               |       |                   | 215,458    |                  |       |   | 148,028 |   |   |
| Less: Allowance  for losses  |       |                   | (12,945    | )                     |       |   | (12,489 | ) |   |
| Net                          |       |                   | $          | 1,765,794             |       |   |   | $ | 1,693,922 |   |   |

 

During the three and nine months ended September 30,2006, the Company purchased $25.5 million and $96.1 million, respectively, ofmortgage loans from unrelated third parties.

Activityin the allowance for losses on instalment notes is summarized as follows (inthousands):

| ** **                      | ** ** | **For the nine months ended**                                | ** ** |
|---------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                      | ** ** | **September 30,**                                                           | ** ** |
| ** **                      | ** ** | **      2006      ** | ** ** | **      2005      ** | ** ** |
| Balance at  beginning of period |       |                                                                             | $          | 12,489 |   |   |   | $ | 11,200 |   |   |
| Provisions  charged to income   |       |                                                                             | 6,761      |   |   |   | 8,210 |   |   |
| Charge-offs, net  of recoveries |       |                                                                             | (6,305     | ) |   |   | (7,104 | ) |   |
| Balance at end of period        |       |                                                                             | $          | 12,945 |   |   |   | $ | 12,306 |   |   |

 

16

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**Note 8—Inventories**

Inventoriesare summarized as follows (in thousands):

| ** **                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Finished goods                      |       |                   | $          | 282,265               |       |   |   | $ | 278,347 |   |   |
| Goods in process                    |       |                   | 157,151    |                  |       |   | 144,846 |   |   |
| Raw materials and  supplies         |       |                   | 88,056     |                  |       |   | 97,490 |   |   |
| Repossessed  houses held for resale |       |                   | 29,711     |                  |       |   | 30,610 |   |   |
| Total inventories                   |       |                   | $          | 557,183               |       |   |   | $ | 551,293 |   |   |

 

**Note 9—Acquisitions,Goodwill and Identifiable Intangible Assets**

In January 2006, the Company acquired HuntIndustries, Inc. (“Hunt”), a manufacturer of meter pits and meter yokeswhich are sold by Mueller Co., for $6.8 million in cash. In January 2006,the Company also acquired the operating assets of CCNE, L.L.C. (“CCNE”), a Connecticut-basedmanufacturer of check valves for sale to the water and wastewater treatmentmarkets, for $8.8 million in cash.

Goodwill increased to $876.4 million at September 30,2006 from $867.6 million at December 31, 2005. During the nine months endedSeptember 30, 2006, the Company recorded changes to goodwill as follows(in thousands):

| ** **                             | ** ** | **Mueller Co.** | ** ** | **Anvil** | ** ** | **U.S. Pipe** | ** ** | **Financing** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|----------------------|------------|-----------|------------|--------------------|------------|---------------|------------|-----------|------------|
| Balance as of  December 31, 2005  |       |                 | $          | 710,450   |       |               | $          | 87,800        |       | $         | 58,411     |   |   | $ | 10,895 |   |   | $ | 867,556 |   |
| Acquisitions                           |       |                 | 6,776      |      |       | —             |       | —        |       |      | —     |   |   | 6,776 |   |
| Restructuring  charges                 |       |                 | 3,159      |      |       | 6,199              |       | —        |       |      | —     |   |   | 9,358 |   |
| Other                                  |       |                 | (3,005     | )         |       | (4,315             | )          | —        |       |      | —     |   |   | (7,320 | ) |
| Balance as of  September 30, 2006 |       |                 | $          | 717,380   |       |               | $          | 89,684        |       | $         | 58,411     |   |   | $ | 10,895 |   |   | $ | 876,370 |   |

 

Changes in identifiableintangibles during the period include intangibles of $6.7 million in connectionwith the CCNE acquisition and a $1.0 million adjustment to the Mueller Waterpurchase accounting allocation, increasing customer relationship intangibles.

**Note 10—Debt**

Debt consisted of the following (in thousands):

| ** **                              | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                              | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Mortgage-Backed/Asset-Backed  Notes:    |       |                   | $          | 1,687,968             |       |   |   | $ | 1,727,329 |   |   |
| Other debt:                             |       |                   |       |                  |       |   |   |   |   |
| 2005 Mueller Credit Agreement           |       |                   | 793,742    |                  |       |   | 1,047,375 |   |   |
| 2005 Walter Credit Agreement            |       |                   | 274,335    |                  |       |   | 448,875 |   |   |
| 10% Senior Subordinated Notes (1)       |       |                   | 215,122    |                  |       |   | 333,162 |   |   |
| 14 3¤4%  Senior Discount Notes (2) |       |                   | 116,251    |                  |       |   | 165,697 |   |   |
| Convertible Senior Subordinated Notes   |       |                   | 148,400    |                  |       |   | 175,000 |   |   |
| Capital Lease Obligations               |       |                   | 2,142      |                  |       |   | 2,344 |   |   |
|                                    |       |                   | 1,549,992  |                  |       |   | 2,172,453 |   |   |
| Total                                   |       |                   | $          | 3,237,960             |       |   |   | $ | 3,899,782 |   |   |

----

(1)          The effective interestrate was 7.29%.

(2)          Theeffective interest rate was 10.63%.

17

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**2005 Mueller CreditAgreement**

On October 3, 2005, Mueller Group, LLC, (“MuellerGroup”) a wholly-owned subsidiary of Mueller Water, entered into a$1,195.0 million credit agreement (“2005 Mueller Credit Agreement”) whichincludes (1) an amortizing term loan facility (27 quarterly principalpayments) in an initial aggregate principal amount of $1,050.0 million, ofwhich $793.7 million was outstanding as of September 30, 2006, and (2) a$145.0 million revolving credit facility, which provides for loans andletters of credit. As of September 30, 2006, Mueller Group had noborrowings outstanding under the revolving credit facility but issued $31.9million in letters of credit, which reduced availability for borrowings to$113.1 million. The revolving credit facility will terminate on October 4,2010, and the term loan will mature on November 1, 2011 (or October 3,2012, if the 10% senior subordinated notes due 2012 are paid in full orrefinanced prior to such date).

In June 2006, $246.0million from the proceeds of the IPO was used to repay a portion of the termloan. As a result of thisprepayment, $4.1 million of unamortized debt expense was charged to interestexpense.

**2005 Walter CreditAgreement**

On October 3, 2005, Walter Industries enteredinto a $675.0 million credit agreement (“2005 Walter Credit Agreement”)which includes (1) an amortizing term loan facility (27 quarterlyprincipal payments) in an initial aggregate principal amount of$450.0 million, of which $274.3 million was outstanding as of September 30,2006, and (2) a $225.0 million revolving credit facility, whichprovides for loans and letters of credit. As of September 30, 2006, theCompany had issued $63.4 million in letters of credit, which reducedavailability for borrowings under the revolving credit facility to $161.6million and there were no borrowings outstanding under the revolving creditfacility. The revolving credit facility will terminate on October 4, 2010,and the term loan will mature on October 3, 2012.

In February 2006, theCompany sold 2.65 million shares of common stock for $168.7 million of net cashproceeds. Of these proceeds, $102.9 million was used to repay the term loanfacility. In addition, during the nine months ended September 30, 2006,the Company repaid $71.6 million on the term loan facility using available cashflow. As a result of these term loan prepayments, $2.4 million of unamortizeddebt expense was charged to interest expense during 2006. In November 2006,the Company made an additional $25.0 million optional prepayment of the termloan and will charge interest expense for $0.4 million of related unamortizeddebt expense.

**Senior SubordinatedNotes and Senior Discount Notes**

In 2004, Mueller Group, a subsidiary of Mueller Water,issued $315.0 million aggregate principal amount of 10% senior subordinatedpublic notes, which will mature on May 1, 2012. The senior subordinatednotes are guaranteed by each of Mueller Group’s existing domestic restrictedsubsidiaries.

Also in 2004, Mueller Water sold 223,000 unitsconsisting of $1,000 principal amount at maturity of senior discount publicnotes due 2014, for gross proceeds of approximately $110.1 million. Thenotes accrete at a rate of 14 3/4%and compound semi-annually to April 2009 to a principal amount at maturityof $223.0 million. The notes are senior unsecured obligations and areeffectively subordinated to all liabilities of Mueller Group and itssubsidiaries.

On July 3, 2006,Mueller Water used $123.1 million of the proceeds from their IPO for a partialredemption of the senior subordinated notes and to pay a prepayment premium of$11.0 million. In addition, Mueller Water used $60.2 million of the proceedsfrom the IPO for a partial redemption of the senior discount notes and to pay aprepayment premium of $7.7 million. A pre-tax loss on the extinguishment ofthis debt totaling approximately $4.5 million was recognized during the thirdquarter of 2006 as additional interest expense.

18

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**Convertible SeniorSubordinated Notes**

In 2004, the Company issued $175 million ofconvertible senior subordinated notes, which will mature on May 1, 2024,unless earlier converted, redeemed or repurchased. The notes are redeemable bythe Company at par on or after May 6, 2011. The holders of the notes mayrequire the Company to repurchase some or all of the notes at par plus accruedand unpaid interest, including contingent interest, if any, initially on May 1,2014, and subsequently on May 1, 2019, or at any time prior to theirmaturity following a fundamental change, as defined in the indenture.

The notes are currently convertible having satisfied avariety of conditions including, the common stock sales price condition. Thenotes may be convertible during future periods if the common stock sale pricecondition or other conditions are satisfied. During the nine months ended September 30,2006, holders of $26.6 million of the Company’s Convertible Senior SubordinatedNotes surrendered their convertible notes in exchange for approximately1,490,000 shares of the Company’s common stock and approximately $1.6 millionof inducement fees which were expensed as additional interest expense.

In November 2006, aholder of $11.0 million of the Company’s Convertible Senior Subordinated Notessurrendered convertible notes in exchange for approximately 616,333 shares ofthe Company’s common stock and approximately $1.1 million of inducement feesthat will be expensed during the fourth quarter of 2006.

**Interest Rate HedgeAgreements**

In February 2006, theCompany entered into three interest rate hedge agreements (“swaps”) with acumulative notional value of $125 million with three separate counter-parties. Thestructure of the swaps is a 14-year, forward-starting swap which startson December 15, 2006, which was the originally forecasted issuance date ofthe Company’s next mortgage-backed securitization. The swaps call for theCompany to make fixed rate payments over the term at 5.05% per annum andreceive payments based on one-month LIBOR from the counter-parties. In November 2006,these swaps were settled in connection with the November 2, 2006mortgage-backed securitization, see Note 17. The Company will continue toaccount for the swaps as cash flow hedges. Changes in the fair value of theswaps through the date of securitization were recorded in accumulated othercomprehensive income (loss).

**Note 11—Pension andOther Employee Benefits**

Thecomponents of net periodic benefit cost are as follows (in thousands):

| ** **                                | ** ** | **Pension Benefits**               | ** ** | **Other Benefits**                 | ** ** |
|-------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
| ** **                                | ** ** | **For the three months** | ** ** | **For the three months** | ** ** |
| ** **                                | ** ** | **ended September 30,**       | ** ** | **ended September 30,**       | ** ** |
| ** **                                | ** ** | **2006**                                | ** ** | **2005**                                | ** ** | **2006** | ** ** | **2005** | ** ** |
| Components of net  periodic benefit cost: |       |                                    |       |                                    |       |   |   |   |   |
| Service cost                              |       | $                                       | 2,700      |                                    | $          | 2,061 |   | $ | 675 |   | $ | 448 |   |
| Interest cost                             |       | 7,009                                   |       | 5,539                                   |       | 4,088 |   | 4,010 |   |
| Expected return on plan assets            |       | (7,837                                  | )          | (6,246                                  | )          | — |   | — |   |
| Amortization of prior service cost        |       | 185                                     |       | 164                                     |       | (1,727 | ) | (1,715 | ) |
| Amortization of net loss (gain)           |       | 2,051                                   |       | 1,575                                   |       | 981 |   | 497 |   |
| Net periodic  benefit cost                |       | $                                       | 4,108      |                                    | $          | 3,093 |   | $ | 4,017 |   | $ | 3,240 |   |

 

19

----

 

| ** **                                        | ** ** | **Pension Benefits**              | ** ** | **Other Benefits**                | ** ** |
|---------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------|------------|
| ** **                                        | ** ** | **For the nine months** | ** ** | **For the nine months** | ** ** |
| ** **                                        | ** ** | **ended September 30,**      | ** ** | **ended September 30,**      | ** ** |
| ** **                                        | ** ** | **2006**                               | ** ** | **2005**                               | ** ** | **2006** | ** ** | **2005** | ** ** |
| Components of net  periodic benefit cost:         |       |                                   |       |                                   |       |   |   |   |   |
| Service cost                                      |       | $                                      | 8,100      |                                   | $          | 6,183 |   | $ | 2,025 |   | $ | 1,344 |   |
| Interest cost                                     |       | 21,027                                 |       | 16,617                                 |       | 12,265 |   | 12,034 |   |
| Expected return on plan assets                    |       | (23,511                                | )          | (18,738                                | )          | — |   | — |   |
| Amortization of prior service cost                |       | 555                                    |       | 492                                    |       | (5,181 | ) | (5,157 | ) |
| Amortization of net loss (gain)                   |       | 6,153                                  |       | 4,725                                  |       | 2,943 |   | 1,491 |   |
|                                              |       | 12,324                                 |       | 9,279                                  |       | 12,052 |   | 9,712 |   |
| Curtailments and termination benefits loss (gain) |       | 5,021                                  |       | —                                 |       | (1,709 | ) | — |   |
| Net periodic  benefit cost                        |       | $                                      | 17,345     |                                   | $          | 9,279 |   | $ | 10,343 |   | $ | 9,712 |   |

 

The curtailments andtermination benefits loss (gain) shown above are related to the closure of theU.S. Pipe Chattanooga, Tennessee plant as described in Note 4. These componentsof net periodic benefit cost for pension and postretirement plans were chargedto restructuring expense in the consolidated statement of operations.

**Note 12—Net Incomeper Share**

A reconciliation of the basic and diluted net incomeper share computations for the three and nine months ended September 30,2006 and 2005 are as follows (in thousands, except per share data):

| ** **                                                                               | ** ** | **For the three months ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                                                               | ** ** | **2006**                                                                   | ** ** | **2005** | ** ** |
| ** **                                                                               | ** ** | **Basic**                                                                  | ** ** | **Diluted** | ** ** | **Basic** | ** ** | **Diluted** | ** ** |
| Numerator:                                                                               |       |                                                                       |       |   |   |   |   |   |   |
| Net income                                                                               |       | $                                                                          | 63,245     |   | $ | 63,245 |   | $ | 20,197 |   | $ | 20,197 |   |
| Effect of  dilutive securities:                                                          |       |                                                                       |       |   |   |   |   |   |   |
| Interest expense related to 3.75% convertible senior  subordinated notes, net of tax (a) |       | —                                                                     |       | 904 |   | — |   | 1,066 |   |
|                                                                                     |       | $                                                                          | 63,245     |   | $ | 64,149 |   | $ | 20,197 |   | $ | 21,263 |   |
| Denominator:                                                                             |       |                                                                       |       |   |   |   |   |   |   |
| Average number of common shares outstanding                                              |       | 43,634                                                                     |       | 43,634 |   | 38,759 |   | 38,759 |   |
| Effect of  dilutive securities:                                                          |       |                                                                       |       |   |   |   |   |   |   |
| Stock options and restricted stock units (“units”)  (b)                        |       | —                                                                     |       | 228 |   | — |   | 650 |   |
| 3.75% convertible senior subordinated notes (a)                                          |       | —                                                                     |       | 8,315 |   | — |   | 9,805 |   |
|                                                                                     |       | 43,634                                                                     |       | 52,177 |   | 38,759 |   | 49,214 |   |
| Net income per share                                                                     |       | $                                                                          | 1.45       |   | $ | 1.23 |   | $ | 0.52 |   | $ | 0.43 |   |

 

Stock optionsoutstanding of 313,269 and 13,707 for the three months ended September 30,2006 and 2005, respectively, were excluded from the calculation above becausetheir effect would have been anti-dilutive.

20

----

 

| ** **                                                                               | ** ** | **For the nine months ended September 30,** | ** ** |
|------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                                                               | ** ** | **2006**                                                                  | ** ** | **2005** | ** ** |
| ** **                                                                               | ** ** | **Basic**                                                                 | ** ** | **Diluted** | ** ** | **Basic** | ** ** | **Diluted** | ** ** |
| Numerator:                                                                               |       |                                                                      |       |   |   |   |   |   |   |
| Net income                                                                               |       | $                                                                         | 162,505    |   | $ | 162,505 |   | $ | 80,443 |   | $ | 80,443 |   |
| Effect of dilutive securities:                                                           |       |                                                                      |       |   |   |   |   |   |   |
| Interest expense related to 3.75% convertible senior  subordinated notes, net of tax (a) |       | —                                                                    |       | 2,832 |   | — |   | 3,198 |   |
|                                                                                     |       | $                                                                         | 162,505    |   | $ | 165,337 |   | $ | 80,443 |   | $ | 83,641 |   |
| Denominator:                                                                             |       |                                                                      |       |   |   |   |   |   |   |
| Average number of common shares outstanding                                              |       | 42,511                                                                    |       | 42,511 |   | 38,325 |   | 38,325 |   |
| Effect of dilutive securities:                                                           |       |                                                                      |       |   |   |   |   |   |   |
| Stock options and restricted stock units (b)                                             |       | —                                                                    |       | 334 |   | — |   | 830 |   |
| 3.75% convertible senior subordinated notes (a)                                          |       | —                                                                    |       | 8,756 |   | — |   | 9,805 |   |
|                                                                                     |       | 42,511                                                                    |       | 51,601 |   | 38,325 |   | 48,960 |   |
| Net income per  share                                                                    |       | $                                                                         | 3.82       |   | $ | 3.20 |   | $ | 2.10 |   | $ | 1.71 |   |

 

Stock options outstanding of 219,619 and 4,853 for thenine months ended September 30, 2006 and 2005, respectively, were excludedfrom the calculation above because their effect would have been anti-dilutive.

----

(a)           This addition to thenumerator represents the weighted-average interest expense, net of tax, andthis addition to the denominator represents the weighted-average sharesissuable upon conversion related to the Company’s 3.75% convertible seniorsubordinated notes.

(b)          Representsthe number of shares of common stock issuable on the exercise of dilutiveemployee stock options and units less the number of shares of common stockwhich could have been purchased with the proceeds from the exercise of suchoptions and units. These purchases were assumed to have been made at the higherof either the market price of the common stock at the end of the period or theaverage market price for the period.

21

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**Note 13—SegmentInformation**

Summarizedfinancial information concerning the Company’s reportable segments is shown inthe following tables (in thousands):

| ** **                                                                         | ** ** | **For the three months  ended September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                                          | ** ** | **2005** | ** ** |
| Net sales and revenues:                                                            |       |                                                              |       |   |   |
| Mueller Co. (a)                                                                    |       | $                                                                 | 222,975    |   | $ | — |   |
| Anvil (a)                                                                          |       | 139,018                                                           |       | — |   |
| U.S. Pipe                                                                          |       | 164,063                                                           |       | 170,274 |   |
| Mueller Water                                                                      |       | 526,056                                                           |       | 170,274 |   |
| Natural Resources                                                                  |       | 184,392                                                           |       | 106,796 |   |
| Homebuilding                                                                       |       | 68,287                                                            |       | 55,994 |   |
| Financing                                                                          |       | 54,587                                                            |       | 56,621 |   |
| Homebuilding and Financing Group                                                   |       | 122,874                                                           |       | 112,615 |   |
| Other                                                                              |       | 38,616                                                            |       | 35,758 |   |
| Consolidating eliminations                                                         |       | (14,913                                                           | )          | (6,748 | ) |
| Net sales and revenues                                                             |       | $                                                                 | 857,025    |   | $ | 418,695 |   |
| Segment operating  income (loss):                                                  |       |                                                              |       |   |   |
| Mueller Co. (a)                                                                    |       | $                                                                 | 48,701     |   | $ | — |   |
| Anvil (a)                                                                          |       | 13,661                                                            |       | — |   |
| U.S. Pipe                                                                          |       | 12,869                                                            |       | 10,086 |   |
| Mueller Water                                                                      |       | 75,231                                                            |       | 10,086 |   |
| Natural Resources                                                                  |       | 55,641                                                            |       | 29,249 |   |
| Homebuilding                                                                       |       | (3,608                                                            | )          | (10,454 | ) |
| Financing (b)                                                                      |       | 14,225                                                            |       | 521 |   |
| Homebuilding and Financing Group                                                   |       | 10,617                                                            |       | (9,933 | ) |
| Other                                                                              |       | (3,506                                                            | )          | (1,748 | ) |
| Consolidating eliminations                                                         |       | 222                                                               |       | (8 | ) |
| Operating income                                                                   |       | 138,205                                                           |       | 27,646 |   |
| Less other debt interest expense                                                   |       | (36,390                                                           | )          | (3,595 | ) |
| Income from continuing operations before income tax  expense and minority interest |       | 101,815                                                           |       | 24,051 |   |
| Income tax expense                                                                 |       | (29,744                                                           | )          | (3,681 | ) |
| Income from continuing operations before minority  interest                        |       | 72,071                                                            |       | 20,370 |   |
| Minority interest in net income of affiliates                                      |       | (6,889                                                            | )          | — |   |
| Income from  continuing operations                                                 |       | $                                                                 | 65,182     |   | $ | 20,370 |   |

 

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|                             |   | **For the three months  ended September 30,** |       |
|----------------------------------|--------|-------------------------------------------------------------------|------------|
|                             |   | **2006**                                                          | ** ** | **2005** |   |
| Depreciation:                    |   |                                                              |       |   |   |
| Mueller Co. (a)                  |   | $                                                                 | 6,816      |   | $ | — |   |
| Anvil (a)                        |   | 4,905                                                             |       | — |   |
| U.S. Pipe                        |   | 5,709                                                             |       | 6,224 |   |
| Mueller Water                    |   | 17,430                                                            |       | 6,224 |   |
| Natural Resources                |   | 7,004                                                             |       | 5,121 |   |
| Homebuilding                     |   | 1,346                                                             |       | 1,233 |   |
| Financing                        |   | 349                                                               |       | 341 |   |
| Homebuilding and Financing Group |   | 1,695                                                             |       | 1,574 |   |
| Other                            |   | 1,483                                                             |       | 1,319 |   |
| Total                            |   | $                                                                 | 27,612     |   | $ | 14,238 |   |
| Amortization:                    |   |                                                              |       |   |   |
| Mueller Co. (a)                  |   | $                                                                 | 6,264      |   | $ | — |   |
| Anvil (a)                        |   | 859                                                               |       | — |   |
| Financing                        |   | 561                                                               |       | 837 |   |
| Total                            |   | $                                                                 | 7,684      |   | $ | 837 |   |

 

 

| ** **                        | ** ** | **For the nine months  ended September 30,** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                                              | ** ** | **2005** | ** ** |
| Net sales and revenues:           |       |                                                                  |       |   |   |
| Mueller Co. (a)                   |       | $                                                                     | 641,539    |   | $ | — |   |
| Anvil (a)                         |       | 403,028                                                               |       | — |   |
| U.S. Pipe                         |       | 427,515                                                               |       | 456,929 |   |
| Mueller Water                     |       | 1,472,082                                                             |       | 456,929 |   |
| Natural Resources                 |       | 526,584                                                               |       | 378,324 |   |
| Homebuilding                      |       | 197,421                                                               |       | 161,790 |   |
| Financing                         |       | 166,425                                                               |       | 174,320 |   |
| Homebuilding and  Financing       |       | 363,846                                                               |       | 336,110 |   |
| Other                             |       | 112,833                                                               |       | 104,566 |   |
| Consolidating  eliminations       |       | (39,318                                                               | )          | (22,999 | ) |
| Net sales and revenues            |       | $                                                                     | 2,436,027  |   | $ | 1,252,930 |   |
| Segment operating income (loss):  |       |                                                                  |       |   |   |
| Mueller Co. (a)                   |       | $                                                                     | 134,761    |   | $ | — |   |
| Anvil (a)                         |       | 24,522                                                                |       | — |   |
| U.S. Pipe                         |       | 18,149                                                                |       | 27,687 |   |
| Mueller Water                     |       | 177,432                                                               |       | 27,687 |   |
| Natural Resources                 |       | 182,670                                                               |       | 112,409 |   |
| Homebuilding                      |       | (16,748                                                               | )          | (32,997 | ) |
| Financing (b)                     |       | 40,575                                                                |       | 29,323 |   |
| Homebuilding and  Financing Group |       | 23,827                                                                |       | (3,674 | ) |

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|                                                                               |   | **For the nine months  ended September 30,** |       |
|------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------|------------|
|                                                                               |   | **2006**                                                              | ** ** | **2005** |   |
| Other                                                                              |   | (9,791                                                                | )          | (9,018 | ) |
| Consolidating  eliminations                                                        |   | (1,347                                                                | )          | (2,839 | ) |
| Operating income                                                                   |   | 372,791                                                               |       | 124,565 |   |
| Less corporate debt  interest expense                                              |   | (121,045                                                              | )          | (11,304 | ) |
| Income from continuing  operations before income tax expense and minority interest |   | 251,746                                                               |       | 113,261 |   |
| Income tax expense                                                                 |   | (79,856                                                               | )          | (32,228 | ) |
| Income from continuing  operations before minority interest                        |   | 171,890                                                               |       | 81,033 |   |
| Minority interest in net  income of affiliates                                     |   | (7,176                                                                | )          | — |   |
| Income from continuing  operations                                                 |   | $                                                                     | 164,714    |   | $ | 81,033 |   |
| Depreciation:                                                                      |   |                                                                  |       |   |   |
| Mueller Co. (a)                                                                    |   | $                                                                     | 20,172     |   | $ | — |   |
| Anvil (a)                                                                          |   | 14,829                                                                |       | — |   |
| U.S. Pipe                                                                          |   | 16,447                                                                |       | 19,401 |   |
| Mueller Water                                                                      |   | 51,448                                                                |       | 19,401 |   |
| Natural Resources                                                                  |   | 19,549                                                                |       | 15,351 |   |
| Homebuilding                                                                       |   | 3,980                                                                 |       | 3,645 |   |
| Financing                                                                          |   | 1,031                                                                 |       | 1,056 |   |
| Homebuilding and  Financing Group                                                  |   | 5,011                                                                 |       | 4,701 |   |
| Other                                                                              |   | 3,924                                                                 |       | 3,610 |   |
| Total                                                                              |   | $                                                                     | 79,932     |   | $ | 43,063 |   |
| Amortization:                                                                      |   |                                                                  |       |   |   |
| Mueller Co. (a)                                                                    |   | $                                                                     | 18,802     |   | $ | — |   |
| Anvil (a)                                                                          |   | 2,711                                                                 |       | — |   |
| Financing                                                                          |   | 1,900                                                                 |       | 2,823 |   |
| Total                                                                              |   | $                                                                     | 23,413     |   | $ | 2,823 |   |

----

(a)           The Mueller Co. andAnvil segments were acquired by the Company on October 3, 2005.

(b)          Operating income amountsfor Financing include interest expense on the mortgage-backed/asset-backednotes of $29,465 and $30,046 for the three months ended September 30, 2006and 2005, respectively, and $88,399 and $92,583 for the nine months ended September 30,2006 and 2005, respectively.

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**Note14—Discontinued Operations**

In December 2003, theCompany sold Applied Industrial Materials Corporation (“AIMCOR”), previously awholly-owned subsidiary of the Company to Oxbow Carbon and Minerals LLC(“Oxbow”) for $127.7 million, subject to certain post-closing adjustments.  Per the sales agreement for the divestitureof AIMCOR, the final sales price is subject to certain post-closing cash andnet working capital adjustments.  Theseadjustments are defined in the sales agreement and are subject to resolutionand arbitration processes provided for in the agreement.  As a result of this transaction, the Companyrecognized a receivable for estimated net cash and working capital adjustmentsdue to the Company.  During the quarterended September 30, 2006, the Company recognized a charge of approximately $1.7million, net of a tax benefit of $0.9 million to reflect the current estimatednet realizable value of the receivable of $11.3 million.  This charge, as well as other legal andconsulting costs resulting from the transaction, is included as a loss fromdiscontinued operations in the consolidated statement of operations.

**Note15—Commitments and Contingencies**

*Income Tax Litigation*

On February 20, 2006, theIRS completed its audit of the Company’s Federal tax returns for the yearsended May 31, 2000, December 31, 2000 and December 31, 2001 and issued 30-dayletters proposing tax deficiencies in the amount of $82.2 million.  The issues relate primarily to the Company’smethod of recognizing revenue on the sale of homes and interest on the relatedinstalment notes receivable.  The itemsat issue relate primarily to the timing of revenue recognition andconsequently, should the IRS prevail on its positions, the Company’s financialexposure is limited to interest and penalties.

On December 27, 1989, theCompany and most of its subsidiaries each filed a voluntary petition forreorganization under Chapter 11 of Title 11 of the United States Code (the“Bankruptcy Proceedings”) in the United States Bankruptcy Court for the MiddleDistrict of Florida, Tampa Division (the “Bankruptcy Court”).  The Company emerged from bankruptcy on March17, 1995 (the “Effective Date”) pursuant to the Amended Joint Plan ofReorganization Dated as of December 9, 1994, as modified on March 1, 1995 (asso modified the “Consensual Plan”). Despite the confirmation and effectiveness of the Consensual Plan, theBankruptcy Court continues to have jurisdiction over, among other things, theresolution of disputed prepetition claims against the Company and other mattersthat may arise in connection with or related to the Consensual Plan, includingclaims related to Federal income taxes.

A controversy exists withregard to Federal income taxes allegedly owed by the Company for fiscal years1980 through 1994.  In connection withthe bankruptcy proceedings, the IRS filed a proof of claim in the BankruptcyCourt (the “Proof of Claim”) for a substantial amount of taxes, interest andpenalties with respect to fiscal years ended August 31, 1980 and August 31,1983 through May 31, 1994.  The Companyfiled an adversary proceeding in the Bankruptcy Court disputing the Proof ofClaim (the “Adversary Proceeding”) and the various issues have been and arebeing litigated in the Bankruptcy Court.

The amounts initiallyasserted by the Proof of Claim do not reflect the subsequent resolution ofvarious issues through settlements or concessions by the parties.  After adjustment for these items, the Companyestimates that the amount of tax presently claimed by the IRS is approximately$34 million for issues currently in dispute in the Adversary Proceeding.  This amount is subject to interest andpenalties. Of the $34 million in claimed tax, $21 million represents issues inwhich the IRS is not challenging the deductibility of the particular expensebut only whether such expense is deductible in a particular year. Consequently,the Company believes that, should the IRS prevail on any such issues, theCompany’s financial exposure is limited to interest and possible penalties andthe amount of tax claimed will be offset by deductions in other years.Substantially all of the issues in the Proof of Claim, which have not beensettled or conceded, have been litigated before the Bankruptcy Court and aresubject to appeal but only at the conclusion of the entire AdversaryProceeding.

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The Company believes thatthose portions of the Proof of Claim that remain in dispute or are subject toappeals substantially overstate the amount of taxes allegedly owing. However,because of the complexity of the issues presented and the uncertaintiesassociated with litigation, the Company is unable to predict the ultimateoutcome of the Adversary Proceeding.

The Company believes thatits current and prior tax filing positions have substantial merit and intendsto defend vigorously any tax claims asserted. The Company believes that it has sufficient accruals to address anyclaims, including interest and penalties.

*Environmental Matters*

The Company is subject toa wide variety of laws and regulations concerning the protection of theenvironment, both with respect to the construction and operation of many of itsplants, mines and other facilities and with respect to remediatingenvironmental conditions that may exist at its own and other properties. The Companybelieves that it is in substantial compliance with federal, state and localenvironmental laws and regulations. The Company accrues for environmentalexpenses resulting from existing conditions that relate to past operations whenthe costs are probable and reasonably estimable.

U.S. Pipe has implementedan Administrative Consent Order (‘‘ACO’’) for its Burlington, New Jersey plantthat was required under the New Jersey Environmental Cleanup Responsibility Act(now known as the Industrial Site Recovery Act). The ACO required soil andground water cleanup, and U.S. Pipe has completed, and has received finalapproval on, the soil cleanup required by the ACO.  U.S. Pipe is continuing to address groundwater issues at this site. Further remediation could be required. Theseremediation costs are expected to be minimal. Long-term ground water monitoringwill be required to verify natural attenuation. It is not known how long groundwater monitoring will be required. Management does not believe monitoring or furthercleanup costs, if any, will have a material adverse effect on the financialcondition or results of operations of the Company and its subsidiaries.

The Federal ComprehensiveEnvironmental Response, Compensation and Liability Act (‘‘CERCLA’’) generallyimposes liability, which may be joint and several and is without regard tofault or the legality of waste generation or disposal, on certain classes ofpersons, including owners and operators of sites at which hazardous substancesare released into the environment (or pose a threat of such release), personsthat disposed or arranged for the disposal of hazardous substances at suchsites, and persons who owned or operated such sites at the time of suchdisposal. CERCLA authorizes the EPA, the States and, in some circumstances,private entities to take actions in response to public health or environmentalthreats and to seek to recover the costs they incur from the same classes ofpersons. Certain governmental authorities can also seek recovery for damages tonatural resources. Currently, U.S. Pipe has been identified as a potentiallyresponsible party (‘‘PRP’’) by the EPA under CERCLA with respect to cleanup oflead and other hazardous substances in Anniston, Alabama.  U.S. Pipe is among many PRP’s at such siteand a significant number of the PRP’s are substantial companies. The PRP’s havenegotiated an administrative consent order (ACO) with the EPA and the PRP’shave agreed to divide clean-up costs pro-rata subject to later adjustment basedon the relative contribution by each PRP to the contamination. Managementpreviously estimated the Company’s share of liability for cleanup, afterallocation among several PRPs, to be approximately $4.0 million, which wasaccrued in 2004. In the third quarter of 2006, U.S. Pipe and Phelps Dodge (aco-signer of the ACO) agreed that Phelps Dodge would assume U.S. Pipe’sobligations and liabilities relating to the ACO. As a result, the Companyrecognized a pre-tax benefit related to the settlement of this obligation,which was not material to the Company’s financial statements. Phelps Dodge hadpreviously entered into similar agreements with all other signatories to theACO.

Solutia, Inc and PharmaciaCorporation filed suit against U.S. Pipe and the Company on January 5, 2003 (Solutia,Inc and Pharmacia Corporation v. United States Pipe and Foundry Company, WalterIndustries, Inc., et al, Case No. CV-03-PWG-1345-E) in US District court forthe Northern District of Alabama.  Thisis a civil action for contribution and cost recovery by Solutia with respect tocosts incurred 

26

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and tobe incurred by Solutia in performing remediation of PCBs and heavy metalsmandated by EPA in Anniston, Alabama with respect to the ACO describedabove.  The ACO provides protection against contribution claims by thirdparties, such as Solutia.  Management believes that the likelihood ofliability in the contribution litigation is remote. The Magistrate has entered an Order stayingdiscovery in this matter but has allowed Solutia to proceed with “on-site” samplingdiscovery.

The Company and U.S. Pipehave been named in a suit filed by Isaiah Evans on April 8, 2005 (Isaiah Evanset al v. Walter Industries, Inc., United States Pipe and Foundry Company, Inc.,et al, Case No. CV:05-258) in the Circuit Court of Calhoun County,Alabama.  This is a purported civil classaction case filed against 18 foundries in the Anniston, Alabama area allegingstate law tort claims in the creation and disposal of foundry sand alleged tocontain lead and PCB's.   The plaintiffs are seeking damages forpersonal injury and property damage.  The class action lawsuit is still inthe early stages of litigation and no substantial discovery has yet takenplace.  In addition, management believesthat both procedural and substantive defenses would be available to the Companyshould this litigation proceed.  The case is presently infederal court.  A Motion to Dismiss Walter Industries, Inc.has been filed but not ruled on.  Accordingly,management believes that presently there is no reasonable basis for managementto form a view with respect to the probability of liability in this matter.

Sloss, U.S. Pipe, WalterIndustries Inc., and Mueller recently received a letter from attorneysrepresenting a purported group of residents of the North Birmingham area ofJefferson County, Alabama alleging Personal Injury, Property Damage, Nuisance,and Trespass involving the release of toxic emissions into the North Birminghamenvironment causing injury.  The allegationsagainst Sloss result from their coking emissions into the environment.  The allegations against U. S. Pipe resultfrom the use of coal tar products and their emissions into the North Birminghamenvironment.  Walter and Mueller arenamed in this litigation because of ownership interest.

Sloss has been named in asuit (Adkins v. Sloss, et al. in Circuit Court, Wayne County, West Virginia;Civil Action No. 04-C261). This is the lead case of 8 suits filed in WayneCounty, WV, over the spill of “light oil” from a railcar loaded at the Slossfacility.  Sloss and one other defendantare engaging in settlement discussions with the plaintiffs.  The Court has ruled that it will not allowpunitive damages, nor will it allow most medical monitoring claims to goforward.  All other defendants havesettled with all of the plaintiffs. At September 30, 2006, the Company hasrecognized a liability of $1.0 million for the estimated settlement of thismatter.  In October 2006, Sloss settledwith the majority of plaintiffs in this case for an amount that was not materialto the Company’s financial statements.

Although the Company nowproduces a small amount of no-lead brass products, most of the Company’s brassvalve products contain approximately 5.0% lead. Environmental advocacy groups, relying on standards established byCalifornia’s Proposition 65, are seeking to eliminate or reduce the content oflead in water infrastructure products offered for sale in California.  Some of the Company’s subsidiaries haveentered into settlement agreements with these environmental advocacy groups tomodify products or offer substitutes for sale in California.  Legislation to substantially restrict leadcontent in water infrastructure products has been introduced in the UnitedStates Congress.  Congress or statejurisdictions other than California may enact legislation similar toProposition 65 to restrict the content of lead in water products, which couldrequire the Company to incur additional capital expenses to modifyproduction.  To date, we have undertakena capital project to implement a no-lead brass production line that willrequire the Company to incur approximately $8.0 million in incremental capitalspending over the next two years.  Inaddition, advocacy groups or other parties may file suit against the Companyunder Proposition 65 or under new, similar legislation adopted in otherjurisdictions that could result in additional costs in connection withmarketing and selling brass products in California or in such otherjurisdictions.

27

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Over the next year, theCompany is expected to incur between $12.5 million and $15.0 millionof capital costs at its foundries to comply with the United StatesEnvironmental Protection Agency's National Emissions Standards for HazardousAir Pollutants which were issued April 22, 2004 and go into effect onApril 22, 2007.

In the acquisitionagreement pursuant to which Tyco International (“Tyco”) sold Mueller Water toits prior owners in August 1999, Tyco agreed to indemnify Mueller Waterand its affiliates for all “Excluded Liabilities”. Excluded Liabilitiesinclude, among other things, substantially all liabilities relating to the timeprior to the August 1999 Tyco Transaction. The indemnity survivesindefinitely and is not subject to any deductibles or caps. However, MuellerWater may be responsible for these liabilities in the event that Tyco everbecomes financially unable to, or otherwise fails to comply with, the terms ofthe indemnity. In addition, Tyco’s indemnity does not cover environmentalliabilities to the extent caused by Mueller Water or the operation of itsbusiness after the August 1999 Tyco Transaction, nor does it coverenvironmental liabilities arising with respect to businesses or sites acquiredafter the August 1999 Tyco Transaction, which would include the U.S. Pipebusiness and facilities.

Sloss Industries enteredinto a consent order in 1989 relative to a Resource Conservation Recovery Act(“RCRA”) compliance program mandated by the EPA.  A RCRA Facility Investigation (“RFI”) WorkPlan was prepared which proposed investigative tasks to assess the presence ofcontamination at the Sloss facility. The Work Plan was approved in 1994 and thePhase I investigations were conducted and completed between 1995 and 1999.Phase II investigations for the Chemical Plant/Coke Plant and BiologicalTreatment Facility and Sewers/Land Disposal Areas were performed in 2000 and2001 and are substantively complete.  Atthe end of 2004, EPA re-directed Sloss’ RFI efforts toward completion of theEnvironmental Indicator (“EI”) determinations for the *CurrentHuman Exposures*.  This EIeffort was completed to assist EPA in meeting goals set by the GovernmentPerformance Results Act (“GPRA”) for RCRA by the year 2005.  Sloss implemented the approved EI SamplingPlan in April 2005.  EPAapproved/finalized the EI determinations for Sloss’ Birmingham facility inSeptember 2005.  In an effort to refocusthe RFI, EPA has now provided technical comments on the Phase II RFI report andthe report recently submitted as part of the EI effort.  A Phase III work plan will be submitted tothe EPA during the first quarter of 2007.

Although no assurances canbe given that the Company will not be required in the future to make materialexpenditures relating to these or other sites, management does not believe atthis time that the cleanup costs, if any, associated with these or other siteswill have a material adverse effect on the financial condition or results ofoperations of the Company, but such cleanup costs could be material to resultsof operations in a future reporting period.

In 2005, the Companyentered into a settlement and release agreement with a former insurer wherebythe former insurer agreed to pay $5.1 million, net of legal fees, to theCompany for environmental historical insurance claims previously expensed asincurred by the Company. Such claims had not previously been submitted to theinsurance company for reimbursement. The Company released the insurer of bothpast and future claims.  During 2005, theCompany received $2.8 million, and the remainder was received in the firstquarter of 2006.  The Company recorded a$5.1 million reduction to selling, general and administrative expenses in thefirst quarter of 2005 in the U.S. Pipe segment.

*Miscellaneous Litigation*

CC Arbitrage,Ltd.("CC Arbitrage"), filed suit against the Company in the FederalDistrict Court in the Southern District of New York on October 25, 2006 (CCArbitrage v. Walter Industries, Inc., Civil Action No. 06-CV-11378). CCArbitrage claims that it is the holder of approximately $22.5 million in 3.75%Convertible Senior Subordinated Notes (the "Notes") issued bythe Company under the indenture dated April 20, 2004 (the"Indenture") entered into between the Company and the Bank of NewYork Company, N.A., as Trustee, and alleges that the supplemental indenturedated as of August 10, 2006 (the 

28

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"SupplementalIndenture") was improperly adopted. The suit filed by CC Arbitrage seeksan entry of a declaratory judgment holding that the Supplemental Indenture isinvalid and of no legal effect and a breach of the Indenture, seeking recoveryof damages in excess of $75,000.00. Two other holders of the Notes, CNH CAMaster Account, L.P. and CSS, LLC, which purport to hold Notes withprincipal amounts of $66.575 million and $10.0 million, respectively, havewritten to the indenture trustee requesting that the trustee initiate legalaction against the Company on similar grounds. Management believes that theclaims by CC Arbitrage, CNH and CSS, are entirely without merit and thatthe CC Arbitrage civil matter and the letter from CNH andCSS represent attempts by a few Note holders to disrupt theplanned spin-off distribution by the Company of its remaining shares in MuellerWater and to profit improperly at the expense of the Company's shareholders.The Company will vigorously defend the CC Arbitrage matter and any othersimilar action that may be filed.

Drummond Company, Inc.filed suit in state court in Tuscaloosa County, Alabama on October 29, 2001,against the Company and several of its subsidiaries (Drummond Company, Inc. v.Walter Industries, Inc., et al., Case No. CV 2002-0673).  Drummond claims that it is entitled toexclusive surface mining rights on certain lands owned by United LandCorporation, a wholly-owned subsidiary of the Company, and alleges in excess of$350 million in damages.  The Companyfiled a counterclaim seeking injunctive relief, substantial actual damages andpunitive damages against Drummond based on fraud. The Company and itssubsidiaries were granted summary judgment on all of Drummond’s claims on March29, 2005. A jury trial denied United Land Corporation’s counter-claim on April8, 2005. Drummond and the Company have appealed. Drummond's claims do notaffect the underground mining operations of the Jim Walter Resources subsidiary.  Management does not believe that thislitigation will have a material adverse effect on the financial condition orresults of operations of the Company and its subsidiaries.

The Company has reached anunderstanding in principle with Oxbow Carbon and Minerals LLC to resolve alloutstanding disputes in respect of the sale by the Company to Oxbow of theCorporation’s former AIMCOR subsidiary. Under the AIMCOR purchase agreement, the final sales price was subjectto post-closing net cash and working capital adjustments.  In 2003, the Company recorded a receivable ofapproximately $16 million for estimated net cash and working capitaladjustments the Company believed were due under the agreement.  The Company and Oxbow disputed theseadjustments, and arbitration proceedings ensued.  During the pendency of the dispute, the $16million receivable was reduced by insurance proceeds to approximately $14million.  As a result of recent settlementdiscussions, the Company has reduced this receivable to $11.3 million, which itbelieves will be the amount paid to it in connection with the settlement of alloutstanding disputes with Oxbow.

The Los Angeles Departmentof Water and Power, ex rel. Nora Armenta (“Armenta”) filed suit against theCompany’s subsidiaries, James Jones Company and Mueller Co. (Superior Court,Los Angeles County, California; Case No. BC 173487) on June 27, 1997.  In addition, the City of Banning (“City ofBanning”) filed suit against the Company’s subsidiaries, James Jones Companyand Mueller Co. (Superior Court, Los Angeles County; Case No. BC 321513) onSeptember 15, 2004.  The Armenta matteris a false claims lawsuit brought on behalf of cities, water districts, andmunicipalities alleging that the defendants sold allegedly non-conformingpublic water system parts to various government entities. The lawsuit seeksconsequential damages, penalties, and punitive damages relating to the repairand replacement of the water systems to remove the allegedly non-conformingparts. In January 2004, the Armenta trial court granted Mueller Co.’s motion,and dismissed Mueller Co. from the Armenta litigation.  In August 2006, the California Court ofAppeal reversed the lower court’s dismissal of Mueller Co.  In October 2006, Mueller Co. filed a petitionwith the California Supreme Court for review of the appellate decision.  On September 15, 2004, the Armenta trialcourt ruled against the intervention of approximately 30 municipalities thathad failed to intervene within the time deadlines previously specified by thecourt. The trial court also ruled that the majority of municipalities that hadpurchased James Jones products from contractors or distributors, were not inprivity with the James Jones Company and were not entitled to 

29

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punitivedamages. Following the Armenta court's September 15, 2004 ruling, the waterdistricts and municipalities filed the City of Banning action against the JamesJones Company, Mueller Co., and Watts (former parent company of James JonesCompany), alleging fraud and intentional misrepresentation. This lawsuit isbased on the same underlying facts as the Armenta lawsuit. Any liabilityassociated with these lawsuits is covered by the Tyco indemnity, and thedefense is being paid for and conducted by Tyco, all in accordance with theindemnity obligation of Tyco described above in *EnvironmentalMatters*.

The Company and itssubsidiaries are parties to a number of other lawsuits arising in the ordinarycourse of their businesses.  The Companyprovides for costs relating to these matters when a loss is probable and theamount is reasonably estimable.  Theeffect of the outcome of these matters on the Company’s future results ofoperations cannot be predicted with certainty as any such effect depends onfuture results of operations and the amount and timing of the resolution ofsuch matters.  While the results oflitigation cannot be predicted with certainty, the Company believes that thefinal outcome of such other litigation will not have a materially adverseeffect on the Company’s consolidated financial statements.

*Commitments and Contingencies—Other*

As part of the acquisitionof the Star Pipe business on January 15, 2004, Anvil has agreed to a futurepayment to be made to the seller of a business Anvil acquired to the extentthat the gross profit of the acquired business exceeds a targeted gross profit.The maximum potential payment amount is $23 million. Management currentlyestimates the payment could total approximately $3 million to $6 millionfor the payment period that began February 1, 2004 and endsJanuary 31, 2007. The payment amount indicated above is based onmanagement's best estimate, but the actual adjustment could be materiallydifferent. The liability for such payment will be recorded at the end of eachpayment period in accordance with the purchase agreement, with a correspondingcharge to goodwill.

In the opinion ofmanagement, accruals associated with contingencies incurred in the normalcourse of business are sufficient. Resolution of existing known contingenciesis not expected to significantly affect the Company's financial position andresult of operations.

**Note16—New Accounting Pronouncements**

In February 2006, the FASBissued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments – anamendment of FASB Statements No. 133 and 140,” which resolves issues associatedwith the bifurcation requirements of SFAS No. 133 as  it relates to certain hybrid financialinstruments that contain an embedded derivative, and amends SFAS No. 140 toeliminate the prohibition on a qualifying special-purpose entity from holding aderivative financial instrument that pertains to a beneficial interest otherthan another derivative financial instrument. SFAS No. 155 is effective for all financial instruments acquired, issuedor subject to a remeasurement event occurring in fiscal years beginning afterSeptember 15, 2006.  The adoption of thisstatement is not anticipated to have a significant impact on the Company’sfinancial condition or results of operations.

In March 2006, the FASBissued SFAS No. 156, “Accounting for Servicing of Financial Assets – anamendment of FASB Statement No. 140,” which amends SFAS No. 140 to (i) requirethat all separately recognized servicing assets and servicing liabilities beinitially measured at fair value, if practicable; (ii) permits, but does notrequire, the subsequent measurement of separately recognized servicing assetsand servicing liabilities at fair value; (iii) requires an entity that usesderivative instruments to mitigate the risks inherent in servicing assets andservicing liabilities to account for those derivative instruments at fairvalue; and (iv) permits an entity to elect subsequent fair value measurement toaccount for its separately recognized servicing assets and liabilities.  SFAS No. 156 is effective for all separatelyrecognized servicing assets and servicing liabilities in fiscal years beginningafter September 15, 2006.  The adoptionof this statement is not anticipated to have a significant impact on theCompany’s financial condition or results of operations.

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In July 2006, the FASBissued Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in IncomeTaxes,” which provides the minimum recognition threshold that a tax provisionmust meet before being recognized in the financial statements.  This interpretation also provides guidance onderecognition of income tax assets and liabilities, classification of currentand deferred income tax assets and liabilities, accounting for interest and penaltiesassociated with tax positions, accounting for income taxes in interim periods,and income tax disclosures.  FIN No. 48applies to all tax positions related to income taxes subject to SFAS No. 109,“Accounting for Income Taxes.”  TheCompany has not yet determined the estimated impact the adoption of thisinterpretation, which becomes effective January 1, 2007, will have on itsconsolidated financial statements.

In September 2006, theSecurities and Exchange Commission (“SEC”) staff issued Staff AccountingBulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatementswhen Quantifying Misstatements in Current Year Financial Statements,” whichprovides guidance for companies on how to quantify financial statementmisstatements.  SAB No. 108 requires thequantification of financial statement misstatements based on the effects ofmisstatements on each of the company’s financial statements and their relatedfinancial statement disclosures.  SECregistrants must begin applying the provisions of SAB No. 108 for all fiscalyears ending after November 15, 2006. The Company has not yet determined what impact, if any, the adoption ofthis guidance will have on its consolidated financial statements.

In September 2006, theFASB issued SFAS No. 157, “Fair Value Measurements,” which provides adefinition of fair value, establishes a framework for measuring fair value andexpands financial statement disclosure requirements.  SFAS No. 157 requires companies to base fairvalues on what they would receive from a sale to a third party in the openmarket.  The Company has not yetdetermined what impact, if any, the adoption of this statement, which becomeseffective January 1, 2008, will have on its consolidated financial statements.

In September 2006, theFASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pensionand Other Postretirement Plans,” which requires SEC registrants to recognize anet liability or asset to report the funded status of the Company’s definedbenefit pension and other postretirement benefit plans on the balance sheet.The Company has not yet determined what impact, the adoption of this statement,which becomes effective December 31, 2006, will have on its consolidatedfinancial statements.

**Note17—Subsequent Events**

On November 2, 2006,Mid-State Capital Corporation, a wholly owned subsidiary of the Companycompleted its 2006-1 Trust private offering of $256.9 million in asset-backedbonds.  The notes were issued in fourseparate classes with a single maturity date of October 2040 and with aweighted average, fixed interest coupon of 6.28%.  The net proceeds will be used to repayborrowings under the Mid-State Trust IX and Mid-State Trust XIV mortgagewarehouse facilities and will provide approximately $39.2 million of liquidityfor the Company’s general corporate purposes.

On November 6, 2006, theCompany declared a 2-for-1 stock split (the “Stock Split”) and a tax-freespin-off distribution of its 85.8 million Series B shares held in Mueller Wateras a tax-free transfer (the “Spin-Off”). The Stock Split and the Spin-Off each have a record date of December 6,2006 and a distribution date of December 14, 2006.  The Company currently has approximately 44.3million shares outstanding.  Based onthis share count, each share of the Company will be entitled to a distributionratio of 1.94 shares of  Mueller Water’sSeries B common stock.  The amount of theCompany’s common stock outstanding could change significantly prior to therecord date based on the number of additional shares of the Company issued fromthe potential conversion of the Company’s Convertible Senior Subordinated Notesand from the potential exercise of vested stock options of the Company.  If all of the Convertible Senior SubordinatedNotes are converted, then an additional 7.7 million shares of the Company wouldbe issued, reducing the distribution ratio of Mueller Water’s Series B commonshares issued to 1.65 for each share of the Company’s common stock.

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**MANAGEMENT’SDISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS,FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCESAND QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

This discussion should beread in conjunction with the condensed consolidated financial statements andnotes thereto of Walter Industries, Inc. and its subsidiaries,particularly Note 13 of “Notes to Condensed Consolidated Financial Statements,”which describe the Company’s net sales and revenues and operating income byoperating segment.

**RESULTS OFOPERATIONS**

**SummaryOperating Results of Continuing Operations for the Three Months ended September 30, 2006 and 2005**

| ** **                                                                   | ** ** | **For the three months ended September 30, 2006** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | ** **                                                                           | ** ** | ** ** | ** ** | **U.S.** | ** ** | **Natural** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Cons** | ** ** | ** ** | ** ** |
| **($ in thousands)**                                               | ** ** | **Mueller Co.**                                                                 | ** ** | **Anvil** | ** ** | **Pipe** | ** ** | **Resources** | ** ** | **Homebuilding** | ** ** | **Financing** | ** ** | **Other** | ** ** | **Elims** | ** ** | **Total** | ** ** |
| Net sales                                                                    |       |                                                                                 | $          | 222,198 |   |   | $ | 138,533 |   | $ | 163,914 |   |   | $ | 178,157 |   |   |   | $ | 67,823 |   |   |   | $ | 3,701 |   |   | $ | 36,142 |   | $ | (14,913 | ) | $ | 795,555 |   |
| Interest income on instalment notes                                          |       |                                                                                 | —     |   |   | — |   | — |   |   | — |   |   |   | — |   |   |   | 49,434 |   |   | — |   | — |   | 49,434 |   |
| Miscellaneous                                                                |       |                                                                                 | 777        |   |   | 485 |   | 149 |   |   | 6,235 |   |   |   | 464 |   |   |   | 1,452 |   |   | 2,474 |   | — |   | 12,036 |   |
| Net sales and revenues                                                       |       |                                                                                 | 222,975    |   |   | 139,018 |   | 164,063 |   |   | 184,392 |   |   |   | 68,287 |   |   |   | 54,587 |   |   | 38,616 |   | (14,913 | ) | 857,025 |   |
| Cost of sales                                                                |       |                                                                                 | 141,947    |   |   | 95,191 |   | 135,497 |   |   | 112,695 |   |   |   | 54,523 |   |   |   | 983 |   |   | 30,274 |   | (15,135 | ) | 555,975 |   |
| Interest expense(1)                                                          |       |                                                                                 | —     |   |   | — |   | — |   |   | — |   |   |   | — |   |   |   | 29,465 |   |   | — |   | — |   | 29,465 |   |
| Depreciation                                                                 |       |                                                                                 | 6,816      |   |   | 4,905 |   | 5,709 |   |   | 7,004 |   |   |   | 1,346 |   |   |   | 349 |   |   | 1,483 |   | — |   | 27,612 |   |
| Selling, general & administrative                                   |       |                                                                                 | 19,247     |   |   | 24,402 |   | 10,376 |   |   | 4,109 |   |   |   | 16,148 |   |   |   | 7,106 |   |   | 10,733 |   | — |   | 92,121 |   |
| Provision for losses on instalment notes                                     |       |                                                                                 | —     |   |   | — |   | — |   |   | — |   |   |   | — |   |   |   | 1,946 |   |   | — |   | — |   | 1,946 |   |
| Postretirement benefits                                                      |       |                                                                                 | —     |   |   | — |   | (388 | ) |   | 4,943 |   |   |   | (122 | ) |   |   | (48 | ) |   | (368 | ) | — |   | 4,017 |   |
| Amortization of Intangibles                                                  |       |                                                                                 | 6,264      |   |   | 859 |   | — |   |   | — |   |   |   | — |   |   |   | 561 |   |   | — |   | — |   | 7,684 |   |
| Operating income (loss)                                                      |       |                                                                                 | $          | 48,701 |   |   | $ | 13,661 |   | $ | 12,869 |   |   | $ | 55,641 |   |   |   | $ | (3,608 | ) |   |   | $ | 14,225 |   |   | $ | (3,506 | ) | $ | 222 |   | $ | 138,205 |   |
| Other debt  interest expense                                                 |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (36,390 | ) |
| Income from continuing  operations before income taxes and minority interest |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 101,815 |   |

----

(1)             Excludes other debt interest expense.

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| ** **                                                                   | ** ** | **For the three months ended September 30, 2005** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | ** **                                                                           | ** ** | **Natural** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **($ in thousands)**                                               | ** ** | **U.S. Pipe**                                                                   | ** ** | **Resources** | ** ** | **Homebuilding** | ** ** | **Financing** | ** ** | **Other** | ** ** | **Cons Elims** | ** ** | **Total** | ** ** |
| Net sales                                                                    |       |                                                                                 | $          | 170,216 |   |   |   | $ | 105,947 |   |   |   | $ | 55,721 |   |   |   | $ | 3,858 |   |   | $ | 32,374 |   |   | $ | (6,070 | ) |   | $ | 362,046 |   |   |
| Interest income on instalment notes                                          |       |                                                                                 | —     |   |   |   | — |   |   |   | — |   |   |   | 50,977 |   |   | — |   |   | — |   |   | 50,977 |   |   |
| Miscellaneous income                                                         |       |                                                                                 | 58         |   |   |   | 849 |   |   |   | 273 |   |   |   | 1,786 |   |   | 3,384 |   |   | (678 | ) |   | 5,672 |   |   |
| Net sales and revenues                                                       |       |                                                                                 | 170,274    |   |   |   | 106,796 |   |   |   | 55,994 |   |   |   | 56,621 |   |   | 35,758 |   |   | (6,748 | ) |   | 418,695 |   |   |
| Cost of sales                                                                |       |                                                                                 | 143,858    |   |   |   | 65,920 |   |   |   | 47,023 |   |   |   | 2,650 |   |   | 27,616 |   |   | (6,740 | ) |   | 280,327 |   |   |
| Interest expense(1)                                                          |       |                                                                                 | —     |   |   |   | — |   |   |   | — |   |   |   | 30,046 |   |   | — |   |   | — |   |   | 30,046 |   |   |
| Depreciation                                                                 |       |                                                                                 | 6,224      |   |   |   | 5,121 |   |   |   | 1,233 |   |   |   | 341 |   |   | 1,319 |   |   | — |   |   | 14,238 |   |   |
| Selling, general & administrative                                   |       |                                                                                 | 10,469     |   |   |   | 3,637 |   |   |   | 18,309 |   |   |   | 7,009 |   |   | 8,904 |   |   | — |   |   | 48,328 |   |   |
| Provision for losses on instalment notes                                     |       |                                                                                 | —     |   |   |   | — |   |   |   | — |   |   |   | 3,076 |   |   | — |   |   | — |   |   | 3,076 |   |   |
| Postretirement benefits                                                      |       |                                                                                 | (363       | ) |   |   | 4,112 |   |   |   | (117 | ) |   |   | (59 | ) |   | (333 | ) |   | — |   |   | 3,240 |   |   |
| Amortization of intangibles                                                  |       |                                                                                 | —     |   |   |   | — |   |   |   | — |   |   |   | 837 |   |   | — |   |   | — |   |   | 837 |   |   |
| Provision for estimated hurricane insurance losses                           |       |                                                                                 | —     |   |   |   | — |   |   |   | — |   |   |   | 12,200 |   |   | — |   |   | — |   |   | 12,200 |   |   |
| Restructuring & impairment charges                                  |       |                                                                                 | —     |   |   |   | (1,243 | ) |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   | (1,243 | ) |   |
| Operating income (loss)                                                      |       |                                                                                 | $          | 10,086 |   |   |   | $ | 29,249 |   |   |   | $ | (10,454 | ) |   |   | $ | 521 |   |   | $ | (1,748 | ) |   | $ | (8 | ) |   | $ | 27,646 |   |   |
| Other debt interest expense                                                  |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (3,595 | ) |   |
| Income from continuing  operations before income taxes and minority interest |       |                                                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 24,051 |   |   |

----

(1)             Excludes other debt interest expense.

***Overview***

The Company’s net income for the quarter ended September 30,2006 was $63.2 million, or $1.23 per diluted share, which compares to netincome in the year-ago period of $20.2 million, or $0.43 per share. Increasednet income for the quarter principally reflects the addition of Mueller Co. andAnvil, acquired on October 3, 2005, higher metallurgical coal volumes andincreased overall average pricing, partially offset by increased coalproduction costs and freight expenses in the Natural Resources segment, reducedhurricane-related claims expense and provision for losses on the mortgageportfolio in the Financing segment, and higher average selling prices and lowerselling, general and administrative costs in the Homebuilding segment. Theseincreases to net income were partially offset by a write-down to net realizablevalue of a receivable related to the December 2003 sale of AIMCOR, apreviously owned subsidiary.

Principal factorsimpacting the current period results compared to the year-ago period included:

·       MuellerCo. and Anvil contributed combined net sales and revenues of $362.0 million andoperating income of $62.4 million.

·       Averageselling prices at Natural Resources for coal increased 24.1% and natural gasprices increased 5.7%, reflecting the benefit of hedging. These increases werepartially offset by higher mining costs, primarily at Mine No. 4, whichresulted from unfavorable geological conditions. Additionally, the prior yearperiod included $12.6 million of idle mine costs at Mine No. 5.

·       Homebuildinghad 25.9% higher average net selling prices, higher on-your-lot deliveries andimproved gross margins, reflecting price increases and tighter cost controls. Reductionsin selling, general and administrative expenses also contributed to improvedresults.

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·       Financingresults in the current period reflect a $12.2 million reduction inhurricane-related claims expense compared to the prior year period. Additionally,provision for losses on the mortgage portfolio improved $1.1 million versus theprior year period.

·       U.S.Pipe’s revenues declined $6.2 million of which approximately $15.5 million isdue to the transfer of the valve and hydrant business to Mueller Co. effective January 1,2006. Shipments of ductile iron pipe products also declined, but were more thanoffset by higher pricing for ductile iron pipe products.

·       Interestexpense on other debt increased $32.8 million to $36.4 million in the currentyear period primarily due to the inclusion of Mueller Water debt and additionalindebtedness incurred to finance the Mueller Water acquisition. In addition,interest expense in the current period included a $4.5 million loss on theearly extinguishment of Mueller debt and a $0.8 million loss on the earlyrepayment of Walter debt.

·       TheCompany’s third quarter 2006 effective tax rate was 29%, versus 15% in theprior year period.

Other strategicinitiatives include:

·       InJune 2006, Mueller Water completed an initial public offering (“IPO”) ofits Series A common stock, par value $0.01 per share. The Company is theholder of all of Mueller Water’s outstanding Series B common stock, parvalue $0.01 per share. As a result of the IPO, the Company’s ownership interestin Mueller Water (consisting of the Mueller Co., U.S. Pipe and Anvil segments)decreased from 100% to 74.9%. In addition, the Company holds 96.3% of thecombined voting interest of all Mueller Water’s common stock outstanding. TheCompany anticipates the completion of a tax-free spin-off of Mueller Water tothe Company’s stockholders on December 14, 2006.

·       InFebruary 2006, the Company announced that it is evaluating a potentialspin-off of its Homebuilding and Financing segments to the Company’sstockholders. The Company expects to provide a more detailed update on thestrategic direction of the combined Homebuilding and Financing segments in2007.

Other developments, trendsand factors that may impact future results include:

**Mueller WaterProducts**

·       Duringthe period August through October of 2006, the Company hasexperienced a downturn in orders for water infrastructure products. Bookingsfor these products have dropped approximately 11% versus the same period lastyear and bookings for pipe products are also down about 10%. The Company anticipates housingstarts to remain weak throughout the year and expects the decline to be at alevel that will have a negative impact on orders of water infrastructure products,primarily iron gate valves, hydrants and ductile iron pipe. Repair andreplacement activity is expected to continue to increase, partially offsettingthe anticipated decline in these sales.

·       Recent price increases in brassingot, which contains approximately 85% copper, have increased the overall costof manufacturing certain Mueller Co. products, including certain hydrant andvalve components. Mueller Co. raised prices on certain brass products by 10%,effective May 1, 2006 and by an additional 12%, effective June 5,2006, as well as price increases on certain hydrants and iron valves containingbrass components, effective May 26, 2006, which is expected to partiallyoffset the increase in costs. The cost of copper and scrap metal has recentlystabilized; however, it may rise again in the future and the Company may needto implement further pricing actions to offset higher raw material costs.

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·       MuellerWater has initiated a synergy plan designed to streamline its manufacturingoperations, add incremental volume through combining sales efforts forcomplementary products and create savings through a coordinated purchasing planto reduce raw material and overall production costs. Mueller Water expects tosubstantially complete the implementation of the synergy plan by early fiscal2008 that will produce ongoing incremental annual operating income improvementsat the high end of its previously announced expected benefit range of $40million to $50 million. The Company achieved run-rate synergy benefits ofapproximately $35.0 million, of which $28.0 million has been recognized todate, excluding certain costs to achieve these benefits, as discussed below. Continuedexecution of the synergy programs is expected to position the Company well inthe face of the slowdown in the housing market.

As part of thesynergy plan, the Company has announced and initiated several plant closuresand transferred production to existing facilities:

·        *Closure ofthe U.S. Pipe Chattanooga, Tennessee plant*:   Effective January 1,2006, the Company transferred the valve and hydrant production of the U.S. PipeChattanooga, Tennessee plant to Mueller Co.’s Chattanooga, Tennessee andAlbertville, Alabama plants, resulting in the termination of approximately 340employees. The U.S. Pipe Chattanooga plant was closed in June 2006 and thefacility was sold on August 31, 2006. Total exit costs related to thisplant closure have accumulated to $49.9 million, of which approximately $28.6million qualified as restructuring and impairment charges. The remaining exitcosts of $21.3 million are comprised of an $11.5 million inventory write-downand a $9.8 million write-off of unabsorbed overhead costs, of which $5.4million was recognized in cost of sales in 2006.

*·**        Closureof Mueller Co.’s Henry Pratt (“Pratt”) Valve Manufacturing Facility in Dixon,Illinois*: On January 26, 2006, Mueller Water announced the closure ofthis facility which is expected to occur in 2007, resulting in the terminationof approximately 100 employees. Total estimated costs for this closure are $3.7million, of which $1.0 million for termination benefits and $1.7 million forfixed asset impairment charges were recorded. The remaining other estimatedcosts of $1.0 million, which include costs to transfer and install equipmentand temporary outsourcing of manufacturing, will be expensed when incurred. Therestructuring costs are recorded to goodwill as the overall plan to close thefacility was identified prior to the acquisition.

*·**        Closureof the Mueller Canada Milton, Ontario (“Milton”) Valve and HydrantManufacturing Facility*:   On April 20, 2006, Mueller Waterannounced the closure of this facility, which was finalized during the quarterended September 30, 2006. Production was transferred to other Mueller Co.facilities in the second quarter of 2006. Total costs related to this closurewere $4.5 million, of which $2.5 million, consisting of termination benefits,and $0.8 million, consisting of fixed asset impairments and contractual futurelease obligation costs, were recorded as adjustments to goodwill. Otherestimated costs of $1.2 million, associated with relocating the Miltonwarehouse and equipment, were expensed as incurred during 2006. Therestructuring costs are recorded to goodwill as the overall plan to close thefacility was identified prior to the acquisition.

*·**        Closureof Mueller Co.’s James Jones Manufacturing Facility in El Monte, California:* On October 24, 2006, Mueller Waterannounced the closure of the James Jones manufacturing facility in El Monte,California. James Jones will transfer the production of its brass products andhydrants to the Decatur, Illinois and Albertville, Alabama plants by June 2007.Approximately 155 employees will be affected by the closure. Total estimatedcosts related to this closure are $1.5 million, of which $0.2 million,consisting of termination benefits, and $0.3 million, consisting of fixed assetimpairments, were recorded as adjustments to goodwill in the 

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nine months ended September 30,2006. Other estimated costs of $1.0 million, associated with relocating the ElMonte warehouse and equipment, will be expensed as incurred. The restructuringcosts are recorded to goodwill as the overall plan to close the facility wasidentified prior to the acquisition.

·       Asof September 30, 2006, scrap metal costs for U.S. Pipe remain high buthave declined slightly compared to the prior quarter and approximately 17% fromtheir peak in 2004. However, scrap costs remain somewhat volatile. The averagecost of scrap iron per ton produced during the current quarter decreased 1.7%over the average cost compared to the prior quarter ended June 30, 2006.However, the average cost of scrap iron per ton produced during the threemonths ended September 30, 2006 increased nearly 25% compared to theaverage cost during the three months ended September 30, 2005.

·       While the Company’srelationships with the ten largest water product distributors have beenlong-lasting, distributors in this industry have experienced significantconsolidation in recent years. As consolidation among distributors continues,pricing pressure may result, which could lead to a decline in the Company’sprofitability. For example, Home Depot acquired National Waterworks in 2005 andin March 2006, announced it had completed its acquisition of Hughes Supply.As a result, two of Mueller Water’s three largest distributors have beencombined under common control. Moreover, the loss of distribution at NationalWaterworks, Hughes Supply or Ferguson Enterprises could significantly reducethe current level of sales and profitability of Mueller Water.

**Natural Resources**

·       Fourthquarter 2006 coal production is expected to total approximately 1.6 milliontons, resulting in a total for 2006 of approximately 5.7 million tons, which islower than previously anticipated. Production at JWR is lower than anticipatedfor the year primarily due to the difficult geological conditions at Mine No. 4during the second and third quarters of 2006. Production at the Kodiak Miningjoint venture was previously expected to total 0.3 million tons in 2006. However,the Company has made the strategic decision to delay some production untilearly 2007, when the venture can improve yields by washing the coal through anew preparation plant slated to be ready by the first quarter of 2007.

·       Productionat Mine No. 4 is returning to historical levels, which is expected toreduce future production costs and return inventory levels to normal. TheCompany also expects Kodiak to generate operating profit beginning in the firsthalf of 2007.

·       TheCompany is now entering the Southwest A panel in Mine No. 7. The start-upwas delayed due to the water ingress problem at Mine No. 5 in 2005, whichprevented the Company from moving mining personnel to Mine No. 7 earlier. TheCompany’s Mine No. 7 East expansion is progressing as expected. Mine No. 5is expected to close by the end of December 2006, as previouslyanticipated.

·       Withrespect to demand for metallurgical coal, the Company continues to see strengthin steel pricing and demand among the majority of its core customers. Inaddition many of the Company’s customers have significant expansion plansunderway. Additionally, due to high ocean transportation rates out of Australiaand Western Canada into Europe, the Company’s Blue Creek coal is becoming morecost competitive.

·       With respect tometallurgical coal pricing, the Company’s long-term outlook remains positive. Themajority of worldwide hard coking coal producers settled their 2006/2007 salescontracts at prices ranging from $100 - $115 per metric ton FOB port. TheCompany settled approximately 80% of its sales volume expected for the period October 1,2006 through June 30, 2007 at the top end of this 

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range (contracttonnage does not include calendar year contracts, which are being negotiated atthis time). Based on continued demand, primarily from countries with expandingeconomies such as China, India and Brazil, as well as limited new supply ofhigh-quality hard coking coal, the Company believes that a favorable pricingenvironment will continue over the next several years.

**Homebuilding andFinancing**

·       TheCompany is focused on executing the turnaround of the Homebuilding segment. On-your-lotcompletions are up, past due backlog is down, average pricing per unit is upand gross margins have increased. Margin improvement principally relates tohigher pricing and stronger discipline around the construction and salesprocess instituted in 2005. Gross margins on third quarter 2006 delivered unitscontracted after October 2005 were approximately 26%; however, unitsdelivered in the third quarter of 2006 that had a contract date prior to October 2005were approximately 9%. As such, the Company expects margins to continue toimprove once all of these aged units in the backlog are delivered. At September 30,2006, there were 232 aged homes in the backlog.

·       Financinghas recently experienced a downward trend in prepayment speeds thereby reducinginterest income from prepayments.

·       Financing has expanded itshigh loan-to-value program to include all credit grades. The goal of thisprogram is to minimize the need for down payments for Homebuilding’s customersif their property values do not meet normal guidelines. In the second quarterof 2006, Financing started approving customers across all credit grades withloan-to-value ratios up to 97.5% in exchange for higher interest rates.

***Summary of Third Quarter Consolidated OperatingResults***

Net sales and revenues for the three months ended September 30,2006 were $857.0 million, a 104.7% increase from $418.7 million for the quarterended September 30, 2005, primarily driven by the addition of the MuellerCo. and Anvil segments along with higher volumes and a shift to higher-pricedmetallurgical coal in the Natural Resources segment and higher average net sellingprices in the Homebuilding segment.

Cost of sales, exclusive of depreciation, increased$275.6 million to $556.0 million and represented 69.9% of net sales in the 2006period versus $280.3 million and 77.4% of net sales in the comparable period of2005. The current year’s cost of sales included $237.1 million at Mueller Co.and Anvil. The gross margin percentage improved from 22.6% for the three monthsended September 30, 2005 to 30.1% for the three months ended September 30,2006. This improvement was primarily the result of the addition of the MuellerCo. and Anvil segments, which generated a combined gross margin percentage of34.3%, as well as improved gross margins at Homebuilding, Financing and NaturalResources.

Depreciation for the three months ended September 30,2006 was $27.6 million, an increase of $13.4 million from the same period in2005, primarily due to the addition of the Mueller Co. and Anvil segments.

Selling, general and administrative expenses of $92.1million were 10.7% of net sales and revenues in the 2006 period, compared to$48.3 million and 11.5% in 2005. The current quarter included a total of $43.6million of selling, general and administrative expenses at Mueller Co. andAnvil.

Provision for losses on instalment notes was $1.9million in the 2006 period, compared to $3.1 million in 2005. Prior yearincluded a $1.3 million charge for expected portfolio losses resulting fromHurricanes Katrina and Rita offset slightly by higher volume of resales in thecurrent period in the Financing segment.

Interest expense on other debt increased $32.8 millionto $36.4 million in the 2006 period due to the inclusion of Mueller Water debtand additional indebtedness incurred to finance the Mueller Water acquisition. Inthe third quarter of 2006, the Company recognized a $4.5 million loss on theextinguishment 

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of Mueller debt and a $0.8million write-off of unamortized debt expense related to a $50.7 million paydown on the 2005 Walter Credit Facility.

Amortization expense of intangibles increased $6.8million to $7.7 million in the 2006 period reflecting amortization ofintangibles associated with the Mueller Water acquisition.

In the third quarter of 2005, the Company recorded aprovision for estimated hurricane insurance losses due to the severity ofHurricanes Katrina and Rita and the resulting impact on areas which representedlarge markets for insurance policies reinsured by the Financing segment. As aresult of the relatively inactive hurricane season in 2006, no such provisionwas recorded in the 2006 period.

The Company’s effectivetax rate of 29.0% and 15.0% for the three months ended September 30, 2006and 2005, respectively, differed from the federal statutory rate primarily dueto favorable depletion deductions related to the Natural Resources segment,partially reduced by the effect of state income taxes.

**Segment Analysis:**

***MuellerCo***.

Net sales and revenues for the period ended September 30,2006 were $223.0 million. Revenues as compared to results as reported for theprior year period, prior to the October 3, 2005 acquisition, reflecthigher selling prices and increased volumes in hydrants, brass water productsand gate valves, plus the addition of U.S. Pipe’s valve and hydrant volumetransferred from its Chattanooga, Tennessee plant.

Mueller Co. operatingincome for the period ended September 30, 2006 was $48.7 million. Resultsfor the quarter reflect improved valve volumes and hydrant margins, offset byhigher brass and scrap iron material costs as well as previously unfavorablepurchase price variances related to brass ingot and other purchased parts thatwere capitalized in previous months and now have been charged to cost of sales.

*Anvil*

Net sales and revenues for the period endedSeptember 30, 2006 were $139.0 million. Anvil’s revenues as compared toresults as reported for the prior year period, prior to the October 3,2005 acquisition,  were driven by highervolume and pricing on its commercial construction and oilfield market products,increased volume in foreign-sourced products and the relatively strong buyingpower of the Canadian dollar.

Operating income for theperiod ended September 30, 2006 was $13.7 million. Current quarter resultsreflect increased volume and higher pricing on commercial construction andoilfield market products, partially offset by cost increases in raw materials.

*U.S. Pipe*

Net sales and revenues were $164.1 million for thethree months ended September 30, 2006 compared to $170.3 million in theprior year period. The decrease in revenue primarily relates to the transfer ofthe valve and hydrant business to Mueller Co. Valve and hydrant revenues were$15.5 million in the prior year period. In addition to the loss of valve andhydrant revenues, current quarter ductile iron pipe and fittings volumes were lowerthan the prior year period reflecting slowness in the large diameter pipeorders and shipments primarily as a result of the housing market slow-down.These volume decreases were partially offset by increased pricing for ductileiron pipe products as compared to the prior year period.

Gross margins on net salesimproved from 15.5% for the 2005 period to 17.4% for the 2006 period. Operatingincome for the segment improved from $10.1 million for the 2005 period to $12.9million for the 2006 period.  These increasesreflect the impact of price increases partially offset by the effect of volumedecreases and increased scrap costs .

38

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*Natural Resources*

Netsales and revenues were $184.4 million for the three months ended September 30,2006, up 72.7% from the prior year period. This increase was primarily drivenby higher metallurgical coal volumes and overall higher average pricing as thesegment shifted all of its coal production to the higher-margin, metallurgicalcoal market. Natural gas volumes were up 13.9% over the 2005 period and pricesincreased 5.7% from the 2005 period. The natural gas price increase in the 2006period reflects the benefit of hedging approximately 55% of production at anaverage of $10.05 per thousand cubic feet.

| ** **                                   | ** ** | **Three months ended** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|
| ** **                                   | ** ** | **September 30,**           | ** ** |
| ** **                                   | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Average Coal  Selling Price (per Ton)        |       | $                                | 105.48     |   | $ | 85.01 |   |
| Tons of Coal Sold  (in millions)             |       | 1.6                              |       | 1.1 |   |
| Tons of Coal  Produced (in millions)         |       | 1.2                              |       | 1.2 |   |
| Average Natural  Gas Selling Price (per MCF) |       | $                                | 8.49       |   | $ | 8.03 |   |
| Billion Cubic  Feet of Natural Gas Produced  |       | 2.0                              |       | 1.7 |   |
| Number of Natural Gas  Wells                 |       | 423                              |       | 406 |   |

 

Approximately 1.6 million tons of metallurgical coalwas shipped in the quarter ended September 30, 2006, compared to 0.7million tons in the prior year period. In addition to the metallurgical coalshipments in the prior year period, approximately 0.3 million tons of steamcoal were shipped. There were no lower-priced steam coal shipments in thequarter ended September 30, 2006, as the steam coal contract with AlabamaPower was satisfied in the first quarter of 2006.

For the three months endedSeptember 30, 2006, Natural Resources’ operating income was $55.6 million,compared to operating income of $29.2 million in the prior year period. Thisimprovement was primarily due to significant increases in metallurgical coalsales volumes and overall higher average pricing as discussed above, partiallyoffset by higher production and freight costs. Cost per ton increased at Mine No. 4,resulting from the continuation of thin coal seams and slower longwall advancerates during the current quarter. Production at Mine No. 4 has improvedsteadily since September, and the mine is now operating closer to historicalperformance levels. The prior year period included $12.6 million of idle minecosts associated with the water ingress problem at Mine No. 5.

*Homebuilding*

Netsales and revenues were $68.3 million for the three months ended September 30,2006, an increase of $12.3 million from the quarter ended September 30,2005, primarily as a result of higher average net selling prices offset by aslight reduction in total unit completions as shown below. Unit completions ofstick-built homes increased 18.9%, while unit completions of modular homesdecreased 63.4% primarily as a result of the discontinuation of severalunprofitable product lines.

| ** **                  | ** ** | **Three months ended** | ** ** |
|-----------------------------|------------|----------------------------------|------------|
| ** **                  | ** ** | **September 30,**           | ** ** |
| ** **                  | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Homes Completed:            |       |                             |       |   |   |
| Stick-built                 |       | 662                              |       | 557 |   |
| Modular                     |       | 74                               |       | 202 |   |
| Average Net  Selling Price: |       |                             |       |   |   |
| Stick-built                 |       | $                                | 91,600     |   | $ | 80,500 |   |
| Modular                     |       | $                                | 100,300    |   | $ | 53,900 |   |

 

39

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The estimated backlog at September 30, 2006 ofstick-built homes to be constructed was 1,716, compared to 2,053, at December 31,2005 and 2,222, at September 30, 2005, reflecting the Company’s focus onreducing the aged backlog of homes under construction.

The operating loss was$3.6 million for the three months ended September 30, 2006 compared to anoperating loss of $10.5 million in the year-ago period. The improvedperformance was due to higher average net selling prices, an increase in grossmargins from 16.1% in the 2005 period to 20.3% in the 2006 period and a $2.2million reduction in selling, general and administrative expenses in thecurrent period.

*Financing*

Net sales and revenues were $54.6 million in the 2006period, a decrease of $2.0 million from $56.6 million for the year-ago period. Thereduction in revenue was attributed partially to a $1.5 million decrease inprepayment income due to lower prepayment speeds. Prepayment speeds were 10.6%in the 2006 period, compared to 11.5% in the prior year period.  Operating income increased by $13.7 million,to $14.2 million in the 2006 period. The prior year period included a provisionof $12.2 million for anticipated claims associated with Hurricanes Katrina andRita while the current period included $1.4 million favorable impact forlowering loss reserves due to an inactive 2006 hurricane season.

Delinquencies (thepercentage of amounts outstanding over 30 days past due) were 4.2% at September 30,2006, down from 5.3% at September 30, 2005, reflecting fewer customersentering into bankruptcy. The calculation of delinquencies excludes fromdelinquent amounts those accounts that are in bankruptcy proceedings that arepaying their mortgage payments in contractual compliance with theirpost-petition obligation.

*Other*

Net sales and revenues were $38.6 million for thethree months ended September 30, 2006, an increase of $2.9 million from$35.8 million in the prior year period. Sloss revenues were $34.4 million, up7.7% versus the prior year period primarily due to higher coke and fibervolumes and improved fiber pricing. Sloss operating income was $1.3 million inthe 2006 period, down $1.2 million from the prior year period primarilyreflecting unsatisfactory plant performance for coke and fiber as well ashigher legal costs; partially offset by improved volumes and pricing.

Net general corporateexpenses, principally included in selling, general and administrative expense,were $7.9 million, or $1.1 million higher than the prior year period. Corporateexpenses increased $2.2 million in stock-based compensation, primarily as aresult of the January 1, 2006 adoption of SFAS 123(R) offset in partby reductions in other discretionary spending.

40

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**RESULTS OFOPERATIONS**

**Summary OperatingResults of Continuing Operations for the Nine Months ended September 30, 2006 and 2005**

| ** **                                                                   | ** ** | **For the nine months ended September 30, 2006** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| **($ in thousands)**                                               | ** ** | **Mueller  Co.**                                                                    | ** ** | **Anvil** | ** ** | **U.S.  Pipe** | ** ** | **Natural  Resources** | ** ** | **Homebuilding** | ** ** | **Financing** | ** ** | **Other** | ** ** | **Cons  Elims** | ** ** | **Total** | ** ** |
| Net sales                                                                    |       | $                                                                                   | 640,762    |   | $ | 402,543 |   | $ | 427,422 |   |   | $ | 510,746 |   |   |   | $ | 196,685 |   |   |   | $ | 10,725 |   |   | $ | 104,506 |   | $ | (38,028 | ) | $ | 2,255,361 |   |
| Interest income on instalment notes                                          |       | —                                                                              |       | — |   | — |   |   | — |   |   |   | — |   |   |   | 150,901 |   |   | — |   | — |   | 150,901 |   |
| Miscellaneous                                                                |       | 777                                                                                 |       | 485 |   | 93 |   |   | 15,838 |   |   |   | 736 |   |   |   | 4,799 |   |   | 8,327 |   | (1,290 | ) | 29,765 |   |
| Net sales and revenues                                                       |       | 641,539                                                                             |       | 403,028 |   | 427,515 |   |   | 526,584 |   |   |   | 197,421 |   |   |   | 166,425 |   |   | 112,833 |   | (39,318 | ) | 2,436,027 |   |
| Cost of sales                                                                |       | 411,069                                                                             |       | 287,536 |   | 358,618 |   |   | 296,659 |   |   |   | 161,341 |   |   |   | 7,083 |   |   | 89,466 |   | (37,971 | ) | 1,573,801 |   |
| Interest expense(1)                                                          |       | —                                                                              |       | — |   | — |   |   | — |   |   |   | — |   |   |   | 88,399 |   |   | — |   | — |   | 88,399 |   |
| Depreciation                                                                 |       | 20,172                                                                              |       | 14,829 |   | 16,447 |   |   | 19,549 |   |   |   | 3,980 |   |   |   | 1,031 |   |   | 3,924 |   | — |   | 79,932 |   |
| Selling, general & administrative                                   |       | 56,735                                                                              |       | 73,430 |   | 30,981 |   |   | 12,877 |   |   |   | 49,214 |   |   |   | 21,866 |   |   | 29,199 |   | — |   | 274,302 |   |
| Provision for losses on instalment notes                                     |       | —                                                                              |       | — |   | — |   |   | — |   |   |   | — |   |   |   | 6,761 |   |   | — |   | — |   | 6,761 |   |
| Postretirement benefits                                                      |       | —                                                                              |       | — |   | (1,167 | ) |   | 14,829 |   |   |   | (366 | ) |   |   | (144 | ) |   | (1,100 | ) | — |   | 12,052 |   |
| Amortization of intangibles                                                  |       | 18,802                                                                              |       | 2,711 |   | — |   |   | — |   |   |   | — |   |   |   | 1,900 |   |   | — |   | — |   | 23,413 |   |
| Credit for estimated hurricane insurance losses                              |       | —                                                                              |       | — |   | — |   |   | — |   |   |   | — |   |   |   | (1,046) |   |   | — |   | — |   | (1,046 | ) |
| Restructuring & impairment charges                                  |       | —                                                                              |       | — |   | 4,487 |   |   | — |   |   |   | — |   |   |   |   |   |   | 1,135 |   |   |   | 5,622 |   |
| Operating income (loss)                                                      |       |  $134,761                                                                      |       | $ | 24,522 |   | $ | 18,149 |   |   | $ | 182,670 |   |   |   | $ | (16,748 | ) |   |   | $ | 40,575 |   |   | $ | (9,791 | ) | $ | (1,347 | ) | $ | 372,791 |   |
| Other debt interest  expense                                                 |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (121,045 | ) |
| Income from continuing operations before income taxes  and minority interest |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 251,746 |   |
|                                                                              |            |                                                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          Excludes other debtinterest expense.

41

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| ** **                                                                   | ** ** | **For the nine months ended September 30, 2005** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | ** **                                                                          | ** ** | **Natural** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **($ in thousands)**                                               | ** ** | **U. S. Pipe**                                                            | ** ** | **Resources** | ** ** | **Homebuilding** | ** ** | **Financing** | ** ** | **Other** | ** ** | **Cons Elims** | ** ** | **Total** | ** ** |
| Net sales                                                                    |       | $                                                                                   | 456,751    |   | $ | 374,730 |   |   | $ | 160,835 |   |   | $ | 11,635 |   | $ | 96,301 |   | $ | (20,965) |   | $ | 1,079,287 |   |
| Interest income on instalment notes                                          |       | —                                                                              |       | — |   |   | — |   |   | 157,580 |   | — |   | — |   | 157,580 |   |
| Miscellaneous income                                                         |       | 178                                                                                 |       | 3,594 |   |   | 955 |   |   | 5,105 |   | 8,265 |   | (2,034) |   | 16,063 |   |
| Net sales and revenues                                                       |       | 456,929                                                                             |       | 378,324 |   |   | 161,790 |   |   | 174,320 |   | 104,566 |   | (22,999) |   | 1,252,930 |   |
| Cost of sales                                                                |       | 384,221                                                                             |       | 227,697 |   |   | 136,031 |   |   | 7,572 |   | 80,689 |   | (20,160) |   | 816,050 |   |
| Interest expense(1)                                                          |       | —                                                                              |       | — |   |   | — |   |   | 92,583 |   | — |   | — |   | 92,583 |   |
| Depreciation                                                                 |       | 19,401                                                                              |       | 15,351 |   |   | 3,645 |   |   | 1,056 |   | 3,610 |   | — |   | 43,063 |   |
| Selling, general & administrative                                   |       | 26,709                                                                              |       | 11,164 |   |   | 55,462 |   |   | 21,288 |   | 30,290 |   | — |   | 144,913 |   |
| Provision for losses on instalment notes                                     |       | —                                                                              |       | — |   |   | — |   |   | 8,210 |   | — |   | — |   | 8,210 |   |
| Postretirement benefits                                                      |       | (1,089)                                                                             |       | 12,336 |   |   | (351) |   |   | (179) |   | (1,005) |   | — |   | 9,712 |   |
| Amortization of                                                              |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| intangibles                                                                  |       | —                                                                              |       | — |   |   | — |   |   | 2,823 |   | — |   | — |   | 2,823 |   |
| Provision for estimated hurricane insurance losses                           |       | —                                                                              |       | — |   |   | — |   |   | 11,644 |   | — |   | — |   | 11,644 |   |
| Restructuring & impairment charges                                  |       | —                                                                              |       | (633) |   |   | — |   |   | — |   | — |   | — |   | (633) |   |
| Operating income (loss)                                                      |       | $                                                                                   | 27,687     |   | $ | 112,409 |   |   | $ | (32,997) |   |   | $ | 29,323 |   | $ | (9,018) |   | $ | (2,839) |   | $ | 124,565 |   |
| Other debt interest expense                                                  |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   | (11,304) |   |
| Income from  continuing operations before income taxes and minority interest |       |                                                                                |       |   |   |   |   |   |   |   |   |   |   |   |   | $ | 113,261 |   |

----

(1)          Excludesother debt interest expense.

***Summary of Year to Date Consolidated Operating Results***

The Company’s net income for the nine months ended September 30,2006 was $162.5 million, or $3.20 per diluted share, which compares to netincome in the year-ago period of $80.4 million, or $1.71 per diluted share. Currentyear net income reflects the addition of Mueller Co. and Anvil, acquired on October 3,2005. In addition, profitability at Natural Resources, Homebuilding andFinancing improved over the prior year period offset in part by decreasedprofitability at U.S. Pipe.

Net sales and revenues for the nine months ended September 30,2006 were $2,436.0 million, a 94.4% increase from $1,252.9 million for the ninemonths ended September 30, 2005, primarily driven by the acquisition ofMueller Co. and Anvil, higher metallurgical coal shipments and overall higheraverage pricing at Natural Resources and higher volumes and pricing atHomebuilding.

Cost of sales, exclusive of depreciation, of $1,573.8million was 69.8% of net sales in the 2006 period versus $816.1 million and75.6% of net sales in the comparable period of 2005. Current year resultsinclude $698.6 million of cost of sales related to the Mueller Co. and Anvilsegments. The decrease in cost of sales as a percentage of net sales is due tosales price increases at Mueller Co., Natural Resources and Homebuilding. Duringthe nine months ended September 30, 2006, the gross margin percentageincreased to 30.2% from 24.4% in the prior year period. This increase wasprimarily the result of the addition of the Mueller Co. and Anvil segments,which generated a combined gross margin percentage of 33.0%, as well asimproved gross margins in the Homebuilding, U.S. Pipe and Natural Resourcessegments.

Depreciation for the nine months ended September 30,2006 was $79.9 million, an increase of $36.9 million from the same period in2005, reflecting $35.0 million of depreciation resulting from the addition ofthe Mueller Co. and Anvil segments.

Selling, general and administrative expenses of $274.3million were 11.3% of net sales and revenues in the 2006 period, compared to$144.9 million and 11.6% of nets sales and revenues in 2005. Current year 

42

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results include $130.2million of selling, general and administrative expenses in the Mueller Co. andAnvil segments.

Provision for losses on instalment notes decreased to$6.8 million in the 2006 period, compared to $8.2 million in 2005. Prior yearincluded a $1.3 million charge for expected portfolio losses resulting fromHurricanes Katrina and Rita.

Interest expense on otherdebt increased $109.7 million to $121.0 million in the 2006 nine-month period dueprimarily to the inclusion of Mueller Water debt and additional indebtednessincurred to finance the Mueller Water acquisition. Year to date, interestexpense includes $6.5 million forwrite-offs of unamortized debt expense related to prepayments on the2005 Mueller Credit Agreement and the2005 Walter Credit Agreement, $4.5 million in losses associated with theextinguishment of Mueller debt and$1.6 million of inducement costs related to the conversion of $26.6 million ofthe Company’s Convertible Senior Subordinated Notes.

The Company’s effectivetax rate of 32.0% and 28.0% for the nine months ended September 30, 2006and 2005, respectively, differed from the federal statutory rate primarily dueto favorable depletion deductions related to the Natural Resources segment,partially offset by the effect of state income taxes.

**Segment Analysis:**

*Mueller Co.*

Net sales and revenues for the nine months endedSeptember 30, 2006 were $641.5 million. Revenues reflect higher sellingprices and increased volumes in hydrants, brass water products and iron gatevalves, plus the addition of U.S. Pipe’s valve and hydrant business transferredfrom its now closed Chattanooga, Tennessee plant.

Mueller’s operating incomefor the nine months ended September 30, 2006 was $134.8 million. Resultsfor the year are attributed to improved valve volumes and hydrant margins,partially offset by higher brass ingot and scrap iron material costs.

*Anvil*

Net sales and revenues for the nine months endedSeptember 30, 2006 were $403.0 million. As compared to reported resultsfor the prior year period, Anvil’s revenues were driven by higher volume andpricing on its commercial construction and oilfield market products, increasedvolume in foreign-sourced products and relatively strong buying power of theCanadian dollar.

Operating income for thenine months ended September 30, 2006 was $24.5 million. Current yearresults reflect increased volume and higher pricing on commercial constructionand oilfield market products, partially offset by cost increases in rawmaterials and increases in sales commission expense and intangibleamortization.

*U.S. Pipe*

Net sales and revenues were $427.5 million for thenine months ended September 30, 2006 compared to $456.9 million in theprior year period. This decrease reflects the transfer of valve and hydrantbusiness to Mueller Co., effective January 1, 2006. In the prior yearperiod, U.S. Pipe revenues related to the valve and hydrant business totaled$43.3 million. Net sales and revenues associated with ductile iron pipeincreased over the prior year period as a result of increased pricing offset inpart by decreased volumes. The increased pricing reflects the industry’sresponse to the rising cost of scrap metal. The volume decreases reflect theimpact of the housing market slow-down. Fittings revenue was also lower thanthe prior year period primarily as a result of reduced volumes.

43

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Operating income was $18.1million for the period compared to $27.7 million in the prior year period. Thedecrease in operating income primarily reflects the transfer of the valve andhydrant business to Mueller Co. as well as $4.5 million of costs to completethe closure of the Chattanooga facility. Prior year results also included a$5.1 million favorable environmental insurance claim settlement.

*Natural Resources*

Net sales and revenues were $526.6 million for thenine months ended September 30, 2006, an increase of $148.3 million from$378.3 million in the prior year period. This increase was primarily driven byhigher metallurgical coal volumes and overall higher average pricing as thesegment shifted its coal production to the higher margin metallurgical coalmarket. Steam coal represented 6.6% and 25.6% of tons sold in the nine monthsending September 30, 2006 and 2005, respectively, as the steam coalcontract with Alabama Power was satisfied in the first quarter of 2006.

| ** **                                                  | ** ** | **Nine months ended** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                  | ** ** | **September 30,**          | ** ** |
| ** **                                                  | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| Average Coal  Selling Price (per Ton)                       |       | $                               | 104.06     |   | $ | 76.64 |   |
| Tons of Coal Sold  (in millions)                            |       | 4.5                             |       | 4.4 |   |
| Tons of Coal  Produced (in millions)                        |       | 4.2                             |       | 4.6 |   |
| Average Natural  Gas Selling Price w hedge effect (per MCF) |       | $                               | 8.74       |   | $ | 7.11 |   |
| Billion Cubic  Feet of Natural Gas Produced                 |       | 5.8                             |       | 5.2 |   |
| Number of Natural Gas  Wells                                |       | 423                             |       | 406 |   |

 

For the nine months ended September 30,2006, Natural Resources’ operating income was $182.7 million, compared tooperating income of $112.4 million in the prior year period. The increase wasprimarily due to the shift to higher margin metallurgical coal sales andincreased natural gas pricing, partially offset by higher freight costs as wellas higher production costs per ton, primarily at Mine No. 4. Cost per tonincreased at Mine No. 4, predominantly due to lower production volumerelative to the prior year period as a result of thin seam conditionsencountered at the beginning of the current longwall panel, which began in April 2006.The thin seam conditions contributed to reduced longwall advance rates anddifficulties with roof control. The longwall at Mine No. 4 has sinceexperienced improved advance rates and is now achieving near normal longwalladvance rates. The Company recognized $0.6 million of idle mine costs duringthe nine months ended September 30, 2006. In the prior year period, theCompany incurred $16.1 million of idle mine costs related to the water ingressproblem at Mine No. 5.

*Homebuilding*

Netsales and revenues were $197.4 million for the nine months ended September 30,2006, an increase of $35.6 million from the nine months ended September 30,2005 as a result of higher average net selling prices and an increase in unitcompletions as shown in the table below.

| ** **                  | ** ** | **Nine months ended** | ** ** |
|-----------------------------|------------|---------------------------------|------------|
| ** **                  | ** ** | **September 30,**          | ** ** |
| ** **                  | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| Homes Completed:            |       |                            |       |   |   |
| Stick-built                 |       | 1,948                           |       | 1,717 |   |
| Modular                     |       | 309                             |       | 440 |   |
| Average Net  Selling Price: |       |                            |       |   |   |
| Stick-built                 |       | $                               | 87,600     |   | $ | 78,100 |   |
| Modular                     |       | $                               | 85,200     |   | $ | 60,700 |   |

 

44

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The operating loss was$16.7 million for the nine months ended September 30, 2006 compared to anoperating loss of $33.0 million in the year-ago period. The improvedperformance was due to higher average net selling prices and an increase inunit completions, as well as cost reduction activities, partially offset by a$1.2 million increase in the allowance for doubtful accounts againstreceivables in the modular homes division.

*Financing*

Net sales and revenueswere $166.4 million in the 2006 period, a decrease of $7.9 million from $174.3million for the year-ago period. This decrease was attributed primarily tolower interest income on instalment notes due to a decrease in prepaymentspeeds. Prepayment speeds were 10.0% in the 2006 period, down from 10.8% in theprior year period. Operating income increased by $11.3 million, to $40.6million in the 2006 period. This was primarily due to a $12.2 million provisionfor claims associated with Hurricanes Katrina and Rita recorded in the thirdquarter of 2005. No such provision was recorded in 2006 as a result of the inactive2006 hurricane season.

*Other*

Net sales and revenues were $112.8 million for thenine months ended September 30, 2006, an increase of $8.3 million from$104.6 million in the prior year period. Sloss revenues were $6.7 millionhigher than the previous period due to higher furnace coke and fiber volumesand selling prices, partially offset by a decrease in foundry coke volumes. Slossoperating income was $5.5 million in the 2006 period, a decrease of $1.7million from the prior year period, primarily due to a non-cash assetimpairment charge of $1.1 million related to Sloss’ chemical division.

Net general corporateexpenses, principally included in selling, general and administrative expense,were $22.5 million for the nine months ended September 30, 2006 comparedto $23.5 million for the nine months ended September 30, 2005 reflectingan increase of $5.0 million in stock-based compensation, primarily as a resultof the January 1, 2006 adoption of SFAS 123(R) partially offset byreductions in other discretionary spending.

**FINANCIAL CONDITION**

Cash increased from $137.4 million at December 31,2005 to $160.6 million at September 30, 2006 reflecting $187.1 million ofcash flows provided by operations, $151.8 million of cash flows used ininvesting activities and $10.0 million of cash flows used in financingactivities. The effect of exchange rates also decreased cash by $2.1 million. Seeadditional discussion in the Statement of Cash Flows section that follows.

Restricted short-term investments decreased $38.3 millionfrom December 31, 2005 to $86.3 million at September 30, 2006 dueprimarily to the use of restricted cash to purchase additional instalment notesreceivable and mortgage loans using the pre-funding feature of Mid-StateCapital Corporation’s 2005-1 Trust offering.

Receivables, net, consisting principally of tradereceivables, were $437.0 million at September 30, 2006, an increase of$85.8 million from December 31, 2005.  The increase in receivables was primarily dueto higher revenues in the third quarter of 2006 as compared to the fourthquarter of 2005 driving increased receivables in the Natural Resources, MuellerCo., U.S. Pipe and Anvil segments.

Prepaid expenses increased $32.7 million from December 31,2005, primarily due to an increase in estimated Federal income tax payments for2006.

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Accounts payable of $197.5million at September 30, 2006 increased $36.2 million compared to December 31,2005 primarily as a result of the timing of vendor payments and volume-relatedseasonal material purchases.

**LIQUIDITY ANDCAPITAL RESOURCES**

*Overview*

The Company’s principal sources of short-term fundingare operating cash flows and borrowings under revolving credit facilities andcommitted secured warehouse lines of credit. The Company’s principal sources oflong-term funding are its senior bank debt, public notes and its financingsunder mortgage-backed/asset-backed notes. As of September 30, 2006, totaldebt has decreased by $661.8 million compared to December 31, 2005. Seediscussion below.

The Company believes that,based on current forecasts and anticipated market conditions, sufficientoperating cash flow will be generated to meet substantially all operatingneeds, to make planned capital expenditures and to make all required interestpayments on indebtedness for the next twelve to eighteen months. However, theCompany’s operating cash flows and liquidity are significantly influenced bynumerous factors, including the general economy and, in particular, prices ofcoal and natural gas, levels of construction activity, levels of governmentspending on water projects, costs of raw materials and interest rates.

*Mortgage-backed/Asset-backedNotes*

At September 30,2006, non-recourse mortgage-backed/asset-backed notes outstanding totaled $1.7billion and primarily consisted of eight issues of public debt providingfinancing for instalment notes receivable purchased by Mid-State Homes (“MSH”).Mortgage debt also includes outstanding borrowings under a $200.0 million and a$150.0 million Variable Funding Loan Agreement (“warehouse facilities”)providing temporary financing to MSH for its current purchases of instalmentnotes and mortgage loans from Jim Walter Homes and Walter Mortgage Company. At September 30,2006, there were $145.0 million of borrowings outstanding under these warehousefacilities, leaving a total of $205.0 million available for future borrowings. Seealso Note 17.

*2005 Walter CreditAgreement*

The 2005 Walter Credit Agreement is a securedobligation of the Company and substantially all of the wholly-owned domesticsubsidiaries of the Company other than Mueller Water and its subsidiaries. The2005 Walter Term Loan requires quarterly principal payments of $0.6 millionthrough October 3, 2012, at which time the remaining principal outstandingis due. The 2005 Walter Term Loan carries a floating interest rate of 175 basispoints over LIBOR. At September 30, 2006, the balance outstanding on theterm loan was $274.3 million and the weighted-average interest rate was 7.1%.The commitment fee on the unused portion of the 2005 Walter Revolving CreditFacility is 0.375% and the interest rate is a floating rate of 150 basis pointsover LIBOR. At September 30, 2006, there were no borrowings outstandingunder the revolving credit facility, but the Company issued $63.4 million inletters of credit, which reduced availability for borrowings to $161.6 million.

In February 2006, theCompany used a portion of the proceeds from the sale of 2.65 million shares ofcommon stock to repay $102.9 million of the term loan facility. In addition,during the nine months ended September 30, 2006, the Company repaid $71.6million on the term loan facility, using available cash flow. In November 2006,the Company made a $25.0 million optional prepayment of the term loan and willcharge interest expense with   $0.4million of related unamortized debt expense.

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*2005 Mueller CreditAgreement*

On October 3, 2005, Mueller Group, entered into acredit agreement (the “2005 Mueller Credit Agreement”) consisting of a$145.0 million senior secured revolving credit facility terminating on October 4,2010 (the “2005 Mueller Revolving Credit Facility”) and a $1,050.0 millionsenior secured term loan (the “2005 Mueller Term Loan”) maturing on the earlierof October 3, 2012 or November 1, 2011, unless the 10% seniorsubordinated notes due 2012 are paid in full prior to such date. The 2005Mueller Term Loan requires quarterly principal payments of $2.6 millionthrough October 3, 2012, at which time the remaining principal outstandingis due. Loans under the senior credit facilities bear interest, at our option,at: LIBOR rate plus 250 basis points or the alternate base rate plus 150 basispoints for borrowings under the revolving credit facility; and LIBOR plus 225basis points or the alternate base rate plus 125 basis points for term loans.At September 30, 2006, the balance outstanding on the term loan was $793.7million and the weighted-average interest rate was 8.3%. The commitment fee onthe unused portion of the 2005 Mueller Revolving Credit Facility is 0.50%. At September 30,2006, there were no borrowings outstanding under the revolving credit facilitybut Mueller Group issued $31.9 million in letters of credit, which reducedavailability for borrowings to $113.1 million.

On June 1, 2006,$246.0 million from the proceeds of the IPO was used to repay a portion of theterm loan in the 2005 Mueller Credit Agreement. As a result of the prepayment, $4.1 million ofunamortized debt expense was charged to interest expense during the secondquarter of 2006.

*Senior SubordinatedNotes*

In 2004, Mueller Group, a subsidiary of Mueller Water,issued $315.0 million aggregate principal amount of 10% seniorsubordinated public notes, which will mature on May 1, 2012. Interest onthe senior subordinated notes is payable in cash on May 1 and November 1of each year. The senior subordinated notes are guaranteed by each of MuellerGroup’s existing domestic restricted subsidiaries.

On July 3, 2006,Mueller Water used $123.1 million of the proceeds from their IPO for a partialredemption of its senior subordinated notes.

*Senior DiscountNotes*

In 2004, Mueller Water sold 223,000 units consistingof $1,000 principal amount at maturity of senior discount public notes due2014, for gross proceeds of approximately $110.1 million. The notesaccrete at a rate of 14 3/4% and compound semi-annually toApril 2009 to a principal amount at maturity of $223.0 million. Thenotes are senior unsecured obligations and are effectively subordinated to allliabilities of Mueller Group and its subsidiaries.

On July 3, 2006,Mueller Water used $60.2 million of the proceeds from the IPO for a partialredemption of its senior discount notes.

*Convertible SeniorSubordinated Notes*

In 2004, the Company issued $175 million ofconvertible senior subordinated notes, which will mature on May 1, 2024,unless earlier converted, redeemed or repurchased. The notes are redeemable bythe Company at par on or after May 6, 2011. The holders of the notes mayrequire the Company to repurchase some or all of the notes at par plus accruedand unpaid interest, including contingent interest, if any, initially on May 1,2014, and subsequently on May 1, 2019, or at any time prior to theirmaturity following a fundamental change, as defined in the indenture.

The notes are currentlyconvertible having satisfied a variety of conditions including, the commonstock sales price condition. The notes may be convertible during future periodsif the common stock sale price condition or other conditions are satisfied. Duringnine months ending September 30, 2006, holders 

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ofapproximately $26.6 million of the Company’s convertible notes surrenderedtheir convertible notes in exchange for approximately 1,490,000 shares of theCompany’s common stock and approximately $1.6 million of inducement payments,which was expensed in the first quarter of 2006. See also Note 10.

*Statement of CashFlows*

Cash totaled $160.6 million and $137.4 million at September 30,2006 and December 31, 2005, respectively. The increase in cash isprimarily the result of cash flows provided by operating activities of $187.1million principally due to $162.5 million of net income adjusted for non cashitems totaling $158.3 million, partially offset by cash used for workingcapital. This cash inflow was partially offset by cash flows used in investingactivities totaling $151.8 million and in financing activities totaling $10.0million.

Cash flows used in investing activities included cashflows used to purchase property, plant and equipment ($131.5 million), topurchase mortgage loans ($96.1 million) and for acquisitions, net of cashproceeds ($5.1 million). These cash outflows were partially offset by principalpayments received on purchased loans totaling $32.3 million and cash inflowsfrom restricted short term investments totaling $38.3 million.  Cash flows used in financing activitiesincluded retirements of other debt ($590.9 million) and retirements ofmortgage-back/asset-backed notes ($184.5 million), partially offset by cashproceeds from Mueller Water’s IPO ($428.9 million), the sale of the Company’scommon stock ($168.7 million) and the issuance of mortgage-backed/asset-backednotes ($145.0 million).

Capital expenditures totaled $131.5 million in thenine months ended September 30, 2006, principally due to expansion-relatedunderground mining and natural gas well equipment purchases at NaturalResources and machinery and equipment purchases at Mueller Water and U.S. Pipe.The Company estimates that gross capital expenditures for the year ending December 31,2006 will approximate $175 million to $185 million. Actual expenditures in 2006may be more or less than this amount, depending upon the level of earnings andcash flow, the timing of projects or expansion opportunities in certainmarkets.

In 2007, U.S. Pipe isconsidering the construction of a “mini mill” which will be designed to producethe Company’s high-volume ductile iron pipe at costs lower than existingfacilities. Construction of this facility could takeapproximately two to three years at an estimated capital cost of $40million to $45 million. The timing and capital estimates, however, could changesignificantly depending on the final design and construction costs. U.S. Pipeplans to finance the construction through operating cash flow, existing cash onhand, local government incentives and funds available under the 2005 MuellerCredit Agreement.

**MARKET RISK**

The Company is exposed to certain market risksinherent in the Company’s operations. These risks generally arise fromtransactions entered into in the normal course of business. The Company’sprimary market risk exposures relate to interest rate risk, commodity risks andforeign currency risks. The Company does not enter into derivatives or otherfinancial instruments for trading or speculative purposes.

There have been nomaterial changes, other than those described below, to the information in “Item7a, Qualitative and Quantitative Disclosures About Market Risk” described inthe Annual Report on Form 10-K for the fiscal year ended December 31,2005.

*Interest rate risk*

On February 28, 2006,the Company entered into three interest rate swap agreements (“swaps”) with acumulative notional value of $125 million with three separate counter-parties. Theobjective of these swaps is to protect against the negative effect that risinginterest rates would have on the Company’s future 

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forecastedissuance of mortgage-backed securities. The structure of the swaps is a 14-year,forward-starting swap which starts on December 15, 2006, which was theoriginally forecasted issuance date of the Company’s next securitization. Theswap agreements call for the Company to make fixed rate payments over the termat 5.05% per annum and receive payments based on one-month LIBOR from thecounter-parties. In November 2006, these swaps were settled as a result ofthe November 2, 2006 mortgage-backed securitization, see Note 17. TheCompany will continue to account for the swap as a cash flow hedge. Changes inthe fair value of the swap through the date of the securitization were recordedin accumulated other comprehensive income (loss). At September 30, 2006,the Company recorded a net unrealized gain from these swaps of $0.2 million,net of tax, as a component of other comprehensive income.

*Commodity risks*

At September 30, 2006, swap contracts to hedgeanticipated sales in 2006 of natural gas totaling 1.1 million mmbtu wereoutstanding. At September 30, 2006, the Company recorded a net unrealizedgain from these hedging agreements of $4.1 million, net of tax, as a componentof other comprehensive income.

In July 2006, JWR entered into a swap contract tohedge anticipated sales from January 2007 through March 2007 totaling0.6 million mmbtu, or approximately 35% of natural gas production for thatthree month period, at a price of $10.54 per mmbtu. This swap contracteffectively converts a portion of forecasted natural gas sales at market pricesto a fixed rate basis.

In October 2006, U.S.Pipe entered into a swap contract to hedge anticipated purchases of natural gasfrom October 2006 through September 2007 totaling 0.5 million mmbtu,or approximately 35% of natural gas purchases. This swap contract effectivelyconverts a portion of forecasted natural gas purchases from market prices to afixed rate basis.

*Foreign currencyrisks*

In March 2006, MuellerWater entered into hedges protecting intercompany loan payments to be made overthe next three years by its Canadian subsidiary to a U.S. subsidiary totaling$37.3 million. With these hedges, the Company sells Canadian dollars for U.S.dollars at an exchange rate of $0.8681.  Unrealized gains or losses on these hedgeswill be recorded in earnings over their lives, and were not material for thethree and nine months ended September 30, 2006.

**NEW ACCOUNTINGPRONOUNCEMENTS**

In February 2006, the FASB issued SFAS No. 155,“Accounting for Certain Hybrid Financial Instruments—an amendment of FASBStatements No. 133 and 140,” which resolves issues associated with thebifurcation requirements of SFAS No. 133 as it relates to certain hybridfinancial instruments that contain an embedded derivative, and amends SFAS No. 140to eliminate the prohibition on a qualifying special-purpose entity fromholding a derivative financial instrument that pertains to a beneficialinterest other than another derivative financial instrument. SFAS No. 155is effective for all financial instruments acquired, issued or subject to aremeasurement event occurring in fiscal years beginning after September 15,2006. The adoption of this statement is not anticipated to have a significant impacton the Company’s financial condition or results of operations.

In March 2006, the FASB issued SFAS No. 156,“Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140,”which amends SFAS No. 140 to (i) require that all separatelyrecognized servicing assets and servicing liabilities be initially measured atfair value, if practicable; (ii) permits, but does not require, thesubsequent measurement of separately recognized servicing assets and servicingliabilities at fair value; (iii) requires an entity that uses derivativeinstruments to mitigate the risks inherent in servicing assets and servicingliabilities to account for those derivative instruments at fair value; and (iv) permitsan entity to elect subsequent fair value measurement to account for itsseparately 

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recognized servicingassets and liabilities. SFAS No. 156 is effective for all separatelyrecognized servicing assets and servicing liabilities in fiscal years beginningafter September 15, 2006. The adoption of this statement is notanticipated to have a significant impact on the Company’s financial conditionor results of operations.

In July 2006, the FASB issued Interpretation (“FIN”)No. 48, “Accounting for Uncertainty in Income Taxes,” which provides theminimum recognition threshold that a tax provision must meet before beingrecognized in the financial statements. This interpretation also providesguidance on derecognition of income tax assets and liabilities, classificationof current and deferred income tax assets and liabilities, accounting forinterest and penalties associated with tax positions, accounting for incometaxes in interim periods, and income tax disclosures. FIN No. 48 appliesto all tax positions related to income taxes subject to SFAS No. 109, “Accountingfor Income Taxes.”  The Company has notyet determined the impact of the adoption of this interpretation, which becomeseffective January 1, 2007, will have on its consolidated financialstatements.

In September 2006, the Securities and ExchangeCommission (“SEC”) staff issued Staff Accounting Bulletin (“SAB”) No. 108,“Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements,” which provides guidancefor companies on how to quantify financial statement misstatements. SAB No. 108requires the quantification of financial statement misstatements based on theeffects of misstatements on each of the company’s financial statements andtheir related financial statement disclosures. SEC registrants must beginapplying the provisions of SAB No. 108 for all fiscal years ending after November 15,2006. The Company has not yet determined what impact, if any, the adoption ofthis guidance will have on its consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements,” which provides a definition of fair value,establishes a framework for measuring fair value and expands financialstatement disclosure requirements. SFAS No. 157 requires companies to basefair values on what they would receive from a sale to a third party in the openmarket. The Company has not yet determined what impact, if any, the adoption ofthis statement, which becomes effective January 1, 2008, will have on itsconsolidated financial statements.

In September 2006, the FASB issued SFAS No. 158,“Employers’ Accounting for Defined Benefit Pension and Other PostretirementPlans,” which requires SEC registrants to recognize a net liability or asset toreport the funded status of the Company’s defined benefit pension and otherpostretirement benefit plans on the balance sheets. The Company has not yetdetermined what impact, the adoption of this statement, which becomes effectiveDecember 31, 2006, will have on its consolidated financial statements.

**CONTROLSAND PROCEDURES**

**ConclusionRegarding the Effectiveness of Disclosure Controls and Procedures**

An evaluation was performed under the supervision andwith the participation of our management, including our Chief Executive Officer(CEO), and Chief Financial Officer (CFO), of the effectiveness of ourdisclosure controls and procedures as of September 30, 2006. Based on thatevaluation, our management, including our CEO and CFO, concluded that ourdisclosure controls and procedures are effective. There has been no change inour internal control over financial reporting during the nine months endedSeptember 30, 2006 that has materially affected, or is reasonably likelyto materially affect, internal control over financial reporting.

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**PRIVATESECURITIES LITIGATION REFORM ACT SAFE HARBOR STATEMENT**

Except for historical information contained herein,the statements in this release are forward-looking and made pursuant to thesafe harbor provisions of the Private Securities Litigation Reform Act of 1995.Forward-looking statements involve known and unknown risks and uncertaintiesthat may cause the Company’s actual results in future periods to differmaterially from forecasted results. Those risks include, among others, changesin customers’ demand for the Company’s products, changes in raw material,labor, equipment and transportation costs and availability, geologic andweather conditions, changes in extraction costs and pricing in the Company’smining operations, changes in customer orders, pricing actions by the Company’scompetitors, potential changes in the mortgage-backed capital market, andgeneral changes in economic conditions. Risks associated with forward-lookingstatements are more fully described in the Company’s filings with theSecurities and Exchange Commission. Those risks also include the timing of andability to execute the spin-off of the Company’s Water Products business andother strategic actions that may be pursued. The Company has no duty to updateits outlook statements as of any future date.

**PART II—OTHERINFORMATION**

**Item1.**                        LegalProceedings

See Note 15 in this Form 10-Qfor a description of current legal proceedings.

The Company and its subsidiaries are parties to anumber of other lawsuits arising in the ordinary course of their businesses. Mostof these cases are in a preliminary stage and the Company is unable to predicta range of possible loss, if any. The Company provides for costs relating tothese matters when a loss is probable and the amount is reasonably estimable(See Note 15 in this Form 10-Q). The effect of the outcome of thesematters on the Company’s future results of operations cannot be predictedbecause any such effect depends on future results of operations and the amountand timing of the resolution of such matters. While the results of litigationcannot be predicted with certainty, the Company believes that the final outcomeof such other litigation will not have a material adverse effect on the Company’sconsolidated financial position.

**Item1A.**                Update to RiskFactors

The Company has made changes to certain Risk Factorsthat were previously disclosed in *Item 1A. Risk Factors*in the Company’s Annual Report on Form 10-K for the year ended December 31,2005. The revised Risk Factors, which primarily relate to the operations of theCompany’s Water Products business, are as follows:

***Our business is subject to risk of price increases andfluctuations and delay in the delivery of raw materials and purchasedcomponents.***

Most of the industries inwhich we operate require significant amounts of raw materials and labor and,therefore, shortages or increased costs of raw materials and labor couldadversely affect our business or results of operations.

Our homebuildingoperations rely on the availability of lumber, drywall, cement and otherbuilding materials. The availability and market prices of these materials areinfluenced by various factors that are beyond our control. Shortages of, andprice increases for, such materials have occurred in the past and may occur inthe future. For example, we have experienced increases in the cost of a varietyof materials since the third quarter of 2005 as a result of the impact of theGulf Coast hurricanes on supplies of and demand for these materials. Further,if we are unable to secure a proper level of skilled labor for our homebuildingoperations, we may be unable to build as many houses or build them as costeffectively, and our levels of revenue and net income may be reduced.

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Our Water Productsbusiness is subject to the risk of price increases and fluctuations andperiodic delays in the delivery of raw materials and purchased components thatare beyond our control. Our Water Products operations require substantialamounts of raw materials or purchased components, such as steel pipe and scrapsteel and iron, brass ingot, sand, resin, and natural gas. Management estimatesthat scrap metal and ferrous alloys used in the U.S. Pipe manufacturingprocess account for up to 40% of the U.S. Pipe cost to manufacture ductileiron pipe. At Mueller Co. and Anvil, raw materials used in our manufacturingprocesses currently account for approximately 18% of cost of goods sold.Fluctuations in the price and delivery of these materials may be driven by thesupply/demand relationship for factors particular to that material. Inaddition, if any of our suppliers seeks bankruptcy relief or otherwise cannotcontinue its business as anticipated or we cannot renew our supply contracts onfavorable terms, the availability of raw materials could be reduced or theprice of raw materials could increase.

The availability and price of certain raw materials orpurchased components, such as steel scrap, brass ingot and natural gas aresubject to market forces largely beyond our control, including North Americanand international freight costs, speculation and foreign exchange rates. Wegenerally purchase raw materials at spot prices and generally do not have theability to hedge our exposure to price changes. We are not always able, and maynot be able in the future, to pass on increases in the price of these rawmaterials to our customers. In particular, when raw material prices increaserapidly or to significantly higher than normal levels, we may not be able topass price increases through to our customers on a timely basis, if at all,which could lead to significant reductions of our operating margins and cashflow. Any fluctuations in the price or availability of raw materials orpurchased components could significantly reduce our levels of production andsales or impair our profitability.

***Foreign competitionis intense and could harm our sales, profitability and cash flows.***

In addition to domesticcompetition, our Water Products business faces intense foreign competition. Theintensity of foreign competition is affected significantly by fluctuations inthe value of the U.S. dollar against foreign currencies, by the relative costto ship competitive products into the North American markets and by the levelof import duties imposed by the U.S. Department of Commerce on certainproducts. Foreign competition is likely to further increase and certain WaterProducts prices will most likely continue to face downward price pressure asour domestic competitors shift their operations or outsource manufacturing requirementsoverseas or source supplies from foreign vendors in an effort to reduceexpenses.

Our coal business faces competition from foreignproducers that sell their coal in the United States and in the export marketand, therefore, fluctuations in exchange rates will affect the demand for coalwe produce. If our competitors’ currencies decline against the U.S. dollar oragainst our customers’ currencies, those competitors may be able to offer lowerprices to our customers. Furthermore, if the currencies of our overseascustomers were to significantly decline in value in comparison to the U.S.dollar, those customers may seek decreased prices for the coal we sell to them.Both of these factors could reduce our profitability or result in lower coalsales.

***We rely on Tyco to indemnify us for certainliabilities and there is a risk that Tyco may become unable or fail to fulfillits obligations.***

Under the terms of the purchase agreement (the “TycoPurchase Agreement”) relating to the August 1999 sale by Tyco International Ltd.(“Tyco”) of Mueller Water’s business to its prior owners, we are indemnified byTyco for all liabilities arising in connection with Mueller Water’s businesswith respect to products manufactured or sold prior to the closing of thattransaction. The indemnity survives forever and is not subject to any dollarlimits. In the past, Tyco has made substantial payments and/or assumed defenseof claims pursuant to this indemnification provision. However, we may beresponsible for these liabilities in the event that Tyco ever becomesfinancially unable, or fails to comply with, the terms of the 

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indemnity.In addition, Tyco’s indemnity does not cover product liabilities to the extentcaused by our products manufactured after that transaction. On January 14,2006, Tyco’s board of directors announced that it approved a plan to separateTyco into three individual, publicly traded companies. At this time, we do notknow which of the new entities will assume the indemnity provided under theterms of the Tyco Purchase Agreement if this plan is implemented. Should Tycoor the entity or entities that assume Tyco’s obligations under the TycoPurchase Agreement ever become financially unable or fail to comply with theterms of the indemnity, we may be responsible for such obligations orliabilities.

***Environmental, health and safety laws and regulationscould subject us to liability for fines, clean-ups and other damages, requireus to incur significant costs to modify our operations and increase ourmanufacturing costs.***

We are subject to a widevariety of laws and regulations concerning the protection of the environmentand human health and safety, both with respect to the construction andoperation of many of our plants, mines and other facilities and with respect toremediating environmental conditions that may exist at our own and otherproperties. Certain of our facilities have been in operation for many yearsand, over time, we and predecessor operators of these facilities may havegenerated, used, handled and disposed of hazardous and other regulated wastes.Environmental liabilities could exist, including cleanup obligations at theseor at other locations where materials from our operations were disposed of,which could result in future expenditures that cannot be currently quantifiedand which could reduce our profits. Failure to comply with any environmental,health or safety requirements could result in the assessment of damages, orimposition of penalties, suspension of production, a required upgrade or changeto equipment or processes or a cessation of operations at one or more of ourfacilities. Because these laws are complex, constantly changing and may beapplied retroactively, there is a risk that these requirements, in particularas they change in the future, may impair our business, profitability andresults of operations. In addition, we will be required to incur costs tocomply with the EPA’s National Emissions Standards for Hazardous Air Pollutants(“NESHAP”) for iron and steel foundries and for our foundries’ paintingoperations. These costs may be substantial.

We may be required toconduct investigations and perform remedial activities that could require us toincur material costs in the future. Our operations involve the use of hazardoussubstances and the disposal of hazardous wastes. We may incur costs to managethese substances and wastes and may be subject to claims for damage forpersonal injury, property damages or damage to natural resources.

Our U.S. Pipe segment has been identified as apotentially responsible party liable under federal environmental laws for aportion of the clean-up costs with regard to two sites, one in Alabama and onein California, and is currently subject to an administrative consent orderrequiring certain monitoring and clean-up with regard to its Burlington, NewJersey facility. Such clean-up costs could be substantial and could have anegative effect on our profitability and cash flows in any given reportingperiod. As described in the immediately preceding risk factor, we rely on Tycoto indemnify us for certain liabilities and there is a risk that Tyco maybecome unable or fail to fulfill its obligation.

***Restrictive covenants in our debt instruments maylimit our ability to engage in certain transactions and may diminish ourability to make payments on our indebtedness.***

Our debt instruments contain various covenants thatlimit our ability to engage in certain transactions. Our 2005 Credit Agreementand the 2005 Mueller Credit Agreement also require the maintenance of specifiedfinancial ratios and the satisfaction of other financial condition tests. Inaddition, our debt instruments require us to provide regular financialinformation to our lenders and bondholders. Such requirements generally may besatisfied by our timely filing with the SEC of annual and quarterly reportsunder the Exchange Act. Our ability to satisfy those financial ratios, tests orcovenants can be affected by events beyond our control, and there is a riskthat we will not meet those tests. A breach of any of these covenants couldresult in a default under our debt instruments. If an event of default were notremedied 

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afterthe delivery of notice of default and lapse of any relevant grace period, theholders of our debt would be able to declare it immediately due and payable.Upon the occurrence of an event of default under our 2005 Credit Agreement orthe 2005 Mueller Credit Agreement, the respective lenders could also terminateall commitments to extend further credit. If we were unable to repay thoseamounts, such lenders could proceed against the collateral granted to them tosecure the indebtedness under our senior credit facilities. We have pledgedsubstantially all of our assets (including our intellectual property), otherthan the assets of our foreign subsidiaries and assets of our Water Productsbusiness, as security under our 2005 Credit Agreement and we pledgedsubstantially all of the assets of our Water Products business (including, itsintellectual property) other than the assets of its foreign subsidiaries, underthe 2005 Mueller Credit Agreement. If the lenders under our credit agreementsor holders of the notes accelerate the repayment of borrowings, we may not havesufficient assets to repay our senior credit facilities and our other indebtedness,which could negatively impact the value of our stock and our ability tocontinue as a going concern.

***Businesses we haveacquired or will acquire may not perform as expected.***

Businesses we have recently acquired or may acquire inthe future may not perform as expected. Acquired businesses may perform belowexpectations after the acquisition for various reasons, including legislativeor regulatory changes that affect the areas in which a business specializes,the loss of key customers after the acquisition has closed, general economicfactors that affect a business in a direct way and the cultural incompatibilityof an acquired management team with us. Any of these factors could impair ourresults of operations.

***Compliance with internal control reportingrequirements and securities laws and regulations is likely to increase ourcompliance costs.***

The Sarbanes-Oxley Act of 2002, as well as rules subsequentlyimplemented by the SEC and the PCAOB, have required changes in the corporategovernance and securities disclosure or compliance practices of publiccompanies over the last few years. We expect these new rules andregulations to continue to increase our legal and financial compliance costs,as well as our ongoing audit costs, and to make legal, accounting andadministrative activities more time-consuming and costly. For example, in 2006,Mueller Water may need to comply with the internal control reportingrequirements of the Sarbanes-Oxley Act, which has had a significant impact onour compliance cost in 2006.

***Compliance with the securities laws and regulations islikely to make it more difficult and expensive for us to obtain directors andofficers liability insurance and to attract and retain qualified members of ourboard of directors.***

We expect the Sarbanes-Oxley Act and the rules andregulations subsequently implemented by the SEC and the PCAOB to make it moredifficult and expensive for us to obtain director and officer liabilityinsurance, and we may be required to accept reduced coverage or incursubstantially higher costs to obtain coverage. These new rules andregulations could also make it more difficult for us to attract and retainqualified members of our board of directors, particularly to serve on our auditcommittee, and executive officers.

***Interruption ofnormal operations at our key manufacturing facilities may impair our productioncapabilities.***

Someof our key water products, including hydrants, valves and ductile iron pipe,are manufactured at five of our largest manufacturing facilities. Theoperations at our major manufacturing facilities may be impaired by variousoperating risks, including, but not limited to:

·       catastrophicevents such as fires, explosions, floods, earthquakes or other similaroccurrences;

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·       interruptionsin raw materials and energy supply;

·       adversegovernment regulation;

·       breakdownsor equipment failures;

·       violationsof our permit requirements or revocation of permits;

·       releasesof pollutants and hazardous substances to air, soil, surface water orgroundwater;

·       shortagesof equipment or spare parts; and

·       labordisputes.

To date, we have successfully managed non-materialoccurrences of the foregoing events, including a fire at the Columbia, PAfacility of our Anvil segment and California’s adoption of laws limiting thelead content of water infrastructure products, without significant disruptionof our operations. More acute occurrences of these events could cause adecrease in, or the elimination of, the revenues generated by our keyfacilities or a substantial increase in the costs of operating such facilitiesthat, in turn, could, impair our cash flows and results of operations.

***Our brass valve products contain lead, which may bereplaced in the future, and certain of our brass valve products may not be incompliance with NSF standards, which could limit the ability of municipalitiesto buy our products.***

Our brass valve productscontain approximately 5.0% lead. Environmental advocacy groups, relying onstandards established by California’s Proposition 65, are seeking to eliminateor reduce the content of lead in some of these products, including water metersand valves, and to limit their sale in California. Some of our business unitshave entered into settlement agreements with these environmental advocacygroups that have required them to either modify some of these products or offersubstitutes for them with respect to products sold in California. Modificationsof or substitutions for our products to meet or conform with regulatoryrequirements will require incremental capital spending of up to$8.0 million in the next two years and will require us to purchase moreexpensive raw materials, and we may not be able to pass these costs on to ourcustomers. Legislation to substantially restrict lead content in water productshas been introduced in the United States Congress. Congress may adoptlegislation that would require us to eliminate lead in our brass productswhich, could require us to incur substantial additional production expenses. Inaddition, advocacy groups may file suit against us under Proposition 65, whichcould result in additional costs in connection with marketing and selling ourbrass products in California.

The National Sanitary Foundation (“NSF”) is anon-profit entity that was contracted by the U.S. Environmental ProtectionAgency (“EPA”) to promulgate standards for the water industry. NSF has issuedNSF 61, which governs the leaching characteristics of valves and devices thatare part of drinking water distribution networks, including certain of ourproducts made from brass. In recent years, a growing majority of states haveadopted, by statute or regulation, a requirement that water distributionsystems utilize products that comply with NSF 61 and/or are certified as NSF 61compliant. We, along with others in the industry, are engaged in the lengthyprocess of attempting to obtain certification of NSF 61 compliance for all ofour relevant products. To date we have obtained certification of approximately95% of our brass valve and fitting products. Approximately 26% of our certifiedproducts use “low lead” brass to comply with current NSF 61 requirements. TheNSF 61 certification process is ongoing with our goal to have all productsrequiring certification completed by January 1, 2007. In the event thatsome of our brass valve products are found not to be in compliance with NSF 61,those products may not be accepted by various municipalities or we may beforced to modify non-conforming products with substitute materials, which mayrequire increased cost, thereby impairing our profitability. In addition, ifour competitors 

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developa complete line of NSF 61 compliant brass valve products before we do, we maybe placed at a competitive disadvantage which may, in turn, impair ourprofitability.

**Item2.**                        UnregisteredSales of Equity Securities and Use of Proceeds

(a)          EquitySecurities Sold by the Company

SeeNote 10 for a description of securities sold during the quarter ended September 30,2006.

(c)          Purchaseof Equity Securities by the Company and Affiliated Purchasers.

During the quarter ended September 30,2006, there were no share repurchases and at September 30, 2006, $7.5million remains available under the Common Stock share repurchase program. TheCompany has not yet decided to terminate the program.

**Item6.**                        Exhibits

(a)          Exhibits

| Exhibit    | ** ** | ** **                                                                                                                            |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------|
| **Number** | ** ** | ** **                                                                                                                            |
|       |       |                                                                                                                                  |
| 12.1       |       | Ratio of Earnings to Fixed Charges                                                                                                    |
|       |       |                                                                                                                                  |
| 31.1       |       | Certification Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002—Chief Executive Officer                            |
|       |       |                                                                                                                                  |
| 31.2       |       | Certification Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002 - Chief Financial Officer                               |
|       |       |                                                                                                                                  |
| 32.1       |       | Certification Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350 - Chief Executive  Officer |
|       |       |                                                                                                                                  |
| 32.2       |       | Certification Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350 - Chief Financial  Officer |

 

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

| WALTER INDUSTRIES, INC.      |
|------------------------------|
| */s/ Joseph J. Troy*         | * * | */s/ Lisa A. Honnold* |
| Joseph J. Troy               | Lisa A. Honnold |
| Executive Vice President and | Senior Vice President, Controller |
| Principal Financial Officer  | and Principal Accounting Officer |
| Date: November 9,  2006 |   |

 

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