**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D. C. 20549**

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**FORM 10-Q**

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

 

**Forthe quarterly period ended March 31, 2006**

**or**

| **o** | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934** | ** ** |
|-------|------------|----------------------------------------------------------------------------------------------------------|------------|

 

**CommissionFile Number 001-13711**

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**WALTER INDUSTRIES, INC.**

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

 

**4211W. Boy Scout Boulevard, Tampa, Florida 33607Telephone Number (813) 871-4811**

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months, and (2) has been subject to such filing requirements for the past90 days. Yes  x   No  o.

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the ExchangeAct. (Check one):

| Large accelerated filer x |   | Accelerated filer  o |   | Non-accelerated  filer o |
|---------------------------|--------|----------------------|--------|--------------------------|

 

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

Therewere 43,503,110 shares of common stock of the registrant outstanding at April 30,2006.

 

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**PART I—FINANCIALINFORMATION**

**ITEM 1. FINANCIALSTATEMENTS**

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

| ** **                                                                          | ** ** | **March 31,  2006**                                 | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                          | ** ** | **(in thousands, except  share amounts)** | ** ** |
| **ASSETS**                                                                          |       |                                                     |       |                        |       |   |   |
| Cash and cash  equivalents                                                          |       | $                                                        | 146,216    |                        |       | $ | 137,396 |   |   |
| Short-term investments,  restricted                                                 |       | 84,442                                                   |       |                        | 124,573    |   |   |
| Instalment notes  receivable, net of allowance of $12,708 and $12,489, respectively |       | 1,726,879                                                |       |                        | 1,693,922  |   |   |
| Receivables, net                                                                    |       | 363,237                                                  |       |                        | 334,322    |   |   |
| Income tax receivable                                                               |       | 20,883                                                   |       |                        | 16,793     |   |   |
| Inventories                                                                         |       | 585,295                                                  |       |                        | 551,293    |   |   |
| Prepaid expenses                                                                    |       | 27,365                                                   |       |                        | 31,320     |   |   |
| Property, plant and  equipment, net                                                 |       | 617,402                                                  |       |                        | 603,350    |   |   |
| Investments                                                                         |       | 6,000                                                    |       |                        | 6,056      |   |   |
| Unamortized debt expense                                                            |       | 70,694                                                   |       |                        | 75,062     |   |   |
| Other long-term assets                                                              |       | 83,288                                                   |       |                        | 73,247     |   |   |
| Identifiable  intangibles, net                                                      |       | 857,155                                                  |       |                        | 858,122    |   |   |
| Goodwill                                                                            |       | 866,392                                                  |       |                        | 867,556    |   |   |
|                                                                                |       | $                                                        | 5,455,248  |                        |       | $ | 5,373,012 |   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                       |       |                                                     |       |                        |       |   |   |
| Accounts payable                                                                    |       | $                                                        | 183,866    |                        |       | $ | 161,215 |   |   |
| Accrued expenses                                                                    |       | 192,966                                                  |       |                        | 213,596    |   |   |
| Deferred income taxes                                                               |       | 236,827                                                  |       |                        | 215,874    |   |   |
| Debt:                                                                               |       |                                                     |       |                        |       |   |   |
| Mortgage-backed/asset-backed  notes                                                 |       | 1,660,591                                                |       |                        | 1,727,329  |   |   |
| Other debt                                                                          |       | 2,042,818                                                |       |                        | 2,172,453  |   |   |
| Accrued interest                                                                    |       | 41,017                                                   |       |                        | 32,619     |   |   |
| Accumulated  postretirement benefits obligation                                     |       | 273,917                                                  |       |                        | 275,336    |   |   |
| Other long-term  liabilities                                                        |       | 288,095                                                  |       |                        | 285,974    |   |   |
| Total liabilities                                                                   |       | 4,920,097                                                |       |                        | 5,084,396  |   |   |
| Commitments and contingencies (Note 12)                                             |       |                                                     |       |                        |       |   |   |
| Stockholders’ equity                                                           |       |                                                     |       |                        |       |   |   |
| Common stock, $.01 par value per share:                                             |       |                                                     |       |                        |       |   |   |
| Authorized—200,000,000 shares                                                  |       |                                                     |       |                        |       |   |   |
| Issued—64,243,661 and  59,818,401 shares                                       |       | 643                                                      |       |                        | 598        |   |   |
| Capital in excess of par  value                                                     |       | 1,411,585                                                |       |                        | 1,210,751  |   |   |
| Accumulated deficit                                                                 |       | (566,703                                                 | )          |                        | (602,002   | ) |   |
| Treasury  stock—20,771,902 shares, at cost                                     |       | (259,317                                                 | )          |                        | (259,317   | ) |   |
| Accumulated other  comprehensive loss                                               |       | (51,057                                                  | )          |                        | (61,414    | ) |   |
| Total stockholders’  equity                                                    |       | 535,151                                                  |       |                        | 288,616    |   |   |
|                                                                                |       | $                                                        | 5,455,248  |                        |       | $ | 5,373,012 |   |   |

 

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

1

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

| ** **                                                   | ** ** | **For the three months  ended March 31,** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **2006**                                                           | ** ** | **2005** | ** ** |
| ** **                                                   | ** ** | **(in thousands, except  per share amounts)**  | ** ** |
| Net sales and revenues:                                      |       |                                                               |       |   |   |
| Net sales                                                    |       | $                                                                  | 694,693    |   | $ | 307,678 |   |
| Interest income on instalment notes                          |       | 50,530                                                             |       | 53,493 |   |
| Miscellaneous                                                |       | 8,046                                                              |       | 5,110 |   |
|                                                         |       | 753,269                                                            |       | 366,281 |   |
| Cost and expenses:                                           |       |                                                               |       |   |   |
| Cost of sales (exclusive of depreciation)                    |       | 493,981                                                            |       | 238,900 |   |
| Depreciation                                                 |       | 25,693                                                             |       | 14,320 |   |
| Selling, general and administrative                          |       | 90,362                                                             |       | 42,570 |   |
| Provision for losses on instalment notes                     |       | 2,305                                                              |       | 3,185 |   |
| Postretirement benefits                                      |       | 4,017                                                              |       | 3,238 |   |
| Interest expense—mortgage-backed/asset-backed notes     |       | 29,976                                                             |       | 31,435 |   |
| Interest expense—other debt                             |       | 42,552                                                             |       | 3,612 |   |
| Amortization of intangibles                                  |       | 7,690                                                              |       | 1,063 |   |
| Credit for estimated hurricane insurance losses              |       | (1,046                                                             | )          | (556 | ) |
| Restructuring and impairment charges                         |       | 4,261                                                              |       | 305 |   |
|                                                         |       | 699,791                                                            |       | 338,072 |   |
| Income from  continuing operations before income tax expense |       | 53,478                                                             |       | 28,209 |   |
| Income tax  expense                                          |       | (18,179                                                            | )          | (9,027 | ) |
| Income from  continuing operations                           |       | 35,299                                                             |       | 19,182 |   |
| Discontinued  operations, net of income taxes                |       | —                                                             |       | (417 | ) |
| Net income                                                   |       | $                                                                  | 35,299     |   | $ | 18,765 |   |
| Basic income per share:                                      |       |                                                               |       |   |   |
| Income from continuing operations                            |       | $                                                                  | 0.86       |   | $ | 0.51 |   |
| Discontinued operations                                      |       | —                                                             |       | (0.01 | ) |
| Net income                                                   |       | $                                                                  | 0.86       |   | $ | 0.50 |   |
| Diluted income per  share:                                   |       |                                                               |       |   |   |
| Income from continuing operations                            |       | $                                                                  | 0.71       |   | $ | 0.41 |   |
| Discontinued operations                                      |       | —                                                             |       | — |   |
| Net income                                                   |       | $                                                                  | 0.71       |   | $ | 0.41 |   |

 

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

2

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**WALTER INDUSTRIES,INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENT OF CHANGES**

**INSTOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME**

**FOR THE THREEMONTHS ENDED MARCH 31, 2006(UNAUDITED)(in thousands)**
|                                                    | ** ** | ** ** | ** ** | ** **        | ** ** | ** **      | ** ** | **Accumulated**        | ** ** | ** ** | ** ** | ** **          | ** ** | ** **   | ** ** |
|----------------------------------------------------|------------|------------|------------|-------------------|------------|-----------------|------------|------------------------|------------|------------|------------|---------------------|------------|--------------|------------|
| ** **                                         | ** ** | ** ** | ** ** | ** **        | ** ** | ** **      | ** ** | **Other**              | ** ** | ** ** | ** ** | **Capital in** | ** ** | ** **   | ** ** |
| ** **                                         | ** ** | ** ** | ** ** | **Comprehensive** | ** ** | **Accumulated** | ** ** | **Comprehensive**      | ** ** | **Common** | ** ** | **Excess of**  | ** ** | **Treasury** | ** ** |
| ** **                                         | ** ** | **Total**  | ** ** | **Income**        | ** ** | **Deficit**     | ** ** | **Income (Loss)** | ** ** | **Stock**  | ** ** | **Par Value**  | ** ** | **Stock**    | ** ** |
| Balance at December 31, 2005                  |       | $          | 288,616    |              |       |            |       |                   |       | $          | (602,002   | )                   |       |         | $          | (61,414 | ) |   |   | $ | 598 |   |   | $ | 1,210,751 |   | $ | (259,317 | ) |
| Comprehensive income:                              |       |       |       |              |       |            |       |                   |       |       |       |                |       |         |       |   |   |   |   |   |   |   |   |
| Net income                                         |       | 35,299     |       |              | $          | 35,299          |       |                   |       | 35,299     |       |                |       |         |       |   |   |   |   |   |   |   |   |   |
| Other comprehensive income, net of tax             |       |       |       |              |       |            |       |                   |       |       |       |                |       |         |       |   |   |   |   |   |   |   |   |
| Cumulative foreign currency translation adjustment |       | (6         | )          |              | (6         | )               |       |                   |       |       |       |                | (6         | )            |       |   |   |   |   |   |   |   |   |
| Net unrealized gain on hedges                 |       | 10,363     |       |              | 10,363     |            |       |                   |       |       |       |                | 10,363     |         |       |   |   |   |   |   |   |   |   |
| Comprehensive income                               |       |       |       |              | $          | 45,656          |       |                   |       |       |       |                |       |         |       |   |   |   |   |   |   |   |   |   |
| Sale of common stock                               |       | 168,829    |       |              |       |            |       |                   |       |       |       |                |       |         |       |   | 26 |   |   | 168,803 |   |   |   |
| Stock issued upon conversion of convertible notes  |       | 25,862     |       |              |       |            |       |                   |       |       |       |                |       |         |       |   | 15 |   |   | 25,847 |   |   |   |
| Stock issued upon exercise of stock options        |       | 2,250      |       |              |       |            |       |                   |       |       |       |                |       |         |       |   | 4 |   |   | 2,246 |   |   |   |
| Tax benefit on the exercise of stock options       |       | 4,051      |       |              |       |            |       |                   |       |       |       |                |       |         |       |   |   |   |   | 4,051 |   |   |   |
| Dividends paid, $.04 per share                     |       | (1,568     | )          |              |       |            |       |                   |       |       |       |                |       |         |       |   |   |   |   | (1,568 | ) |   |   |
| Stock-based compensation                           |       | 1,455      |       |              |       |            |       |                   |       |       |       |                |       |         |       |   |   |   |   | 1,455 |   |   |   |
| Balance at  March 31, 2006                    |       | $          | 535,151    |              |       |            |       |                   |       | $          | (566,703   | )                   |       |         | $          | (51,057 | ) |   |   | $ | 643 |   |   | $ | 1,411,585 |   | $ | (259,317 | ) |

 

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

3

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

| ** **                                                                                     | ** ** | **For the three months  ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                     | ** ** | **2006**                                                           | ** ** | **2005** | ** ** |
| ** **                                                                                     | ** ** | **(in thousands)**                                            | ** ** |
| OPERATING ACTIVITIES                                                                           |       |                                                               |       |   |   |
| Net income                                                                                     |       | $                                                                  | 35,299     |   | $ | 18,765 |   |
| Adjustments to  reconcile net income to net cash provided by (used in) continuing operations:  |       |                                                               |       |   |   |
| Discontinued operations, net of tax                                                            |       | —                                                             |       | 417 |   |
| Provision for losses on instalment notes receivable                                            |       | 2,305                                                              |       | 3,185 |   |
| Depreciation                                                                                   |       | 25,693                                                             |       | 14,320 |   |
| Provision for (benefit from) deferred income taxes                                             |       | 16,558                                                             |       | (3,870 | ) |
| Tax benefit on the exercise of employee stock options                                          |       | (4,051                                                             | )          | 12,995 |   |
| Decrease in other long-term assets                                                             |       | 6,456                                                              |       | — |   |
| Increase in other long-term liabilities                                                        |       | 2,121                                                              |       | 3,041 |   |
| Amortization of intangibles                                                                    |       | 7,690                                                              |       | 1,063 |   |
| Amortization of debt expense                                                                   |       | 4,345                                                              |       | 1,626 |   |
| Stock-based compensation expense                                                               |       | 1,455                                                              |       | 363 |   |
| Other                                                                                          |       | 2,949                                                              |       | (1,399 | ) |
| Decrease  (increase) in assets:                                                                |       |                                                               |       |   |   |
| Receivables                                                                                    |       | (28,710                                                            | )          | (3,767 | ) |
| Income tax receivable                                                                          |       | (4,093                                                             | )          | (74 | ) |
| Inventories                                                                                    |       | (31,915                                                            | )          | (52,906 | ) |
| Prepaid expenses                                                                               |       | 3,968                                                              |       | (992 | ) |
| Increase  (decrease) in liabilities:                                                           |       |                                                               |       |   |   |
| Accounts payable                                                                               |       | 3,378                                                              |       | 10,569 |   |
| Accrued expenses                                                                               |       | (21,200                                                            | )          | (11,104 | ) |
| Accrued interest                                                                               |       | 8,398                                                              |       | 466 |   |
| Cash flows provided by (used in) continuing operations                                         |       | 30,646                                                             |       | (7,302 | ) |
| Cash flows used in discontinued operations                                                     |       | —                                                             |       | (417 | ) |
| Cash flows provided by (used in) operating activities                                          |       | 30,646                                                             |       | (7,719 | ) |
| INVESTING  ACTIVITIES                                                                          |       |                                                               |       |   |   |
| Acquisitions of businesses, net of cash acquired                                               |       | (5,095                                                             | )          | — |   |
| Notes from sales and resales of homes, purchases of  loans, repossessions and write-offs  |       | (127,882                                                           | )          | (93,812 | ) |
| Cash collections on accounts and payouts in advance  of maturity                               |       | 92,620                                                             |       | 106,915 |   |
| Decrease in short-term investments, restricted                                                 |       | 40,131                                                             |       | 686 |   |
| Additions to property, plant and equipment                                                     |       | (43,338                                                            | )          | (23,323 | ) |
| Cash proceeds from sale of property, plant and  equipment                                      |       | 2,699                                                              |       | 366 |   |
| Decrease in investments                                                                        |       | 56                                                                 |       | 328 |   |
| Cash flows used in investing activities                                                        |       | (40,809                                                            | )          | (8,840 | ) |
| FINANCING  ACTIVITIES                                                                          |       |                                                               |       |   |   |
| Issuance of mortgage-backed/asset-backed notes                                                 |       | —                                                             |       | 30,500 |   |
| Retirement of mortgage-backed/asset-backed notes                                               |       | (66,781                                                            | )          | (70,260 | ) |
| Proceeds from issuance of other debt                                                           |       | —                                                             |       | 16,900 |   |
| Retirements of other debt                                                                      |       | (106,406                                                           | )          | (10,000 | ) |
| Increase in dollar value of bank checks outstanding                                            |       | 19,261                                                             |       | — |   |
| Cash dividends paid                                                                            |       | (1,568                                                             | )          | (1,494 | ) |
| Sale of common stock                                                                           |       | 168,829                                                            |       | — |   |
| Exercise of employee stock options                                                             |       | 2,250                                                              |       | 13,319 |   |
| Tax benefit on the exercise of employee stock options                                          |       | 4,051                                                              |       | — |   |
| Other                                                                                          |       | (653                                                               | )          | (583 | ) |
| Cash flows provided by (used in) financing activities                                          |       | 18,983                                                             |       | (21,618 | ) |
| Net increase (decrease) in cash and cash equivalents                                           |       | 8,820                                                              |       | (38,177 | ) |
| Cash and cash equivalents at beginning of period                                               |       | 137,396                                                            |       | 46,924 |   |
| Cash and cash  equivalents at end of period                                                    |       | $                                                                  | 146,216    |   | $ | 8,747 |   |

 

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

4

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**WALTER INDUSTRIES, INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSAS OF AND FOR THE THREE MONTHS ENDED MARCH 31, 2005(Unaudited)**

**Note 1—Basis ofPresentation**

Walter Industries, Inc. (“Walter”), together withits consolidated subsidiaries (“the Company”), is a diversified company whichoperates in seven reportable segments: Homebuilding, Financing, Mueller, Anvil, U.S. Pipe, Natural Resourcesand Other, see Note 11. Through these operating segments, the Company offers adiversified line of products and services including home construction andmortgage financing, water infrastructure and flow control products, coal,natural gas, furnace and foundry coke, chemicals and slag fiber.

The accompanying unaudited condensed consolidated financialstatements of the Company have been prepared in accordance with accountingprinciples generally accepted in the United States for interim financialinformation 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, 2006 are not necessarily indicative of the resultsthat may be expected for the year ending December 31, 2006.

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

**Note 2—Share-BasedCompensation Plans**

As of January 1, 2006, the Company adoptedStatement of Financial Accounting Standards No. 123 (revised 2004), “Share-BasedPayment” (“SFAS 123(R)”) which requires the Company to value and record, ascompensation expense, stock awards granted to employees under a fair valuebased method. Prior to January 1, 2006, the Company accounted for stockawards granted to employees under the recognition and measurement principles ofAccounting Principles Board Opinion No. 25, “Accounting for Stock Issuedto Employees,” and related interpretations. As a result, no compensationexpense was previously recognized for stock options granted to employeesbecause all stock options granted had exercise prices equal to the market valueof the Company’s stock at the date of the grant while compensation expenseassociated with restricted stock unit grants was being recognized over thevesting period of the grant.

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

5

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Theeffect of adoption of SFAS 123(R) on the financial performance of theCompany for the three months ended March 31, 2006 was as follows (inthousands, except per share data):

| ** **                                                         | ** ** | **For the  three months ended  March 31, 2006** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| Decrease in  income from continuing operations before income taxes |       |                                                                     | $          | 810 |   |   |
| Decrease in net  income                                            |       |                                                                     | $          | 526 |   |   |
| Cash outflow from  operating activities                            |       |                                                                     | $          | 4,051 |   |   |
| Cash inflow from  financing activities                             |       |                                                                     | $          | 4,051 |   |   |
| Decrease in basic and  diluted earnings per share                  |       |                                                                     | $          | 0.01 |   |   |

 

Inaccordance with the modified prospective transition method, the Company’sConsolidated Financial Statements for periods ending prior to January 1,2006 have not been restated to reflect, and do not include, the impact of SFAS123(R). Had compensation cost for the Company’s option plans for the threemonths ended March 31, 2005 been determined based on the fair value at thegrant dates as prescribed by SFAS 123(R), the Company’s net income and netincome per share on a pro forma basis would have been (in thousands, except pershare data):

| ** **                                                                                                                                    | ** ** | **For the  three months ended  March 31, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| Net income, as  reported                                                                                                                      |       |                                                                     | $          | 18,765 |   |   |
| Add: Stock-based  compensation expense included in reported net income, net of related tax  effects                                           |       |                                                                     | 236        |   |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based method  for all awards, net of related tax effects |       |                                                                     | (727       | ) |   |
| Pro forma net income                                                                                                                          |       |                                                                     | $          | 18,274 |   |   |

 

| ** **               | ** ** | **For the  three months ended  March 31, 2005** | ** ** |
|--------------------------|------------|--------------------------------------------------------------------------|------------|
| Net income per  share    |       |                                                                     |       |   |   |
| Basic—as reported   |       |                                                                     | $          | 0.50 |   |   |
| Basic—pro forma     |       |                                                                     | 0.48       |   |   |
| Diluted—as reported |       |                                                                     | 0.41       |   |   |
| Diluted—pro forma   |       |                                                                     | 0.40       |   |   |
|                          |            |                                                                          |            |  |  |  |

 

Thepreceding pro forma results were calculated with the use of the Black Scholesoption-pricing model. Weighted average assumptions used for the three monthsended March 31, 2005 were:

| Risk free  interest rate |   | 4.16  | %      |
|--------------------------|--------|-------|--------|
| Dividend yield           |   | 0.40  | %      |
| Expected life  (years)   |   | 6.00  |   |
| Volatility               |   | 39.23 | %      |

 

6

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**Equity Award Plans**

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

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

Under both plans (collectively, the “Equity AwardPlans”), an option becomes exercisable at such times and in such installmentsas set by the Compensation Committee of the Board of Directors (generally,vesting occurs over three or five years in equal annual increments), but nooption will be exercisable after the tenth anniversary of the date on which itis granted.

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

During the three months ended March 31, 2006 and2005, the Company recorded stock-based compensation expense of approximately$1.5 million and $0.4 million, respectively. These amounts are reflected inselling, general and administrative expenses and have been allocated to thereportable segments. The total income tax benefits recognized in the statementsof operations for share-based compensation arrangements was $0.5 million and$0.1 million for the three months ended March 31, 2006 and 2005,respectively.

Asummary of activity related to stock options under the Equity Award Plans as ofMarch 31, 2006 and changes during the three months then ended is presentedbelow:

| ** **                           | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in years)** | ** ** | **Aggregate  Intrinsic Value  ($000)** | ** ** |
|--------------------------------------|------------|------------|------------|--------------------------------------------|------------|--------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| Outstanding at  January 1, 2006 |       | 879,568    |       |                                       | $          | 15.800                                                                   |       |                                        |       |   |   |   |   |   |   |   |
| Granted                              |       | 293,703    |       |                                       | 63.506     |                                                                     |       |                                        |       |   |   |   |   |   |   |
| Exercised                            |       | 232,009    |       |                                       | 9.819      |                                                                     |       |                                        |       |   |   |   |   |   |   |
| Cancelled                            |       | 664        |       |                                       | 38.720     |                                                                     |       |                                        |       |   |   |   |   |   |   |
| Outstanding at  March 31, 2006  |       | 940,598    |       |                                       | 32.169     |                                                                     |       |                                        | 7.89       |   |   |   | $ | 32,349 |   |   |
| Exercisable at  March 31, 2006  |       | 391,886    |       |                                       | $          | 12.453                                                                   |       |                                        |       | 5.98 |   |   |   | $ | 21,204 |   |   |

 

Weightedaverage assumptions used to determine the grant-date fair value of optionsgranted during the three months ended March 31, 2006 were:

| Risk free  interest rate |   | 4.60  | %      |
|--------------------------|--------|-------|--------|
| Dividend yield           |   | 0.30  | %      |
| Expected life  (years)   |   | 5.50  |   |
| Volatility               |   | 38.30 | %      |
| Forfeiture rate          |   | 4.50  | %      |

 

7

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Approximately 125,000 and 58,000 restricted stockunits were granted and exercised during the three months ended March 31,2006, respectively. Approximately 312,000 and 245,000 restricted stock unitswere outstanding at March 31, 2006 and December 31, 2005,respectively. At March 31, 2006, the weighted-average remainingcontractual term on the Company’s restricted stock units was 3.4 years.

The weighted-averagegrant-date fair value of stock options and restricted stock units grantedduring the three months ended March 31, 2006 was $26.73 and $64.77,respectively. The total intrinsic value of stock options exercised or convertedduring the three months ended March 31, 2006 was approximately $16.9million. As of March 31, 2006, there was approximately $18.7 million ofunrecognized compensation cost related to non-vested share-based compensationarrangements granted under the Equity Award Plans; that cost is to berecognized over a weighted average period of 2.9 years.

**Note 3—Restructuringand Impairments**

On January 26, 2006, the Company announced plansto close its Henry Pratt (“Pratt”) valve manufacturing facility in Dixon,Illinois, which is included in the Company’s Mueller segment. The eventualclosure of the facility is expected to occur during 2006, resulting in thetermination of approximately 100 employees. The Pratt closure is part of theCompany’s continued facility rationalization strategy and was identified priorto the October 3, 2005 acquisition date of Mueller Water Products, Inc.and subsidiaries (“Mueller Water”). Total estimated costs are expected to be$2.2 million, of which $1.4 million is expected to be recorded as an adjustmentto goodwill. During the quarter ended March 31, 2006, $0.3 million wasrecorded as an adjustment to goodwill.

On October 26, 2005, the Company announced plansto close U.S. Pipe’s Chattanooga, Tennessee plant and transfer the valve andhydrant production of that plant to Mueller Water’s Chattanooga, Tennessee andAlbertville, Alabama plants. The eventual closure of the U.S. Pipe Chattanoogaplant is expected to occur in the second quarter of 2006, resulting in thetermination of approximately 340 employees. Total exit costs are expected toaccumulate to $47.6 million of which approximately $29.3 million qualify asrestructuring and impairment charges. The remaining exit costs of $18.3 millionare comprised of an inventory write-down totaling $10.7 million and a $7.6million write-off of unabsorbed overhead costs, of which $15.9 million and $2.4million were recognized in cost of sales during the fourth quarter of 2005 andfirst quarter of 2006, respectively.

Totalestimated restructuring and impairment charges and the amounts recorded to restructuringexpenses are as follows (in thousands):

| ** **                                   | ** ** | **Total  Expected Costs** | ** ** | **Restructuring  charges expensed  from inception to  March 31, 2006** | ** ** | **Restructuring  charges expensed  for the three months  ended March 31, 2006** | ** ** | **Restructuring  charges expensed  in 2005** | ** ** |
|----------------------------------------------|------------|--------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| Termination  benefits                        |       |                           | $          | 3,566                                                                                           |       |                                                                                                               |       | $                                                      | 3,423      |   |   |   | $ | 427 |   |   |   | $ | 2,996 |   |   |
| Other  employee-related costs                |       |                           | 3,311      |                                                                                            |       |                                                                                                               | 3,834      |                                                   |       |   | 3,834 |   |   |   | — |   |   |
| Other associated  costs                      |       |                           | 3,365      |                                                                                            |       |                                                                                                               | 2,094      |                                                   |       |   | — |   |   |   | 2,094 |   |   |
| Impairment of  property, plant and equipment |       |                           | 19,048     |                                                                                            |       |                                                                                                               | 19,048     |                                                   |       |   | — |   |   |   | 19,048 |   |   |
| Total                                        |       |                           | $          | 29,290                                                                                          |       |                                                                                                               |       | $                                                      | 28,399     |   |   |   | $ | 4,261 |   |   |   | $ | 24,138 |   |   |

 

Termination benefits relating to the U.S. PipeChattanooga plant closure totaling $0.4 million in the three months ended March 31,2006 consist primarily of severance for staff reductions of hourly personnel. Inaddition, the Company recognized $3.8 million of other employee-related costsduring the three months ended March 31, 2006 consisting primarily ofpension and other postretirement curtailments and termination benefits. TheCompany expects to recognize reductions, as a result of the curtailment gain,to 

8

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these costs of $0.5million during the remainder of 2006. The Company also expects to recognize$1.3 million of environmental-related costs, as those costs are incurred,during 2006.

In 2003, the Company announced that it expected toclose Mine No. 5 in 2004. In 2004, the Company decided to extend its coalproduction schedule for Mine No. 5 into the fourth quarter of 2006 due tofavorable metallurgical coal pricing, which more than offset the high costsnecessary to mine the coal. Total expected costs are approximately $11.8million, of which $6.7 million qualify as restructuring costs. The Company hasalready incurred $6.6 million of these restructuring costs and none wereincurred during the three months ended March 31, 2006. Other costs,primarily representing estimated workers’ compensation and other incrementalcosts related to the closure of the mine, will be charged to expense whenincurred.

Activityin accrued restructuring was as follows (in thousands):

| ** **                      | ** ** | **For the three  months ended  March 31, 2006** | ** ** | **For the  year ended  December 31, 2005** | ** ** |
|---------------------------------|------------|--------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| Beginning balance               |       |                                                                     | $          | 4,460                                                          |       |   |   | $ | 1,588 |   |   |
| Restructuring  expenses accrued |       |                                                                     | 775        |                                                           |       |   | 6,568 |   |   |
| Restructuring  payments         |       |                                                                     | (984       | )                                                              |       |   | (2,248 | ) |   |
| Reversal of prior  accruals     |       |                                                                     | —     |                                                           |       |   | (1,448 | ) |   |
| Ending balance                  |       |                                                                     | $          | 4,251                                                          |       |   |   | $ | 4,460 |   |   |

 

**Note 4—RestrictedShort-Term Investments**

Restricted short-terminvestments at March 31, 2006 and December 31, 2005 include(i) temporary investments primarily in commercial paper or money marketaccounts with maturities less than 90 days from collections on instalment notesreceivable owned by various Mid-State Trusts (the “Trusts”) ($78.0 million and$118.2 million, respectively) which are available only to pay expenses of theTrusts and principal and interest on indebtedness of the Trusts, and(ii) miscellaneous other segregated accounts restricted to specific uses($6.4 million).

**Note 5—InstalmentNotes Receivable**

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

| ** **                   | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Instalment notes  receivable |       | $                        | 1,559,172  |                        |       | $ | 1,558,383 |   |   |
| Mortgage loans               |       | 180,415                  |       |                        | 148,028    |   |   |
| Less: Allowance  for losses  |       | (12,708                  | )          |                        | (12,489    | ) |   |
| Net                          |       | $                        | 1,726,879  |                        |       | $ | 1,693,922 |   |   |

 

During the three monthsended March 31, 2006 and 2005, Walter Mortgage Company, a wholly-ownedsubsidiary of the Company, purchased $­39.1 million and $11.4 million of thirdparty mortgage loans, respectively.

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**Note 6—Inventories**

Inventoriesare summarized as follows (in thousands):

| ** **                          | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Finished goods                      |       | $                        | 313,360    |                        |       | $ | 278,347 |   |   |
| Goods in process                    |       | 144,592                  |       |                        | 144,846    |   |   |
| Raw materials and  supplies         |       | 98,259                   |       |                        | 97,490     |   |   |
| Repossessed  houses held for resale |       | 29,084                   |       |                        | 30,610     |   |   |
| Total inventories                   |       | $                        | 585,295    |                        |       | $ | 551,293 |   |   |

 

**Note 7—Acquisitions,Goodwill and Identifiable Intangible Assets**

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

Goodwill decreased to $866.4 million at March 31,2006 from $867.6 million at December 31, 2005. During the quarter endedMarch 31, 2006, the Company recorded $6.8 million of goodwill related tothe acquisition of Hunt, a $0.6 million increase related to the execution ofcertain restructuring plans identified by the Company prior to the acquisitionof Mueller Water, a $2.4 million adjustment related to deferred taxes on theforeign currency transaction gain on partial repayment of theforeign-denominated intercompany loans of Mueller Water that existed atOctober 3, 2005; a $0.5 million decrease related to adjustments to theproperty valuations recorded as part of the purchase price allocation and a$10.5 million reduction to goodwill in the Mueller and Anvil segments due tothe settlement of the final working capital and cash adjustments to the MuellerWater purchase price.

Net identifiableintangibles decreased by $0.9 million to $857.2 million at March 31, 2006.The Company acquired $6.8 million of identifiable intangible assets inconnection with the CCNE acquisition, consisting of technology representingprocesses related to the design and development of products. Amortization ofdefinite-lived intangible assets was $7.7 million for the three months endedMarch 31, 2006.

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**Note 8—Debt**

Debtconsisted of the following (in thousands):

| ** **                            | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Mortgage-Backed/Asset-Backed  Notes:  |       | $                        | 1,660,591  |                        |       | $ | 1,727,329 |   |   |
| Other debt:                           |       |                     |       |                        |       |   |   |
| 2005 Mueller Credit Agreement         |       | 1,044,750                |       |                        | 1,047,375  |   |   |
| 2005 Walter Credit Agreement          |       | 345,094                  |       |                        | 448,875    |   |   |
| 10% Senior Subordinated Notes(1)      |       | 332,426                  |       |                        | 333,162    |   |   |
| 143¤4% Senior  Discount Notes(2) |       | 169,785                  |       |                        | 165,697    |   |   |
| Convertible Senior Subordinated Notes |       | 148,400                  |       |                        | 175,000    |   |   |
| Capital Lease Obligations             |       | 2,363                    |       |                        | 2,344      |   |   |
|                                  |       | 2,042,818                |       |                        | 2,172,453  |   |   |
| Total                                 |       | $                        | 3,703,409  |                        |       | $ | 3,899,782 |   |   |

----

(1)          The 10% seniorsubordinated notes were recorded at fair value at October 3, 2005, whichwas an increase of $18.9 million over Mueller Water’s carrying amount. Thisamount is amortized over the life of the notes as a reduction to interestexpense. As of March 31, 2006, the unamortized fair value adjustment was$17.4 million. The effective interest rate was 7.3% as of March 31, 2006.

(2)          The143¤4% seniordiscount notes were recorded at fair value on October 3, 2005, which wasan increase of $36.0 million over Mueller Water’s carrying amount. This amountis amortized over the remaining life of the notes as a reduction to interestexpense. As of March 31, 2006, the unamortized fair value adjustment was$33.6 million. The effective interest rate was 10.4% as of March 31, 2006.

**2005 Mueller CreditAgreement**

On October 3, 2005, Mueller Group, LLC, (“MuellerGroup”) a wholly-owned subsidiary of Mueller Water, entered into a$1,195.0 million credit agreement (“2005 Mueller Credit Agreement”) whichincludes (1) an amortizing term loan facility (27 quarterly principalpayments) in an initial aggregate principal amount of $1,050.0 million, ofwhich $1,044.8 million was outstanding as of March 31, 2006, and (2) a$145.0 million revolving credit facility, which provides for loans andletters of credit. As of March 31, 2006, Mueller Group had issued $31.4million in letters of credit, which reduced availability for borrowings underthe revolving credit facility to $113.6 million and there were no borrowingsoutstanding under the revolving credit facility. The revolving credit facilitywill terminate on October 4, 2010, and the term loan will mature on November 1,2011 (or October 3, 2012, if the 10% senior subordinated notes due 2012are paid in full or refinanced prior to such date).

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

**2005 Walter CreditAgreement**

On October 3, 2005, Walter Industries enteredinto a $675.0 million credit agreement (“2005 Walter Credit Agreement”)which includes (1) an amortizing term loan facility (27 quarterlyprincipal payments) in an initial aggregate principal amount of$450.0 million, of which $345.1 million was outstanding as of March 31,2006, and (2) a $225.0 million revolving credit facility, whichprovides for loans and letters of credit. As of March 31, 2006, theCompany had issued $68.4 million in letters of credit, which reducedavailability for borrowings under the revolving credit facility to $156.6million and there were no 

11

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borrowings outstandingunder the revolving credit facility. The revolving credit facility willterminate on October 4, 2010, and the term loan will mature on October 3,2012.

In February 2006, theCompany sold 2.65 million shares of common stock for approximately $169.0million of net cash proceeds. Of these proceeds, $67.9 million was used torepay the term loan facility on a mandatory basis and $35.0 million was used torepay the term loan facility on an optional basis. As a result of these termloan prepayments, $1.6 million of unamortized debt expense was charged tointerest expense during the first quarter of 2006.

**Convertible SeniorSubordinated Notes**

During the three monthsended March 31, 2006, holders of $26.6 million of the Company’sConvertible Senior Subordinated Notes surrendered their convertible notes inexchange for approximately 1,490,000 shares of the Company’s common stock and,as a result, approximately $1.6 million of premiums was expensed during thefirst quarter of 2006.

**Interest Rate HedgeAgreements**

In February 2006, the Company entered into threeinterest rate hedge agreements (“swaps”) with a cumulative notional value of$125 million with three separate counter-parties. The structure of the swaps isa 14-year, forward-starting swap which starts on December 15, 2006,which is the forecasted issuance date of the Company’s next mortgage-backedsecuritization. The swaps call for the Company to make fixed rate payments overthe term at 5.05% per annum and receive payments based on one-month LIBOR fromthe counter-parties. It is anticipated that the swaps will be settled atsecuritization, and the Company will account for the swaps as cash flowhedges. Changes in the fair value of the swaps through the date ofsecuritization that take place will be recorded in accumulated other comprehensiveincome (loss), assuming the securitization remains likely.

**Note 9—Pensionand Other Postretirement Benefits**

The components ofnet periodic benefit cost are as follows (in thousands):

| ** **                                         | ** ** | **Pension Benefits**                                          | ** ** | **Other Benefits**                                            | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                         | ** ** | **For the three months  ended March 31,** | ** ** | **For the three months  ended March 31,** | ** ** |
| ** **                                         | ** ** | **2006**                                                           | ** ** | **2005**                                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
| Components of net  periodic benefit cost:          |       |                                                               |       |                                                               |       |   |   |   |   |
| Service cost                                       |       | $                                                                  | 2,700      |                                                               | $          | 2,061 |   | $ | 675 |   | $ | 448 |   |
| Interest cost                                      |       | 7,009                                                              |       | 5,539                                                              |       | 4,088 |   | 4,014 |   |
| Expected return  on plan assets                    |       | (7,837                                                             | )          | (6,246                                                             | )          | — |   | — |   |
| Amortization of  prior service cost                |       | 292                                                                |       | 164                                                                |       | (1,727 | ) | (1,721 | ) |
| Amortization of  net loss                          |       | 2,735                                                              |       | 1,575                                                              |       | 981 |   | 497 |   |
|                                               |       | 4,899                                                              |       | 3,093                                                              |       | 4,017 |   | 3,328 |   |
| Curtailments and  termination benefits loss (gain) |       | 4,956                                                              |       | —                                                             |       | (1,122 | ) | — |   |
| Net periodic benefit  cost                         |       | $                                                                  | 9,855      |                                                               | $          | 3,093 |   | $ | 2,895 |   | $ | 3,238 |   |

 

The curtailments andtermination benefits loss (gain) shown in the schedule above are related to theclosure of the U.S. Pipe Chattanooga, Tennessee plant as described in Note 3.These components of net periodic benefit cost for pension and postretirementplans were charged to restructuring expense in the statement of operations.

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**Note 10—Net Income(Loss) Per Share**

Areconciliation of the basic and diluted net income (loss) per sharecomputations for the three months ended March 31, 2006 and 2005 are asfollows (in thousands, except per share data):

| ** **                                                                      | ** ** | **For the three months ended March 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                                                      | ** ** | **2006**                                                               | ** ** | **2005** | ** ** |
| ** **                                                                      | ** ** | **Basic**                                                              | ** ** | **Diluted** | ** ** | **Basic** | ** ** | **Diluted** | ** ** |
| Numerator:                                                                      |       |                                                                   |       |   |   |   |   |   |   |
| Net income (loss)                                                               |       | $                                                                      | 35,299     |   | $ | 35,299 |   | $ | 18,765 |   | $ | 18,765 |   |
| Effect of dilutive  securities:                                                 |       |                                                                   |       |   |   |   |   |   |   |
| Interest related to 3.75% convertible senior  subordinated notes, net of tax(a) |       | —                                                                 |       | 1,024 |   | — |   | 1,066 |   |
|                                                                            |       | $                                                                      | 35,299     |   | $ | 36,323 |   | $ | 18,765 |   | $ | 19,831 |   |
| Denominator:                                                                    |       |                                                                   |       |   |   |   |   |   |   |
| Average number of common shares outstanding                                     |       | 40,882                                                                 |       | 40,882 |   | 37,720 |   | 37,720 |   |
| Effect of dilutive  securities:                                                 |       |                                                                   |       |   |   |   |   |   |   |
| Stock options and restricted stock units  (“units”)(b)                |       | —                                                                 |       | 680 |   | — |   | 1,275 |   |
| 3.75% convertible senior subordinated notes(a)                                  |       | —                                                                 |       | 9,419 |   | — |   | 9,805 |   |
|                                                                            |       | 40,882                                                                 |       | 50,981 |   | 37,720 |   | 48,800 |   |
| Net income (loss)  per share                                                    |       | $                                                                      | 0.86       |   | $ | 0.71 |   | $ | 0.50 |   | $ | 0.41 |   |

----

(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 number ofshares of common stock issuable on the exercise of dilutive employee stockoptions and units less the number of shares of common stock which could havebeen purchased with the proceeds from the exercise of such options and units.These purchases were assumed to have been made at the higher of either themarket price of the common stock at the end of the period or the average marketprice for the period.

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**Note 11—SegmentInformation**

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

| ** **                                                         | ** ** | **For the three months  ended March 31,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                         | ** ** | **2006**                                                           | ** ** | **2005** | ** ** |
| Net sales and revenues:                                            |       |                                                               |       |   |   |
| Homebuilding                                                       |       | $                                                                  | 64,389     |   | $ | 48,679 |   |
| Financing                                                          |       | 56,019                                                             |       | 59,093 |   |
| Mueller(a)                                                         |       | 193,339                                                            |       | — |   |
| Anvil(a)                                                           |       | 127,471                                                            |       | — |   |
| U.S. Pipe                                                          |       | 119,734                                                            |       | 124,689 |   |
| Natural Resources                                                  |       | 169,098                                                            |       | 108,695 |   |
| Other                                                              |       | 36,448                                                             |       | 33,277 |   |
| Consolidating  eliminations                                        |       | (13,229                                                            | )          | (8,152 | ) |
| Net sales and revenues                                             |       | $                                                                  | 753,269    |   | $ | 366,281 |   |
| Segment operating income  (loss):                                  |       |                                                               |       |   |   |
| Homebuilding                                                       |       | $                                                                  | (6,308     | ) | $ | (8,549 | ) |
| Financing(b)                                                       |       | 12,992                                                             |       | 14,586 |   |
| Mueller(a)                                                         |       | 33,917                                                             |       | — |   |
| Anvil(a)                                                           |       | 1,355                                                              |       | — |   |
| U.S. Pipe                                                          |       | (5,159                                                             | )          | 5,480 |   |
| Natural Resources                                                  |       | 63,925                                                             |       | 24,542 |   |
| Other                                                              |       | (3,132                                                             | )          | (2,478 | ) |
| Consolidating  eliminations                                        |       | (1,560                                                             | )          | (1,760 | ) |
| Operating income                                                   |       | 96,030                                                             |       | 31,821 |   |
| Less other debt interest  expense                                  |       | (42,552                                                            | )          | (3,612 | ) |
| Income from continuing  operations before income tax expense  |       | 53,478                                                             |       | 28,209 |   |
| Income tax expense                                                 |       | (18,179                                                            | )          | (9,027 | ) |
| Income from continuing  operations                                 |       | $                                                                  | 35,299     |   | $ | 19,182 |   |
| Depreciation:                                                      |       |                                                               |       |   |   |
| Homebuilding                                                       |       | $                                                                  | 1,312      |   | $ | 1,196 |   |
| Financing                                                          |       | 342                                                                |       | 360 |   |
| Mueller(a)                                                         |       | 6,706                                                              |       | — |   |
| Anvil(a)                                                           |       | 5,001                                                              |       | — |   |
| U.S. Pipe                                                          |       | 5,322                                                              |       | 6,552 |   |
| Natural Resources                                                  |       | 5,845                                                              |       | 5,047 |   |
| Other                                                              |       | 1,165                                                              |       | 1,165 |   |
| Total                                                              |       | $                                                                  | 25,693     |   | $ | 14,320 |   |
| Amortization:                                                      |       |                                                               |       |   |   |
| Financing                                                          |       | $                                                                  | 697        |   | $ | 1,063 |   |
| Mueller(a)                                                         |       | 6,269                                                              |       | — |   |
| Anvil(a)                                                           |       | 724                                                                |       | — |   |
| Total                                                              |       | $                                                                  | 7,690      |   | $ | 1,063 |   |

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

(b)          Operatingincome amounts for Financing include interest expense on themortgage-backed/asset-backed notes of $30.0 million and $31.4 million for thethree months ended March 31, 2006 and 2005, respectively.

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**Note 12—Commitmentsand Contingencies**

*Income TaxLitigation*

On February 20, 2006, the IRS completed its auditof the Company’s Federal income tax returns for the years ended May 31,2000, December 31, 2000 and December 31, 2001 and issued a 30-dayletter proposing tax deficiencies in the amount of $80.4 million. The issuesrelate primarily to the Company’s method of recognizing revenue on the sale ofhomes and interest on the related instalment notes receivable. The items atissue relate primarily to the timing of revenue recognition and consequently,should the IRS prevail on its positions, the Company’s financial exposure islimited 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 fiscal years 1980 through 1994. Inconnection with the bankruptcy proceedings, the IRS filed a proof of claim inthe Bankruptcy Court (the “Proof of Claim”) for a substantial amount of taxes,interest and penalties with respect to fiscal years ended August 31, 1980and August 31, 1983 through May 31, 1994. The Company filed anadversary proceeding in the Bankruptcy Court disputing the Proof of Claim (the “AdversaryProceeding”) and the various issues have been and are being litigated in theBankruptcy Court.

The amounts initially asserted by the Proof of Claimdo not reflect the subsequent resolution of various issues through settlementsor concessions by the parties. After adjustment for these items, the Companyestimates that the amount of tax presently claimed by the IRS is approximately$34 million for issues currently in dispute in the Adversary Proceeding. Thisamount is subject to interest and penalties. Of the $34 million in claimed tax,$21 million represents issues in which the IRS is not challenging thedeductibility of the particular expense but only whether such expense isdeductible in a particular year. Consequently, the Company believes that,should the IRS prevail on any such issues, the Company’s financial exposure islimited to interest and possible penalties and the amount of tax claimed willbe offset by deductions in other years. Substantially all of the issues in theProof of Claim, which have not been settled or conceded, have been litigatedbefore the Bankruptcy Court and are subject to appeal but only at theconclusion of the entire Adversary Proceeding.

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

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

*EnvironmentalMatters*

The Company is subject to a wide variety of laws andregulations concerning the protection of the environment, both with respect tothe construction and operation of many of its plants, mines and other 

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facilities and withrespect to remediating environmental conditions that may exist at its own andother properties. The Company believes that it is in substantial compliancewith federal, state and local environmental laws and regulations. The Companyaccrues for environmental expenses resulting from existing conditions thatrelate to past operations when the costs are probable and reasonably estimable.

U.S. Pipe has implemented an Administrative ConsentOrder (‘‘ACO’’) for its Burlington, New Jersey plant that was required underthe New Jersey Environmental Cleanup Responsibility Act (now known as theIndustrial Site Recovery Act). The ACO required soil and ground water cleanup,and U.S. Pipe has completed, and has received final approval on, the soilcleanup required by the ACO. U.S. Pipe is continuing to address ground waterissues at this site. Further remediation could be required. These remediationcosts are expected to be minimal. Long-term ground water monitoring will berequired to verify natural attenuation. It is not known how long ground watermonitoring will be required. Management does not believe monitoring or furthercleanup costs, if any, will have a material adverse effect on the financialcondition or results of operations of the Company and its subsidiaries.

The Federal Comprehensive Environmental Response,Compensation and Liability Act (‘‘CERCLA’’) generally imposes liability, whichmay be joint and several and is without regard to fault or the legality ofwaste generation or disposal, on certain classes of persons, including ownersand operators of sites at which hazardous substances are released into theenvironment (or pose a threat of such release), persons that disposed orarranged for the disposal of hazardous substances at such sites, and personswho owned or operated such sites at the time of such disposal. CERCLAauthorizes the EPA, the States and, in some circumstances, private entities totake actions in response to public health or environmental threats and to seekto recover the costs they incur from the same classes of persons. Certaingovernmental authorities can also seek recovery for damages to naturalresources. Currently, U.S. Pipe has been identified as a potentiallyresponsible party (‘‘PRP’’) by the EPA under CERCLA with respect to cleanup oflead and other hazardous substances in Anniston, Alabama. U.S. Pipe is amongmany PRP’s at such site and a significant number of the PRP’s are substantialcompanies. The PRP’s have negotiated an administrative consent order (ACO) withthe EPA and the PRP’s have agreed to divide clean-up costs pro-rata subject tolater adjustment based on the relative contribution by each PRP to thecontamination. Management estimates the Company’s share of liability forcleanup, after allocation among several PRPs, will be approximately $4.0million, which was accrued in 2004. Management does not believe that U.S. Pipe’sshare of any liability under the ACO will have a material adverse effect on thefinancial condition of the Company, but could be material to results ofoperations in future reporting periods.

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

The Company and U.S. Pipe have been named in a suitfiled by Isaiah Evans on April 8, 2005 (Isaiah Evans et al v. WalterIndustries, Inc., United States Pipe and Foundry Company, Inc., etal, Case No. CV:05-258) in the Circuit Court of Calhoun County,Alabama. This is a purported civil class action case filed against 18 foundriesin the Anniston, Alabama area alleging state law tort claims in the creationand disposal of foundry sand alleged to contain lead and PCB’s.  The plaintiffs are seeking damages forpersonal injury and property damage. The class action lawsuit is still in earlystages of litigation and no substantial discovery has taken place yet. Inaddition, management believes that both procedural and substantive defenseswould be available to the Company should this litigation proceed. Accordingly, 

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management believes thatpresently, there is no reasonable basis for management to form a view withrespect to the probability of liability in this matter.

Although we now produce a small amount of no-leadbrass products, most of our brass valve products contain approximately 5.0%lead. Environmental advocacy groups, relying on standards established byCalifornia’s Proposition 65, are seeking to eliminate or reduce the content oflead in water infrastructure products offered for sale in California. Some ofour subsidiaries have entered into settlement agreements with theseenvironmental advocacy groups to modify products or offer substitutes for salein California. Legislation to substantially restrict lead content in waterinfrastructure products has been introduced in the United States Congress. Congressor state jurisdictions other than California may enact legislation similar toProposition 65 to restrict the content of lead in water products, which couldrequire us to incur additional capital expenses to modify our production. Todate, we have undertaken a capital project to implement a no-lead brassproduction line that will require us to incur approximately $8 million inincremental capital spending over the next two years. In addition, advocacygroups or other parties may file suit against us under Proposition 65 or undernew, similar legislation adopted in other jurisdictions that could result inadditional costs in connection with marketing and selling our brass products inCalifornia or in such other jurisdictions.

Over the next two years, the Company could potentiallyincur between $8.5 million and $12.5 million of capital costs at itssteel and iron foundries to comply with the United States EnvironmentalProtection Agency’s National Emissions Standards for Hazardous Air Pollutantswhich were issued April 22, 2004. The Company is in the process ofperforming an analysis to assess the impact of these standards on the financialresults of the Company.

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

Sloss Industries entered into a consent order in 1989relative to a Resource Conservation Recovery Act (“RCRA”) compliance programmandated by the EPA. A RCRA Facility Investigation (“RFI”) Work Plan wasprepared which proposed investigative tasks to assess the presence ofcontamination at the Sloss facility. The Work Plan was approved in 1994 and thePhase I investigations were conducted and completed between 1995 and 1999.Phase II investigations for the Chemical Plant/Coke Plant and BiologicalTreatment Facility and Sewers/Land Disposal Areas were performed in 2000 and2001 and are substantively complete. At the end of 2004, EPA re-directed Sloss’RFI efforts toward completion of the Environmental Indicator (EI)determinations for the *Current Human Exposures*.This EI effort was completed to assist EPA in meeting goals set by theGovernment Performance Results Act (GPRA) for RCRA by the year 2005. Slossimplemented the approved EI Sampling Plan in April 2005. EPA approved/finalizedthe EI determinations for Sloss’ Birmingham facility in September 2005. Inan effort to refocus the RFI, EPA has now provided technical comments on thereport recently submitted as part of the EI effort.

Although no assurances can be given that the Companywill not be required in the future to make material expenditures relating tothese or other sites, management does not believe at this time that the cleanupcosts, if any, associated with these or other sites will have a material adverseeffect on the financial 

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condition or results ofoperations of the Company, but such cleanup costs could be material to resultsof operations in a future reporting period.

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

*MiscellaneousLitigation*

Drummond Company, Inc. filed suit in state courtin Tuscaloosa County, Alabama on October 29, 2001, against the Company andseveral of its subsidiaries (Drummond Company, Inc. v. Walter Industries, Inc.,et al., Case No. CV 2002-0673). Drummond claims that it is entitledto exclusive surface mining rights on certain lands owned by United LandCorporation, a wholly-owned subsidiary of the Company, and alleges in excess of$350 million in damages. The Company filed a counterclaim seeking injunctiverelief, substantial actual damages and punitive damages against Drummond basedon fraud. The Company and its subsidiaries were granted summary judgment on allof Drummond’s claims on March 29, 2005. A jury trial denied United LandCorporation’s counter-claim on April 8, 2005. Drummond and the Companyhave appealed. Drummond’s claims do not affect the underground miningoperations of the Jim Walter Resources subsidiary. Management does not believethat this litigation will have a material adverse effect on the financialcondition or results of operations of the Company and its subsidiaries.

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

The Los Angeles Department of Water and Power, ex rel.Nora Armenta (“Armenta”) filed suit against the Company’s subsidiaries, JamesJones Company, Mueller Co. et al. (Superior Court, Los Angeles County,California; Case No. BC 173487) on June 27, 1997. In addition, theCity of Banning (“City of Banning”) filed suit against the Company’ssubsidiary, James Jones Company et. al., (Superior Court, Los Angeles County;Case No. BC 321513) on September 15, 2004. The Armenta matter is afalse claims lawsuit brought on behalf of cities, water districts andmunicipalities against the James Jones Company and alleging that the defendantssold allegedly non-conforming public water system parts to various governmententities. The lawsuit seeks consequential damages, penalties and punitivedamages 

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relating to the repair andreplacement of the water systems to remove the allegedly non-conforming parts.Mueller Co., which had also been named as a defendant in the Armenta matter,brought a summary judgment motion and was dismissed from this litigation in January 2004.On September 15, 2004, the Armenta trial court ruled against theintervention of approximately 30 municipalities that had failed to intervenewithin the time deadlines previously specified by the court. The trial courtalso ruled that the majority of municipalities that had purchased James Jonesproducts from contractors or distributors, were not in privity with the JamesJones Company and were not entitled to punitive damages. Following the Armentacourt’s ruling, the water districts and municipalities filed the City of Banningaction against the James Jones Company and Watts (former parent company ofJames Jones Company), alleging fraud and intentional misrepresentation. Thislawsuit is based on the same underlying facts as the Armenta lawsuit. Anyliability associated with these lawsuits is covered by the Tyco indemnity, andthe defense is being paid for and conducted by Tyco, all in accordance with theindemnity obligation of Tyco described above in *EnvironmentalMatters*.

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

*Commitments andContingencies—Other*

As part of the Star Pipe, Inc. acquisition on January 15,2004, Anvil has agreed to a future payment to be made to the seller of abusiness Anvil acquired to the extent that the gross profit of the acquiredbusiness exceeds a targeted gross profit. The maximum potential payment amountis $23 million. Management currently estimates the payment could totalapproximately $3 million to $6 million for the payment period that began February 1,2004 and ends January 31, 2007. The payment amount indicated above isbased on management’s best estimate, but the actual adjustment could bematerially different. The liability for such payment will be recorded at theend of each payment period in accordance with the purchase agreement, with acorresponding charge to goodwill.

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

**Note 13—SubsequentEvents**

On April 20, 2006, the Company announced plans toclose Mueller Water’s Milton, Ontario valve and hydrant manufacturing plant bythe end of July 2006. Valve production at Milton will be transferred toMueller’s Chattanooga, Tennessee facility and hydrant production will betransferred to Mueller’s Albertville, Alabama plant.

On April 26, 2006,the Board of Directors declared a $0.04 per share cash dividend, payable on June 9,2006, to stockholders of record on May 12, 2006.

**Note 14—NewAccounting Pronouncements**

In February 2006, the FASB issued SFAS No. 155,“Accounting for Certain Hybrid Financial Instruments—an amendment of FASBStatements No. 133 and 140,” which resolves issues associated with thebifurcation requirements of SFAS No. 133 as  it relates to beneficial interests insecuritized financial assets, and amends SFAS No. 140 to eliminate theprohibition on a qualifying special-purpose entity from 

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holding a derivativefinancial instrument that pertains to a beneficial interest other than anotherderivative financial instrument. The Company has not yet determined whateffect, if any, the adoption of this statement, which becomes effective, January 1,2007, will have on its consolidated financial statements.

In March 2006, the FASB issued SFAS No. 156,“Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140,”which amends SFAS No. 140 to (i) require that all separatelyrecognized servicing assets and servicing liabilities be initially measured atfair value, if practicable; (ii) permits, but does not require, thesubsequent measurement of separately recognized servicing assets and servicingliabilities at fair value; (iii) requires an entity that uses derivativeinstruments to mitigate the risks inherent in servicing assets and servicingliabilities to account for those derivative instruments at fair value; and (iv) permitsan entity to elect subsequent fair value measurement to account for itsseparately recognized servicing assets and liabilities. The Company has not yetdetermined what effect, if any, the adoption of this statement, which becomeseffective January 1, 2007, will have on its consolidated financialstatements.

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

This discussion should beread in conjunction with the condensed consolidated financial statements andnotes thereto of Walter Industries, Inc. and its subsidiaries,particularly Note 11 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, 2006 and 2005**

| ** **                                             | ** ** | **For the three months ended March  31, 2006** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | ** **                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **U.S.** | ** ** | **Natural** | ** ** | ** ** | ** ** | **Cons** | ** ** | ** ** | ** ** |
| ** **                                             | ** ** | **Homebuilding**                                                                       | ** ** | **Financing** | ** ** | **Mueller** | ** ** | **Anvil** | ** ** | **Pipe** | ** ** | **Resources** | ** ** | **Other** | ** ** | **Elims** | ** ** | **Total** | ** ** |
| ** **                                             | ** ** | **($ in thousands)**                                                         | ** ** |
| Net sales                                              |       |                                                                                   | $          | 64,197 |   |   |   | $ | 3,590 |   |   | $ | 193,339 |   | $ | 127,471 |   | $ | 119,768 |   |   | $ | 164,863 |   |   | $ | 33,404 |   | $ | (11,939 | ) | $ | 694,693 |   |
| Interest income on instalment notes                    |       |                                                                                   | —     |   |   |   | 50,530 |   |   | — |   | — |   | — |   |   | — |   |   | — |   | — |   | 50,530 |   |
| Miscellaneous                                          |       |                                                                                   | 192        |   |   |   | 1,899 |   |   | — |   | — |   | (34 | ) |   | 4,235 |   |   | 3,044 |   | (1,290 | ) | 8,046 |   |
| Net sales and revenues                                 |       |                                                                                   | 64,389     |   |   |   | 56,019 |   |   | 193,339 |   | 127,471 |   | 119,734 |   |   | 169,098 |   |   | 36,448 |   | (13,229 | ) | 753,269 |   |
| Cost of sales                                          |       |                                                                                   | 53,270     |   |   |   | 3,195 |   |   | 128,172 |   | 96,418 |   | 105,217 |   |   | 90,234 |   |   | 29,144 |   | (11,669 | ) | 493,981 |   |
| Interest expense(1)                                    |       |                                                                                   | —     |   |   |   | 29,976 |   |   | — |   | — |   | — |   |   | — |   |   | — |   | — |   | 29,976 |   |
| Depreciation                                           |       |                                                                                   | 1,312      |   |   |   | 342 |   |   | 6,706 |   | 5,001 |   | 5,322 |   |   | 5,845 |   |   | 1,165 |   | — |   | 25,693 |   |
| Selling, general & administrative             |       |                                                                                   | 16,237     |   |   |   | 7,606 |   |   | 18,275 |   | 23,973 |   | 10,483 |   |   | 4,151 |   |   | 9,637 |   | — |   | 90,362 |   |
| Provision for losses on instalment notes               |       |                                                                                   | —     |   |   |   | 2,305 |   |   | — |   | — |   | — |   |   | — |   |   | — |   | — |   | 2,305 |   |
| Postretirement benefits                                |       |                                                                                   | (122       | ) |   |   | (48 | ) |   | — |   | — |   | (390 | ) |   | 4,943 |   |   | (366 | ) | — |   | 4,017 |   |
| Amortization of intangibles                            |       |                                                                                   | —     |   |   |   | 697 |   |   | 6,269 |   | 724 |   | — |   |   | — |   |   | — |   | — |   | 7,690 |   |
| Credit for estimated hurricane insurance losses        |       |                                                                                   | —     |   |   |   | (1,046 | ) |   | — |   | — |   | — |   |   | — |   |   | — |   | — |   | (1,046 | ) |
| Restructuring & impairment charges            |       |                                                                                   | —     |   |   |   | — |   |   | — |   | — |   | 4,261 |   |   | — |   |   | — |   | — |   | 4,261 |   |
| Operating income (loss)                           |       |                                                                                   | $          | (6,308 | ) |   |   | $ | 12,992 |   |   | $ | 33,917 |   | $ | 1,355 |   | $ | (5,159 | ) |   | $ | 63,925 |   |   | $ | (3,132 | ) | $ | (1,560 | ) | $ | 96,030 |   |
| Other debt interest expense                            |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (42,552 | ) |
| Income from  continuing operations before income taxes |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 53,478 |   |

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(1)             Excludes other debt interest expense.

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| ** **                                             | ** ** | **For the three months ended March 31, 2005** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | ** **                                                                       | ** ** | ** ** | ** ** | **U.S.** | ** ** | **Natural** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                             | ** ** | **Homebuilding**                                                                 | ** ** | **Financing** | ** ** | **Pipe** | ** ** | **Resources** | ** ** | **Other** | ** ** | **Cons Elims** | ** ** | **Total** | ** ** |
| ** **                                             | ** ** | **($ in thousands)**                                                   | ** ** |
| Net sales                                              |       |                                                                             | $          | 48,590 |   |   |   | $ | 3,875 |   |   | $ | 124,646 |   |   | $ | 106,877 |   |   | $ | 31,164 |   |   | $ | (7,474 | ) |   | $ | 307,678 |   |
| Interest income on instalment notes                    |       |                                                                             | —     |   |   |   | 53,493 |   |   | — |   |   | — |   |   | — |   |   | — |   |   | 53,493 |   |
| Miscellaneous                                          |       |                                                                             | 89         |   |   |   | 1,725 |   |   | 43 |   |   | 1,818 |   |   | 2,113 |   |   | (678 | ) |   | 5,110 |   |
| Net sales and revenues                                 |       |                                                                             | 48,679     |   |   |   | 59,093 |   |   | 124,689 |   |   | 108,695 |   |   | 33,277 |   |   | (8,152 | ) |   | 366,281 |   |
| Cost of sales                                          |       |                                                                             | 38,851     |   |   |   | 2,302 |   |   | 107,672 |   |   | 70,756 |   |   | 25,711 |   |   | (6,392 | ) |   | 238,900 |   |
| Interest expense(1)                                    |       |                                                                             | —     |   |   |   | 31,435 |   |   | — |   |   | — |   |   | — |   |   | — |   |   | 31,435 |   |
| Depreciation                                           |       |                                                                             | 1,196      |   |   |   | 360 |   |   | 6,552 |   |   | 5,047 |   |   | 1,165 |   |   | — |   |   | 14,320 |   |
| Selling, general & administrative             |       |                                                                             | 17,298     |   |   |   | 6,778 |   |   | 5,348 |   |   | 3,933 |   |   | 9,213 |   |   | — |   |   | 42,570 |   |
| Provision for losses on instalment notes               |       |                                                                             | —     |   |   |   | 3,185 |   |   | — |   |   | — |   |   | — |   |   | — |   |   | 3,185 |   |
| Postretirement benefits                                |       |                                                                             | (117       | ) |   |   | (60 | ) |   | (363 | ) |   | 4,112 |   |   | (334 | ) |   | — |   |   | 3,238 |   |
| Amortization of intangibles                            |       |                                                                             | —     |   |   |   | 1,063 |   |   | — |   |   | — |   |   | — |   |   | — |   |   | 1,063 |   |
| Credit for estimated hurricane insurance losses        |       |                                                                             | —     |   |   |   | (556 | ) |   | — |   |   | — |   |   | — |   |   | — |   |   | (556 | ) |
| Restructuring & impairment charges       |       |                                                                             | —     |   |   |   | — |   |   | — |   |   | 305 |   |   | — |   |   | — |   |   | 305 |   |
| Operating income (loss)                                |       |                                                                             | $          | (8,549 | ) |   |   | $ | 14,586 |   |   | $ | 5,480 |   |   | $ | 24,542 |   |   | $ | (2,478 | ) |   | $ | (1,760 | ) |   | $ | 31,821 |   |
| Other debt interest expense                            |       |                                                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | (3,612 | ) |
| Income from  continuing operations before income taxes |       |                                                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 28,209 |   |

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(1)           Excludes other debt interest expense.

***Overview***

The Company’s net income for the quarter ended March 31,2006 was $35.3 million or $0.71 per diluted share, which compares to $18.8million or $0.41 per diluted share in the prior year period.

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

·       Muellerand Anvil contributed combined net sales and revenues of $320.8 million andoperating income of $35.3 million. These results include the recognition of$12.0 million in cost of sales of basis adjustments in inventory due to theallocation of the Mueller Water Products, Inc. (“Mueller Water”) purchaseprice and $7.0 million of intangible amortization. The Company does notanticipate any further recognition of inventory basis adjustments in cost ofsales for the Mueller Water acquisition.

·       Averageselling prices at Natural Resources for coal and natural gas increased 53% and38%, respectively, in the 2006 period compared to the 2005 period.

·       Interestexpense on other debt increased $39.0 million to $42.6 million in the currentyear period primarily due to Mueller Water debt assumed and additionalindebtedness incurred to finance the Mueller Water acquisition.

·       U.S.Pipe results in the current period reflect a 5.6% increase in ductile iron pipeselling prices, partially offset by $4.3 million in restructuring chargesrelated to the closure of the Chattanooga, Tennessee plant and a $5.1 millionfavorable insurance claim settlement recognized in the prior year period.

·       Homebuildinghad 117 more unit completions and 12% higher average net selling pricescompared to the prior period.

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·       Financingresults in the current period reflect $2.2 million in lower prepayment incomecompared to the prior period, partially offset by lower interest expense due toa decline in the portfolio balance and a lower provision for losses.

·       Currentperiod results at Sloss reflect higher furnace and foundry coke pricing,partially offset by highermetallurgical coal raw material costs.

·       TheCompany’s first quarter 2006 effective tax rate was 34%, versus 32% in theprior-year period.

Other strategicinitiatives include:

·       In2005, the Company announced its plan to undertake an initial public offering (“theIPO”) and spin-off of its Water Products business, which includes the Mueller,Anvil and U.S. Pipe segments. The IPO is expected to take place during thesecond quarter of 2006, with a subsequent tax-free spin-off to the Company’sstockholders not earlier than six months after the IPO of the Company’sownership interest in its Water Products business. On February 3, 2006, theCompany filed with the Securities and Exchange Commission a registrationstatement on Form S-1 (Registration No. 333-131536) forthe IPO. The Company filed Amendment No. 1 to the registration statementon Form S-1/A on March 31, 2006 and Amendment No. 2 on May 2,2006. The registration has not yet been declared effective.

·       InFebruary 2006, the Company announced that it is evaluating the spin-off ofits Homebuilding and Financing segments to the Company stockholders.

Other developments,trends and factors that may impact future results include:

·       Recentprice increases in brass ingot, which contains approximately 85% copper, haveincreased the overall cost of manufacturing certain Mueller segment products,including certain hydrant and valve components. The Mueller segment raisedprices on certain brass products by 10%, effective May 1, 2006, andannounced another 2% increase on certain brass products, effective June 5,2006, as well as announcing an increase on certain hydrants and iron valuescontaining brass components, effective May 26, 2006, which is expected topartially offset the increase in brass ingot costs. The cost of coppercontinues to rise and the Company may need to implement pricing further actionsto offset higher raw material costs.

·       EffectiveJanuary 1, 2006, the Company transferred the valve and hydrant productionof the U.S. Pipe Chattanooga, Tennessee plant to the Mueller segment’sChattanooga, Tennessee and Albertville, Alabama plants. The eventual closure ofthe U.S. Pipe Chattanooga, Tennessee plant will occur in fiscal 2006. Totalcosts related to this plant closure are expected to be approximately $47.6, ofwhich $0.8 million are expected to be expensed during the remainder of 2006 asa result of closing this facility.

·       OnJanuary 26, 2006, the Company announced the closure of the Mullersegment’s Henry Pratt (“Pratt”) valve manufacturing facility, in Dixon, Illinoisby the end of September 2006. The process of transferring the Dixon plant’soperations to other Pratt facilities has begun. Severance costs associated withthis plant closure of approximately $1.4 million will be allocated to goodwill.Property impairment charges of $0.8 million also will be charged to goodwill.Costs associated with relocating equipment will be expensed as incurred. Forthe three months ended March 31, 2006, the Company has recorded $0.3million in severance costs as an adjustment to goodwill.

·       OnApril 20, 2006, the Company announced the closure of the Mueller CanadaMilton, Ontario (“Milton”) valve and hydrant manufacturing facility by the endof September 2006. Production will be transferred to other Muellerfacilities beginning in the second quarter of 2006. Severance costs 

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associated with this plantclosure will be charged to goodwill. No costs have been incurred or charged togoodwill for the three months ended March 31, 2006.

·       MuellerWater has announced its intention to issue restricted stock to officers andemployees in connection with the IPO and intends to adopt a new 2006 stockincentive plan designed to promote long-term growth and financial success byproviding incentives to employees, directors and consultants through grants ofstock-based awards. Stock compensation expense, net of tax, resulting from theissuance of restricted stock in connection with the IPO is estimated to be $2.0million in 2006.

·       Assumingthat the IPO is completed during the quarter ending June 30, 2006, theCompany expects to recognize a pre-tax charge of approximately $11 millionassociated with the early redemption of debt. However, the Company has not yetdetermined other effects of the IPO, such as interest savings from the use ofIPO proceeds, minority interest in the earnings of the Water Products businessafter the IPO and other related items.

·       Asof March 31, 2006, scrap metal costs for our U.S. Pipe segment have declinednearly 20% from their peak in 2004. The average cost of scrap iron per tonproduced during the three months ended March 31, 2006 decreased nearly 5%compared to the average cost during the three months ended March 31, 2005.Recently scrap costs have increased and are expected to remain elevated atleast through May 2006.

·       Whilethe Company’s relationships with the ten largest water product distributorshave been of long duration, distributors in this industry have experiencedsignificant consolidation in recent years. As consolidation among distributorscontinues, pricing pressure may result, which could lead to a decline in theCompany’s profitability. For example, Home Depot acquired National Waterworksin 2005 and announced in March 2006 that it had completed its acquisitionof Hughes Supply. As a result, two of the Water Products Group’s three largestdistributors have been combined under common control. Moreover, the loss of anyof National Waterworks, Hughes Supply or Ferguson Enterprises as a distributorcould significantly reduce the levels of sales and profitability of the WaterProducts Group.

·       NaturalResources negotiated and settled a substantial portion of its annualmetallurgical coal contracts for an average price of approximately $115 permetric ton (FOB Port of Mobile) for the July 2006 through June 2007period.

·       NaturalResources has satisfied the remaining 0.3 million tons of its now expired five-yearold steam coal contract obligation with Alabama Power, and all coal sales forthe remainder of 2006 will be directed to the higher-priced metallurgical coalmarket.

·       Financinghas expanded its high loan-to-value program to include all credit grades. Thegoal of this program is to minimize the need for down payments for Homebuilding’scustomers if their property values do not meet normal guidelines. Beginning inthe second quarter of 2006, Financing will approve customers across all creditgrades with loan-to-value ratios up to 97.5% in exchange for higher interestrates.

Net sales and revenues for the three months ended March 31,2006 were $753.3 million, an increase of $387.0 million from the quarter ended March 31,2005 due to the Mueller Water acquisition and higher coal and natural gasprices at Natural Resources along with higher pricing at U.S. Pipe and Sloss.Homebuilding revenues were $64.4 million representing a 32% increase from theprior year period as a result of 117 more unit completions and higher averageselling prices.

Cost of sales, exclusive of depreciation, of $494.0million was 71% of net sales in the 2006 period versus $238.9 million or 78% ofnet sales in the comparable period of 2005. The current year’s cost of sales 

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included $224.6 million atMueller and Anvil. The gross margin percentage improved as compared to 2005because of increases in sales prices at Natural Resources, U.S. Pipe and Slossand the acquisition of Mueller Water, which generated gross margins of 30% in2006. Gross margins were also impacted by $12.0 million of purchaseaccounting-related inventory step-up costs at Mueller and Anvil, higher miningcosts, particularly at Mine No. 5 in its last year of production, higherroyalties on coal and natural gas sales and lower margins at Homebuilding dueto increased cycle times, higher cost of labor and materials and higher salescommissions.

Depreciation for the three months ended March 31,2006 was $25.7 million, an increase of $11.4 million compared to the prior period,due to the acquisition of Mueller Water.

Selling, general and administrative expenses of $90.4million were 12.0% of net sales and revenues in the 2006 period, compared to$42.6 million and 11.6% of net sales and revenues in 2005. The current year included$42.2 million of selling, general and administrative expenses at Mueller andAnvil. The prior year period included a $5.1 million favorable insurance claimsettlement at U.S. Pipe.

Provision for losses on instalment notes decreased to$2.3 million in the 2006 period, compared to $3.2 million in 2005 due toimproved loss experience.

Interest expense for mortgage-backed and asset-backednotes decreased to $30.0 million in the 2006 period, compared to $31.4 millionin the prior year period primarily due to a decline in the debt balances as aresult of fewer note originations from the Homebuilding segment.

Interest expense on other debt increased $39.0 millionto $42.6 million in 2006 due to Mueller Water debt assumed and additionalindebtedness incurred to finance the Mueller Water acquisition. Interestexpense also includes $1.6 million of inducement costs related to theconversion of $26.6 million of the Company’s Convertible Senior SubordinatedNotes. In addition, the Company wrote off $1.6 million of unamortized debtexpense in the first quarter of 2006 relating to $102.9 million of prepaymentson the 2005 Walter Credit Agreement made using proceeds from the Company’s $169million common stock sale in February 2006.

Amortization of intangibles increased to $7.7 millionin 2006 from $1.1 million in 2005 due to acquisition-related amortization oftechnology and customer relationship intangibles at Mueller and Anvil.

The Company’s effective tax rate for the three monthsended March 31, 2006 and 2005 was lower than the federal statutory rateprimarily due to favorable depletion deductions related to the Company’sNatural Resources operations, substantially offset by the effect of stateincome taxes.

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SegmentAnalysis:

*Homebuilding*

Netsales and revenues were $64.4 million for the three months ended March 31,2006, an increase of $15.7 million from the quarter ended March 31, 2005as a result of higher unit completions and higher average selling prices. Totalunit completions increased by 117 units, or 18%, compared to the three monthsended March 31, 2005. The modular business completed 113 homes in thecurrent quarter, three more than the three months ended March 31, 2005.Excluding the modular business, 654 units were completed in the current period,compared to 540 in the three months ended March 31, 2005.

| ** **                  | ** ** | **Three months ended  March 31,** | ** ** |
|-----------------------------|------------|--------------------------------------------------|------------|
| ** **                  | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Homes Completed:            |       |                                             |       |   |   |
| Stick-built                 |       | 654                                              |       | 540 |   |
| Modular                     |       | 113                                              |       | 110 |   |
| Average Net  Selling Price: |       |                                             |       |   |   |
| Stick-built                 |       | $                                                | 84,300     |   | $ | 76,400 |   |
| Modular                     |       | $                                                | 80,400     |   | $ | 66,800 |   |

 

The estimated backlog at March 31, 2006 of homesto be constructed was $170 million, or 2,035 homes, compared to $163 million,or 2,178 homes, at December 31, 2005 and $164 million, or 2,198 homes, atMarch 31, 2005.

The operating loss was$6.3 million for the three months ended March 31, 2006 compared to anoperating loss of $8.5 million for the three months ended March 31, 2005.The improvement in operating results was due to an increase in unitcompletions, higher average net selling prices and lower legal, advertising andconsulting expenses, partially offset by (i) higher material,subcontractor labor and repair costs due to increased cycle times in certainregions and (ii) higher sales commissions.

*Financing*

Net sales and revenues were $56.0 million in thefirst quarter of 2006, a decrease of $3.1 million from $59.1 millionfor the three months ended March 31, 2005. This decrease was attributableto $2.2 million of lower prepayment income and lower payment income from areduced instalment note receivable portfolio balance. Operating incomedecreased by $1.6 million, to $13.0 million in the first quarter of2006. The lower operating income relates primarily to lower prepayment income,partially offset by lower interest expense and a reduction to the provision forlosses on instalment notes.

Prepayment speeds were9.1% in the first quarter of 2006, down from 10.5% in the fourth quarter of2005, reflecting industry-wide increases in mortgage rates during the periodresulting in lower refinancing activity. Prepayment speeds were 10.0% in thefirst quarter of 2005. Delinquencies (the percentage of amounts outstandingover 30 days past due) were 3.7% at March 31, 2006, down from 3.9% at March 31,2005 and from 5.2% at December 31, 2005, primarily as a result of fewercustomers entering into bankruptcy, partially offset by higher delinquencies inareas impacted by the 2005 hurricanes.

*Mueller*

Net sales and revenues for the period ended March 31,2006 were $193.3 million. Revenues reflect increased demand for iron gatevalves and fire hydrants, plus the addition of U.S. Pipe’s valve and hydrantvolume transferred from its Chattanooga, Tennessee plant.

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Mueller’s operating incomefor the period ended March 31, 2006 was $33.9 million. Operatingincome included $6.8 million of acquisition-related inventory step-upexpense. Excluding this expense, operating income was $40.7 million. Resultsfor the quarter are attributed to improved valve volumes and hydrant margins,partially offset by higher brass and scrap iron material costs.

*Anvil*

Net sales and revenues for the period ended March 31,2006 were $127.5 million. Anvil’s revenues were driven by higher volumeand pricing on its commercial construction and oil field market products.

Operating income for theperiod ended March 31, 2006 was $1.4 million. Anvil’s operatingresults include $5.2 million of acquisition-related inventory step-up. Excludingthis expense, Anvil’s operating income for the quarter ended March 31,2006 was $6.6 million, reflecting increased shipments and higher sellingprices, partially offset by increased freight costs and higher depreciation.

*U.S. Pipe*

Net sales and revenues were $119.7 million forthe three months ended March 31, 2006 compared to $124.7 million forthe three months ended March 31, 2005. Revenues in the prior-year periodincluded $13.2 million from the valve and hydrant business. As of January 1,2006, the valve and hydrant business was transferred to Mueller. The effect ofthis decrease was partially offset by a 5.6% increase in ductile iron pipeselling prices and a 1% increase in ductile iron pipe shipments. Prices werehigher than the prior year as the industry has been raising prices to mitigaterising scrap metal cost increases.

The estimated order backlog consisting of pressurepipe and fittings at March 31, 2006 was approximately $72.5 millioncompared to $78.8 million at December 31, 2005 and $85.0 millionat March 31, 2005.

Operating loss for thesegment totaled $5.2 million for the quarter, compared to operating incomeof $5.5 million in the prior-year period. Current year results included$4.3 million of restructuring charges related to the closure of U.S. Pipe’sChattanooga, Tennessee facility. Results for the prior year included a $5.1 millionfavorable environmental insurance claim settlement and $2.7 million invalve and hydrant operating income. As of January 1, 2006, the valve andhydrant business was transferred to Mueller. Excluding these items, operatingincome improved $1.4 million as compared with the prior-year periodprimarily due to higher ductile iron pipe pricing and volumes.

*Natural Resources*

Net sales and revenueswere $169.1 million for the three months ended March 31, 2006, anincrease of $60.4 million from net sales and revenues of $108.7 millionfor the three months ended March 31, 2005. The increase was primarily dueto a 51.8% increase in metallurgical coal prices and a 37.6% increase innatural gas prices.

| ** **                                   | ** ** | **Three months ended** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|
| ** **                                   | ** ** | **March 31,**               | ** ** |
| ** **                                   | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Average Coal  Selling Price (per Ton)        |       | $                                | 97.78      |   | $ | 64.05 |   |
| Tons of Coal Sold  (in millions)        |       | 1.5                              |       | 1.5 |   |
| Average Natural  Gas Selling Price (per MCF) |       | $                                | 9.29       |   | $ | 6.75 |   |
| Billion Cubic  Feet of Natural Gas Sold      |       | 1.8                              |       | 1.8 |   |
| Number of Natural Gas  Wells                 |       | 415                              |       | 391 |   |

 

For the three months endedMarch 31, 2006, Natural Resources’ operating income was $63.9 million,compared to $24.5 million in the prior-year period. The increase wasprimarily due to higher metallurgical 

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coal andnatural gas prices, partially offset by higher royalty costs related to higherprices and higher mining costs. Mining production costs in the first quarter of2006 exceeded those in the first quarter of 2005 primarily due to lowerproduction volumes and higher freight, supplies and labor costs.

*Other*

Net sales and revenues were $36.4 million for thethree months ended March 31, 2006, an increase of $3.1 million fromnet sales and revenues of $33.3 million in the prior-year period. Slossrevenues were $2.1 million higher than the prior-year period primarily dueto higher furnace and foundry coke prices. Sloss’ operating income was $2.2 millionin the first quarter of 2006, an increase of $0.4 million compared to theprior-year period, as higher furnace and foundry coke pricing was partiallyoffset by higher metallurgical coal raw material costs.

Net general corporateexpenses, principally included in selling, general and administrative expense,were $7.6 million for the three months ended March 31, 2006 comparedto $6.7 million for the three months ended March 31, 2005. Corporateexpenses increased primarily due to $0.8 million of compensation expenserecognized in the first quarter of 2006 for stock-based awards, as a result ofthe January 1, 2006 adoption of SFAS 123(R).

**FINANCIAL CONDITION**

Cash increased from $137.4 million at December 31,2005 to $146.2 million at March 31, 2006 reflecting $30.6 of cashflows provided by operations, $40.8 million of cash flows used ininvesting activities and $19.0 million of cash flows provided by financingactivities. See additional discussion in the Statement of Cash Flows sectionthat follows.

Restricted short-term investments decreased $40.2 millionto $84.4 million at March 31, 2006 due to the use of restricted cashto purchase additional instalment notes receivable using the pre-fundingfeature of Mid-State Capital Corporation’s 2005-1 Trust offering.

Income tax receivable increased to $20.9 millionat March 31, 2006 from $16.8 million at December 31, 2005primarily due to estimated state income tax payments made during the firstquarter of 2006.

Prepaid expenses were $27.4 million at March 31,2006, a decrease of $3.9 million from December 31, 2005 due to thetiming of insurance payments and longwall move costs at Natural Resources.

Other long-term assets increased $10.1 millionfrom December 31, 2005 to $83.4 million at March 31, 2006 as theresult of a $15.6 million favorable mark-to-market adjustment onderivative instruments, partially offset by a decrease in the prepaid pensionasset resulting from the actuarially-determined pension expense recognizedduring the first quarter of 2006.

Accounts payable of $183.9 million at March 31,2006 increased $22.7 million compared to December 31, 2005 primarilyas a result of the timing of vendor payments and the seasonality of materialpurchases.

Accrued interest increased$8.4 million to $41.0 million at March 31, 2006 due to thetiming of Mueller Water interest payments.

**LIQUIDITY ANDCAPITAL RESOURCES**

*Overview*

The Company’s principal sources of short-term fundingare operating cash flows and borrowings under revolving credit facilities andcommitted secured warehouse lines of credit. The Company’s principal 

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sources of long-termfunding are its senior bank debt, public notes and its financings undermortgage-backed/asset-backed notes.

The Company believes that, based on current forecastsand anticipated market conditions, sufficient operating cash flow will begenerated to meet substantially all operating needs, to make planned capitalexpenditures and to make all required interest payments on indebtedness. However,the Company’s operating cash flows and liquidity are significantly influencedby numerous factors, including the general economy and, in particular, pricesof coal and natural gas, levels of construction activity, levels of governmentspending on water projects, costs of raw materials and interest rates.

As of March 31, 2006, total debt has decreased by$196.4 million compared to December 31, 2005, primarily resultingfrom $103.8 million of principal payments on the 2005 Walter CreditAgreement, $66.7 million of principal payments on the Company’smortgage-backed/asset-backed notes and the conversion of $26.6 million ofconvertible notes into common stock.

At March 31, 2006,non-recourse mortgage-backed/asset-backed notes outstanding totaled $1.7billion and primarily consisted of eight issues of public debt providingfinancing for instalment notes receivable purchased by Mid-State Homes (“MSH”).Mortgage debt also includes outstanding borrowings under two $200.0 millionVariable Funding Loan Agreements (“warehouse facilities”) providing temporaryfinancing to MSH for its current purchases of instalment notes and mortgageloans from Jim Walter Homes and Walter Mortgage Company. At March 31,2006, there were no balances outstanding under these warehouse facilities,leaving the total $400.0 million available for future borrowings.

*2005 Walter CreditAgreement*

The 2005 Walter Credit Agreement is a securedobligation of the Company and substantially all of the wholly-owned domesticsubsidiaries of the Company other than Mueller Water and its subsidiaries. The2005 Walter Term Loan requires quarterly principal payments of $0.8 millionthrough October 3, 2012, at which time the remaining principal outstandingis due. The 2005 Walter Term Loan carries a floating interest rate of 200 basispoints over LIBOR. At March 31, 2006, the balance outstanding on the termloan was $345.1 million and the weighted-average interest rate was 6.4%.The commitment fee on the unused portion of the 2005 Walter Revolving CreditFacility is 0.50% and the interest rate is a floating rate of 225 basis pointsover LIBOR. At March 31, 2006, there were no borrowings outstanding underthe revolving credit facility.

In February 2006, theCompany used a portion of the proceeds from the sale of 2.65 millionshares of common stock to repay $67.9 million of the term loan facility ona mandatory basis and $35.0 million on an optional basis. In April 2006,the Company repaid an additional $19.2 million on the term loan facilityon a mandatory basis related to an excess cash flow recapture provision.

*2005 Mueller CreditAgreement*

On October 3, 2005, Mueller Group, entered into acredit agreement (the “2005 Mueller Credit Agreement”) consisting of a $145.0 millionsenior secured revolving credit facility terminating on October 4, 2010(the “2005 Mueller Revolving Credit Facility”) and a $1,050.0 millionsenior secured term loan (the “2005 Mueller Term Loan”) maturing on the earlierof October 3, 2012 or November 1, 2011, unless the 10% seniorsubordinated notes due 2012 are paid in full prior to such date. Loans underthe senior credit facilities bear interest, at our option, at: LIBOR rate plus250 basis points or the alternate base rate plus 150 basis points forborrowings under the revolving credit facility; and LIBOR plus 225 basis pointsor the alternate base rate plus 125 basis points for term loans. The 2005Mueller Term Loan requires quarterly principal payments of $2.6 million throughOctober 3, 2012, at which time the remaining principal outstanding is due.At March 31, 2006, the balance outstanding on the term loan was $1,044.8 millionand the weighted-average interest rate was 7.0%. The commitment fee on theunused 

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portion of the 2005Mueller Revolving Credit Facility is 0.50%. At March 31, 2006, there wereno borrowings outstanding under the revolving credit facility.

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

*Senior SubordinatedNotes*

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

If the intended MuellerWater IPO is completed, Mueller Water expects to use a portion of the netproceeds to redeem a portion of the senior subordinated notes and to payaccrued interest and premium associated with such redemption.

*Senior DiscountNotes*

In 2004, Mueller Water sold 223,000 units consistingof $1,000 principal amount at maturity of senior discount public notes due2014, for gross proceeds of approximately $110.1 million. The notesaccrete at a rate of 143¤4%and compound semi-annually to April 2009 to a principal amount at maturityof $223.0 million. The notes are senior unsecured obligations and areeffectively subordinated to all liabilities of Mueller Group and itssubsidiaries.

If the intended MuellerWater IPO is completed, Mueller Water expects to use a portion of the netproceeds to redeem a portion of the senior discount notes and to pay thepremium associated with such redemption.

*Convertible SeniorSubordinated  Notes*

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

The notes are currentlyconvertible having satisfied a variety of conditions including, the commonstock sales price condition. The notes may be convertible during future periodsif the common stock sale price condition or other conditions are satisfied. Duringthe first quarter of 2006, holders of approximately $26.6 million of theCompany’s convertible notes surrendered their convertible notes in exchange forapproximately 1,490,000 shares of the Company’s common stock and approximately$1.6 million of premiums, which was expensed in the first quarter of 2006.

*Statement of CashFlows*

Cash totaled $146.2 million and $137.4 millionat March 31, 2006 and December 31, 2005, respectively. The increasein cash is primarily the result of cash proceeds from the sale of common stock($168.8 million), a decrease in restricted short-term investments ($40.1 million)and cash flows provided by operating activities ($30.6 million), partiallyoffset by retirements of debt ($173.2 million), purchases of property,plant and equipment ($43.3 million) and cash flows used in other financingand investing activities ($14.2 million).

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Cash flows provided byoperating activities for the three months ended March 31, 2006 were $30.6 millioncompared to $7.7 million used in operating activities for the three monthsended March 31, 2005. The increase in cash flows provided by operatingactivities was principally due an increase in net income as adjusted fornon-cash items, such as depreciation and amortization, partially offset by anincrease in net working capital.

Capital expenditurestotaled $43.3 million in the three months ended March 31, 2006related principally to underground mining and natural gas well equipment atNatural Resources and machinery and equipment at Mueller Water. Commitments forcapital expenditures at March 31, 2006 were not significant; however, itis estimated that gross capital expenditures for the year ending December 31,2006 will approximate $200 million to $230 million. Actualexpenditures in 2006 may be more or less than this amount, depending upon thelevel of earnings and cash flow, the timing of projects or expansionopportunities in certain markets.

**MARKET RISK**

The Company is exposed tocertain market risks inherent in the Company’s operations. These risksgenerally arise from transactions entered into in the normal course of business.The Company’s primary market risk exposures relate to interest rate risk,commodity risks and foreign currency risks. The Company does not enter intoderivatives or other financial instruments for trading or speculative purposes.

There have been nomaterial changes, other than those described below, to the information in “Item 7a,Qualitative and Quantitative Disclosures About Market Risk” described in the AnnualReport on Form 10-K for the fiscal year ended December 31,2005.

*Interest rate risk*

On February 28, 2006,the Company entered into three interest rate hedge agreements (“swaps”) with acumulative notional value of $125 million with three separate counter-parties.The objective of these swaps is to protect against the negative effect thatrising interest rates would have on the Company’s future forecasted issuance ofmortgage-backed securities. The structure of the swaps is a 14-year,forward-starting swap which starts on December 15, 2006, which is theforecasted issuance date of the Company’s next securitization. The swapagreements call for the Company to make fixed rate payments over the term at5.05% per annum and receive payments based on one-month LIBOR from thecounter-parties. It is anticipated that the swap will be settled atsecuritization, and the Company will account for the swap as a cash flow hedge.Changes in the fair value of the swap through the date of securitization thattake place are recorded in accumulated other comprehensive income (loss),assuming the securitization remains likely. At March 31, 2006, the Companyrecorded a net unrealized gain from these swaps of $1.1 million, net oftax, as a component of other comprehensive income (loss) from.

*Commodity risks*

At March 31, 2006,swap contracts to hedge anticipated sales in 2006 of natural gas totaling 3.15 millionmmbtu were outstanding. At March 31, 2006, the Company recorded a netunrealized gain from these hedging agreements of $4.9 million, net of tax,as a component of other comprehensive income (loss).

*Foreign currency risks*

In March 2006,Mueller Water entered into hedges protecting intercompany loan payments to bemade over the next three years by its Canadian subsidiary to a U.S. subsidiarytotaling $37.3 million. With these hedges, the Company sells Canadiandollars for U.S. dollars at an exchange rate of $0.8681.  Unrealized gains or losses on these hedgeswill be recorded in earnings over their lives, and were not material for thethree months ended March 31, 2006.

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**NEW ACCOUNTINGPRONOUNCEMENTS**

In February 2006, the FASB issued SFAS No. 155,“Accounting for Certain Hybrid Financial Instruments—an amendment of FASBStatements No. 133 and 140,” which resolves issues associated with thebifurcation requirements of SFAS No. 133 as  it relates to beneficial interests insecuritized financial assets, and amends SFAS No. 140 to eliminate theprohibition on a qualifying special-purpose entity from holding a derivativefinancial instrument that pertains to a beneficial interest other than anotherderivative financial instrument. The Company has not yet determined whateffect, if any, the adoption of this statement, which becomes effective January 1,2007, will have on its consolidated financial statements.

In March 2006, theFASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets—anamendment of FASB Statement No. 140,” which amends Statement140 to: 1) requirethat all separately recognized servicing assets and servicing liabilities beinitially measured at fair value, if practicable; 2) permits, but does notrequire, the subsequent measurement of separately recognized servicing assetsand servicing liabilities at fair value; 3) requires an entity that usesderivative instruments to mitigate the risks inherent in servicing assets andservicing liabilities to account for those derivative instruments at fairvalue; and 4) permits an entity to elect subsequent fair value measurementto account for its separately recognized servicing assets and liabilities. Thisstatement is to be applied on a prospective basis for new servicing assets andservicing liabilities. The Company has not yet determined what effect, if any,the adoption of this statement, which becomes January 1, 2007, will haveon its consolidated financial statements.

**CONTROLS ANDPROCEDURES**

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

An evaluation wasperformed under the supervision and with the participation of our management,including our Chief Executive Officer (CEO), and Chief Financial Officer (CFO),of the effectiveness of our disclosure controls and procedures as of March 31,2006. Based on that evaluation, our management, including our CEO and CFO,concluded that our disclosure controls and procedures are effective to ensurethat information required to be disclosed by us in reports that we file orsubmit under the Exchange Act is recorded, processed, summarized and reportedas specified in the SEC’s rules and forms. There has been no change in ourinternal control over financial reporting during the three months ended March 31,2006 that has materially affected, or is reasonably likely to materiallyaffect, internal control over financial reporting.

**PRIVATE SECURITIESLITIGATION REFORM ACT SAFE HARBOR STATEMENT**

Except for historical information contained herein,the statements in this release are forward-looking and made pursuant to thesafe harbor provisions of the Private Securities Litigation Reform Act of 1995.Forward-looking statements involve known and unknown risks and uncertaintiesthat may cause the Company’s actual results in future periods to differmaterially from forecasted results. Those risks include, among others, changesin customers’ demand for the Company’s products, changes in raw material,labor, equipment and transportation costs and availability, geologic andweather conditions, changes in extraction costs and pricing in the Company’smining operations, changes in customer orders, pricing actions by the Company’scompetitors, the collection of approximately $14 million of receivablesassociated with a working capital adjustment arising from the sale of asubsidiary in 2003, potential changes in the mortgage-backed capital market,and general changes in economic conditions. Risks associated withforward-looking statements are more fully described in the Company’s filingswith the Securities and Exchange Commission. Those risks also include thetiming of and ability to execute the initial public offering and spin-off ofthe Company’s Water Products business and other strategic actions that may bepursued. The Company has no duty to update its outlook statements as of anyfuture date.

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**PART II—OTHERINFORMATION**

**Item 1. LegalProceedings**

See Note 12 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 (See Note 12 of the “Notes to CondensedConsolidated Financial Statements”). The effect of the outcome of these matterson the Company’s future results of operations cannot be predicted because anysuch effect depends on future results of operations and the amount and timingof the resolution of such matters. While the results of litigation cannot bepredicted with certainty, the Company believes that the final outcome of suchother litigation will not have a material adverse effect on the Company’sconsolidated financial position.

**Item 1A. RiskFactors**

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

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

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

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

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

The availability and priceof certain raw materials or purchased components, such as steel scrap, brassingot and natural gas are subject to market forces largely beyond our control,including North American 

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andinternational freight costs, speculation and foreign exchange rates. Wegenerally purchase raw materials at spot prices and generally do not have theability to hedge our exposure to price changes. We are not always able, and maynot be able in the future, to pass on increases in the price of these rawmaterials to our customers. In particular, when raw material prices increaserapidly or to significantly higher than normal levels, we may not be able topass price increases through to our customers on a timely basis, if at all,which could lead to significant reductions of our operating margins and cashflow. Any fluctuations in the price or availability of raw materials orpurchased components could significantly reduce our levels of production andsales or impair our profitability.

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

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

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

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

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

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

We are subject to a wide variety of laws andregulations concerning the protection of the environment and human health andsafety, both with respect to the construction and operation of many of ourplants, mines and other facilities and with respect to remediatingenvironmental conditions that may exist at our 

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

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

Our U.S. Pipe segmenthas been identified as a potentially responsible party liable under federalenvironmental laws for a portion of the clean-up costs with regard to twosites, one in Alabama and one in California, and is currently subject to an administrativeconsent order requiring certain monitoring and clean-up with regard to itsBurlington, New Jersey facility. Such clean-up costs could be substantial andcould have a negative effect on our profitability and cash flows in any givenreporting period. As described in the immediately preceding risk factor, werely on Tyco to indemnify us for certain liabilities and there is a risk thatTyco may become unable of fail to fulfill its obligation.

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

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

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

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

***Compliance withinternal control reporting requirements and securities laws and regulations islikely to increase our compliance costs.***

The Sarbanes-Oxley Act of2002, as well as rules subsequently implemented by the SEC and the PCAOB,have required changes in the corporate governance and securities disclosure orcompliance practices of public companies over the last few years. We expectthese new rules and regulations to continue to increase our legal andfinancial compliance costs, as well as our ongoing audit costs, and to makelegal, accounting and administrative activities more time-consuming and costly.For example, in 2006, Mueller will need to comply with the internal controlreporting requirements of the Sarbanes-Oxley Act, which will have a significantimpact on our compliance cost in 2006.

***Compliance with thesecurities laws and regulations is likely to make it more difficult andexpensive for us to obtain directors and officers liability insurance and toattract and retain qualified members of our board of directors.***

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

***Interruption of normal operations at our keymanufacturing facilities may impair our production capabilities.***

Some of our keywater products, including hydrants, valves and ductile iron pipe, are manufacturedat five of our largest manufacturing facilities. The operations at our majormanufacturing facilities may be impaired by various operating risks, including,but not limited to:

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

·       interruptionsin raw materials and energy supply;

·       adversegovernment regulation;

·       breakdownsor equipment failures;

·       violationsof our permit requirements or revocation of permits;

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

·       shortagesof equipment or spare parts; and

·       labordisputes.

To date, we havesuccessfully managed non-material occurrences of the foregoing events,including a fire at the Columbia, PA facility of our Anvil segment andCalifornia’s adoption of laws limiting the lead content of water infrastructureproducts, without significant disruption of our operations. More acute 

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occurrencesof these events could cause a decrease in, or the elimination of, the revenuesgenerated by our key facilities or a substantial increase in the costs ofoperating such facilities that, in turn, could, impair our cash flows andresults of operations.

***Our brass valveproducts contain lead, which may be replaced in the future, and certain of ourbrass valve products may not be in compliance with NSF standards, which couldlimit the ability of municipalities to buy our products.***

Our brass valve products contain approximately 5.0%lead. Environmental advocacy groups, relying on standards established byCalifornia’s Proposition 65, are seeking to eliminate or reduce the content oflead in some of these products, including water meters and valves, and to limittheir sale in California. Some of our business units have entered into settlementagreements with these environmental advocacy groups that have required them toeither modify some of these products or offer substitutes for them with respectto products sold in California. Modifications of or substitutions for ourproducts to meet or conform with regulatory requirements will requireincremental capital spending of up to $8.0 million in the next two yearsand will require us to purchase more expensive raw materials, and we may not beable to pass these costs on to our customers. Legislation to substantiallyrestrict lead content in water products has been introduced in the UnitedStates Congress. Congress may adopt legislation that would require us toeliminate lead in our brass products which could require us to incursubstantial additional production expenses. In addition, advocacy groups mayfile suit against us under Proposition 65, which could result in additionalcosts in connection with marketing and selling our brass products inCalifornia.

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

**Item 2.**                        UnregisteredSales of Equity Securities and Use of Proceeds

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

During the quarter ended March 31,2006, there were no share repurchases and at March 31, 2006, $7.5 millionremains available under the Common Stock share repurchase program. The Companyhas not yet decided to terminate the program.

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

None

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**Item 6. Exhibits****

(a)   Exhibits

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

 

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**SIGNATURES**

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

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

 

Date:  May 9,2006

 

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