**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D. C. 20549**

**FORM 10-Q**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

**Forthe quarterly period ended March 31, 2007**

**or**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15 (d) OF THESECURITIES EXCHANGE ACT OF 1934

**CommissionFile Number 001-13711**

**WALTER INDUSTRIES, INC.**

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

 

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

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

Indicate by check 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):  Largeaccelerated filer x   Acceleratedfiler**o   Non-acceleratedfiler o

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

There were 52,062,364shares of common stock of the registrant outstanding at April 30, 2007.

 

----

**PART I—FINANCIALINFORMATION**

**ITEM1. FINANCIAL STATEMENTS**

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

| ** **                                                                               | ** ** | **March 31,              2007            ** | ** ** | **December 31,              2006            ** | ** ** |
|------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                               | ** ** | **(in thousands, except share amounts)**                                                                                                             | ** ** |
| **ASSETS**                                                                               |       |                                                                                                                                                                     |       |                                                                                                                                                                        |       |   |   |   |   |
| Cash and cash equivalents                                                                |       |                                                                                                                                                                     | $          | 100,902                                                                                                                                                                     |       |   |   | $ | 127,369 |   |   |
| Short-term  investments, restricted                                                      |       |                                                                                                                                                                     | 84,306     |                                                                                                                                                                        |       |   | 90,042 |   |   |
| Instalment notes  receivable, net of allowance of $12,640 and $13,011, respectively |       |                                                                                                                                                                     | 1,803,732  |                                                                                                                                                                        |       |   | 1,779,697 |   |   |
| Receivables, net                                                                         |       |                                                                                                                                                                     | 75,563     |                                                                                                                                                                        |       |   | 85,094 |   |   |
| Inventories                                                                              |       |                                                                                                                                                                     | 113,896    |                                                                                                                                                                        |       |   | 105,527 |   |   |
| Prepaid expenses                                                                         |       |                                                                                                                                                                     | 27,360     |                                                                                                                                                                        |       |   | 29,727 |   |   |
| Property, plant  and equipment, net                                                      |       |                                                                                                                                                                     | 324,908    |                                                                                                                                                                        |       |   | 310,163 |   |   |
| Other long-term  assets                                                                  |       |                                                                                                                                                                     | 135,561    |                                                                                                                                                                        |       |   | 135,274 |   |   |
| Goodwill                                                                                 |       |                                                                                                                                                                     | 10,895     |                                                                                                                                                                        |       |   | 10,895 |   |   |
| Assets of  discontinued operations                                                       |       |                                                                                                                                                                     | 10,977     |                                                                                                                                                                        |       |   | 10,327 |   |   |
|                                                                                     |       |                                                                                                                                                                     | $          | 2,688,100                                                                                                                                                                   |       |   |   | $ | 2,684,115 |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                           |       |                                                                                                                                                                     |       |                                                                                                                                                                        |       |   |   |   |   |
| Accounts payable                                                                         |       |                                                                                                                                                                     | $          | 67,635                                                                                                                                                                      |       |   |   | $ | 62,323 |   |   |
| Accrued expenses                                                                         |       |                                                                                                                                                                     | 70,857     |                                                                                                                                                                        |       |   | 94,930 |   |   |
| Accrued interest  on debt                                                                |       |                                                                                                                                                                     | 15,460     |                                                                                                                                                                        |       |   | 17,053 |   |   |
| Debt:                                                                                    |       |                                                                                                                                                                     |       |                                                                                                                                                                        |       |   |   |   |   |
| Mortgage-backed/asset-backed notes                                                       |       |                                                                                                                                                                     | 1,737,168  |                                                                                                                                                                        |       |   | 1,736,706 |   |   |
| Corporate debt                                                                           |       |                                                                                                                                                                     | 220,979    |                                                                                                                                                                        |       |   | 249,491 |   |   |
| Accumulated  postretirement benefits obligation                                          |       |                                                                                                                                                                     | 331,172    |                                                                                                                                                                        |       |   | 330,241 |   |   |
| Other long-term  liabilities                                                             |       |                                                                                                                                                                     | 212,554    |                                                                                                                                                                        |       |   | 189,458 |   |   |
| Liabilities of  discontinued operations                                                  |       |                                                                                                                                                                     | 3,836      |                                                                                                                                                                        |       |   | 2,005 |   |   |
| Total liabilities                                                                        |       |                                                                                                                                                                     | 2,659,661  |                                                                                                                                                                        |       |   | 2,682,207 |   |   |
| Commitments and  contingencies (Note 13)                                                 |       |                                                                                                                                                                     |       |                                                                                                                                                                        |       |   |   |   |   |
| Stockholders’  equity                                                               |       |                                                                                                                                                                     |       |                                                                                                                                                                        |       |   |   |   |   |
| Common stock,  $.01 par value per share:                                                 |       |                                                                                                                                                                     |       |                                                                                                                                                                        |       |   |   |   |   |
| Authorized—200,000,000  shares                                                      |       |                                                                                                                                                                     |       |                                                                                                                                                                        |       |   |   |   |   |
| Issued—52,053,712 and 72,730,770 shares                                             |       |                                                                                                                                                                     | 520        |                                                                                                                                                                        |       |   | 728 |   |   |
| Capital in excess of par value                                                           |       |                                                                                                                                                                     | 500,196    |                                                                                                                                                                        |       |   | 757,699 |   |   |
| Accumulated deficit                                                                      |       |                                                                                                                                                                     | (373,360   | )                                                                                                                                                                           |       |   | (398,564 | ) |   |
| Treasury stock—0 shares and 20,771,902 shares, at  cost                             |       |                                                                                                                                                                     | —     |                                                                                                                                                                        |       |   | (259,317 | ) |   |
| Accumulated other comprehensive loss                                                     |       |                                                                                                                                                                     | (98,917    | )                                                                                                                                                                           |       |   | (98,638 | ) |   |
| Total stockholders’ equity                                                          |       |                                                                                                                                                                     | 28,439     |                                                                                                                                                                        |       |   | 1,908 |   |   |
|                                                                                     |       |                                                                                                                                                                     | $          | 2,688,100                                                                                                                                                                   |       |   |   | $ | 2,684,115 |   |   |

 

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

1

----

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

| ** **                                                   | ** ** | **For the three months ended March 31,**                                                                                               | ** ** |
|--------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **             2007             ** | ** ** | **             2006             ** | ** ** |
| ** **                                                   | ** ** | **(in thousands, except per share amounts)**                                                                                                | ** ** |
| Net sales and revenues:                                      |       |                                                                                                                                                                 |       |   |   |   |   |   |   |
| Net sales                                                    |       |                                                                                                                                                                 | $          | 259,387 |   |   |   | $ | 254,474 |   |   |
| Interest income on instalment notes                          |       |                                                                                                                                                                 | 49,565     |   |   |   | 50,530 |   |   |
| Miscellaneous                                                |       |                                                                                                                                                                 | 11,342     |   |   |   | 8,070 |   |   |
|                                                         |       |                                                                                                                                                                 | 320,294    |   |   |   | 313,074 |   |   |
| Costs and  expenses:                                         |       |                                                                                                                                                                 |       |   |   |   |   |   |   |
| Cost of sales (exclusive of depreciation)                    |       |                                                                                                                                                                 | 171,640    |   |   |   | 163,792 |   |   |
| Depreciation                                                 |       |                                                                                                                                                                 | 10,630     |   |   |   | 8,434 |   |   |
| Selling, general and administrative                          |       |                                                                                                                                                                 | 37,451     |   |   |   | 35,174 |   |   |
| Provision for losses on instalment notes                     |       |                                                                                                                                                                 | 2,897      |   |   |   | 2,305 |   |   |
| Postretirement benefits                                      |       |                                                                                                                                                                 | 6,332      |   |   |   | 4,407 |   |   |
| Interest expense—mortgage-backed/asset-backed notes     |       |                                                                                                                                                                 | 29,771     |   |   |   | 29,976 |   |   |
| Interest expense—corporate debt                         |       |                                                                                                                                                                 | 7,347      |   |   |   | 12,469 |   |   |
| Amortization of intangibles                                  |       |                                                                                                                                                                 | 478        |   |   |   | 697 |   |   |
|                                                         |       |                                                                                                                                                                 | 266,546    |   |   |   | 257,254 |   |   |
| Income from continuing operations before income tax  expense |       |                                                                                                                                                                 | 53,748     |   |   |   | 55,820 |   |   |
| Income tax  expense                                          |       |                                                                                                                                                                 | 21,613     |   |   |   | 19,070 |   |   |
| Income from  continuing operations                           |       |                                                                                                                                                                 | 32,135     |   |   |   | 36,750 |   |   |
| Discontinued  operations                                     |       |                                                                                                                                                                 | (2,510     | ) |   |   | (1,451 | ) |   |
| Net income                                                   |       |                                                                                                                                                                 | $          | 29,625 |   |   |   | $ | 35,299 |   |   |
| Basic income per  share:                                     |       |                                                                                                                                                                 |       |   |   |   |   |   |   |
| Income from continuing operations                            |       |                                                                                                                                                                 | $          | 0.62 |   |   |   | $ | 0.90 |   |   |
| Discontinued operations                                      |       |                                                                                                                                                                 | (0.05      | ) |   |   | (0.04 | ) |   |
| Net income                                                   |       |                                                                                                                                                                 | $          | 0.57 |   |   |   | $ | 0.86 |   |   |
| Diluted income  per share:                                   |       |                                                                                                                                                                 |       |   |   |   |   |   |   |
| Income from continuing operations                            |       |                                                                                                                                                                 | $          | 0.61 |   |   |   | $ | 0.74 |   |   |
| Discontinued operations                                      |       |                                                                                                                                                                 | (0.05      | ) |   |   | (0.03 | ) |   |
| Net income                                                   |       |                                                                                                                                                                 | $          | 0.56 |   |   |   | $ | 0.71 |   |   |
| Dividends  declared per common share                         |       |                                                                                                                                                                 | $          | 0.05 |   |   |   | $ | 0.04 |   |   |

 

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

2

----

**WALTER INDUSTRIES,INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENT OF CHANGESIN STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOMEFOR THE THREE MONTHS ENDED MARCH 31, 2007(UNAUDITED)(in thousands)**

| ** **                                                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | ** **             | ** ** | ** **      | ** ** | ** **   | ** ** | **Accumulated**        | ** ** |
|--------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|---------------------|------------|------------------------|------------|-----------------|------------|--------------|------------|------------------------|------------|
| ** **                                                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | **Capital in** | ** ** | ** **             | ** ** | ** **      | ** ** | ** **   | ** ** | **Other**              | ** ** |
| ** **                                                                                       | ** ** | ** ** | ** ** | **Common** | ** ** | **Excess of**  | ** ** | **Comprehensive**      | ** ** | **Accumulated** | ** ** | **Treasury** | ** ** | **Comprehensive**      | ** ** |
| ** **                                                                                       | ** ** | **Total**  | ** ** | **Stock**  | ** ** | **Par Value**  | ** ** | **Income (Loss)** | ** ** | **Deficit**     | ** ** | **Stock**    | ** ** | **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                                                                                       |       | 29,625     |       |       |       |                |       |                   |       |            |       |         | $          | 29,625                 |       |   |   | 29,625 |   |   |   |   |   |   |   |   |
| Other comprehensive income (loss), net of tax:                                                   |       |       |       |       |       |                |       |                   |       |            |       |         |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Amortization of prior  service cost and net actuarial loss on postretirement benefits obligation |       | 2,025      |       |       |       |                |       |                   |       |            |       |         | 2,025      |                   |       |   |   |   |   |   |   |   | 2,025 |   |   |
| Net unrealized loss on  hedges                                                                   |       | (2,304     | )          |       |       |                |       |                   |       |            |       |         | (2,304     | )                      |       |   |   |   |   |   |   |   | (2,304 | ) |   |
| Comprehensive income                                                                             |       |       |       |       |       |                |       |                   |       |            |       |         | $          | 29,346                 |       |   |   |   |   |   |   |   |   |   |   |   |
| Retirement of treasury stock                                                                     |       | —     |       |       | (208       | )                   |       |                   | (259,901   | )               |       |         |       |                   |       |   |   |   |   | 260,109 |   |   |   |   |   |
| Stock issued upon the  exercise of stock options                                                 |       | 219        |       |       |       |                |       |                   | 219        |            |       |         |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Tax benefit from the  exercise of stock options                                                  |       | 1,062      |       |       |       |                |       |                   | 1,062      |            |       |         |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Dividends paid, $0.05 per  share                                                                 |       | (2,606     | )          |       |       |                |       |                   | (2,606     | )               |       |         |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Stock-based compensation                                                                         |       | 3,723      |       |       |       |                |       |                   | 3,723      |            |       |         |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Other                                                                                            |       | (792       | )          |       |       |                |       |                   |       |            |       |         |       |                   |       |   |   |   |   | (792 | ) |   |   |   |   |
| Balance at March 31, 2007                                                                   |       | $          | 28,439     |       |       | $                   | 520        |                   |       |            | $          | 500,196      |       |                   |       |   |   |   |   | $ | (373,360 | ) |   | $ | — |   |   | $ | (98,917 | ) |   |

 

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

3

----

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

| ** **                                                                                      | ** ** | **For the three months  ended March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                      | ** ** | **2007**                                                           | ** ** | **2006** | ** ** |
| ** **                                                                                      | ** ** | **(in thousands)**                                            | ** ** |
| OPERATING ACTIVITIES                                                                            |       |                                                               |       |   |   |
| Net income                                                                                      |       | $                                                                  | 29,625     |   | $ | 35,299 |   |
| Loss from  discontinued operations                                                              |       | 2,510                                                              |       | 1,451 |   |
| Income from  continuing operations                                                              |       | 32,135                                                             |       | 36,750 |   |
| Adjustments to reconcile  income from continuing operations to net cash provided by operations: |       |                                                               |       |   |   |
| Provision for  losses on instalment notes receivable                                            |       | 2,897                                                              |       | 2,305 |   |
| Depreciation                                                                                    |       | 10,630                                                             |       | 8,434 |   |
| Provision for  deferred income taxes                                                            |       | 21,613                                                             |       | 15,922 |   |
| Other                                                                                           |       | 1,060                                                              |       | 3,742 |   |
| Decrease (increase) in assets:                                                                  |       |                                                               |       |   |   |
| Receivables                                                                                     |       | 10,535                                                             |       | (24,937 | ) |
| Inventories                                                                                     |       | (8,369                                                             | )          | (1,673 | ) |
| Prepaid expenses                                                                                |       | 3,078                                                              |       | 4,049 |   |
| Instalment notes  receivable, net                                                               |       | (20,540                                                            | )          | (4,112 | ) |
| Increase (decrease) in liabilities:                                                             |       |                                                               |       |   |   |
| Accounts payable                                                                                |       | 4,255                                                              |       | (560 | ) |
| Accrued expenses                                                                                |       | (24,195                                                            | )          | (6,720 | ) |
| Accrued interest                                                                                |       | (1,593                                                             | )          | (360 | ) |
| Cash flows  provided by operating activities                                                    |       | 31,506                                                             |       | 32,840 |   |
| INVESTING ACTIVITIES                                                                            |       |                                                               |       |   |   |
| Purchases of loans                                                                              |       | (18,107                                                            | )          | (39,120 | ) |
| Principal payments  received on purchased loans                                                 |       | 11,715                                                             |       | 7,970 |   |
| Decrease in  short-term investments, restricted                                                 |       | 5,736                                                              |       | 40,131 |   |
| Additions to  property, plant and equipment                                                     |       | (25,527                                                            | )          | (27,930 | ) |
| Escrow release  from prior acquisition                                                          |       | —                                                             |       | 10,500 |   |
| Other                                                                                           |       | 26                                                                 |       | 288 |   |
| Cash flows used in  investing activities                                                        |       | (26,157                                                            | )          | (8,161 | ) |
| FINANCING ACTIVITIES                                                                            |       |                                                               |       |   |   |
| Issuance of  mortgage-backed/asset-backed notes                                                 |       | 59,250                                                             |       | — |   |
| Payments of  mortgage-backed/asset-backed notes                                                 |       | (58,816                                                            | )          | (66,781 | ) |
| Retirements of  corporate debt                                                                  |       | (28,512                                                            | )          | (103,781 | ) |
| Dividends paid                                                                                  |       | (2,606                                                             | )          | (1,568 | ) |
| Tax benefit on the  exercise of employee stock options                                          |       | 1,062                                                              |       | 4,051 |   |
| Sale of common  stock                                                                           |       | —                                                             |       | 168,829 |   |
| Other                                                                                           |       | 326                                                                |       | 11,654 |   |
| Cash flows  provided by (used in) financing activities                                          |       | (29,296                                                            | )          | 12,404 |   |
| Cash flows  provided by (used in) continuing operations                                         |       | $                                                                  | (23,947    | ) | $ | 37,083 |   |
| CASH FLOWS FROM DISCONTINUED OPERATIONS                                                         |       |                                                               |       |   |   |
| Cash flows used in  operating activities                                                        |       | $                                                                  | (2,510     | ) | $ | (6,306 | ) |
| Cash flows used in  investing activities                                                        |       | —                                                             |       | (28,536 | ) |
| Cash flows  provided by financing activities                                                    |       | —                                                             |       | 6,579 |   |
| Cash flows used in  discontinued operations                                                     |       | $                                                                  | (2,510     | ) | $ | (28,263 | ) |
| Net increase  (decrease) in cash and cash equivalents                                           |       | $                                                                  | (26,457    | ) | $ | 8,820 |   |
| 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                                           |       | (26,457                                                            | )          | 8,820 |   |
| Less: Cash and  cash equivalents of discontinued operations at end of period                    |       | 11                                                                 |       | 50,885 |   |
| Cash and cash  equivalents at end of period                                                     |       | $                                                                  | 100,902    |   | $ | 95,331 |   |

 

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

4

----

**WALTER INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSAS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 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 12. 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. The first quarter of 2006 has been revised to reflect thischange.

The accompanying unaudited condensed consolidatedfinancial statements of the Company have been prepared in accordance withaccounting principles generally accepted in the United States for interimfinancial information and with the instructions to Form 10-Q and Article 10of Regulation S-X. Accordingly, they do not include all of the information andfootnotes required by accounting principles generally accepted in the UnitedStates for complete financial statements. In the opinion of management, alladjustments (consisting of normal recurring accruals) considered necessary fora fair presentation have been included. Operating results for the three monthperiod ended March 31, 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,amounts previously reported in the Mueller Co., Anvil and U.S. Pipe segments(collectively, “Mueller Water”) are presented as discontinued operations forthe first quarter of 2006.

**Modular HomesDivision**

During the first quarter of2007, the Company decided to exit the manufacture and distribution ofmodular homes due to the poor performance of this division, which operates asCrestline Homes, Inc. (“Crestline”). As such, the Company has reported theresults of operations, assets, liabilities and cash flows of Crestline asdiscontinued operations for all periods presented. Crestline’s results werepreviously included in the Homebuilding segment. The Company recognized apre-tax charge of $2.0 million included in the loss from discontinuedoperations in the first quarter of 2007 for severance liabilities and to writedown the net assets to estimated fair value. The business is expected to besold within the year.

5

----

Thetable below presents the significant components of operating results includedin loss from discontinued operations for the quarters ended March 31, 2007and 2006 (in thousands):

| ** **                                                   | ** ** | **For the three months  ended March 31,** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **2007**                                                           | ** ** | **2006** | ** ** |
| Net sales and  revenues                                      |       | $                                                                  | 7,041      |   | $ | 440,195 |   |
| Loss from discontinued operations before income tax  benefit |       | $                                                             | (3,861     | ) | $  | (2,342 | ) |
| Income tax  benefit                                          |       | 1,351                                                              |       | 891 |   |
| Loss from discontinued  operations                           |       | $                                                                  | (2,510     | ) | $ | (1,451 | ) |

 

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 reflected as discontinued operations in theconsolidated balance sheet as of March 31, 2007 and December 31, 2006are shown below (in thousands):

| ** **                          | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| Cash and cash  equivalents          |       |               | $          | 11                    |       |   |   | $ | 1 |   |   |
| Receivables, net                    |       |               | 3,808      |                  |       |   | 3,549 |   |   |
| Inventories                         |       |               | 2,770      |                  |       |   | 3,344 |   |   |
| Prepaid expenses                    |       |               | 538        |                  |       |   | 419 |   |   |
| Property, plant  and equipment, net |       |               | 991        |                  |       |   | 1,026 |   |   |
| Other long-term  assets             |       |               | 2,859      |                  |       |   | 1,988 |   |   |
| Total assets                        |       |               | $          | 10,977                |       |   |   | $ | 10,327 |   |   |
| Accounts payable                    |       |               | $          | 396                   |       |   |   | $ | 383 |   |   |
| Accrued expenses                    |       |               | 3,440      |                  |       |   | 1,622 |   |   |
| Total liabilities                   |       |               | $          | 3,836                 |       |   |   | $ | 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 PlannedMajor Maintenance Activities” (“AUG AIR-1”), which provides guidance onwhich methods are allowed to properly account for planned major maintenanceactivities. The adoption of this statement did not have a material effect onthe Company’s operating results, financial position or cash flows.

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 providesguidance on derecognition, classification, interest and penalties, accountingin interim periods, disclosure and transition. As a result of adoption, theCompany recognized an increase of $4.4 million in the liability forunrecognized tax benefits with a corresponding increase to the accumulateddeficit as of January 1, 2007. Asof the date of adoption and after the impact of recognizing the increase inliability noted above, the Company’s liability for unrecognized tax benefitstotaled $53.3 million, of which $36.9 million, if recognized, would impact theeffective rate. The Company 

6

----

doesnot anticipate any significant increase or decrease to the liability forunrecognized 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 March 31,2007 and 2006, interest expense includes $2.0 million and $1.1 million,respectively, for interest accrued on the liability for unrecognized taxbenefits.

**Note 4—ConsolidatedStatements of Cash Flows**

The Company has revised its consolidated statement ofcash flows for the quarter ended March 31, 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 three months ended** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                           | ** ** | **March 31, 2006**                       | ** ** |
| ** **                                           | ** ** | **Previous**                                       | ** ** | ** ** | ** ** | **As** | ** ** |
| ** **                                           | ** ** | **Presentation**                                   | ** ** | **Change** | ** ** | **Revised** | ** ** |
| Instalment notes  receivable, net                    |       |                                               | $          | — |   |   | $ | (4,112 | ) | $ | (4,112 | ) |
| Net cash provided  by operating activities           |       |                                               | $          | 36,952 |   |   | $ | (4,112 | ) | $ | 32,840 |   |
| Purchases of loans                                   |       |                                               | $          | (127,882 | ) |   | $ | 88,762 |   | $ | (39,120 | ) |
| Principal  payments received on purchased loans      |       |                                               | $          | 92,620 |   |   | $ | (84,650 | ) | $ | 7,970 |   |
| Net cash provided by  (used in) investing activities |       |                                               | $          | (12,273 | ) |   | $ | 4,112 |   | $ | (8,161 | ) |

 

**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.

**Note 6—RestrictedShort-Term Investments**

**Restrictedshort-term investments at March 31, 2007 and December 31, 2006include (i) temporary investments primarily in commercial paper or moneymarket accounts with maturities less than 90 days from collections oninstalment notes receivable owned by various Mid-State Trusts (the “Trusts”)($76.9 million and $84.0 million, respectively) which are available only to payexpenses of the Trusts and principal and interest on indebtedness of theTrusts, and (ii) miscellaneous other segregated accounts restricted tospecific uses ($7.4 million and $6.0 million, respectively).**

7

----

**Note 7—InstalmentNotes Receivable**

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

| ** **                   | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                   | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| Instalment notes  receivable |       | $                  | 1,590,563  |                  |       | $ | 1,578,760 |   |   |
| Mortgage loans               |       | 225,809            |       |                  | 213,948    |   |   |
| Less: Allowance  for losses  |       | (12,640            | )          |                  | (13,011    | ) |   |
| Net                          |       | $                  | 1,803,732  |                  |       | $ | 1,779,697 |   |   |

 

**Note 8—Inventories**

Inventoriesare summarized as follows (in thousands):

| ** **                          | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| Finished goods                      |       | $                  | 49,578     |                  |       | $ | 35,138 |   |   |
| Goods in process                    |       | 23,031             |       |                  | 25,830     |   |   |
| Raw materials and  supplies         |       | 15,567             |       |                  | 15,145     |   |   |
| Repossessed  houses held for resale |       | 25,720             |       |                  | 29,414     |   |   |
| Total inventories                   |       | $                  | 113,896    |                  |       | $ | 105,527 |   |   |

 

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

The Company’s variable funding loan facilities, whichprovide temporary financing to the Company’s wholly owned subsidiary, Mid-StateHomes, for its current purchases of instalment notes and mortgage loans fromHomebuilding and Walter Mortgage Company, expire within the next 12 months. TheCompany expects to renew these facilities on similar terms prior to theexpiration. At March 31, 2007, there were $59.3 million of borrowingsoutstanding under these facilities.

During the first quarterof 2007, the Company entered into two interest rate hedge agreements, such thatat March 31, 2007 the Company had interest rate hedge agreements withcombined notional values totaling $135.0 million designed to protect againstchanges in the benchmark interest rate on the forecasted issuance of mortgage-backedbonds anticipated to be priced in April 2008. The hedges will be settledon or before maturity and are being accounted for as cash flow hedges. As such,changes in the fair value of the hedges that take place through the date ofmaturity are recorded in accumulated other comprehensive income (loss).

**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 March 31,**           | ** ** | **ended March 31,**           | ** ** |
| ** **                                | ** ** | **2007**                                | ** ** | **2006**                                | ** ** | **2007** | ** ** | **2006** | ** ** |
| Components of net  periodic benefit cost: |       |                                    |       |                                    |       |   |   |   |   |
| Service cost                              |       | $                                       | 1,014      |                                    | $          | 936 |   | $ | 750 |   | $ | 531 |   |
| Interest cost                             |       | 2,725                                   |       | 2,366                                   |       | 4,803 |   | 3,739 |   |
| Expected return  on plan assets           |       | (3,059                                  | )          | (2,846                                  | )          | — |   | — |   |
| Amortization of  prior service cost       |       | 104                                     |       | 104                                     |       | (1,064 | ) | (1,101 | ) |
| Amortization of  net actuarial loss       |       | 1,142                                   |       | 1,057                                   |       | 1,843 |   | 1,238 |   |
| Net periodic  benefit cost                |       | $                                       | 1,926      |                                    | $          | 1,617 |   | $ | 6,332 |   | $ | 4,407 |   |

 

8

----

In January 2007, JimWalter Resources signed a new contract with the United Mine Workers of America(UMWA) which eliminated certain retiree deductible requirements for members ofthe UMWA employed by Jim Walter Resources. The effect of this enhanced benefitwill be recognized beginning in the second quarter of 2007 and is expected toincrease postretirement benefits costs by $1.4 million in 2007. In addition,the reported accumulated benefit obligation is expected to increase anestimated $15.5 million as a result of this amendment.

**Note 11—Net Income(Loss) Per Share**

Areconciliation of the basic and diluted net income (loss) per sharecomputations for the three months ended March 31, 2007 and 2006 are asfollows (in thousands, except per share data):

| ** **                                                                      | ** ** | **For the three months ended March 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                                                      | ** ** | **2007**                                                               | ** ** | **2006** | ** ** |
| ** **                                                                      | ** ** | **Basic**                                                              | ** ** | **Diluted** | ** ** | **Basic** | ** ** | **Diluted** | ** ** |
| Numerator:                                                                      |       |                                                                   |       |   |   |   |   |   |   |
| Income from  continuing operations                                              |       | $                                                                      | 32,135     |   | $ | 32,135 |   | $ | 36,750 |   | $ | 36,750 |   |
| Effect of  dilutive securities:                                                 |       |                                                                   |       |   |   |   |   |   |   |
| Interest related to 3.75% convertible senior  subordinated notes, net of tax(a) |       | —                                                                 |       | 5 |   | — |   | 1,024 |   |
|                                                                            |       | $                                                                      | 32,135     |   | $ | 32,140 |   | $ | 36,750 |   | $ | 37,774 |   |
| Net loss from  discontinued operations                                          |       | $                                                                      | (2,510     | ) | $ | (2,510 | ) | $ | (1,451 | ) | $ | (1,451 | ) |
| Denominator:                                                                    |       |                                                                   |       |   |   |   |   |   |   |
| Average number of  common shares outstanding                                    |       | 52,013                                                                 |       | 52,013 |   | 40,882 |   | 40,882 |   |
| Effect of  dilutive securities:                                                 |       |                                                                   |       |   |   |   |   |   |   |
| Stock options and restricted stock units  (“units”)(b)                |       | —                                                                 |       | 416 |   | — |   | 680 |   |
| 3.75% convertible senior subordinated notes(a)                                  |       | —                                                                 |       | 84 |   | — |   | 9,419 |   |
|                                                                            |       | 52,013                                                                 |       | 52,513 |   | 40,882 |   | 50,981 |   |
| Income from continuing operations per share                                     |       | $                                                                 | 0.62       |   | $  | 0.61 |   | $  | 0.90 |   | $  | 0.74 |   |
| Loss from  discontinued operations per share                                    |       |      (0.05                                         | )          |      (0.05 | ) | (0.04 | ) |      (0.03 | ) |
| Net income per  share                                                           |       | $                                                                      | 0.57       |   | $ | 0.56 |   | $ | 0.86 |   | $ | 0.71 |   |

----

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

(b)          Represents the weightedaverage number of shares of common stock issuable on the exercise of dilutiveemployee stock options and units less the number of shares of common stockwhich could have been purchased with the proceeds from the exercise of suchoptions and units. These purchases were assumed to have been made at theaverage market price of the common stock for the period. Weighted averagenumber of stock options and units outstanding at March 31, 2007 and 2006totaling 600,735 and 69,297, respectively, were excluded from the calculationabove because their effect would have been anti-dilutive.

9

----

**Note 12—SegmentInformation**

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

| ** **                                                   | ** ** | **For the three months  ended March 31,** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **2007**                                                           | ** ** | **2006** | ** ** |
| Net sales and revenues:                                      |       |                                                               |       |   |   |
| Natural Resources                                            |       | $                                                                  | 170,175    |   | $ | 169,098 |   |
| Sloss                                                        |       | 32,801                                                             |       | 33,285 |   |
| Natural Resources and Sloss                                  |       | 202,976                                                            |       | 202,383 |   |
| Financing                                                    |       | 53,747                                                             |       | 56,019 |   |
| Homebuilding                                                 |       | 62,133                                                             |       | 55,288 |   |
| Financing and Homebuilding Group                             |       | 115,880                                                            |       | 111,307 |   |
| Other                                                        |       | 3,518                                                              |       | 3,163 |   |
| Consolidating eliminations                                   |       | (2,080                                                             | )          | (3,779 | ) |
| Sales and revenues                                           |       | $                                                                  | 320,294    |   | $ | 313,074 |   |
| Segment operating  income (loss):                            |       |                                                               |       |   |   |
| Natural Resources                                            |       | $                                                                  | 56,441     |   | $ | 63,925 |   |
| Sloss                                                        |       | 1,306                                                              |       | 2,182 |   |
| Natural Resources and Sloss                                  |       | 57,747                                                             |       | 66,107 |   |
| Financing(a)                                                 |       | 10,571                                                             |       | 12,992 |   |
| Homebuilding                                                 |       | (2,678                                                             | )          | (4,851 | ) |
| Financing and Homebuilding Group                             |       | 7,893                                                              |       | 8,141 |   |
| Other                                                        |       | (4,545                                                             | )          | (5,314 | ) |
| Consolidating eliminations                                   |       | —                                                             |       | (645 | ) |
| Operating income from continuing operations                  |       | 61,095                                                             |       | 68,289 |   |
| Less corporate debt interest expense                         |       | (7,347                                                             | )          | (12,469 | ) |
| Income from continuing operations before income tax  expense |       | 53,748                                                             |       | 55,820 |   |
| Income tax expense                                           |       | 21,613                                                             |       | 19,070 |   |
| Income from  continuing operations                           |       | $                                                                  | 32,135     |   | $ | 36,750 |   |
| Depreciation:                                                |       |                                                               |       |   |   |
| Natural Resources                                            |       | $                                                                  | 7,800      |   | $ | 5,845 |   |
| Sloss                                                        |       | 916                                                                |       | 940 |   |
| Natural Resources and Sloss                                  |       | 8,716                                                              |       | 6,785 |   |
| Financing                                                    |       | 281                                                                |       | 342 |   |
| Homebuilding                                                 |       | 1,234                                                              |       | 1,082 |   |
| Financing and Homebuilding Group                             |       | 1,515                                                              |       | 1,424 |   |
| Other                                                        |       | 399                                                                |       | 225 |   |
| Total                                                        |       | $                                                                  | 10,630     |   | $ | 8,434 |   |

----

(a)           Operatingincome amounts for Financing include interest expense on the mortgage-backed/asset-backednotes of $29.8 million and $30.0 million for the three months ended March 31,2007 and 2006, respectively.

10

----

**Note 13—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 the30-day letter relate primarily to the Company’s method of recognizing revenueon the sale of homes and related interest on the instalment notes receivable.The items 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 BankruptcyCourt.

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.

11

----

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 entered into a decree order in 1989relative to a Resource Conservation Recovery Act (“RCRA”) compliance programmandated by the EPA. A RCRA Facility Investigation (“RFI”) Work Plan wasprepared which proposed investigative tasks to assess the presence ofcontamination at the Sloss facility. The Work Plan was approved in 1994 and thePhase I investigations were conducted and completed between 1995 and 1999.Phase II investigations for the Chemical Plant/Coke Plant and BiologicalTreatment Facility and Sewers/Land Disposal Areas were performed in 2000 and2001 and are substantially complete. At the end of 2004, EPA re-directed Sloss’RFI efforts toward completion of the Environmental Indicator (“EI”)determinations for the Current Human Exposures. This EI effort was completed toassist EPA in meeting goals set by the Government Performance Results Act (“GPRA”)for RCRA by 2005. Sloss implemented the approved EI Sampling Plan in April 2005.EPA approved/finalized the EI determinations for Sloss’ Birmingham facility in September 2005.In an effort to refocus the RFI, 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 has been submitted to the EPA during the first quarter of2007.

Although no assurances canbe given that the Company will not be required in the future to make materialexpenditures relating to the Sloss site or other sites, management does notbelieve at this time that the cleanup costs, if any, associated with thesesites will have a material adverse effect on the financial condition of theCompany, but such cleanup costs could be material to results of operations in afuture 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. The Company and its subsidiaries weregranted summary judgment on all of Drummond’s claims on March 29, 2005. Ajury trial denied United Land Corporation’s counter-claim on April 8,2005. Drummond and the Company appealed the trial court’s decision and in December 2006the Alabama Supreme Court ruled in favor of the Company, and the case 

12

----

has been sent back to thetrial court for further proceedings to determine the damages in favor of theCompany.

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

*Commitments and Contingencies—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 14—IncomeTaxes**

**The Company’s effective tax ratefor the three months ended March 31, 2007 and 2006 was 40.2% and 34.2%,respectively. The increase in the effective tax rate in 2007 is due to theunfavorable impact of a $4.4 million write-off of certain deferred taxassets no longer considered realizable. Excluding this unusual adjustment, theeffective tax rate for 2007 is 32.0%. Both 2007 and 2006 differ from theFederal statutory rate primarily due to the benefit from percentage depletiondeductions.**

13

----

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OFOPERATIONS,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 12 of “Notes to Condensed Consolidated Financial Statements,”which describe the Company’s net sales and revenues and operating income byoperating segment.

**RESULTS OFOPERATIONS**

**Summary Operating Results of Continuing Operations forthe Three Months Ended March 31, 2007 and 2006**

| ** **                                             | ** ** | **For the three months ended March 31, 2007** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                             | ** ** | **Natural**                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Cons** | ** ** | ** ** | ** ** |
| ** **                                             | ** ** | **Resources**                                 | ** ** | **Sloss** | ** ** | **Financing** | ** ** | **Homebuilding** | ** ** | **Other** | ** ** | **Elims** | ** ** | **Total** | ** ** |
| ** **                                             | ** ** | **(in thousands)**                       | ** ** |
| Net sales                                              |       | $                                             | 162,644    |   | $ | 32,564 |   |   | $ | 3,073 |   |   |   | $ | 62,109 |   |   | $ | 1,077 |   | $ | (2,080 | ) | $ | 259,387 |   |
| Interest income  on instalment notes                   |       | —                                        |       | — |   |   | 49,565 |   |   |   | — |   |   | — |   | — |   | 49,565 |   |
| Miscellaneous  income                                  |       | 7,531                                         |       | 237 |   |   | 1,109 |   |   |   | 24 |   |   | 2,441 |   | — |   | 11,342 |   |
| Net sales and   revenues                               |       | 170,175                                       |       | 32,801 |   |   | 53,747 |   |   |   | 62,133 |   |   | 3,518 |   | (2,080 | ) | 320,294 |   |
| Cost of sales                                          |       | 94,918                                        |       | 28,311 |   |   | 1,797 |   |   |   | 47,974 |   |   | 720 |   | (2,080 | ) | 171,640 |   |
| Interest  expense(1)                                   |       | —                                        |       | — |   |   | 29,771 |   |   |   | — |   |   | — |   | — |   | 29,771 |   |
| Depreciation                                           |       | 7,800                                         |       | 916 |   |   | 281 |   |   |   | 1,234 |   |   | 399 |   | — |   | 10,630 |   |
| Selling,  general, & administrative           |       | 3,969                                         |       | 2,484 |   |   | 8,058 |   |   |   | 15,751 |   |   | 7,189 |   | — |   | 37,451 |   |
| Provision for  losses on instalment notes              |       | —                                        |       | — |   |   | 2,897 |   |   |   | — |   |   | — |   | — |   | 2,897 |   |
| Postretirement  benefits                               |       | 7,047                                         |       | (216 | ) |   | (106 | ) |   |   | (148 | ) |   | (245 | ) | — |   | 6,332 |   |
| Amortization of  intangibles                           |       | —                                        |       | — |   |   | 478 |   |   |   | — |   |   | — |   | — |   | 478 |   |
| Operating income (loss)                                |       | $                                             | 56,441     |   | $ | 1,306 |   |   | $ | 10,571 |   |   |   | $ | (2,678 | ) |   | $ | (4,545 | ) | $ | — |   | $ | 61,095 |   |
| Corporate debt interest expense                        |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (7,347 | ) |
| Income from continuing  operations before income taxes |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 53,748 |   |

----

(1)          Excludescorporate debt interest expense.

14

----

 

| ** **                                             | ** ** | **For the three months ended March 31, 2006** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                             | ** ** | **Natural**                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Cons** | ** ** | ** ** | ** ** |
| ** **                                             | ** ** | **Resources**                                 | ** ** | **Sloss** | ** ** | **Financing** | ** ** | **Homebuilding** | ** ** | **Other** | ** ** | **Elims** | ** ** | **Total** | ** ** |
| ** **                                             | ** ** | **(in thousands)**                       | ** ** |
| Net sales                                              |       | $                                             | 164,863    |   | $ | 33,154 |   |   | $ | 3,590 |   |   |   | $ | 55,106 |   |   | $ | 250 |   | $ | (2,489 | ) | $ | 254,474 |   |
| Interest income  on instalment notes                   |       | —                                        |       | — |   |   | 50,530 |   |   |   | — |   |   | — |   | — |   | 50,530 |   |
| Miscellaneous  income                                  |       | 4,235                                         |       | 131 |   |   | 1,899 |   |   |   | 182 |   |   | 2,913 |   | (1,290 | ) | 8,070 |   |
| Net sales and  revenues                                |       | 169,098                                       |       | 33,285 |   |   | 56,019 |   |   |   | 55,288 |   |   | 3,163 |   | (3,779 | ) | 313,074 |   |
| Cost of sales                                          |       | 90,234                                        |       | 28,339 |   |   | 3,195 |   |   |   | 44,353 |   |   | 805 |   | (3,134 | ) | 163,792 |   |
| Interest  expense(1)                                   |       | —                                        |       | — |   |   | 29,976 |   |   |   | — |   |   | — |   | — |   | 29,976 |   |
| Depreciation                                           |       | 5,845                                         |       | 940 |   |   | 342 |   |   |   | 1,082 |   |   | 225 |   | — |   | 8,434 |   |
| Selling,  general, & administrative           |       | 4,151                                         |       | 1,994 |   |   | 6,560 |   |   |   | 14,826 |   |   | 7,643 |   | — |   | 35,174 |   |
| Provision for  losses on instalment notes              |       | —                                        |       | — |   |   | 2,305 |   |   |   | — |   |   | — |   | — |   | 2,305 |   |
| Postretirement  benefits                               |       | 4,943                                         |       | (170 | ) |   | (48 | ) |   |   | (122 | ) |   | (196 | ) | — |   | 4,407 |   |
| Amortization of   intangibles                          |       | —                                        |       | — |   |   | 697 |   |   |   | — |   |   | — |   | — |   | 697 |   |
| Operating income (loss)                                |       | $                                             | 63,925     |   | $ | 2,182 |   |   | $ | 12,992 |   |   |   | $ | (4,851 | ) |   | $ | (5,314 | ) | $ | (645 | ) | $ | 68,289 |   |
| Corporate debt interest expense                        |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (12,469 | ) |
| Income from  continuing operations before income taxes |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 55,820 |   |

----

(1)          Excludescorporate debt interest expense.

*Overview*

The Company’s income from continuing operations forthe quarter ended March 31, 2007 was $32.1 million, or $0.61 per dilutedshare, which compares to $36.8 million, or $0.74 per diluted share in the prioryear period.

In the three months ended March 31,2007, the Company’s results reflected an increase in net sales and revenues of2.3% and a 10.5% reduction in operating income from continuing operationsversus the same period in 2006. Metallurgical coal sales volumes increased 22%and the Company benefited from strong coal production. In addition,Homebuilding delivered higher on-your-lot average net selling prices. Theseimprovements were more than offset by lower metallurgical coal pricing, lowernatural gas pricing and higher operating expenses at Natural Resources.

*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 pricing isexpected to average approximately $101 per metric ton (equivalent toapproximately $92 per short ton), FOB Port of Mobile.

·       TheCompany expects coal production to total between 6.5 million and 6.9 milliontons in 2007, including approximately 400,000 tons from Kodiak Mining LLC(“Kodiak”). Output in the second and third quarters is expected to be lowerthan the first quarter of 2007 due to the thinner coal seam at Mine No. 7and the timing of upcoming longwall moves.

15

----

·       Production costs per ton recognizedin 2007 are expected to be in the low-to-mid-$40-per-ton range, whichexcludes freight, royalties, selling, general and administrative expenses andpostretirement benefits. This performance improvement from 2006 is expected tobe tempered by higher labor and employee benefits due to the new agreement withthe UMWA signed in January 2007, which is expected to increase costsapproximately $15.0 million over 2006. Of this increase, approximately $2.7million was recognized in the first quarter of 2007. The Company also expectsproduction costs per ton will increase in the second and third quarters due tolower volumes, as discussed above.

·       The Company has hedged thesale of approximately 3.6 billion cubic feet of natural gas for the remainderof 2007 at an average price of $8.23 per mmbtu. Although the Companyexperienced strong natural gas production in the first quarter, the Companystill expects full year production to be between 6.8 and 7.1 billion cubicfeet.

·       At Kodiak, the Company’sproduction target remains 400,000 tons in 2007. However, the Company expectsfurther operating losses from this business in the second quarter with positivecontributions to earnings and cash flow during the second half of 2007.

·       Demand in the Company’sprime markets of Europe and South America remains strong. The Company isoptimistic that this will continue as it is seeing significant expansion ofsteel production capacity in South America. Natural Resources is positioned toprovide high-quality coking coal to this and other strategic markets in thefuture.

·       The Company is focused ongrowing its Natural Resources business internally and externally. Internalgrowth is expected from the Mine No. 7 East expansion project, whichremains on track. The Company is also evaluating acquisition opportunities.

**Homebuilding andFinancing**

·       TheCompany remains largely insulated from the highly publicized problems in themortgage finance industry. Unlike most of the industry, the Company’s uniquefinancing business focuses on consistent underwriting programs, fixed rateproducts and a disciplined servicing platform that emphasizes direct customerinterface.

·       Prepaymentspeeds slowed significantly in the current period, reflecting the mortgageindustry’s tightened underwriting guidelines. While slower prepayment speedshurt near-term income, it is a positive over the long term. The Company expectsprepayment rates to remain below the prior year estimates for the remainder of2007 and does not expect refinancing activity to significantly increase.

·       Significant progress hasbeen made to reduce the Homebuilding aged backlog and improve gross margins. TheCompany expects to achieve a break-even run-rate in 2007.

·       Construction starts in thefirst quarter were down 7% versus the prior year quarter, reflecting a lowerbacklog at December 31, 2006. The results of slow starts to date in 2007will have a negative impact on second quarter unit deliveries; however,expected on-your-lot unit completion estimates remain at 2,700 to 3,000 for thefull year 2007.

·       Duringthe first quarter of 2007, the Company decided to exit the manufacture anddistribution of modular homes due to the poor performance of this division,which operates as Crestline Homes, Inc. (“Crestline”). As such, theCompany has reported the results of operations, assets, liabilities and cashflows of Crestline as discontinued operations for all periods presented. TheCompany recognized a pre-tax charge of $2.0 million included in the loss fromdiscontinued operations in the first quarter of 2007 for severance liabilitiesand to write down the net assets to estimated fair value. The business isexpected to be sold within the year.

16

----

·       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**

·       Pension and otherpostretirement benefits expense will increase $15.4 million in 2007 versus 2006levels, which is $1.4 million higher than the Company’s previous estimate,resulting from updated actuarial information, see Note 10.

·       Quarterly interest expensefor the balance of 2007 will be substantially similar to the first quarter2007.

*ConsolidatedResults of Continuing Operations*

Net sales and revenues for the three months ended March 31,2007 were $320.3 million. Revenues grew by $7.2 million, or 2.3% from $313.1million in the prior year period. Increased revenues are primarily attributableto higher average net selling prices in the Homebuilding segment. Additionally,Natural Resources’ revenues increased primarily due to higher average coalsales prices, as the prior year included lower-priced steam coal sales. Theseincreases were partially offset by decreased revenues at Financing and Sloss.

Cost of sales, exclusive of depreciation, increased$7.8 million to $171.6 million and represented 66.2% of net sales in 2007versus $163.8 million and 64.4% of net sales in the prior year. The decline inmargin percentage in 2007 was primarily the result of higher production costsrecognized at Natural Resources, partially offset by improved margins atHomebuilding.

Depreciation for the three months ended March 31,2007 was $10.6 million, an increase of $2.2 million compared to the priorperiod. The increase is primarily due to the Company’s continued investment inthe expansion of Natural Resources’ mine operations and replacement ofequipment.

Selling, general and administrative expenses of $37.5million were 11.7% of net sales and revenues in 2007, compared to $35.2 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.

Postretirement benefits expense increased to $6.3million in the 2007 period, compared to $4.4 million in the 2006 period,primarily due to an unfavorable change in actuarial assumptions year over year.

Interest expense for the mortgage-backed andasset-backed notes remained virtually unchanged compared to the same period in2006 due to a lower effective interest rate on a higher average debt balance.

Interest expense on corporate debt decreased $5.1million to $7.3 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 Company’s effectivetax rate for the three months ended March 31, 2007 and 2006 was 40.2% and34.2%, respectively. The increase in the effective tax rate in 2007 is due tothe unfavorable impact of a $4.4 million write-off of certain deferred taxassets no longer considered realizable. Excluding this unusual adjustment, theeffective tax rate for 2007 is 32.0%. Both 2007 and 2006 differ from theFederal statutory rate primarily due to the benefit from percentage depletiondeductions.

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

17

----

*Segment Analysis*

**Natural Resources**

NaturalResources, which includes the operations of Jim Walter Resources and KodiakMining, reported revenues of $170.2 million in the first quarter, up slightlyversus the same period last year. Prices for metallurgical coal were lower inthe current quarter; however, average coal sales prices were higher due to theelimination of lower-priced steam coal sales which were present in the prioryear period. Coal sales volumes declined slightly and natural gas prices werelower versus last year’s first quarter, partially offsetting the higher averagecoal pricing.

| ** **                                   | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                   | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Average Coal Selling  Price (per Ton)        |       | $                                                | 100.34     |   | $ | 97.78 |   |
| Tons of Coal Sold (in  thousands)            |       | 1,522                                            |       | 1,543 |   |
| Average Natural Gas  Selling Price (per MCF) |       | $                                                | 7.92       |   | $ | 9.29 |   |
| Billion Cubic Feet of  Natural Gas Sold      |       | 1.9                                              |       | 1.8 |   |
| Number of Natural Gas Wells                  |       | 424                                              |       | 415 |   |

 

Natural Resources reportedoperating income of $56.4 million in the first quarter, compared to $63.9 millionin the prior year period. Results in the current year period include $2.3million in increased freight costs, $2.1 million in higher postretirementhealthcare costs, $2.0 million in higher depreciation expense and increasedoperating expenses at Kodiak. In addition, Jim Walter Resources incurredapproximately $2.7 million of incremental expenses related to the new laborcontract with the UMWA, which were more than offset by positive volumevariances due to strong production performance at both Mine Nos. 4 and 7 in thecurrent quarter. The unfavorable impacts were also partially offset byincreased profits on higher metallurgical coal sales volumes.

**Sloss**

Net sales and revenueswere $32.8 million for the three month period ended March 31, 2007, adecrease of $0.5 million compared to the prior year period. Revenues decreasedin 2007 due to reduced furnace coke pricing and decreased foundry coke salesvolumes, partially offset by increased furnace coke sales volumes. Operatingincome decreased by $0.9 million to $1.3 million for the three months endedMarch 31, 2007, primarily as a result of increased legal and environmentalexpenses compared to the same period in 2006.

**Financing**

Net sales and revenueswere $53.7 million for the three month period ended March 31, 2007, adecrease of $2.3 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 $10.6 million in 2007, compared to$13.0 million in 2006. The decrease in operating income is primarily as aresult of lower prepayment income, increased stock option expenses and anincrease in the provision for losses on instalment notes. The prior year periodalso included a $1.0 million credit to revise the estimate for the 2005hurricane losses.

18

----

Delinquencies (thepercentage of amounts outstanding over 30 days past due) were 3.4% at March 31,2007, down from 3.7% at March 31, 2006 primarily as a result of consistentunderwriting and a strong mortgage servicing platform. The calculation ofdelinquencies excludes from delinquent amounts those accounts that are inbankruptcy proceedings that are paying their mortgage payments in contractualcompliance with bankruptcy court approved mortgage payment obligations.

**Homebuilding**

Netsales and revenues were $62.1 million for the three month period ended March 31,2007, an increase of $6.8 million from the quarter ended March 31, 2006 asa result of higher average net selling prices, which increased 16.3% over theprior year period.

| ** **                 | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------|------------|--------------------------------------------------|------------|
| ** **                 | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| Unit completions           |       | 634                                              |       | 654 |   |
| Average net selling  price |       | $                                                | 98,000     |   | $ | 84,300 |   |
|                            |            |                                                  |            |  |  |  |  |

 

Homebuilding’s operatingloss was $2.7 million for the three months ended March 31, 2007 comparedto an operating loss of $4.9 million for the three months ended March 31,2006. The improved performance in 2007 was due to higher average net sellingprices, partially offset by an increase in selling, general and administrativeexpenses resulting from increased stock option and advertising expenses.

**Other**

Results in the “Other”segment, comprised of the Company’s corporate expenses and land subsidiaries,improved by approximately $0.8 million in the first quarter, driven by lowersalaries expense and professional fees, partially offset by higher stock optionexpenses.

**FINANCIAL CONDITION**

Cash and cash equivalents of continuing operationsdecreased from $127.4 million at December 31, 2006 to $100.9 million at March 31,2007 reflecting $31.5 million in cash flows provided by continuing operatingactivities, $26.2 million of cash flows used in investing activities ofcontinuing operations, $29.3 million of cash flows used in financingactivities of continuing operations and $2.5 million in cash flows used indiscontinued operating activities. See additional discussion in the Statementof Cash Flows section that follows.

Net receivables were $75.6 million at March 31,2007, a decrease of $9.5 million from December 31, 2006 primarily due tothe receipt of $18.0 million from the Company’s insurance carrier for the settlementof claims associated with the 2005 water ingress problem at Mine No. 5,which was recorded as a receivable in December 2006. This decrease waspartially offset by a $9.0 million increase in receivables for othercoal-related activity at Natural Resources.

Accrued expenses of $70.9 million at March 31,2007 decreased from $94.9 million at December 31, 2006 primarily due tothe payment of 2006 annual bonuses and 2006 fourth quarter taxes during thefirst quarter of 2007.

Corporate debt decreased $28.5 million from December 31,2006, reflecting a $28.0 million voluntary prepayment of the term loan facilityusing available cash flow.

Other long-termliabilities increased $23.1 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 to the liability for unrecognized taxbenefits.

19

----

**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 March 31, 2007,total debt has decreased by $28.1 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*

At March 31, 2007,non-recourse mortgage-backed/asset-backed notes outstanding totaled $1.7billion and consisted of eight issues of public debt and one issue of privatedebt providing financing for instalment notes receivable purchased by Mid-StateHomes (“MSH”). Mortgage debt also includes outstanding borrowings, under a$200.0 million and a $150.0 million Variable Funding Loan Agreement (“warehousefacilities”) providing temporary financing to MSH for its current purchases ofinstalment notes and mortgage loans from Homebuilding and Walter Mortgage Company. These facilities expirewithin the next 12 months; however, the Company expects to renew thesefacilities on similar terms prior to the expiration. At March 31, 2007,there were $59.3 million of borrowings outstanding under these facilities.

*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 March 31, 2007,the balance outstanding on the term loan was $220.2 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 March 31,2007, there were no borrowings outstanding under the revolving credit facility,but the Company had $53.4 million in letters of credit outstanding, reducingavailability for revolver borrowings to $171.6 million.

Duringthe three months ended March 31, 2007, repayments of the term loanfacility totaling $28.5 million were made using available cash flow. Therepayments include $28.0 million of voluntary prepayments.

*Statement of CashFlows*

Cash of continuing operations was approximately $100.9million and $127.4 million at March 31, 2007 and December 31, 2006,respectively. The decrease in cash was primarily due to the $28.0 millionprepayment of term debt.

Cash flows provided by operating activities ofcontinuing operations for the three months ended March 31, 2007 werecomparable to those for the three months ended March 31, 2006.

20

----

Cash flows used in investing activities of continuingoperations for the three months ended March 31, 2007 were $26.2 millioncompared to $8.2 million for the prior year period. Capital expenditures werecomparable year-over-year; however, the prior year period benefited from anincrease of $40.2 million of restricted cash and a $10.5 million escrow releasefrom the acquisition of Mueller Water in 2005, partially offset by cash used topurchase mortgage loans.

Cash flows used infinancing activities of continuing operations for the three months ended March 31,2007 were $29.3 million compared to cash flows provided by financing activitiesof continuing operations of $12.4 million in the prior year period. The currentyear period includes $28.5 million of term loan payments. Financing activitiesin 2006 included $103.8 million of principal payments on the 2005 Walter CreditAgreement and $66.8 million of principal payments on the Company’smortgage-backed/asset-backed notes, partially offset by $168.8 million of cashflows provided by the sale of common stock.

**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 first quarter 2007 compared tothose described in the Annual Report on Form 10-K for the fiscalyear ended December 31, 2006.

**CONTROLS ANDPROCEDURES**

**Conclusion Regardingthe 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 March 31, 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 financial reportingduring the three months ended March 31, 2007 that has materially affected,or is reasonably likely to materially affect, internal control over financialreporting.

**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.

21

----

**PART II—OTHERINFORMATION**

**Item 1.**                        *Legal Proceedings*

See Note 13 of the “Notes to Condensed ConsolidatedFinancial Statements” in this Form 10-Q for a description of currentlegal proceedings.

The Company and itssubsidiaries are parties to a number of other lawsuits arising in the ordinarycourse of their businesses. Most of these cases are in a preliminary stage andthe Company is unable to predict a range of possible loss, if any. The Companyprovides for costs relating to these matters when a loss is probable and theamount is reasonably estimable. 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 10K 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 March 31,2007, there were no share repurchases that reduced the availability under theCompany’s Common Stock share repurchase program and at March 31, 2007,$7.5 million remains available under this program.

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

None

**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     |

 

22

----

**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: May 9, 2007    |   |   |

 

23

----