**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, 2007**

**or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGEACT OF 1934

**CommissionFile Number 001-13711**

**WALTER INDUSTRIES, INC.**

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

 

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

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

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months, and (2) hasbeen subject to such filing requirements for the past 90 days. Yes x  No o.

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one): Large accelerated filer x  Acceleratedfiler o  Non-accelerated filer o

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act. (Check one):Yes o  No x.

There were 52,112,812 shares of common stock of theregistrant outstanding at July 31, 2007.

 

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**PART I—FINANCIALINFORMATION**

**ITEM1. FINANCIAL STATEMENTS**

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

| ** **                                                                               | ** ** | **June 30,**                                                                                                                                        | ** ** | **December 31,**                                                                                                                                    | ** ** |
|------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                               | ** ** | **            2007            ** | ** ** | **            2006            ** | ** ** |
| ** **                                                                               | ** ** | **(in thousands, except share amounts)**                                                                                             | ** ** |
| **ASSETS**                                                                               |       |                                                                                                                                                     |       |                                                                                                                                                     |       |   |   |   |   |
| Cash and cash equivalents                                                                |       |                                                                                                                                                     | $          | 39,491                                                                                                                                                   |       |   |   | $ | 127,369 |   |   |
| Short-term  investments, restricted                                                      |       |                                                                                                                                                     | 83,517     |                                                                                                                                                     |       |   | 90,042 |   |   |
| Instalment notes  receivable, net of allowance of $12,802 and $13,011, respectively |       |                                                                                                                                                     | 1,829,486  |                                                                                                                                                     |       |   | 1,779,697 |   |   |
| Receivables, net                                                                         |       |                                                                                                                                                     | 77,921     |                                                                                                                                                     |       |   | 85,094 |   |   |
| Inventories                                                                              |       |                                                                                                                                                     | 110,770    |                                                                                                                                                     |       |   | 105,527 |   |   |
| Prepaid expenses                                                                         |       |                                                                                                                                                     | 44,714     |                                                                                                                                                     |       |   | 29,727 |   |   |
| Property, plant  and equipment, net                                                      |       |                                                                                                                                                     | 349,151    |                                                                                                                                                     |       |   | 310,163 |   |   |
| Other long-term  assets                                                                  |       |                                                                                                                                                     | 170,490    |                                                                                                                                                     |       |   | 135,274 |   |   |
| Goodwill                                                                                 |       |                                                                                                                                                     | 10,895     |                                                                                                                                                     |       |   | 10,895 |   |   |
| Assets of  discontinued operations                                                       |       |                                                                                                                                                     | —     |                                                                                                                                                     |       |   | 10,327 |   |   |
|                                                                                     |       |                                                                                                                                                     | $          | 2,716,435                                                                                                                                                |       |   |   | $ | 2,684,115 |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                           |       |                                                                                                                                                     |       |                                                                                                                                                     |       |   |   |   |   |
| Accounts payable                                                                         |       |                                                                                                                                                     | $          | 59,937                                                                                                                                                   |       |   |   | $ | 62,323 |   |   |
| Accrued expenses                                                                         |       |                                                                                                                                                     | 71,210     |                                                                                                                                                     |       |   | 94,930 |   |   |
| Accrued interest  on debt                                                                |       |                                                                                                                                                     | 14,855     |                                                                                                                                                     |       |   | 17,053 |   |   |
| Debt:                                                                                    |       |                                                                                                                                                     |       |                                                                                                                                                     |       |   |   |   |   |
| Mortgage-backed/asset-backed notes                                                       |       |                                                                                                                                                     | 1,731,519  |                                                                                                                                                     |       |   | 1,736,706 |   |   |
| Corporate debt                                                                           |       |                                                                                                                                                     | 232,936    |                                                                                                                                                     |       |   | 249,491 |   |   |
| Accumulated  postretirement benefits obligation                                          |       |                                                                                                                                                     | 347,846    |                                                                                                                                                     |       |   | 330,241 |   |   |
| Other long-term  liabilities                                                             |       |                                                                                                                                                     | 214,535    |                                                                                                                                                     |       |   | 189,458 |   |   |
| Liabilities of  discontinued operations                                                  |       |                                                                                                                                                     | —     |                                                                                                                                                     |       |   | 2,005 |   |   |
| Total liabilities                                                                        |       |                                                                                                                                                     | 2,672,838  |                                                                                                                                                     |       |   | 2,682,207 |   |   |
| Commitments and contingencies (Note 14)                                                  |       |                                                                                                                                                     |       |                                                                                                                                                     |       |   |   |   |   |
| Stockholders’ equity                                                                |       |                                                                                                                                                     |       |                                                                                                                                                     |       |   |   |   |   |
| Common stock, $.01 par value per share:                                                  |       |                                                                                                                                                     |       |                                                                                                                                                     |       |   |   |   |   |
| Authorized—200,000,000 shares                                                       |       |                                                                                                                                                     |       |                                                                                                                                                     |       |   |   |   |   |
| Issued—52,108,586 and 72,730,770 shares                                             |       |                                                                                                                                                     | 521        |                                                                                                                                                     |       |   | 728 |   |   |
| Capital in excess of par value                                                           |       |                                                                                                                                                     | 501,192    |                                                                                                                                                     |       |   | 757,699 |   |   |
| Accumulated deficit                                                                      |       |                                                                                                                                                     | (355,309   | )                                                                                                                                                        |       |   | (398,564 | ) |   |
| Treasury stock—0 shares and 20,771,902 shares, at  cost                             |       |                                                                                                                                                     | —     |                                                                                                                                                     |       |   | (259,317 | ) |   |
| Accumulated other comprehensive loss                                                     |       |                                                                                                                                                     | (102,807   | )                                                                                                                                                        |       |   | (98,638 | ) |   |
| Total stockholders’ equity                                                          |       |                                                                                                                                                     | 43,597     |                                                                                                                                                     |       |   | 1,908 |   |   |
|                                                                                     |       |                                                                                                                                                     | $          | 2,716,435                                                                                                                                                |       |   |   | $ | 2,684,115 |   |   |

 

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,**                                                                                                | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                              | ** ** | **             2007             ** | ** ** | **             2006             ** | ** ** |
| ** **                                                                              | ** ** | **(in thousands, except per share amounts)**                                                                                                | ** ** |
| Net sales and revenues:                                                                 |       |                                                                                                                                                                 |       |   |   |   |   |   |   |
| Net sales                                                                               |       |                                                                                                                                                                 | $          | 239,146 |   |   |   | $ | 258,354 |   |   |
| Interest income on instalment notes                                                     |       |                                                                                                                                                                 | 50,662     |   |   |   | 50,937 |   |   |
| Miscellaneous                                                                           |       |                                                                                                                                                                 | 6,716      |   |   |   | 9,699 |   |   |
|                                                                                    |       |                                                                                                                                                                 | 296,524    |   |   |   | 318,990 |   |   |
| Costs and  expenses:                                                                    |       |                                                                                                                                                                 |       |   |   |   |   |   |   |
| Cost of sales (exclusive of depreciation)                                               |       |                                                                                                                                                                 | 174,457    |   |   |   | 168,359 |   |   |
| Depreciation                                                                            |       |                                                                                                                                                                 | 11,591     |   |   |   | 9,414 |   |   |
| Selling, general and administrative                                                     |       |                                                                                                                                                                 | 38,125     |   |   |   | 35,784 |   |   |
| Provision for losses on instalment notes                                                |       |                                                                                                                                                                 | 2,493      |   |   |   | 2,510 |   |   |
| Postretirement benefits                                                                 |       |                                                                                                                                                                 | 6,687      |   |   |   | 4,407 |   |   |
| Interest expense—mortgage-backed/asset-backed notes                                |       |                                                                                                                                                                 | 29,745     |   |   |   | 28,958 |   |   |
| Interest expense—corporate debt                                                    |       |                                                                                                                                                                 | 7,218      |   |   |   | 8,920 |   |   |
| Amortization of intangibles                                                             |       |                                                                                                                                                                 | 442        |   |   |   | 642 |   |   |
|                                                                                    |       |                                                                                                                                                                 | 270,758    |   |   |   | 258,994 |   |   |
| Income from continuing operations before income tax  expense and minority interest |       |                                                                                                                                                                 | 25,766     |   |   |   | 59,996 |   |   |
| Income tax  expense                                                                     |       |                                                                                                                                                                 | 7,996      |   |   |   | 16,737 |   |   |
| Income from  continuing operations before minority interest                             |       |                                                                                                                                                                 | 17,770     |   |   |   | 43,259 |   |   |
| Minority interest  in net loss of affiliate                                             |       |                                                                                                                                                                 | —     |   |   |   | 941 |   |   |
| Income from  continuing operations                                                      |       |                                                                                                                                                                 | 17,770     |   |   |   | 44,200 |   |   |
| Discontinued  operations                                                                |       |                                                                                                                                                                 | 281        |   |   |   | 19,761 |   |   |
| Net income                                                                              |       |                                                                                                                                                                 | $          | 18,051 |   |   |   | $ | 63,961 |   |   |
| Basic income per share:                                                                 |       |                                                                                                                                                                 |       |   |   |   |   |   |   |
| Income from continuing operations                                                       |       |                                                                                                                                                                 | $          | 0.34 |   |   |   | $ | 1.02 |   |   |
| Discontinued operations                                                                 |       |                                                                                                                                                                 | 0.01       |   |   |   | 0.45 |   |   |
| Net income                                                                              |       |                                                                                                                                                                 | $          | 0.35 |   |   |   | $ | 1.47 |   |   |
| Diluted income per share:                                                               |       |                                                                                                                                                                 |       |   |   |   |   |   |   |
| Income from continuing operations                                                       |       |                                                                                                                                                                 | $          | 0.33 |   |   |   | $ | 0.86 |   |   |
| Discontinued operations                                                                 |       |                                                                                                                                                                 | 0.01       |   |   |   | 0.38 |   |   |
| Net income                                                                              |       |                                                                                                                                                                 | $          | 0.34 |   |   |   | $ | 1.24 |   |   |
| Dividends  declared per common share                                                    |       |                                                                                                                                                                 | $          | 0.05 |   |   |   | $ | 0.04 |   |   |

 

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,**                                                                                                              | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **              2007              ** | ** ** | **              2006              ** | ** ** |
| ** **                                                                         | ** ** | **(in thousands, except per share amounts)**                                                                                                            | ** ** |
| Net sales and revenues:                                                            |       |                                                                                                                                                                             |       |   |   |   |   |   |   |
| Net sales                                                                          |       |                                                                                                                                                                             | $          | 498,533 |   |   |   | $ | 512,828 |   |   |
| Interest income on instalment notes                                                |       |                                                                                                                                                                             | 100,227    |   |   |   | 101,467 |   |   |
| Miscellaneous                                                                      |       |                                                                                                                                                                             | 18,058     |   |   |   | 17,769 |   |   |
|                                                                               |       |                                                                                                                                                                             | 616,818    |   |   |   | 632,064 |   |   |
| Costs and  expenses:                                                               |       |                                                                                                                                                                             |       |   |   |   |   |   |   |
| Cost of sales (exclusive of depreciation)                                          |       |                                                                                                                                                                             | 346,097    |   |   |   | 332,151 |   |   |
| Depreciation                                                                       |       |                                                                                                                                                                             | 22,221     |   |   |   | 17,848 |   |   |
| Selling, general and administrative                                                |       |                                                                                                                                                                             | 75,576     |   |   |   | 70,958 |   |   |
| Provision for losses on instalment notes                                           |       |                                                                                                                                                                             | 5,390      |   |   |   | 4,815 |   |   |
| Postretirement benefits                                                            |       |                                                                                                                                                                             | 13,019     |   |   |   | 8,814 |   |   |
| Interest expense—mortgage-backed/asset-backed notes                           |       |                                                                                                                                                                             | 59,516     |   |   |   | 58,934 |   |   |
| Interest expense—corporate debt                                               |       |                                                                                                                                                                             | 14,565     |   |   |   | 21,389 |   |   |
| Amortization of intangibles                                                        |       |                                                                                                                                                                             | 920        |   |   |   | 1,339 |   |   |
|                                                                               |       |                                                                                                                                                                             | 537,304    |   |   |   | 516,248 |   |   |
| Income from continuing operations before income tax  expense and minority interest |       |                                                                                                                                                                             | 79,514     |   |   |   | 115,816 |   |   |
| Income tax  expense                                                                |       |                                                                                                                                                                             | 29,609     |   |   |   | 35,807 |   |   |
| Income from  continuing operations before minority interest                        |       |                                                                                                                                                                             | 49,905     |   |   |   | 80,009 |   |   |
| Minority interest  in net loss of affiliate                                        |       |                                                                                                                                                                             | —     |   |   |   | 941 |   |   |
| Income from  continuing operations                                                 |       |                                                                                                                                                                             | 49,905     |   |   |   | 80,950 |   |   |
| Discontinued  operations                                                           |       |                                                                                                                                                                             | (2,229     | ) |   |   | 18,310 |   |   |
| Net income                                                                         |       |                                                                                                                                                                             | $          | 47,676 |   |   |   | $ | 99,260 |   |   |
| Basic income  (loss) per share:                                                    |       |                                                                                                                                                                             |       |   |   |   |   |   |   |
| Income from continuing operations                                                  |       |                                                                                                                                                                             | $          | 0.96 |   |   |   | $ | 1.93 |   |   |
| Discontinued operations                                                            |       |                                                                                                                                                                             | (0.04      | ) |   |   | 0.43 |   |   |
| Net income                                                                         |       |                                                                                                                                                                             | $          | 0.92 |   |   |   | $ | 2.36 |   |   |
| Diluted income  (loss) per share:                                                  |       |                                                                                                                                                                             |       |   |   |   |   |   |   |
| Income from continuing operations                                                  |       |                                                                                                                                                                             | $          | 0.95 |   |   |   | $ | 1.61 |   |   |
| Discontinued operations                                                            |       |                                                                                                                                                                             | (0.04      | ) |   |   | 0.36 |   |   |
| Net income                                                                         |       |                                                                                                                                                                             | $          | 0.91 |   |   |   | $ | 1.97 |   |   |
| Dividends  declared per common share                                               |       |                                                                                                                                                                             | $          | 0.10 |   |   |   | $ | 0.08 |   |   |

 

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 CHANGESIN STOCKHOLDERS’ EQUITY** AND COMPREHENSIVE INCOME FOR THE SIX MONTHS ENDED JUNE 30, 2007(UNAUDITED)(in thousands)

| ** **                                                                                           | ** ** | **Total** | ** ** | **Common  Stock** | ** ** | **Capital in  Excess of  Par Value** | ** ** | **Comprehensive  Income (Loss)** | ** ** | **Accumulated  Deficit** | ** ** | **Treasury  Stock** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-----------|------------|-------------------|------------|-----------------------------------------------------|------------|---------------------------------------|------------|--------------------------|------------|---------------------|------------|-----------------------------------------------------------|------------|
| Balance at December 31,  2006                                                                        | ** ** | $         | 1,908      |              |       | $                                                   | 728        |                                  |       |                     | $          | 757,699             | ** ** |                                                      |       |   |   |   |   | $ | (398,564 | ) |   | $ | (259,317 | ) |   | $ | (98,638 | ) |   |
| Adjustment to initially apply FIN 48                                                                 | ** ** | (4,421    | )          |              |       |                                                |       |                                  |       |                     |       |                |       |                                                      |       |   | (4,421 | ) |   |   |   |   |   |   |   |
| Adjusted balance at  January 1, 2007                                                            |       | $         | (2,513     | )                 |       | $                                                   | 728        |                                  |       |                     | $          | 757,699             |       |                                                      |       |   |   |   |   | $ | (402,985 | ) |   | $ | (259,317 | ) |   | $ | (98,638 | ) |   |
| Comprehensive  income:                                                                               |       |      |       |              |       |                                                |       |                                  |       |                     |       |                |       |                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                                           |       | 47,676    |       |              |       |                                                |       |                                  |       |                     |       |                | $          | 47,676                                                    |       |   |   | 47,676 |   |   |   |   |   |   |   |   |
| Other  comprehensive income (loss), net of tax:                                                 |       |      |       |              |       |                                                |       |                                  |       |                     |       |                |       |                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Amortization of prior service cost and net actuarial loss  on postretirement benefits obligation     |       | 4,051     |       |              |       |                                                |       |                                  |       |                     |       |                | 4,051      |                                                      |       |   |   |   |   |   |   |   | 4,051 |   |   |
| Increase in accumulated postretirement benefit  obligation for plan amendment after measurement date |       | (9,347    | )          |              |       |                                                |       |                                  |       |                     |       |                | (9,347     | )                                                         |       |   |   |   |   |   |   |   | (9,347 | ) |   |
| Net unrealized gain on  hedges                                                                       |       | 1,127     |       |              |       |                                                |       |                                  |       |                     |       |                | 1,127      |                                                      |       |   |   |   |   |   |   |   | 1,127 |   |   |
| Comprehensive income                                                                                 |       |      |       |              |       |                                                |       |                                  |       |                     |       |                | $          | 43,507                                                    |       |   |   |   |   |   |   |   |   |   |   |   |
| Retirement of treasury stock                                                                         |       | —    |       |              | (207       | )                                                   |       |                                  | (259,902   | )                        |       |                |       |                                                      |       |   |   |   |   | 260,109 |   |   |   |   |   |
| Stock issued upon the exercise of stock options                                                      |       | 643       |       |              |       |                                                |       |                                  | 643        |                     |       |                |       |                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Tax benefit from the exercise of stock options                                                  |       | 1,460     |       |              |       |                                                |       |                                  | 1,460      |                     |       |                |       |                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Dividends paid, $0.10 per  share                                                                     |       | (5,209    | )          |              |       |                                                |       |                                  | (5,209     | )                        |       |                |       |                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Stock-based compensation                                                                             |       | 6,501     |       |              |       |                                                |       |                                  | 6,501      |                     |       |                |       |                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Other                                                                                                |       | (792      | )          |              |       |                                                |       |                                  |       |                     |       |                |       |                                                      |       |   |   |   |   | (792 | ) |   |   |   |   |
| Balance at  June 30, 2007                                                                       |       | $         | 43,597     |              |       | $                                                   | 521        |                                  |       |                     | $          | 501,192             |       |                                                      |       |   |   |   |   | $ | (355,309 | ) |   | $ | — |   |   | $ | (102,807 | ) |   |

 

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,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2007**                                                        | ** ** | **2006** | ** ** |
| ** **                                                                                                 | ** ** | **(in thousands)**                                         | ** ** |
| OPERATING ACTIVITIES                                                                                       |       |                                                            |       |   |   |
| Net income                                                                                                 |       | $                                                               | 47,676     |   | $ | 99,260 |   |
| Loss (income) from  discontinued operations                                                                |       | 2,229                                                           |       | (18,310 | ) |
| Income from  continuing operations                                                                         |       | 49,905                                                          |       | 80,950 |   |
| Adjustments to reconcile income from continuing  operations to net cash provided by continuing operations: |       |                                                            |       |   |   |
| Provision for  losses on instalment notes receivable                                                       |       | 5,390                                                           |       | 4,815 |   |
| Depreciation                                                                                               |       | 22,221                                                          |       | 17,848 |   |
| Provision for (benefit  from) deferred income taxes                                                        |       | (12,454                                                         | )          | 14,167 |   |
| Other                                                                                                      |       | 17,256                                                          |       | 6,765 |   |
| Decrease (increase) in assets:                                                                             |       |                                                            |       |   |   |
| Receivables                                                                                                |       | 8,874                                                           |       | (29,011 | ) |
| Inventories                                                                                                |       | (5,175                                                          | )          | 536 |   |
| Prepaid expenses                                                                                           |       | (639                                                            | )          | 3,350 |   |
| Instalment notes  receivable, net                                                                          |       | (41,099                                                         | )          | (7,071 | ) |
| Increase (decrease) in liabilities:                                                                        |       |                                                            |       |   |   |
| Accounts payable                                                                                           |       | (2,888                                                          | )          | 457 |   |
| Accrued expenses                                                                                           |       | (23,852                                                         | )          | (10,768 | ) |
| Accrued interest                                                                                           |       | (2,198                                                          | )          | (2,176 | ) |
| Cash flows  provided by operating activities of continuing operations                                      |       | 15,341                                                          |       | 79,862 |   |
| INVESTING ACTIVITIES                                                                                       |       |                                                            |       |   |   |
| Purchases of loans                                                                                         |       | (34,988                                                         | )          | (70,614 | ) |
| Principal payments  received on purchased loans                                                            |       | 20,908                                                          |       | 18,458 |   |
| Decrease in  short-term investments, restricted                                                            |       | 6,525                                                           |       | 37,575 |   |
| Additions to  property, plant and equipment                                                                |       | (60,956                                                         | )          | (51,679 | ) |
| Escrow release  from prior acquisition                                                                     |       | —                                                          |       | 10,500 |   |
| Other                                                                                                      |       | 2,613                                                           |       | 1,921 |   |
| Cash flows used in  investing activities of continuing operations                                          |       | (65,898                                                         | )          | (53,839 | ) |
| FINANCING ACTIVITIES                                                                                       |       |                                                            |       |   |   |
| Issuance of  mortgage-backed/asset-backed notes                                                            |       | 113,350                                                         |       | 97,600 |   |
| Payments of  mortgage-backed/asset-backed notes                                                            |       | (118,598                                                        | )          | (126,080 | ) |
| Retirements of  corporate debt                                                                             |       | (29,071                                                         | )          | (123,847 | ) |
| Dividends paid                                                                                             |       | (5,209                                                          | )          | (3,309 | ) |
| Tax benefit on the  exercise of employee stock options                                                     |       | 1,460                                                           |       | 6,156 |   |
| Issuance of common  stock                                                                                  |       | —                                                          |       | 168,680 |   |
| Other                                                                                                      |       | 116                                                             |       | 12,293 |   |
| Cash flows  provided by (used in) financing activities of continuing operations                            |       | (37,952                                                         | )          | 31,493 |   |
| Cash flows  provided by (used in) continuing operations                                                    |       | $                                                               | (88,509    | ) | $ | 57,516 |   |
| CASH FLOWS FROM  DISCONTINUED OPERATIONS                                                                   |       |                                                            |       |   |   |
| Cash flows  provided by operating activities                                                               |       | $                                                               | 630        |   | $ | 27,256 |   |
| Cash flows used in  investing activities                                                                   |       | —                                                          |       | (45,913 | ) |
| Cash flows  provided by financing activities                                                               |       | —                                                          |       | 187,272 |   |
| Cash flows  provided by discontinued operations                                                            |       | $                                                               | 630        |   | $ | 168,615 |   |
| Net increase  (decrease) in cash and cash equivalents                                                      |       | $                                                               | (87,879    | ) | $ | 226,131 |   |
| Cash and cash  equivalents at beginning of period                                                          |       | $                                                               | 127,369    |   | $ | 64,424 |   |
| Add: Cash and cash  equivalents of discontinued operations at beginning of period                          |       | 1                                                               |       | 72,972 |   |
| Net increase  (decrease) in cash and cash equivalents                                                      |       | (87,879                                                         | )          | 226,131 |   |
| Less: Cash and  cash equivalents of discontinued operations at end of period                               |       | —                                                          |       | (251,708 | ) |
| Cash and cash  equivalents at end of period                                                                |       | $                                                               | 39,491     |   | $ | 111,819 |   |
| SUPPLEMENTAL DISCLOSURES                                                                                   |       |                                                            |       |   |   |
| Financing Activities:                                                                                      |       |                                                            |       |   |   |
| Non-cash transaction:                                                                                      |       |                                                            |       |   |   |
| One-year property  insurance policy financing agreement                                                    |       | $                                                               | 12,516     |   | $ | — |   |

 

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

5

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**WALTER INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSAS OF AND FOR THE SIX MONTHS ENDED**JUNE 30, 2007(Unaudited)

**Note 1—Basis ofPresentation**

Walter Industries, Inc. (“Walter”), together withits consolidated subsidiaries (“the Company”), is a diversified company whichoperates in five reportable segments: Natural Resources, Sloss, Financing,Homebuilding and Other, see Note 13. Through these operating segments, theCompany offers a diversified line of products and services including coal andnatural gas, furnace and foundry coke, slag fiber, mortgage financing and homeconstruction. In the fourth quarter of 2006, the Company began reporting Slossas a separate segment due to its significance in relation to all continuingoperating segments. Prior to the fourth quarter of 2006, Sloss was included inthe Other segment. Results for 2006 have been revised to reflect this change.

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 six monthperiod ended June 30, 2007 are not necessarily indicative of the resultsthat may be expected for the year ending December 31, 2007.

The balance sheet at December 31,2006 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—DiscontinuedOperations**

**Spin-off of MuellerWater Products, Inc.**

On December 14, 2006,the Company distributed all of its 85.8 millionshares of Mueller Water Products, Inc. (“Mueller Water”) Series Bcommon stock to its shareholders and no longer holds any interest in MuellerWater. As a result of the spin-off,Mueller Water’s previously reported 2006 results are presented as discontinuedoperations.

**Modular HomesDivision**

During the first quarter of 2007, the Company decidedto exit the manufacture and distribution of modular homes due to the poorperformance of this division, which operated as Crestline Homes, Inc. (“Crestline”).As such, the Company has reported the results of operations, assets,liabilities and cash flows of Crestline as discontinued operations for allperiods presented. Crestline’s results were previously reported in theHomebuilding segment. The Company recognized a pre-tax charge of $2.0 millionincluded in the loss from discontinued operations in the first quarter of 2007for severance liabilities and to write down the net assets to estimated fairvalue. In May 2007, the Company completed the sale of certain assets andliabilities of Crestline for$2.6 million. As a result of the sale, the Company reversed $1.3 million of thepreviously recorded severance liabilities and recognized an additional pre-taxgain on the sale of the net assets totaling $0.8 million in discontinuedoperations during the second quarter of 2007.

6

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Netsales and revenues and income from the discontinued operations of Mueller Waterand Crestline were as follows (in thousands):

| ** **                                                                           | ** ** | **For the three months  ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                                           | ** ** | **2007**                                                          | ** ** | **2006** | ** ** |
| Net sales and  revenues                                                              |       | $                                                                 | 5,317      |   | $ | 506,743 |   |
| Income from  discontinued operations before income tax expense and minority interest |       | 433                                                               |       | 36,037 |   |
| Income tax  expense                                                                  |       | (152                                                              | )          | (15,048 | ) |
| Minority interest  in net income of affiliate                                        |       | —                                                            |       | (1,228 | ) |
| Net income (loss) from  discontinued operations                                      |       | $                                                                 | 281        |   | $ | 19,761 |   |

 

| ** **                                                                                             | ** ** | **For the six months  ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                                                                             | ** ** | **2007**                                                        | ** ** | **2006** | ** ** |
| Net sales and  revenues                                                                                |       | $                                                               | 12,358     |   | $ | 946,938 |   |
| Income (loss) from  discontinued operations before income tax benefit (expense) and minority  interest |       | (3,428                                                          | )          | 33,695 |   |
| Income tax  benefit (expense)                                                                          |       | 1,199                                                           |       | (14,157 | ) |
| Minority interest  in net income of affiliate                                                          |       | —                                                          |       | (1,228 | ) |
| Net income (loss) from  discontinued operations                                                        |       | $                                                               | (2,229     | ) | $ | 18,310 |   |

 

The Company allocated certain corporate expenses,limited to specifically identified costs and other corporate shared serviceswhich supported segment operations, to discontinued operations. These costsrepresent expenses that have historically been allocated to and recorded by theCompany’s operating segments as selling, general and administrative expenses. TheCompany did not elect to allocate additional interest expense to discontinuedoperations.

Theassets and liabilities of Crestline included as discontinued operations in theconsolidated balance sheet as of December 31, 2006 are shown below (inthousands):

| ** **                          | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2006**              | ** ** |
| Cash and cash  equivalents          |       |                  | $          | 1 |   |   |
| Receivables, net                    |       |                  | 3,549      |   |   |
| Inventories                         |       |                  | 3,344      |   |   |
| Prepaid expenses                    |       |                  | 419        |   |   |
| Property, plant  and equipment, net |       |                  | 1,026      |   |   |
| Other long-term  assets             |       |                  | 1,988      |   |   |
| Total assets                        |       |                  | $          | 10,327 |   |   |
| Accounts payable                    |       |                  | $          | 383 |   |   |
| Accrued expenses                    |       |                  | 1,622      |   |   |
| Total liabilities                   |       |                  | $          | 2,005 |   |   |

 

**Note 3—Adoption ofNew Accounting Pronouncements**

On January 1, 2007, as required, the Companyadopted FASB Staff Position No. AUG AIR-1, “Accounting for Planned MajorMaintenance Activities” (“AUG AIR-1”), which provides guidance on which methodsare allowed to properly account for planned major maintenance activities. Theadoption of this statement did not have a material effect on the Company’soperating results, financial position or cash flows.

7

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On January 1, 2007, as required, the Companyadopted FASB Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes” (“FIN 48”). FIN 48 clarifies the accounting for income taxes byprescribing a minimum recognition threshold a tax position is required to meetbefore being recognized in the financial statements. FIN 48 also provides guidanceon derecognition, classification, interest and penalties, accounting in interimperiods, disclosure and transition. As a result of adoption, the Companyrecognized an increase of $4.4 million in the liability for unrecognized taxbenefits with a corresponding increase to the accumulated deficit as of January 1,2007. As of the date of adoption andafter the impact of recognizing the increase in liability noted above, theCompany’s liability for unrecognized tax benefits totaled $53.3 million, ofwhich $36.9 million, if recognized, would impact the effective rate. TheCompany does not anticipate any significant increase or decrease to theliability for unrecognized tax benefits during the next twelve months.

Also, as of the adoptiondate, the Company had accrued interest and penalties related to theunrecognized tax benefits of $67.3 million. The Company recognizes interestrelated to unrecognized tax benefits in interest expense and penalties inselling, general and administrative expenses. For the three months ended June 30,2007 and 2006, interest expense includes $2.3 million and $1.2 million,respectively, for interest accrued on the liability for unrecognized taxbenefits. For the six months ended June 30, 2007 and 2006, interestexpense includes $4.3 million and $2.3 million, respectively, for this accrual.

**Note 4—ConsolidatedStatements of Cash Flows**

The Company has revised its consolidated statement ofcash flows for the six months ended June 30, 2006 to reflect the netincrease or decrease in Financing’s instalment note receivable balance relatingto the portfolio of assets originated by Homebuilding as an element indetermining cash flows from operating activities. Previously, this item wasreported in investing activities. The previous cash flow treatment followed theCompany’s principal lines of business reporting; however, on a consolidatedbasis, there is no cash flow resulting from Financing’s purchase of instalmentnotes from Homebuilding. Financing’s purchases of loans from third parties, aswell as the principal portion of cash collections on those loans, remain ininvesting activities.

Prioramounts reported after restating for discontinued operations have been revisedas follows (in thousands):

| ** **                                                                    | ** ** | **For the six months ended** | ** ** |
|-------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                    | ** ** | **June 30, 2006**                      | ** ** |
| ** **                                                                    | ** ** | **Previous**                                     | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                                                    | ** ** | **Presentation**                                 | ** ** | **Change** | ** ** | **Revised** | ** ** |
| Instalment notes  receivable, net                                             |       |                                             | $          | — |   |   | $ | (7,071 | ) | $ | (7,071 | ) |
| Net cash provided  by operating activities of continuing operations           |       |                                             | $          | 86,933 |   |   | $ | (7,071 | ) | $ | 79,862 |   |
| Purchases of loans                                                            |       |                                             | $          | (278,669 | ) |   | $ | 208,055 |   | $ | (70,614 | ) |
| Principal  payments received on purchased loans                               |       |                                             | $          | 219,442 |   |   | $ | (200,984 | ) | $ | 18,458 |   |
| Net cash provided by  (used in) investing activities of continuing operations |       |                                             | $          | (60,910 | ) |   | $ | 7,071 |   | $ | (53,839 | ) |

 

**Note 5—SubsidiaryEquity Award**

Effective March 1,2007, JWH Holding Company, LLC, a wholly owned subsidiary of the Company,adopted the 2007 Long-term Incentive Award Plan (the “2007 Plan”) of JWHHolding Company, LLC, under which up to 20% of the LLC interest may be awardedor granted as incentive and non-qualified stock options to eligible employees,consultants and directors.

8

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**Note 6—RestrictedShort-Term Investments**

**Restrictedshort-term investments at June 30, 2007 and December 31, 2006 include(i) temporary investments primarily in commercial paper or money marketaccounts with maturities less than 90 days from collections on instalment notesreceivable owned by various Mid-State Trusts (the “Trusts”) ($75.7 millionand $84.0 million, respectively) which are available only to pay expenses ofthe Trusts and principal and interest on indebtedness of the Trusts, and (ii) miscellaneousother segregated accounts restricted to specific uses ($7.8 million and $6.0million, respectively).**

**Note 7—InstalmentNotes Receivable**

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

| ** **                   | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                   | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| Instalment notes  receivable |       | $                 | 1,599,917  |                  |       | $ | 1,578,760 |   |   |
| Mortgage loans               |       | 242,371           |       |                  | 213,948    |   |   |
| Less: Allowance  for losses  |       | (12,802           | )          |                  | (13,011    | ) |   |
| Net                          |       | $                 | 1,829,486  |                  |       | $ | 1,779,697 |   |   |

 

**Note 8—Inventories**

Inventoriesare summarized as follows (in thousands):

| ** **                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| Finished goods                      |       | $                 | 46,657     |                  |       | $ | 35,138 |   |   |
| Goods in process                    |       | 21,501            |       |                  | 25,830     |   |   |
| Raw materials and  supplies         |       | 15,978            |       |                  | 15,145     |   |   |
| Repossessed  houses held for resale |       | 26,634            |       |                  | 29,414     |   |   |
| Total inventories                   |       | $                 | 110,770    |                  |       | $ | 105,527 |   |   |

 

**Note 9—Debt andInterest Rate Hedge Agreements**

The Company has two variable funding loan facilitiestotaling $350.0 million that provide temporary financing to the Company’swholly owned subsidiary, Walter Mortgage Company, the successor by merger toMid-State Homes, Inc., for its current purchases of instalment notes fromHomebuilding and mortgage loans from originations and third party purchases. The$150.0 million Trust IX facility was renewed on July 30, 2007, undersubstantially similar terms as the previous facility, and matures July 28,2008. The $200.0 million Trust XIV facility will expire on November 27,2007 and the Company expects to renew this facility on similar terms prior toexpiration. At June 30, 2007, there were $113.4 million of borrowingsoutstanding under these facilities.

During June 2007 and July 2007,the Company entered into four interest rate hedge agreements with notionalvalues totaling $80.0 million such that the Company now has interest rate hedgeagreements with combined notional values totaling $215.0 million designed toprotect against changes in the benchmark interest rate on the forecastedissuance of mortgage-backed bonds anticipated to be issued in April 2008.The hedges will be settled on or before maturity and are being accounted for ascash flow hedges. As such, changes in the fair value of the hedges that takeplace through the date of maturity are recorded in accumulated othercomprehensive income (loss).

9

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**Note 10—Pension andOther Postretirement 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,**            | ** ** |
| ** **                                | ** ** | **2007**                                | ** ** | **2006**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
| Components of net  periodic benefit cost: |       |                                    |       |                                    |       |   |   |   |   |
| Service cost                              |       | $                                       | 1,014      |                                    | $          | 936 |   | $ | 783 |   | $ | 531 |   |
| Interest cost                             |       | 2,725                                   |       | 2,366                                   |       | 4,968 |   | 3,739 |   |
| Expected return  on plan assets           |       | (3,059                                  | )          | (2,846                                  | )          | — |   | — |   |
| Amortization of  prior service cost       |       | 104                                     |       | 104                                     |       | (887 | ) | (1,101 | ) |
| Amortization of  net actuarial loss       |       | 1,142                                   |       | 1,057                                   |       | 1,823 |   | 1,238 |   |
| Net periodic  benefit cost                |       | $                                       | 1,926      |                                    | $          | 1,617 |   | $ | 6,687 |   | $ | 4,407 |   |

 

| ** **                                | ** ** | **Pension Benefits**             | ** ** | **Other Benefits**               | ** ** |
|-------------------------------------------|------------|---------------------------------------|------------|---------------------------------------|------------|
| ** **                                | ** ** | **For the six months** | ** ** | **For the six months** | ** ** |
| ** **                                | ** ** | **ended June 30,**          | ** ** | **ended June 30,**          | ** ** |
| ** **                                | ** ** | **2007**                              | ** ** | **2006**                              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Components of net  periodic benefit cost: |       |                                  |       |                                  |       |   |   |   |   |
| Service cost                              |       | $                                     | 2,028      |                                  | $          | 1,872 |   | $ | 1,533 |   | $ | 1,062 |   |
| Interest cost                             |       | 5,450                                 |       | 4,732                                 |       | 9,771 |   | 7,478 |   |
| Expected return  on plan assets           |       | (6,118                                | )          | (5,692                                | )          | — |   | — |   |
| Amortization of  prior service cost       |       | 208                                   |       | 208                                   |       | (1,951 | ) | (2,202 | ) |
| Amortization of  net actuarial loss       |       | 2,285                                 |       | 2,114                                 |       | 3,666 |   | 2,476 |   |
| Net periodic  benefit cost                |       | $                                     | 3,853      |                                  | $          | 3,234 |   | $ | 13,019 |   | $ | 8,814 |   |

 

In January 2007, JimWalter Resources signed a new contract with the United Mine Workers of America(UMWA) which eliminated certain retiree deductible requirements for employeeswho are members of the UMWA. This enhanced employee benefit will increasepostretirement benefit costs by $1.3 million in 2007, the effect of which theCompany began recognizing in the second quarter of 2007. In addition, thereported accumulated postretirement benefits obligation increased $15.4 millionin the second quarter of 2007 as a result of this amendment.

**Note 11—ComprehensiveIncome**

Comprehensive income is comprised primarily of netincome, gains or losses from the effect of cash flow hedges and changes inaccumulated postretirement benefits obligations. Comprehensive income for thethree months ended June 30, 2007 and 2006 was $14.2 million and $68.3million, respectively. For the six months ended June 30, 2007 and 2006,comprehensive income was $43.5 million and $113.9 million, respectively.

10

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**Note 12—Net Income(Loss) Per Share**

Areconciliation of the basic and diluted net income (loss) per sharecomputations for the three and six months ended June 30, 2007 and 2006 areas follows (in thousands, except per share data):

| ** **                                                                      | ** ** | **For the three months ended June 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                      | ** ** | **2007**                                                              | ** ** | **2006** | ** ** |
| ** **                                                                      | ** ** | **Basic**                                                             | ** ** | **Diluted** | ** ** | **Basic** | ** ** | **Diluted** | ** ** |
| Numerator:                                                                      |       |                                                                  |       |   |   |   |   |   |   |
| Income from continuing  operations                                              |       | $                                                                     | 17,770     |   | $ | 17,770 |   | $ | 44,200 |   | $ | 44,200 |   |
| Effect of dilutive securities:                                                  |       |                                                                  |       |   |   |   |   |   |   |
| Interest related to  3.75% convertible senior subordinated notes, net of tax(a) |       | —                                                                |       | 5 |   | — |   | 904 |   |
|                                                                            |       | $17,770                                                               |       | $ | 17,775 |   | $ | 44,200 |   | $ | 45,104 |   |
| Income from discontinued  operations                                            |       | $                                                                     | 281        |   | $ | 281 |   | $ | 19,761 |   | $ | 19,761 |   |
| Denominator:                                                                    |       |                                                                  |       |   |   |   |   |   |   |
| Average number of common  shares outstanding                                    |       | 52,081                                                                |       | 52,081 |   | 43,530 |   | 43,530 |   |
| Effect of dilutive securities:                                                  |       |                                                                  |       |   |   |   |   |   |   |
| Stock options and  restricted stock units (“units”)(b)                |       | —                                                                |       | 410 |   | — |   | 330 |   |
| 3.75% convertible senior  subordinated notes(a)                                 |       | —                                                                |       | 84 |   | — |   | 8,315 |   |
|                                                                            |       | 52,081                                                                |       | 52,575 |   | 43,530 |   | 52,175 |   |
| Income from continuing  operations per share                                    |       | $                                                                     | 0.34       |   | $ | 0.33 |   | $ | 1.02 |   | $ | 0.86 |   |
| Income from discontinued  operations per share                                  |       | 0.01                                                                  |       | 0.01 |   | 0.45 |   | 0.38 |   |
| Net income per share                                                            |       | $                                                                     | 0.35       |   | $ | 0.34 |   | $ | 1.47 |   | $ | 1.24 |   |

 

| ** **                                                                      | ** ** | **For the six months ended June 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                                      | ** ** | **2007**                                                            | ** ** | **2006** | ** ** |
| ** **                                                                      | ** ** | **Basic**                                                           | ** ** | **Diluted** | ** ** | **Basic** | ** ** | **Diluted** | ** ** |
| Numerator:                                                                      |       |                                                                |       |   |   |   |   |   |   |
| Income from continuing  operations                                              |       | $                                                                   | 49,905     |   | $ | 49,905 |   | $ | 80,950 |   | $ | 80,950 |   |
| Effect of dilutive securities:                                                  |       |                                                                |       |   |   |   |   |   |   |
| Interest related to  3.75% convertible senior subordinated notes, net of tax(a) |       | —                                                              |       | 10 |   | — |   | 1,928 |   |
|                                                                            |       | $49,905                                                             |       | $ | 49,915 |   | $ | 80,950 |   | $ | 82,878 |   |
| Income (loss) from  discontinued operations                                     |       | $                                                                   | (2,229     | ) | $ | (2,229 | ) | $ | 18,310 |   | $ | 18,310 |   |
| Denominator:                                                                    |       |                                                                |       |   |   |   |   |   |   |
| Average number of common  shares outstanding                                    |       | 52,046                                                              |       | 52,046 |   | 42,025 |   | 42,025 |   |
| Effect of dilutive securities:                                                  |       |                                                                |       |   |   |   |   |   |   |
| Stock options and  restricted stock units (“units”)(b)                |       | —                                                              |       | 395 |   | — |   | 384 |   |
| 3.75% convertible senior  subordinated notes(a)                                 |       | —                                                              |       | 84 |   | — |   | 8,946 |   |
|                                                                            |       | 52,046                                                              |       | 52,525 |   | 42,025 |   | 51,355 |   |
| Income from continuing  operations per share                                    |       | $                                                                   | 0.96       |   | $ | 0.95 |   | $ | 1.93 |   | $ | 1.61 |   |
| Income (loss) from  discontinued operations per  share                          |       | (0.04                                                               | )          | (0.04 | ) | 0.43 |   | 0.36 |   |
| Net income per share                                                            |       | $                                                                   | 0.92       |   | $ | 0.91 |   | $ | 2.36 |   | $ | 1.97 |   |

 

----

(a)           Thenumerator represents the weighted-average interest, net of tax, and thedenominator represents the weighted-average shares issuable upon conversionrelated to the Company’s 3.75% contingent convertible senior subordinatednotes.

11

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(b)          Representsthe weighted average number of shares of common stock issuable on the exerciseof dilutive employee stock options and restricted stock units less the numberof shares of common stock which could have been purchased with the proceedsfrom the exercise of such stock awards. These purchases were assumed to havebeen made at the average market price of the common stock for the period.Weighted average number of stock options and restricted stock units outstandingfor the three months ended June 30, 2007 and 2006 totaling 578,491 and290,029, respectively, were excluded from the calculation above because theireffect would have been anti-dilutive. Additionally, weighted average number ofstock options and units outstanding for the six months ended June 30, 2007and 2006 totaling 784,569 and 180,230, respectively, were excluded becausetheir effect would have been anti-dilutive.

12

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**Note 13—SegmentInformation**

Summarizedfinancial information of the Company’s reportable segments is shown in thefollowing table (in thousands):

| ** **                                                                         | ** ** | **For the three months  ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                                          | ** ** | **2006** | ** ** |
| Net sales and revenues:                                                            |       |                                                              |       |   |   |
| Natural Resources                                                                  |       | $                                                                 | 137,490    |   | $ | 173,094 |   |
| Sloss                                                                              |       | 33,122                                                            |       | 34,912 |   |
| Natural Resources and Sloss                                                        |       | 170,612                                                           |       | 208,006 |   |
| Financing                                                                          |       | 55,046                                                            |       | 55,819 |   |
| Homebuilding                                                                       |       | 68,175                                                            |       | 54,925 |   |
| Financing and Homebuilding Group                                                   |       | 123,221                                                           |       | 110,744 |   |
| Other                                                                              |       | 4,965                                                             |       | 2,857 |   |
| Consolidating eliminations                                                         |       | (2,274                                                            | )          | (2,617 | ) |
| Net sales and revenues                                                             |       | $                                                                 | 296,524    |   | $ | 318,990 |   |
| Segment operating  income (loss) from continuing operations:                       |       |                                                              |       |   |   |
| Natural Resources                                                                  |       | $                                                                 | 21,764     |   | $ | 63,104 |   |
| Sloss                                                                              |       | 2,948                                                             |       | 2,077 |   |
| Natural Resources and Sloss                                                        |       | 24,712                                                            |       | 65,181 |   |
| Financing(a)                                                                       |       | 13,045                                                            |       | 13,358 |   |
| Homebuilding                                                                       |       | (467                                                              | )          | (4,394 | ) |
| Financing and Homebuilding Group                                                   |       | 12,578                                                            |       | 8,964 |   |
| Other                                                                              |       | (4,306                                                            | )          | (5,229 | ) |
| Consolidating eliminations                                                         |       | —                                                            |       | — |   |
| Operating income from continuing operations                                        |       | 32,984                                                            |       | 68,916 |   |
| Less corporate debt interest expense                                               |       | (7,218                                                            | )          | (8,920 | ) |
| Income from continuing operations before income tax  expense and minority interest |       | 25,766                                                            |       | 59,996 |   |
| Income tax expense                                                                 |       | 7,996                                                             |       | 16,737 |   |
| Income from continuing operations before minority  interest                        |       | 17,770                                                            |       | 43,259 |   |
| Minority interest                                                                  |       | —                                                            |       | 941 |   |
| Income from continuing operations                                                  |       | $                                                                 | 17,770     |   | $ | 44,200 |   |
| Depreciation:                                                                      |       |                                                              |       |   |   |
| Natural Resources                                                                  |       | $                                                                 | 8,696      |   | $ | 6,700 |   |
| Sloss                                                                              |       | 943                                                               |       | 908 |   |
| Natural Resources and Sloss                                                        |       | 9,639                                                             |       | 7,608 |   |
| Financing                                                                          |       | 273                                                               |       | 340 |   |
| Homebuilding                                                                       |       | 1,272                                                             |       | 1,098 |   |
| Financing and Homebuilding Group                                                   |       | 1,545                                                             |       | 1,438 |   |
| Other                                                                              |       | 407                                                               |       | 368 |   |
| Total                                                                              |       | $                                                                 | 11,591     |   | $ | 9,414 |   |

 

13

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| ** **                                                                         | ** ** | **For the six months  ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                                        | ** ** | **2006** | ** ** |
| Net sales and revenues:                                                            |       |                                                            |       |   |   |
| Natural Resources                                                                  |       | $                                                               | 307,665    |   | $ | 342,192 |   |
| Sloss                                                                              |       | 65,923                                                          |       | 68,197 |   |
| Natural Resources and Sloss                                                        |       | 373,588                                                         |       | 410,389 |   |
| Financing                                                                          |       | 108,793                                                         |       | 111,838 |   |
| Homebuilding                                                                       |       | 130,308                                                         |       | 110,213 |   |
| Financing and Homebuilding Group                                                   |       | 239,101                                                         |       | 222,051 |   |
| Other                                                                              |       | 8,483                                                           |       | 6,020 |   |
| Consolidating eliminations                                                         |       | (4,354                                                          | )          | (6,396 | ) |
| Net sales and revenues                                                             |       | $                                                               | 616,818    |   | $ | 632,064 |   |
| Segment operating  income (loss) from continuing operations:                       |       |                                                            |       |   |   |
| Natural Resources                                                                  |       | $                                                               | 78,205     |   | $ | 127,029 |   |
| Sloss                                                                              |       | 4,254                                                           |       | 4,259 |   |
| Natural Resources and Sloss                                                        |       | 82,459                                                          |       | 131,288 |   |
| Financing(a)                                                                       |       | 23,616                                                          |       | 26,350 |   |
| Homebuilding                                                                       |       | (3,145                                                          | )          | (9,245 | ) |
| Financing and Homebuilding Group                                                   |       | 20,471                                                          |       | 17,105 |   |
| Other                                                                              |       | (8,851                                                          | )          | (10,543 | ) |
| Consolidating eliminations                                                         |       | —                                                          |       | (645 | ) |
| Operating income from continuing operations                                        |       | 94,079                                                          |       | 137,205 |   |
| Less corporate debt interest expense                                               |       | (14,565                                                         | )          | (21,389 | ) |
| Income from continuing operations before income tax  expense and minority interest |       | 79,514                                                          |       | 115,816 |   |
| Income tax expense                                                                 |       | 29,609                                                          |       | 35,807 |   |
| Income from continuing operations before minority  interest                        |       | 49,905                                                          |       | 80,009 |   |
| Minority interest                                                                  |       | —                                                          |       | 941 |   |
| Income from continuing operations                                                  |       | $                                                               | 49,905     |   | $ | 80,950 |   |
| Depreciation:                                                                      |       |                                                            |       |   |   |
| Natural Resources                                                                  |       | $                                                               | 16,496     |   | $ | 12,545 |   |
| Sloss                                                                              |       | 1,859                                                           |       | 1,848 |   |
| Natural Resources and Sloss                                                        |       | 18,355                                                          |       | 14,393 |   |
| Financing                                                                          |       | 554                                                             |       | 682 |   |
| Homebuilding                                                                       |       | 2,506                                                           |       | 2,180 |   |
| Financing and Homebuilding Group                                                   |       | 3,060                                                           |       | 2,862 |   |
| Other                                                                              |       | 806                                                             |       | 593 |   |
| Total                                                                              |       | $                                                               | 22,221     |   | $ | 17,848 |   |

 

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(a)           Operatingincome amounts for Financing include interest expense on themortgage-backed/asset-backed notes of $29.7 million and $29.0 million for thethree months ended June 30, 2007 and 2006, respectively, and $59.5 millionand $58.9 million for the six months ended June 30, 2007 and 2006,respectively.

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**Note 14—Commitmentsand Contingencies**

*Income TaxLitigation*

The Company is currently under audit by the InternalRevenue Service (the “IRS”) for the years ended December 31, 2002 through December 31,2005. No material adjustments have been proposed as a result of these audits.

In 2006, the IRS completed an audit of the Company’sFederal income tax returns and issued a 30-day letter proposing taxdeficiencies in the amount of $82.2 million for the years ended May 31,2000, December 31, 2000 and December 31, 2001. The issues in the 30-dayletter relate primarily to the Company’s method of recognizing revenue on thesale of homes and related interest on the instalment notes receivable. Theitems at issue relate primarily to the timing of revenue recognition andconsequently, should the IRS prevail on its positions, the Company’s financialexposure is limited to interest and penalties.

On December 27, 1989, 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 the years ended August 31, 1980and August 31, 1983 through May 31, 1994. In connection with thebankruptcy proceedings, the IRS filed a proof of claim in the Bankruptcy Court(the “Proof of Claim”) for a substantial amount of taxes, interest andpenalties with respect to the years ended August 31, 1980 and August 31,1983 through May 31, 1994. The Company filed an adversary proceeding inthe Bankruptcy Court disputing the Proof of Claim (the “Adversary Proceeding”)and the various issues have been and are being litigated in the Bankruptcy 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 isdeductible in a particular year.

Consequently, the Company believes that, should theIRS prevail 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 which remain in dispute or are subject to appeal substantiallyoverstate the amount of taxes allegedly owed. 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.

15

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The Company believes thatall of its current and prior tax filing positions have substantial merit andintends to defend vigorously any tax claims asserted. The Company believes thatit has sufficient accruals to address any claims, including interest andpenalties.

*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 its plants, mines and other facilities andwith respect to remediating environmental conditions that may exist at its ownand other properties.

The Company believes that it is in substantialcompliance with federal, state and local environmental laws and regulations.The Company accrues for environmental expenses resulting from existingconditions that relate to past operations when the costs are probable andreasonably estimable.

Sloss and Walter Industries Inc. have received aletter from attorneys purporting to represent a group of residents of the NorthBirmingham area of Jefferson County, Alabama alleging personal injury, propertydamage, nuisance and trespass. The allegations against Sloss relate to airemissions from its coking facility. Walter is named in this litigation becauseof its ownership interest in Sloss. Management believes that if a suit is filedon these allegations, Sloss and Walter will have substantial defenses.

Sloss Industries enteredinto a decree order in 1989 relative to a Resource Conservation Recovery Act (“RCRA”)compliance program mandated by the EPA. A RCRA Facility Investigation (“RFI”)Work Plan was prepared which proposed investigative tasks to assess thepresence of contamination at the Sloss facility. The Work Plan was approved in1994 and the Phase I investigations were conducted and completed between 1995and 1999. Phase II investigations for the Chemical Plant/Coke Plant andBiological Treatment Facility and Sewers/Land Disposal Areas were performed in2000 and 2001 and are substantially complete. At the end of 2004, the EPAre-directed Sloss’ RFI efforts toward completion of the Environmental Indicator(“EI”) determinations for the Current Human Exposures. This EI effort wascompleted to assist the EPA in meeting goals set by the Government PerformanceResults Act (“GPRA”) for RCRA by 2005. Sloss implemented the approved EISampling Plan in April 2005. The EPA approved/finalized the EIdeterminations for Sloss’ Birmingham facility in September 2005. In aneffort to refocus the RFI, the EPA has now provided technical comments on thePhase II RFI report and the report recently submitted as part of the EI effort.A Phase III work plan was submitted to the EPA during the first quarter of 2007. The EPA has commented on the Phase III planand Sloss has responded. A meeting has been scheduled with the EPA for thethird quarter of 2007 in order to finalize the Phase III plan. Althoughno assurances can be given that the Company will not be required in the futureto make material expenditures relating to the Sloss site or other sites,management does not believe at this time that the cleanup costs, if any, associatedwith these sites will have a material adverse effect on the financial conditionof the Company, but such cleanup costs could be material to results ofoperations in a future reporting period.

*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 claimed that it was entitled toexclusive surface mining rights on certain lands owned by United LandCorporation, a wholly owned subsidiary of the Company. The Company filed acounterclaim seeking injunctive relief, substantial actual damages and punitivedamages against Drummond based on fraud. Drummond’s claims have been denied bythe Alabama Supreme Court. United Land’s counter claims are on appeal to theAlabama Supreme Court from a summary judgment ruling against them by the trialcourt.

16

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The Company and itssubsidiaries are parties to a number of other lawsuits arising in the ordinarycourse of their businesses. The Company records costs relating to these matterswhen a loss is probable and the amount is reasonably estimable. The effect ofthe outcome of these matters on the Company’s future results of operationscannot be predicted with certainty as any such effect depends on future resultsof operations and the amount and timing of the resolution of such matters.While the results of litigation cannot be predicted with certainty, the Companybelieves that the final outcome of such other litigation will not have amaterially adverse effect on the Company’s consolidated financial statements.

*Commitments andContingencies—Other*

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 15—IncomeTaxes**

The Company’s effective tax rate related to continuingoperations for the three and six months ended June 30, 2007 was 31.0% and37.2%, respectively comparedto 27.9% and 30.9% for the same periods in fiscal year 2006. Theincrease in the effective tax rate for the six months ended June 30, 2007as compared to the same period in 2006 is primarily due to the unfavorableimpact of a $4.4 million write-off in the first quarter of 2007 of certaindeferred tax assets no longer considered realizable. Excluding this unusualadjustment, the effective tax rate for the six months ended June 30, 2007is 31.7%. Both 2007 and 2006 effective tax rates differ from the Federalstatutory rate primarily due to the benefit from percentage depletiondeductions.

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

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

**RESULTS OFOPERATIONS**

**Summary Operating Results of Continuing Operations forthe Three Months Ended June 30, 2007 and 2006 **

| ** **                                             | ** ** | **For the three months ended June 30, 2007** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **Natural**                                                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Cons** | ** ** | ** ** | ** ** |
| ** **                                             | ** ** | **Resources**                                                                   | ** ** | **Sloss** | ** ** | **Financing** | ** ** | **Homebuilding** | ** ** | **Other** | ** ** | **Elims** | ** ** | **Total** | ** ** |
| ** **                                             | ** ** | **(in thousands)**                                                         | ** ** |
| Net sales                                              |       | $                                                                               | 135,174    |   | $ | 32,975 |   |   | $ | 3,360 |   |   |   | $ | 68,150 |   |   | $ | 1,761 |   | $ | (2,274 | ) | $ | 239,146 |   |
| Interest income  on instalment notes                   |       | —                                                                          |       | — |   |   | 50,662 |   |   |   | — |   |   | — |   | — |   | 50,662 |   |
| Miscellaneous income                                   |       | 2,316                                                                           |       | 147 |   |   | 1,024 |   |   |   | 25 |   |   | 3,204 |   | — |   | 6,716 |   |
| Net sales and revenues                                 |       | 137,490                                                                         |       | 33,122 |   |   | 55,046 |   |   |   | 68,175 |   |   | 4,965 |   | (2,274 | ) | 296,524 |   |
| Cost of sales                                          |       | 95,105                                                                          |       | 27,050 |   |   | 2,208 |   |   |   | 51,444 |   |   | 924 |   | (2,274 | ) | 174,457 |   |
| Interest  expense(1)                                   |       | —                                                                          |       | — |   |   | 29,745 |   |   |   | — |   |   | — |   | — |   | 29,745 |   |
| Depreciation                                           |       | 8,696                                                                           |       | 943 |   |   | 273 |   |   |   | 1,272 |   |   | 407 |   | — |   | 11,591 |   |
| Selling,  general & administrative            |       | 4,525                                                                           |       | 2,397 |   |   | 6,946 |   |   |   | 16,074 |   |   | 8,183 |   | — |   | 38,125 |   |
| Provision for  losses on instalment notes              |       | —                                                                          |       | — |   |   | 2,493 |   |   |   | — |   |   | — |   | — |   | 2,493 |   |
| Postretirement  benefits                               |       | 7,400                                                                           |       | (216 | ) |   | (106 | ) |   |   | (148 | ) |   | (243 | ) | — |   | 6,687 |   |
| Amortization of  intangibles                           |       | —                                                                          |       | — |   |   | 442 |   |   |   | — |   |   | — |   | — |   | 442 |   |
| Operating income (loss)                                |       | $                                                                               | 21,764     |   | $ | 2,948 |   |   | $ | 13,045 |   |   |   | $ | (467 | ) |   | $ | (4,306 | ) | $ | — |   | $ | 32,984 |   |
| Corporate debt interest expense                        |       |                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (7,218 | ) |
| Income from  continuing operations before income taxes |       |                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 25,766 |   |

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(1)          Excludes corporate debtinterest expense.

18

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| ** **                                                                   | ** ** | **For the three months ended June 30, 2006** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **Natural**                                                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Cons** | ** ** | ** ** | ** ** |
| ** **                                                                   | ** ** | **Resources**                                                                   | ** ** | **Sloss** | ** ** | **Financing** | ** ** | **Homebuilding** | ** ** | **Other** | ** ** | **Elims** | ** ** | **Total** | ** ** |
| ** **                                                                   | ** ** | **(in thousands)**                                                         | ** ** |
| Net sales                                                                    |       | $                                                                               | 167,726    |   | $ | 34,815 |   |   | $ | 3,434 |   |   |   | $ | 54,851 |   |   | $ | 145 |   | $ | (2,617 | ) | $ | 258,354 |   |
| Interest income  on instalment notes                                         |       | —                                                                          |       | — |   |   | 50,937 |   |   |   | — |   |   | — |   | — |   | 50,937 |   |
| Miscellaneous  income                                                        |       | 5,368                                                                           |       | 97 |   |   | 1,448 |   |   |   | 74 |   |   | 2,712 |   | — |   | 9,699 |   |
| Net sales and revenues                                                       |       | 173,094                                                                         |       | 34,912 |   |   | 55,819 |   |   |   | 54,925 |   |   | 2,857 |   | (2,617 | ) | 318,990 |   |
| Cost of sales                                                                |       | 93,730                                                                          |       | 29,109 |   |   | 2,905 |   |   |   | 44,294 |   |   | 938 |   | (2,617 | ) | 168,359 |   |
| Interest  expense(1)                                                         |       | —                                                                          |       | — |   |   | 28,958 |   |   |   | — |   |   | — |   | — |   | 28,958 |   |
| Depreciation                                                                 |       | 6,700                                                                           |       | 908 |   |   | 340 |   |   |   | 1,098 |   |   | 368 |   | — |   | 9,414 |   |
| Selling,  general & administrative                                  |       | 4,617                                                                           |       | 2,988 |   |   | 7,154 |   |   |   | 14,049 |   |   | 6,976 |   | — |   | 35,784 |   |
| Provision for  losses on instalment notes                                    |       | —                                                                          |       | — |   |   | 2,510 |   |   |   | — |   |   | — |   | — |   | 2,510 |   |
| Postretirement  benefits                                                     |       | 4,943                                                                           |       | (170 | ) |   | (48 | ) |   |   | (122 | ) |   | (196 | ) | — |   | 4,407 |   |
| Amortization of  intangibles                                                 |       | —                                                                          |       | — |   |   | 642 |   |   |   | — |   |   | — |   | — |   | 642 |   |
| Operating income (loss)                                                      |       | $                                                                               | 63,104     |   | $ | 2,077 |   |   | $ | 13,358 |   |   |   | $ | (4,394 | ) |   | $ | (5,229 | ) | $ | — |   | $ | 68,916 |   |
| Corporate debt interest expense                                              |       |                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (8,920 | ) |
| Income from  continuing operations before income taxes and minority interest |       |                                                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 59,996 |   |

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(1)          Excludescorporate debt interest expense.

*Overview*

The Company’s income from continuing operations forthe quarter ended June 30, 2007 was $17.8 million, or $0.33 per dilutedshare, compared to $44.2 million, or $0.86 per diluted share in the prior-yearperiod.

Net sales and revenues from continuing operations forthe second quarter totaled $296.5 million, down from $319.0 million in theprior-year period. The decline was primarily a result of lower metallurgicalcoal sales prices and volumes at Natural Resources, as well as higher demurragecharges. These negative comparisons were partially offset by higher pricing andincreased unit completions at Homebuilding.

Operating income fromcontinuing operations for the second quarter totaled $33.0 million compared to$68.9 million in the second quarter of 2006. Lower operating income in thecurrent-year period primarily reflects lower metallurgical coal pricing,worse-than-anticipated geologic conditions and, as a result, lower productionvolumes at Jim Walter Resources’ Mine No. 7 and increased losses at KodiakMining. The lower sales volumes and increases in production costs at Jim WalterResources during the current quarter were driven by hard bottom-rock conditionson Mine No. 7’s longwall panel. These adverse conditions causedsignificant downtime at Mine No. 7 and reduced its coal inventoryavailable for sale. At Kodiak Mining, low productivity and a $1.5 millioninventory write-off drove the unfavorable results. These negatives werepartially offset by improved results at Homebuilding.

19

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*Outlook andStrategic Initiatives*

**Natural Resourcesand Sloss**

·       TheCompany has a significant portion of its annual metallurgical coal productionunder contract for the 2007 - 2008 contract year, and the new contract pricingis expected to average approximately $101 per metric ton (equivalent toapproximately $92 per short ton), FOB Port of Mobile.

·       TheCompany expects coal production to total between 6.0 million and 6.3 milliontons in 2007, with production from Kodiak Mining LLC (“Kodiak”) expected tocontribute 0.1 million to 0.2 million tons. This projection is lower than thepreviously provided projection of 6.5 million to 6.9 million tons of coalproduction for 2007 which reflected estimated production from Kodiak at 0.4million tons.

·       Long-termcoal production estimates are as follows: 2008: 7.0 million to 7.5 million tons; 2009: 8.4 million to 9.0 milliontons; 2010:  9.1 million to 9.6 milliontons. These production estimates include 100% of Kodiak’s production. TheCompany believes it will recognize all of Kodiak’s production and operatingresults through 2010, as losses recognized by the Company have significantlyexceeded the venture partner’s initial investment. The growth in tonnage isexpected to result primarily from the Company’s Southwest “A” panel and theMine No. 7 East expansion.

·       TheCompany will continue to mine a thinner coal seam section of Mine No. 7’snorth panel through August 2007; however, the Company is nearing the endof this panel and plans to move the longwall in early September, resulting inthe mining of a thicker coal seam section throughout the fourth quarter of2007.

·       Production costs per ton,which excludes freight, royalties, selling, general and administrative expensesand postretirement benefits, are expected to be in the mid-to-high-$40-per-tonrange for the full year 2007.

·       At Kodiak, tons producedsince inception are significantly lower than originally projected. Factors suchas lower yields, significant equipment downtime and adverse geologicalconditions have all contributed to the shortfall. The Company is addressingthese issues and expects modest improvements in productivity and operatingresults during the second half of 2007.

·       The Company is optimisticabout the prospects for U.S. metallurgical coal producers. World crude steelproduction is up 8.4% for the first six months of 2007, driven by continuedincreases in worldwide demand. U.S. coal is attractive to South American andEuropean customers on a delivered basis as a result of higher ocean freightrates incurred by competitors in Australia. Production and quality problemsfrom some eastern European coal producers have led the Company’s strategiccustomers to seek out more U.S. supply. Australia continues to experiencelimited export capacity, and exchange rates are working in the Company’s favor,as international coal is traded in dollar-denominated contracts. NaturalResources continues to be positioned to provide high-quality coking coal tothese and other strategic markets in the future.

·       The Company is focused ongrowing its Natural Resources business internally and externally. Internalgrowth is expected from the Mine No. 7 East expansion project, which remainson track. The Company is also evaluating acquisition opportunities. The Company continuesto evaluate expansion opportunities, including potentialacquisitions and further investments in coal and natural gas.The Company routinely evaluates potential new coalreserves and also explores for natural gas to supplement its existingbusinesses, both within close proximity and outside of its existingoperations. While there are coal seams adjacent to Jim Walter Resources’mines that have substantially similar characteristics to the Company’s existingcoal products, there is no assurance that these coal seams would have economicviability. The Company is also exploring for additional 

20

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sources of natural gas within coal beds and various shalestrata at depths down to approximately 8,000 feet below the surface.Although natural gas is known to exist in many of thesestrata, there is no assurance that this exploration activity will resultin commercially viable operations.

**Homebuilding andFinancing**

·       The Company remains largelyinsulated from the weakness in the housing sector and the highly publicizedproblems in the mortgage finance industry. The Company’s Homebuilding businessdoes not own large tracts of land for subdivision development or inventories ofunsold homes. This eliminates the Company’s exposure to potential write-downsif home values decline. Unlike most of the industry, the Company’s uniqueFinancing business focuses on consistent underwriting processes, fixed rateproducts and a disciplined servicing platform that emphasizes direct customerinterface.

·       The portfolio performanceof the Company’s Financing business remains strong. The largely fixed-rateportfolio insulates the Company and its customers from defaults resulting frompayment shock associated with rising rates from adjustable rate mortgage(“ARM”) adjustments. Additionally, the servicing operation continues to deliveroutstanding results. Virtually all of the key barometers and metrics point to acontinuation of this performance in the future.

·       Prepayment speeds slowedsignificantly in the current period, reflecting rising mortgage interest ratesand the departure of numerous sub-prime lenders from the market. While slowerprepayment speeds hurt near-term income, it is positive for the mortgageportfolio over the long term.

·       Significant progress hasbeen made during the quarter to improve Homebuilding’s operating results. Marginexpansion continues as the Company’s construction process becomes moreefficient and price increases are further realized. The Company expects toachieve a profitable run-rate in 2007.

·       At June 30, 2007,there were 1,426 units in the backlog reflecting a 22.7% decrease versus theprior year. However, the dollar value of the backlog only declined 18.3% as aresult of price increases. Expected on-your-lot unit completion estimates havebeen reduced to a range of 2,500 to 2,700 for the full year 2007 as a result ofthe lower backlog.

·       During the first quarter of2007, the Company decided to exit the manufacture and distribution of modularhomes due to the poor performance of this division, which operated as CrestlineHomes, Inc. (“Crestline”). As such, the Company has reported the resultsof operations, assets, liabilities and cash flows of Crestline as discontinuedoperations for all periods presented. The Company recognized a pre-tax chargeof $2.0 million included in the loss from discontinued operations in the firstquarter of 2007 for severance liabilities and to write down the net assets toestimated fair value. In May 2007, the Company completed the sale ofcertain assets and liabilities of Crestline for $2.6 million. As a result ofthe sale, the Company reversed $1.3 million of the previously recordedseverance liabilities and recognized an additional pre-tax gain on the sale ofthe net assets totaling $0.8 million in discontinued operations during thesecond quarter of 2007.

·       TheCompany continues to evaluate various strategies to separate its Financing andHomebuilding businesses from its Natural Resources group; however, the timingand form of the separation cannot be determined at this time.

**Other**

·       Accumulated otherpostretirement benefits obligations increased $15.4 million in the secondquarter of 2007 and postretirement benefits expense will increase by anadditional $1.3 million in 2007 resulting from updated actuarial information,see Note 10.

21

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*Summary of SecondQuarter Consolidated Results of Continuing Operations*

Net sales and revenues for the three months ended June 30,2007 were $296.5 million. Revenues decreased by $22.5 million, or 7.0% from$319.0 million in the prior-year period. Decreased revenues are primarilyattributable to lower metallurgical coal sales prices and volumes at NaturalResources, partially offset by increased unit completions and higher averagenet selling prices in the Homebuilding segment.

Cost of sales, exclusive of depreciation, increased$6.1 million to $174.5 million and represented 73.0% of net sales in 2007versus $168.4 million, or 65.2% of net sales in the prior year. The increase inthe percentage in 2007 was primarily the result of higher production anddemurrage charges recognized at Natural Resources, partially offset by areduction in the percentage at Homebuilding from 80.8% in 2006 to 75.5% in thecurrent-year period.

Depreciation for the three months ended June 30,2007 was $11.6 million, an increase of $2.2 million compared to the prior-yearperiod. The increase is primarily due to the Company’s continued investment inthe expansion of Natural Resources’ mine operations and the replacement ofmining equipment.

Selling, general and administrative expenses of $38.1million were 12.9% of net sales and revenues in 2007, compared to $35.8 millionand 11.2% in 2006. The increase was primarily attributable to increased stockaward expense, increased advertising at Homebuilding and increased legal andenvironmental expenses at Sloss. A $1.1 million of impairment charge related tothe 2006 sale of the chemical division was included in the prior-year period.

Postretirement benefits expense increased to $6.7million in the 2007 period, compared to $4.4 million in the 2006 period,primarily due to an unfavorable change in actuarial assumptions year over yearand a plan amendment resulting from the new contract with the United MineWorkers of America.

Interest expense for the mortgage-backed/asset-backednotes increased to $29.7 million compared to $29.0 million the same period in2006 as a result of an increase in the average debt balance for the threemonths ended June 30, 2007, partially offset by a reduction in theeffective interest rate.

Interest expense on corporate debt decreased $1.7million to $7.2 million primarily as a result of reduced bank debt outstandingcompared to the same period in 2006 and the conversion of nearly all of theCompany’s convertible senior subordinated debt into equity in the fourthquarter of 2006.

The current-year andprior-year period results also include the impact of the factors discussed inthe following segment analysis.

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*Segment Analysis*

**Natural Resources**

NaturalResources, which includes the operations of Jim Walter Resources and KodiakMining, reported revenues of $137.5 million in the second quarter, down $35.6million versus the same period last year. The decline in revenues wasprincipally driven by a $15.26 per ton reduction in metallurgical coal pricesversus the prior-year period, as well as a 110,000-ton decline in coalsales volumes. Lower coal prices include the impact of reduced contract pricingand increased demurrage charges. Lower revenues also reflect a decline innatural gas volumes and pricing.

| ** **                                                | ** ** | **Three months ended** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                | ** ** | **June 30,**                | ** ** |
| ** **                                                | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| Average  Metallurgical Coal Selling Price (per short ton) |       | $                                | 94.29      |   | $ | 109.55 |   |
| Tons of Coal Sold  (in thousands)                         |       | 1,301                            |       | 1,411 |   |
| Average Natural  Gas Selling Price (per MCF)              |       | $                                | 7.96       |   | $ | 8.49 |   |
| Billion Cubic  Feet of Natural Gas Sold                   |       | 1.8                              |       | 2.0 |   |
| Number of Natural Gas  Wells                              |       | 427                              |       | 414 |   |

 

The Natural Resources segment reported operatingincome of $21.8 million in the second quarter, compared to $63.1 million in theprior-year period. Results in the current-year period include lower coal andgas sales volumes and pricing, increased production costs at Mine No. 7,higher labor costs and $5.7 million of operating losses at Kodiak Mining.

Production costs at Mine No. 7were $71.23 per ton versus $39.76 per ton in the prior-year period, primarilyreflecting additional spending due to a shift in mix to higher-cost continuousminer tons, approximately $8.70 per ton due to lower volumes produced and $3.50per ton for higher UMWA contract labor costs. Three incremental continuousminer units were operated at Mine No. 7 during the second quarter versusthe same period last year, two of which are developing the Southwest “A” panel.This development work increased spending by approximately $13.60 per ton atMine No. 7 in the second quarter and will set the stage for incremental,lower-cost longwall production in 2008.

**Sloss**

Sloss generated secondquarter revenues of $33.1 million, down $1.8 million from the prior-yearperiod, and operating income of $2.9 million, up $0.9 million from theprior-year period. Results in the prior-year period included a $1.1 millionasset impairment charge related to the segment’s chemicals business, which wassold in November 2006.

**Financing**

Net sales and revenues were $55.0 million in thesecond quarter, a decrease of $0.8 million from the prior-year period. Thisdecrease is primarily attributable to lower prepayment-related interest incomeresulting from rising mortgage interest rates and the departure of numeroussub-prime lenders from the market which significantly slowed refinancingactivity. Operating income was $13.0 million in the current-year period,compared to $13.4 million in the prior-year period. The decrease in operatingincome is primarily a result of lower prepayment income and increased stockoption expense, partially offset by increased net interest margin fromyear-over-year portfolio growth.

Delinquencies (the percentage of amounts outstandingover 30 days past due) were 3.8% at June 30, 2007, down from 4.0% at June 30,2006, primarily as a result of consistent underwriting and a strong mortgageservicing platform. As compared to the first quarter of 2007, delinquenciesrose slightly, representing a typical seasonal increase. The calculation ofdelinquencies excludes from delinquent 

23

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amounts those accountsthat are in bankruptcy proceedings that are paying their mortgage payments incontractual compliance with bankruptcy court approved mortgage paymentobligations.

The number of repossessedunits declined 14.2% and Real Estate Owned (“REO”) inventory as a percent ofthe total mortgage portfolio declined 13.2% versus the second quarter lastyear.

**Homebuilding**

Netsales and revenues were $68.2 million for the second quarter, an increase of$13.3 million from the prior-year period as a result of higher averageon-your-lot selling prices and unit completions. For the current period, newsales orders, net of cancellations, were up 7.2% compared to the second quarterlast year.

| ** **                 | ** ** | **Three months ended** | ** ** |
|----------------------------|------------|----------------------------------|------------|
| ** **                 | ** ** | **June 30,**                | ** ** |
| ** **                 | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| Unit completions           |       | 689                              |       | 632 |   |
| Average net selling  price |       | $                                | 98,911     |   | $ | 86,790 |   |
|                            |            |                                  |            |  |  |  |  |

 

Homebuilding’s operatingloss was $0.5 million for the three months ended June 30, 2007 compared toan operating loss of $4.4 million for the same period in 2006 reflectingnumerous improvements implemented to raise pricing, eliminate the backlog oflow-margin units, speed up cycle times and enhance construction quality.

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**Other**

Results in the “Other”segment, comprised of the Company’s corporate expenses and land subsidiaries,improved by approximately $0.9 million in the second quarter of 2007 over theprior-year period, driven by higher interest income.

**RESULTS OF OPERATIONS**

**Summary Operating Results of Continuing Operations forthe Six Months Ended June 30, 2007 and 2006**

| ** **                                             | ** ** | **For the six months ended June 30, 2007** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **Natural  Resources**                                                        | ** ** | **Sloss** | ** ** | **Financing** | ** ** | **Homebuilding** | ** ** | **Other** | ** ** | **Cons  Elims** | ** ** | **Total** | ** ** |
| ** **                                             | ** ** | **(in thousands)**                                                       | ** ** |
| Net sales                                              |       |                                                                          | $          | 297,818 |   |   | $ | 65,539 |   |   | $ | 6,433 |   |   |   | $ | 130,259 |   |   | $ | 2,838 |   | $ | (4,354 | ) | $ | 498,533 |   |
| Interest income on  instalment notes                   |       |                                                                          | —     |   |   | — |   |   | 100,227 |   |   |   | — |   |   | — |   | — |   | 100,227 |   |
| Miscellaneous  income                                  |       |                                                                          | 9,847      |   |   | 384 |   |   | 2,133 |   |   |   | 49 |   |   | 5,645 |   | — |   | 18,058 |   |
| Net sales and  revenues                                |       |                                                                          | 307,665    |   |   | 65,923 |   |   | 108,793 |   |   |   | 130,308 |   |   | 8,483 |   | (4,354 | ) | 616,818 |   |
| Cost of sales                                          |       |                                                                          | 190,023    |   |   | 55,361 |   |   | 4,005 |   |   |   | 99,418 |   |   | 1,644 |   | (4,354 | ) | 346,097 |   |
| Interest  expense(1)                                   |       |                                                                          | —     |   |   | — |   |   | 59,516 |   |   |   | — |   |   | — |   | — |   | 59,516 |   |
| Depreciation                                           |       |                                                                          | 16,496     |   |   | 1,859 |   |   | 554 |   |   |   | 2,506 |   |   | 806 |   | — |   | 22,221 |   |
| Selling,  general & administrative            |       |                                                                          | 8,494      |   |   | 4,881 |   |   | 15,004 |   |   |   | 31,825 |   |   | 15,372 |   | — |   | 75,576 |   |
| Provision for  losses on instalment notes              |       |                                                                          | —     |   |   | — |   |   | 5,390 |   |   |   | — |   |   | — |   | — |   | 5,390 |   |
| Postretirement  benefits                               |       |                                                                          | 14,447     |   |   | (432 | ) |   | (212 | ) |   |   | (296 | ) |   | (488 | ) | — |   | 13,019 |   |
| Amortization of  intangibles                           |       |                                                                          | —     |   |   | — |   |   | 920 |   |   |   | — |   |   | — |   | — |   | 920 |   |
| Operating income  (loss)                               |       |                                                                          | $          | 78,205 |   |   | $ | 4,254 |   |   | $ | 23,616 |   |   |   | $ | (3,145 | ) |   | $ | (8,851 | ) | $ | — |   | $ | 94,079 |   |
| Corporate debt  interest expense                       |       |                                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (14,565 | ) |
| Income from  continuing operations before income taxes |       |                                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 79,514 |   |

----

(1)             Excludes corporate debt interest expense.

| ** **                                                                   | ** ** | **For the six months ended June 30, 2006** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **Natural  Resources**                                                        | ** ** | **Sloss** | ** ** | **Financing** | ** ** | **Homebuilding** | ** ** | **Other** | ** ** | **Cons  Elims** | ** ** | **Total** | ** ** |
| ** **                                                                   | ** ** | **(in thousands)**                                                       | ** ** |
| Net sales                                                                    |       |                                                                          | $          | 332,589 |   |   | $ | 67,969 |   |   | $ | 7,024 |   |   |   | $ | 109,957 |   |   | $ | 395 |   | $ | (5,106 | ) | $ | 512,828 |   |
| Interest income on  instalment notes                                         |       |                                                                          | —     |   |   | — |   |   | 101,467 |   |   |   | — |   |   | — |   | — |   | 101,467 |   |
| Miscellaneous  income                                                        |       |                                                                          | 9,603      |   |   | 228 |   |   | 3,347 |   |   |   | 256 |   |   | 5,625 |   | (1,290 | ) | 17,769 |   |
| Net sales and revenues                                                       |       |                                                                          | 342,192    |   |   | 68,197 |   |   | 111,838 |   |   |   | 110,213 |   |   | 6,020 |   | (6,396 | ) | 632,064 |   |
| Cost of sales                                                                |       |                                                                          | 183,964    |   |   | 57,448 |   |   | 6,100 |   |   |   | 88,647 |   |   | 1,743 |   | (5,751 | ) | 332,151 |   |
| Interest  expense(1)                                                         |       |                                                                          | —     |   |   | — |   |   | 58,934 |   |   |   | — |   |   | — |   | — |   | 58,934 |   |
| Depreciation                                                                 |       |                                                                          | 12,545     |   |   | 1,848 |   |   | 682 |   |   |   | 2,180 |   |   | 593 |   | — |   | 17,848 |   |
| Selling,  general & administrative                                  |       |                                                                          | 8,768      |   |   | 4,982 |   |   | 13,714 |   |   |   | 28,875 |   |   | 14,619 |   | — |   | 70,958 |   |
| Provision for  losses on instalment notes                                    |       |                                                                          | —     |   |   | — |   |   | 4,815 |   |   |   | — |   |   | — |   | — |   | 4,815 |   |
| Postretirement  benefits                                                     |       |                                                                          | 9,886      |   |   | (340 | ) |   | (96 | ) |   |   | (244 | ) |   | (392 | ) | — |   | 8,814 |   |
| Amortization of  intangibles                                                 |       |                                                                          | —     |   |   | — |   |   | 1,339 |   |   |   | — |   |   | — |   | — |   | 1,339 |   |
| Operating income  (loss)                                                     |       |                                                                          | $          | 127,029 |   |   | $ | 4,259 |   |   | $ | 26,350 |   |   |   | $ | (9,245 | ) |   | $ | (10,543 | ) | $ | (645 | ) | $ | 137,205 |   |
| Corporate debt  interest expense                                             |       |                                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (21,389 | ) |
| Income from  continuing operations before income taxes and minority interest |       |                                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 115,816 |   |

----

(1)             Excludes corporate debt interest expense.

*Summary of Year toDate Consolidated Results of Continuing Operations*

Net sales and revenues for the six months ended June 30,2007 were $616.8 million. Revenues decreased by $15.3 million, or 2.4% from$632.1 million in the prior-year period. Decreased revenues are primarilyattributable to lower coal sales volumes and pricing at Natural Resources and,to a lesser extent, due to decreased revenues in the Financing and Slosssegments. These decreases were offset in part by 

25

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increased revenues fromHomebuilding primarily due to increased unit completions and higher average netselling prices.

Cost of sales, exclusiveof depreciation, increased $13.9 million to $346.1 million and represented69.4% of net sales in 2007 versus $332.2 million and 64.8% of net sales in theprior year. The increase in the percentage in 2007 was primarily the result ofhigher production and demurrage charges recognized at Natural Resources,partially offset by improvements at Homebuilding where cost of sales, exclusiveof depreciation, as a percentage of net sales decreased from 80.6% to 76.3%.

Depreciation for the sixmonths ended June 30, 2007 was $22.2 million, an increase of $4.4 millioncompared to the prior-year period. The increase is primarily due to the Company’scontinued investment in the expansion of Natural Resources’ mine operations andreplacement of mining equipment.

Selling, general andadministrative expenses of $75.6 million were 12.3% of net sales and revenuesin 2007, compared to $71.0 million and 11.2% in 2006. The increase wasprimarily attributable to increased stock award expense, increased advertisingat Homebuilding and increased employee healthcare costs.

Postretirement benefitsexpense increased to $13.0 million in the 2007 period, compared to $8.8 millionin the 2006 period, primarily due to an unfavorable change in actuarialassumptions year over year and a plan amendment resulting from the new contractwith the United Mine Workers of America.

Interest expense for themortgage-backed/ asset-backed notes increased $0.6 million to $59.5 millioncompared to $58.9 million the same period in 2006 reflecting an increase in theaverage year-to-date debt balance partially offset by a reduction in theeffective interest rate.

Interest expense oncorporate debt decreased $6.8 million to $14.6 million primarily as a result ofreduced bank debt outstanding compared to the same period in 2006 and theconversion of nearly all of the Company’s convertible senior subordinated debtinto equity in the fourth quarter of 2006, offset in part by an increase in theeffective interest rate.

The Company’s effectivetax rate related to continuing operations for the six months ended June 30,2007 and 2006 was 37.2% and 30.9%, respectively. The increase in the effectivetax rate in 2007 is primarily due to the unfavorable impact of a $4.4 millionwrite-off in the first quarter of 2007 of certain deferred tax assets no longerconsidered realizable. Excluding this unusual adjustment, the effective taxrate for 2007 is 31.7%. Both 2007 and 2006 differ from the Federal statutoryrate primarily due to the benefit from percentage depletion deductions.

The current and prior-yearperiod results also include the impact of the factors discussed in thefollowing segment analysis.

*Segment Analysis*

**Natural Resources**

Natural Resources, whichincludes the operations of Jim Walter Resources and Kodiak Mining, reportedrevenues of $307.7 million in the six months ended June 30, 2007, down$34.5 million versus the same period last year. The decline in revenues wasdriven in part by a $13.47 per ton reduction in metallurgical coal pricesversus the prior-year period, as well as a 132,000-ton decline in coalsales volumes. Lower revenues also reflect a decline in natural gas volumes andpricing.

| ** **                                                | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                | ** ** | **2007**                                      | ** ** | **2006** | ** ** |
| Average Metallurgical Coal Selling Price (per short  ton) |       | $                                             | 97.55      |   | $ | 111.02 |   |
| Tons of Coal Sold (in thousands)                          |       | 2,823                                         |       | 2,955 |   |
| Average Natural Gas Selling Price (per MCF)               |       | $                                             | 7.94       |   | $ | 8.88 |   |
| Billion Cubic Feet of Natural Gas Sold                    |       | 3.6                                           |       | 3.8 |   |
| Number of Natural Gas Wells                               |       | 427                                           |       | 414 |   |

 

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Natural Resources reportedoperating income of $78.2 million for the six month period in 2007, compared to$127.0 million in the prior-year period. Results in the current-year periodinclude lower coal and gas sales volumes and pricing, higher production andlabor costs at Jim Walter Resources and $8.9 million of pre-tax losses atKodiak Mining. Kodiak’s losses reflect difficult geological conditions and slowadvance rates. Additionally, Kodiak wrote off $1.5 million of inventory in thesecond quarter of 2007 as a result of lower-than-expected yields from the mine.

**Sloss**

Net sales and revenueswere $65.9 million for the six months ended June 30, 2007, a decrease of$2.3 million compared to the prior-year period. The prior-year period included$4.8 million of revenues from the chemical business, which was sold in November 2006.This unfavorable variance was partially offset by increased furnace and foundrycoke volumes for the six months ended June 2007. Operating income of $4.3million for the six months ended June 30, 2007 was comparable to the same periodin 2006.

**Financing**

Net sales and revenueswere $108.8 million for the six months ended June 30, 2007, a decrease of$3.0 million from the prior-year period. This decrease is primarilyattributable to lower prepayment-related interest income resulting fromindustry-wide tightened underwriting standards which significantly slowedrefinancing activity. Operating income was $23.6 million in 2007, compared to$26.4 million in 2006. The decrease in operating income reflects this lowerprepayment income, as well as increases in the stock option expense and theprovision for losses on instalment notes.

**Homebuilding**

Netsales and revenues were $130.3 million for the six months ended June 30,2007, an increase of $20.1 million from the six months ended June 30, 2006predominantly due to higher average net selling prices, which increased 15.2%over the prior-year period, and, to a lesser extent, from higher unitcompletions.

| ** **                 | ** ** | **Six months ended  June 30,** | ** ** |
|----------------------------|------------|-----------------------------------------------|------------|
| ** **                 | ** ** | **2007**                                      | ** ** | **2006** | ** ** |
| Unit completions           |       | 1,323                                         |       | 1,286 |   |
| Average net selling  price |       | $                                             | 98,458     |   | $ | 85,504 |   |
|                            |            |                                               |            |  |  |  |  |

 

Homebuilding’s operatingloss of $3.1 million for the six months ended June 30, 2007 improved $6.1million when compared to an operating loss of $9.2 million for the six monthsended June 30, 2006. The improved performance in 2007 was due to improvedgross margins resulting from decreased cycle times, better pricing and someimprovement in materials costs, partially offset by an increase in selling,general and administrative expenses resulting from increased stock option andadvertising expenses.

**Other**

Results in the “Other”segment, comprised of the Company’s corporate expenses and land subsidiaries,improved by $1.7 million in the six month period ended June 30, 2007,driven by higher land sales.

**FINANCIAL CONDITION**

Cash and cash equivalents of continuing operationsdecreased from $127.4 million at December 31, 2006 to $39.5 million at June 30,2007 resulting from $15.3 million in cash flows provided by continuing 

27

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operating activities,$65.9 million of cash flows used in investing activities of continuingoperations, $37.9 million of cash flows used in financing activities ofcontinuing operations and $0.6 million in cash flows provided by discontinuedoperating activities. See additional discussion in the Statement of Cash Flowssection that follows.

Prepaid expenses were $44.7 million at June 30,2007, an increase of $15.0 million from December 31, 2006 primarily as aresult of the June 2007 annual renewal of property insurance for $12.5million and increased longwall move prepayments.

Other long-term assets were $170.5 million at June 30,2007, up $35.2 million from December 31, 2006 predominantly due to anincrease in the Company’s deferred tax assets as a result of initially applyingFIN 48 on January 1, 2007 and increased deferred tax assetsestablished for postretirement benefits accruals.

Accrued expenses of $71.2 million at June 30,2007 decreased from $94.9 million at December 31, 2006 due to a decreasein current taxes payable and accrued bonuses resulting from payments in thefirst half of 2007 for accruals established in 2006.

Other long-termliabilities increased $25.1 million from $189.5 million at December 31,2006 primarily as a result of adjustments made to initially apply FIN 48 on January 1,2007, which required an increase of $30.9 million to the liability forunrecognized tax benefits, offset in part by a reduction in the accrued pensionliability due to $7.7 million of payments made in the first half of 2007 tofund the plans.

**LIQUIDITY ANDCAPITAL RESOURCES**

*Overview*

The Company’s principal sources of short-term fundingare its existing cash balances, operating cash flows and borrowings under itsrevolving credit facility and mortgage warehouse facilities. The Company’sprincipal sources of long-term funding are its bank term loan and itsfinancings under mortgage-backed/asset-backed notes. As of June 30, 2007,total debt has decreased by $21.7 million compared to December 31, 2006.See discussion below.

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

*Mortgage-backed/Asset-backedNotes*

The Company has twovariable funding loan facilities totaling $350.0 million that provide temporaryfinancing to the Company’s wholly owned subsidiary, Walter Mortgage Company,the successor by merger to Mid-State Homes, Inc., for its currentpurchases of instalment notes from Homebuilding and mortgage loans fromoriginations and third party purchases. The $150.0 million Trust IX facilitywas renewed on July 30, 2007, under substantially similar terms as theprevious facility, and matures July 28, 2008. The $200.0 million Trust XIVfacility will expire on November 27, 2007, and the Company expects torenew this facility on similar terms prior to expiration. At June 30,2007, there were $113.4 million of borrowings outstanding under thesefacilities.

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*2005 Walter CreditAgreement*

The 2005 Walter Credit Agreement is a securedobligation of the Company and substantially all of its wholly owned domesticsubsidiaries. The 2005 Walter Term Loan currently requires quarterly principalpayments of $0.6 million through October 3, 2012, at which time theremaining principal outstanding is due. The 2005 Walter Term Loan carries afloating interest rate of 175 basis points over LIBOR. At June 30, 2007,the balance outstanding on the term loan was $219.6 million and theweighted-average interest rate was 7.1%. The commitment fee on the unusedportion of the $225.0 million 2005 Walter Revolving Credit Facility is 0.375%and the interest rate is a floating rate of 150 basis points over LIBOR. At June 30,2007, there were no borrowings outstanding under the revolving credit facility,but the Company had $50.0 million in letters of credit outstanding, reducingavailability for revolver borrowings to $175.0 million.

Duringthe six months ended June 30, 2007, repayments of the term loanfacility totaling $29.1 million were made using cash and available cash flow. Therepayments included $28.0 million of voluntary prepayments.

*Statement of CashFlows*

Cash of continuing operations was $39.5 million and$127.4 million at June 30, 2007 and December 31, 2006, respectively.The decrease in cash was primarily due to $61.0 million of capital expendituresand a $28.0 million prepayment of term debt.

Cash flows provided by operating activities ofcontinuing operations for the six months ended June 30, 2007 were $15.3million compared to $79.9 million for the six months ended June 30, 2006. The$64.6 million decrease is primarily a result of a $31.0 million decrease in incomefrom continuing operations and an increase in instalment notes receivable andtaxes paid, partially offset by decreases in trade receivables.

Cash flows used in investing activities of continuingoperations for the six months ended June 30, 2007 were $65.9 millioncompared to $53.8 million for the prior-year period. Results from investingactivities primarily reflect capital expenditures which were $61.0 million forthe six months ended June 30, 2007 compared to $51.7 million for the sameperiod in 2006. Capital expenditures for the remainder of 2007 are expected tobe $60.0 million to $90.0 million and relate primarily to Jim Walter Resources’Mine No. 7 East expansion project.

Cash flows used infinancing activities of continuing operations for the six months ended June 30,2007 were $37.9 million compared to cash flows provided by financing activitiesof continuing operations of $31.5 million in the prior-year period. Thecurrent-year period includes $29.1 million of term loan payments, $5.2 millionof net principal payments on the Company’s mortgage-backed/asset-backed notesand $5.2 million of dividends paid. Financing activities in 2006 included$123.8 million of term loan payments, $28.5 million of net principal paymentson the Company’s mortgage-backed/asset-backed notes and $3.3 million ofdividends paid. Additionally, the prior-year period benefited from the sale ofcommon stock, a net cash inflow of $168.7 million.

**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 and commodity risks.The Company does not enter into derivatives or other financial instruments fortrading or speculative purposes.

There have been nomaterial changes to market risk exposures in the second quarter 2007 comparedto those described in the Annual Report on Form 10-K for the fiscalyear ended December 31, 2006.

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**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 Vice Chairman (Principal Executive Officer) and Chief FinancialOfficer (CFO), of the effectiveness of our disclosure controls and proceduresas of June 30, 2007. Based on that evaluation, our management, includingour Principal Executive Officer and CFO, concluded that our disclosure controlsand procedures are effective to ensure that information required to bedisclosed by us in reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported as specified in the SEC’s rules andforms. There has been no change in our internal control over financialreporting during the six months ended June 30, 2007 that has materiallyaffected, or is reasonably likely to materially affect, internal control overfinancial reporting.

**PRIVATE SECURITIESLITIGATION REFORM ACT SAFE HARBOR STATEMENT**

Except for historical information contained herein,the statements in this release are forward-looking and made pursuant to thesafe harbor provisions of the Private Securities Litigation Reform Act of 1995.Forward-looking statements involve known and unknown risks and uncertaintiesthat may cause the Company’s actual results in future periods to differmaterially from forecasted results. Those risks include, among others, changesin customers’ demand for the Company’s products, changes in raw material,labor, equipment and transportation costs and availability, geologic andweather conditions, changes in extraction costs and pricing in the Company’smining operations, changes in customer orders, pricing actions by the Company’scompetitors, potential changes in the mortgage-backed capital market, andgeneral changes in economic conditions. Risks associated with forward-lookingstatements are more fully described in the Company’s filings with theSecurities and Exchange Commission. Those risks also include the timing of andability to execute other strategic actions that may be pursued. The Company hasno duty to update its outlook statements as of any future date.

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**PART II—OTHERINFORMATION**

**Item 1.**                        *Legal Proceedings*

See Note 14 of the “Notes to Condensed ConsolidatedFinancial Statements” in this Form 10-Q for a description of current legalproceedings.

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. The effect of the outcome of these matters onthe Company’s future results of operations cannot be predicted because any sucheffect depends on future results of operations and the amount and timing of theresolution of such matters. While the results of litigation cannot be predictedwith certainty, the Company believes that the final outcome of such otherlitigation will not have a material adverse effect on the Company’sconsolidated financial position.

**Item 1A.**                *Risk Factors*

For discussion of theCompany’s risk factors, please refer to Part 1, “Item 1A. Risk Factors” inthe Company’s Annual Report on Form 10-K for the fiscal year ended December 31,2006.

**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 30,2007, there were no share repurchases that reduced the availability under theCompany’s Common Stock share repurchase program and at June 30, 2007, $7.5million remains available under this program.

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

At the Company’sAnnual Meeting of Shareholders on April 25, 2007, the following proposalwas submitted to the Stockholders:

1.     The election of the following directors:

| **Director**               | ** ** | ** ** | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|----------------------------|------------|------------|------------|------------|------------|--------------|------------|
| Howard L.  Clark, Jr. |       | 37,304,084 |       | 11,186,928 |       |
| Jerry W. Kolb              |       | 45,239,099 |       | 3,251,914  |       |
| Patrick A.  Kriegshauser   |       | 47,727,885 |       | 763,127    |       |
| Mark J. O’Brien       |       | 39,196,509 |       | 9,294,503  |       |
| Victor P. Patrick          |       | 39,397,662 |       | 9,093,350  |       |
| Bernard G.  Rethore        |       | 47,885,154 |       | 605,858    |       |
| George R.  Richmond        |       | 39,397,337 |       | 9,093,675  |       |
| Michael T. Tokarz          |       | 45,774,908 |       | 2,746,104  |       |

 

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**Item 6.**                        *Exhibits*

(a)   Exhibits
| Exhibit  Number | ** ** | ** **                                                                                                                                   | ** ** | ** ** |
|-----------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| 31.1            |       | Certification Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002—Principal 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—Principal Executive  Officer |
| 32.2            |       | Certification Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350—Chief Financial  Officer     |

 

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
| WALTER INDUSTRIES, INC.   |
|---------------------------|
| /s/ JOSEPH J. TROY        | * * | /s/ LISA A. HONNOLD |
| Joseph J. Troy            |   | Lisa A. Honnold |
| *Chief Financial Officer* |   | *Senior Vice President, Controller* |
|                      |   | *and Principal Accounting Officer* |

 

Date:  August 8,2007

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