Walter Energy 10Q 2005 Q2 Quarterly report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549

FORM 10-Q

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2005
or
o	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		IRS Employer Identification No. 13-3429953
4211 W. Boy Scout Boulevard, Tampa, Florida 33607
Telephone Number (813) 871-4811

Indicate by check mark whether the registrant (1) 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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý No o.

There were 38,709,762 shares of common stock of the registrant outstanding at July 31, 2005.

PART I—FINANCIAL INFORMATION

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

			June 30, 2005			December 31, 2004
			(in thousands, except share amounts)
ASSETS
Cash and cash equivalents			$	29,207		$	46,924
Short-term investments, restricted				95,249			99,905
Instalment notes receivable, net of allowance of $11,099 and $11,200, respectively				1,703,739			1,717,205
Receivables, net				206,945			170,219
Income tax receivable				15,082			14,977
Inventories				294,263			233,547
Prepaid expenses				19,112			16,871
Property, plant and equipment, net				348,018			334,678
Investments				6,096			6,165
Deferred income taxes				35,412			47,943
Unamortized debt expense				34,442			36,726
Other long-term assets, net				42,955			46,340
Goodwill and other intangibles, net				143,000			144,986

			$	2,973,520		$	2,916,486

LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable			$	108,608		$	90,217
Accrued expenses				123,016			125,681
Debt:
	Mortgage-backed/asset-backed notes			1,697,505			1,763,827
	Senior debt			20,000			—
	Convertible senior subordinated notes			175,000			175,000
Accrued interest				16,403			16,813
Accumulated postretirement benefits obligation				279,485			282,599
Other long-term liabilities				209,861			203,122

	Total liabilities			2,629,878			2,657,259

Commitments and contingencies (Note 14)
Stockholders' equity
	Common stock, $.01 par value per share:
		Authorized—200,000,000 shares
		Issued—59,469,658 and 57,953,136 shares		595			580
Capital in excess of par value				1,204,221			1,178,121
Accumulated deficit				(548,802	)		(609,048	)
Treasury stock—20,771,902 shares, at cost				(259,317	)		(259,317	)
Accumulated other comprehensive loss				(53,055	)		(51,109	)

		Total stockholders' equity		343,642			259,227

			$	2,973,520		$	2,916,486

See accompanying "Notes to Consolidated Financial Statements"

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

		For the three months ended June 30,
		2005			2004
		(in thousands, except per share amounts)
Net sales and revenues:
	Net sales	$	382,823		$	322,363
	Interest income on instalment notes		53,110			56,407
	Miscellaneous		5,281			1,098

			441,214			379,868

Cost and expenses:
	Cost of sales (exclusive of depreciation)		270,083			258,398
	Depreciation		14,505			15,249
	Selling, general and administrative		54,015			50,114
	Provision for losses on instalment notes		1,949			2,902
	Postretirement benefits		3,234			593
	Interest expense—mortgage-backed/asset-backed notes		31,102			30,276
	Interest expense—corporate debt		4,097			6,206
	Amortization of other intangibles		923			1,352
	Restructuring and impairment charges		305			359

			380,213			365,449

Income before income tax expense			61,001			14,419
Income tax expense			(19,520	)		(6,156	)

Net income		$	41,481		$	8,263

Basic income per share:		$	1.07		$	0.22

Diluted income per share:		$	0.87		$	0.20

See accompanying "Notes to Consolidated Financial Statements"

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

		For the six months ended June 30,
		2005			2004
		(in thousands, except per share amounts)
Net sales and revenues:
	Net sales	$	669,553		$	588,046
	Interest income on instalment notes		106,603			111,673
	Miscellaneous		10,391			6,185

			786,547			705,904

Cost and expenses:
	Cost of sales (exclusive of depreciation)		487,479			484,390
	Depreciation		28,825			30,501
	Selling, general and administrative		96,585			98,513
	Provision for losses on instalment notes		5,134			6,393
	Postretirement benefits		6,472			3,105
	Interest expense—mortgage-backed/asset-backed notes		62,537			62,002
	Interest expense—corporate debt		7,709			10,151
	Amortization of other intangibles		1,986			2,837
	Restructuring and impairment charges		610			514

			697,337			698,406

Income from continuing operations before income tax expense			89,210			7,498
Income tax expense			(28,547	)		(3,837	)

Income from continuing operations			60,663			3,661
Discontinued operations, net of income taxes			(417	)		—

Net income		$	60,246		$	3,661

Basic income per share:
	Income from continuing operations	$	1.59		$	0.09
	Discontinued operations		(0.01	)		—

	Net income	$	1.58		$	0.09

Diluted income per share:
	Income from continuing operations	$	1.29		$	0.09
	Discontinued operations		(0.01	)		—

	Net income	$	1.28		$	0.09

See accompanying "Notes to Consolidated Financial Statements"

WALTER INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2005
(UNAUDITED)

			Total			Comprehensive Income			Accumulated Deficit			Accumulated Other Comprehensive Income (Loss)			Common Stock		Capital in Excess			Treasury Stock
			(in thousands)
Balance at December 31, 2004			$	259,227					$	(609,048	)	$	(51,109	)	$	580	$	1,178,121		$	(259,317	)
Comprehensive income:
	Net income			60,246		$	60,246			60,246
	Other comprehensive income (loss), net of tax
		Net unrealized loss on hedges		(1,946	)		(1,946	)					(1,946	)

Comprehensive income						$	58,300

Stock issued upon exercise of stock options				14,725												15		14,710
Tax benefit from the exercise of stock options				13,704														13,704
Dividends paid, $.08 per share				(3,040	)													(3,040	)
Stock-based compensation				726														726

Balance at June 30, 2005			$	343,642					$	(548,802	)	$	(53,055	)	$	595	$	1,204,221		$	(259,317	)

See accompanying "Notes to Consolidated Financial Statements"

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

			For the six months ended June 30,
			2005			2004
			(in thousands)
OPERATING ACTIVITIES
	Income from continuing operations		$	60,663		$	3,661
	Adjustments to reconcile income to net cash provided by continuing operations:
		Provision for losses on instalment notes receivable		5,134			6,393
		Depreciation		28,825			30,501
		Provision for deferred income taxes		12,531			3,978
		Tax benefit on the exercise of employee stock options		13,704			—
		Accumulated postretirement benefits obligation		(3,114	)		(5,837	)
		Provision for other long-term liabilities		4,793			1,389
		Amortization of other intangibles		1,986			2,837
		Amortization of debt expense		3,202			5,475
		Loss on sale of assets		—			1,294
		Stock-based compensation expense		726			364
Decrease (increase) in assets:
	Receivables			(36,726	)		(24,407	)
	Income tax receivable			(105	)		2,609
	Inventories			(60,716	)		(5,812	)
	Prepaid expenses			(2,241	)		(2,708	)
Increase (decrease) in liabilities:
	Accounts payable			18,391			(3,599	)
	Accrued expenses			(2,665	)		6,277
	Accrued interest			(410	)		(995	)

		Cash flows provided by continuing operations		43,978			21,420
		Cash flows used in discontinued operations		(417	)		(3,611	)

		Cash flows provided by operating activities		43,561			17,809

INVESTING ACTIVITIES
	Notes originated from sales and resales of homes and purchases of loan portfolios			(213,772	)		(232,871	)
	Cash collections on accounts and payouts in advance of maturity			222,104			237,443
	Decrease (increase) in short-term investments, restricted			4,656			(2,862	)
	Additions to property, plant and equipment, net of retirements			(42,165	)		(18,369	)
	Decrease (increase) in investments and other assets, net			3,454			(5,910	)
	Proceeds from sale of subsidiary			—			6,000

		Cash flows used in investing activities		(25,723	)		(16,569	)

FINANCING ACTIVITIES
	Issuance of debt			155,232			370,600
	Retirement of debt			(201,554	)		(347,442	)
	Additions to unamortized debt expense			(918	)		(6,067	)
	Purchases of treasury stock			—			(63,020	)
	Dividends paid			(3,040	)		(2,370	)
	Exercise of employee stock options			14,725			2,727

		Cash flows used in financing activities		(35,555	)		(45,572	)

Net decrease in cash and cash equivalents				(17,717	)		(44,332	)
Cash and cash equivalents at beginning of period				46,924			59,982

Cash and cash equivalents at end of period			$	29,207		$	15,650

See accompanying "Notes to Consolidated Financial Statements"

WALTER INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005
(Unaudited)

Note 1—Basis of Presentation

The accompanying unaudited consolidated financial statements of Walter Industries, Inc. ("the Company") have been prepared in accordance with generally accepted accounting principles 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 generally accepted accounting principles 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 six month periods ended June 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005.

The balance sheet at December 31, 2004 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

Note 2—Pending Acquisition of Mueller Water Products, Inc.

The Company has entered into an agreement and as of June 17, 2005 for the acquisition for cash of Mueller Water Products, Inc. and subsidiaries ("Mueller") for approximately $1.9 billion.

The closing of the transaction is subject to the satisfaction or waiver of various closing conditions, including but not limited to the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the availability of the financing described below on substantially the terms and conditions set forth in the Company's commitment letters.

The Company expects to finance the acquisition with a combination of available cash, borrowings under new credit facilities of the Company and Mueller Group, Inc. ("Mueller Group"), a subsidiary of Mueller, pursuant to commitment letters entered into as of June 17, 2005 with Bank of America, N.A., Banc of America Securities LLC, Morgan Stanley Senior Funding, Inc. and Bank of America Bridge LLC. Such financing will consist of $625 million in a senior secured credit facility for the Company and $1.175 billion in a senior secured credit facility for Mueller Group. The financing also includes backstop commitments for $145 million and $320 million, respectively, to finance any repurchases after the acquisition of 14³/4% Senior Discount Notes due 2014 of Mueller and 10% Senior Subordinated Notes due 2012 of Mueller Group pursuant to the rights of holders of those securities following the change of control to put such securities to their respective issuers in accordance with the respective indentures. The Company does not anticipate borrowing under the backstop commitments. These financing commitments are subject to the completion of the acquisition and customary closing conditions, including entering into definitive loan agreements. The closing is expected in September 2005.

Note 3—Stock-Based Compensation Plans

The Company uses the intrinsic value method prescribed in Accounting Principles Board Opinion 25 and related interpretations in accounting for stock options. The Company's restricted stock units are accounted for as a fixed plan under APB Opinion 25. Accordingly, compensation costs are measured using the excess, if any, of the Company's stock price at the grant dates in excess of the option or

restricted stock unit price. Had compensation cost for the Company's option plans been determined based on the fair value at the grant dates as prescribed by Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation," the Company's net income and net income per share on a pro forma basis would have been (in thousands, except per share data):

	For the three months ended June 30,						For the six months ended June 30,
	2005			2004			2005			2004
Net income, as reported	$	41,481		$	8,263		$	60,246		$	3,661
Add: Stock-based compensation expense included in reported net income, net of related tax effects		236			120			472			239
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(696	)		(791	)		(1,423	)		(1,454	)

Pro forma net income	$	41,021		$	7,592		$	59,295		$	2,446

		For the three months ended June 30,				For the six months ended June 30,
		2005		2004		2005		2004
Net income per share:
	Basic—as reported	$	1.07	$	0.22	$	1.58	$	0.09
	Basic—pro forma		1.06		0.20		1.56		0.06
	Diluted—as reported		0.87		0.20		1.28		0.09
	Diluted—pro forma		0.86		0.18		1.26		0.06

The preceding pro forma results were calculated with the use of the Black Scholes option-pricing model. Weighted average assumptions used for stock compensation awards granted in the following periods were:

	For the three months ended March 31,				For the three months ended June 30,
	2005		2004		2005		2004
Risk free interest rate	4.16	%	5.02	%	3.99	%	4.67	%
Dividend yield	0.40	%	1.00	%	0.40	%	1.00	%
Expected life (years)	6.0		7.0		5.5		6.9
Volatility	39.23	%	39.86	%	42.91	%	39.56	%

During the first quarter of 2004, the Company established the Long-Term Incentive Award Plan Restricted Stock Unit Award Agreement (the "Agreement"). The restricted units are subject to accelerated vesting if the stock price of the Company reaches certain pre-established targets within certain time periods after issuance. The Company records an equity and contra-equity amount, both equal to the market value of the restricted stock units on the date of grant, as a component of capital in excess of par value. Compensation expense is charged on a straight-line basis in the income statement based on the vesting period of the restricted stock units with a corresponding credit to

capital in excess of par value. The Company recorded approximately $0.2 million and $0.5 million of compensation expense, net of tax, for the three and six months ended June 30, 2005, respectively, and $0.1 million of compensation expense, net of tax, for the three and six months ended June 30, 2004.

Note 4—Restructuring and Impairments

In December 2003, the Company announced that it expected to close Mine No. 5 during the fourth quarter of 2004 due to continuing adverse geologic conditions. In the fourth quarter of 2004, the Company decided to extend its coal production schedule for Mine No. 5 to the fourth quarter of 2006 due to favorable metallurgical coal pricing. Due to a water ingress problem, the Company has further extended the coal production schedule for Mine No. 5 into 2007. The total expected costs of the shutdown are $14.5 million, of which approximately $9.4 million would qualify as restructuring costs and the remainder of the costs primarily representing workers' compensation and other incremental costs related to the closure of the mine will be charged to expense when incurred. Estimated expected costs associated with the shutdown and the amounts recorded to restructuring expenses are as follows (in thousands):

	Total Expected Costs		Restructuring charges expensed from inception to June 30, 2005		Restructuring charges expended for the three months ended June 30, 2005		Restructuring charges expensed for the six months ended June 30, 2005		Restructuring charges expensed from inception to December 31, 2004
Termination benefits	$	4,046	$	1,921	$	305	$	610	$	1,311
Other employee-related costs		8,475		5,790		—		—		5,790
Other costs		2,001		67		—		—		67

Total	$	14,522	$	7,778	$	305	$	610	$	7,168

Termination benefits consist primarily of one year's post-employment health benefits for United Mine Workers of America ("UMWA") employees and severance related to staff reductions of salaried personnel. Other employee-related costs includes approximately $5.8 million expensed in 2003 related to an increase in benefit costs associated with the curtailment of the UMWA other post-retirement benefits plan.

Activity in accrued restructuring was as follows (in thousands):

	For the three months ended June 30, 2005		For the three months ended March 31, 2005		For the year ended December 31, 2004
Beginning balance	$	1,893	$	1,588	$	1,388
Restructuring expenses accrued		305		305		2,519
Restructuring payments		—		—		(653	)
Reversal of prior accruals		—		—		(1,666	)

Ending balance	$	2,198	$	1,893	$	1,588

Note 5—Restricted Short-Term Investments

Restricted short-term investments at June 30, 2005 and December 31, 2004 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") ($88.7 million and $93.4 million, respectively) which are available only to pay expenses of the Trusts and principal and interest on indebtedness of the Trusts, and (ii) $6.5 million of miscellaneous other segregated accounts restricted to specific uses.

Note 6—Instalment Notes Receivable

The instalment notes receivable is summarized as follows (in thousands):

	June 30, 2005			December 31, 2004
Instalment notes receivable	$	1,582,776		$	1,619,148
Mortgage loans		132,062			109,257
Less: Allowance for losses		(11,099	)		(11,200	)

Net	$	1,703,739		$	1,717,205

During the three and six months ended June 30, 2005, the Company purchased $20.3 million and $31.7 million of third party mortgage loans, respectively.

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

	For the six months ended June 30,
	2005			2004
Balance at beginning of period	$	11,200		$	10,907
Provisions charged to income		5,134			6,393
Charge-offs, net of recoveries		(5,235	)		(5,709	)

Balance at end of period	$	11,099		$	11,591

Note 7—Inventories

Inventories are summarized as follows (in thousands):

	June 30, 2005		December 31, 2004
Finished goods	$	170,889	$	122,956
Goods in process		45,934		37,597
Raw materials and supplies		47,546		44,095
Repossessed houses held for resale		29,894		28,899

Total inventories	$	294,263	$	233,547

Note 8—Debt

Debt, in accordance with its contractual terms, consisted of the following (in thousands):

			June 30, 2005		December 31, 2004
Mortgage-Backed/Asset-Backed Notes:
	Trust IV Asset Backed Notes		$	288,078	$	322,357
	Trust VI Asset Backed Notes			185,552		198,366
	Trust VII Asset Backed Notes			152,754		167,525
	Trust VIII Asset Backed Notes			196,511		214,994
	Trust IX Variable Funding Loan			82,600		36,974
	Trust X Asset Backed Notes			274,945		292,178
	Trust XI Asset Backed Notes			239,809		257,086
	2004-1 Trust Asset Backed Notes			251,156		274,347
	Trust XIV Variable Funding Loan			26,100		—

				1,697,505		1,763,827
Other senior debt:
	Walter Industries, Inc.
		Revolving Credit Facility		20,000		—
		Convertible Senior Subordinated Notes		175,000		175,000

				195,000		175,000

Total			$	1,892,505	$	1,938,827

The Mid-State Trust IX Variable Funding Loan Facility was a $400.0 million warehouse facility, which was reduced to $200.0 million on April 29, 2005, that matures on January 31, 2006. Interest is based on the cost of A-1 and P-1 rated commercial paper plus 0.75%. Other borrowing costs include a facility fee on the unused amount of 0.40%. The weighted average interest rate on amounts outstanding as of June 30, 2005 was 3.47%.

The Mid-State Trust XIV Variable Funding Loan Agreement is a $200.0 million warehouse facility that matures on February 3, 2006. Interest is based on the cost of A-1 and P-1 rated commercial paper plus 0.75%. Other borrowing costs include a facility fee on the unused amount of 0.25%. The weighted average interest rate on amounts outstanding as of June 30, 2005 was 3.35%.

The convertible senior subordinated notes are convertible at the option of the holder through September 30, 2005 having satisfied, as of June 30, 2005, the common stock price condition. The notes may continue to be convertible during future periods if the common stock sales price condition or other conditions are satisfied.

In April 2003, the Company entered into a $500 million bank credit facility (the "2003 Credit Facility") which consisted of a $245 million senior secured revolving credit facility that matures in April 2008 and a $255 million senior secured term loan originally maturing in April 2010. In April 2004, the Company issued $175 million of convertible senior subordinated notes and used a portion of the proceeds to repay the remaining balance of the senior secured term loan. The 2003 Credit Facility is secured by the stock of Walter Industries' subsidiaries and by certain assets (excluding real property) of the Company. The commitment fee on the unused portion of the revolving credit facility and the interest rate was 0.50% and a floating rate of 350 basis points over LIBOR, respectively, until June 30, 2005. The interest rate on the senior secured loan was a floating rate of 425 basis points over LIBOR. LIBOR was 3.2% and 2.4% at June 30, 2005 and December 31, 2004, respectively.

On March 31, 2005, the Company entered into an amendment of its 2003 Credit Facility which increased the revolving credit facility by $20.0 million to a total of $265.0 million and lowered the applicable rate attributed to borrowings, letter of credit fees, and commitment fees; increased the aggregate amount of permitted indebtedness related to capital leases, synthetic lease obligations and purchase money obligations for real property and fixed capital assets from $25.0 million to $50.0 million; provided for up to $200.0 million of subordinated debt; amended the Company's ability to pay dividends and repurchase its common stock to an amount not to exceed in any fiscal year $35.0 million plus 50% of Consolidated Net Income for the immediately preceding fiscal year; allowed the prepayment of subordinated debt under certain conditions; amended the Financial Covenants by (i) increasing the maximum permitted Consolidated Leverage Ratio from 2.75 to 1.0 to 3.50 to 1.0, (ii) adding a new Consolidated Senior Secured Leverage Ratio not to exceed 2.50 to 1.0, (iii) deleting the Fixed Charge Coverage Ratio, and (iv) adding a limitation on Capital Expenditures in each fiscal year; increased the threshold for lender approval for individual cash acquisitions from $50.0 million to $100.0 million; and allowed the Company to increase the Credit Agreement under certain conditions in an aggregate amount not to exceed $110.0 million through increased commitments of existing lenders or the addition of new lenders.

The revolving credit facility includes a sub-facility for trade and other standby letters of credit in an amount up to $100.0 million at any time outstanding. At June 30, 2005, letters of credit with a face amount of $73.0 million were outstanding and approximately $172.0 million was available under the Revolving Credit Facility.

Note 9—Pension and Other Employee Benefits

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

		Pension Benefits						Other Benefits
		For the three months ended June 30,						For the three months ended June 30,
		2005			2004			2005			2004
Components of net periodic benefit cost:
	Service cost	$	2,061		$	1,962		$	448		$	476
	Interest cost		5,539			5,568			4,010			3,928
	Expected return on plan assets		(6,246	)		(5,912	)		—			—
	Amortization of prior service cost		164			180			(1,721	)		(1,634	)
	Amortization of net loss (gain)		1,575			1,541			497			(93	)

	Net periodic benefit cost	$	3,093		$	3,339		$	3,234		$	2,677

		Pension Benefits						Other Benefits
		For the six months ended June 30,						For the six months ended June 30,
		2005			2004			2005			2004
Components of net periodic benefit cost:
	Service cost	$	4,122		$	3,923		$	896		$	951
	Interest cost		11,078			11,136			8,024			7,855
	Expected return on plan assets		(12,492	)		(11,446	)		—			—
	Amortization of prior service cost		328			359			(3,442	)		(3,268	)
	Amortization of net loss (gain)		3,150			3,081			994			(186	)

	Net periodic benefit cost	$	6,186		$	7,053		$	6,472		$	5,352

During the second quarter of 2004, the Company reduced the Other Postretirement Benefits liability by $1.6 million to correct an over accrual for certain retiree life insurance benefits which are provided by UMWA union plans which are indirectly funded by the Natural Resources segment.

Note 10—Income Taxes

The Company established a $1.8 million valuation allowance for Homebuilding segment state deferred tax assets during the second quarter of 2004.

Note 11—Net Income Per Share

A reconciliation of the basic and diluted net income per share computations for the three and six months ended June 30, 2005 and 2004 are as follows (in thousands, except per share data):

			For the three months ended June 30,
			Basic		Diluted		Basic		Diluted
			2005				2004
Numerator:
	Net income		$	41,481	$	41,481	$	8,263	$	8,263
	Effect of dilutive securities:
		Interest related to 3.75% convertible senior subordinated notes, net of tax (a)		—		1,066		—		889

			$	41,481	$	42,547	$	8,263	$	9,152

Denominator:
	Average number of common shares outstanding			38,661		38,661		38,304		38,304
	Effect of dilutive securities:
		Stock options and restricted stock units(b)		—		679		—		705
		3.75% convertible senior subordinated notes(a)		—		9,805		—		7,354

				38,661		49,145		38,304		46,363

Net income per share			$	1.07	$	0.87	$	0.22	$	0.20

			For the three months ended June 30,
			Basic		Diluted		Basic		Diluted
			2005				2004
Numerator:
	Net income		$	60,246	$	60,246	$	3,661	$	3,661
	Effect of dilutive securities:
		Interest related to 3.75% convertible senior subordinated notes, net of tax(a)		—		2,132		—		—

			$	60,246	$	62,378	$	3,661	$	3,661

Denominator:
	Average number of common shares outstanding			38,131		38,131		39,851		39,851
	Effect of dilutive securities:
		Stock options and restricted stock units(b)		—		916		—		597
		3.75% convertible senior subordinated notes(a)		—		9,805		—		—

				38,131		48,852		39,851		40,448

Net income per share			$	1.58	$	1.28	$	0.09	$	0.09

(a): Represents the interest, net of tax, and shares issuable upon conversation related to the Company's $175 million contingent convertible senior subordinated notes. These amounts were not included in the calculation for the six months ended June 30, 2004, as they would have an anti-dilutive effect.
(b): Represents the number of shares of common stock issuable on the exercise of dilutive employee stock options and restricted stock units less the number of shares of common stock, which could have been purchased with the proceeds from the exercise of such awards. These purchases were assumed to have been made at the higher of either the market price of the common stock at the end of the period or the average market price for the period.

Note 12—Financial Instruments

On January 31, 2005, the Company entered into two $50 million hedge transactions with two separate counter-parties. The objective of the hedge is to protect against the negative effect that rising interest rates would have on the Company's future forecasted issuance of mortgage-backed securities. The structure of the hedge is a 7.5-year forward starting swap, which starts on December 1, 2005, the forecasted issuance date of the Company's next securitization. The swap agreements call for the Company to make fixed rate payments over the term at 4.573% per annum and receive payments based on one month LIBOR from the counter-parties. It is anticipated that the swap will be settled upon the next securitization and will be accounted for as a cash flow hedge. As such, changes in the fair value of the swap that take place through the date of securitization will be recorded in accumulated other comprehensive income, assuming the securitization remains likely. As of June 30, 2005, the Company recorded an unrealized loss from these hedging instruments of $1.9 million as a component of other comprehensive income.

On July 25, 2005 and August 4, 2005, the Company entered into swap contracts to hedge anticipated sales of natural gas from August 2005 through March 2006. See Note 15 for additional discussion.

Note 13—Segment Information

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

			For the three months ended June 30,
			2005			2004
Net sales and revenues:
	Homebuilding		$	57,117		$	61,543
	Financing			58,606			62,798
	Industrial Products			151,868			145,007
	Natural Resources			146,729			89,169
	Other			34,993			27,260
	Consolidating eliminations			(8,099	)		(5,909	)

		Net sales and revenues	$	441,214		$	379,868

Segment operating income (loss):
	Homebuilding		$	(13,994	)	$	(6,712	)
	Financing (a)			14,216			16,649
	Industrial Products			12,121			1,401
	Natural Resources			58,618			14,719
	Other			(4,792	)		(4,301	)
	Consolidating eliminations			(1,071	)		(1,131	)

		Operating income		65,098			20,625
	Less corporate debt interest expense			(4,097	)		(6,206	)

	Income before income tax expense			61,001			14,419
	Income tax expense			(19,520	)		(6,156	)

		Net income	$	41,481		$	8,263

Depreciation:
	Homebuilding		$	1,216		$	1,213
	Financing			355			354
	Industrial Products			6,625			6,890
	Natural Resources			5,183			5,570
	Other			1,126			1,222

		Total	$	14,505		$	15,249

(a): Operating income amounts are after deducting amortization of other intangibles of $923 and $1,352 for the three months ended June 30, 2005 and 2004, respectively, and interest expense on the mortgage-backed/asset-backed notes of $31,102 and $30,276 for the three months ended June 30, 2005 and 2004, respectively.

			For the six months ended June 30,
			2005			2004
Net sales and revenues:
	Homebuilding		$	105,796		$	125,660
	Financing			117,699			123,778
	Industrial Products			267,450			259,084
	Natural Resources			244,160			153,823
	Other			67,693			54,082
	Consolidating eliminations			(16,251	)		(10,523	)

		Net sales and revenues	$	786,547		$	705,904

Segment operating income (loss):
	Homebuilding		$	(22,543	)	$	(15,521	)
	Financing(a)			28,802			30,496
	Industrial Products			17,601			(149	)
	Natural Resources			83,160			12,406
	Other			(7,270	)		(8,230	)
	Consolidating eliminations			(2,831	)		(1,353	)

		Operating income		96,919			17,649
	Less corporate debt interest expense			(7,709	)		(10,151	)

	Income from continuing operations before income tax expense			89,210			7,498
	Income tax expense			(28,547	)		(3,837	)

		Income from continuing operations	$	60,663		$	3,661

Depreciation:
	Homebuilding		$	2,412		$	2,458
	Financing			715			692
	Industrial Products			13,177			13,743
	Natural Resources			10,230			11,164
	Other			2,291			2,444

		Total	$	28,825		$	30,501

(a): Operating income amounts are after deducting amortization of other intangibles of $1,986 and $2,837 for the six months ended June 30, 2005 and 2004, respectively, and interest expense on the mortgage-backed/asset-backed notes of $62,537 and $62,002 for the six months ended June 30, 2005 and 2004, respectively.

Note 14—Commitments and Contingencies

Income Tax Litigation

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 Internal Revenue Service (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.

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 million for issues currently in dispute in the Adversary Proceeding. This amount is subject to interest and penalties. Of the $34 million in claimed tax, $21 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. 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 appeals 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 its 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.

Environmental

The Company and its U.S. Pipe subsidiary have been identified as potentially responsible parties ("PRP") by the EPA under CERCLA with respect to cleanup of hazardous substances in Anniston, Alabama. The Company and U.S. Pipe are among many such PRP's, and a significant number of the PRP's are substantial companies. A Consent Order has been negotiated and signed between the PRP's and the EPA. The Consent Order remains subject to a public comment period before it will come into effect. Management estimates the Company's and U.S. Pipe's aggregate share of liability for cleanup under the Consent Order, after allocation among the several PRPs, will be approximately $4.0 million, which was accrued in 2004. Management does not believe that the Company's and U.S. Pipe's share of any liability will have a material adverse effect on the financial condition of the Company and its subsidiaries, but could be material to results of operations in future reporting periods.

Miscellaneous Litigation

During the three months ended March 31, 2005, the Company entered into a settlement and release agreement with a former insurer whereby the former insurer agreed to pay $5.1 million, net of legal fees, to the Company for historical insurance claims that had not previously been submitted to the insurance company for reimbursement. The Company released the insurer of both past and future claims. During the three months ended March 31, 2005, the Company received $2.8 million. The remainder is expected to be received in the first quarter of 2006. The Company recorded a $5.1 million reduction to selling, general and administrative expenses in the Industrial Products segment.

On March 29, 2005, an order granting summary judgment in the Company's favor was entered in a lawsuit that Drummond Company, Inc. had filed in state court in Tuscaloosa County, Alabama on October 29, 2001 against the Company and several of its subsidiaries (Drummond Company, Inc. v. Walter Industries, Inc., et al., Case No. CV 2002-0673). In the lawsuit Drummond had claimed that it was entitled to exclusive surface mining rights on certain lands owned by United Land Corporation, a wholly owned subsidiary of the Company. The court found otherwise. As a result, the Company reversed a $1.1 million accrual for royalty payments to Drummond and recorded a corresponding reduction to cost of sales in the Other segment, which includes United Land Corporation, for the three months ended March 31, 2005. At trial, the jury awarded damages of ten dollars to Drummond and found against the Company on its counterclaim. Drummond has appealed. Management does not

believe that this matter will have a material adverse effect on the financial condition or results of operations of the Company and its subsidiaries.

Per the agreement between the Company and Oxbow Carbon and Minerals LLC for the sale of the AIMCOR business, the final sales price is subject to certain post-closing cash and working capital adjustments defined in the agreement, which are subject to resolution through an arbitration process provided for in the agreement. The Company recorded a receivable in 2003 of approximately $16 million for estimated net cash and working capital adjustments due to the Company based upon the monthly closing financial statements provided by AIMCOR's management as of November 30, 2003. That receivable has been reduced by insurance proceeds, related to claims made prior to the sale, to approximately $14 million as of March 31, 2005. Oxbow claimed that the cash and net working capital adjustment, based on statements Oxbow prepared as of December 2, 2003, should result in a payment to Oxbow of approximately $17.8 million. The Company originally disputed approximately $121 million of post-closing adjustments and working capital items. The Company filed for arbitration against Oxbow in May of 2004. On March 2, 2005, the arbitrator issued an award on $35 million of disputed items that had been submitted to arbitration and awarded $22.7 million to the Company. The Company is pursuing the remaining items totaling $86 million, of which approximately $10 million would need to be adjudicated in the Company's favor in order for the Company to fully collect the receivable. The ultimate collection of the receivable, or any amount in excess of the receivable, is subject to the resolution of the arbitration described above. Management intends to vigorously pursue full recovery. Management does not believe that this matter will have a material adverse effect on the financial condition or results of operations of the Company and its subsidiaries.

The Company and its subsidiaries are parties to a number of other lawsuits arising in the ordinary course of their businesses. 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 its consolidated financial position.

Note 15—Subsequent Events

On July 25, 2005, the Company entered into a swap contract to hedge anticipated sales of natural gas from August 2005 through February 2006 totaling 1.4 million mmbtu, or 34% of expected natural gas production, at a price of $8.54 per mmbtu. These swap contracts effectively convert a portion of forecasted sales at floating-rate natural gas prices to a fixed-rate basis.

On July 29, 2005, the Board of Directors declared a $0.04 per share dividend payable on September 13, 2005 to shareholders of record on August 12, 2005.

On August 4, 2005, the Company entered into a swap contract to hedge anticipated sales of natural gas from November 2005 through March 2006 totaling 0.5 million mmbtu, or 12% of expected natural gas production, at a price of $9.365 per mmbtu. These swap contracts effectively convert a portion of forecasted sales at floating-rate natural gas prices to a fixed-rate basis.

Note 16—New Accounting Pronouncements

In December 2004, the FASB released revised FASB No. 123(R), "Share-Based Payment", ("FAS 123R") which requires companies to expense the fair value of employee stock options and other forms of stock-based compensation. FAS 123R will be adopted by the Company beginning January 1, 2006. The Company expects to utilize the modified prospective application method of adoption, which excludes restatement of prior periods in the year of adoption. The impact of the adoption of FAS 123R on the 2006 financial statements has not yet been determined. However, see Note 3 for information

related to the pro forma effects on the Company's reported net income and net income per share of applying the fair value recognition provisions of the previous FAS 123, "Accounting for Stock-Based Compensation."

In March 2005, the FASB issued FASB Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations" ("FIN 47"), which is an interpretation of FASB No. 143, "Accounting for Asset Retirement Obligations" ("FAS 143"). This interpretation clarifies terminology within FAS 143 and requires companies to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability's fair value can be reasonably estimated. This interpretation does not have a material impact on the Company's financial condition or results of operations.

In June 2005, the FASB issued FASB No. 154, "Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3" ("FAS 154"), which changes the requirements for accounting for and reporting of a change in accounting principle. FAS 154 requires retrospective application to prior periods' financial statements of a voluntary change in accounting principle unless it is impracticable. FAS 154 also requires that a change in method of depreciation, amortization or depletion for long-lived, nonfinancial assets be accounted for as a change in accounting estimate that is effected by a change in accounting principle. FAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, but does not change the transition provisions of any existing accounting pronouncements, including those that are in a transition phase as of the effective date of FAS 154. The adoption of FAS 154 will not have a material impact on the Company's financial condition or results of operations.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS,
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
AND QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

This discussion should be read in conjunction with the consolidated financial statements and notes thereto of Walter Industries, Inc. and its subsidiaries, particularly Note 13 of "Notes to 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 Continuing Operations for the Three Months ended June 30, 2005 and 2004

		For the three months ended June 30, 2005
		Homebuilding			Financing			Industrial Products			Natural Resources		Other			Cons Elims			Total
		($ in thousands)
Net sales		$	56,524		$	3,902		$	151,791		$	145,802	$	32,225		$	(7,421	)	$	382,823
Interest income on instalment notes			—			53,110			—			—		—			—			53,110
Miscellaneous income			593			1,594			77			927		2,768			(678	)		5,281

Net sales and revenues			57,117			58,606			151,868			146,729		34,993			(8,099	)		441,214
Cost of sales			50,157			2,620			122,593			74,917		26,824			(7,028	)		270,083
Interest expense(1)			—			31,102			—			—		—			��			31,102

			6,960			24,884			29,275			71,812		8,169			(1,071	)		140,029
Depreciation			1,216			355			6,625			5,183		1,126			—			14,505
Selling, general & administrative			19,855			7,501			10,892			3,594		12,173			—			54,015
Provision for losses on instalment notes			—			1,949			—			—		—			—			1,949
Postretirement benefits			(117	)		(60	)		(363	)		4,112		(338	)		—			3,234
Amortization of other intangibles			—			923			—			—		—			—			923
Restructuring & impairment charges			—			—			—			305		—			—			305

	Operating income (loss)	$	(13,994	)	$	14,216		$	12,121		$	58,618	$	(4,792	)	$	(1,071	)		65,098

Corporate debt interest expense																				(4,097	)

Income before income taxes																			$	61,001

(1): Excludes corporate debt interest expense.

		For the three months ended June 30, 2004
		Homebuilding			Financing			Industrial Products			Natural Resources		Other			Cons Elims			Total
		($ in thousands)
Net sales		$	61,520		$	4,988		$	145,806		$	88,721	$	26,106		$	(4,778	)	$	322,363
Interest income on instalment notes			—			56,407			—			—		—			—			56,407
Miscellaneous income			23			1,403			(799	)		448		1,154			(1,131	)		1,098

	Net sales and revenues		61,543			62,798			145,007			89,169		27,260			(5,909	)		379,868
Cost of sales			47,921			3,120			127,957			62,803		21,375			(4,778	)		258,398
Interest expense(1)			—			30,276			—			—		—			—			30,276

			13,622			29,402			17,050			26,366		5,885			(1,131	)		91,194
Depreciation			1,213			354			6,890			5,570		1,222			—			15,249
Selling, general & administrative			19,244			8,199			9,352			4,062		9,257			—			50,114
Provision for losses on instalment notes			—			2,902			—			—		—			—			2,902
Postretirement benefits			(123	)		(54	)		(418	)		1,481		(293	)		—			593
Amortization of other intangibles			—			1,352			—			—		—			—			1,352
Restructuring & impairment charges			—			—			(175	)		534		—			—			359

	Operating income (loss)	$	(6,712	)	$	16,649		$	1,401		$	14,719	$	(4,301	)	$	(1,131	)		20,625

Corporate debt interest expense																				(6,206	)

Income before income taxes																			$	14,419

(1): Excludes corporate debt interest expense.

Overview

The Company's net income for the quarter ended June 30, 2005 was $41.5 million, or $0.87 per diluted share, which compares to net income in the year ago period of $8.3 million, or $0.20 per share. Net income for the quarter principally reflects increased pricing in the Natural Resources segment and higher pricing in the Industrial Products segment partially offset by an increased loss in the Homebuilding segment and lower operating income at Financing.

Principal factors impacting the current period results compared to the year ago period included:

•: Metallurgical coal selling prices increased 92% to $83.90 per ton in the current period compared to the prior year period.
•: Industrial Products' current period results reflect a 22.8% increase in ductile iron pipe prices and favorable plant performance partially offset by a 12.3% decrease in ductile iron pipe shipments and 10.2% higher scrap metal costs.
•: Homebuilding had 15% fewer unit completions and $3.2 million of charges related to repair, rework and other non-recoverable costs for under-construction homes, additional legal accruals, write-down of supplies inventory for shortages and obsolescence, plus additional warranty and loss accruals, partially offset by 8% higher sales prices.
•: Natural Resources incurred idle mine costs of $3.6 million due to a water ingress problem in Mine No. 5, which is discussed below.
•: Financing results in the current period reflect a $3.3 million decrease in interest income due to declining mortgage origination production from the Homebuilding segment, lower prepayment

income of $1.9 million and higher interest expense partially offset by lower selling, general and administrative expenses and a reduced provision for losses as delinquencies improved by 60 basis points.

•: Current period results at Sloss reflect higher furnace and foundry coke pricing, partially offset by higher metallurgical coal raw material costs.
•: The Company established a $1.8 million valuation allowance in 2004, recorded in income tax expense, for Homebuilding segment state deferred tax assets.
•: Unamortized debt costs and discounts of $1.6 million, net of tax, were expensed in the 2004 period due to the early retirement of $112 million in variable interest rate term debt.
•: Vestal Manufacturing was sold in 2004, resulting in a prior period loss of $0.8 million, net of tax.

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

•: A water ingress problem at Mine No. 5 halted production on May 31, 2005 and caused several roof-falls, which blocked the main roadway and several conveyor areas. Most of the excess water has been pumped out of the mine and work crews are underground restoring operations. As a result of the damage caused by the water, Mine No. 5 is expected to be idle through the fourth quarter of 2005. This will result in reduced production for 2005 of approximately 450,000 tons and approximately $24 million of idle mine costs in the second half of 2005. Delayed production in 2005 will be additive to expected 2006 production by 200,000 tons with the balance additive to 2007. The Company expects to meet all of its contracted delivery schedules. Additionally, given the down time expected for the remainder of the year at Mine No. 5, gas volume is expected to be lower through the balance of 2005.
•: In addition to the previously announced $135 million Mine No. 7 expansion, the Company is pursuing an additional expansion opportunity at Mine No. 7 to produce approximately 700,000 million tons of coal in 2007. Costs to develop this area and build the required infrastructure are estimated at approximately $6.1 million.
•: The Company expects to complete a new barge loading facility in August 2005, which will provide an alternative method of transporting metallurgical coal to the port in Mobile, Alabama.
•: As of June 30, 2005, scrap metal costs used by the Industrial Products segment have declined 11.2% from their peak in the fourth quarter of 2004. There is some evidence of downward pricing pressure in certain markets in response to the decline in scrap metal prices. However, due to the volatility of scrap metal costs, the Company is holding prices firm.
•: Inventories of ductile iron pipe are higher than anticipated in the Industrial Products segment due to industry-wide delays in construction projects, some of which are due to weather-related problems. The Company has revised production schedules to address current inventory levels.
•: The Financing segment expects to increase loan acquisition activity through Walter Mortgage Company as a strategy to offset the lower level of mortgage origination production from the Homebuilding segment. During the first six months of 2005, Walter Mortgage Company purchased $31.7 million in loans and estimates total purchases of $80 million for the year.
•: Homebuilding has completed 35 renovations of its home parks and models, including 20 in the first six months of 2005, and plans to complete 30 more during the year.
•: Recent marketing initiatives and home park sales center enhancements are driving improved sales order trends in Homebuilding with same-store sales orders, net of cancellations, up 31% in the second quarter versus the prior year period. In addition, the value of the backlog rose 50% from the prior year period.

•: The Southeast and Atlantic Homebuilding divisions continue to experience construction-related delays primarily related to personnel turnover and sub-contractor availability. The Company is aggressively addressing these issues and has dedicated additional human resources and information technology personnel to resolve these critical constraints.
•: The Homebuilding segment continues to implement initiatives to increase productivity and profitability, and the segment expects to achieve a breakeven run-rate in the fourth quarter of 2005.
•: The Company received a favorable ruling in the Drummond case over surface mining rights for coal on certain Company-owned properties. Although the ruling has been appealed, the Company is moving aggressively to develop these deposits of steam and metallurgical coal. The Company has submitted permit applications for several areas and expects to firm up estimates of potential reserves and definitive mining plans by December 31, 2005.
•: The Company's future financial information will include the financial results as of and subsequent to the acquisition of Mueller Water Products, Inc. and subsidiaries, including any purchase accounting adjustments that may be required in the period in which the transaction occurs. The closing is expected in September 2005.

Net sales and revenues for the three months ended June 30, 2005 were $441.2 million, a 16.1% increase from $379.9 million for the quarter ended June 30, 2004, primarily driven by higher metallurgical coal prices at Natural Resources along with higher pricing at Industrial Products and Sloss partially offset by decreases at Homebuilding and Financing.

Cost of sales, exclusive of depreciation, of $270.1 million was 70.6% of net sales in the 2005 period versus $258.4 million and 80.2% of net sales in the comparable period of 2004. The decrease in cost of sales as a percentage of net sales is due to increases in metallurgical coal sales prices at Natural Resources and ductile iron pipe prices at Industrial Products, partially offset by idle mine costs of $3.6 million due to the water ingress problem at Natural Resources' Mine No. 5, 10.2% higher scrap metal costs at Industrial Products, increased metallurgical coal raw material costs at Sloss and non-recoverable costs for units under construction at Homebuilding.

Depreciation for the three months ended June 30, 2005 was $14.5 million, a decrease of $0.7 million from the same period in 2004, primarily in the Natural Resources segment.

Selling, general and administrative expenses of $54.0 million were 12.2% of net sales and revenues in the 2005 period, compared to $50.1 million and 13.2% in 2004. The increase is primarily due to costs recorded in the Other segment for severance and other personnel costs, partially offset by lower medical costs.

Provision for losses on instalment notes decreased to $1.9 million in the 2005 period, compared to $2.9 million in 2004 due to lower delinquency rates and higher recovery rates.

Interest expense on corporate debt decreased $2.1 million to $4.1 million in the 2005 period due to prior year write-offs of unamortized term loan debt issuance costs of $1.2 million and debt discount costs of $1.3 million resulting from the early retirement of the term loan.

The Company's effective tax rate of 32.0% and 42.7% for the three months ended June 30, 2005 and 2004, respectively, differed from the federal statutory rate primarily due to depletion deductions related to the Natural Resources segment and the effect of state income taxes. Additionally, the Company established a $1.8 million valuation allowance for Homebuilding segment state deferred tax assets which was expensed during the quarter ended June 30, 2004.

Segment Analysis:

Homebuilding

Net sales and revenues were $57.1 million for the three months ended June 30, 2005, a decrease of $4.4 million from the quarter ended June 30, 2004 as a result of lower unit completions, partially offset by higher average selling prices. Total unit completions decreased by 130, or 14.8%, compared to the year earlier period. The modular business completed 128 homes in the current quarter, 16 fewer than the year-ago period. Excluding the modular business, 620 units were completed in the current period, compared to 734 in the year-ago period. This decrease is due to fewer sales orders in the fourth quarter of last year, fewer sales branches in 2005 compared to the prior year and construction challenges in two divisions due to personnel turnover and sub-contractor availability. Since June 30, 2004, the Company has closed 21 underperforming sales branches, which delivered 111 unit completions in the prior year period. The higher average selling price reflects the Company's ongoing strategy to market and sell larger homes with more amenities.

	Three months ended June 30,
	2005		2004
Homes Completed		748		878
Average Net Selling Price	$	75,600	$	70,100

The estimated backlog at June 30, 2005 of homes to be constructed was $201 million, or 2,440 homes, compared to $143 million, or 2,001 homes, at December 31, 2004 and $134 million, or 1,912 homes, at June 30, 2004.

The operating loss was $14.0 million for the three months ended June 30, 2005 compared to an operating loss of $6.7 million in the year-ago period. The increase was due to fewer unit completions and charges related to repair, rework and other non-recoverable costs for under construction homes, additional legal accruals, write-down of supplies inventory for shortages and obsolescence, plus warranty and loss accruals ($3.2 million) which address historical quality issues. Additional unrecoverable costs related to homes completed during the quarter were offset by cost reductions resulting from the closure of underperforming sales branches.

As a result of construction delays caused by personnel sub-contractor availability, the efforts of the strengthened purchasing group are being redirected from internal system matters to more proactive sub-contractor and supplies procurement and cost performance.

Financing

Net sales and revenues were $58.6 million in the 2005 period, a decrease of $4.2 million from $62.8 million for the year-ago period. The reduction in revenue was attributed to a decrease in the overall instalment note portfolio due to declining mortgage origination production from the Homebuilding segment. Prepayment revenue also declined by $1.9 million due to lower prepayment speeds.

Operating income decreased by $2.4 million, to $14.2 million in the 2005 period due to the impact of a reduced instalment note portfolio balance, lower prepayment income and higher interest expense due to increased levels of fixed-rate securitized debt partially offset by lower selling, general and administrative expenses and an improvement in the provision for losses.

Prepayment speeds were 10.5% in the 2005 period, down 50 basis points from the prior year period. Delinquencies (the percentage of amounts outstanding over 30 days past due) were 4.0% at June 30, 2005, down from 4.6% at June 30, 2004 and from 4.9% at December 31, 2004, reflecting improved mortgage servicing performance.

Industrial Products

Net sales and revenues were $151.9 million for the three months ended June 30, 2005 compared to $145.0 million in the year-earlier period. The increase was primarily due to a 22.8% increase in ductile iron pipe selling prices, partially offset by a 12.3% decrease in ductile iron pipe sales shipments due to industry-wide construction delays, some of which are due to weather-related problems, which affected demand for 8-to-12 inch diameter product. The Company expects sales of 8-to-12 inch diameter products to improve in the second half of 2005. Prices were higher than the prior year as the industry has been increasing prices to offset surging scrap costs. U.S. Pipe's pricing actions since June 2003 have offset scrap metal and other manufacturing cost increases.

The estimated order backlog consisting of pressure pipe, valves and hydrants, fittings and castings at June 30, 2005 was approximately $143 million compared to $115 million at December 31, 2004 and $98 million at June 30, 2004. The increase in backlog is due to increased orders for larger diameter pipe and higher pricing.

Operating income for the segment totaled $12.1 million for the quarter, compared to $1.4 million in the prior-year period. The $10.7 million operating income improvement is due to higher ductile iron pipe pricing and favorable plant performance, partially offset by higher scrap metal costs. The prior year period included a loss of $1.2 million related to the sale of Vestal Manufacturing.

Natural Resources

Net sales and revenues were $146.7 million for the three months ended June 30, 2005, up 64.6% from the prior year period. The increase was primarily due to higher metallurgical coal and natural gas pricing. Higher metallurgical coal pricing is being driven by worldwide increases in steel production, especially in China, India and Brazil.

	Three months ended June 30,
	2005		2004
Average Coal Selling Price (per Ton)	$	73.29	$	41.47
Tons of Coal Sold		1.8 million		1.9 million
Tons of Coal Mined		1.5 million		1.9 million
Average Natural Gas Selling Price (per MCF)	$	6.56	$	5.77
Billion Cubic Feet of Natural Gas Sold		1.8		2.0
Number of Natural Gas Wells		403		375

For the three months ended June 30, 2005, Natural Resources' operating income was $58.6 million, compared to operating income of $14.7 million in the prior year period. The increase was primarily due to higher metallurgical coal prices, a favorable sales mix of metallurgical versus steam coal and increased natural gas prices partially offset by higher production costs due to an extended longwall move and idle mine charges of $3.6 million at Mine No. 5 due to the water ingress problem and lower natural gas volumes in Mine No. 4 and Mine No. 5. During the second quarter of 2005, sales of 140,000 tons of metallurgical coal were shipped earlier than planned, and steam coal deliveries of 55,000 tons were deferred. The net result of this positive sales mix was an increase in second quarter revenues and operating income of approximately $9.4 million and $6.4 million, respectively. The decrease in natural gas volume is primarily attributable to Mine No. 4 production occurring in a heavily degassed area of the mine and the idling of Mine No. 5.

Other

Net sales and revenues were $35.0 million for the three months ended June 30, 2005, an increase of $7.7 million from $27.3 million in the prior year period. Sloss revenues were $32.2 million, up 25.1%

versus the prior year period due to higher furnace coke and foundry coke prices partially offset by lower volumes. Sloss operating income was $3.0 million in the 2005 period compared to $2.3 million in the prior year period as higher furnace and foundry coke pricing was partially offset by increased metallurgical coal raw material costs. Operating results for the Other segment also include an increase of $0.6 million in operating income for the Land Group from additional real estate sales.

Net general corporate expenses, principally included in selling, general and administrative expense, were $8.6 million for the three months ended June 30, 2005 compared to $6.8 million for the three months ended June 30, 2004. Corporate expenses increased due to higher severance and other personnel costs of $3.2 million partially offset by lower medical costs of $1.8 million.

RESULTS OF OPERATIONS

Summary Operating Results of Continuing Operations for the Six Months ended June 30, 2005 and 2004

		For the three months ended June 30, 2005
		Homebuilding			Financing			Industrial Products			Natural Resources		Other			Cons Elims			Total
		($ in thousands)
Net sales		$	105,114		$	7,777		$	267,330		$	241,415	$	62,812		$	(14,895	)	$	669,553
Interest income on instalment notes			—			106,603			—			—		—			—			106,603
Miscellaneous income			682			3,319			120			2,745		4,881			(1,356	)		10,391

	Net sales and revenues		105,796			117,699			267,450			244,160		67,693			(16,251	)		786,547
Cost of sales			89,008			4,366			221,158			134,409		51,958			(13,420	)		487,479
Interest expense(1)			—			62,537			—			—		—			—			62,537

			16,788			50,796			46,292			109,751		15,735			(2,831	)		236,531
Depreciation			2,412			715			13,177			10,230		2,291			—			28,825
Selling, general & administrative			37,153			14,279			16,240			7,527		21,386			—			96,585
Provision for losses on instalment notes			—			5,134			—			—		—			—			5,134
Postretirement benefits			(234	)		(120	)		(726	)		8,224		(672	)		—			6,472
Amortization of other intangibles			—			1,986			—			—		—			—			1,986
Restructuring & impairment charges			—			—			—			610		—			—			610

Operating income (loss)		$	(22,543	)	$	28,802		$	17,601		$	83,160	$	(7,270	)	$	(2,831	)		96,919

Corporate debt interest expense																				(7,709	)

Income from continuing operations before income taxes																			$	89,210

	For the six months ended June 30, 2004
($ in thousands)	Homebuilding			Financing			Industrial Products			Natural Resources		Other			Cons Elims			Total
Net sales	$	125,580		$	9,286		$	259,596		$	151,755	$	50,995		$	(9,166	)	$	588,046
Interest income on instalment notes		—			111,673			—			—		—			—			111,673
Miscellaneous income		80			2,819			(512	)		2,068		3,087			(1,357	)		6,185

Net sales and revenues		125,660			123,778			259,084			153,823		54,082			(10,523	)		705,904
Cost of sales		99,924			6,283			227,013			118,147		42,113			(9,090	)		484,390
Interest expense(1)		—			62,002			—			—		—			—			62,002

		25,736			55,493			32,071			35,676		11,969			(1,433	)		159,512
Depreciation		2,458			692			13,743			11,164		2,444			—			30,501
Selling, general & administrative		39,045			15,173			19,218			6,820		18,337			(80	)		98,513
Provision for losses on instalment notes		—			6,393			—			—		—			—			6,393
Postretirement benefits		(246	)		(98	)		(862	)		4,893		(582	)		—			3,105
Amortization of other intangibles		—			2,837			—			—		—			—			2,837
Restructuring & impairment charges		—			—			121			393		—			—			514

Operating income (loss)	$	(15,521	)	$	30,496		$	(149	)	$	12,406	$	(8,230	)	$	(1,353	)		17,649

Corporate debt interest expense																			(10,151	)

Income from continuing operations before income taxes																		$	7,498

(1): Excludes corporate debt interest expense.

Overview

The Company's net income for the six months ended June 30, 2005 was $60.2 million, or $1.28 per diluted share, which compares to net income in the year ago period of $3.7 million, or $0.09 per share. Profitability at Natural Resources increased significantly over the prior year period primarily driven by higher contractual selling prices for metallurgical coal. The improvement in Industrial Products over the prior year is due to improved ductile iron pipe selling prices, which were partially offset by higher scrap metal costs. The results for the current period include consistent earnings in the Financing segment and losses in the Homebuilding segment as a result of fewer unit completions and higher than anticipated costs driven by repair, rework and other non-recoverable costs related to home construction.

Principal factors impacting the current period results compared to the year ago period included:

•: Metallurgical coal selling prices increased 87.6% to $75.22 per ton in the current period compared to the prior year period, while metallurgical coal tons sold increased 4.9%.
•: Homebuilding had 21.9% fewer unit completions and additional charges related to repair, rework and other non-recoverable costs related to home construction that caused overall gross margins to decline by 22.5% compared to the prior year period, which were partially offset by 7.3% higher average selling prices.

•: Financing results in the current period reflect a 4.6% decrease in interest income due to the decline in the portfolio balance partially offset by a reduction in selling, general and administrative expenses and favorable loss experience on delinquencies.
•: Ductile iron pipe price increases of 24.5% have helped offset increases in scrap metal costs, while tons shipped have decreased by 11.5% compared to the prior year period.
•: Current period results at Sloss reflect higher furnace and foundry coke pricing, partially offset by increases in production costs and higher metallurgical coal raw material costs.
•: Industrial Products results in the current period include a $5.1 million insurance claims settlement.
•: Unamortized debt costs and discounts of $1.6 million, net of tax, were expensed in the 2004 period due to the early retirement of $112 million in variable interest rate term debt.
•: The Company established a $1.8 million valuation allowance in 2004, recorded in income tax expense, for Homebuilding segment state deferred tax assets.
•: Vestal Manufacturing was sold in 2004, resulting in a prior period loss of $0.8 million, net of tax.

Net sales and revenues for the six months ended June 30, 2005 were $786.5 million, an 11.4% increase from $705.9 million for the six months ended June 30, 2004, primarily driven by higher metallurgical coal sales prices at Natural Resources along with higher pricing at U.S. Pipe and Sloss partially offset by decreases at Homebuilding and Financing.

Cost of sales, exclusive of depreciation, of $487.5 million was 72.8% of net sales in the 2005 period versus $484.4 million and 82.4% of net sales in the comparable period of 2004. The decrease in cost of sales as a percentage of net sales is due to increases in sales prices at Natural Resources, Industrial Products and Sloss partially offset by higher scrap metal costs in the Industrial Products segment, increased metallurgical coal raw material costs at Sloss, idle mine costs of $3.6 million due to the water ingress problem at Natural Resources' Mine No. 5 and lower margins at Homebuilding.

Depreciation for the six months ended June 30, 2005 was $28.8 million, a decrease of $1.7 million from the same period in 2004, primarily in the Natural Resources and Industrial Products segments.

Selling, general and administrative expenses of $96.6 million were 12.3% of net sales and revenues in the 2005 period, compared to $98.5 million and 14.0% in 2004. The decrease is primarily due to a $5.1 million insurance claim settlement in the Industrial Products segment, a $1.9 million decrease in the Homebuilding segment due to lower costs from 21 branch closures, severance and employee-related costs, and lower property tax and consulting expenses in Financing. These were partially offset by higher severance, audit fees and other employee-related costs in the Other segment and higher legal costs in the Natural Resources segment. The prior year results also include $1.0 million for Vestal Manufacturing which was sold in 2004.

Provision for losses on instalment notes decreased to $5.1 million in the 2005 period, compared to $6.4 million in 2004 due to lower delinquency rates and higher recovery rates.

Interest expense on corporate debt decreased $2.4 million to $7.7 million in the 2005 period due to the write-off of unamortized term loan debt issuance costs of $1.2 million and debt discount costs of $1.3 million in the prior year period resulting from the early retirement of the term loan.

The Company's effective tax rate of 32.0% and 51.2% for the six months ended June 30, 2005 and 2004, respectively, differed from the federal statutory rate primarily due to depletion deductions related to the Natural Resources segment and the effect of state income taxes. Additionally, the Company established a $1.8 million valuation allowance for Homebuilding segment state deferred tax assets which was expensed during the quarter ended June 30, 2004.

Segment Analysis:

Homebuilding

Net sales and revenues were $105.8 million for the six months ended June 30, 2005, a decrease of $19.9 million from the six months ended June 30, 2004 as a result of lower unit completions, partially offset by higher average selling prices. Total unit completions decreased by 393 or 21.9%, compared to the year earlier period. The modular business completed 238 homes in the current period, 56 less than the year-ago period due to poor weather in 2005. Excluding the modular business, 1,160 units were completed in the current period, compared to 1,497 in the year-ago period.

	Six months ended June 30,
	2005		2004
Homes Completed		1,398		1,791
Average Net Selling Price	$	75,200	$	70,100

The operating loss was $22.5 million for the six months ended June 30, 2005 compared to an operating loss of $15.5 million in the year-ago period. The increase was due to fewer unit completions, other non-recoverable costs for homes under construction and completed homes, additional legal accruals, write-down of supplies inventory for shortages and obsolescence, plus warranty and loss accruals partially offset by higher sales prices and lower overhead costs resulting from 21 branch closures since June 30, 2004.

Financing

Net sales and revenues were $117.7 million in the 2005 period, a decrease of $6.1 million from $123.8 million for the year-ago period. This decrease was attributed to reduced yields on the instalment note portfolio, as well as a decrease in the instalment notes portfolio balance caused by lower Homebuilding segment mortgage origination production. Operating income decreased by $1.7 million, to $28.8 million in the 2005 period. Reduced selling, general and administrative costs and a lower provision for losses on instalment notes for the current period were offset by the overall decline in portfolio earnings.

Industrial Products

Net sales and revenues were $267.5 million for the six months ended June 30, 2005 compared to $259.1 million in the year-earlier period. The increase was primarily due to a 24.5% increase in ductile iron pipe selling prices, partially offset by an 11.5% decrease in ductile iron pipe shipments mainly due to industry-wide delays in construction projects, some of which are due to weather-related problems. Prices were higher than the prior year as the industry has been increasing prices to offset surging scrap costs. U.S. Pipe's pricing actions since June 2003 have offset scrap metal and other manufacturing cost increases.

Operating income for the segment totaled $17.6 million for the period, compared to an operating loss of $0.1 million in the prior-year period. Current period operating income was favorably impacted by a $5.1 million insurance claim settlement. Excluding this settlement, operating income improved $12.6 million as compared with the prior year period due to higher pricing partially offset by lower volumes due to poor weather and higher scrap metal costs. Prior period results also included a $1.2 million loss from the $6.0 million sale of Vestal Manufacturing.

Natural Resources

Net sales and revenues were $244.2 million for the six months ended June 30, 2005, an increase of $90.3 million from $153.8 million in the prior year period. The increase was primarily due to higher metallurgical coal prices.

	Six months ended June 30,
	2005		2004
Average Coal Selling Price (per Ton)	$	65.72	$	38.78
Tons of Coal Sold		3.3 million		3.3 million
Tons of Coal Mined		3.5 million		3.4 million
Average Natural Gas Selling Price (per MCF)	$	6.66	$	5.96
Billion Cubic Feet of Natural Gas Sold		3.5		4.1
Number of Natural Gas Wells		403		375

For the six months ended June 30, 2005, Natural Resources' operating income was $83.2 million, compared to operating income of $12.4 million in the prior year period. The increase was primarily due to higher metallurgical coal prices, partially offset by idle mine costs at Mine No. 5 and higher costs per ton at Mine No. 7 and Mine No. 5. Also, the Company recorded a $1.6 million reduction of other post-employment benefits liability in 2004.

Other

Net sales and revenues were $67.7 million for the six months ended June 30, 2005, an increase of $13.6 million from $54.1 million in the prior year period. Sloss revenues were $12.5 million higher than the previous period due to higher furnace coke and foundry coke prices. Sloss operating income was $4.8 million in the 2005 period, an increase of $0.6 million from the prior year period, due to higher furnace and foundry coke pricing and was partially offset by increases in production costs, higher metallurgical coal raw material costs and expenses from a legal settlement. Operating income for the segment included an accrual reduction of $1.1 million in the Company's land group recorded in cost of sales due to a favorable court ruling related to a coal mineral rights dispute.

Net general corporate expenses, principally included in selling, general and administrative expense, were $14.3 million for the six months ended June 30, 2005 compared to $12.7 million for the six months ended June 30, 2004. Corporate expenses increased due to higher severance and other personnel costs of $4.0 million and higher professional fees related to audit services of $1.0 million partially offset by lower medical expenses of $3.1 million.

FINANCIAL CONDITION

Cash decreased from $46.9 million at December 31, 2004 to $29.2 million at June 30, 2005 reflecting $43.6 million of cash flows provided by operations, $25.7 million of cash flows used in investing activities, and $35.6 million of cash flows used in financing activities. See additional discussion in the Statement of Cash Flows section that follows.

Instalment notes receivable include instalment notes generated principally from the financing of homes constructed by the Homebuilding segment and purchased by the Financing segment and mortgage loans originated or purchased by the Financing segment. Instalment notes were $1,582.8 million at June 30, 2005, a decrease of $36.3 million from December 31, 2004 principally as a result of reduced volume of Homebuilding units and prepayments of outstanding balances. Mortgage loans were $132.1 million at June 30, 2005, an increase of $22.8 million from December 31, 2004 resulting from acquisitions of third party loans and refinancing of instalment notes.

The allowance for losses on instalment notes receivable was $11.1 million at June 30, 2005 and $11.2 million at December 31, 2004. Delinquencies (the percentage of amounts outstanding over 30 days past due) were 4.0% at June 30, 2005, 4.6% at June 30, 2004 and 4.9% at December 31, 2004. Activity in the allowance for losses on instalment notes is summarized as follows (in thousands):

	For the six months ended June 30,
	2005			2004
Balance at beginning of period	$	11,200		$	10,907
Provisions charged to income		5,134			6,393
Charge-offs, net of recoveries		(5,235	)		(5,709	)

Balance at end of period	$	11,099		$	11,591

Receivables, net, consisting principally of trade receivables, were $206.9 million at June 30, 2005, an increase of $36.7 million from December 31, 2004. The increase in receivables was primarily due to higher selling prices and volumes in the Natural Resources ($27.7 million) and Industrial Products ($13.2 million) segments, partially offset by the collection of proceeds from the exercise of employee stock options ($6.8 million).

Inventories increased $60.8 million to $294.3 million at June 30, 2005 compared to $233.5 million at December 31, 2004, primarily related to (i) Industrial Products ($45.6 million) due to scheduled inventory buildups associated with the seasonality of the business and wet weather which delayed shipments to construction projects, (ii) Natural Resources ($12.3 million) due to increased coal production, coupled with rail transportation congestion preventing deliveries to the Port of Mobile, Alabama and (iii) Homebuilding ($3.5 million) due to increased homes under construction.

Prepaid expenses were $19.1 million at June 30, 2005, an increase of $2.2 million from December 31, 2004, due to the timing of insurance payments, which are amortized over the coverage period.

Property, plant and equipment was $348.0 million at June 30, 2005, an increase of $13.3 million reflecting additions, net of retirements, of $42.1 million, partially offset by depreciation of $28.8 million. The increase in additions is primarily due to equipment and mine expansion costs at Natural Resources.

Deferred income taxes decreased $12.5 million to $35.4 million at June 30, 2005 from $47.9 million at December 31, 2004, due to the deferred tax provision partially offset by tax benefits on the exercise of employee stock options and interest rate hedging activities.

Accounts payable of $108.6 million at June 30, 2005 increased $18.4 million compared to December 31, 2004 primarily as a result of the timing of vendor payments and the seasonality of material purchases.

Mortgage-backed/asset-backed notes decreased to $1,697.5 million from $1,763.8 million due to principal payments on the trusts, partially offset by borrowings on new loan originations from the sale of homes.

Senior debt of $20.0 million at June 30, 2005 represents short-term borrowings on the revolving credit facility.

LIQUIDITY AND CAPITAL RESOURCES

Overview

The Company's principal sources of short-term funding are operating cash flows, borrowings under the revolving credit facility and committed secured warehouse lines of credit. The Company's principal sources of long-term funding are the convertible senior subordinated notes and its financings under mortgage-backed/asset-backed notes.

The Company believes that, based on current forecasts and anticipated market conditions, sufficient operating cash flow will be generated to meet substantially all operating needs, to make planned capital expenditures and to make all required interest payments on indebtedness. However, the Company's operating cash flows and liquidity are significantly influenced by numerous factors, including the general economy and, in particular, mining conditions, prices of coal and gas, levels of construction activity, levels of government spending on water projects, costs of raw materials and interest rates.

At June 30, 2005, non-recourse mortgage-backed/asset-backed notes outstanding totaled $1.7 billion and primarily consisted of seven separate issues of public debt providing financing for instalment notes receivable and mortgage loans purchased by Mid-State. Mortgage debt also includes outstanding borrowings under two $200.0 million warehouse facilities (the "Trust IX Variable Funding Loan Facility" and the "Trust XIV Variable Funding Loan Facility") providing temporary financing to Mid-State for its current purchases of instalment notes from Homebuilding and its purchases of mortgage loans from Walter Mortgage Company. At June 30, 2005, there was $82.6 and $26.1 million outstanding under the Trust IX and Trust XIV Variable Funding Loan Facilities, respectively, and $291.3 million was available for future borrowings.

As of June 30, 2005, total debt has decreased by $46.3 million compared to December 31, 2004, resulting from principal payments on the various mortgage-backed/asset-backed notes amounting to $138.0 million partially offset by new loan originations from the sale of homes of $71.7 million and net borrowings on the revolving credit facility of $20.0 million.

Convertible Notes and Senior Debt

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

The notes bear interest at 3.75% per annum. Commencing on May 1, 2011, the Company will pay contingent interest for the applicable interest period if the average trading price of the notes during the specified five trading days in the applicable interest period equals or exceeds 120% of the principal amount of the notes. The contingent interest payable per note will equal 0.40% per year of the average trading price of such note during the applicable five trading-day reference period. The notes are convertible into shares of the Company's common stock, initially at a conversion rate of 56.0303 shares of common stock per $1,000 principal amount of notes (equivalent to a conversion price of approximately $17.85 per share), subject to adjustment and under certain circumstances as outlined in the indenture. Holders can surrender their notes for conversion in any fiscal quarter after the quarter ending June 30, 2004 if the last reported sale price per share of Walter Industries' common stock for at least 20 trading days during the period of 30 consecutive trading days ending on the last trading day of the previous fiscal quarter is greater than or equal to 130% of the applicable conversion price per share of Walter Industries' common stock on such last trading day. Holders may also convert the notes if certain trading price conditions are met, the notes are called for redemption, upon the occurrence of

certain corporate transactions or if credit ratings are three or more subcategories below the initial credit rating.

Other than the occurrence of certain corporate transactions, such as the sale of the Company, the agreement has no provisions that accelerate the maturity of the debt. A significant downgrade of the credit rating of the debt or a suspension of the ratings by both rating agencies would result in an acceleration of the conversion feature of the notes.

Proceeds upon issuance of the notes were $168.9 million, net of approximately $6.1 million of underwriting fees and expenses. A portion of the proceeds was used to repay in full the Term Loan, which had a principal balance outstanding of $111.7 million. Using the remaining proceeds and borrowings under the revolving credit facility, the Company repurchased 4,960,784 shares of its common stock for approximately $63.0 million.

The 2003 Credit Facility, as amended, contains a number of significant covenants that, among other things, restrict the ability of the Company and certain subsidiaries to dispose of assets, incur additional indebtedness, pay dividends and repurchase stock, create liens on assets, enter into capital leases, make investments or acquisitions, engage in mergers or consolidations, or engage in certain transactions with subsidiaries and affiliates and otherwise restrict corporate activities (including a change of control). In addition, under the 2003 Credit Facility, the Company and its Restricted

Subsidiaries (as defined in the 2003 Credit Facility) are required to maintain specified financial ratios and comply with certain other financial tests.

EBITDA, as defined in the 2003 Credit Facility, excludes the EBITDA generated by the Financing subsidiary, and substitutes instead, the cash released to the Company via its ownership of the residual beneficial interest in the financing trusts and the net cash proceeds from the periodic issuance of asset-backed notes. EBITDA also excludes certain non-cash restructuring charges, non-cash write-downs of goodwill and asset impairments. The Company's failure to comply with the covenants in its 2003 Credit Facility could result in an event of default, which, if not cured, amended, or waived, could result in the Company's senior secured debt becoming immediately due and payable. At June 30, 2005, the Company was in compliance with these covenants.

At June 30, 2005, there was $20.0 million outstanding under the $265 million revolving credit facility. The revolving credit facility includes a sub-facility for trade and other standby letters of credit in an amount up to $100.0 million at any time outstanding. At June 30, 2005, letters of credit with a face amount of $73.0 million were outstanding and approximately $172.0 million was available under the revolving credit facility.

As of June 30, 2005, the Company's 2003 Credit Facility was rated BB by Standard & Poors and Ba2 by Moody's Investor Services, both with a stable outlook. Additionally, the Company's convertible senior subordinated notes were rated B1 by Moody's and B+ by Standard & Poors.

Both Standard & Poors and Moody's placed the Company's credit ratings on review based on the pending acquisition of Mueller Water Products, Inc. Standard & Poors took the additional action of lowering the Company's credit rating to BB- and the rating of the Company's convertible senior subordinated notes to B.

The Company expects to finance the acquisition of Mueller with a combination of available cash, borrowings under new credit facilities of the Company and Mueller Group, Inc., a subsidiary of Mueller, pursuant to commitment letters entered into as of June 17, 2005 with Bank of America, N.A., Banc of America Securities LLC, Morgan Stanley Senior Funding, Inc. and Bank of America Bridge LLC. This financing will consist of $625 million in senior secured credit facility for the Company and $1.175 billion in senior secured credit facilities for Mueller Group. The financing also includes backstop commitments for $145 million and $320 million, respectively, to finance any repurchases of 14³/4% Senior Discount Notes due 2014 of Mueller and 10% Senior Subordinated Notes due 2012 of Mueller Group pursuant to the rights of holders of those securities following the change of control resulting from the consummation of the acquisition to put such securities to their respective issuers in accordance with the respective indentures. The Company does not anticipate borrowing under the backstop commitments. These financing commitments are subject to the completion of the acquisition and customary closing conditions, including entering into definitive loan agreements. The closing is expected in September 2005. Following the closing, the Company's debt is expected to increase by approximately $1.9 billion.

Mid-State Activity

Trust IX and Trust XIV ("the Trusts") are Delaware Statutory Trusts whose assets are limited to pledged instalment notes, mortgage notes and mortgages purchased from Mid-State. The Trusts' covenants, among other things, restrict the ability of the Trusts to dispose of assets, create liens and engage in mergers or consolidations. In addition, events of default related to a Reserve Account Event include the mortgage pool exceeding average consecutive three-month delinquency and default ratios of 2.5% and 5.0%. The failure to comply with these and other covenants could result in an event of default, which, if not cured, amended or waived, could result in the entire principal balances and accrued interest becoming immediately due and payable. A default that remains uncured might result in the curtailment of the Company's production activities and negatively affect its ability to securitize its production, which would have a material adverse effect on its business, financial condition, liquidity, and results of operations. The Trusts were in compliance with these covenants at June 30, 2005.

Mid-State Homes and Walter Mortgage Company are servicers under the Trusts and make customary representations and warranties with regard to their servicing activities. A servicer default under the Trusts, which includes the maintenance of a minimum net worth at Mid-State, if not cured, amended or waived, could result in the servicers being terminated and replaced by a successor servicer. The replacement of Mid-State and WMC would have a negative effect on their financial condition.

The Company believes that the Mid-State Trust IX Variable Funding Loan Facility, the Mid-State Trust XIV Variable Funding Loan Agreement or similar warehouse lines of credit, will provide Mid-State with the funds needed to purchase the instalment notes and mortgage loans generated by the Homebuilding segment and Walter Mortgage Company.

In December 2003, Mid-State Capital Corporation, a wholly-owned subsidiary of Mid-State Holdings Corporation, filed a shelf registration statement on Form S-3 totaling $1.2 billion for future permanent financings of instalment notes and mortgage loans. It is anticipated that Mid-State will continue to use the Trust IX Variable Funding Loan Facility, the Mid-State Trust XIV Variable Funding Loan Agreement or similar warehouse lines of credit, to finance the purchase of additional instalment notes from the future sales of homes and mortgage loans generated by Walter Mortgage Company. The Company also expects to utilize all or a significant portion of the remaining $906 million under its shelf registration to provide long-term financing of its originated mortgage assets.

Statement of Cash Flows

Cash totaled $29.2 million and $46.9 million at June 30, 2005 and December 31, 2004, respectively. The decrease in cash is primarily the result of net pay-downs of debt ($46.3 million) and purchases of property, plant and equipment ($42.2 million), which exceeded cash flows provided by operating activities ($43.6 million) and cash flow provided by other investing and financing activities.

Cash flows provided by operating activities for the six months ended June 30, 2005 were $43.6 million compared with $17.8 million for the six months ended June 30, 2004. The increase in cash flows provided by continuing operations was principally due to increased income from continuing operations of $57.0 million and a $13.7 million tax benefit from the exercise of employee stock options, partially offset by an increase in net working capital.

Capital expenditures, net of retirements, totaled $42.2 million in the six months ended June 30, 2005 related principally to underground mining and natural gas well equipment at Natural Resources and molding equipment at Industrial Products. Commitments for capital expenditures at June 30, 2005 were not significant; however, it is estimated that gross capital expenditures for the year ending December 31, 2005 will approximate $136 million. Actual expenditures in 2005 may be more or less than this amount, depending upon the level of earnings and cash flow, or expansion opportunities in certain markets.

For the six months ended June 30, 2005, the Company paid approximately $6.8 million of interest on corporate debt. For the year ending December 31, 2005, the Company estimates that total cash interest payments related to corporate debt will be approximately $13.6 million.

On July 29, 2005, the Board of Directors declared a $0.04 per share dividend payable on September 13, 2005 to shareholders of record on August 12, 2005.

MARKET RISK

The Company's primary market risk exposures relate to (i) restricted short-term investments, (ii) interest rate risk during the build-up of assets in the mortgage warehouse lines, (iii) prepayments on the instalment notes receivable portfolio, (iv) interest rate risk on short and long-term borrowings, (v) interest rate risk on pension and other post employment benefit obligations, (vi) commodity risks associated with the purchase of raw materials and hedge contracts with respect to the purchase and sales of natural gas, and (vii) interest rate risk associated with hedge contracts with respect to the issuance of mortgage-backed securities. There have been no material changes, other than those described below, to the information in "Item 7a. Qualitative and Quantitative Disclosures About Market Risk" described in the Annual Report on Form 10-K for the fiscal year ended December 31, 2004.

The Company's exposure to interest rate risk has been reduced due to the issuance of fixed-rate convertible senior subordinated notes and the payoff of the variable-rate Term Loan during April 2004.

The Company's fixed-rate instalment notes receivables and mortgage loans were $1.715 billion and fixed-rate mortgage-backed/asset-backed notes were $1.589 billion as of June 30, 2005. The fixed rate nature of these instruments and their offsetting positions effectively mitigate significant interest rate risk exposure from these instruments although changes in interest rates could affect the fair value of such instruments. If interest rates decrease, the Company may be exposed to higher prepayment speeds. This could result in a modest increase in short-term profitability. However, it could adversely impact long-term profitability as a result of a shrinking portfolio. Changes in interest rates may impact the fair value of these financial instruments.

The level of prepayments on the fixed rate instalment notes will fluctuate with changes in interest rates. Income generated from prepayments will vary each period based on the current interest rate environment and the interest rates associated with the outstanding instalment notes.

NEW ACCOUNTING PRONOUNCEMENTS

CONTROLS AND PROCEDURES

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer (CEO), and Chief Financial Officer (CFO), of the effectiveness of our disclosure controls and procedures as of June 30, 2005. Based on that evaluation, our management, including our CEO and CFO, concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported as specified in the SEC's rules and forms. There has been no change in our internal control over financial reporting during the three months ended June 30, 2005 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 involve known and unknown risks and uncertainties that may cause the Company's actual results in future periods to differ materially from forecasted results. Those risks include, among others, changes in customers' demand for the Company's products, changes in raw material, labor, equipment and transportation costs and availability, geologic and weather conditions, changes in extraction costs and pricing in the Company's mining operations, changes in customer orders, pricing actions by the Company's competitors, the collection of approximately $14 million of receivables associated with a working capital adjustment arising from the sale of a subsidiary in 2003, potential changes in the mortgage-backed capital market, and general changes in economic conditions. Risks associated with forward-looking statements are more fully described in the Company's filings with the Securities and Exchange Commission. The Company assumes no duty to update its outlook statements as of any future date.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings

See Note 14 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 (See Note 14 in this Form 10-Q). 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 2. Unregistered Sales of Equity Securities and Use of Proceeds

Purchase of Equity Securities by the Company and Affiliated Purchasers.

During the quarter ended June 30, 2005, there were no share repurchases and at June 30, 2005, $7.5 million remains available under the Common Stock share repurchase program. During the quarter ended June 30, 2005, the Company has not determined to terminate the program.

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

At the Company's Annual Meeting of Shareholders on April 28, 2005, the following proposals were submitted to the Stockholders:

1.: The election of the following directors:

Director	For	Withhold
Donald N. Boyce	35,247,971	460,023
Howard L. Clark, Jr.	35,248,019	459,975
Don DeFosset	35,462,445	245,549
Jerry W. Kolb	35,628,699	79,295
Bernard G. Rethore	35,453,084	254,910
Neil A. Springer	35,636,083	71,911
Michael T. Tokarz	35,177,851	530,143

2.: A proposal to ratify the appointment of PricewaterhouseCoopers LLP as independent certified public accountants for the year ending December 31, 2005: For, 35,452,106; Against, 254,939; Abstain, 949.

Item 6. Exhibits and Reports on Form 8-K

(a): Exhibits

Exhibit Number
10.12.1		Amended Variable Funding Loan Agreement, dated as of April 29, 2005, among YC Susi Trust, Atlantic Asset Securitization Corporation, Mid-State Trust IX, Wachovia Bank, N.A., Bank of America, N.A and Calyon New York Branch.
12.1		Ratio of Earnings to Fixed Charges

31.1		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002—Chief Executive Officer
31.2		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002—Chief Financial Officer
32.1		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350—Chief Executive Officer
32.2		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350—Chief Financial Officer
(b)		Current Reports on Form 8-K
		The Company filed a Current Report on Form 8-K on April 1, 2005 announcing the Seventh Amendment of its Credit Agreement dated April 17, 2003 effective March 31, 2005, and also announcing the commencement of a conversion period for its holders of its 3.75% convertible senior subordinated notes.
		The Company filed a Current Report on Form 8-K on April 20, 2005 with respect to the press release issued on April 20, 2005 announcing the resignation of an officer.
		The Company filed a Current Report on Form 8-K on April 27, 2005 with respect to the press releases issued on April 26, 2005 announcing the first quarter 2005 earnings and second quarter and full year 2005 earnings expectations.
		The Company filed a Current Report on Form 8-K on May 4, 2005 announcing an Amendment to the Amended and Restated Mid-State Trust IX Variable Funding Loan Facility, dated April 29, 2005.
		The Company filed a Current Report on Form 8-K on May 18, 2005 with respect to the press release issued on May 18, 2005 announcing a significant increase to Jim Walter Resources' long-term metallurgical coal production estimates over the 2006-2009 periods.
		The Company filed a Current Report on Form 8-K on May 27, 2005 with respect to the press release dated May 26, 2005 announcing the appointment of Joseph B. Leonard and Mark J. O'Brien to the Board of Directors.
		The Company filed a Current Report on Form 8-K on June 20, 2005 with respect to the press release issued on June 19, 2005 announcing that the Company entered into a binding agreement to acquire Mueller Water Products, Inc. for $1.91 billion.
		The Company filed a Current Report on Form 8-K on June 22, 2005 announcing the Agreement and Plan of Merger dated June 17, 2005 with Mueller Water Products, Inc., DLJ Merchant Banking II, Inc. and the Company's wholly-owned subsidiary, JW MergerCo, Inc.

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/ W. F. OHRT W. F. Ohrt Executive Vice President and Principal Financial Officer				/s/ C. E. CAUTHEN C.E. Cauthen Senior Vice President, Controller and Principal Accounting Officer

Date: August 9, 2005

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PART I—FINANCIAL INFORMATION WALTER INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED)
WALTER INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
WALTER INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
WALTER INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE SIX MONTHS ENDED JUNE 30, 2005 (UNAUDITED)
WALTER INDUSTRIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
WALTER INDUSTRIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005 (Unaudited)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS, FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES AND QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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Walter Energy Inactive 10-Q2005 Q2 Quarterly report

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