UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

FORM 10-Q

ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended September 30, 2008oro

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


Commission File Number 001-13711

WALTER INDUSTRIES, INC.

Incorporated in Delaware

13-3429953IRS Employer Identification No.4211 W. Boy Scout Boulevard, Tampa, Florida

33607(813) 871-4811Telephone Number


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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ý

Accelerated filer o

Non-accelerated filer o (Do not check if a smaller reporting company)

Smaller reporting company o


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

Number of shares of common stock outstanding as of October 31, 2008:54,337,291.



---





PART IFINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

WALTER INDUSTRIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

September 30, 2008

December 31, 2007ASSETSCash and cash equivalents

$
31,190

$
30,614Short-term investments, restricted


58,830


75,851Instalment notes receivable, net of allowance of $14,936 and $13,992, respectively


1,804,610


1,837,059Receivables, net


173,294


81,698Inventories


122,159


101,676Prepaid expenses


39,023


38,340Property, plant and equipment, net


523,248


435,035Other assets


143,954


156,113Goodwill





10,895$
2,896,308

$
2,767,281LIABILITIES AND STOCKHOLDERS' EQUITYAccounts payable

$
82,924

$
72,072Accrued expenses


122,763


83,072Accrued interest


11,628


13,940Debt:Mortgage-backed/asset-backed notes


1,402,234


1,706,218Other debt


205,933


225,860Accumulated postretirement benefits obligation


345,921


335,034Other liabilities


222,732


216,372Total liabilities


2,394,135


2,652,568Commitments and contingencies (Note 16)Stockholders' equityCommon stock, $0.01 par value per share:Authorized200,000,000 sharesIssued55,515,393 and 51,991,134 shares


555


520Capital in excess of par value


773,885


497,032Accumulated deficit


(189,314
)

(290,986
)Accumulated other comprehensive loss:Pension and post retirement benefit plans, net of tax


(84,492
)

(87,071
)Unrealized gain (loss) on hedges, net of tax


1,539


(4,782
)Total stockholders' equity


502,173


114,713$
2,896,308

$
2,767,281


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

1

---





WALTER INDUSTRIES, INC. AND SUBSIDIARIES        CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)        (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

For the three months ended September 30,2008

2007Net sales and revenues:Net sales

$
339,156

$
249,163Interest income on instalment notes


46,243


49,712Miscellaneous


2,591


13,331387,990


312,206Costs and expenses:Cost of sales (exclusive of depreciation)


193,292


184,535Depreciation


14,786


12,089Selling, general and administrative


35,390


34,088Provision for losses on instalment notes


5,607


3,366Postretirement benefits


6,595


6,863Interest expensemortgage-backed/asset-backed notes


24,279


29,996Interest expenseother debt


5,478


7,358Amortization of intangibles


302


455Provision for estimated hurricane insurance losses


3,853


Restructuring and impairment charges


17,380


306,962


278,750Income before income tax expense


81,028


33,456Income tax expense


26,028


9,093Net income

$
55,000

$
24,363Basic net income per share

$
0.99

$
0.47Diluted net income per share

$
0.97

$
0.46Dividends declared per common share

$
0.10

$
0.05


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

2

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

For the nine months ended September 30,2008

2007Net sales and revenues:Net sales

$
897,842

$
747,696Interest income on instalment notes


142,975


149,939Miscellaneous


12,899


31,3891,053,716


929,024Costs and expenses:Cost of sales (exclusive of depreciation)


568,221


530,632Depreciation


42,386


34,310Selling, general and administrative


110,660


109,664Provision for losses on instalment notes


12,934


8,756Postretirement benefits


19,783


19,882Interest expensemortgage-backed/asset-backed notes


78,433


89,512Interest rate hedge ineffectiveness


16,981


Interest expenseother debt


22,377


21,923Amortization of intangibles


1,007


1,375Provision for estimated hurricane insurance losses


3,853


Restructuring and impairment charges


24,150


900,785


816,054Income from continuing operations before income tax expense


152,931


112,970Income tax expense


46,656


38,702Income from continuing operations


106,275


74,268Loss from discontinued operations





(2,229
)Net income

$
106,275

$
72,039Basic income (loss) per share:Income from continuing operations

$
1.98

$
1.42Loss from discontinued operations





(0.04
)Net income

$
1.98

$
1.38Diluted income (loss) per share:Income from continuing operations

$
1.95

$
1.41Loss from discontinued operations





(0.04
)Net income

$
1.95

$
1.37Dividends declared per common share

$
0.20

$
0.15


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

3

---





WALTER INDUSTRIES, INC. AND SUBSIDIARIES        CONDENSED CONSOLIDATED STATEMENT OF CHANGES        IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)        FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (UNAUDITED)        (IN THOUSANDS)

Total

Common
Stock

Capital in
Excess of
Par Value

Comprehensive
Income

Accumulated
Deficit

Accumulated
Other
Comprehensive
Income (Loss)Balance at December 31, 2007

$
114,713

$
520

$
497,032




$
(290,986
)
$
(91,853
)Comprehensive income:Net income


106,275







$
106,275


106,275Other comprehensive income (loss), net of tax:Change in pension and postretirement benefit plans


1,909








1,909





1,909Change in unrealized gain (loss) on hedges, net of taxes


6,321








6,321





6,321Comprehensive income










$
114,505Effects of changing the pension plan measurement date pursuant to FASB 158:Service cost, interest cost, and expected return on plan assets for October 1December 31, 2007, net of taxes


(4,603
)










(4,603
)Amortization of actuarial gain and prior service cost for October 1December 31, 2007, net of taxes


670














670Purchases of stock under stock repurchase program


(14,461
)

(2
)

(14,459
)Proceeds from public stock offering


280,432


32


280,400Stock issued upon the exercise of stock options


7,903


4


7,899Stock issued upon conversion of convertible notes


785


1


784Tax benefit from the exercise of stock options


6,673





6,673Dividends paid, $0.20 per share


(10,799
)




(10,799
)Stock-based compensation


7,757





7,757Other


(1,402
)




(1,402
)Balance at September 30, 2008

$
502,173

$
555

$
773,885




$
(189,314
)
$
(82,953
)


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

4

---





WALTER INDUSTRIES, INC. AND SUBSIDIARIES        CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)        (IN THOUSANDS)

For the nine months
ended September 30,2008

2007OPERATING ACTIVITIESNet income

$
106,275

$
72,039Loss from discontinued operations





2,229Income from continuing operations


106,275


74,268Adjustments to reconcile income from continuing operations to net cash provided by operating activities:Provision for losses on instalment notes receivable


12,934


8,756Depreciation


42,386


34,310Non-cash restructuring and impairment charges


21,960


Other


5,768


22,364Decrease (increase) in assets, net of effect of acquisitions:Receivables


(73,530
)

(6,675
)Inventories


(17,855
)

15,107Prepaid expenses


9,456


(2,628
)Instalment notes receivable, net


7,636


(55,242
)Increase (decrease) in liabilities, net of effect of acquisitions:Accounts payable


8,899


3,536Accrued expenses


37,507


(21,807
)Accrued interest


(2,331
)

(2,904
)Cash flows provided by operating activities


159,105


69,085INVESTING ACTIVITIESAcquisitions, net of cash acquired


(17,871
)

(11,650
)Purchases of loans





(39,900
)Principal payments received on purchased loans


11,879


31,267Decrease in short-term investments, restricted


17,021


3,829Additions to property, plant and equipment


(88,804
)

(110,345
)Other


4,888


5,388Cash flows used in investing activities


(72,887
)

(121,411
)FINANCING ACTIVITIESIssuance of mortgage-backed/asset-backed notes


25,000


172,200Payments of mortgage-backed/asset-backed notes


(329,035
)

(170,719
)Proceeds from issuances of other debt


330,000


Retirement of other debt


(376,351
)

(40,831
)Proceeds from public stock offering


280,432


Other


(15,688
)

(13,165
)Cash flows used in financing activities


(85,642
)

(52,515
)Cash flows provided by (used in) continuing operations


576


(104,841
)CASH FLOWS FROM DISCONTINUED OPERATIONSCash flows provided by operating activities





630Cash flows provided by discontinued operations





630Net increase (decrease) in cash and cash equivalents

$
576

$
(104,211
)Cash and cash equivalents at beginning of period

$
30,614

$
127,369Add: Cash and cash equivalents of discontinued operations at beginning of period





1Net increase (decrease) in cash and cash equivalents


576


(104,211
)Cash and cash equivalents at end of period

$
31,190

$
23,159


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

5

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(IN THOUSANDS)

For the nine months ended September 30,2008

2007SUPPLEMENTAL DISCLOSURESInvesting Activities:Acquisition of Taft Coal Sales & Associates, Inc. (2008) and Tuscaloosa Resources, Inc (2007):Fair value of assets acquired

$
38,924

$
26,260Fair value of liabilities assumed


(18,885
)

(14,216
)Less: Cash acquired


(3,011
)

(394
)Net cash paid

$
17,028

$
11,650Financing Activities:Non-cash transaction:One-year property insurance policy financing agreement

$
9,291

$
8,383Acquisition of property, plant and equipment under capital lease and other obligations

$
22,587

$



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

6

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (Unaudited)

Note 1Basis of Presentation

Walter Industries, Inc. ("Walter"), together with its consolidated subsidiaries ("the Company"), is a diversified company which operates in five reportable segments: Natural
Resources, Sloss, Financing, Homebuilding and Other. See Note 15. Through these operating segments, the Company offers a diversified line of products and services including coal and natural
gas, furnace and foundry coke, slag fiber, mortgage financing and home construction. In the fourth quarter of 2007, the Company began reporting United Land, the parent of Kodiak Mining Co.,
Tuscaloosa Resources, Inc. ("TRI"), and Taft Coal Sales & Associates, Inc. ("Taft"), as part of Natural Resources due to its natural resource holdings. Prior to the fourth quarter of
2007, United Land was included in the Other segment. Operating results for the three and nine months ended September 30, 2007 have been revised to reflect this change.

The
accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of
normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2008 are not necessarily
indicative of the results that may be expected for the year ending December 31, 2008.

The
balance sheet at December 31, 2007 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by
accounting principles generally accepted in the United States for complete financial statements.

Note 2Business Separation and Merger

On September 30, 2008, the Company outlined its plans to separate its Financing business from the Company's core Natural Resources businesses. The Company plans to distribute 100%
of its interest in JWH Holding Company, LLC ("JWH Holding Company"), a wholly-owned subsidiary of the Company and parent company of the entities included in the Financing and Homebuilding
segments, to its shareholders. Prior to this distribution, Homebuilding will be sold or otherwise separated from JWH Holding Company and will not be part of the spin-off entity.

Also
on September 30, 2008, as amended and restated on October 28, 2008, JWH Holding Company entered into a definitive agreement to merge with Hanover Capital Mortgage
Holdings, Inc. ("Hanover"), a New Jersey-based real estate investment trust ("REIT"). The merger will occur immediately following the spin-off and the combined company will continue
to operate as a publicly traded REIT following the merger. The new company will be named Walter Investment Management Corporation ("Walter Investment Management"), be headquartered in Tampa, Fla. and
have approximately 225 employees. The spin-off and merger are expected to be completed in early 2009. After the spin-off and merger, Walter's shareholders will own
approximately 98.5% of Walter Investment Management's publicly traded common stock. Shareholders of Hanover will own the remaining 1.5%. Walter Investment Management plans to apply to list its shares
on the American Stock Exchange.

7

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (Unaudited)

Note 2Business Separation and Merger (Continued)

The
transaction is subject to certain closing conditions including, but not limited to, approval of the merger by Hanover's shareholders, favorable rulings from the Internal Revenue
Service, and the Securities and Exchange Commission declaring effective the required S-4 registration statement and associated proxy statement filings. The Company will continue to
consolidate its Financing segment until the date of the spin-off, at which time the historical results of operations of the Financing segment will be reported as discontinued operations.

Note 3Acquisition of Taft Coal Sales & Associates, Inc.

On September 2, 2008, Walter, through its wholly owned subsidiary United Land Corporation, acquired 100% of the outstanding common shares of Taft for a cash payment of
$17.0 million, net of $3.0 million of acquired cash. The fair value of assets acquired and liabilities assumed totaled $38.9 million and $18.9 million, respectively. Taft,
located in Jasper, Alabama, currently operates a surface steam and
industrial coal mine and primarily mines coal for the industrial and electric utility markets. The acquisition of Taft, included in the Natural Resources segment, expands the Company's coal production
base in the southern Appalachian coal region of Alabama and will be instrumental in helping to grow the Company's domestic Natural Resources business.

The
financial results of Taft have been included in the Company's consolidated financial statements since the date of acquisition of September 2, 2008. Assets acquired and
liabilities assumed were recorded at their estimated fair values as of the date of acquisition. The purchase price allocation is preliminary and is subject to future adjustments based on the
resolution of certain asset valuations, loss contingencies, contractual obligations and tax matters. The resolution of these items are not expected to be completed until the first quarter of 2009.

Note 4Discontinued Operations

Modular Homes Division

During the first quarter of 2007, the Company decided to exit the manufacture and distribution of modular homes, which operated as
Crestline Homes, Inc. ("Crestline"). As such, the Company has reported the results of operations, assets, liabilities and cash flows of Crestline, previously included in the Homebuilding
segment, as discontinued operations. This business was sold on May 30, 2007.

The
table below presents the significant components of operating results included in the income (loss) from discontinued operations (in thousands):

For the nine
months ended
September 30,
2007Net sales and revenues

$
12,358Income (loss) from discontinued operations before income taxes

$
(3,428
)Income tax (expense) benefit


1,199Income (loss) from discontinued operations

$
(2,229
)


8

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (Unaudited)

Note 4Discontinued Operations (Continued)

The
Company allocated certain corporate expenses, limited to specifically identified costs and other corporate shared services which supported segment operations, to discontinued
operations. These costs represent expenses that have historically been allocated to and recorded by the Company's operating segments as selling, general and administrative expenses. The Company did
not elect to allocate additional interest expense to discontinued operations.

Note 5Adoption of New Accounting Pronouncements

In 2006, the FASB issued SFAS No. 157, "Fair Value Measurements," which provides a definition of fair value, establishes a framework for measuring fair value and expands fair
value financial statement disclosure requirements. SFAS No. 157 is intended to eliminate the diversity in practice associated with measuring fair value under existing accounting pronouncements
and does not require any new fair value measurements. The adoption of SFAS No. 157 for financial assets and financial liabilities on January 1, 2008 did not have a material effect on the
Company's consolidated financial statements. See Note 18 for fair value disclosures.

In
2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans," which, among other changes, requires companies to
measure plan assets and liabilities as of the fiscal year-end reporting date. On January 1, 2008, the Company adopted the measurement provisions of SFAS No. 158 and elected
the alternative transition method.
Based on the actuarial valuation performed as of September 30, 2007, the Company's actuary provided a 15-month projection of net periodic pension cost to December 31, 2008.
In recognizing the effects of changing the Company's measurement date from September 30 to December 31, the Company recorded a charge to accumulated deficit of $4.6 million, net
of taxes of $3.1 million, increases in accumulated postretirement benefits obligation and pension liability of $6.1 million and $0.4 million, respectively, and a credit to
accumulated other comprehensive loss of $0.7 million, net of taxes of $0.5 million.

In
June 2008, the FASB ratified EITF Issue No. 08-3, Accounting by Lessees for Maintenance Deposits Under Lease Arrangements, (EITF 08-3).
EITF 08-3 provides guidance for accounting for nonrefundable maintenance deposits. EITF 08-3 is effective for fiscal years beginning after December 15,
2008. The Company is currently evaluating the impact that the adoption of EITF 08-3 will have on its consolidated financial statements.

Note 6Restructuring and Impairment

On February 19, 2008, the Company announced a restructuring of JWH Holding Company, LLC, the Company's Financing and Homebuilding business. Thirty-six
underperforming Jim Walter Homes sales centers have been closed as part of the restructuring. As a result, the Company recorded a restructuring charge of $6.8 million in the first quarter of
2008, in Homebuilding, of which $4.3 million related to impairments of property, plant and equipment, $1.7 million related to severance obligations due to a 25% reduction in workforce at
Homebuilding and $0.8 million related to lease obligations of closed sales centers.

During
the three months ended September 30, 2008, Homebuilding recorded a charge of $6.5 million, of which $6.0 million related to the impairment of property, plant
and equipment due to the decline in the estimated values of the assets and $0.5 million for severance payments related to

9

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (Unaudited)

Note 6Restructuring and Impairment (Continued)

additional
headcount reductions. As a result of continued losses in the Homebuilding segment, the Company reviewed its long-lived assets for potential impairment. Projected undiscounted
cash flows generated from the remaining sales centers were lower than the net book value of the model park assets at those sales centers. As a result, the estimated fair values of the model parks were
compared to book values, resulting in an impairment charge of $6.0 million. The estimated fair values were determined based on Homebuilding's recent sales of similar assets.

Also
during the three months ended September 30, 2008, the Company recorded a charge of $10.9 million for the impairment of Financing's goodwill. As discussed in
Note 2, Walter announced its plans to separate its Financing segment via a spin-off to Walter shareholders and merger with Hanover. As a result of this decision, the Company
analyzed goodwill for potential impairment. The fair value of the reporting unit was determined using a discounted cash flow approach which indicated that the carrying value exceeded the fair value
and that the implied value of goodwill was $0. The discount rate of interest used to determine both the fair value of the reporting unit and the implied value of goodwill was a contributing factor in
this impairment charge. The continued increase in perceived risk in the financial services markets resulted in a significant increase in the discount rate applied to projected future cash flows, as
compared to the discount rate applied to similar analyses performed in previous periods.

The
charges as described above appear as restructuring and impairment charges in the statement of income.

The
following table summarizes restructuring activity for the three months ended September 30, 2008 (in thousands):

Balance
at
June 30,
2008

Restructuring
and
Impairment
Charges

Cash
Payments

Other
Non-Cash
Charges

Balance at
September 30,
2008Impairment of goodwill

$


$
10,895

$


$
(10,895
)
$
Impairment of property, plant and equipment





5,985





(5,985
)

Severance obligations


451


500


(450
)




501Lease obligations


407





(150
)




257Total

$
858

$
17,380

$
(600
)
$
(16,880
)
$
758


10

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (Unaudited)

Note 6Restructuring and Impairment (Continued)

The
following table summarizes restructuring activity for the nine months ended September 30, 2008 (in thousands):

Balance at
January 1,
2008

Restructuring
and
Impairment
Charges

Cash
Payments

Other
Non-Cash
Charges

Balance at
September 30,
2008Impairment of goodwill

$


$
10,895

$


$
(10,895
)
$
Impairments of property, plant and equipment





10,307





(10,307
)

Severance obligations





2,169


(1,668
)




501Lease obligations





779


(522
)




257Total

$


$
24,150

$
(2,190
)
$
(21,202
)
$
758


Note 7Restricted Short-Term Investments

Restricted short-term investments at September 30, 2008 and December 31, 2007 include (i) temporary investments, primarily in commercial paper or money
market accounts, with maturities less than 90 days from collections on instalment notes receivable owned by various Mid-State Trusts (the "Trusts") ($51.7 million and
$68.8 million, respectively) which are available only to pay expenses of the Trusts and principal and interest on indebtedness of the Trusts, and (ii) miscellaneous other segregated
accounts restricted to specific uses ($7.1 million at both September 30, 2008 and December 31, 2007).

Note 8Instalment Notes Receivable

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

September 30,
2008

December 31,
2007Instalment notes receivable

$
1,597,832

$
1,616,753Mortgage loans


221,714


234,298Less: Allowance for losses


(14,936
)

(13,992
)Net

$
1,804,610

$
1,837,059


11

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (Unaudited)

Note 9Inventories

Inventories are summarized as follows (in thousands):

September 30,
2008

December 31,
2007Finished goods

$
38,412

$
29,650Goods in process


11,994


19,598Raw materials and supplies


30,426


16,021Repossessed houses held for resale


41,327


36,407Total inventories

$
122,159

$
101,676


Note 10Debt

Debt consisted of the following (in thousands):

September 30,
2008

December 31,
2007Mortgage-backed/asset-backed notes

$
1,402,234

$
1,706,218Other debt:2005 Walter term loan


139,293


218,517Convertible Senior Subordinated Notes





7852005 Walter revolving credit facility


50,000


Other(1)


16,640


6,558205,933


225,860Total

$
1,608,167

$
1,932,078






2005 Walter Credit Agreement

In 2005, Walter entered into a $675.0 million credit agreement ("2005 Walter Credit Agreement") which includes (1) an
amortizing term loan facility with an initial aggregate principal amount of $450.0 million, $139.3 million of which was outstanding as of September 30, 2008 with a weighted
average interest rate of 5.280%, and (2) a $225.0 million revolving credit facility which provides for loans and letters of credit. The 2005 Walter Credit Agreement is a secured
obligation of the Company and substantially all of its wholly owned domestic subsidiaries. The term loan requires quarterly principal payments of $0.4 million through October 3, 2012, at
which time the remaining outstanding principal is due.

On
April 30, 2008, Walter amended the 2005 Walter Credit Agreement to allow an additional $250.0 million of borrowings under the revolving credit facility, thereby
increasing the revolving credit facility to $475.0 million. Available funds of $214.8 million were used to repay principal, interest and fees and terminate the Mid-State
Trust IX and Mid-State Trust XIV mortgage warehouse facilities,

12

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (Unaudited)

Note 10Debt (Continued)

which
were due to mature in July 2008 and October 2008, respectively. The amendment also increased the interest rate on the revolving credit facility and the term loan to LIBOR plus 300 basis points.
The commitment fee on the unused portion of the revolving facility also increased from 0.375% per year to 0.5% per year. In addition, the amended 2005 Walter Credit Agreement contains a reducing
revolver commitment feature, where the total available revolver commitment may not exceed $400.0 million at March 31, 2009, $350.0 million at June 30, 2009,
$300.0 million at September 30, 2009, and $250.0 million at December 31, 2009.

Certain
other terms, including affirmative and negative covenants as well as restrictions on the Company's ability to engage in specified activities, were also amended and include, but
are not limited to, increased indebtedness and approval of certain activities associated with the Company's strategic initiatives in the Homebuilding and Financing business.

In
connection with the amendment to the 2005 Walter Credit Agreement, the Company incurred $3.9 million of refinancing fees. These fees were deferred and are being amortized over
the remaining life of the revolving credit facility.

During
the nine months ended September 30, 2008, the Company borrowed $330.0 million under the revolving credit facility. On June 16, 2008, the Company completed an
offering of shares of its common stock and received $280.4 million of net proceeds, as more fully discussed in Note 13. During June 2008, the net proceeds from the offering were used to
repay $77.9 million on the outstanding term loan and $202.5 million on the revolving credit facility. Additional repayments on the revolving credit facility during the nine months ended
September 30, 2008 totaled $77.5 million. At September 30, 2008, the Company had $50.0 million outstanding under the revolving credit facility at a weighted average
interest rate of 4.903%.

Under
the terms of the Company's amended 2005 Walter Credit Agreement, availability under the revolving credit facility was reduced from $475.0 million to $373.8 million in
connection with the completion of the stock offering. As of September 30, 2008, the Company had $51.2 million in outstanding stand-by letters of credit and
$272.6 million of availability for future borrowings under the revolving credit facility.

In
connection with the repayments discussed above, the Company recognized an additional amortization of $3.1 million of previously deferred financing fees. This amortization
charge is included in interest expense in the statement of income.

Mortgage-Backed and Asset-Backed Notes and Variable Funding Loan Facilities

At the beginning of 2008, the Company had two variable funding loan facilities ("warehouse facilities") totaling $350.0 million
that provided temporary warehouse financing to Walter Mortgage Company ("WMC") for its current purchases of instalment notes and mortgages originated by Homebuilding.

On
April 30, 2008, the Company repaid all outstanding borrowings and terminated these facilities using proceeds from the amended 2005 Walter Credit Agreement, as discussed above.
With the termination of the warehouse facilities, the Company no longer uses mortgage warehouse facilities or accesses the mortgage-backed securitization market.

13

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (Unaudited)

Note 10Debt (Continued)

In
addition, after May 1, 2008, WMC no longer provides financing to new customers of Homebuilding and has transitioned to a third-party financing model including the use of
government-sponsored loan programs. However, substantially all of the backlog of homes with signed contracts and those which were under construction as of May 1, 2008, have been or are expected
to be completed over the next three months and financed by WMC. The Company will finance these WMC instalment notes receivable with operating cash flows or funds from borrowings under the revolving
credit facility.

Prior
to their termination on April 1,2008, the Company held multiple interest rate hedge agreements with various counterparties with an aggregate notional value of
$215.0 million, the objective of which was to protect against changes in the benchmark interest rate on the forecasted issuance of mortgage-backed notes in a securitization (the "Securitization
Hedges"). At March 31, 2008, these Securitization Hedges no longer qualified for hedge accounting treatment because the Company no longer planned to access the distressed securitization market.
As a result, the Company recognized a loss on interest rate hedge ineffectiveness of $17.0 million in the first quarter of 2008. On April 1, 2008, the Company settled the Securitization
Hedges for a payment of $17.0 million.

Convertible Notes

In January 2008, the holders of the remaining $0.8 million 3.75% Convertible Senior Subordinated Notes agreed to convert the
principal amount in exchange for 84,013 shares of the Company's common stock and $0.1 million of conversion inducement payments.

Other

In October 2008, the Company entered into a $32.3 million equipment financing arrangement for certain previously procured mining
equipment. This financing arrangement will mature in the first quarter of 2014 and carries an annual interest rate of LIBOR plus 375 basis points.

Note 11Pension and Other Postretirement Benefits

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

Pension Benefits

Other BenefitsFor the three months
ended September 30,

For the three months
ended September 30,2008

2007

2008

2007Components of net periodic benefit cost:Service cost

$
1,002

$
1,014

$
753

$
799Interest cost


3,003


2,725


5,377


5,283Expected return on plan assets


(3,632
)

(3,059
)




Amortization of prior service cost


76


104


(794
)

(799
)Amortization of net actuarial loss


615


1,142


1,259


1,580Net periodic benefit cost

$
1,064

$
1,926

$
6,595

$
6,863


14

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (Unaudited)

Note 11Pension and Other Postretirement Benefits (Continued)



Pension Benefits

Other BenefitsFor the nine months ended September 30,

For the nine months ended September 30,2008

2007

2008

2007Components of net periodic benefit cost:Service cost

$
3,006


3,042

$
2,259

$
2,331Interest cost


9,006


8,175


16,129


15,213Expected return on plan assets


(10,896
)

(9,177
)




Amortization of prior service cost


228


312


(2,382
)

(2,751
)Amortization of net actuarial loss


1,845


3,428


3,777


5,089Net periodic benefit cost

$
3,189

$
5,780

$
19,783

$
19,882


Note 12Comprehensive Income

Comprehensive income is comprised primarily of net income, gains or losses from the effect of cash flow hedges and changes in pension and postretirement benefits obligations.
Comprehensive income for the three months ended September 30, 2008 and 2007 was $66.3 million and $21.1 million, respectively. Comprehensive income for the nine months ended
September 30, 2008 and 2007 was $114.5 million and $64.6 million, respectively.

Note 13Stockholders' Equity

On June 16, 2008, the Company completed a public offering of 3,220,000 shares of its common stock at a price of $90.75 per share. The Company received $280.4 million of net
proceeds from this offering, after deducting underwriting discounts and offering expenses. The Company used the net proceeds from this offering to repay $280.4 million of the borrowings
outstanding under the Company's 2005 Walter Credit Agreement. See Note 10.

On
July 31, 2008, the Board of Directors approved an increase in the Company's regular quarterly dividend rate from $0.05 per common share to $0.10 per common share.

During
the third quarter ended September 30, 2008, the Company repurchased 237,127 shares at an average price of $59.43 under its $25 million share repurchase program, and
in October 2008, the Company repurchased 105,729 shares at an average price of $46.56 thereby fulfilling the program's authorized allotment. On September 26, 2008, the Board of Directors
approved a new $50.0 million share repurchase program, which is intended to replace the previously authorized $25 million share repurchase program. Repurchases will be made based on
liquidity, market conditions and alternative opportunities to invest in and grow the Company's core businesses. Through November 6, 2008, the Company has repurchased 1,184,243 shares at an
average price of $35.32 under its $50.0 million share repurchase program.

15

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (Unaudited)

Note 14Net Income Per Share

A reconciliation of the basic and diluted net income per share computations for the three and nine months ended September 30, 2008 and 2007 are as follows (in thousands, except
per share data):

For the three months ended September 30,2008

2007Basic

Diluted

Basic

DilutedNumerator:Net income

$
55,000

$
55,000

$
24,363

$
24,363Effect of dilutive securities:Interest related to 3.75% convertible senior subordinated notes, net of tax(a)











5$
55,000

$
55,000

$
24,363

$
24,368Denominator:Average number of common shares outstanding


55,686


55,686


52,035


52,035Effect of dilutive securities:Stock options and restricted stock units ("units")(b)





764





4033.75% convertible senior subordinated notes(a)











8455,686


56,450


52,035


52,522Net income per share

$
0.99

$
0.97

$
0.47

$
0.46


16

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (Unaudited)

Note 14Net Income Per Share (Continued)

For the nine months ended September 30,2008

2007Basic

Diluted

Basic

DilutedNumerator:Income from continuing operations

$
106,275

$
106,275

$
74,268

$
74,268Effect of dilutive securities:Interest related to 3.75% convertible senior subordinated notes, net of tax(a)











14$
106,275

$
106,275

$
74,268

$
74,282Loss from discontinued operations

$


$


$
(2,229
)
$
(2,229
)Denominator:Average number of common shares outstanding


53,614


53,614


52,035


52,035Effect of dilutive securities:Stock options and restricted stock units ("units")(b)





749





3983.75% convertible senior subordinated notes(a)











8453,614


54,363


52,035


52,517Income from continuing operations per share

$
1.98

$
1.95

$
1.42

$
1.41Loss from discontinued operations per share








(0.04
)

(0.04
)Net income per share

$
1.98

$
1.95

$
1.38

$
1.37


---

17

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (Unaudited)

Note 15Segment Information

Summarized financial information of the Company's reportable segments is shown in the following table (in thousands):

For the three months ended
September 30,2008

2007Net sales and revenues:Natural Resources

$
268,503

$
165,490Sloss


53,738


34,471Natural Resources and Sloss


322,241


199,961Financing


50,187


54,104Homebuilding


23,058


58,060Financing and Homebuilding Group


73,245


112,164Other


2,039


1,025Consolidating eliminations of intersegment activity


(9,535
)

(944
)Net sales and revenues

$
387,990

$
312,206Segment operating income (loss):Natural Resources

$
95,353

$
31,735Sloss


14,638


3,231Natural Resources and Sloss


109,991


34,966Financing(a)(b)


(4,785
)

11,247Homebuilding(d)


(12,601
)

(82
)Financing and Homebuilding Group


(17,386
)

11,165Other


(6,085
)

(5,317
)Consolidating eliminations of intersegment activity


(14
)

Operating income


86,506


40,814Less other debt interest expense


(5,478
)

(7,358
)Income before income tax expense


81,028


33,456Income tax expense


26,028


9,093Net income

$
55,000

$
24,363Depreciation:Natural Resources

$
12,847

$
9,182Sloss


1,048


965Natural Resources and Sloss


13,895


10,147Financing


73


312Homebuilding


582


1,290Financing and Homebuilding Group


655


1,602Other


236


340Total

$
14,786

$
12,089


18

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (Unaudited)

Note 15Segment Information (Continued)

For the nine months ended September 30,2008

2007Net sales and revenues:Natural Resources

$
658,962

$
475,955Sloss


157,874


100,394Natural Resources and Sloss


816,836


576,349Financing


154,013


162,897Homebuilding


102,357


188,368Financing and Homebuilding Group


256,370


351,265Other


3,163


5,563Consolidating eliminations of intersegment activity


(22,653
)

(4,153
)Net sales and revenues

$
1,053,716

$
929,024Segment operating income (loss):Natural Resources

$
177,736

$
111,675Sloss


48,429


7,485Natural Resources and Sloss


226,165


119,160Financing(a), (b), (c)


2,837


34,863Homebuilding(d)


(30,571
)

(3,227
)Financing and Homebuilding Group


(27,734
)

31,636Other


(22,465
)

(15,903
)Consolidating eliminations of intersegment activity


(658
)

Operating income from continuing operations


175,308


134,893Less other debt interest expense


(22,377
)

(21,923
)Income from continuing operations before income tax expense


152,931


112,970Income tax expense


46,656


38,702Income from continuing operations

$
106,275

$
74,268Depreciation:Natural Resources

$
35,750

$
25,838Sloss


3,033


2,824Natural Resources and Sloss


38,783


28,662Financing


331


866Homebuilding


2,576


3,796Financing and Homebuilding Group


2,907


4,662Other


696


986Total

$
42,386

$
34,310


---

19

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (Unaudited)

Note 15Segment Information (Continued)



Note 16Commitments and Contingencies



The Internal Revenue Service (the "IRS") has completed its audit of the Company's Federal income tax returns for the years ended May
2000 through December 31, 2005. The unresolved issues relate primarily to the Company's method of recognizing revenue on the sale of homes and related interest on the instalment notes
receivable. The items at issue relate primarily to the timing of revenue recognition and consequently, should the IRS prevail on its positions, the Company's financial exposure is limited to interest
and penalties.

On
December 27, 1989, the Company and most of its subsidiaries each filed a voluntary petition for reorganization under Chapter 11 of Title 11 of the United States Code
(the "Bankruptcy Proceedings")
in the United States Bankruptcy Court for the Middle District of Florida, Tampa Division (the "Bankruptcy Court"). The Company emerged from bankruptcy on March 17, 1995 (the "Effective Date")
pursuant to the Amended Joint Plan of Reorganization Dated as of December 9, 1994, as modified on March 1, 1995 (as so modified the "Consensual Plan"). Despite the confirmation and
effectiveness of the Consensual Plan, the Bankruptcy Court continues to have jurisdiction over, among other things, the resolution of disputed prepetition claims against the Company and other matters
that may arise in connection with or related to the Consensual Plan, including claims related to Federal income taxes.

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

20

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (Unaudited)

Note 16Commitments and Contingencies (Continued)

The amounts initially asserted by the Proof of Claim do not reflect the subsequent resolution of various issues through settlements or concessions by the parties. After adjustment for
these items, the Company estimates that the amount of tax presently claimed by the IRS is approximately $34.0 million for issues currently in dispute in the Adversary Proceeding. This amount is
subject to interest and penalties. Of the $34.0 million in claimed tax, $21.0 million represents issues in which the IRS is not challenging the deductibility of the particular expense
but only whether such expense is deductible in a particular year. Consequently, the Company believes that, should the IRS prevail on any such issues, the Company's financial exposure is limited to
interest and possible penalties and the amount of tax claimed will be offset by deductions in other years. Substantially all of the issues in the Proof of Claim, which have not been settled or
conceded, have been litigated before the Bankruptcy Court and are subject to appeal but only at the conclusion of the entire Adversary Proceeding.

The
Company believes that those portions of the Proof of Claim which remain in dispute or are subject to appeal substantially overstate the amount of taxes allegedly owing. However,
because of the complexity of the issues presented and the uncertainties associated with litigation, the Company is unable to predict the ultimate outcome of the Adversary Proceeding.

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



The Company is subject to a wide variety of laws and regulations concerning the protection of the environment, both with respect to the
construction and operation of its plants, mines and other facilities and with respect to remediating environmental conditions that may exist at its own and other properties.

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

Sloss
and Walter Industries, Inc. have received a letter from attorneys purporting to represent a group of residents of the North Birmingham area of Jefferson County, Alabama
alleging personal injury, property damage, nuisance and trespass. The allegations against Sloss relate to air emissions from its coking facility. Walter is named in this litigation because of its
ownership interest in Sloss. The Company has reached an agreement for the settlement of these allegations. As a result, the Company recognized a charge of $2.4 million in the nine months ended
September 30, 2008, which is included in selling, general and administrative expenses in the statement of income.

Sloss
Industries entered into a decree order in 1989 relative to a Resource Conservation Recovery Act ("RCRA") compliance program mandated by the EPA. A RCRA Facility Investigation
("RFI") Work Plan was prepared which proposed investigative tasks to assess the presence of contamination at the Sloss facility. The Work Plan was approved in 1994 and the Phase I
investigations were conducted and completed between 1995 and 1999. Phase II investigations for the Chemical Plant/Coke Plant and Biological Treatment Facility and Sewers/Land Disposal Areas
were performed in 2000 and 2001 and are substantially complete. At the end of 2004, the 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 the EPA in meeting goals set by the Government Performance

21

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (Unaudited)

Note 16Commitments and Contingencies (Continued)

Results
Act ("GPRA") for RCRA by 2005. Sloss implemented the approved EI Sampling Plan in April 2005. The EPA approved/finalized the EI determinations for Sloss' Birmingham facility in September 2005.
In an effort to refocus the RFI, the EPA has now provided technical comments on the Phase II RFI report and the report recently submitted as part of the EI effort. A Phase III work plan
was submitted to the EPA during the first quarter of 2007. The EPA commented on the Phase III plan and Sloss has responded. Subsequently, a meeting was held with the EPA during the third
quarter of 2007 with the objective of finalization of the Phase III Plan. However, additional requests by EPA have expanded and continue to expand the scope of the project and will necessitate
additional sampling and testing.

The
Company has incurred costs to investigate the presence of contamination at the Sloss site, and to define remediation actions to address this environmental liability in accordance
with the agreements reached with the EPA per the findings in the Phase I and Phase II investigations. In conjunction with the Phase III work plan, the Company continues to incur
costs related to defining remediation efforts and establishing a plan for remediation. As of September 30, 2008, the Company has accrued an amount that is probable and can be reasonably
estimated for the costs to be incurred to identify necessary remediation actions and establish a remediation plan. Additional future costs which may be incurred in order to remediate liabilities
defined by the Phase III analysis cannot be determined at this time. Although no assurances can be given that the Company will not be required in the future to make material expenditures
relating to the Sloss site or other sites, management does not believe at this time that the cleanup costs, if any, associated with these sites will have a material adverse effect on the financial
condition of the Company, but such cleanup costs could be material to results of operations in a future reporting period.



The Company and its subsidiaries are parties to a number of other lawsuits arising in the ordinary course of their businesses. The
Company records costs relating to these matters when a loss is probable and the amount is reasonably estimable. The effect of the outcome of these matters on the Company's future results of operations
cannot be predicted with certainty as any
such effect depends on future results of operations and the amount and timing of the resolution of such matters. While the results of litigation cannot be predicted with certainty, the Company
believes that the final outcome of such other litigation will not have a materially adverse effect on the Company's consolidated financial statements.

In
the opinion of management, accruals associated with contingencies incurred in the normal course of business are sufficient. Resolution of existing known contingencies is not expected
to significantly affect the Company's financial position and result of operations.



During the third quarter of 2008, the Company entered into an arrangement in which a vendor will provide certain parts, components and
an exchange and rebuild service for certain of the Company's mining equipment. This arrangement extends to a period of up to five years and will require the Company to spend approximately
$57.1 million over the contract term. These types of maintenance costs have been incurred by Natural Resources in prior periods. Also, in connection with its expanding mining operations, the
Company had commitments of approximately $43.6 million at September 30, 2008, for the acquisition of property and equipment, most of which is expected to be incurred in 2009.

22

---



WALTER INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

AS OF AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 (Unaudited)

Note 16Commitments and Contingencies (Continued)

Commitments and ContingenciesOther

In the opinion of management, accruals associated with contingencies incurred in the normal course of business are sufficient.
Resolution of existing known contingencies is not expected to significantly affect the Company's financial position and result of operations

Note 17Income Taxes

The Company's effective tax rate for the three and nine months ended September 30, 2008 was 32.1% and 30.5%, respectively, compared to 27.2% and 34.3% for the same periods in
2007. The effective tax rate for the nine months ended September 30, 2008 includes the unfavorable effect of a $10.9 million nondeductible goodwill impairment charge and the favorable
impact of a $3.9 million tax credit resulting from the resolution of certain Federal tax matters associated with the IRS audit for the years ended May 31, 2000, December 31, 2000
and December 31, 2001. Excluding these items, the effective tax rate for the nine months ended September 30, 2008 would have been 30.7%. The resolution of certain Federal tax matters
also resulted in a net reduction to the accrual for unrecognized tax benefits of $1.1 million in 2008. The effective tax rate in 2007 includes the unfavorable impact of a $4.4 million
write-off of certain deferred tax assets no longer considered realizable. Excluding this discrete item, the effective tax rate for the nine months ended September 30, 2007 would
have been 30.4%. In addition to the effect of these discrete items, both 2008 and 2007 effective tax rates differ from the Federal statutory rate primarily due to the benefit from percentage depletion
and domestic production deductions.

Note 18Fair Value of Financial Instruments

The Company measures certain financial instruments at fair value on a recurring basis, including
interest rate and natural gas hedging agreements. The following table summarizes the fair value of these financial instruments at September 30, 2008 by type of inputs used (in thousands):

Assets

Total

Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)

Significant Other
Observable Inputs
(Level 2)

Significant
Unobservable Inputs
(Level 3)Natural gas hedge agreements

$
1,776

$


$
1,776

$
LiabilitiesInterest rate hedge agreements

$
276

$


$
276

$



The
interest rate and natural gas hedge agreements are classified within Level 2 of the fair value hierarchy because they are valued using quoted dealer prices for similar
contracts.

Note 19Hurricane Insurance Claim Losses

The Company recorded a provision for estimated hurricane insurance losses of $3.9 million during the three months ended September 30, 2008. These estimated losses, recorded
in the Financing segment, were for estimated claim insurance losses as a result of property damage from Hurricanes Gustav and Ike in 2008 that impacted the Company's market area.

23

---





ITEM 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS, FINANCIAL CONDITION AND LIQUIDITY AND CAPITAL RESOURCES

This discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto of Walter
Industries, Inc. and its subsidiaries, particularly Note 15 of "Notes to Condensed Consolidated Financial Statements," which describe the Company's net sales and revenues and operating
income by operating segment.

RESULTS OF OPERATIONS

Summary Operating Results of Operations for the Three Months Ended September 30, 2008 and 2007

For the three months ended September 30, 2008(in thousands)

Natural
Resources

Sloss

Financing

Homebuilding

Other

Cons Elims

TotalNet sales

$
267,496

$
53,589

$
3,491

$
22,593

$
1,522

$
(9,535
)
$
339,156Interest income on instalment notes








46,243











46,243Miscellaneous income


1,007


149


453


465


517





2,591Net sales and revenues


268,503


53,738


50,187


23,058


2,039


(9,535
)

387,990Cost of sales (exclusive of depreciation)


146,263


35,586


1,570


19,183


211


(9,521
)

193,292Interest expense(1)








24,279











24,279Depreciation


12,847


1,048


73


582


236





14,786Selling, general & administrative


6,693


2,627


8,572


9,560


7,938





35,390Provision for losses on instalment notes








5,607











5,607Postretirement benefits


7,280


(161
)

(112
)

(151
)

(261
)




6,595Amortization of intangibles


67





235











302Provision for estimated hurricane insurance losses








3,853











3,853Restructuring & impairment charges








10,895


6,485








17,380Operating income (loss)

$
95,353

$
14,638

$
(4,785
)
$
(12,601
)
$
(6,085
)
$
(14
)

86,506Other debt interest expense




















(5,478
)Income before income taxes



















$
81,028


---

For the three months ended September 30, 2007(in thousands)

Natural
Resources

Sloss

Financing

Homebuilding

Other

Cons Elims

TotalNet sales

$
154,411

$
34,337

$
3,347

$
57,521

$
491

$
(944
)
$
249,163Interest income on instalment notes








49,712











49,712Miscellaneous income


11,079


134


1,045


539


534





13,331Net sales and revenues


165,490


34,471


54,104


58,060


1,025


(944
)

312,206Cost of sales (exclusive of depreciation)


112,315


28,375


2,172


42,389


228


(944
)

184,535Interest expense(1)








29,996











29,996Depreciation


9,182


965


312


1,290


340





12,089Selling, general & administrative


4,590


2,116


6,755


14,611


6,016





34,088Provision for losses on instalment notes








3,366











3,366Postretirement benefits


7,575


(216
)

(106
)

(148
)

(242
)




6,863Amortization of intangibles


93





362











455Operating income (loss)

$
31,735

$
3,231

$
11,247

$
(82
)
$
(5,317
)
$



40,814Other debt interest expense




















(7,358
)Income before income taxes



















$
33,456


---

24

---



Overview

The Company's net income for the three months ended September 30, 2008 was $55.0 million, or $0.97 per diluted share,
which compares to $24.4 million, or $0.46 per diluted share, for the three months ended September 30, 2007.

In
the three months ended September 30, 2008, the Company's results included a 24.3% increase in net sales and revenues and a 112.0% increase in operating income versus the same
period in 2007. These results were led by the Company's core Natural Resources and Sloss businesses that generated combined revenues of $322.2 million, up 61.2% versus the same period in 2007,
and combined operating income of $110.0 million, up 214.6% versus the same period in 2007. These increases were primarily the result of higher average metallurgical coal and coke pricing.
Partially offsetting these favorable increases from Natural Resources and Sloss were decreases in net sales and revenues and operating
income from the combined Homebuilding and Financing businesses. Revenues and operating income from these businesses declined due to fewer unit deliveries and an increase in the discount required to
record originations of instalment notes receivable at estimated market value during the third quarter of 2008 at Homebuilding as well as lower prepayment-related interest income at Financing. Also
contributing to the decrease in operating income was a $10.9 million goodwill impairment charge at Financing, $6.5 million of asset impairments and severance costs at Homebuilding and a
$3.9 million provision for estimated hurricane-related insurance losses at Financing, resulting from Hurricanes Gustav and Ike. The impact of these factors on the combined operating income for
these businesses was partially offset by lower interest expense at Financing as a result of the April 2008 repayment of all outstanding borrowings under its variable funding loan facilities
("warehouse facilities") as discussed in Note 10 of the "Notes to Condensed Consolidated Financial Statements."

Outlook and Strategic Initiatives



25

---





26

---





Homebuilding and Financing





27

---





Other



28

---





Summary of Third Quarter Consolidated Results of Operations

Net sales and revenues for the three months ended September 30, 2008 were $388.0 million, an increase of
$75.8 million, or 24.3% from $312.2 million in the same period in 2007. This increase in revenues was primarily driven by higher metallurgical coal and coke pricing, partially offset by
declines in unit deliveries at Homebuilding, a $3.8 million increase in the discount charge on instalment notes receivable originated during the third quarter of 2008 and lower Financing
prepayment income.

Cost
of sales, exclusive of depreciation, increased $8.8 million to $193.3 million and represented 57.0% of net sales for the three months ended September 30, 2008
versus $184.5 million or 74.1% of net sales for the same period in 2007. The increase in costs primarily results from increased production costs at Natural Resources as well as increased
material costs at Sloss. These increases were partially offset by lower costs at Homebuilding resulting from fewer unit deliveries. The decrease in cost of sales as a percentage of net sales in 2008
as compared to 2007 results primarily from increased sales pricing, which outpaced cost increases at Natural Resources and Sloss.

Depreciation
for the three months ended September 30, 2008 was $14.8 million, an increase of $2.7 million compared to the same period in 2007. The increase was
primarily due to the Company's continued investment in the expansion of and replacement of equipment at Natural Resources' mining operations.

Interest
expense on mortgage-backed notes was $24.3 million for the three months ended September 30, 2008, down $5.7 million compared to the same period in 2007.
This decrease was due to a reduction in the weighted average borrowings outstanding for the three months ended September 30, 2008 as compared to the same period in 2007 resulting from the
pay-off and termination of the warehouse facilities in April 2008 totaling $214.0 million, as well as due to normal repayments on the other securitized notes. The weighted average
interest rate for the three months ended September 30, 2008 was also slightly lower as compared to the same period in 2007.

Provision
for estimated hurricane insurance losses reflects a $3.9 million provision recorded during the quarter for hurricane-related losses due to Hurricanes Gustav and Ike.

Restructuring
charges of $17.4 million in the three months ended September 30, 2008 includes a charge of $6.5 million at Homebuilding, of which $6.0 million
related to the impairment of long-lived assets and $0.5 million for severance costs, as well as a charge of $10.9 million for the impairment of

29

---



Financing's
goodwill. For a further discussion, see Note 6 of "Notes to Condensed Consolidated Financial Statements."

Interest
expense on other debt decreased $1.9 million to $5.5 million for the three months ended September 30, 2008, primarily as a result of a reduction in both the
weighted average borrowings for the period and the weighted average interest rate.

The
Company's effective tax rate for the three months ended September 30, 2008 and 2007 was 32.1% and 27.2%, respectively. The effective tax rate for the three months ended
September 30, 2008 includes the effect of a $10.9 million nondeductible goodwill impairment charge. Excluding the impact of this item, the effective tax rate for the quarter would have
been 28.3%, comparable to the same period in 2007. Both the 2008 and 2007 effective tax rates differ from the Federal statutory rate primarily due to the benefits from percentage depletion and
domestic production deductions.

The
current and prior-year period results also include the impact of the factors discussed in the following segment analysis.

Segment Analysis



Natural Resources, which include the operations of Jim Walter Resources, Kodiak Mining, TRI, Taft and United Land, reported revenues of
$268.5 million in the third quarter of 2008, an increase of $103.0 million from the same period last year. The increase in revenues was
primarily due to an 81.5% increase in selling prices for metallurgical coal, as compared to the same period in 2007. Additionally, there was an increase in sales from Kodiak Mining and the addition of
TRI and Taft sales in 2008. Statistics presented in the following table relate to Jim Walter Resources only.

Three months ended
September 30,2008

2007Average Coal Selling Price (per short ton)

$
161.92

$
89.22Tons of Coal Sold (in thousands)


1,384


1,570Average Natural Gas Selling Price (per MCF)

$
8.69

$
7.59Billion Cubic Feet of Natural Gas Sold


1.7


1.8Number of Natural Gas Wells


421


418


Natural
Resources reported operating income of $95.4 million in the third quarter of 2008, compared to $31.7 million in the same period in 2007. The $63.7 million
increase in operating income was primarily the result of the increase in net sales and revenues discussed above, partially offset by an increase in cost of sales of $33.9 million. The increase
in cost of sales is mostly due to increased production costs per ton at Jim Walter Resources resulting from inflationary increases in labor, material and power and a higher mix of continuous miner
tons to longwall tons associated with the development of the Mine No. 7 Southwest "A" panel and the Mine No. 7 East expansion. Also contributing to the increase in cost per ton were
delays in the delivery of new production equipment at Mine No. 4, which resulted in lower volumes of production. Additionally, depreciation expense increased $3.7 million.



Sloss generated net sales and revenues of $53.7 million for the three months ended September 30, 2008, an increase of
55.9% compared to the same period in 2007, and generated operating income of $14.6 million, an increase of $11.4 million compared to the same period in 2007. These increases resulted
from a 77.0% increase in metallurgical coke selling prices due to both higher contract pricing and favorable spot sales during the current period as compared to the same period in 2007. The effect

30

---



of
increased pricing was offset in part by a decrease of approximately 9,000 tons sold and by higher raw material coal costs in the current quarter as compared to the same period in 2007.



Net sales and revenues were $50.2 million for the three months ended September 30, 2008, a decrease of
$3.9 million from the same period in 2007 primarily due to lower prepayment income. Financing had an operating loss of $4.8 million in the three months ended September 30, 2008, a
decrease of $16.0 million from the same period in 2007. The decrease in operating results was primarily due to a $10.9 million impairment of goodwill reflecting a continuing decline in
valuations as a result of disruptions in the financial markets, a $3.9 million provision for estimated hurricane insurance losses, a decrease in revenues, as discussed above, offset in part by
a reduction in interest expense. The decrease in interest expense resulted from a reduction in the weighted average borrowings outstanding for the three months ended September 30, 2008 as
compared to the same period in 2007 due to the pay-off and termination of the warehouse facilities totaling $214.0 million in April 2008, as well as due to normal repayments on the
other securitized notes. The weighted average interest rate for the three months ended September 30, 2008 was also slightly lower as compared to the same period in 2007.

Delinquencies
(the percentage of amounts outstanding over 30 days past due) were 5.0% at September 30, 2008, compared to 4.9% at September 30, 2007. The calculation
of delinquencies excludes from delinquent amounts those accounts that are in bankruptcy proceedings that are paying their mortgage payments in contractual compliance with bankruptcy court approved
mortgage payment obligations.



Net sales and revenues were $23.1 million for the three months ended September 30, 2008, a decrease of
$35.0 million from the same period in 2007 primarily as a result of a 58.2% decrease in unit completions and a $3.8 million increase in the discount required to record instalment notes
receivable at estimated market value. As a result of the current volatility and lack of liquidity in the residential mortgage market, the discount required to fairly value the instalment notes
receivable increased significantly and resulted in an additional discount within Homebuilding. The discount will be recognized as interest income over the life of the instalment notes receivable in
the Financing segment. Below are significant statistics for Homebuilding:

Three months ended
September 30,2008

2007Unit completions


243


581Average revenue per home sold(1)

$
88,600

$
98,300






Homebuilding's
operating loss was $12.6 million for the three months ended September 30, 2008 compared to an operating loss of $0.1 million for the three months
ended September 30, 2007. The increase in operating loss was primarily due to the effect of lower sales volume and the increase in the discount discussed above and a $6.5 million
restructuring and impairment charge, partially offset by lower personnel related cost as a result of the restructuring as further discussed in Note 6 of the "Notes to Condensed Consolidated
Financial Statements."

31

---



RESULTS OF OPERATIONS

Summary Operating Results of Continuing Operations for the Nine Months Ended September 30, 2008 and 2007

For the nine months ended September 30, 2008Natural
Resources

Sloss

Financing

Homebuilding

Other

Cons
Elims

Total(in thousands)Net sales

$
651,284

$
157,113

$
9,244

$
101,252

$
1,602

$
(22,653
)
$
897,842Interest income on instalment notes








142,975











142,975Miscellaneous income


7,678


761


1,794


1,105


1,561





12,899Net sales and revenues


658,962


157,874


154,013


102,357


3,163


(22,653
)

1,053,716Cost of sales (exclusive of depreciation)


406,240


95,953


4,801


82,994


228


(21,995
)

568,221Interest expense(1)








78,433











78,433Interest rate hedge ineffectiveness








16,981











16,981Depreciation


35,750


3,033


331


2,576


696





42,386Selling, general & administrative


17,185


10,943


22,484


34,558


25,490





110,660Provision for losses on instalment notes








12,934











12,934Postretirement benefits


21,845


(484
)

(337
)

(455
)

(786
)




19,783Amortization of intangibles


206





801











1,007Provision for estimated hurricane insurance losses








3,853











3,853Restructuring & impairment charges








10,895


13,255








24,150Operating income (loss)

$
177,736

$
48,429

$
2,837

$
(30,571
)
$
(22,465
)
$
(658
)

175,308Other debt interest expense




















(22,377
)Income from continuing operations before income taxes



















$
152,931


---

For the nine months ended September 30, 2007Natural
Resources

Sloss

Financing

Homebuilding

Other

Cons
Elims

Total(in thousands)Net sales

$
452,229

$
99,876

$
9,780

$
187,780

$
2,184

$
(4,153
)
$
747,696Interest income on instalment notes








149,939











149,939Miscellaneous income


23,726


518


3,178


588


3,379





31,389Net sales and revenues


475,955


100,394


162,897


188,368


5,563


(4,153
)

929,024Cost of sales (exclusive of depreciation)


302,184


83,736


6,177


141,807


881


(4,153
)

530,632Interest expense(1)








89,512











89,512Depreciation


25,838


2,824


866


3,796


986





34,310Selling, general & administrative


14,145


6,997


21,759


46,436


20,327





109,664Provision for losses on instalment notes








8,756











8,756Postretirement benefits


22,020


(648
)

(318
)

(444
)

(728
)




19,882Amortization of intangibles


93





1,282











1,375Operating income (loss)

$
111,675

$
7,485

$
34,863

$
(3,227
)
$
(15,903
)
$



134,893Other debt interest expense




















(21,923
)Income from continuing operations before income taxes



















$
112,970


---

32

---



Summary of Year to Date Consolidated Results of Continuing Operations

Net sales and revenues for the nine months ended September 30, 2008 were $1,053.7 million, up $124.7 million, or
13.4% from $929.0 million in the same period in 2007. The
increase in revenues was primarily driven by higher metallurgical coal and coke pricing and increased coal sales volumes, partially offset by declines in unit deliveries at Homebuilding, an additional
discount on instalment notes originated during the first nine months of 2008, as well as a decline in Financing's prepayment income.

Cost
of sales, exclusive of depreciation, increased $37.6 million to $568.2 million for the nine months ended September 30, 2008 and represented 63.3% of net sales
in 2008 versus $530.6 million and 71.0% of net sales in the same period of 2007. Increased costs were primarily a result of increased sales volumes at Natural Resources and increased material,
labor and freight costs at the Natural Resources and Sloss segments, partially offset by a decrease in Homebuilding's cost of sales as a result of fewer unit deliveries. The decrease in cost of sales
as a percentage of net sales in 2008 resulted primarily from increased metallurgical coal and coke pricing, which outpaced increased costs at Natural Resources and Sloss.

Depreciation
for the nine months ended September 30, 2008 was $42.4 million, an increase of $8.1 million compared to the same period in 2007. The increase was
primarily due to the Company's continued investment in the expansion and replacement of equipment Natural Resources' mining operations, offset in part by a decrease in depreciation expense at
Homebuilding of $1.2 million primarily due to asset impairments taken during the nine months ended September 30, 2008.

Provision
for losses on instalment notes increased $4.1 million to $12.9 million for the nine months ended September 30, 2008 compared to $8.8 million for the
same period in 2007. This increase primarily relates to increased losses on the ARM portion of the mortgage loans in the instalment notes receivable portfolio, an increase in repossession volume due
to foreclosures and a slight decrease in the recovery on foreclosed properties.

Interest
expense on the mortgage-backed/asset-backed notes decreased $11.1 million for the nine months ended September 30, 2008 compared to the same period in 2007. This
decrease was due to a reduction in the weighted average borrowings outstanding for the nine months ended September 30, 2008 as compared to the same period in 2007 primarily due to the
pay-off and retirement of the warehouse facilities in April 2008 totaling $214.0 million and due to normal repayments on securitized notes. The weighted average interest rate for
the nine months ended September 30, 2008 was also slightly lower as compared to the same period in 2007.

The
interest rate hedge ineffectiveness charge of $17.0 million in the nine months ended September 30, 2008 was recorded to recognize a loss on Financing's maturing
interest rate swaps that no longer qualified for hedge accounting treatment. The interest rate swaps, originally intended to hedge the Company's next securitization, no longer qualified for hedge
accounting treatment because the Company does not plan to access the distressed securitization market. This loss would normally have been amortized over the life of the securitization and the cash
outflow would have been offset by increased securitization cash proceeds. All of Financing's hedges were settled on April 1, 2008 and Financing has no more hedges outstanding.

Provision
for estimated hurricane insurance losses reflects a $3.9 million provision recorded during the third quarter ended September 30, 2008 for estimated insurance
losses related to Hurricanes Gustav and Ike.

Restructuring
and impairment charges of $24.2 million in the nine months ended September 30, 2008 represent $13.3 million relating to asset impairment charges and
severance costs for Homebuilding, as well as a $10.9 million impairment of Financing goodwill. These charges are further discussed in Note 6 of the "Notes to Condensed Consolidated
Financial Statements.".

33

---



The
Company's effective tax rate for the nine months ended September 30, 2008 and 2007 was 30.5% and 34.3%, respectively. The effective tax rate for the nine months ended
September 30, 2008 includes the unfavorable effect of a $10.9 million nondeductible goodwill impairment charge and the favorable impact of a $3.9 million tax credit resulting from
the resolution of certain Federal tax matters associated with the IRS audit for the years ended May 31, 2000, December 31, 2000 and December 31, 2001. Excluding the effect of
these items, the effective tax rate for 2008 would have been 30.7%. The effective tax rate in 2007 includes the unfavorable impact of a $4.4 million write-off of certain deferred
tax assets no longer considered realizable. Excluding this discrete item, the effective tax rate for the nine months ended September 30, 2007 would have been 30.4%. In addition to the discrete
items, both the 2008 and 2007 effective tax rates differ from the Federal statutory rate primarily due to the benefits from percentage depletion and domestic production deductions.

The
current and prior-year period results also include the impact of the factors discussed in the following segment analysis.

Segment Analysis



Natural Resources reported revenues of $659.0 million for the nine months ended September 30, 2008, up
$183.0 million from the same period in 2007. The increase in revenues was driven primarily by increased metallurgical coal volumes and coal pricing versus the prior-year period.
Statistics presented in the following table relate to Jim Walter Resources only.

Nine months ended
September 30,2008

2007Average Metallurgical Coal Selling Price (per short ton)

$
117.55

$
94.57Tons of Coal Sold (in thousands)


4,623


4,393Average Natural Gas Selling Price (per MCF)

$
8.55

$
7.82Billion Cubic Feet of Natural Gas Sold


4.8


5.4Number of Natural Gas Wells


421


418


Natural
Resources reported operating income of $177.7 million for the nine month period in 2008, compared to $111.7 million in the same period in 2007. Results in the
current-year period benefitted from increased coal sales volumes and pricing, which were partially offset by higher production costs on a per-ton basis. Production costs per
ton for the nine months of 2008 were higher than the same period in 2007 due to inflationary increases in labor and materials as well as a higher mix of continuous miner tons to longwall tons
associated with the development of the Mine No. 7 Southwest "A" panel and the Mine No. 7 East expansion at Jim Walter Resources. In addition, 2007 benefitted from certain tax credits
that were discontinued in 2008.



Net sales and revenues were $157.9 million for the nine months ended September 30, 2008, an increase of
$57.5 million compared to the same period in 2007. This increase in revenues is mostly related to an increase in metallurgical coke average sales price per ton, which more than offset a slight
decrease in tons sold. Sloss reported operating income of $48.4 million for the nine months ended September 30, 2008 compared to $7.5 million in the same period in 2007, an
increase of $40.9 million. Most of the increase results from the increase in metallurgical coke average sales price per ton as noted above, partially offset by higher raw material coal cost and
a $2.4 million charge related to the resolution of a legal matter.

34

---





Net sales and revenues were $154.0 million for the nine months ended September 30, 2008, a decrease of
$8.9 million from the prior-year period. This decrease is primarily attributable to lower prepayment-related interest income. Operating income was $2.8 million for the nine
months ended September 30, 2008, a decrease of $32.0 million from the prior-year period. The decrease in operating income is primarily a result of recognizing a
$17.0 million loss on interest rate hedge ineffectiveness, a $10.9 million impairment of goodwill and a $3.9 million provision for estimated hurricane losses during the nine
months ended September 30, 2008.



Net sales and revenues were $102.4 million for the nine months ended September 30, 2008, a decrease of
$86.0 million from the nine months ended September 30, 2007 primarily as a result of a 41.7% decrease in unit completions and a $12.2 million increase in the discount required to
record instalment notes receivable at estimated market value.

Nine months ended
September 30,2008

2007Unit completions


1,106


1,896Average revenue per home sold(1)

$
88,400

$
98,400






Homebuilding's
operating loss of $30.6 million for the nine months ended September 30, 2008 increased $27.4 million when compared to an operating loss of
$3.2 million for the nine months ended September 30, 2007. The increase in operating loss was primarily due to the effect of lower sales volumes, the increase in the discount discussed
above, and restructuring and impairment charges totaling $13.3 million, as further discussed in Note 6 of the "Notes to Condensed Consolidated Financial Statements."



The operating loss in the "Other" segment, comprised of the Company's corporate expenses and land subsidiaries other than United Land,
increased by $6.6 million in the nine months ended September 30, 2008 when compared to the same period in 2007. The increased operating loss was primarily due to reduced land sales and
increased employee-related expenses and professional fees.

FINANCIAL CONDITION

Cash and cash equivalents of continuing operations increased by $0.6 million from $30.6 million at December 31,
2007 to $31.2 million at September 30, 2008 reflecting $159.1 million in cash flows provided by continuing operating activities, partially offset by $72.9 million of cash
flows used in investing activities and $85.6 million of cash flows used in financing activities. See additional discussion in the Statement of Cash Flows section that follows.

Short-term
investments were $58.8 million at September 30, 2008, down $17.0 million from December 31, 2007, attributable to cash collections on
mortgages previously pledged as collateral against the warehouse facilities no longer being restricted as a result of the payoff and termination of the warehouse facilities in April 2008.

35

---





Net instalment notes receivable were $1,804.6 million at September 30, 2008, down $32.4 million from December 31, 2007 as a result of payments received on
outstanding notes exceeding new loan originations. The reduction in new loan originations is the result of WMC no longer providing financing to new customers of Homebuilding effective May 1,
2008.

Net
receivables were $173.3 million at September 30, 2008, an increase of $91.6 million from December 31, 2007 primarily attributable to increased selling
prices within the Natural Resources and Sloss businesses and timing of sales within the third quarter of 2008 as compared to the fourth quarter of 2007.

Inventories
were $122.2 million at September 30, 2008, an increase of $20.5 million from December 31, 2007 primarily due to increased raw materials at Sloss
and Natural Resources in preparation for completing customer orders, as well as an increase in repossessed property at Financing. These increases were partially offset by a reduction of goods in
process at Homebuilding as a result of a decrease in the number of homes under construction.

Net
property, plant and equipment was $523.2 million at September 30, 2008, up $88.2 million from December 31, 2007 primarily due to the Company's continued
investment in the replacement of equipment and expansion at Natural Resources' mining operations.

Accounts
payable was $82.9 million at September 30, 2008, up $10.9 million from December 31, 2007 primarily due to the timing of payments on purchased coal
and freight.

Accrued
expenses were $122.8 million at September 30, 2008, up $39.7 million from December 31, 2007 primarily due to an increase in taxes payable relating to
increased estimated taxable income in 2008.

Mortgage-backed/asset-backed
notes were $1,402.2 million at September 30, 2008, down $304.0 million from December 31, 2007 as a result of debt principal
payments, which included the $214.0 million payoff and termination of the warehouse facilities in April 2008.

Other
debt decreased by $19.9 million from December 31, 2007 primarily due to $359.2 million of payments on the amended 2005 Walter Credit Agreement, offset in part
by $330.0 million in borrowings under the amended 2005 Walter Credit Agreement during the nine months ended September 30, 2008. See Note 10 of the "Notes to Condensed Consolidated
Financial Statements" for further discussion.

LIQUIDITY AND CAPITAL RESOURCES

Overview

The Company's principal sources of short-term funding are its existing cash balances, operating cash flows and borrowings
under its revolving credit facility. The Company's principal source of long-term funding is its bank term loan. As of September 30, 2008, total debt decreased $323.9 million
as compared to December 31, 2007. See discussion below and Note 10 of "Notes to Condensed Consolidated Financial Statements."

The
Company believes that, based on current forecasts and anticipated market conditions, funding generated from operating cash flows and available sources of liquidity will be sufficient
to meet substantially all operating needs, to make planned capital expenditures and to make all required interest and principal payments on indebtedness for the next twelve to eighteen months.
However, the Company's operating cash flows and liquidity are significantly influenced by numerous factors, including prices of coal and natural gas, coal production, costs of raw materials and
interest rates and the general economy. Currently there is an unprecedented uncertainty in the financial markets, less availability and higher costs of credit, potential counterparty defaults, and
commercial and investment bank failures.

36

---



While
we have no indication that the uncertainty in the financial markets would impact our current credit facility or our current credit providers, the possibility does exist.



In 2005, Walter entered into a $675.0 million credit agreement ("2005 Walter Credit Agreement") which includes (1) an
amortizing term loan facility with an initial aggregate principal amount of $450.0 million, $139.3 million of which was outstanding as of September 30, 2008 with a weighted
average interest rate of 5.280%, and (2) a $225.0 million revolving credit facility which provides for loans and letters of credit. The 2005 Walter Credit Agreement is a secured
obligation of the Company and substantially all of its wholly owned domestic subsidiaries. The term loan requires quarterly principal payments of $0.4 million through October 3, 2012, at
which time the remaining outstanding principal is due.

On
April 30, 2008, Walter amended the 2005 Walter Credit Agreement to allow an additional $250.0 million of borrowings under the revolving credit facility, thereby
increasing the revolving credit facility to $475.0 million. Funds available of $214.8 million were used to repay principal, interest and fees and terminate the Mid-State
Trust IX and Mid-State Trust XIV mortgage warehouse facilities, which were due to mature in July 2008 and October 2008, respectively. The amendment also increases the interest rate on the
revolving credit facility and the term loan to LIBOR plus 300 basis points. The commitment fee on the unused portion of the revolving facility also increases from 0.375% per year to 0.5% per year. In
addition, the amended 2005 Walter Credit Agreement contains a reducing revolver commitment feature, where the total available revolver commitment may not exceed $400.0 million at
March 31, 2009, $350.0 million at September 30, 2009, $300.0 million at June 30, 2009, and $250.0 million at December 31, 2009.

Certain
other terms, including affirmative and negative covenants as well as restrictions on the Company's ability to engage in specified activities, were also amended and include, but
are not limited to, increased indebtedness and approval of certain activities associated with the Company's strategic initiatives in the Homebuilding and Financing business.

In
connection with the amendment to the 2005 Walter Credit Agreement, the Company incurred $3.9 million of refinancing fees. These fees were deferred and are being amortized over
the remaining life of the revolving credit facility.

During
the nine months ended September 30, 2008, the Company borrowed $330.0 million under the revolving credit facility. On June 16, 2008, the Company completed an
offering of shares of its common stock and received $280.4 million of net proceeds, as more fully discussed in Note 13 of "Notes to Condensed Consolidated Financial Statements." During
June 2008, the net proceeds from the offering were used to repay $77.9 million on the term loan and $202.5 million on the revolving credit facility. Additional repayments on the
revolving credit facility during the nine months ended September 30, 2008 totaled $77.5 million. At September 30, 2008, the Company had $50.0 million outstanding under the
revolving credit facility at a weighted average interest rate of 4.903%.

Under
the terms of the Company's amended 2005 Walter Credit Agreement, availability under the revolving credit facility was reduced from $475.0 million to $373.8 million in
connection with the completion of the stock offering. As of September 30, 2008, the Company had $51.2 million in outstanding stand-by letters of credit and
$272.6 million of availability for future borrowings under the revolving credit facility.

In
connection with the repayments discussed above, the Company recognized an additional amortization of $3.1 million of previously deferred financing fees. This amortization
charge is included in interest expense in the statement of income.

37

---





At the beginning of 2008, the Company had two warehouse facilities totaling $350.0 million that provided temporary warehouse
financing to WMC for its current purchases of instalment notes and mortgages originated by Homebuilding.

On
April 30, 2008, the Company repaid all outstanding borrowings and terminated these facilities using proceeds from the amended 2005 Walter Credit Agreement, as discussed above.
With the termination of the warehouse facilities, the Company is no longer reliant on the availability of mortgage warehouse facilities or the mortgage-backed securitization market.

In
addition, after May 1, 2008, WMC is no longer providing financing to new customers of Homebuilding. However, the backlog of homes with signed contracts and those which were
under construction as of May 1, 2008, have been or are expected to be completed by the end of the first quarter of 2009 and financed by WMC. As of September 30, 2008, an estimated 120
homes remain in the backlog, representing a total of approximately $11.4 million in value to be funded by WMC. The Company will finance these WMC instalment notes receivable with operating cash
flows or funds from borrowings under the increased revolving credit facility. Homebuilding is transitioning to a third-party financing model including the use of government-sponsored loan programs.



In January 2008, the holders of the remaining $0.8 million 3.75% Convertible Senior Subordinated Notes agreed to convert the
principal amount in exchange for 84,013 shares of the Company's common stock and $0.1 million of conversion inducement payments.

Statement of Cash Flows

The following table sets forth, for the periods indicated, selected consolidated cash flow information (in thousands):

Nine months ended
September 30,2008

2007Cash flows provided by operating activities

$
159,105

$
69,085Cash flows used in investing activities


(72,887
)

(121,411
)Cash flows used in financing activities


(85,642
)

(52,515
)Cash flows provided by (used in) continuing operations


576


(104,841
)Cash flows provided by discontinued operations





630Net increase (decrease) in cash and cash equivalents

$
576

$
(104,211
)


Cash
balances were $31.2 million and $30.6 million at September 30, 2008 and December 31, 2007, respectively. The primary sources of cash in the nine months
ended September 30, 2008 were cash provided by operating activities of $159.1 million, proceeds from the June 2008 stock offering that totaled $280.4 million and
$11.9 million from the receipt of payments on purchased loans. These sources of cash were partially offset by cash outflows for capital expenditures of $88.8 million, net payments of
mortgage-backed/asset- backed notes of $304.0 million, net payments on other debt that totaled $46.4 million and the acquisition of Taft for $17.0 million, net of cash acquired.

Net
cash provided by operating activities was $159.1 million for the nine months ended September 30, 2008 as compared to $69.1 million for the same period in 2007.
The improvement in net cash provided by operating activities in 2008 was primarily the result of a $32.0 million increase in income from continuing operations, a $17.6 million increase
in non-cash charges to net income and a

38

---



$40.4 million
improvement in cash from operating assets and liabilities for the nine months ended September 30, 2008 as compared to the same period in 2007. Additionally, in the 2008
period, the conversion to cash cycle time for operating assets has been reduced as instalment receivables have decreased reflecting the fact that the Company is no longer providing financing to new
customers of Homebuilding effective May 1, 2008.

Cash
flows used in investing activities of continuing operations for the nine months ended September 30, 2008 were $72.9 million compared to $121.4 million for the
same period in 2007. Significant cash flows used in investing activities in the 2008 period included the acquisition of Taft for $17.0 million, net of cash acquired and additions to property,
plant and equipment totaling $88.8 million as the Company continued to invest in the replacement of equipment and expansion of Natural Resources' mining operations. The Company has revised its
forecast for 2008 capital expenditures from an expected range of $110.0 million to $135.0 million to approximately $154 million primarily as a result
of additional capital spending needs at Natural Resources. Significant cash flows used in investing activities in the 2007 period included $110.0 million of additions to property plant and
equipment, primarily in the Natural Resources segment, and the acquisition of TRI for $11.7 million, net of cash acquired.

Cash
flows used in financing activities of continuing operations for the nine months ended September 30, 2008 were $85.6 million compared to $52.5 million in the
same period in 2007. Cash flows used in financing activities in 2008 included: net payments of mortgage-backed/asset-backed notes of $304.0 million, primarily as a result of the April 2008
payoff and termination of WMC's two warehouse facilities discussed above and net retirements of other debt of $46.4 million, partially offset by proceeds from the June 2008 stock offering of
$280.4 million. See Note 13 to the "Notes to Condensed Consolidated Financial Statements" for additional discussion. Cash flows used in financing activities for the nine months ended
September 30, 2007, were primarily attributable to $40.8 million of net retirements on other debt.

Contractual Obligations and Commercial Commitments

During the third quarter of 2008, the Company entered into an arrangement in which a vendor will provide certain parts, components and
an exchange and rebuild service for certain of the Company's mining equipment. This arrangement extends to a period of up to five years and will require the Company to expend approximately
$57.1 million over the contract term. These types of maintenance costs have been incurred by Natural Resources in prior periods. Also, in connection with its expanding mining operations, the
Company had commitments of approximately $43.6 million at September 30, 2008, for the acquisition of property and equipment, most of which is expected to be incurred in 2009.

Pension Benefits

As a result of the unprecedented distress in the credit and capital markets, the fair value of the Company's pension plan assets has
declined substantially since December 31, 2007. A sustained decline in the fair value of pension plan assets will result in increased pension contributions in 2009 and future years.



In October 2008, the Company entered into a $32.3 million equipment financing arrangement for certain previously procured mining
equipment. This financing arrangement will mature in the first quarter of 2014 and carries an annual interest rate of LIBOR plus 375 basis points.

39

---



ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to certain market risks inherent in the Company's operations. These risks generally arise from transactions
entered into in the normal course of business. The Company's primary market risk exposures relate to interest rate risk and commodity risks. The Company does not enter into derivatives or other
financial instruments for trading or speculative purposes.

In
April 2008, the Company settled interest rate hedge agreements with an aggregate notional value of $215.0 million that were originally designed to hedge the Company's next
securitization. No similar hedges remain outstanding.

ITEM 4.    CONTROLS AND PROCEDURES



An evaluation was performed under the supervision and with the participation of our management, including our Vice Chairman (principal
executive and financial officer), of the effectiveness of our disclosure controls and procedures as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934
as amended ("Exchange Act") as of the end of the period covered by this quarterly report on Form 10-Q. Based on that evaluation, our management, including our principal executive
and financial officer, concluded that our disclosure controls and procedures are effective as of September 30, 2008 to ensure that information required to be disclosed by us in reports that we
file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and (2) accumulated and
communicated to our management, including our principal executive and financial officer, as appropriate to allow timely decisions regarding required disclosures. There has been no change in our
internal control over financial reporting during the nine months ended September 30, 2008 that has materially affected, or is reasonably likely to materially affect, internal control over
financial reporting.

PRIVATE SECURITIES LITIGATION REFORM ACT SAFE HARBOR STATEMENT

Except for historical information contained herein, the statements in this release are forward-looking and made pursuant to the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements, including expressions such as "believe," "anticipate," "expect," "estimate," "intend," "may,"
"will," and similar expressions involve known and unknown risks, and uncertainties, and other factors that may cause the Company's actual results in future periods to differ materially from the
expectations expressed or implied by such forward-looking statements. These factors include, among others, the following: the market demand for the Company's products as well as changes in costs and
the availability of raw material, labor, equipment and transportation; changes in weather and geologic conditions; changes in extraction costs and pricing and our assumptions and projections
concerning our reserves in the Company's mining operations; changes in customer orders; pricing actions by the Company's competitors, customers, suppliers and contractors; changes in governmental
policies and laws; changes in general economic conditions; and the successful implementation and anticipated timing of any strategic actions and objectives that my be pursued, including our announced
separation of the Financing and Homebuilding business from the Company. Forward- looking statements made by the Company in this release, or elsewhere, speak only as of the date on which the statements
were made. Any forward-looking statements should be considered in context with the various disclosures made by us about our business, including the Risk Factors described in the Company's Prospectus
filed with the Securities and Exchange Commission on June 9, 2008 and our other filings with the Securities and Exchange Commission. The Company disclaims any duty to update its forward-looking
statements as of any future date.

40

---





PART IIOTHER INFORMATION

Item 1.    Legal Proceedings

See Note 16 of the "Notes to Condensed Consolidated Financial Statements" in this Form 10-Q for a description
of current legal proceedings.

The
Company and its subsidiaries are parties to a number of other lawsuits arising in the ordinary course of their businesses. Most of these cases are in a preliminary stage and the
Company is unable to predict a range of possible loss, if any. The Company provides for costs relating to these matters when a loss is probable and the amount is reasonably estimable. The effect of
the outcome of these matters on the Company's future results of operations cannot be predicted because any such effect depends on future results of operations and the amount and timing of the
resolution of such matters. While the results of litigation cannot be predicted with certainty, the Company believes that the final outcome of such other litigation will not have a material adverse
effect on the Company's consolidated financial position.

Item 1A.    Risk Factors

The Company's business, financial condition, operating results and cash flows can be impacted by a number of factors, any one of which
could cause our actual results to vary materially from recent results or from our anticipated future results. For a discussion identifying additional risk factors and important factors that could
cause actual results to differ materially from those anticipated, see the discussion in "Risk Factors" in the Company's Prospectus filed with the Securities And Exchange Commission on June 9,
2008. In addition to the risk factors previously disclosed in our Prospectus filed with the Securities and Exchange Commission on June 9, 2008, you should consider the following risks prior to
making an investment in our Company:

Disruptions in the credit markets have created uncertainty, which could adversely affect our business.

The financial markets in the United States, Europe, South America and Asia have been experiencing extreme disruption in recent months.
As widely reported, these markets have experienced, among other things, extreme volatility in security prices, commodities and currencies; severely diminished liquidity and credit availability, rating
downgrades and declining valuations of certain investments. The current tightening of credit in financial markets could adversely affect our customers' ability to obtain financing for operations,
result in a decrease in the demand for our products and negatively impact our collection of trade receivables from our customers. Continuation or worsening of the current economic conditions, a
prolonged global, national or regional economic recession or other similar events could have a material adverse effect on the demand for our products and on our sales, pricing and profitability. We
are unable to predict the likely duration and severity of the current disruption in financial markets and adverse economic conditions in the U.S. and other countries and the impact these events may
have on our operations and the industry in general.

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

Recent Sales of Unregistered Securities

In January 2008, the holders of the remaining $0.8 million of the Company's Convertible Senior Subordinated Notes agreed to
convert the principal amount in exchange for 84,013 shares of the Company's common stock and $0.1 million of conversion inducement payments.

Purchase of Equity Securities by the Company and Affiliated Purchasers

On August 13, 2007, the Company's Board of Directors authorized a $25.0 million Common Stock Open Market share buyback
program to replace the July 21, 2003 authorized program which was fully utilized on October 3, 2008. During January 2008, the Company acquired 11,400 shares at an average

41

---



price
of $31.83 per share. During the third quarter ended September 30, 2008, the Company repurchased 237,127 shares at an average price of $59.43 under its $25 million share repurchase
program, and in October 2008, the Company repurchased 105,729 shares at an average price of $46.56 thereby fulfilling the program's authorized allotment.

On
September 26, 2008, the Board of Directors approved a new $50.0 million share repurchase program, which is intended to replace the previously authorized
$25 million share repurchase program. Repurchases will be made based on liquidity, market conditions and alternative opportunities to invest in and grow the Company's core businesses. Through
November 6, 2008, the Company has repurchased 1,184,243 shares at an average price of $35.32 under its $50.0 million share repurchase program.

On
February 25, 2008, the Company acquired 26,800 shares from employees at an average price of $52.41 per share. These shares were acquired to satisfy the employees' tax
withholding obligations associated with the lapse of restrictions on certain stock awards granted under the 1995 Long-Term Incentive Stock Plan and the 2002 Long-Term Incentive
Award Plan. Upon acquisition, these shares were retired.

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

None.

Item 5.    Other Information



Item 6.    Exhibits



Exhibit
Number31.1

Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002Principal Executive and Financial Officer32.1

Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Session 1350Principal Executive and Financial Officer


42

---



SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.

WALTER INDUSTRIES, INC./s/ VICTOR P. PATRICKVice Chairman, Chief Financial Officer and General Counsel
(Principal Executive and Financial Officer)


Date:
November 7, 2008

---



QuickLinks