**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 10-Q**

**x**                              QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934

**Forthe quarterly period ended June 30, 2006**

**or**

**o**                                 TRANSITION REPORT PURSUANTTO SECTION 13 OR 15 (d) OFTHE SECURITIES EXCHANGE ACT OF 1934

**CommissionFile 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 by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months, and (2) has been subject to such filing requirements for the past90 days. 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 acceleratedfiler” in Rule 12b-2 of the Exchange Act. (Check one): Largeaccelerated filer x* *Accelerated filer o Non-acceleratedfiler o

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act. (Check one): Yes o Nox.

Therewere 43,598,213 shares of common stock of the registrant outstanding at July 31,2006.

 

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**PART I—FINANCIALINFORMATION**

**ITEM1.   FINANCIAL STATEMENTS**

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

| ** **                                                                          | ** ** | **June 30,**                                              | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                          | ** ** | **2006**                                                       | ** ** | **2005**              | ** ** |
| ** **                                                                          | ** ** | **(in thousands, except   share amounts)** | ** ** |
| *ASSETS*                                                                            |       |                                                           |       |                  |       |   |   |
| Cash and cash  equivalents                                                          |       | $                                                              | 363,528    |                  |       | $ | 137,396 |   |   |
| Short-term investments,  restricted                                                 |       | 86,998                                                         |       |                  | 124,573    |   |   |
| Instalment notes  receivable, net of allowance of $12,847 and $12,489, respectively |       | 1,748,334                                                      |       |                  | 1,693,922  |   |   |
| Receivables, net                                                                    |       | 417,707                                                        |       |                  | 351,115    |   |   |
| Inventories                                                                         |       | 587,644                                                        |       |                  | 551,293    |   |   |
| Prepaid expenses                                                                    |       | 30,186                                                         |       |                  | 31,320     |   |   |
| Property, plant and  equipment, net                                                 |       | 626,402                                                        |       |                  | 603,350    |   |   |
| Unamortized debt expense                                                            |       | 63,724                                                         |       |                  | 75,062     |   |   |
| Other long-term assets                                                              |       | 95,330                                                         |       |                  | 79,303     |   |   |
| Identifiable  intangibles, net                                                      |       | 850,096                                                        |       |                  | 858,122    |   |   |
| Goodwill                                                                            |       | 871,583                                                        |       |                  | 867,556    |   |   |
|                                                                                |       | $                                                              | 5,741,532  |                  |       | $ | 5,373,012 |   |   |
| *LIABILITIES AND STOCKHOLDERS’ EQUITY*                                         |       |                                                           |       |                  |       |   |   |
| Accounts payable                                                                    |       | $                                                              | 192,799    |                  |       | $ | 161,215 |   |   |
| Accrued expenses                                                                    |       | 203,627                                                        |       |                  | 213,596    |   |   |
| Deferred income taxes                                                               |       | 239,715                                                        |       |                  | 215,874    |   |   |
| Debt:                                                                               |       |                                                           |       |                  |       |   |   |
| Mortgage-backed/asset-backed  notes                                                 |       | 1,698,930                                                      |       |                  | 1,727,329  |   |   |
| Other debt                                                                          |       | 1,777,482                                                      |       |                  | 2,172,453  |   |   |
| Accrued interest                                                                    |       | 29,280                                                         |       |                  | 32,619     |   |   |
| Accumulated  postretirement benefits obligation                                     |       | 272,185                                                        |       |                  | 275,336    |   |   |
| Other long-term  liabilities                                                        |       | 287,773                                                        |       |                  | 285,974    |   |   |
| Total liabilities                                                                   |       | 4,701,791                                                      |       |                  | 5,084,396  |   |   |
| Minority interest                                                                   |       | 300,805                                                        |       |                  | —     |   |   |
| Commitments and contingencies (Note 13)                                             |       |                                                           |       |                  |       |   |   |
| Stockholders’ equity                                                           |       |                                                           |       |                  |       |   |   |
| Common stock, $.01 par value per share:                                             |       |                                                           |       |                  |       |   |   |
| Authorized—200,000,000 shares                                                  |       |                                                           |       |                  |       |   |   |
| Issued—64,367,414 and  59,818,401 shares                                       |       | 644                                                            |       |                  | 598        |   |   |
| Capital in excess of par  value                                                     |       | 1,547,118                                                      |       |                  | 1,210,751  |   |   |
| Accumulated deficit                                                                 |       | (502,742                                                       | )          |                  | (602,002   | ) |   |
| Treasury  stock—20,771,902 shares, at cost                                     |       | (259,317                                                       | )          |                  | (259,317   | ) |   |
| Accumulated other  comprehensive loss                                               |       | (46,767                                                        | )          |                  | (61,414    | ) |   |
| Total stockholders’  equity                                                    |       | 738,936                                                        |       |                  | 288,616    |   |   |
|                                                                                |       | $                                                              | 5,741,532  |                  |       | $ | 5,373,012 |   |   |

 

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

1

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

| ** **                                                                         | ** ** | **For the three months   ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                                                | ** ** | **2005** | ** ** |
| ** **                                                                         | ** ** | **(in thousands, except   per share amounts)** | ** ** |
| Net sales and revenues:                                                            |       |                                                                    |       |   |   |
| Net sales                                                                          |       | $                                                                       | 765,113    |   | $ | 409,563 |   |
| Interest income on instalment notes                                                |       | 50,937                                                                  |       | 53,110 |   |
| Miscellaneous                                                                      |       | 9,683                                                                   |       | 5,281 |   |
|                                                                               |       | 825,733                                                                 |       | 467,954 |   |
| Cost and  expenses:                                                                |       |                                                                    |       |   |   |
| Cost of sales (exclusive of depreciation)                                          |       | 523,845                                                                 |       | 296,823 |   |
| Depreciation                                                                       |       | 26,627                                                                  |       | 14,505 |   |
| Selling, general and administrative                                                |       | 91,819                                                                  |       | 54,015 |   |
| Provision for losses on instalment notes                                           |       | 2,510                                                                   |       | 1,949 |   |
| Postretirement benefits                                                            |       | 4,018                                                                   |       | 3,234 |   |
| Interest expense—mortgage-backed/asset-backed notes                           |       | 28,958                                                                  |       | 31,102 |   |
| Interest expense—other debt                                                   |       | 42,103                                                                  |       | 4,097 |   |
| Amortization of intangibles                                                        |       | 8,039                                                                   |       | 923 |   |
| Restructuring and impairment charges                                               |       | 1,361                                                                   |       | 305 |   |
|                                                                               |       | 729,280                                                                 |       | 406,953 |   |
| Income from continuing operations before income tax  expense and minority interest |       | 96,453                                                                  |       | 61,001 |   |
| Income tax  expense                                                                |       | (31,932                                                                 | )          | (19,520 | ) |
| Income from  continuing operations before minority interest                        |       | 64,521                                                                  |       | 41,481 |   |
| Minority interest  in net income of affiliates, net of income taxes                |       | (287                                                                    | )          | — |   |
| Income from  continuing operations                                                 |       | 64,234                                                                  |       | 41,481 |   |
| Discontinued  operations, net of income taxes                                      |       | (273                                                                    | )          | — |   |
| Net income                                                                         |       | $                                                                       | 63,961     |   | $ | 41,481 |   |
| Basic income per  share:                                                           |       |                                                                    |       |   |   |
| Income from continuing operations                                                  |       | $                                                                       | 1.48       |   | $ | 1.07 |   |
| Discontinued operations                                                            |       | (0.01                                                                   | )          | — |   |
| Net income                                                                         |       | $                                                                       | 1.47       |   | $ | 1.07 |   |
| Diluted income  per share:                                                         |       |                                                                    |       |   |   |
| Income from continuing operations                                                  |       | $                                                                       | 1.25       |   | $ | 0.87 |   |
| Discontinued operations                                                            |       | (0.01                                                                   | )          | — |   |
| Net income                                                                         |       | $                                                                       | 1.24       |   | $ | 0.87 |   |

 

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 six months   ended June 30,**   | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                                                | ** ** | **2005** | ** ** |
| ** **                                                                         | ** ** | **(in thousands, except per   share amounts)** | ** ** |
| Net sales and revenues:                                                            |       |                                                                    |       |   |   |
| Net sales                                                                          |       | $                                                                       | 1,459,806  |   | $ | 717,241 |   |
| Interest income on instalment notes                                                |       | 101,467                                                                 |       | 106,603 |   |
| Miscellaneous                                                                      |       | 17,729                                                                  |       | 10,391 |   |
|                                                                               |       | 1,579,002                                                               |       | 834,235 |   |
| Cost and  expenses:                                                                |       |                                                                    |       |   |   |
| Cost of sales (exclusive of depreciation)                                          |       | 1,017,826                                                               |       | 535,723 |   |
| Depreciation                                                                       |       | 52,320                                                                  |       | 28,825 |   |
| Selling, general and administrative                                                |       | 182,181                                                                 |       | 96,585 |   |
| Provision for losses on instalment notes                                           |       | 4,815                                                                   |       | 5,134 |   |
| Postretirement benefits                                                            |       | 8,035                                                                   |       | 6,472 |   |
| Interest expense—mortgage-backed/asset-backed notes                           |       | 58,934                                                                  |       | 62,537 |   |
| Interest expense—other debt                                                   |       | 84,655                                                                  |       | 7,709 |   |
| Amortization of intangibles                                                        |       | 15,729                                                                  |       | 1,986 |   |
| Credit for estimated hurricane insurance losses                                    |       | (1,046                                                                  | )          | (556 | ) |
| Restructuring and impairment charges                                               |       | 5,622                                                                   |       | 610 |   |
|                                                                               |       | 1,429,071                                                               |       | 745,025 |   |
| Income from continuing operations before income tax  expense and minority interest |       | 149,931                                                                 |       | 89,210 |   |
| Income tax  expense                                                                |       | (50,111                                                                 | )          | (28,547 | ) |
| Income from  continuing operations before minority interest                        |       | 99,820                                                                  |       | 60,663 |   |
| Minority interest  in net income of affiliates, net of income taxes                |       | (287                                                                    | )          | — |   |
| Income from continuing  operations                                                 |       | 99,533                                                                  |       | 60,663 |   |
| Discontinued  operations, net of income taxes                                      |       | (273                                                                    | )          | (417 | ) |
| Net income                                                                         |       | $                                                                       | 99,260     |   | $ | 60,246 |   |
| Basic income per  share:                                                           |       |                                                                    |       |   |   |
| Income from continuing operations                                                  |       | $                                                                       | 2.37       |   | $ | 1.59 |   |
| Discontinued operations                                                            |       | (0.01                                                                   | )          | (0.01 | ) |
| Net income                                                                         |       | $                                                                       | 2.36       |   | $ | 1.58 |   |
| Diluted income  per share:                                                         |       |                                                                    |       |   |   |
| Income from continuing operations                                                  |       | $                                                                       | 1.98       |   | $ | 1.29 |   |
| Discontinued operations                                                            |       | (0.01                                                                   | )          | (0.01 | ) |
| Net income                                                                         |       | $                                                                       | 1.97       |   | $ | 1.28 |   |

 

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

3

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**WALTER INDUSTRIES, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITYFOR THE SIX MONTHS ENDED JUNE 30, 2006(UNAUDITED)(in thousands)**

| ** **                                                                | ** ** | ** ** | ** ** | ** **        | ** ** | ** **      | ** ** | **Accumulated**        | ** ** | ** ** | ** ** | ** **          | ** ** | ** **   | ** ** |
|---------------------------------------------------------------------------|------------|------------|------------|-------------------|------------|-----------------|------------|------------------------|------------|------------|------------|---------------------|------------|--------------|------------|
| ** **                                                                | ** ** | ** ** | ** ** | ** **        | ** ** | ** **      | ** ** | **Other**              | ** ** | ** ** | ** ** | **Capital in** | ** ** | ** **   | ** ** |
| ** **                                                                | ** ** | ** ** | ** ** | **Comprehensive** | ** ** | **Accumulated** | ** ** | **Comprehensive**      | ** ** | **Common** | ** ** | **Excess of**  | ** ** | **Treasury** | ** ** |
| ** **                                                                | ** ** | **Total**  | ** ** | **Income**        | ** ** | **Deficit**     | ** ** | **Income (Loss)** | ** ** | **Stock**  | ** ** | **Par Value**  | ** ** | **Stock**    | ** ** |
| Balance at December 31, 2005                                         |       | $          | 288,616    |              |       |            |       |                   |       | $          | (602,002   | )                   |       |         | $          | (61,414 | ) |   |   | $ | 598 |   |   | $ | 1,210,751 |   | $ | (259,317 | ) |
| Comprehensive income:                                                     |       |       |       |              |       |            |       |                   |       |       |       |                |       |         |       |   |   |   |   |   |   |   |   |
| Net income                                                                |       | 99,260     |       |              | $          | 99,260          |       |                   |       | 99,260     |       |                |       |         |       |   |   |   |   |   |   |   |   |   |
| Other  comprehensive income, net of tax                              |       |       |       |              |       |            |       |                   |       |       |       |                |       |         |       |   |   |   |   |   |   |   |   |
| Cumulative foreign currency translation  adjustment                  |       | 1,620      |       |              | 1,620      |            |       |                   |       |       |       |                | 1,620      |         |       |   |   |   |   |   |   |   |   |
| Net unrealized gain on  hedges                                            |       | 13,027     |       |              | 13,027     |            |       |                   |       |       |       |                | 13,027     |         |       |   |   |   |   |   |   |   |   |
| Comprehensive income                                                      |       |       |       |              | $          | 113,907         |       |                   |       |       |       |                |       |         |       |   |   |   |   |   |   |   |   |   |
| 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 |       | 131,141    |       |              |       |            |       |                   |       |       |       |                |       |         |       |   |   |   |   | 131,141 |   |   |   |
| Stock issued upon exercise of stock options                          |       | 3,617      |       |              |       |            |       |                   |       |       |       |                |       |         |       |   | 5 |   |   | 3,612 |   |   |   |
| Tax benefit on the exercise of stock options                         |       | 6,156      |       |              |       |            |       |                   |       |       |       |                |       |         |       |   |   |   |   | 6,156 |   |   |   |
| Dividends paid, $.08 per share                                            |       | (3,309     | )          |              |       |            |       |                   |       |       |       |                |       |         |       |   |   |   |   | (3,309 | ) |   |   |
| Stock-based compensation                                                  |       | 4,266      |       |              |       |            |       |                   |       |       |       |                |       |         |       |   |   |   |   | 4,266 |   |   |   |
| Balance at  June 30, 2006                                            |       | $          | 738,936    |              |       |            |       |                   |       | $          | (502,742   | )                   |       |         | $          | (46,767 | ) |   |   | $ | 644 |   |   | $ | 1,547,118 |   | $ | (259,317 | ) |

 

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

4

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

| ** **                                                                                           | ** ** | **For the six months ended**                     | ** ** |
|------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                                                                           | ** ** | **June 30,**                                                    | ** ** |
| ** **                                                                                           | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** |
| ** **                                                                                           | ** ** | **(in thousands)**                                              | ** ** |
| OPERATING ACTIVITIES                                                                                 |       |                                                                 |       |   |   |   |   |   |   |
| Net income                                                                                           |       |                                                                 | $          | 99,260 |   |   |   | $ | 60,246 |   |   |
| Adjustments to reconcile income to net cash provided  by continuing operations:                      |       |                                                                 |       |   |   |   |   |   |   |
| Minority interest in net  income of affiliates, net of tax                                           |       |                                                                 | 287        |   |   |   | — |   |   |
| Discontinued operations,  net of tax                                                                 |       |                                                                 | 273        |   |   |   | 417 |   |   |
| Provision for losses on  instalment notes receivable                                                 |       |                                                                 | 4,815      |   |   |   | 5,134 |   |   |
| Depreciation                                                                                         |       |                                                                 | 52,320     |   |   |   | 28,825 |   |   |
| Restructuring and  impairment charges                                                                |       |                                                                 | 1,135      |   |   |   | — |   |   |
| Provision for deferred  income taxes                                                                 |       |                                                                 | 17,266     |   |   |   | 12,531 |   |   |
| Tax benefit on the  exercise of employee stock options                                               |       |                                                                 | 6,156      |   |   |   | 13,704 |   |   |
| Excess tax benefit from  stock-based compensation                                                    |       |                                                                 | (6,156     | ) |   |   | — |   |   |
| Amortization of  intangibles                                                                         |       |                                                                 | 15,729     |   |   |   | 1,986 |   |   |
| Amortization of debt  expense                                                                        |       |                                                                 | 11,353     |   |   |   | 3,202 |   |   |
| Other                                                                                                |       |                                                                 | 20,813     |   |   |   | 2,405 |   |   |
| Decrease  (increase) in assets:                                                                      |       |                                                                 |       |   |   |   |   |   |   |
| Receivables                                                                                          |       |                                                                 | (71,311    | ) |   |   | (36,831 | ) |   |
| Inventories                                                                                          |       |                                                                 | (31,971    | ) |   |   | (60,716 | ) |   |
| Prepaid expenses                                                                                     |       |                                                                 | 1,975      |   |   |   | (2,241 | ) |   |
| Increase (decrease) in liabilities:                                                                  |       |                                                                 |       |   |   |   |   |   |   |
| Accounts payable                                                                                     |       |                                                                 | 11,258     |   |   |   | 18,391 |   |   |
| Accrued expenses                                                                                     |       |                                                                 | (15,401    | ) |   |   | (2,665 | ) |   |
| Accrued interest                                                                                     |       |                                                                 | (3,339     | ) |   |   | (410 | ) |   |
| Cash flows provided by  continuing operations                                                        |       |                                                                 | 114,462    |   |   |   | 43,978 |   |   |
| Cash flows used in  discontinued operations                                                          |       |                                                                 | (273       | ) |   |   | (417 | ) |   |
| Cash flows provided by  operating activities                                                         |       |                                                                 | 114,189    |   |   |   | 43,561 |   |   |
| INVESTING ACTIVITIES                                                                                 |       |                                                                 |       |   |   |   |   |   |   |
| Acquisitions, net of cash  acquired                                                                  |       |                                                                 | (5,095     | ) |   |   | — |   |   |
| Notes originated from  sales and resales of homes, purchases of loans, repossessions  and write-offs |       |                                                                 | (278,669   | ) |   |   | (213,772 | ) |   |
| Cash collections on  accounts and payouts in advance of maturity                                     |       |                                                                 | 219,442    |   |   |   | 222,104 |   |   |
| Decrease in short-term  investments, restricted                                                      |       |                                                                 | 37,575     |   |   |   | 4,656 |   |   |
| Additions to property,  plant and equipment                                                          |       |                                                                 | (84,006    | ) |   |   | (48,088 | ) |   |
| Cash proceeds from sale  of property, plant and equipment                                            |       |                                                                 | 3,916      |   |   |   | 5,923 |   |   |
| Decrease in investments                                                                              |       |                                                                 | 14         |   |   |   | 3,454 |   |   |
| Cash flows used in  investing activities                                                             |       |                                                                 | (106,823   | ) |   |   | (25,723 | ) |   |
| FINANCING ACTIVITIES                                                                                 |       |                                                                 |       |   |   |   |   |   |   |
| Issuance of  mortgage-backed/asset-backed notes                                                      |       |                                                                 | 97,600     |   |   |   | 71,732 |   |   |
| Retirement of  mortgage-backed/asset-backed notes                                                    |       |                                                                 | (126,080   | ) |   |   | (138,054 | ) |   |
| Proceeds from issuance of  other debt                                                                |       |                                                                 | —     |   |   |   | 83,500 |   |   |
| Retirement of debt                                                                                   |       |                                                                 | (375,476   | ) |   |   | (63,500 | ) |   |
| Sale of common stock                                                                                 |       |                                                                 | 168,680    |   |   |   | — |   |   |
| Proceeds from  subsidiary’s initial public offering                                             |       |                                                                 | 429,325    |   |   |   | — |   |   |
| Excess tax benefit from  stock-based compensation                                                    |       |                                                                 | 6,156      |   |   |   | — |   |   |
| Increase in dollar value  of bank checks outstanding                                                 |       |                                                                 | 20,795     |   |   |   | — |   |   |
| Other                                                                                                |       |                                                                 | (364       | ) |   |   | 10,767 |   |   |
| Cash flows provided by  (used in) financing activities                                               |       |                                                                 | 220,636    |   |   |   | (35,555 | ) |   |
| Effect of exchange  rate changes on cash                                                             |       |                                                                 | (1,870     | ) |   |   | — |   |   |
| Net increase  (decrease) in cash and cash equivalents                                                |       |                                                                 | 226,132    |   |   |   | (17,717 | ) |   |
| Cash and cash  equivalents at beginning of period                                                    |       |                                                                 | 137,396    |   |   |   | 46,924 |   |   |
| Cash and cash equivalents  at end of period                                                          |       |                                                                 | $          | 363,528 |   |   |   | $ | 29,207 |   |   |

 

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

5

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**SUPPLEMENTALDISCLOSURES:**

(a)          TheCompany recorded restructuring and impairment charges of $5.6 million for thesix months ended June 30, 2006. The non-cash portion of these chargesprimarily consists of an asset impairment charge for Sloss Industries’, includedin the “Other” segment. A reconciliation of non-cash restructuring andimpairment charges is provided below.

| ** **                                  | ** ** | **For the**               | ** ** |
|---------------------------------------------|------------|--------------------------------|------------|
| ** **                                  | ** ** | **six months ended** | ** ** |
| ** **                                  | ** ** | **June 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.

6

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**WALTER INDUSTRIES,INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSAS OF AND FOR THE THREE AND SIX MONTHS ENDED JUNE 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: Homebuilding, Financing, Mueller (“Mueller Co.”), Anvil, U.S. Pipe,Natural Resources and Other, see Note 12. Through these operating segments, theCompany offers a diversified line of products and services including homeconstruction and mortgage financing, water infrastructure and flow controlproducts, coal, natural gas, furnace and foundry coke, chemicals 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 and sixmonth periods ended June 30, 2006 are not necessarily indicative of theresults 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, par value $0.01 per share at an offering price of$16.00 per share (NYSE: MWA). The gross proceeds of $460.0 million were reducedby $27.6 million in underwriter fees and $3.1 million of other costs associatedwith the IPO. The net proceeds were used to repay a portion of Mueller Water’sexisting debt, see Note 9.

In connection with the issuance of the Series Acommon stock, Mueller Water also issued 85.8 million shares of Series Bcommon stock to the Company in exchange for the Company’s one share held priorto the IPO. After the completion of the IPO, Mueller Water had 114.6 millionshares of common stock outstanding.

Following the completionof the IPO, the Company owned 74.9% of Mueller Water’s common stock outstandingin the form of 100% ownership of the Series B common stock outstanding,which provides eight votes per share. As a result the Company has an effectivevoting interest of 96.3% of the combined voting power of all of Mueller Water’soutstanding common stock. The Company recognized a gain of $131.1 million onthe sale of the 25.1% ownership interest, included in stockholders’ equity at June 30,2006. The minority interest of $300.8 million at June 30, 2006 representsthe 25.1% interest held by non-Walter shareholders in the net assets ofMueller Water, including $1.2 million of minority interest in June’s netincome.

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**Note 3—Share-BasedCompensation Plans**

*Share-basedCompensation—Walter Industries Stock*

As of January 1, 2006, the Company adopted Statementof 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 Stock Issuedto Employees,” and related interpretations. As a result, no compensationexpense was previously recognized for stock options granted to employeesbecause all stock options granted had exercise prices equal to the market valueof the Company’s stock at the date of the grant, while compensation expenseassociated with restricted stock unit grants was being recognized over thevesting period of the 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 in 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 compensation costas an operating cash outflow and a financing cash inflow. Consistent with therequirement of SFAS 123(R), the Company uses the Black-Scholes option pricingmodel to value its stock option grants and estimates forfeitures in calculatingthe 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 six months ended June 30,2006 was as follows (in thousands, except per share data):

| ** **                                                         | ** ** | **For the three months  ended June 30, 2006** | ** ** | **For the six months  ended June 30, 2006** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| Decrease in  income from continuing operations before income taxes |       |                                                                        | $          | 1,461                                                                     |       |   |   | $ | 2,270 |   |   |
| Decrease in net  income                                            |       |                                                                        | $          | 950                                                                       |       |   |   | $ | 1,476 |   |   |
| Cash outflow from  operating activities                            |       |                                                                        | $          | 2,105                                                                     |       |   |   | $ | 6,156 |   |   |
| Cash inflow from  financing activities                             |       |                                                                        | $          | 2,105                                                                     |       |   |   | $ | 6,156 |   |   |
| Decrease in basic  earnings per share                              |       |                                                                        | $          | 0.02                                                                      |       |   |   | $ | 0.04 |   |   |
| Decrease in diluted  earnings per share                            |       |                                                                        | $          | 0.02                                                                      |       |   |   | $ | 0.03 |   |   |

 

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Inaccordance with the modified prospective transition method, the Company’sConsolidated Financial Statements for periods ended prior to January 1,2006 have not been restated to reflect, and do not include, the impact of SFAS123(R). Had compensation cost for the Company’s option plans for the three andsix months ended June 30, 2005 been determined based on the fair value atthe grant dates as prescribed by SFAS 123(R), the Company’s net income and netincome per share on a pro forma basis would have been (in thousands, except pershare data):

| ** **                                                                                                                                    | ** ** | **For the three months** | ** ** | **For the six months**  | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **ended June 30, 2005**  | ** ** | **ended June 30, 2005** | ** ** |
| Net income, as  reported                                                                                                                      |       |                                    | $          | 41,481                                 |       |   |   | $ | 60,246 |   |   |
| Add: Stock-based  compensation expense included in reported net income, net of related tax  effects                                           |       |                                    | 236        |                                   |       |   | 472 |   |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based method  for all awards, net of related tax effects |       |                                    | (696       | )                                      |       |   | (1,423 | ) |   |
| Pro forma net income                                                                                                                          |       |                                    | $          | 41,021                                 |       |   |   | $ | 59,295 |   |   |

 

| ** **               | ** ** | **For the three months** | ** ** | **For the six months**  | ** ** |
|--------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **               | ** ** | **ended June 30, 2005**  | ** ** | **ended June 30, 2005** | ** ** |
| Net income per share:    |       |                                    |       |                                   |       |   |   |   |   |
| Basic—as reported   |       |                                    | $          | 1.07                                   |       |   |   | $ | 1.58 |   |   |
| Basic—pro forma     |       |                                    | 1.06       |                                   |       |   | 1.56 |   |   |
| Diluted—as reported |       |                                    | 0.87       |                                   |       |   | 1.28 |   |   |
| Diluted—pro forma   |       |                                    | 0.86       |                                   |       |   | 1.26 |   |   |
|                          |            |                                         |            |                                        |            |  |  |  |  |  |  |

 

The preceding pro forma results were calculated usingthe Black Scholes option-pricing model. Weighted average assumptions used forstock compensation awards granted in the following prior year periods were:

| ** **               | ** ** | **For the three months** | ** ** | **For the six months**  | ** ** |
|--------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| ** **               | ** ** | **ended June 30, 2005**  | ** ** | **ended June 30, 2005** | ** ** |
| Risk free  interest rate |       |                                    | 3.99       | %                                      |       |   | 4.13 | % |   |
| Dividend yield           |       |                                    | 0.40       | %                                      |       |   | 0.40 | % |   |
| Expected life  (years)   |       |                                    | 5.5        |                                   |       |   | 5.9 |   |   |
| Volatility               |       |                                    | 42.91      | %                                      |       |   | 39.94 | % |   |

 

**Equity Award 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,vesting occurs over three or five years in equal annual increments), but nooption will be exercisable after the tenth anniversary of the date on which itis granted.

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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 six months ended June 30,2006, the Company recorded stock-based compensation expense of approximately$2.4 million and $3.9 million, respectively, and $0.4 million and $0.7 millionfor the three and six months ended June 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 $0.8 million and $1.4 million for the three and six monthsended June 30, 2006, respectively, and $0.1 million and $0.4 million forthe three and six months ended June 30, 2005, respectively.

Asummary of activity related to stock options under the Equity Award Plans as ofJune 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                                |       | 321,703    |       |                                       | 64.01      |                                                                     |       |                                        |       |   |   |   |   |   |   |
| Exercised                              |       | (357,947   | )          |                                       | 10.87      |                                                                     |       |                                        |       |   |   |   |   |   |   |
| Cancelled                              |       | (3,937     | )          |                                       | 27.31      |                                                                     |       |                                        |       |   |   |   |   |   |   |
| Outstanding at  June 30, 2006     |       | 839,387    |       |                                       | $          | 36.33                                                                    |       |                                        |       | 8.00 |   |   |   | $ | 16,323 |   |   |
| Exercisable at  June 30, 2006     |       | 302,614    |       |                                       | $          | 13.55                                                                    |       |                                        |       | 6.03 |   |   |   | $ | 12,778 |   |   |

 

Weightedaverage assumptions used to determine the grant-date fair value of optionsgranted during the three and six months ended June 30, 2006 were:

| ** **               | ** ** | **For the three  months ended** | ** ** | **For the six  months ended** | ** ** |
|--------------------------|------------|------------------------------------------------|------------|----------------------------------------------|------------|
| ** **               | ** ** | **June 30, 2006**                    | ** ** | **June 30, 2006**                  | ** ** |
| Risk free  interest rate |       |                                           | 4.70       | %                                            |       |   | 4.60 | % |   |
| Dividend yield           |       |                                           | 0.30       | %                                            |       |   | 0.30 | % |   |
| Expected life  (years)   |       |                                           | 5.10       |                                         |       |   | 5.50 |   |   |
| Volatility               |       |                                           | 36.90      | %                                            |       |   | 38.20 | % |   |
| Forfeiture rate          |       |                                           | 4.80       | %                                            |       |   | 4.50 | % |   |

 

Approximately 125,000 and 58,000 restricted stockunits were granted and vested during the six months ended June 30, 2006,respectively. Approximately 310,000 and 245,000 restricted stock units wereoutstanding at June 30, 2006 and December 31, 2005, respectively. At June 30,2006, the weighted-average remaining contractual term on the Company’srestricted stock units was 3.3 years.

The weighted-averagegrant-date fair value of stock options and restricted stock units grantedduring the three and six months ended June 30, 2006 was $26.64 and $63.72,respectively. The total intrinsic value of stock options exercised or convertedduring the six months ended June 30, 2006 was approximately $19.3 million.As of June 30, 2006, there was approximately $17.0 million of unrecognizedcompensation cost related to non-vested share-based compensation arrangementsgranted under the Equity Award Plans; that cost is to be recognized over aweighted average period of 2.75 years.

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*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, 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 of thedate on which it is granted.

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

| ** **                                                         | ** ** | **For the  three months ended  June 30, 2006** | ** ** | **For the  six months ended  June 30, 2006** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| Decrease in  income from continuing operations before income taxes |       |                                                                    | $          | 0.5                                                                   |       |   |   | $ | 0.5 |   |   |
| Decrease in net  income                                            |       |                                                                    | $          | 0.2                                                                   |       |   |   | $ | 0.2 |   |   |
| Cash outflow from  operating activities                            |       |                                                                    | $          | —                                                                |       |   |   | $ | — |   |   |
| Cash inflow from  financing activities                             |       |                                                                    | $          | —                                                                |       |   |   | $ | — |   |   |
| Decrease in basic and  diluted earnings per share                  |       |                                                                    | $          | —                                                                |       |   |   | $ | — |   |   |

 

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

| ** **                          | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|-------------------------------------|------------|------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | ** ** | ** ** | ** **                                 | ** ** | **(in years)**                                 | ** ** | **($ millions)**          | ** ** |
| Outstanding at  March 31, 2006 |       | —     |       |                                       | $          | —                                              |       |                           |       |   |   |   |   |   |   |   |
| Granted                             |       | 85,600     |       |                                       | 16.00      |                                                |       |                           |       |   |   |   |   |   |   |
| Exercised                           |       | —     |       |                                       | —     |                                                |       |                           |       |   |   |   |   |   |   |
| Cancelled                           |       | —     |       |                                       | —     |                                                |       |                           |       |   |   |   |   |   |   |
| Outstanding at  June 30, 2006  |       | 85,600     |       |                                       | 16.00      |                                                |       |                           | 9.9        |   |   |   | $ | 0.1 |   |   |
| Exercisable at  June 30, 2006  |       | —     |       |                                       | $          | —                                              |       |                           |       | — |   |   |   | $ | — |   |   |

 

Weightedaverage assumptions used to determine the grant-date fair value of optionsgranted during the three months ended June 30, 2006 were:

| Risk free  interest rate |   | 5.05  | %      |
|--------------------------|--------|-------|--------|
| Dividend yield           |   | 0.44  | %      |
| Expected life  (years)   |   | 6.50  |   |
| Volatility               |   | 31.80 | %      |
| Forfeiture rate          |   | 5.00  | %      |

 

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Approximately 1.1 million restricted stock units weregranted and none were exercised during the three months ended June 30,2006. As such, approximately 1.1 million restricted stock units wereoutstanding at June 30, 2006. At June 30, 2006, the weighted-averageremaining contractual term on Mueller Water’s restricted stock units was 2.9years.

The weighted-averagegrant-date fair value of stock options and restricted stock units grantedduring the three months and six months ended June 30, 2006 was $6.52 for stockoptions and $16.00 for restricted stock units. There were no stock optionsexercised or converted during the three months ended June 30, 2006. As ofJune 30, 2006, there was approximately $17.8 million of unrecognizedcompensation cost related to non-vested share-based compensation arrangementsgranted under the 2006 Plan; that cost is to be recognized over the three yearperiod during which they vest.

**Note 4—Restructuringand Impairments**

On April 20, 2006, Mueller Water announced theclosure of the Mueller Canada valve and hydrant manufacturing facility inMilton, Ontario, Canada, which is included in Mueller Co. The eventual closureof the facility is expected to occur during the third quarter ending 2006,resulting in the termination of approximately 130 employees. The transfer ofproduction to other Mueller Co. facilities began in the second quarter of 2006.Total estimated costs related to this closure are $3.9 million, of which $2.5million, consisting of termination benefits, and $0.2 million, consisting offixed asset impairments, were recorded as adjustments to goodwill in the threemonths ended June 30, 2006. Other estimated costs of $1.2 million,associated with relocating the Milton warehouse and equipment, will be expensedas incurred. The restructuring costs are recorded to goodwill as the overallplan to close the facility was identified prior to the acquisition.

On January 26, 2006, Mueller Water announced theclosure of the Henry Pratt valve manufacturing facility in Dixon, Illinois,which is included in Mueller Co. The eventual closure of the facility isexpected to occur during the third quarter ending 2006, resulting in thetermination of approximately 100 employees. Total estimated costs related tothis closure are $3.4 million, of which $1.0 million, related to terminationbenefits, and $1.4 million, consisting of fixed asset impairment charges, wererecorded as adjustments to goodwill. The remaining other estimated costs of$1.0 million include costs to transfer and install equipment and temporaryoutsourcing of manufacturing and will be expensed when incurred. During thethree and six months ended June 30, 2006, $0.7 million and $1.0 million,respectively, of termination benefits and $1.4 million of fixed assetimpairment charges were recorded as adjustments to goodwill. The restructuringcosts are recorded to goodwill as the overall plan to close the facility was identifiedprior to the acquisition.

During the quarter ended June 30, 2006, theCompany recorded an impairment charge of $1.1 million relating to SlossIndustries’ chemical division. The Company is considering a plan to sell theseassets before the end of their useful life. The fair value used to determinethe impairment charge is based on a good faith quote from a willing buyer.

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. During June 2006, the U.S. Pipe Chattanooga plant waseffectively closed. Total exit costs have accumulated to $49.9 million of whichapproximately $28.6 million qualified as restructuring and impairment charges.The remaining exit costs of $21.3 million are comprised of an inventorywrite-down totaling $11.5 million and a $9.8 million write-off of unabsorbedoverhead costs, of which $15.9 million, $2.4 million and $3.0 million wererecognized in cost of sales during the fourth quarter of 2005, the firstquarter of 2006, and the second quarter of 2006, respectively.

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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 six**   | ** ** | **for the three**       | ** ** | **Restructuring**                 | ** ** |
| ** **                                   | ** ** | **from inception to** | ** ** | **months ended**       | ** ** | **months ended**             | ** ** | **charges expensed in** | ** ** |
| ** **                                   | ** ** | **June 30, 2006**     | ** ** | **June 30, 2006** | ** ** | **June 30, 2006 ** | ** ** | **2005**                          | ** ** |
| Termination  benefits                        |       |                            | $          | 3,816                       |       |                              |       | $                                 | 820        |   |   |   | $ | 393 |   |   |   | $ | 2,996 |   |   |
| Other  employee-related  costs               |       |                            | 3,312      |                        |       |                              | 3,312      |                              |       |   | (522 | ) |   |   | — |   |   |
| Other associated  costs                      |       |                            | 2,094      |                        |       |                              | —     |                              |       |   | — |   |   |   | 2,094 |   |   |
| Impairment of  property, plant and equipment |       |                            | 19,403     |                        |       |                              | 355        |                              |       |   | 355 |   |   |   | 19,048 |   |   |
| Total                                        |       |                            | $          | 28,625                      |       |                              |       | $                                 | 4,487      |   |   |   | $ | 226 |   |   |   | $ | 24,138 |   |   |

 

Termination benefits relating to the U.S. PipeChattanooga plant closure totaling $0.4 million and $0.8 million in the threeand six months ended June 30, 2006, respectively, consist primarily ofseverance for staff reductions of hourly personnel. In addition, the Companyrecognized $0.5 million in reductions, as a result of a curtailment gain, and$3.3 million of other employee-related costs for the three and six months endedJune 30, 2006, respectively, consisting primarily of pension and otherpostretirement curtailments and termination benefits. The Company does notexpect to recognize any additional charges or benefits; however, thisassumption is contingent upon the sale of the facility and related equipment atits estimated fair market value.

In 2003, the Company announced that it expected toclose Mine No. 5 in 2004. In 2004, the Company decided to extend its coalproduction schedule for Mine No. 5 into the fourth quarter of 2006 due tofavorable metallurgical coal pricing, which more than offset the high costsnecessary to mine the coal. Total expected costs to close the mine decreasedfrom $11.8 million to $8.5 million due to a decrease in the expected costs ofemployee benefits and workers’ compensation. Approximately $6.6 million of theexpected closure costs qualify as restructuring costs and have been recorded bythe Company. There were no costs incurred related to Mine No. 5 closureduring the six months ended June 30, 2006. Other costs, primarilyrepresenting estimated workers’ compensation and other incremental costsrelated to the closure of the mine will be charged to expense when incurred.

The Company’s activity in accruedrestructuring was as follows (in thousands):

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

 

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**Note 5—RestrictedShort-Term Investments**

Restricted short-terminvestments at June 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”) ($79.7 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)miscellaneous other segregated accounts restricted to specific uses ($7.3million and $6.4 million, respectively).

**Note 6—InstalmentNotes Receivable**

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

| ** **                   | ** **   | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------|--------------|-------------------|------------|-----------------------|------------|
| ** **                   | ** **   | **2006**          | ** ** | **2005**              | ** ** |
| Instalment notes  receivable | ** **   | $                 | 1,558,348  | ** **            |       | $ | 1,558,383 | ** ** |   |
| Mortgage loans               | ** **   | 202,833           | ** ** |                  | 148,028    | ** ** |   |
| Less: Allowance  for losses  | *** *** | (12,847           | **)**      |                  | (12,489    | **)** |   |
| Net                          | ** **   | $1,748,334        | ** ** |                  | $          | 1,693,922 | ** ** |   |
|                              |              |                   |            |                       |            |  |  |  |  |

 

During the three and six months ended June 30,2006, the Company purchased $31.5 million and $70.6 million mortgage loans,respectively, from unrelated third parties.

Activity in the allowancefor losses on instalment notes is summarized as follows (in thousands):

| ** **                      | ** ** | **For the six months ended**                     | ** ** |
|---------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                      | ** ** | **June 30,**                                                    | ** ** |
| ** **                      | ** ** | **     2006     ** | ** ** | **     2005     ** | ** ** |
| Balance at beginning of  period |       |                                                                 | $          | 12,489 | * * |   |   | $ | 11,200 | * * |   |
| Provisions charged to  income   |       |                                                                 | 4,815      | * * |   |   | 5,134 | * * |   |
| Charge-offs, net of  recoveries |       |                                                                 | (4,457     | ) |   |   | (5,235 | ) |   |
| Balance at end of period        |       |                                                                 | $          | 12,847 | * * |   |   | $ | 11,099 | * * |   |

 

**Note 7—Inventories**

Inventories are summarizedas follows (in thousands):

| ** **                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| Finished goods                      |       | $                 | 314,253    |                  |       | $ | 278,347 |   |   |
| Goods in process                    |       | 148,718           |       |                  | 144,846    |   |   |
| Raw materials and  supplies         |       | 95,202            |       |                  | 97,490     |   |   |
| Repossessed  houses held for resale |       | 29,471            |       |                  | 30,610     |   |   |
| Total inventories                   |       | $                 | 587,644    |                  |       | $ | 551,293 |   |   |

 

**Note 8—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”), aConnecticut-based manufacturer of check valves for sale to the water andwastewater treatment markets, for $8.8 million in cash.

14

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Goodwillincreased to $871.6 million at June 30, 2006 from $867.6 million at December 31,2005. During the six months ended June 30, 2006, the Company recordedchanges to its goodwill as follows ($ 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 |   |
| Resolution of  purchase price contingency—working capital adjustment |       |                 | (9,427     | )         |       | (1,100             | )          | —        |       |      | —     |   |   | (10,527 | ) |
| Acquisitions                                                              |       |                 | 6,783      |      |       | —             |       | —        |       |      | —     |   |   | 6,783 |   |
| Restructuring  charges                                                    |       |                 | 4,331      |      |       | 315                |       | —        |       |      | —     |   |   | 4,646 |   |
| Other                                                                     |       |                 | 6,411      |      |       | (3,286             | )          | —        |       |      | —     |   |   | 3,125 |   |
| Balance as of  June 30, 2006                                         |       |                 | $          | 718,548   |       |               | $          | 83,729        |       | $         | 58,411     |   |   | $ | 10,895 |   |   | $ | 871,583 |   |

 

Identifiable intangiblesdecreased to $850.1 million at June 30, 2006 from $858.1 at December 31,2005. Changes during the period include an acquired intangible of $6.8 millionin connection with the CCNE acquisition and a $1.0 million adjustment to theMueller Water purchase price allocation, increasing the customer relationshipintangibles. Amortization of definite-lived intangible assets was $8.0 millionand $15.7 million for the three and six months ended June 30, 2006,respectively.

**Note 9—Debt**

Debtconsisted of the following (in thousands):

| ** **                            | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| Mortgage-Backed/Asset-Backed  Notes:  |       | $                 | 1,698,930  |                  |       | $ | 1,727,329 |   |   |
| Other debt:                           |       |              |       |                  |       |   |   |
| 2005 Mueller Credit Agreement         |       | 795,746           |       |                  | 1,047,375  |   |   |
| 2005 Walter Credit Agreement          |       | 325,028           |       |                  | 448,875    |   |   |
| 10% Senior Subordinated Notes(1)      |       | 331,691           |       |                  | 333,162    |   |   |
| 143¤4% Senior  Discount Notes(2) |       | 174,189           |       |                  | 165,697    |   |   |
| Convertible Senior Subordinated Notes |       | 148,400           |       |                  | 175,000    |   |   |
| Capital Lease Obligations             |       | 2,428             |       |                  | 2,344      |   |   |
|                                  |       | 1,777,482         |       |                  | 2,172,453  |   |   |
| Total                                 |       | $                 | 3,476,412  |                  |       | $ | 3,899,782 |   |   |

----

       (1) The effective interest rate was 8.0% as of June 30, 2006.

       (2) The effective interest rate was 10.6% as of June 30,2006.

**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 $795.7 million was outstanding as of June 30, 2006, and (2) a$145.0 million revolving credit facility, which provides for loans andletters of credit. As of June 30, 2006, Mueller Group had no borrowingsoutstanding under the revolving credit facility but issued $31.8 million inletters of credit, which reduced availability for borrowings to $113.2 million.The revolving credit facility will terminate on October 4, 2010, and theterm loan will mature on November 1, 2011 (or October 3, 2012, if the10% senior subordinated notes due 2012 are paid in full or refinanced prior tosuch date).

15

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An amendment to the 2005 Mueller Credit Agreement madein January 2006 provides that in the event of an initial public offering,Mueller Group may pay annual dividends of up to $8.5 million to Mueller Waterto pay its common shareholders.

In June 2006, Mueller Water used $246.0 millionfrom the proceeds of the IPO to repay a portion of the term loan under the 2005Mueller Credit Agreement. Asa result of this prepayment, $4.1 million of unamortized debt expense wascharged to interest expense during the quarter ended June 30, 2006.

On July 3, 2006,Mueller Water used $60.2 million of the proceeds from the IPO for a partialredemption of $61.0 million of the senior discount notes and to pay aprepayment premium of $7.7 million. In addition, Mueller Water used $123.1 ofthe proceeds from the IPO for a partial redemption of $116.1 million ofthe senior subordinated notes, to pay accrued interest of $1.8 million and topay a prepayment premium of $11.0 million. During the third quarter of 2006, apre-tax loss on the extinguishment of this debt totaling $8.0 million will berecognized as additional interest expense. This loss consists of prepayment premiumstotaling $18.7 million offset in part by the recognition of other unamortizedcarrying values totaling $10.7 million.

**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 $325.0 million was outstanding as of June 30,2006, and (2) a $225.0 million revolving credit facility, whichprovides for loans and letters of credit. As of June 30, 2006, the Companyhad issued $63.4 million in letters of credit, which reduced availabilityfor borrowings under the revolving credit facility to $161.6 million and therewere no borrowings outstanding under the revolving credit facility. Therevolving credit facility will terminate on October 4, 2010, and the termloan 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, $67.9 million was used to repay the term loanfacility on a mandatory basis and $35.0 million was used to repay the term loanfacility on an optional basis. As a result of these term loan prepayments, $1.6million of unamortized debt expense was charged to interest expense during thefirst quarter of 2006.

**Convertible SeniorSubordinated Notes**

During the six monthsended June 30, 2006, holders of $26.6 million of the Company’s ConvertibleSenior Subordinated Notes surrendered their convertible notes in exchange forapproximately 1,490,000 shares of the Company’s common stock and, as aresult, approximately $1.6 million of inducement fees were expensed during2006.

**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 is the forecasted issuance date of the Company’snext mortgage-backed securitization. The swaps call for the Company to makefixed rate payments over the term at 5.05% per annum and receive payments basedon one-month LIBOR from the counter-parties. It is anticipated that the swapswill be settled at securitization, and the Company will account for the swapsas cash flow hedges. Changes in the fair value of the swaps through thedate of securitization that take place will be recorded in accumulated othercomprehensive income (loss), assuming the securitization remains likely.

16

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**Note 10—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 June 30,**            | ** ** | **ended June 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                                   |       | 4,089 |   | 4,010 |   |
| Expected return on plan assets                    |       | (7,837                                  | )          | (6,246                                  | )          | — |   | — |   |
| Amortization of prior service cost                |       | 185                                     |       | 164                                     |       | (1,727 | ) | (1,721 | ) |
| Amortization of net loss (gain)                   | * *   | 2,051                                   | * *   | 1,575                                   | * *   | 981 | * * | 497 |   |
|                                              |       | 4,108                                   |       | 3,093                                   |       | 4,018 |   | 3,234 |   |
| Curtailments and termination benefits loss (gain) | * *   | 65                                      |       | —                                  | * *   | (587 | ) | — |   |
| Net periodic  benefit cost                        |       | $                                       | 4,173      |                                    | $          | 3,093 |   | $ | 3,431 |   | $ | 3,234 |   |

 

| ** **                                         | ** ** | **Pension Benefits**             | ** ** | **Other Benefits**               | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|---------------------------------------|------------|
| ** **                                         | ** ** | **For the six months** | ** ** | **For the six months** | ** ** |
| ** **                                         | ** ** | **ended June 30,**          | ** ** | **ended June 30,**          | ** ** |
| ** **                                         | ** ** | **2006**                              | ** ** | **2005**                              | ** ** | **2006** | ** ** | **2005** | ** ** |
| Components of net  periodic benefit cost:          |       |                                  |       |                                  |       |   |   |   |   |
| Service cost                                       |       | $                                     | 5,400      |                                  | $          | 4,122 |   | $ | 1,350 |   | $ | 896 |   |
| Interest cost                                      |       | 14,018                                |       | 11,078                                |       | 8,177 |   | 8,024 |   |
| Expected return  on plan assets                    |       | (15,674                               | )          | (12,492                               | )          | — |   | — |   |
| Amortization of  prior service cost                |       | 370                                   |       | 328                                   |       | (3,454 | ) | (3,442 | ) |
| Amortization of  net loss (gain)                   |       | 4,102                                 |       | 3,150                                 |       | 1,962 |   | 994 |   |
|                                               |       | 8,216                                 |       | 6,186                                 |       | 8,035 |   | 6,472 |   |
| Curtailments and  termination benefits loss (gain) |       | 5,021                                 |       | —                                |       | (1,709 | ) | — |   |
| Net periodic benefit  cost                         |       | $                                     | 13,237     |                                  | $          | 6,186 |   | $ | 6,326 |   | $ | 6,472 |   |

 

The curtailments and termination benefits loss (gain)shown in the schedule above are related to the closure of the U.S. PipeChattanooga, Tennessee plant as described in Note 4. These components of netperiodic benefit cost for pension and postretirement plans were charged torestructuring expense in the statement of operations.

17

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**Note 11—Net Incomeper Share**

Areconciliation of the basic and diluted net income per share computations forthe three and six months ended June 30, 2006 and 2005 are as follows (inthousands, except per share data):

| ** **                                                                                       | ** ** | **For the three months ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2006**                                                              | ** ** | **2005** | ** ** |
| ** **                                                                                       | ** ** | **Basic**                                                             | ** ** | **Diluted** | ** ** | **Basic** | ** ** | **Diluted** | ** ** |
| Numerator:                                                                                       |       |                                                                  |       |   |   |   |   |   |   |
| Net income                                                                                       |       | $                                                                     | 63,961     |   | $ | 63,961 |   | $ | 41,481 |   | $ | 41,481 |   |
| Effect of dilutive securities:                                                                   |       |                                                                  |       |   |   |   |   |   |   |
| Interest related to  3.75% convertible senior subordinated notes, net of tax(a)                  |       | —                                                                |       | 904 |   | — |   | 1,066 |   |
|                                                                                             |       | $                                                                     | 63,961     |   | $ | 64,865 |   | $ | 41,481 |   | $ | 42,547 |   |
| Denominator:                                                                                     |       |                                                                  |       |   |   |   |   |   |   |
| Average number of common  shares outstanding                                                     |       | 43,529                                                                |       | 43,529 |   | 38,661 |   | 38,661 |   |
| Effect of dilutive  securities:  Stock options and restricted stock units (“units”)(b) |       | —                                                                |       | 330 |   | — |   | 679 |   |
| 3.75% convertible senior  subordinated notes(a)                                                  |       | —                                                                |       | 8,315 |   | — |   | 9,805 |   |
|                                                                                             |       | 43,529                                                                |       | 52,174 |   | 38,661 |   | 49,145 |   |
| Net income per share                                                                             |       | $                                                                     | 1.47       |   | $ | 1.24 |   | $ | 1.07 |   | $ | 0.87 |   |

 

The Company had 290,029 and 703 weighted average anti-dilutivestock options outstanding for the three months ended June 30, 2006 and2005, respectively, excluded from the calculation above.

| ** **                                                                      | ** ** | **For the six months ended June 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                                      | ** ** | **2006**                                                            | ** ** | **2005** | ** ** |
| ** **                                                                      | ** ** | **Basic**                                                           | ** ** | **Diluted** | ** ** | **Basic** | ** ** | **Diluted** | ** ** |
| Numerator:                                                                      |       |                                                                |       |   |   |   |   |   |   |
| Net income                                                                      |       | $                                                                   | 99,260     |   | $ | 99,260 |   | $ | 60,246 |   | $ | 60,246 |   |
| Effect of dilutive  securities:                                                 |       |                                                                |       |   |   |   |   |   |   |
| Interest related to  3.75% convertible senior subordinated notes, net of tax(a) |       | —                                                              |       | 1,928 |   | — |   | 2,132 |   |
|                                                                            |       | $                                                                   | 99,260     |   | $ | 101,188 |   | $ | 60,246 |   | $ | 62,378 |   |
| Denominator:                                                                    |       |                                                                |       |   |   |   |   |   |   |
| Average number of common  shares outstanding                                    |       | 42,024                                                              |       | 42,024 |   | 38,131 |   | 38,131 |   |
| Effect of dilutive  securities:                                                 |       |                                                                |       |   |   |   |   |   |   |
| Stock options and  restricted stock units(b)                                    |       | —                                                              |       | 384 |   | — |   | 916 |   |
| 3.75% convertible senior  subordinated   notes(a)                               |       | —                                                              |       | 8,946 |   | — |   | 9,805 |   |
|                                                                            |       | 42,024                                                              |       | 51,354 |   | 38,131 |   | 48,852 |   |
| Net income per share                                                            |       | $                                                                   | 2.36       |   | $ | 1.97 |   | $ | 1.58 |   | $ | 1.28 |   |

 

The Company had180,230 and 354 weighted average anti-dilutive stock options  outstanding for the six months ended June 30,2006 and 2005, respectively, excluded from the calculation above.

----

(a)           The numeratorrepresents the weighted-average interest, net of tax, and the denominatorrepresents the weighted-average shares issuable upon conversion related to theCompany’s 3.75% contingent convertible senior subordinated 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 

18

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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.

***Note 12—SegmentInformation***

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

| ** **                                                                         | ** ** | **For the three months ended June 30,**                                                                        | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **           2006           ** | ** ** | **           2005           ** | ** ** |
| Net sales and revenues:                                                            |       |                                                                                                                                         |       |   |   |   |   |   |   |
| Homebuilding                                                                       |       |                                                                                                                                         | $          | 64,745 |   |   |   | $ | 57,117 |   |   |
| Financing                                                                          |       |                                                                                                                                         | 55,819     |   |   |   | 58,606 |   |   |
| Mueller Co.(a)                                                                     |       |                                                                                                                                         | 225,225    |   |   |   | — |   |   |
| Anvil(a)                                                                           |       |                                                                                                                                         | 136,539    |   |   |   | — |   |   |
| U.S. Pipe                                                                          |       |                                                                                                                                         | 143,718    |   |   |   | 161,966 |   |   |
| Natural Resources                                                                  |       |                                                                                                                                         | 173,094    |   |   |   | 162,833 |   |   |
| Other                                                                              |       |                                                                                                                                         | 37,769     |   |   |   | 35,531 |   |   |
| Consolidating  eliminations                                                        |       |                                                                                                                                         | (11,176    | ) |   |   | (8,099 | ) |   |
| Net sales and revenues                                                             |       |                                                                                                                                         | $          | 825,733 |   |   |   | $ | 467,954 |   |   |
| Segment operating income (loss):                                                   |       |                                                                                                                                         |       |   |   |   |   |   |   |
| Homebuilding                                                                       |       |                                                                                                                                         | $          | (6,832 | ) |   |   | $ | (13,994 | ) |   |
| Financing(b)                                                                       |       |                                                                                                                                         | 13,358     |   |   |   | 14,216 |   |   |
| Mueller Co.(a)                                                                     |       |                                                                                                                                         | 52,143     |   |   |   | — |   |   |
| Anvil(a)                                                                           |       |                                                                                                                                         | 9,506      |   |   |   | — |   |   |
| U.S. Pipe                                                                          |       |                                                                                                                                         | 10,439     |   |   |   | 12,121 |   |   |
| Natural Resources                                                                  |       |                                                                                                                                         | 63,104     |   |   |   | 58,618 |   |   |
| Other                                                                              |       |                                                                                                                                         | (3,153     | ) |   |   | (4,792 | ) |   |
| Consolidating  eliminations                                                        |       |                                                                                                                                         | (9         | ) |   |   | (1,071 | ) |   |
| Operating income                                                                   |       |                                                                                                                                         | 138,556    |   |   |   | 65,098 |   |   |
| Less other debt interest  expense                                                  |       |                                                                                                                                         | (42,103    | ) |   |   | (4,097 | ) |   |
| Income from continuing  operations before income tax expense and minority interest |       |                                                                                                                                         | 96,453     |   |   |   | 61,001 |   |   |
| Income tax expense                                                                 |       |                                                                                                                                         | (31,932    | ) |   |   | (19,520 | ) |   |
| Income from continuing  operations before minority interest                        |       |                                                                                                                                         | 64,521     |   |   |   | 41,481 |   |   |
| Minority interest in net  income of affiliates, net of income taxes                |       |                                                                                                                                         | (287       | ) |   |   | — |   |   |
| Income from continuing  operations                                                 |       |                                                                                                                                         | $          | 64,234 |   |   |   | $ | 41,481 |   |   |
| Depreciation:                                                                      |       |                                                                                                                                         |       |   |   |   |   |   |   |
| Homebuilding                                                                       |       |                                                                                                                                         | $          | 1,322 |   |   |   | $ | 1,216 |   |   |
| Financing                                                                          |       |                                                                                                                                         | 340        |   |   |   | 355 |   |   |
| Mueller Co.(a)                                                                     |       |                                                                                                                                         | 6,650      |   |   |   | — |   |   |
| Anvil(a)                                                                           |       |                                                                                                                                         | 4,923      |   |   |   | — |   |   |
| U.S. Pipe                                                                          |       |                                                                                                                                         | 5,416      |   |   |   | 6,625 |   |   |
| Natural Resources                                                                  |       |                                                                                                                                         | 6,700      |   |   |   | 5,183 |   |   |
| Other                                                                              |       |                                                                                                                                         | 1,276      |   |   |   | 1,126 |   |   |
| Total                                                                              |       |                                                                                                                                         | $          | 26,627 |   |   |   | $ | 14,505 |   |   |
| Amortization:                                                                      |       |                                                                                                                                         |       |   |   |   |   |   |   |
| Financing                                                                          |       |                                                                                                                                         | $          | 642 |   |   |   | $ | 923 |   |   |
| Mueller Co.(a)                                                                     |       |                                                                                                                                         | 6,269      |   |   |   | — |   |   |
| Anvil(a)                                                                           |       |                                                                                                                                         | 1,128      |   |   |   | — |   |   |
| Total                                                                              |       |                                                                                                                                         | $          | 8,039 |   |   |   | 923 |   |   |

 

19

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| ** **                                                                         | ** ** | **For the six months ended June 30,**                                                                          | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **           2006           ** | ** ** | **           2005           ** | ** ** |
| Net sales and revenues:                                                            |       |                                                                                                                                         |       |   |   |   |   |   |   |
| Homebuilding                                                                       |       |                                                                                                                                         | $          | 129,134 |   |   |   | $ | 105,796 |   |   |
| Financing                                                                          |       |                                                                                                                                         | 111,838    |   |   |   | 117,699 |   |   |
| Mueller Co.(a)                                                                     |       |                                                                                                                                         | 418,564    |   |   |   | — |   |   |
| Anvil(a)                                                                           |       |                                                                                                                                         | 264,010    |   |   |   | — |   |   |
| U.S. Pipe                                                                          |       |                                                                                                                                         | 263,452    |   |   |   | 286,655 |   |   |
| Natural Resources                                                                  |       |                                                                                                                                         | 342,192    |   |   |   | 271,528 |   |   |
| Other                                                                              |       |                                                                                                                                         | 74,217     |   |   |   | 68,808 |   |   |
| Consolidating  eliminations                                                        |       |                                                                                                                                         | (24,405    | ) |   |   | (16,251 | ) |   |
| Net sales and revenues                                                             |       |                                                                                                                                         | $          | 1,579,002 |   |   |   | $ | 834,235 |   |   |
| Segment operating income (loss):                                                   |       |                                                                                                                                         |       |   |   |   |   |   |   |
| Homebuilding                                                                       |       |                                                                                                                                         | $          | (13,140 | ) |   |   | $ | (22,543 | ) |   |
| Financing(b)                                                                       |       |                                                                                                                                         | 26,350     |   |   |   | 28,802 |   |   |
| Mueller Co.(a)                                                                     |       |                                                                                                                                         | 86,060     |   |   |   | — |   |   |
| Anvil(a)                                                                           |       |                                                                                                                                         | 10,861     |   |   |   | — |   |   |
| U.S. Pipe                                                                          |       |                                                                                                                                         | 5,280      |   |   |   | 17,601 |   |   |
| Natural Resources                                                                  |       |                                                                                                                                         | 127,029    |   |   |   | 83,160 |   |   |
| Other                                                                              |       |                                                                                                                                         | (6,285     | ) |   |   | (7,270 | ) |   |
| Consolidating  eliminations                                                        |       |                                                                                                                                         | (1,569     | ) |   |   | (2,831 | ) |   |
| Operating income                                                                   |       |                                                                                                                                         | 234,586    |   |   |   | 96,919 |   |   |
| Less corporate debt  interest expense                                              |       |                                                                                                                                         | (84,655    | ) |   |   | (7,709 | ) |   |
| Income from continuing  operations before income tax expense and minority interest |       |                                                                                                                                         | 149,931    |   |   |   | 89,210 |   |   |
| Income tax expense                                                                 |       |                                                                                                                                         | (50,111    | ) |   |   | (28,547 | ) |   |
| Income from continuing  operations before minority interest                        |       |                                                                                                                                         | 99,820     |   |   |   | 60,663 |   |   |
| Minority interest in net  income of affiliates, net of income taxes                |       |                                                                                                                                         | (287       | ) |   |   | — |   |   |
| Income from continuing  operations                                                 |       |                                                                                                                                         | $          | 99,533 |   |   |   | $ | 60,663 |   |   |
| Depreciation:                                                                      |       |                                                                                                                                         |       |   |   |   |   |   |   |
| Homebuilding                                                                       |       |                                                                                                                                         | $          | 2,634 |   |   |   | $ | 2,412 |   |   |
| Financing                                                                          |       |                                                                                                                                         | 682        |   |   |   | 715 |   |   |
| Mueller Co.(a)                                                                     |       |                                                                                                                                         | 13,356     |   |   |   | — |   |   |
| Anvil(a)                                                                           |       |                                                                                                                                         | 9,924      |   |   |   | — |   |   |
| U.S. Pipe                                                                          |       |                                                                                                                                         | 10,738     |   |   |   | 13,177 |   |   |
| Natural Resources                                                                  |       |                                                                                                                                         | 12,545     |   |   |   | 10,230 |   |   |
| Other                                                                              |       |                                                                                                                                         | 2,441      |   |   |   | 2,291 |   |   |
| Total                                                                              |       |                                                                                                                                         | $          | 52,320 |   |   |   | $ | 28,825 |   |   |
| Amortization:                                                                      |       |                                                                                                                                         |       |   |   |   |   |   |   |
| Financing                                                                          |       |                                                                                                                                         | $          | 1,339 |   |   |   | $ | 1,986 |   |   |
| Mueller Co.(a)                                                                     |       |                                                                                                                                         | 12,538     |   |   |   | — |   |   |
| Anvil(a)                                                                           |       |                                                                                                                                         | 1,852      |   |   |   | — |   |   |
| Total                                                                              |       |                                                                                                                                         | $          | 15,729 |   |   |   | $ | 1,986 |   |   |

----

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

       (b) Operating income amounts for Financing includeinterest expense on the mortgage-backed/asset-backed notes of $28,958 and$31,102 for the three months ended June 30, 2006 and 2005, respectively,and $58,934 and $62,537 for the six months ended June 30, 2006 and 2005,respectively.

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**Note 13—Commitmentsand Contingencies**

*Income TaxLitigation*

On February 20, 2006, the IRS completed its auditof the Company’s Federal tax returns for the years ended May 31, 2000, December 31,2000 and December 31, 2001 and issued 30-day letters proposing taxdeficiencies in the amount of $82.2 million. The issues relate primarily to theCompany’s method of recognizing revenue on the sale of homes and interest onthe related instalment notes receivable. The items at issue relate primarily tothe timing of revenue recognition and consequently, should the IRS prevail onits positions, the Company’s financial exposure is limited to interest andpenalties.

On December 27, 1989, the Company and most of itssubsidiaries each filed a voluntary petition for reorganization under Chapter11 of Title 11 of the United States Code (the “Bankruptcy Proceedings”) in theUnited States Bankruptcy Court for the Middle District of Florida, TampaDivision (the “Bankruptcy Court”). The Company emerged from bankruptcy on March 17,1995 (the “Effective Date”) pursuant to the Amended Joint Plan ofReorganization Dated as of December 9, 1994, as modified on March 1,1995 (as so modified the “Consensual Plan”). Despite the confirmation andeffectiveness of the Consensual Plan, the Bankruptcy Court continues to havejurisdiction over, among other things, the resolution of disputed prepetitionclaims against the Company and other matters that may arise in connection withor related to the Consensual Plan, including claims related to Federal incometaxes.

A controversy exists with regard to Federal incometaxes allegedly owed by the Company for fiscal years 1980 through 1994. Inconnection with the bankruptcy proceedings, the IRS filed a proof of claim inthe Bankruptcy Court (the “Proof of Claim”) for a substantial amount of taxes,interest and penalties with respect to fiscal years ended August 31, 1980and August 31, 1983 through May 31, 1994. The Company filed anadversary proceeding in the Bankruptcy Court disputing the Proof of Claim (the “AdversaryProceeding”) and the various issues have been and are being litigated in theBankruptcy Court.

The amounts initially asserted by the Proof of Claimdo not reflect the subsequent resolution of various issues through settlementsor 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. Thisamount is subject to interest and penalties. Of the $34 million in claimed tax,$21 million represents issues in which the IRS is not challenging thedeductibility of the particular expense but only whether such expense is deductiblein a particular year. Consequently, the Company believes that, should the IRSprevail on any such issues, the Company’s financial exposure is limited tointerest and possible penalties and the amount of tax claimed will be offset bydeductions in other years. Substantially all of the issues in the Proof ofClaim, which have not been settled or conceded, have been litigated before theBankruptcy Court and are subject to appeal but only at the conclusion of theentire Adversary Proceeding.

The Company believes that those portions of the Proofof Claim that remain in dispute or are subject to appeals substantiallyoverstate the amount of taxes allegedly owing. However, because of thecomplexity of the issues presented and the uncertainties associated withlitigation, the Company is unable to predict the ultimate outcome of theAdversary 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 hassufficient accruals to address any claims, including interest and penalties.

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*EnvironmentalMatters*

The Company is subject to a wide variety of laws andregulations concerning the protection of the environment, both with respect tothe construction and operation of many of its plants, mines and otherfacilities and with respect to remediating environmental conditions that mayexist at its own and other properties. The Company believes that it is insubstantial compliance with federal, state and local environmental laws andregulations. The Company accrues for environmental expenses resulting fromexisting conditions that relate to past operations when the costs are probableand reasonably estimable.

U.S. Pipe has implemented an Administrative ConsentOrder (‘‘ACO’’) for its Burlington, New Jersey plant that was required underthe New Jersey Environmental Cleanup Responsibility Act (now known as theIndustrial Site Recovery Act). The ACO required soil and ground water cleanup,and U.S. Pipe has completed, and has received final approval on, the soilcleanup required by the ACO. U.S. Pipe is continuing to address ground waterissues at this site. Further remediation could be required. These remediationcosts are expected to be minimal. Long-term ground water monitoring will berequired to verify natural attenuation. It is not known how long ground watermonitoring 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 Comprehensive Environmental Response,Compensation and Liability Act (‘‘CERCLA’’) generally imposes liability, whichmay be joint and several and is without regard to fault or the legality ofwaste generation or disposal, on certain classes of persons, including ownersand operators of sites at which hazardous substances are released into theenvironment (or pose a threat of such release), persons that disposed orarranged for the disposal of hazardous substances at such sites, and personswho owned or operated such sites at the time of such disposal. CERCLAauthorizes the EPA, the States and, in some circumstances, private entities totake actions in response to public health or environmental threats and to seekto recover the costs they incur from the same classes of persons. Certaingovernmental authorities can also seek recovery for damages to naturalresources. 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 amongmany PRP’s at such site and a significant number of the PRP’s are substantialcompanies. The PRP’s have negotiated an administrative consent order (ACO) withthe EPA and the PRP’s have agreed to divide clean-up costs pro-rata subject tolater adjustment based on the relative contribution by each PRP to thecontamination. Management estimates the Company’s share of liability forcleanup, after allocation among several PRPs, will be approximately $4.0million, which was accrued in 2004. Management does not believe that U.S. Pipe’sshare of any liability under the ACO will have a material adverse effect on thefinancial condition of the Company, but could be material to results ofoperations in future reporting periods.

Solutia, Inc and Pharmacia Corporation filed suitagainst U.S. Pipe and the Company on January 5, 2003 (Solutia, Inc andPharmacia Corporation v. United States Pipe and Foundry Company, WalterIndustries, Inc., et al, Case No. CV-03-PWG-1345-E)in US District court for the Northern District of Alabama. This is a civilaction for contribution and cost recovery by Solutia with respect to costsincurred and to be incurred by Solutia in performing remediation of PCBs andheavy metals mandated by EPA in Anniston, Alabama with respect to the ACOdescribed above. The ACO provides protection against contribution claims bythird parties, such as Solutia. Management believes that the likelihood ofliability in the contribution litigation is remote.

The Company and U.S. Pipe have been named in a suitfiled by Isaiah Evans on April 8, 2005 (Isaiah Evans et al v. WalterIndustries, Inc., United States Pipe and Foundry Company, Inc., etal, Case No. CV:05-258) in the Circuit Court of Calhoun County,Alabama. This is a purported civil class action case filed against 18 foundriesin the Anniston, Alabama area alleging state law tort claims in the creationand disposal of foundry sand alleged to contain lead and PCB’s.  The plaintiffs are seeking damages for 

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personal injury andproperty damage. The class action lawsuit is still in early stages oflitigation and no substantial discovery has yet taken place. In addition,management believes that both procedural and substantive defenses would beavailable to the Company should this litigation proceed. 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.

Although the Company now produces a small amount ofno-lead brass products, most of the Company’s brass valve products containapproximately 5.0% lead. Environmental advocacy groups, relying on standardsestablished by California’s Proposition 65, are seeking to eliminate or reducethe content of lead in water infrastructure products offered for sale inCalifornia. Some of the Company’s subsidiaries have entered into settlementagreements with these environmental advocacy groups to modify products or offersubstitutes for sale in California. Legislation to substantially restrict leadcontent in water infrastructure products has been introduced in the UnitedStates Congress. Congress or state jurisdictions other than California mayenact legislation similar to Proposition 65 to restrict the content of lead inwater products, which could require the Company to incur additional capitalexpenses to modify production. To date, we have undertaken a capital project toimplement a no-lead brass production line that will require the Company toincur approximately $8.0 million in incremental capital spending over the nexttwo years. In addition, advocacy groups or other parties may file suit againstthe Company under Proposition 65 or under new, similar legislation adopted inother jurisdictions that could result in additional costs in connection withmarketing and selling brass products in California or in such otherjurisdictions.

Over the next two years, the Company could potentiallyincur between $8.5 million and $12.5 million of capital costs at itsfoundries to comply with the United States Environmental Protection Agency’sNational Emissions Standards for Hazardous Air Pollutants which were issued April 22,2004. The Company is in the process of performing an analysis to assess theimpact of these standards on the financial results of the Company.

In the acquisition agreement pursuant to which TycoInternational (“Tyco”) sold Mueller Water to its prior owners in August 1999,Tyco agreed to indemnify Mueller Water and its affiliates for all “ExcludedLiabilities”. Excluded Liabilities include, among other things, substantiallyall liabilities relating to the time prior to the August 1999 TycoTransaction. The indemnity survives indefinitely and is not subject to anydeductibles or caps. However, Mueller Water may be responsible for theseliabilities in the event that Tyco ever becomes financially unable to, orotherwise fails to comply with, the terms of the indemnity. In addition, Tyco’sindemnity does not cover environmental liabilities to the extent caused byMueller Water or the operation of its business after the August 1999 TycoTransaction, nor does it cover environmental liabilities arising with respectto businesses or sites acquired after the August 1999 Tyco Transaction,which would include the U.S. Pipe business and facilities.

Sloss Industries entered into a consent order in 1989relative to a Resource Conservation Recovery Act (“RCRA”) compliance programmandated by the EPA. A RCRA Facility Investigation (“RFI”) Work Plan wasprepared 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. At the end of 2004, EPA re-directed Sloss’RFI efforts toward completion of the Environmental Indicator (“EI”) determinationsfor the *Current Human Exposures*. This EI effortwas completed to assist EPA in meeting goals set by the Government PerformanceResults Act (“GPRA”) for RCRA by the year 2005. Sloss implemented the approvedEI Sampling Plan in April 2005. EPA approved/finalized the EIdeterminations for Sloss’ Birmingham facility in September 2005. In aneffort to refocus the RFI, EPA has now provided technical comments on the PhaseII RFI report and the report recently submitted as part of the EI effort.

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Although no assurances can be given that the Companywill not be required in the future to make material expenditures relating tothese or other sites, management does not believe at this time that the cleanupcosts, if any, associated with these or other sites will have a materialadverse effect on the financial condition or results of operations of theCompany, but such cleanup costs could be material to results of operations in afuture 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, the Company received $2.8 million, and theremainder was received in the first quarter 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.

*MiscellaneousLitigation*

Drummond Company, Inc. filed suit in state courtin Tuscaloosa County, Alabama on October 29, 2001, against the Company andseveral of its subsidiaries (Drummond Company, Inc. v. Walter Industries, Inc.,et al., Case No. CV 2002-0673). Drummond claims that it is entitledto exclusive 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 Company filed a counterclaim seeking injunctiverelief, substantial actual damages and punitive damages against Drummond basedon fraud. The Company and its subsidiaries were granted summary judgment on allof Drummond’s claims on March 29, 2005. A jury trial denied United LandCorporation’s counter-claim on April 8, 2005. Drummond and the Companyhave appealed. Drummond’s claims do not affect the underground miningoperations of the Jim Walter Resources subsidiary. Management does not believethat this litigation will have a material adverse effect on the financialcondition or results of operations of the Company and its subsidiaries.

Per the agreement between the Company and Oxbow Carbonand Minerals LLC for the sale of the AIMCOR business, the final sales price issubject to certain post-closing cash and working capital adjustments defined inthe agreement and are subject to resolution through an arbitration processprovided for in the agreement. The Company recorded a receivable in 2003 ofapproximately $16 million for estimated net cash and working capitaladjustments due to the Company based upon the monthly closing financialstatements provided by AIMCOR’s management as of November 30, 2003. Thatreceivable has been reduced by insurance proceeds to approximately $14 million.Oxbow claimed that the cash and net working capital adjustment, based onstatements Oxbow prepared as of December 2, 2003, should result in apayment to Oxbow in excess of $20 million. The Company filed for arbitrationagainst Oxbow in May of 2004. On March 2, 2005, the arbitrator issuedan award on the initial $35 million in disputed items that had been submittedto arbitration and awarded $22.7 million to the Company and $12.3 million toOxbow. Items totaling $86 million remain in dispute, of which approximately $10million would need to be adjudicated in the Company’s favor in order to fullycollect the receivable.The parties have chosen an arbitrator for the second phase of the purchaseprice arbitration. The ultimate collection of the receivable, or any amount inexcess of the receivable, is subject to the resolution of the resolutionof Oxbow’s litigation and the arbitration described above. Management intendsto vigorously pursue full recovery. Management does not believe that thismatter will have a material adverse effect on the financial condition orresults of operations of the Company and its subsidiaries.

The Los Angeles Department of Water and Power, ex rel.Nora Armenta (“Armenta”) filed suit against the Company’s subsidiaries, JamesJones 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 of Banning”) filed suit against the Company’s subsidiaries, James JonesCompany and Mueller Co. (Superior Court, Los Angeles County; Case No. BC321513) on September 15, 2004. The Armenta matter is a false 

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claims lawsuit brought onbehalf of cities, water districts and municipalities alleging that thedefendants sold allegedly non-conforming public water system parts to variousgovernment entities. The lawsuit seeks consequential damages, penalties andpunitive damages relating to the repair and replacement of the water systems toremove the allegedly non-conforming parts. Mueller Co., which had also beennamed as a defendant in the Armenta matter, brought a summary judgment motionand was dismissed from this litigation in January 2004; James JonesCompany remains a defendant in the action. On September 15, 2004, theArmenta trial court ruled against the intervention of approximately 30municipalities that had failed to intervene within the time deadlinespreviously specified by the court. The trial court also ruled that the majorityof municipalities that had purchased James Jones products from contractors ordistributors, were not in privity with the James Jones Company and were notentitled to punitive damages. Following the Armenta court’s ruling, the waterdistricts and municipalities filed the City of Banning action against the JamesJones Company and Watts (former parent company of James Jones Company),alleging fraud and intentional misrepresentation. This lawsuit is based on thesame underlying facts as the Armenta lawsuit. Any liability associated withthese lawsuits is covered by the Tyco indemnity, and the defense is being paidfor and conducted by Tyco, all in accordance with the indemnity obligation ofTyco described above in *Environmental Matters*.

The Company and itssubsidiaries are parties to a number of other lawsuits arising in the ordinarycourse of their businesses. The Company provides for costs relating to thesematters when a loss is probable and the amount 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 of litigation cannot be predicted withcertainty, the Company believes that the final outcome of such other litigationwill not have a materially adverse effect on the Company’s consolidatedfinancial statements.

*Commitments andContingencies—Other*

As part of the acquisition of the Star Pipe businesson January 15, 2004, Anvil has agreed to a future payment to be made tothe seller of a business Anvil acquired to the extent that the gross profit ofthe acquired business exceeds a targeted gross profit. The maximum potentialpayment amount is $23 million. Management currently estimates the paymentcould total approximately $3 million to $6 million for the payment periodthat began February 1, 2004 and ends January 31, 2007. The paymentamount indicated above is based on management’s best estimate, but the actualadjustment could be materially different. The liability for such payment willbe recorded at the end of each payment period in accordance with the purchaseagreement, with a corresponding charge 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.

**Note 14—NewAccounting Pronouncements**

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 hybrid financialinstruments 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 significantimpact on the Company’s financial condition or results of operations.

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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, the subsequentmeasurement of separately recognized servicing assets and servicing liabilitiesat fair value; (iii) requires an entity that uses derivative instrumentsto mitigate the risks inherent in servicing assets and servicing liabilities toaccount for those derivative instruments at fair value; and (iv) permitsan entity to elect subsequent fair value measurement to account for itsseparately recognized servicing assets and liabilities. SFAS No. 156 iseffective for all separately recognized servicing assets and servicingliabilities in fiscal years beginning after September 15, 2006. Theadoption of this statement is not anticipated to have a significant impact onthe Company’s financial condition or 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 what impact, if any, the adoption of this interpretation, whichbecomes effective January 1, 2007, will have on its consolidated financialstatements.

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**MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OFOPERATIONS,**

**FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES**

**ANDQUANTITATIVE 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 12 of “Notes to Condensed Consolidated Financial Statements,”which describe the Company’s net sales and revenues and operating income byoperating segment.

**RESULTS OFOPERATIONS**

**Summary Operating Results of Continuing Operations forthe Three Months ended June 30, 2006 and 2005**

| ** **                                                                   | ** ** | **For the three months ended June 30, 2006** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | ** **                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **U.S.** | ** ** | **Natural** | ** ** | ** ** | ** ** | **Cons** | ** ** | ** ** | ** ** |
| ** **                                                                   | ** ** | **Homebuilding**                                                                | ** ** | **Financing** | ** ** | **Mueller Co.** | ** ** | **Anvil** | ** ** | **Pipe** | ** ** | **Resources** | ** ** | **Other** | ** ** | **Elims** | ** ** | **Total** | ** ** |
| ** **                                                                   | ** ** | **($ in thousands)**                                                  | ** ** |
| Net sales                                                                    |       |                                                                            | $          | 64,665 |   |   |   | $ | 3,434 |   |   |   | $ | 225,225 |   |   | $ | 136,539 |   | $ | 143,740 |   |   | $ | 167,726 |   |   | $ | 34,960 |   | $ | (11,176 | ) | $ | 765,113 |   |
| Interest income on instalment notes                                          |       |                                                                            | —     |   |   |   | 50,937 |   |   |   | — |   |   | — |   | — |   |   | — |   |   | — |   | — |   | 50,937 |   |
| Miscellaneous                                                                |       |                                                                            | 80         |   |   |   | 1,448 |   |   |   | — |   |   | — |   | (22 | ) |   | 5,368 |   |   | 2,809 |   | — |   | 9,683 |   |
| Net sales and  revenues                                                      |       |                                                                            | 64,745     |   |   |   | 55,819 |   |   |   | 225,225 |   |   | 136,539 |   | 143,718 |   |   | 173,094 |   |   | 37,769 |   | (11,176 | ) | 825,733 |   |
| Cost of sales                                                                |       |                                                                            | 53,548     |   |   |   | 2,905 |   |   |   | 140,950 |   |   | 95,927 |   | 117,904 |   |   | 93,730 |   |   | 30,048 |   | (11,167 | ) | 523,845 |   |
| Interest expense(1)                                                          |       |                                                                            | —     |   |   |   | 28,958 |   |   |   | — |   |   | — |   | — |   |   | — |   |   | — |   | — |   | 28,958 |   |
| Depreciation                                                                 |       |                                                                            | 1,322      |   |   |   | 340 |   |   |   | 6,650 |   |   | 4,923 |   | 5,416 |   |   | 6,700 |   |   | 1,276 |   | — |   | 26,627 |   |
| Selling, general & administrative                                   |       |                                                                            | 16,829     |   |   |   | 7,154 |   |   |   | 19,213 |   |   | 25,055 |   | 10,122 |   |   | 4,617 |   |   | 8,829 |   | — |   | 91,819 |   |
| Provision for losses on                                                      |       |                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| instalment notes                                                             |       |                                                                            | —     |   |   |   | 2,510 |   |   |   | — |   |   | — |   | — |   |   | — |   |   | — |   | — |   | 2,510 |   |
| Postretirement benefits                                                      |       |                                                                            | (122       | ) |   |   | (48 | ) |   |   | — |   |   | — |   | (389 | ) |   | 4,943 |   |   | (366 | ) | — |   | 4,018 |   |
| Amortization of intangibles                                                  |       |                                                                            | —     |   |   |   | 642 |   |   |   | 6,269 |   |   | 1,128 |   | — |   |   | — |   |   | — |   | — |   | 8,039 |   |
| Restructuring & impairment charges                                  |       |                                                                            | —     |   |   |   | — |   |   |   | — |   |   | — |   | 226 |   |   | — |   |   | 1,135 |   | — |   | 1,361 |   |
| Operating income (loss)                                                      |       |                                                                            | $          | (6,832 | ) |   |   | $ | 13,358 |   |   |   | $ | 52,143 |   |   | $ | 9,506 |   | $ | 10,439 |   |   | $ | 63,104 |   |   | $ | (3,153 | ) | $ | (9 | ) | $ | 138,556 |   |
| Other debt  interest expense                                                 |       |                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (42,103 | ) |
| Income from  continuing operations before income taxes and minority interest |       |                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 96,453 |   |

 

| ** **                                             | ** ** | **For the three months ended June 30, 2005** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | ** **                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | **Natural** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                             | ** ** | **Homebuilding**                                                                | ** ** | **Financing** | ** ** | **U.S. Pipe** | ** ** | **Resources** | ** ** | **Other** | ** ** | **Cons Elims** | ** ** | **Total** | ** ** |
| ** **                                             | ** ** | **($ in thousands)**                                                  | ** ** |
| Net sales                                              |       |                                                                            | $          | 56,524 |   |   |   | $ | 3,902 |   |   |   | $ | 161,889 |   |   |   | $ | 161,906 |   |   | $ | 32,763 |   |   | $ | (7,421 | ) |   | $ | 409,563 |   |
| Interest income on  instalment notes                   |       |                                                                            | —     |   |   |   | 53,110 |   |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   | 53,110 |   |
| Miscellaneous  income                                  |       |                                                                            | 593        |   |   |   | 1,594 |   |   |   | 77 |   |   |   | 927 |   |   | 2,768 |   |   | (678 | ) |   | 5,281 |   |
| Net sales and  revenues                                |       |                                                                            | 57,117     |   |   |   | 58,606 |   |   |   | 161,966 |   |   |   | 162,833 |   |   | 35,531 |   |   | (8,099 | ) |   | 467,954 |   |
| Cost of sales                                          |       |                                                                            | 50,157     |   |   |   | 2,620 |   |   |   | 132,691 |   |   |   | 91,021 |   |   | 27,362 |   |   | (7,028 | ) |   | 296,823 |   |
| Interest expense(1)                                    |       |                                                                            | —     |   |   |   | 31,102 |   |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   | 31,102 |   |
| Depreciation                                           |       |                                                                            | 1,216      |   |   |   | 355 |   |   |   | 6,625 |   |   |   | 5,183 |   |   | 1,126 |   |   | — |   |   | 14,505 |   |
| Selling,  general & administrative            |       |                                                                            | 19,855     |   |   |   | 7,501 |   |   |   | 10,892 |   |   |   | 3,594 |   |   | 12,173 |   |   | — |   |   | 54,015 |   |
| Provision for  losses on instalment notes              |       |                                                                            | —     |   |   |   | 1,949 |   |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   | 1,949 |   |
| Postretirement  benefits                               |       |                                                                            | (117       | ) |   |   | (60 | ) |   |   | (363 | ) |   |   | 4,112 |   |   | (338 | ) |   | — |   |   | 3,234 |   |
| Amortization of  intangibles                           |       |                                                                            | —     |   |   |   | 923 |   |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   | 923 |   |
| Restructuring & impairment                    |       |                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| charges                                                |       |                                                                            | —     |   |   |   | — |   |   |   | — |   |   |   | 305 |   |   | — |   |   | — |   |   | 305 |   |
| Operating income  (loss)                               |       |                                                                            | $          | (13,994 | ) |   |   | $ | 14,216 |   |   |   | $ | 12,121 |   |   |   | $ | 58,618 |   |   | $ | (4,792 | ) |   | $ | (1,071 | ) |   | $ | 65,098 |   |
| Other debt  interest expense                           |       |                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (4,097 | ) |
| Income from  continuing operations before income taxes |       |                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 61,001 |   |

----

          (1) Excludesother debt interest expense.

27

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***Overview***

The Company’s net income for the quarter ended June 30,2006 was $64.0 million, or $1.24 per diluted share, which compares to netincome in the year-ago period of $41.5 million, or $0.87 per share. Increasednet income for the quarter principally reflects the addition of Mueller Co. andAnvil, acquired on October 3, 2005, along with higher pricing in theNatural Resources segment and higher average selling prices and lower selling,general and administrative costs in the Homebuilding segment.

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

·       MuellerCo. and Anvil contributed combined net sales and revenues of $361.8 million andoperating income of $61.6 million.

·       Averageselling prices at Natural Resources for metallurgical coal and natural gasincreased 15.2% and 29.4%, respectively. These increases were partially offsetby higher mining costs at Mine No. 4, which resulted from lower productionvolumes due to unfavorable geologic conditions.

·       Homebuildinghad 13.5% higher average net selling prices and improved gross margins,reflecting reduced warranty claims and tighter cost controls. Reductions inselling, general and administrative expenses also contributed to improvedresults.

·       Financingresults in the current period reflect $1.4 million in lower prepayment incomecompared to the prior period, partially offset by lower interest expense.

·       U.S.Pipe’s revenues declined $18.2 million of which $14.6 million is due to thetransfer of the valve and hydrant business to Mueller Co. effective January 1,2006. In addition, U.S. Pipe recognized $3.2 million of costs in the secondquarter associated with the closure of the Chattanooga plant.

·       Interestexpense on other debt increased $38.0 million to $42.1 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 $4.1 million write-off ofunamortized debt expense associated with the partial repayment of Mueller Water’sterm debt in the second quarter.

·       TheCompany’s second quarter 2006 effective tax rate was 33%, versus 32% 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 intends to complete a tax-free spin-off of Mueller Water to the Company’sstockholders before the end of December 2006.

·       InFebruary 2006, the Company announced that it is evaluating a potentialspin-off of its Homebuilding and Financing segments to the Companystockholders. No time frame has been provided for the completion of thisevaluation.

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

**Mueller WaterProducts**

·       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.

·       OnJune 1, 2006, Mueller Water, used $246.0 million of the $429.3 million inproceeds from Mueller Water’s IPO to prepay a portion of the term loanoutstanding under the 2005 Mueller Credit Agreement. On July 3, 2006,Mueller Water used $123.1 million of the proceeds from the IPO to redeem $116.1million of the senior subordinated notes, to pay accrued interest of $1.8million and to pay a prepayment premium of $11.0 million. Additionally, on July 3,2006, Mueller Water used $60.2 million of the proceeds from the IPO to redeem$61.0 million of the senior discount notes and to pay a $7.7 million prepaymentpremium. Mueller Water expects to recognize a net pre-tax loss of approximately$8.0 million associated with this early redemption of debt during thequarter ending September 30, 2006. This loss consists of prepaymentpremiums totaling $18.7 million offset in part by the recognition of otherunamortized carrying values totaling $10.7 million.

·       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 $30.0 million, of which $14.0 million has been recognized todate, excluding certain costs to achieve these benefits, as discussed below.

As part of the synergy plan, we announced and haveinitiated several plant closures and transferred production to existingfacilities:

·*        Closureof the 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. During June 2006, the U.S. Pipe Chattanoogaplant was effectively closed. Total exit costs related to this plant closurehave accumulated to $49.9 million. Costs recorded as components of cost ofsales for the three months and six months ended June 30, 2006 were $3.0million and $5.4 million, respectively, related to inventory obsolescence andadditional facility expenses. In addition, restructuring costs of $0.2 millionand $4.5 million, respectively, have been incurred primarily related to fixedasset impairments, severance and net pension curtailment settlement.

·        *Closure ofMueller Co.’s Henry Pratt (“Pratt”) Valve Manufacturing Facility in Dixon,Illinois*:   On January 26, 2006, Mueller Water announced theclosure of this facility by the end of fiscal 2006. The process of transferringDixon plant’s operations to other Pratt facilities has begun. Severance costsassociated with this plant closure of approximately $1.0 million and fixedasset impairment charges of approximately $1.4 million have been allocated togoodwill. Costs associated with relocating equipment will be expensed asincurred.

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·*        Closureof the Mueller Canada Milton, Ontario (“Milton”) Valve and HydrantManufacturing Facility*:   On April 20, 2006, Mueller Waterannounced the closure of this facility by the end of fiscal 2006. Productionwas transferred to other Mueller Co. facilities in the second quarter of 2006.Severance costs associated with this plant closure of approximately $3.2million and fixed asset impairment charges of approximately $0.2 million havebeen be charged to goodwill. Costs associated with relocating the Miltonwarehouse and equipment will be expensed as incurred.

·       MuellerWater adopted a new 2006 Stock Incentive Plan designed to promote long-termgrowth and financial success by providing incentives to Mueller Water employeesand directors through grants of stock-based awards. Pre-tax stock compensationexpense, resulting from the issuance of restricted stock and stock options inconnection with the IPO, is estimated to be $3.6 million in 2006, of which $0.5million was recognized in the second quarter of 2006.

·       Asof June 30, 2006, scrap metal costs for U.S. Pipe remain high but havedeclined approximately 10% from their peak in 2004. However, scrap costs remainsomewhat volatile and recently scrap costs have increased: e.g., the averagecost of scrap iron per ton produced during the month of June 2006increased 9.8% over the average cost during the three months ended March 31,2006. The average cost of scrap iron per ton produced during the three monthsended June 30, 2006 increased nearly 6% compared to the average costduring the three months ended June 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**

·       Demandfor the Company’s high-quality, hard coking coal is driven by steel productionwhich, on a worldwide basis versus the prior year, increased 7.3% and remainsstrong. As a result, the Company expects to sell at least 0.5 million incrementaltons of metallurgical coal in the second half of the year versus the first halfof 2006. Additionally, the Company expects Mine No. 4, which hasexperienced reduced levels of coal production due to unfavorable geologicconditions, to produce 1.4 million to 1.5 million tons of coal in the secondhalf of 2006. Throughout 2006, Natural Resources is expected to produce 6.5million to 6.7 million total tons of coal, including forecasted tons from theKodiak mining joint venture. In 2007, the Company expects to produce 7.4million to 7.8 million total tons of coal. The reduction in the 2007 estimatefrom the previous forecast is due to the extended development time necessary toprepare the “Southwest A” panel at Mine No. 7 for longwall mining.

·       With respect tometallurgical coal pricing, the Company’s long-term outlook remains positive. Recently,the majority of worldwide hard coking coal producers settled their 2006/2007sales contracts at prices ranging from $100 - $115 per metric ton FOB port. TheCompany settled approximately 87% of its sales volume expected for the period July 1,2006 through December 31, 2006 at the top end of this range. Pricing onthe remaining 13% of forecasted sales for the second half of 2006 has not beensettled. Based on continued demand, primarily from countries with expandingeconomies such as China, India and Brazil, as well as limited new supply ofhigh-quality 

30

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hard coking coal,the Company believes that a favorable pricing environment will continue overthe next several years.

**Homebuilding andFinancing**

·       TheCompany’s progress toward reducing Homebuilding’s aged backlog of homes underconstruction is slower than previously anticipated. Consequently, repair andrework costs remain high. However, during the last 30 days, the Company hasbeen encouraged by the increased availability of subcontractors, especially inFlorida and other Southeast regions where the aged backlog is greatest. TheCompany is proactively increasing the use of ‘panelization’ and offeringmodular options through Jim Walter Homes’ sales centers to speed up unitdeliveries, and reduce reliance on outside contractors. The Company expectsimprovement in Homebuilding during the second half of the year, as theprofit-enhancement measures established in the third quarter of last year areworking to enforce discipline around the sales and construction processes. Furthermore,as the aged backlog of low-margin units are purged, these actions are expectedto have an even more positive impact on future operating results.

·       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 Second Quarter Consolidated OperatingResults***

Net sales and revenues for the three months ended June 30,2006 were $825.7 million, a 76.5% increase from $468.0 million for the quarterended June 30, 2005, primarily driven by the addition of the Mueller Co.and Anvil segments along with higher metallurgical coal and natural gas sellingprices in the Natural Resources segment and higher average net selling pricesin the Homebuilding segment.

Cost of sales, exclusive of depreciation, increased$227.0 million to $523.8 million and represented 68.5% of net sales in the 2006period versus $296.8 million and 72.5% of net sales in the comparable period of2005. The current year’s cost of sales included $236.9 million at Mueller Co.and Anvil. The gross margin percentage improved from 27.5% for the three monthsended June 30, 2005 to 31.5% for the three months ended June 30, 2006.This improvement was primarily the result of the addition of the Mueller Co.and Anvil segments, which generated a combined gross margin percentage of34.5%, as well as improved gross margins at Homebuilding and Natural Resources.

Depreciation for the three months ended June 30,2006 was $26.6 million, an increase of $12.1 million from the same period in2005, primarily due to the addition of the Mueller Co. and Anvil segments.

Selling, general and administrative expenses of $91.8million were 11.1% of net sales and revenues in the 2006 period, compared to$54.0 million and 11.5% in 2005. The current quarter included a total of $44.3million of selling, general and administrative expenses at Mueller Co. andAnvil. In addition, selling, general and administrative expenses in theHomebuilding and Other segments collectively were $6.0 million less than thecomparable prior period.

Provision for losses on instalment notes was $2.5million in the 2006 period, compared to $1.9 million in 2005 due to lowerrecovery rates and higher volume of resales versus the prior year period in theFinancing segment.

Interest expense on other debt increased $38.0 millionto $42.1 million in the 2006 period due to the inclusion of Mueller Water debtand additional indebtedness incurred to finance the Mueller Water acquisition. Inaddition, during the quarter, the Company wrote off $4.1 million of unamortizeddebt 

31

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expense relating to $246.0million of prepayments made on the term loan under the 2005 Mueller CreditAgreement using proceeds from Mueller Water’s IPO.

The Company’s effectivetax rate of 33.0% and 32.0% for the three months ended June 30, 2006 and2005, respectively, differed from the federal statutory rate primarily due tofavorable depletion deductions related to the Natural Resources segment,partially reduced by the effect of state income taxes.

**Segment Analysis:**

*Homebuilding*

Net sales and revenueswere $64.7 million for the three months ended June 30, 2006, an increaseof $7.6 million from the quarter ended June 30, 2005, primarily as aresult of higher average net selling prices and total unit completions as shownbelow.

| ** **                 | ** ** | **Three months ended** | ** ** |
|----------------------------|------------|----------------------------------|------------|
| ** **                 | ** ** | **June 30,**                | ** ** |
| ** **                 | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Homes Completed:           |       |                             |       |   |   |
| Stick-built                |       | 632                              |       | 620 |   |
| Modular                    |       | 122                              |       | 128 |   |
| Average Net Selling Price: |       |                             |       |   |   |
| Stick-built                |       | $                                | 86,800     |   | $ | 77,500 |   |
| Modular                    |       | $                                | 80,400     |   | $ | 66,200 |   |

 

The estimated backlog at June 30, 2006 ofstick-built homes to be constructed was 1,844, compared to 2,053, at December 31,2005 and 2,257, at June 30, 2005, reflecting the Company’s focus onreducing the aged backlog of homes under construction.

The operating loss was$6.8 million for the three months ended June 30, 2006 compared to anoperating loss of $14.0 million in the year-ago period. The improvedperformance was due to higher average net selling prices, an increase inon-your-lot gross margins and lower selling, general and administrativeexpenses in the current period, partially offset by a $1.2 million increase inthe allowance for doubtful accounts against receivables in the modular homedivision. The prior year period included other non-recoverable costs of $3.2million for repair and rework on homes under construction, supplies inventorywrite-downs and additional accruals for legal and warranty issues.

*Financing*

Net sales and revenues were $55.8 million in the 2006period, a decrease of $2.8 million from $58.6 million for the year-ago period. Thereduction in revenue was attributed partially to a $1.4 million decrease inprepayment income due to lower prepayment speeds. Prepayment speeds were 10.2%in the 2006 period, down 30 basis points from the prior year period. Operatingincome decreased by $0.9 million, to $13.4 million in the 2006 period. Thelower operating income primarily relates to the reduction in interest income oninstalment notes, partially offset by lower interest expense of approximately$2.1 million.

Delinquencies (the percentage of amounts outstandingover 30 days past due) were 4.0% at June 30, 2006, consistent with June 30,2005 and down from 5.2% at December 31, 2005, reflecting fewer customersentering into bankruptcy, partially offset by higher delinquencies in areasimpacted by the 2005 hurricanes.

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*Mueller Co.*

Net sales and revenues for the period ended June 30,2006 were $225.2 million. Revenues reflect higher selling prices and increasedvolumes in hydrants, brass water products and gate valves, plus the addition ofU.S. Pipe’s valve and hydrant volume transferred from its Chattanooga,Tennessee plant.

Mueller Co. operatingincome for the period ended June 30, 2006 was $52.1 million. Results forthe quarter reflect improved valve volumes and hydrant margins, partiallyoffset by higher brass and scrap iron material costs.

*Anvil*

Net sales and revenues for the period ended June 30,2006 were $136.5 million. 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 theperiod ended June 30, 2006 was $9.5 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 $143.7 million for thethree months ended June 30, 2006 compared to $162.0 million in the prioryear period. The decrease in revenue primarily relates to the transfer of thevalve and hydrant business to Mueller Co. Valve and hydrant revenues were $14.6million in the prior year period. In addition to the loss of valve and hydrantrevenues, current quarter fittings volumes were lower than the prior year period.Ductile iron pipe revenues were consistent with the prior year period, ashigher pricing offset a 4.4% decline in tons shipped.

The estimated order backlog, consisting of pressurepipe and fittings, at June 30, 2006, was approximately $80.0 millioncompared to $78.8 million at December 31, 2005, and $79.7 million at June 30, 2005.

Operating income for thesegment totaled $10.4 million for the quarter, compared to $12.1 million in theprior year period. Results for the current period include $3.2 million of coststo complete the closure of the Chattanooga facility. Prior year operatingresults include a loss of $0.8 million from the Chattanooga plant. Excludingthese items, U.S. Pipe’s operating income declined slightly, as increased scrapiron cost and slightly lower volumes were offset in part by higher ductile ironpipe prices.

*Natural Resources*

Netsales and revenues were $173.1 million for the three months ended June 30,2006, up 6.3% from the prior year period. The increase was primarily due to 15.2%higher metallurgical coal pricing, 29.4% higher natural gas pricing and a 12.6%increase in natural gas production. Natural gas prices in the current periodreflect the benefit of hedging approximately 53% of production at $10.05 perthousand cubic feet.

| ** **                                   | ** ** | **Three months ended** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|
| ** **                                   | ** ** | **June 30,**                | ** ** |
| ** **                                   | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Average Coal  Selling Price (per Ton)        |       | $                                | 109.35     |   | $ | 82.08 |   |
| Tons of Coal Sold  (in millions)             |       | 1.4                              |       | 1.8 |   |
| Tons of Coal  Produced (in millions)         |       | 1.2                              |       | 1.5 |   |
| Average Natural  Gas Selling Price (per MCF) |       | $                                | 8.49       |   | $ | 6.56 |   |
| Billion Cubic  Feet of Natural Gas Sold      |       | 2.0                              |       | 1.8 |   |
| Number of Natural Gas  Wells                 |       | 414                              |       | 403 |   |

 

33

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Approximately 1.4 million tons of metallurgical coalwere shipped in the quarter ended June 30, 2006, which was consistent withthe prior year period. In addition to the metallurgical coal shipments in theprior year period, approximately 0.4 million tons of steam coal were shipped. Therewere virtually no lower-priced steam coal shipments in the quarter ended June 30,2006, as the steam coal contract with Alabama Power was satisfied in the firstquarter of 2006.

For the three months endedJune 30, 2006, Natural Resources’ operating income was $63.1 million,compared to operating income of $58.6 million in the prior year period. Theincrease was primarily due to higher metallurgical coal and natural gas pricesand an increase in natural gas production, partially offset by lower coalshipments and higher costs at Mine No. 4. Cost per ton increased at Mine No. 4,predominantly due to lower production volume relative to the prior year periodas a result of thin seam conditions encountered at the beginning of the currentlongwall panel, which began in April 2006. The thin seam conditionscontributed to reduced longwall advance rates and difficulties with roofcontrol. The longwall at Mine No. 4 has since experienced improved advancerates and its production is expected to be a more normal 1.4 million to 1.5million tons during the second half of 2006. The prior year period included$3.6 million of idle mine costs associated with the water ingress problem atMine No. 5. In the current quarter, idle mine costs related to Mine No. 4were approximately $0.2 million.

*Other*

Net sales and revenues were $37.8 million for thethree months ended June 30, 2006, an increase of $2.2 million from $35.5million in the prior year period. Sloss revenues were $34.9 million, up 6.2%versus the prior year period due to a 27.3% increase in furnace coke and anincrease in fiber volumes and pricing, partially offset by lower foundry cokepricing and volumes. Sloss operating income was $2.1 million in the 2006 periodcompared to $3.0 million in the prior year period. The decrease in operatingincome primarily reflects a non-cash asset impairment charge of $1.1 millionrelated to the chemical division. The Company is considering a plan to sellthese assets before the end of their useful life. The fair value used todetermine the impairment charge is based on a good faith quote from a willingbuyer.

Net general corporateexpenses, principally included in selling, general and administrative expense,were $7.0 million, or $3.0 million lower than the prior year period. Corporateexpenses decreased due to lower severance and recruiting costs, partiallyoffset by an increase of $2.4 million in stock-based compensation, primarily asa result of the January 1, 2006 adoption of SFAS 123(R).

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**RESULTS OF OPERATIONS**

**Summary Operating Results of Continuing Operations forthe Six Months ended June 30, 2006 and 2005**

| ** **                                                                   | ** ** | **For the six months ended June 30, 2006** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | ** **                                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **U.S.** | ** ** | **Natural** | ** ** | ** ** | ** ** | **Cons** | ** ** | ** ** | ** ** |
| ** **                                                                   | ** ** | **Homebuilding**                                                              | ** ** | **Financing** | ** ** | **Mueller Co.** | ** ** | **Anvil** | ** ** | **Pipe** | ** ** | **Resources** | ** ** | **Other** | ** ** | **Elims** | ** ** | **Total** | ** ** |
| ** **                                                                   | ** ** | **($ in thousands)**                                                | ** ** |
| Net sales                                                                    |       |                                                                          | $          | 128,862 |   |   |   | $ | 7,024 |   |   |   | $ | 418,564 |   |   | $ | 264,010 |   | $ | 263,508 |   |   | $ | 332,589 |   |   | $ | 68,364 |   | $ | (23,115 | ) | $ | 1,459,806 |   |
| Interest income on instalment notes                                          |       |                                                                          | —     |   |   |   | 101,467 |   |   |   | — |   |   | — |   | — |   |   | — |   |   | — |   | — |   | 101,467 |   |
| Miscellaneous                                                                |       |                                                                          | 272        |   |   |   | 3,347 |   |   |   | — |   |   | — |   | (56 | ) |   | 9,603 |   |   | 5,853 |   | (1,290 | ) | 17,729 |   |
| Net sales and  revenues                                                      |       |                                                                          | 129,134    |   |   |   | 111,838 |   |   |   | 418,564 |   |   | 264,010 |   | 263,452 |   |   | 342,192 |   |   | 74,217 |   | (24,405 | ) | 1,579,002 |   |
| Cost of sales                                                                |       |                                                                          | 106,818    |   |   |   | 6,100 |   |   |   | 269,122 |   |   | 192,345 |   | 223,121 |   |   | 183,964 |   |   | 59,192 |   | (22,836 | ) | 1,017,826 |   |
| Interest expense(1)                                                          |       |                                                                          | —     |   |   |   | 58,934 |   |   |   | — |   |   | — |   | — |   |   | — |   |   | — |   | — |   | 58,934 |   |
| Depreciation                                                                 |       |                                                                          | 2,634      |   |   |   | 682 |   |   |   | 13,356 |   |   | 9,924 |   | 10,738 |   |   | 12,545 |   |   | 2,441 |   | — |   | 52,320 |   |
| Selling, general & administrative                                   |       |                                                                          | 33,066     |   |   |   | 14,760 |   |   |   | 37,488 |   |   | 49,028 |   | 20,605 |   |   | 8,768 |   |   | 18,466 |   | — |   | 182,181 |   |
| Provision for losses on instalment notes                                     |       |                                                                          | —     |   |   |   | 4,815 |   |   |   | — |   |   | — |   | — |   |   | — |   |   | — |   | — |   | 4,815 |   |
| Postretirement benefits                                                      |       |                                                                          | (244       | ) |   |   | (96 | ) |   |   | — |   |   | — |   | (779 | ) |   | 9,886 |   |   | (732 | ) | — |   | 8,035 |   |
| Amortization of intangibles                                                  |       |                                                                          | —     |   |   |   | 1,339 |   |   |   | 12,538 |   |   | 1,852 |   | — |   |   | — |   |   | — |   | — |   | 15,729 |   |
| Credit for estimated hurricane insurance losses                              |       |                                                                          | —     |   |   |   | (1,046 | ) |   |   | — |   |   | — |   | — |   |   | — |   |   | — |   | — |   | (1,046 | ) |
| Restructuring & impairment charges                                  |       |                                                                          | —     |   |   |   | — |   |   |   | — |   |   | — |   | 4,487 |   |   | — |   |   | 1,135 |   | — |   | 5,622 |   |
| Operating income (loss)                                                      |       |                                                                          | $          | (13,140) |   |   |   | $ | 26,350 |   |   |   | $ | 86,060 |   |   | $ | 10,861 |   | $ | 5,280 |   |   | $ | 127,029 |   |   | $ | (6,285 | ) | $ | (1,569 | ) | $ | 234,586 |   |
| Other debt interest expense                                                  |       |                                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (84,655 | ) |
| Income from  continuing operations before income taxes and minority interest |       |                                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 149,931 |   |

 

| ** **                                             | ** ** | **For the six months ended June 30, 2005** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | ** **                                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Natural** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                             | ** ** | **Homebuilding**                                                              | ** ** | **Financing** | ** ** | **U.S. Pipe** | ** ** | **Resources** | ** ** | **Other** | ** ** | **Cons Elims** | ** ** | **Total** | ** ** |
| ** **                                             | ** ** | **($ in thousands)**                                                | ** ** |
| Net sales                                              |       |                                                                          | $          | 105,114 |   |   |   | $ | 7,777 |   |   |   | $ | 286,535 |   |   |   | $ | 268,783 |   |   | $ | 63,927 |   |   | $ | (14,895 | ) |   | $ | 717,241 |   |
| Interest income on instalment notes                    |       |                                                                          | —     |   |   |   | 106,603 |   |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   | 106,603 |   |
| Miscellaneous income                                   |       |                                                                          | 682        |   |   |   | 3,319 |   |   |   | 120 |   |   |   | 2,745 |   |   | 4,881 |   |   | (1,356 | ) |   | 10,391 |   |
| Net sales and revenues                                 |       |                                                                          | 105,796    |   |   |   | 117,699 |   |   |   | 286,655 |   |   |   | 271,528 |   |   | 68,808 |   |   | (16,251 | ) |   | 834,235 |   |
| Cost of sales                                          |       |                                                                          | 89,008     |   |   |   | 4,922 |   |   |   | 240,363 |   |   |   | 161,777 |   |   | 53,073 |   |   | (13,420 | ) |   | 535,723 |   |
| Interest expense(1)                                    |       |                                                                          | —     |   |   |   | 62,537 |   |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   | 62,537 |   |
| Depreciation                                           |       |                                                                          | 2,412      |   |   |   | 715 |   |   |   | 13,177 |   |   |   | 10,230 |   |   | 2,291 |   |   | — |   |   | 28,825 |   |
| Selling, general & administrative             |       |                                                                          | 37,153     |   |   |   | 14,279 |   |   |   | 16,240 |   |   |   | 7,527 |   |   | 21,386 |   |   | — |   |   | 96,585 |   |
| Provision for losses on instalment notes               |       |                                                                          | —     |   |   |   | 5,134 |   |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   | 5,134 |   |
| Postretirement benefits                                |       |                                                                          | (234       | ) |   |   | (120 | ) |   |   | (726 | ) |   |   | 8,224 |   |   | (672 | ) |   | — |   |   | 6,472 |   |
| Amortization of intangibles                            |       |                                                                          | —     |   |   |   | 1,986 |   |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   | 1,986 |   |
| Credit for estimated hurricane Insurance losses        |       |                                                                          | —     |   |   |   | (556 | ) |   |   | — |   |   |   | — |   |   | — |   |   | — |   |   | (556 | ) |
| Restructuring & impairment charges            |       |                                                                          | —     |   |   |   | — |   |   |   | — |   |   |   | 610 |   |   | — |   |   | — |   |   | 610 |   |
| Operating income (loss)                                |       |                                                                          | $          | (22,543 | ) |   |   | $ | 28,802 |   |   |   | $ | 17,601 |   |   |   | $ | 83,160 |   |   | $ | (7,270 | ) |   | $ | (2,831 | ) |   | $ | 96,919 |   |
| Other debt interest expense                            |       |                                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (7,709 | ) |
| Income from  continuing operations before income taxes |       |                                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 89,210 |   |

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          (1) Excludesother debt interest expense.

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

The Company’s net income for the six months ended June 30,2006 was $99.3 million, or $1.97 per diluted share, which compares to netincome in the year-ago period of $60.2 million, or $1.28 per share. Currentyear net income reflects the addition of Mueller Co. and Anvil, acquired on October 3,2005. In addition, profitability at Natural Resources and Homebuilding improvedover the prior year period primarily driven by higher pricing, partially offsetby decreases in U.S. Pipe and Financing.

Net sales and revenues for the six months ended June 30,2006 were $1,579.0 million, an 89.3% increase from $834.2 million for the sixmonths ended June 30, 2005, primarily driven by the acquisition of MuellerCo. and Anvil, higher metallurgical coal sales prices at Natural Resources andhigher pricing at Homebuilding and Sloss; partially offset in part by decreasesat U.S. Pipe and Financing.

Cost of sales, exclusive of depreciation, of $1,017.8million was 69.7% of net sales in the 2006 period versus $535.7 million and74.7% of net sales in the comparable period of 2005. Current year resultsinclude $461.5 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 six months ended June 30, 2006, the gross margin percentage increasedto 30.3% from 25.3% in the prior year period. This increase was primarily theresult of the addition of the Mueller Co. and Anvil segments, which generated acombined gross margin percentage of 32.4%, as well as improved gross margins inthe Homebuilding and Natural Resources segments.

Depreciation for the six months ended June 30,2006 was $52.3 million, an increase of $23.5 million from the same period in2005, reflecting $23.3 million of depreciation resulting from the addition ofthe Mueller Co. and Anvil segments.

Selling, general and administrative expenses of $182.2million were 11.5% of net sales and revenues in the 2006 period, compared to$96.6 million and 11.6% of nets sales and revenues in 2005. Current yearresults include $86.5 million of selling, general and administrative expensesin the Mueller Co. and Anvil segments.

Provision for losses on instalment notes decreased to$4.8 million in the 2006 period, compared to $5.1 million in 2005, due tohigher recovery rates and lower resales in the current year versus the prioryear.

Interest expense on other debt increased $76.9 millionto $84.7 million in the 2006 six-month period due primarily to the inclusion ofMueller Water debt and additional indebtedness incurred to finance the MuellerWater acquisition. Interest expense also includes $1.6 million of inducementcosts related to the conversion of $26.6 million of the Company’s ConvertibleSenior Subordinated Notes. In addition, the Company wrote off $1.6 million ofunamortized debt expense in the first quarter of 2006 relating to $102.9 millionof prepayments on the 2005 Walter Credit Agreement made using proceeds from theCompany’s $169 million common stock sale in February 2006. In June 2006, theCompany wrote off $4.1 million of unamortized debt expense relating to a$246.0 million prepayment on the 2005 Mueller Credit Agreement made usingproceeds from Mueller Water’s IPO.

The Company’s effectivetax rate of 33.0% and 32.0% for the six months ended June 30, 2006 and2005, respectively, differed from the federal statutory rate primarily due tofavorable depletion deductions related to the Natural Resources segment,partially offset by the effect of state income taxes.

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**Segment Analysis:**

*Homebuilding*

Netsales and revenues were $129.1 million for the six months ended June 30,2006, an increase of $23.3 million from the six months ended June 30, 2005as a result of higher average net selling prices and an increase in unitcompletions as shown in the table below.

| ** **                  | ** ** | **Six months ended** | ** ** |
|-----------------------------|------------|--------------------------------|------------|
| ** **                  | ** ** | **June 30,**              | ** ** |
| ** **                  | ** ** | **2006**                       | ** ** | **2005** | ** ** |
| Homes Completed:            |       |                           |       |   |   |
| Stick-built                 |       | 1,286                          |       | 1,160 |   |
| Modular                     |       | 235                            |       | 238 |   |
| Average Net  Selling Price: |       |                           |       |   |   |
| Stick-built                 |       | $                              | 85,500     |   | $ | 77,000 |   |
| Modular                     |       | $                              | 80,400     |   | $ | 66,500 |   |

 

The operating loss was$13.1 million for the six months ended June 30, 2006 compared to anoperating loss of $22.5 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. The prior year included othernon-recoverable costs of $3.2 million for repair and rework on homes underconstruction, supplies inventory write-downs and additional accruals for legaland warranty issues.

*Financing*

Net sales and revenueswere $111.8 million in the 2006 period, a decrease of $5.9 million from$117.7 million for the year-ago period. This decrease was attributed tolower interest income on instalment notes due to a decrease in prepaymentspeeds. Prepayment speeds were 9.6% in the 2006 period, down 70 basispoints from the prior year period. Operating income decreased by $2.5 million,to $26.4 million in the 2006 period primarily due to lower interest income oninstalment notes, partially offset by a decrease of approximately $3.6 millionin interest expense.

*Mueller Co.*

Net sales and revenues forthe six months ended June 30, 2006 were $418.6 million. Revenues reflecthigher selling prices and increased volumes in hydrants, brass water productsand iron gate valves, plus the addition of U.S. Pipe’s valve and hydrantbusiness transferred from its now closed Chattanooga, Tennessee plant.

Mueller’s operating incomefor the six months ended June 30, 2006 was $86.1 million. Results for theyear are attributed to improved valve volumes and hydrant margins, partiallyoffset by higher brass ingot and scrap iron material costs.

*Anvil*

Net sales and revenues forthe six months ended June 30, 2006 were $264.0 million. Anvil’s revenueswere driven by higher volume and pricing on its commercial construction andoilfield market products, increased volume in foreign-sourced products andrelatively strong buying power of the Canadian dollar.

Operating income for thesix months ended June 30, 2006 was $10.9 million. Current year resultsreflect increased volume and higher pricing on commercial construction andoilfield market products, partially offset by cost increases in raw materials.

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*U.S. Pipe*

Net sales and revenues were $263.5 million for the sixmonths ended June 30, 2006 compared to $286.7 million in the prior yearperiod. This decrease reflects the transfer of valve and hydrant business toMueller Co., effective January 1, 2006. In the prior year period, U.S.Pipe revenues related to the valve and hydrant business totaled $27.8 million. Thisdecrease was partially offset by a 5.1% increase in ductile iron pipe pricesduring the six months ended June 30, 2006, compared to the prior yearperiod. Prices were higher than the prior year as the industry has been raisingprices to offset increasing scrap metal costs.

Operating income was $5.3million for the period compared to $17.6 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 $9.9 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*

Netsales and revenues were $342.2 million for the six months ended June 30,2006, an increase of $70.7 million from $271.5 million in the prior year period.The increase was primarily due to higher metallurgical coal and natural gasselling prices.

| ** **                                   | ** ** | **Six months ended** | ** ** |
|----------------------------------------------|------------|--------------------------------|------------|
| ** **                                   | ** ** | **June 30,**              | ** ** |
| ** **                                   | ** ** | **2006**                       | ** ** | **2005** | ** ** |
| Average Coal  Selling Price (per Ton)        |       | $                              | 103.31     |   | $ | 73.93 |   |
| Tons of Coal Sold  (in millions)             |       | 3.0                            |       | 3.3 |   |
| Tons of Coal Produced  (in millions)         |       | 3.0                            |       | 3.5 |   |
| Average Natural  Gas Selling Price (per MCF) |       | $                              | 8.88       |   | $ | 6.66 |   |
| Billion Cubic  Feet of Natural Gas Sold      |       | 3.8                            |       | 3.5 |   |
| Number of Natural Gas  Wells                 |       | 414                            |       | 403 |   |

 

For the six months ended June 30,2006, Natural Resources’ operating income was $127.0 million, compared tooperating income of $83.2 million in the prior year period. The increase wasprimarily due to higher metallurgical coal and natural gas selling prices,partially offset by lower coal shipments and higher costs per ton, primarily atMine No. 4. Cost per ton increased at Mine No. 4, predominantly dueto lower production volume relative to the prior year period as a result ofthin seam conditions encountered at the beginning of the current longwallpanel, which began in April 2006. The thin seam conditions contributed toreduced longwall advance rates and difficulties with roof control. The longwallat Mine No. 4 has since experienced improved advance rates and itsproduction is expected to be a more normal 1.4 million to 1.5 million tonsduring the second half of 2006. The Company recognized $0.4 million of idlemine costs during the six months ended June 30, 2006. In the prior yearperiod, the Company incurred $3.6 million of idle mine costs related to thewater ingress problem at Mine No. 5.

*Other*

Net sales and revenues were $74.2 million for the sixmonths ended June 30, 2006, an increase of $5.4 million from $68.8million in the prior year period. Sloss revenues were $4.2 million higher thanthe previous period due to higher furnace coke and fiber selling prices andincreased volumes, partially offset by a decrease in foundry coke volumes. Slossoperating income was $4.3 million in the 2006 period, a decrease of $0.6million from the prior year period, due to a non-cash asset impairment chargeof $1.1 related to Sloss’ chemical division and a decrease in foundry cokevolumes, partially offset by higher furnace coke and fiber pricing.

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Net general corporateexpenses, principally included in selling, general and administrative expense,were $14.6 million for the six months ended June 30, 2006 compared to$16.7 million for the six months ended June 30, 2005. Corporate expensesdecreased due to lower severance, legal and recruiting costs, partially offsetby an increase of $3.9 million in stock-based compensation, primarily as aresult of the January 1, 2006 adoption of SFAS 123(R).

**FINANCIAL CONDITION**

Cash increased from $137.4 million at December 31,2005 to $363.5 million at June 30, 2006 reflecting $114.5 million of cashflows provided by operations, $106.8 million of cash flows used in investingactivities and $220.6 million of cash flows provided by financing activities. Seeadditional discussion in the Statement of Cash Flows section that follows.

Restricted short-term investments decreased $37.6million from December 31, 2005 to $87.0 million at June 30, 2006 dueto 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 $417.7 million at June 30, 2006, an increase of $66.6million from December 31, 2005. The increase in receivables was primarilydue to higher revenues in the second quarter of 2006 as compared to the fourthquarter of 2005 driving increased receivables in the Natural Resources, MuellerCo. and Anvil segments.

Other long-term assets increased $16.0 million from December 31,2005 to $95.3 million at June 30, 2006 due to a $22.8 million favorablemark-to-market adjustment on derivative instruments partially offset by adecrease in the prepaid pension asset resulting from the actuarially-determinedpension expense recognized during the first half of 2006.

Accounts payable of $192.8 million at June 30,2006 increased $31.6 million compared to December 31, 2005 primarily as aresult of the timing of vendor payments and volume-related seasonal materialpurchases.

Other debt decreased$395.0 million from December 31, 2005 to $1,777.5 million at June 30,2006, primarily reflecting $251.6 million and $123.8 million in principalpayments on the 2005 Mueller Credit Agreement and 2005 Walter Credit Agreement,respectively. Also, holders of approximately $26.6 million of the Company’scontingent convertible notes surrendered their convertible notes in exchangefor approximately 1.5 million shares of the Company’s common stock. Thedecrease in other debt was partially offset by accretion on the Senior DiscountNotes.

**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.

The Company believes that, based on current forecastsand anticipated market conditions, sufficient operating cash flow will begenerated to meet substantially all operating needs, to make planned capitalexpenditures and to make all required interest payments on indebtedness for thenext twelve to eighteen months. However, the Company’s operating cashflows and liquidity are significantly influenced by numerous factors, includingthe general economy and, in particular, prices of coal and natural gas, levelsof construction activity, levels of government spending on water projects,costs of raw materials and interest rates.

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As of June 30, 2006, total debt has decreased by$423.4 million compared to December 31, 2005, primarily resulting fromusing the cash proceeds from the Company’s equity offering and Mueller Water’sIPO to make $251.6 million and $123.8 million of principal payments on the 2005Mueller Credit Agreement and the 2005 Walter Credit Agreement, respectively,$126.1 million of principal payments on the Company’smortgage-backed/asset-backed notes and the conversion of $26.6 million ofconvertible notes into common stock, partially offset by the issuance of $97.6million of mortgage-backed/asset-backed notes and accretion on the SeniorDiscount Notes.

At June 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 instalment notesand mortgage loans from Jim Walter Homes and Walter Mortgage Company. At June 30,2006, there were $97.6 million of borrowings outstanding under these warehousefacilities, leaving a total of $252.4 million available for future borrowings.

*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 $0.8 millionthrough October 3, 2012, at which time the remaining principal outstandingis due. The 2005 Walter Term Loan carries a floating interest rate of 200 basispoints over LIBOR. At June 30, 2006, the balance outstanding on the termloan was $325.0 million and the weighted-average interest rate was 7.0%. Thecommitment fee on the unused portion of the 2005 Walter Revolving CreditFacility is 0.50% and the interest rate is a floating rate of 225 basispoints over LIBOR. At June 30, 2006, there were no borrowings outstandingunder the revolving credit facility.

In February 2006, theCompany used a portion of the proceeds from the sale of 2.65 million shares ofcommon stock to repay $67.9 million of the term loan facility on a mandatorybasis and $35.0 million on an optional basis. In April 2006, the Companyrepaid an additional $19.2 million on the term loan facility on a mandatorybasis related to an excess cash flow recapture provision.

*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. Loans underthe senior credit facilities bear interest, at our option, at: LIBOR rate plus250 basis points or the alternate base rate plus 150 basis points forborrowings under the revolving credit facility; and LIBOR plus 225 basis pointsor the alternate base rate plus 125 basis points for term loans. The 2005Mueller Term Loan requires quarterly principal payments of $2.6 millionthrough October 3, 2012, at which time the remaining principal outstandingis due. At June 30, 2006, the balance outstanding on the term loan was$795.7 million and the weighted-average interest rate was 7.2%. The commitmentfee on the unused portion of the 2005 Mueller Revolving Credit Facility is0.50%. At June 30, 2006, there were no borrowings outstanding under therevolving credit facility.

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An amendment to the 2005 Mueller Credit Agreement madein January 2006 provides that in the event of an initial public offering,Mueller Group may pay annual dividends of up to $8.5 million to Mueller Waterso it can pay its common shareholders.

On June 1, 2006,Mueller Water used $246.0 million from the proceeds of the IPO to repay aportion of the term 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% senior subordinatedpublic notes, which will mature on May 1, 2012. Interest on the senior subordinatednotes is payable in cash on May 1 and November 1 of each year. Thesenior subordinated notes are guaranteed by each of Mueller Group’s existingdomestic restricted subsidiaries.

On July 3, 2006,Mueller Water used $123.1 of the proceeds from their IPO for a partialredemption of $116.1 million of the 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 143¤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 $60.2 million of the proceeds from the IPO for a partialredemption of $61.0 million of the 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 may requirethe Company to repurchase some or all of the notes at par plus accrued andunpaid 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. During2006, holders of approximately $26.6 million of the Company’s convertible notessurrendered their convertible notes in exchange for approximately 1,490,000shares of the Company’s common stock and approximately $1.6 million ofincentive payments, which was expensed in the first quarter of 2006.

*Statement of CashFlows*

Cash totaled $363.5 million and $137.4 million at June 30,2006 and December 31, 2005, respectively. The increase in cash isprimarily the result of cash proceeds from Mueller Water’s IPO ($429.3million), the sale of common stock ($168.7 million), the issuance of mortgage-backed/asset-backednotes ($97.6 million) and cash flows provided by operating activities($114.2 million), partially offset by retirements of other debt ($375.5million), retirements of mortgage-back/asset-backed notes ($126.1 million)and purchases of property, plant and equipment ($84.0 million).

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Cash flows provided by operating activities for thesix months ended June 30, 2006 were $114.2 million compared to $43.6million provided by operating activities for the six months ended June 30,2005. The increase in cash flows provided by operating activities isprincipally due to a $39.0 million increase in net income as adjusted for a$23.5 million increase in depreciation, a $13.7 million increase in theamortization of intangibles and a $28.7 million decrease in inventory,partially offset by a $34.5 million increase in receivables.

Capital expenditurestotaled $84.0 million in the six months ended June 30, 2006, principallydue to expansion related underground mining and natural gas well equipment atNatural Resources and machinery and equipment at Mueller Water. Commitments forcapital expenditures at June 30, 2006 were not significant; however, it isestimated that gross capital expenditures for the year ending December 31, 2006will approximate $180 million to $200 million. Actual expenditures in 2006 maybe more or less than this amount, depending upon the level of earnings and cashflow, the timing of projects or expansion opportunities in certain markets.

**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 “Item 7a,Qualitative and Quantitative Disclosures About Market Risk” described in theAnnual 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 forecasted issuance ofmortgage-backed securities. The structure of the swaps is a 14-year,forward-starting swap which starts on December 15, 2006, which is theforecasted issuance date of the Company’s next securitization. The swapagreements call for the Company to make fixed rate payments over the term at5.05% per annum and receive payments based on one-month LIBOR from thecounter-parties. It is anticipated that the swap will be settled at securitization,and the Company will account for the swap as a cash flow hedge. Changes in thefair value of the swap through the date of securitization that take place arerecorded in accumulated other comprehensive income (loss), assuming thesecuritization remains likely. At June 30, 2006, the Company recorded anet unrealized gain from these swaps of $2.4 million, net of tax, as acomponent of other comprehensive income.

*Commodity risks*

At June 30, 2006, swap contracts to hedgeanticipated sales in 2006 of natural gas totaling 2.1 million mmbtu wereoutstanding. At June 30, 2006, the Company recorded a net unrealized gainfrom these hedging agreements of $4.4 million, net of tax, as a component ofother comprehensive income.

In July 2006, JWRentered into a swap contract to hedge anticipated sales from January 2007through March 2007 totaling 0.6 million mmbtu, or approximately 40% ofnatural gas production for that three month period, at a price of $10.54per mmbtu. This swap contract effectively converts a portion of forecastednatural gas sales at market prices to a fixed rate basis.

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*Foreign currencyrisks*

In March 2006,Mueller Water entered into hedges protecting intercompany loan payments to bemade over the next three years by its Canadian subsidiary to a U.S. subsidiarytotaling $37.3 million. With these hedges, the Company sells Canadian dollarsfor U.S. dollars at an exchange rate of $0.8681. Unrealized gains or losses onthese hedges will be recorded in earnings over their lives, and were not materialfor the three and six months ended June 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 from holdinga derivative financial instrument that pertains to a beneficial interest otherthan another derivative financial instrument. SFAS No. 155 is effectivefor all financial instruments acquired, issued or subject to a remeasurementevent occurring in fiscal years beginning after September 15, 2006. Theadoption of this statement is not anticipated to have a significant impact onthe 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 recognized servicing assets and liabilities. SFAS No. 156 iseffective for all separately recognized servicing assets and servicingliabilities in fiscal years beginning after September 15, 2006. Theadoption of this statement is not anticipated to have a significant impact onthe Company’s financial condition or results of operations.

In July 2006, theFASB issued Interpretation (“FIN”) No. 48, “Accounting for Uncertainty inIncome Taxes,” which provides the minimum recognition threshold that a taxprovision must meet before being recognized in the financial statements. Thisinterpretation also provides guidance on derecognition of income tax assets andliabilities, classification of current and deferred income tax assets andliabilities, accounting for interest and penalties associated with taxpositions, accounting for income taxes in interim periods, and income taxdisclosures. FIN No. 48 applies to all tax positions related to incometaxes subject to SFAS No. 109, “Accounting for Income Taxes.” The Companyhas not yet determined what impact, if any, the adoption of thisinterpretation, which becomes effective January 1, 2007, will have on itsconsolidated financial statements.

**CONTROLS ANDPROCEDURES**

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

An evaluation wasperformed under the supervision and with the participation of our management,including our Chief Executive Officer (CEO), and Chief Financial Officer (CFO),of the effectiveness of our disclosure controls and procedures as of June 30,2006. Based on that evaluation, our management, including our CEO and CFO, concludedthat our disclosure controls and procedures are effective. There has been nochange in our internal control over financial reporting during the six monthsended June 30, 2006 that has materially affected, or is reasonablylikely to materially affect, internal control over financial reporting.

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**PRIVATE SECURITIESLITIGATION REFORM ACT SAFE HARBOR STATEMENT**

Except for historicalinformation contained herein, the statements in this release areforward-looking and made pursuant to the safe harbor provisions of the PrivateSecurities Litigation Reform Act of 1995. Forward-looking statements involveknown and unknown risks and uncertainties that may cause the Company’s actualresults in future periods to differ materially from forecasted results. Thoserisks include, among others, changes in customers’ demand for the Company’sproducts, changes in raw material, labor, equipment and transportation costsand availability, geologic and weather conditions, changes in extraction costsand pricing in the Company’s mining operations, changes in customer orders,pricing actions by the Company’s competitors, the collection of approximately$14 million of receivables associated with a working capital adjustment arisingfrom the sale of a subsidiary in 2003, potential changes in the mortgage-backedcapital market, and general changes in economic conditions. Risks associatedwith forward-looking statements are more fully described in the Company’sfilings with the Securities and Exchange Commission. Those risks also includethe timing of and ability to execute the spin-off of the Company’s WaterProducts business and other strategic actions that may be pursued. The Companyhas no duty to update its outlook statements as of any future date.

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**PART II—OTHERINFORMATION**

**Item 1.**                        *Legal Proceedings*

See Note 13 in this Form 10-Q for a descriptionof current legal proceedings.

The Company and itssubsidiaries are parties to a number of other lawsuits arising in the ordinarycourse of their businesses. Most of these cases are in a preliminary stage andthe Company is unable to predict a range of possible loss, if any. The Companyprovides for costs relating to these matters when a loss is probable and theamount is reasonably estimable (See Note 13 in this Form 10-Q). The effectof the outcome of these matters on the Company’s future results of operationscannot be predicted because any such effect depends on future results ofoperations and the amount and timing of the resolution of such matters. Whilethe results of litigation cannot be predicted with certainty, the Companybelieves that the final outcome of such other litigation will not have amaterial adverse effect on the Company’s consolidated financial position.

**Item 1A.**                *Update to Risk Factors*

The Company has madechanges to certain Risk Factors that were previously disclosed in *Item 1A. Risk Factors* in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2005. The revised Risk Factors, whichprimarily relate to the operations of the Company’s Water Products business,are as follows:

***Our business issubject to risk of price increases and fluctuations and delay in the deliveryof raw materials and purchased components.***

Most of the industries in which we operate requiresignificant amounts of raw materials and labor and, therefore, shortages orincreased costs of raw materials and labor could adversely affect our businessor results of operations.

Our homebuilding operations rely on the availabilityof lumber, drywall, cement and other building materials. The availability andmarket prices of these materials are influenced by various factors that arebeyond our control. Shortages of, and price increases for, such materials haveoccurred in the past and may occur in the future. For example, we haveexperienced increases in the cost of a variety of materials since the thirdquarter of 2005 as a result of the impact of the Gulf Coast hurricanes onsupplies of and demand for these materials. Further, if we are unable to securea proper level of skilled labor for our homebuilding operations, we may beunable to build as many houses or build them as cost effectively, and ourlevels of revenue and net income may be reduced.

Our Water Products business is subject to the risk ofprice increases and fluctuations and periodic delays in the delivery of rawmaterials and purchased components that are beyond our control. Our WaterProducts operations require substantial amounts of raw materials or purchasedcomponents, such as steel pipe and scrap steel and iron, brass ingot, sand, resin,and natural gas. Management estimates that scrap metal and ferrous alloys usedin the U.S. Pipe manufacturing process account for up to 40% of theU.S. Pipe cost to manufacture ductile iron pipe. At Mueller Co. and Anvil,raw materials used in our manufacturing processes currently account forapproximately 18% of cost of goods sold. Fluctuations in the price and deliveryof these materials may be driven by the supply/demand relationship for factorsparticular to that material. In addition, if any of our suppliers seeksbankruptcy relief or otherwise cannot continue its business as anticipated orwe cannot renew our supply contracts on favorable terms, the availability ofraw materials could be reduced or the price of raw materials could increase.

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The availability and priceof certain raw materials or purchased components, such as steel scrap, brassingot and natural gas are subject to market forces largely beyond our control,including North American and international freight costs, speculation and foreignexchange rates. We generally purchase raw materials at spot prices andgenerally do not have the ability to hedge our exposure to price changes. Weare not always able, and may not be able in the future, to pass on increases inthe price of these raw materials to our customers. In particular, when rawmaterial prices increase rapidly or to significantly higher than normal levels,we may not be able to pass price increases through to our customers on a timelybasis, if at all, which could lead to significant reductions of our operatingmargins and cash flow. Any fluctuations in the price or availability of rawmaterials or purchased components could significantly reduce our levels ofproduction and sales or impair our profitability.

***Foreign competition is intense and could harm oursales, profitability and cash flows.***

In addition to domestic competition, our WaterProducts business faces intense foreign competition. The intensity of foreigncompetition is affected significantly by fluctuations in the value of the U.S.dollar against foreign currencies, by the relative cost to ship competitiveproducts into the North American markets and by the level of import dutiesimposed by the U.S. Department of Commerce on certain products. Foreigncompetition is likely to further increase and certain Water Products priceswill most likely continue to face downward price pressure as our domesticcompetitors shift their operations or outsource manufacturing requirementsoverseas or source supplies from foreign vendors in an effort to reduceexpenses.

Our coal business facescompetition from foreign producers that sell their coal in the United Statesand in the export market and, therefore, fluctuations in exchange rates willaffect the demand for coal we produce. If our competitors’ currencies declineagainst the U.S. dollar or against our customers’ currencies, those competitorsmay be able to offer lower prices to our customers. Furthermore, if thecurrencies of our overseas customers were to significantly decline in value incomparison to the U.S. dollar, those customers may seek decreased prices forthe coal we sell to them. Both of these factors could reduce our profitabilityor result in lower coal sales.

***We rely on Tyco toindemnify us for certain liabilities and there is a risk that Tyco may becomeunable or fail to fulfill its obligations.***

Under the terms of thepurchase agreement (the “Tyco Purchase Agreement”) relating to the August 1999sale by Tyco International Ltd. (“Tyco”) of Mueller Water’s business toits prior owners, we are indemnified by Tyco for all liabilities arising inconnection with Mueller Water’s business with respect to products manufacturedor sold prior to the closing of that transaction. The indemnity survivesforever and is not subject to any dollar limits. In the past, Tyco has madesubstantial payments and/or assumed defense of claims pursuant to thisindemnification provision. However, we may be responsible for these liabilitiesin the event that Tyco ever becomes financially unable, or fails to complywith, the terms of the indemnity. In addition, Tyco’s indemnity does not coverproduct liabilities to the extent caused by our products manufactured afterthat transaction. On January 14, 2006, Tyco’s board of directors announcedthat it approved a plan to separate Tyco into three individual, publicly tradedcompanies. At this time, we do not know which of the new entities will assumethe indemnity provided under the terms of the Tyco Purchase Agreement if thisplan is implemented. Should Tyco or the entity or entities that assume Tyco’sobligations under the Tyco Purchase Agreement ever become financially unable orfail to comply with the terms of the indemnity, we may be responsible for suchobligations or liabilities.

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***Environmental,health and safety laws and regulations could subject us to liability for fines,clean-ups and other damages, require us to incur significant costs to modifyour operations and increase our manufacturing costs.***

We are subject to a wide variety of laws andregulations concerning the protection of the environment and human health andsafety, both with respect to the construction and operation of many of ourplants, mines and other facilities and with respect to remediatingenvironmental conditions that may exist at our own and other properties.Certain of our facilities have been in operation for many years and, over time,we and predecessor operators of these facilities may have generated, used,handled and disposed of hazardous and other regulated wastes. Environmentalliabilities could exist, including cleanup obligations at these or at otherlocations where materials from our operations were disposed of, which couldresult in future expenditures that cannot be currently quantified and whichcould reduce our profits. Failure to comply with any environmental, health orsafety requirements could result in the assessment of damages, or imposition ofpenalties, suspension of production, a required upgrade or change to equipmentor processes or a cessation of operations at one or more of our facilities.Because these laws are complex, constantly changing and may be appliedretroactively, there is a risk that these requirements, in particular as theychange in the future, may impair our business, profitability and results of operations.In addition, we will be required to incur costs to comply with the EPA’sNational Emissions Standards for Hazardous Air Pollutants (“NESHAP”) for ironand steel foundries and for our foundries’ painting operations. These costs maybe substantial.

We may be required to conduct investigations andperform remedial activities that could require us to incur material costs inthe future. Our operations involve the use of hazardous substances and thedisposal of hazardous wastes. We may incur costs to manage these substances andwastes and may be subject to claims for damage for personal injury, propertydamages or damage to natural resources.

Our U.S. Pipe segmenthas been identified as a potentially responsible party liable under federalenvironmental laws for a portion of the clean-up costs with regard to twosites, one in Alabama and one in California, and is currently subject to anadministrative consent order requiring certain monitoring and clean-up withregard to its Burlington, New Jersey facility. Such clean-up costs could besubstantial and could have a negative effect on our profitability and cashflows in any given reporting period. As described in the immediately precedingrisk factor, we rely on Tyco to indemnify us for certain liabilities and thereis a risk that Tyco may become unable or fail to fulfill its obligation.

***Restrictivecovenants in our debt instruments may limit our ability to engage in certaintransactions and may diminish our ability to make payments on our indebtedness.***

Our debt instrumentscontain various covenants that limit our ability to engage in certaintransactions. Our 2005 Credit Agreement and the 2005 Mueller Credit Agreementalso require the maintenance of specified financial ratios and the satisfactionof other financial condition tests. In addition, our debt instruments requireus to provide regular financial information to our lenders and bondholders.Such requirements generally may be satisfied by our timely filing with the SECof annual and quarterly reports under the Exchange Act. Our ability to satisfythose financial ratios, tests or covenants can be affected by events beyond ourcontrol, and there is a risk that we will not meet those tests. A breach of anyof these covenants could result in a default under our debt instruments. If anevent of default were not remedied after the delivery of notice of default andlapse of any relevant grace period, the holders of our debt would be able todeclare it immediately due and payable. Upon the occurrence of an event ofdefault under our 2005 Credit Agreement or the 2005 Mueller Credit Agreement,the respective lenders could also terminate all commitments to extend furthercredit. If we were unable to repay those amounts, such lenders could proceedagainst the collateral granted to them to secure the indebtedness under oursenior credit facilities. We have pledged substantially all of our assets(including our intellectual property), other than the assets of our foreignsubsidiaries and assets of our Water Products business, as security under our2005 Credit Agreement and we pledged substantially all of the assets of ourWater Products business (including, its 

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intellectualproperty) other than the assets of its foreign subsidiaries, under the 2005Mueller Credit Agreement. If the lenders under our credit agreements or holdersof the notes accelerate the repayment of borrowings, we may not have sufficientassets to repay our senior credit facilities and our other indebtedness, whichcould negatively impact the value of our stock and our ability to continue as agoing concern.

***Businesses we have acquired or will acquire may notperform as expected.***

Businesses we haverecently acquired or may acquire in the future may not perform as expected.Acquired businesses may perform below expectations after the acquisition forvarious reasons, including legislative or regulatory changes that affect theareas in which a business specializes, the loss of key customers after theacquisition has closed, general economic factors that affect a business in adirect way and the cultural incompatibility of an acquired management team withus. Any of these factors could impair our results of operations.

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

The Sarbanes-Oxley Act of2002, as well as rules subsequently implemented by the SEC and the PCAOB,have required changes in the corporate governance and securities disclosure orcompliance practices of public companies over the last few years. We expectthese new rules and regulations to continue to increase our legal andfinancial compliance costs, as well as our ongoing audit costs, and to makelegal, accounting and administrative activities more time-consuming and costly.For example, in 2006, Mueller Water may need to comply with the internalcontrol reporting requirements of the Sarbanes-Oxley Act, which will havea significant impact on our 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 theSarbanes-Oxley Act and the rules and regulations subsequently implementedby the SEC and the PCAOB to make it more difficult and expensive for us toobtain director and officer liability insurance, and we may be required toaccept reduced coverage or incur substantially higher costs to obtain coverage.These new rules and regulations could also make it more difficult for usto attract and retain qualified members of our board of directors, particularlyto serve on our audit committee, and executive officers.

***Interruption of normal operations at our key manufacturingfacilities may impair our production capabilities.***

Some of our key water products, including hydrants,valves and ductile iron pipe, are manufactured at five of our largestmanufacturing facilities. The operations at our major manufacturing facilitiesmay be impaired by various operating risks, including, but not limited to:

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

·       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;

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·       shortagesof equipment or spare parts; and

·       labordisputes.

To date, we havesuccessfully managed non-material occurrences of the foregoing events,including a fire at the Columbia, PA facility of our Anvil segment andCalifornia’s adoption of laws limiting the lead content of water infrastructureproducts, without significant disruption of our operations. More acuteoccurrences of these events could cause a decrease in, or the elimination of,the revenues generated by our key facilities or a substantial increase in thecosts of operating such facilities that, in turn, could, impair our cash flowsand 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 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 some of these products, including water meters and valves, and to limittheir sale in California. Some of our business units have entered intosettlement agreements with these environmental advocacy groups that haverequired them to either modify some of these products or offer substitutes forthem with respect to products sold in California. Modifications of orsubstitutions for our products to meet or conform with regulatory requirementswill require incremental capital spending of up to $8.0 million in thenext two years and will require us to purchase more expensive raw materials,and we may not be able to pass these costs on to our customers. Legislation tosubstantially restrict lead content in water products has been introduced inthe United States Congress. Congress may adopt legislation that would requireus to eliminate lead in our brass products which, could require us to incursubstantial additional production expenses. In addition, advocacy groups mayfile suit against us under Proposition 65, which could result in additionalcosts in connection with marketing and selling our brass products inCalifornia.

The National SanitaryFoundation (“NSF”) is a non-profit entity that was contracted by the U.S.Environmental Protection Agency (“EPA”) to promulgate standards for the waterindustry. NSF has issued NSF 61, which governs the leaching characteristics ofvalves and devices that are part of drinking water distribution networks,including certain of our products made from brass. In recent years, a growingmajority of states have adopted, by statute or regulation, a requirement thatwater distribution systems utilize products that comply with NSF 61 and/or arecertified as NSF 61 compliant. We, along with others in the industry, areengaged in the lengthy process of attempting to obtain certification of NSF 61compliance for all of our relevant products. To date we have obtainedcertification of approximately 95% of our brass valve and fitting products. Approximately26% of our certified products use “low lead” brass to comply with current NSF61 requirements. The NSF 61 certification process is ongoing with our goal tohave all products requiring certification completed by January 1, 2007. Inthe event that some of our brass valve products are found not to be incompliance with NSF 61, those products may not be accepted by variousmunicipalities or we may be forced to modify non-conforming products withsubstitute materials, which may require increased cost, thereby impairing ourprofitability. In addition, if our competitors develop a complete line of NSF61 compliant brass valve products before we do, we may be placed at acompetitive disadvantage which may, in turn, impair our profitability.

**Item 2.**                        *Unregistered Sales of Equity Securities and Use of Proceeds*

*Purchase of EquitySecurities by the Company and Affiliated Purchasers.*

During the quarter ended June 30,2006, there were no share repurchases and at June 30, 2006, $7.5 millionremains available under the Common Stock share repurchase program. The Companyhas not yet decided to terminate the program.

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**Item 4.**                        *Submission of Matters to a Vote of Security Holders*

At the Company’s Annual Meeting of Shareholders on April 26,2006, the following proposals were submitted to the Stockholders:

1.                Theelection of the following directors:

| **Director**               | ** ** | ** ** | ** ** | **For**   | ** ** | **Withheld** | ** ** |
|----------------------------|------------|------------|------------|-----------|------------|--------------|------------|
| Howard L.  Clark, Jr. |       | 28,047,725 |       | 9,526,731 |       |
| Gregory E. Hyland          |       | 36,690,717 |       | 883,739   |       |
| Jerry W. Kolb              |       | 37,036,135 |       | 538,321   |       |
| Patrick A. Kriegshauser    |       | 37,256,736 |       | 371,720   |       |
| Joseph B. Leonard          |       | 36,999,314 |       | 575,142   |       |
| Mark J. O’Brien       |       | 36,736,805 |       | 837,651   |       |
| Bernard G. Rethore         |       | 37,035,958 |       | 538,498   |       |
| Michael T. Tokarz          |       | 36,619,798 |       | 954,658   |       |

 

2.                A proposal toratify the appointment of PricewaterhouseCoopers LLP as independent certifiedpublic accountants for the year ending December 31, 2006: For, 36,698,335;Against, 873,909; Abstain, 2,212.

3.                Aproposal to approve the Walter Industries, Inc. Executive Incentive Plan:For, 29,539,341; Against, 7,871,010; Abstain, 164,104.

**Item 6.**                        *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***

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

WALTER INDUSTRIES, INC.
| /s/ W. F. OHRT                  |                                | /s/ LISA A.  HONNOLD |   |
|---------------------------------|-------------------------------------|----------------------|--------|
| W. F. Ohrt                      | Lisa A. Honnold                     |
| *Executive  Vice President and* | *Senior Vice President, Controller* |
| *Principal  Financial Officer*  | *and Principal Accounting Officer*  |

 

Date: August 9, 2006

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