**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

# **FORM 10-Q**

# ** **

| **(Mark One)** |
|----------------|
| **x**          | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES** |
| ** **     | ** ** | **EXCHANGE  ACT OF 1934.** |
| ** **     | ** ** | ** ** |
| ** **     | ** ** | **For the quarterly period ended December 31, 2007** |
| ** **     | ** ** | ** ** |
| ** **     | ** ** | **OR** |
| ** **     | ** ** | ** ** |
| **o**          | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES** |
| ** **     | ** ** | **EXHANGE  ACT OF 1934.** |
| ** **     | ** ** | ** ** |
| ** **     | ** ** | **FOR THE TRANSITION  PERIOD                      TO                      .** |

 

#### **Commission File No. 1-6830**

#### ** **

**ORLEANS HOMEBUILDERS, INC.**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                     | ** ** | **59-0874323**             |
|----------------------------------|------------|----------------------------|
| (State or other  jurisdiction of |       | (I.R.S. Employer I.D. No.) |
| incorporation or  organization)  |       |                       |

 

**3333 Street Road, Suite 101**

**Bensalem, PA 19020**

(Address of principal executive offices)

 
| ** ** | **Telephone:** | **(215) 245-7500** |
|------------|----------------|--------------------|

(Registrant’s telephone number, includingarea code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes x  No o

 

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

 

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

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes o No x

 

Number of shares of commonstock, par value $0.10 per share, outstanding as of February 5, 2008:  18,481,641

(excluding 216,490 shares held in Treasury).

 

 

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# ** **

# **ORLEANS HOMEBUILDERS, INC. AND SUBSIDIARIES**

# ** **

| ** **   | ** **                                                                                                           | **PAGE**   |
|--------------|----------------------------------------------------------------------------------------------------------------------|------------|
|         | **PART 1  – FINANCIAL INFORMATION**                                                                        |       |
|         |                                                                                                                 |       |
| Item 1.      | Financial Statements (unaudited)                                                                                     |       |
|         |                                                                                                                 |       |
|         | Condensed Consolidated  Balance Sheets at December 31, 2007 and June 30, 2007                              | 1          |
|         |                                                                                                                 |       |
|         | Condensed Consolidated  Statements of Operations for the Three and Six Months Ended December 31,  2007 and 2006 | 2          |
|         |                                                                                                                 |       |
|         | Condensed Consolidated  Statements of Shareholders’ Equity for the Six Months Ended December 31,  2007     | 3          |
|         |                                                                                                                 |       |
|         | Condensed Consolidated  Statements of Cash Flows for the Six Months Ended December 31, 2007 and  2006           | 4          |
|         |                                                                                                                 |       |
|         | Notes to  Consolidated Financial Statements                                                                          | 5          |
|         |                                                                                                                 |       |
| Item 2.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                          | 17         |
|         |                                                                                                                 |       |
| Item  3.     | Quantitative  and Qualitative Disclosures About Market Risk                                                          | 34         |
|         |                                                                                                                 |       |
| Item 4.      | Controls  and Procedures                                                                                             | 34         |
|         |                                                                                                                 |       |
| ** **   | **PART II – OTHER INFORMATION**                                                                            | ** ** |
|         |                                                                                                                 |       |
| Item 1A.     | Risk Factors                                                                                                         | 35         |
|         |                                                                                                                 |       |
| Item  4.     | Submission  of Matters to a Vote of Security Holders                                                                 | 35         |
|         |                                                                                                                 |       |
| **Item  6.** | **Exhibits**                                                                                                         | **36**     |

 

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**OrleansHomebuilders, Inc. and SubsidiariesCondensed Consolidated Balance Sheets(Unaudited)(dollars in thousands, except par value)**
| ** **                                                                                        | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|------------------|------------|--------------|------------|
| ** **                                                                                        | ** ** | **2007**         | ** ** | **2007**     | ** ** |
| Assets                                                                                            |       |             |       |         |       |
| Cash and  cash equivalents                                                                        |       | $                | 31,766     |         | $          | 19,991 |   |
| Restricted  cash - due from title company                                                         |       | 9,125            |       | 25,483       |       |
| Restricted  cash - customer deposits                                                              |       | 9,412            |       | 11,362       |       |
| Real estate  held for development and sale:                                                       |       |             |       |         |       |
| Residential properties completed or under  construction                                           |       | 223,250          |       | 228,146      |       |
| Land held for development or sale and  improvements                                               |       | 406,507          |       | 511,872      |       |
| Inventory not owned - Variable Interest  Entities                                                 |       | 51,200           |       | 47,214       |       |
| Inventory not owned - Other Financial  Interests                                                  |       | 13,425           |       | —       |       |
| Property and  equipment, at cost, less accumulated depreciation                                   |       | 2,043            |       | 2,555        |       |
| Deferred  taxes                                                                                   |       | 34,121           |       | 23,480       |       |
| Goodwill                                                                                          |       | 4,180            |       | 4,180        |       |
| Receivables,  deferred charges and other assets                                                   |       | 60,846           |       | 23,559       |       |
| Land  deposits and costs of future development                                                    |       | 9,865            |       | 13,102       |       |
| Total Assets                                                                                      |       | $                | 855,740    |         | $          | 910,944 |   |
|                                                                                              |       |             |       |         |       |
| Liabilities  and Shareholders’ Equity                                                        |       |             |       |         |       |
| Liabilities:                                                                                      |       |             |       |         |       |
| Accounts payable                                                                                  |       | $                | 38,985     |         | $          | 30,891 |   |
| Accrued expenses                                                                                  |       | 50,980           |       | 26,303       |       |
| Customer deposits                                                                                 |       | 15,265           |       | 15,392       |       |
| Obligations related to inventory not owned  - Variable Interest Entities                          |       | 41,467           |       | 38,914       |       |
| Obligations related to inventory not owned  - Other Financial Interests                           |       | 13,425           |       | —       |       |
| Mortgage and other note obligations                                                               |       | 419,129          |       | 469,123      |       |
| Subordinated notes                                                                                |       | 105,000          |       | 105,000      |       |
| Other notes payable                                                                               |       | 755              |       | 787          |       |
| Total Liabilities                                                                                 |       | 685,006          |       | 686,410      |       |
|                                                                                              |       |             |       |         |       |
| Commitments  and contingencies (See Note 14)                                                      |       |             |       |         |       |
|                                                                                              |       |             |       |         |       |
| Shareholders’  Equity:                                                                       |       |             |       |         |       |
| Common  stock, $0.10 par, 23,000,000 shares authorized, 18,698,131 shares issued at  December 31, |       |             |       |         |       |
| 2007 and June 30, 2007                                                                            |       | 1,870            |       | 1,870        |       |
| Capital in  excess of par value - common stock                                                    |       | 74,107           |       | 73,012       |       |
| Accumulated  other comprehensive income                                                           |       | (1,862           | )          | (1,862       | )          |
| Retained  earnings                                                                                |       | 99,108           |       | 154,003      |       |
| Treasury  stock, at cost (196,490 shares held at December 31, 2007 and June 30, 2007)             |       | (2,489           | )          | (2,489       | )          |
| Total  Shareholders’ Equity                                                                  |       | 170,734          |       | 224,534      |       |
|                                                                                              |       |             |       |         |       |
| Total  Liabilities and Shareholders’ Equity                                                  |       | $                | 855,740    |         | $          | 910,944 |   |

 

See accompanying notes whichare an integral part of the consolidated financial statements.

 

1

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**OrleansHomebuilders, Inc. and SubsidiariesCondensed Consolidated Statements of Operations(Unaudited)(in thousands, except per share amounts)**
| ** **                                           | ** ** | **Three Months Ended  December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                           | ** ** | **2007**                             | ** ** | **2006**                           | ** ** | **2007** | ** ** | **2006** | ** ** |
| Earned  revenues                                     |       |                                 |       |                               |       |   |   |   |   |
| Residential properties                               |       | $                                    | 144,490    |                               | $          | 153,172 |   | $ | 263,847 |   | $ | 314,944 |   |
| Land sales                                           |       | 8,224                                |       | 1,797                              |       | 9,410 |   | 2,205 |   |
| Other income                                         |       | 2,229                                |       | 2,159                              |       | 4,562 |   | 5,081 |   |
|                                                 |       | 154,943                              |       | 157,128                            |       | 277,819 |   | 322,230 |   |
| Costs and  expenses                                  |       |                                 |       |                               |       |   |   |   |   |
| Residential properties                               |       | 147,425                              |       | 135,327                            |       | 250,378 |   | 266,640 |   |
| Land sales                                           |       | 44,784                               |       | 1,231                              |       | 46,042 |   | 1,605 |   |
| Other                                                |       | 1,441                                |       | 1,515                              |       | 3,435 |   | 3,511 |   |
| Selling, general and administrative                  |       | 24,588                               |       | 30,599                             |       | 42,863 |   | 55,442 |   |
| Interest:                                            |       |                                 |       |                               |       |   |   |   |   |
| Incurred                                             |       | 13,035                               |       | 12,096                             |       | 25,704 |   | 24,386 |   |
| Less capitalized                                     |       | (13,035                              | )          | (12,096                            | )          | (25,704 | ) | (24,386 | ) |
|                                                 |       | 218,238                              |       | 168,672                            |       | 342,718 |   | 327,198 |   |
|                                                 |       |                                 |       |                               |       |   |   |   |   |
| Loss from  continuing operations before income taxes |       | (63,295                              | )          | (11,544                            | )          | (64,899 | ) | (4,968 | ) |
| Income tax  benefit                                  |       | (24,688                              | )          | (4,515                             | )          | (24,529 | ) | (1,981 | ) |
|                                                 |       |                                 |       |                               |       |   |   |   |   |
| Loss from  continuing operations                     |       | (38,607                              | )          | (7,029                             | )          | (40,370 | ) | (2,987 | ) |
|                                                 |       |                                 |       |                               |       |   |   |   |   |
| Discontinued  operations:                            |       |                                 |       |                               |       |   |   |   |   |
| Loss from discontinued operations, net of  taxes     |       | (12,778                              | )          | (495                               | )          | (13,070 | ) | (638 | ) |
|                                                 |       |                                 |       |                               |       |   |   |   |   |
| Net loss                                             |       | $                                    | (51,385    | )                                  | $          | (7,524 | ) | $ | (53,440 | ) | $ | (3,625 | ) |
|                                                 |       |                                 |       |                               |       |   |   |   |   |
| Basic /  diluted loss per share                      |       |                                 |       |                               |       |   |   |   |   |
| Continuing operations                                |       | $                                    | (2.09      | )                                  | $          | (0.38 | ) | $ | (2.18 | ) | $ | (0.16 | ) |
| Discontinued operations                              |       | $                                    | (0.69      | )                                  | $          | (0.03 | ) | $ | (0.71 | ) | $ | (0.03 | ) |
| Net loss                                             |       | $                                    | (2.78      | )                                  | $          | (0.41 | ) | $ | (2.89 | ) | $ | (0.20 | ) |
|                                                 |       |                                 |       |                               |       |   |   |   |   |
| Dividends  declared per share                        |       | $                                    | 0.02       |                               | $          | 0.04 |   | $ | 0.04 |   | $ | 0.04 |   |
|                                                 |       |                                 |       |                               |       |   |   |   |   |
| Basic /  diluted weighted average shares outstanding |       | 18,502                               |       | 18,476                             |       | 18,502 |   | 18,419 |   |

 

See accompanying notes whichare an integral part of the consolidated financial statements.

 

2

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**OrleansHomebuilders, Inc. and SubsidiariesCondensed Consolidated Statements of Shareholders’ Equity(Unaudited)(dollars in thousands)**
| ** **                                | ** ** | ** **       | ** ** | ** ** | ** ** | ** **      | ** ** | **Capital in**   | ** ** | ** **         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|------------------|------------|------------|------------|-----------------|------------|------------------|------------|--------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                | ** ** | **Common Stock** | ** ** | ** ** | ** ** | **Excess of**   | ** ** | ** **       | ** ** | **Treasury Stock** | ** ** | ** ** | ** ** |
| ** **                                | ** ** | **Shares**       | ** ** | ** ** | ** ** | **Accumulated** | ** ** | **Par Value -**  | ** ** | **Retained**       | ** ** | **Shares** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                | ** ** | **Issued**       | ** ** | **Amount** | ** ** | **OCI**         | ** ** | **Common Stock** | ** ** | **Earnings**       | ** ** | **Held**   | ** ** | **Amount** | ** ** | **Total**  | ** ** |
| Balance at June 30, 2007                  |       | 18,698,131       |       | $          | 1,870      |            | $          | (1,862           | )          | $                  | 73,012     |       | $          | 154,003    |       | 196,490    |       | $ | (2,489 | ) | $ | 224,534 |   |
|                                      |       |             |       |       |       |            |       |             |       |               |       |       |       |       |       |       |       |
| FIN 48 transition adjustment              |       |             |       |       |       |            |       |             |       | (715               | )          |       |       |       |       | (715       | )          |
|                                      |       |             |       |       |       |            |       |             |       |               |       |       |       |       |       |       |       |
| Shares awarded under Stock Award Plan     |       |             |       |       |       |            |       | 122              |       |               |       |       |       |       |       | 122        |       |
|                                      |       |             |       |       |       |            |       |             |       |               |       |       |       |       |       |       |       |
| Fair market value of stock options issued |       |             |       |       |       |            |       | 7                |       |               |       |       |       |       |       | 7          |       |
|                                      |       |             |       |       |       |            |       |             |       |               |       |       |       |       |       |       |       |
| Stock options, net                        |       |             |       |       |       |            |       | 966              |       |               |       |       |       |       |       | 966        |       |
|                                      |       |             |       |       |       |            |       |             |       |               |       |       |       |       |       |       |       |
| Dividends paid on common stock            |       |             |       |       |       |            |       |             |       | (740               | )          |       |       |       |       | (740       | )          |
|                                      |       |             |       |       |       |            |       |             |       |               |       |       |       |       |       |       |       |
| Net loss                                  |       |             |       |       |       |            |       |             |       | (53,440            | )          |       |       |       |       | (53,440    | )          |
|                                      |       |             |       |       |       |            |       |             |       |               |       |       |       |       |       |       |       |
| Balance at December 31, 2007              |       | 18,698,131       |       | $          | 1,870      |            | $          | (1,862           | )          | $                  | 74,107     |       | $          | 99,108     |       | 196,490    |       | $ | (2,489 | ) | $ | 170,734 |   |

 

See accompanying notes whichare an integral part of the consolidated financial statements.

 

3

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**OrleansHomebuilders, Inc. and  SubsidiariesCondensed Consolidated Statements of Cash Flows(Unaudited)(dollars in thousands)**
| ** **                                                                                 | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                 | ** ** | **December 31,**     | ** ** |
| ** **                                                                                 | ** ** | **2007**             | ** ** | **2006** | ** ** |
| Cash flows from  operating activities:                                                     |       |                 |       |   |   |
| Net loss                                                                                   |       | $                    | (53,440    | ) | $ | (3,625 | ) |
| Adjustments  to reconcile net loss to net cash provided by (used in) operating activities: |       |                 |       |   |   |
| Depreciation and amortization                                                              |       | 552                  |       | 659 |   |
| Write-off of real estate held for  development and sale                                    |       | 80,901               |       | 9,850 |   |
| Write-off of land deposits and costs of  future development                                |       | 862                  |       | 9,584 |   |
| Amortization of note discount                                                              |       | —               |       | 6 |   |
| Deferred taxes                                                                             |       | (10,641              | )          | — |   |
| Stock based compensation expense                                                           |       | 1,095                |       | 906 |   |
| Changes in  operating assets and liabilities:                                              |       |                 |       |   |   |
| Restricted cash - due from title company                                                   |       | 16,358               |       | 16,198 |   |
| Restricted cash - customer deposits                                                        |       | 1,950                |       | 952 |   |
| Real estate held for development and sale                                                  |       | 18,060               |       | (50,050 | ) |
| Receivables, deferred charges and other  assets                                            |       | (37,287              | )          | (65 | ) |
| Land deposits and costs of future  developments                                            |       | (12,483              | )          | 2,955 |   |
| Accounts payable and other liabilities                                                     |       | 32,056               |       | (59,431 | ) |
| Customer deposits                                                                          |       | (127                 | )          | (2,484 | ) |
| Net cash  provided by (used in) operating activities                                       |       | 37,856               |       | (74,545 | ) |
|                                                                                       |       |                 |       |   |   |
| Cash flows  from investing activities:                                                     |       |                 |       |   |   |
| Purchases of property and equipment                                                        |       | (40                  | )          | (175 | ) |
| Net proceeds from disposition of business                                                  |       | 11,300               |       | — |   |
| Net cash  provided by (used in) investing activities                                       |       | 11,260               |       | (175 | ) |
|                                                                                       |       |                 |       |   |   |
| Cash flows  from financing activities:                                                     |       |                 |       |   |   |
| Borrowings from loans secured by real  estate assets                                       |       | 25,000               |       | 108,000 |   |
| Repayment of loans secured by real estate  assets                                          |       | (74,994              | )          | (18,491 | ) |
| Repayment of other note obligations                                                        |       | (32                  | )          | (5,040 | ) |
| Liability associated with other financial  interests                                       |       | 13,425               |       | — |   |
| Purchase of treasury stock                                                                 |       | —               |       | (949 | ) |
| Tax benefit from exercise of stock options                                                 |       | —               |       | 948 |   |
| Common stock cash dividend paid                                                            |       | (740                 | )          | (739 | ) |
| Net cash  (used in) provided by financing activities                                       |       | (37,341              | )          | 83,729 |   |
|                                                                                       |       |                 |       |   |   |
| Net increase  in cash and cash equivalents                                                 |       | 11,775               |       | 9,009 |   |
| Cash and  cash equivalents at beginning of year                                            |       | 19,991               |       | 15,964 |   |
| Cash and  cash equivalents at end of period                                                |       | $                    | 31,766     |   | $ | 24,973 |   |

 

See accompanying notes whichare an integral part of the consolidated financial statements.

 

4

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**ORLEANS HOMEBUILDERS, INC.AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)(Dollars in thousands, except per share amounts)**

**1.****             ****BASIS OF PRESENTATION AND SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

Orleans Homebuilders, Inc.and its subsidiaries (collectively, the “Company”) market, develop and buildhigh-quality, single-family homes, townhomes and condominiums to serve varioustypes of homebuyers, including move-up, luxury, empty nester, active adult andfirst-time homebuyers. The Company also generates revenue from the sale ofland.

 

During thethree and six months ended December 31, 2007, the Company incurred a net lossof $51,385 and $53,440, respectively, compared to a net loss of $7,524 and$3,625 for the three and six months ended December 31, 2006, respectively.  The homebuilding industry is cyclical andaffected by changes in national and local economic, business and otherconditions.  During the second half offiscal 2006 and all of fiscal 2007, the Company and the entire homebuildingindustry have faced several significant challenges in the housing and mortgagemarkets as a whole.  These challengescontinued throughout the six months ended December 31, 2007 and includedecreased homebuyer demand due to lower consumer confidence in the overallhousing market, increased uncertainty in the overall mortgage market, increasedunderwriting standards and an increase in foreclosures.  The Company is responding to theseunfavorable market conditions by attempting to maintain absorption levelsthrough the use of sales incentives, reevaluating its individual land holdingsand reducing its land expenditures and emphasizing cost reductions to adjustfor lower levels of production.

 

***Interim Financial Information***

 

These condensed financialstatements have been prepared in accordance with the rules of theSecurities and Exchange Commission for interim financial statements and do notinclude all annual disclosures required by accounting principles generallyaccepted in the United States. These financial statements should be read inconjunction with the audited consolidated financial statements and notesthereto included in the Company’s Form 10-K for the fiscal year ended June 30,2007. The condensed financial information as of December 31, 2007 and forthe three and six months ended December 31, 2007 and 2006 is unaudited,but includes all adjustments, consisting of normal recurring accruals, thatmanagement considers necessary for a fair presentation of the Company’s consolidatedresults of operations, financial position and cash flows. Results for the threeand six months ended December 31, 2007 are not necessarily indicative ofresults to be expected for the full fiscal year 2008 or any other futureperiods.

 

InJune 2006, the Financial Accounting Standards Board (“FASB”) issued FASBInterpretation No. 48, “Accounting for Uncertainty in Income Taxes-AnInterpretation of FASB Statement 109” (“FIN 48”). FIN 48 prescribes amore-likely than not recognition threshold as well as a measurement attributefor the financial statement recognition and measurement of tax positions takenor expected to be taken in a tax return. The Company adopted the provisions ofFIN 48, as of July 1, 2007. See Note 11 below for additional discussionregarding the impact of the implementation of FIN 48.

 

On December 31, 2007, the Company committed to exiting its Arizonamarket and, in connection with this decision, on that date it disposed of itsentire land position and its related work-in-process homes in Arizona, whichconstituted substantially all of its assets in the western region. TheConsolidated Financial Statements have been reclassified for all prior periodspresented to reflect this business as discontinued operations (see note 12 – ‘DiscontinuedOperations’).

 

***Income Taxes***

 

Income taxes are accountedfor in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 109,“Accounting for Income Taxes”*,*(“SFAS 109”). The Company recordsincome taxes under the asset and liability method, whereby deferred tax assetsand liabilities are recognized based on the future tax consequencesattributable to temporary differences between the financial statement carryingamounts of existing assets and liabilities and their respective tax basis andattributable to operating loss and tax credit carryforwards. Deferred taxassets and liabilities are measured using enacted tax rates expected to applyin the years in which the temporary differences are expected to be recovered orpaid. The effect on deferred tax assets and liabilities of a change in taxrates is recognized in earnings in the period when the changes are enacted.

 

SFAS 109 requires areduction of the carrying amounts of deferred tax assets by a valuationallowance if, based on the available evidence, it is more likely than not thatsuch assets will not be realized. Accordingly, the need to establish valuationallowances for deferred tax assets are assessed periodically by the Companybased on the SFAS 109 more-likely-than-not realization threshold criterion. Inthe assessment for a valuation allowance, appropriate consideration is given toall positive and negative evidence related to the realization of the deferredtax assets. This assessment considers, among other matters, the nature,frequency and severity of current and cumulative losses, forecasts of futureprofitability, excess of appreciated asset value over the tax basis of netassets, the duration of statutory carryforward periods, the Company’sexperience with operating loss and tax credit carryforwards not expiringunused, and tax planning alternatives.

 

The Company’s analysis ofthe need for a valuation allowance recognizes that the Company has incurred acumulative loss over its evaluation period (three years for the period ending December 31,2007), including a substantial loss during the 2007 calendar year. A majorityof the current loss was the result of the difficult current market conditions,as well as losses and impairment charges incurred on the nine asset sales thattook place during December 2007, that led to the impairments of certain realestate held for development or sale as well as goodwill. The Company believesit will generate taxable earnings in its combined primary markets.Consideration has also been given to the 

 

5

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period over which these netdeferred tax assets can be realized, and the Company’s history of not havingFederal tax loss carryforwards expire unused.

 

At December 31, 2007and June 30, 2007, the Company’s net deferred tax asset was $34,121 and$23,480, respectively. Based on the Company’s assessment, it appears morelikely than not that the net deferred tax asset will be realized through futuretaxable earnings and the excess of appreciated asset value over the tax basisof the Company’s net assets. Accordingly, no valuation allowance has beenestablished for the Company’s net deferred tax asset. The Company will continueto assess the need for a valuation allowance in the future. If future resultsare less than projected particularly in the Company’s primary markets, taxplanning alternatives no longer are viable, or there is not excess appreciatedasset value over the tax basis of net assets, a valuation allowance may be required to reduce the deferred taxassets, which could have a material impact on our results of operations in theperiod in which it is recorded.

 

**2.****             ****RESIDENTIAL PROPERTIES COMPLETEDOR UNDER CONSTRUCTION**

 

Residentialproperties completed or under construction consist of the following:

 
| ** **                                                    | ** ** | **December 31,** | ** **    | **June 30,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------|---------------|-------------------|------------|
| ** **                                                    | ** ** | **2007**              | ** **    | **2007**          | ** ** |
| Under contract for sale                                       | ** ** | $                     |  132,979 |              | $          |  126,856 | ** ** |
| Unsold                                                        |       | 90,271                |          | 101,290           |       |
| Total  residential properties completed or under construction |       | $                     | 223,250       |              | $          | 228,146 |   |

 

**3.****             ****MORTGAGE AND OTHER NOTEOBLIGATIONS AND SUBORDINATED NOTES**

 

The$419,129 outstanding balance in mortgage and other note obligations at December 31,2007 consists of $418,950 outstanding under the Revolving Credit Facility,which is discussed below, and $179 under mortgage obligations collateralized byland held for development and sale and improvements. The average daily balanceduring the six months ended December 31, 2007 was $486,798.

 

The$105,000 outstanding balance in subordinated notes relates to the sale andissuance of trust preferred securities as discussed below.

 

***Revolving Credit Facility***

 

OnDecember 21, 2007 and effective December 1, 2007, the Company enteredinto an amendment to the Amended and Restated Credit Agreement described below(“Fifth Amendment”). The Fifth Amendment amended certain covenants and terms ofthe Amended and Restated Credit Agreement, generally to permit the Company tocomplete the land sales discussed in note 4 — ‘Land Sales’ below. As of December 31,2007, the Company was in compliance with all of its covenants as they exist subsequentto the Fifth Amendment.

 

OnSeptember 6, 2007 and effective June 30, 2007, the Company enteredinto an amendment to the Amended and Restated Credit Agreement described below(“Fourth Amendment”). The Fourth Amendment extended the maturity on a portionof the Credit Facility to December 20, 2009 and reduced the total size to$585,000, as well as amended certain covenants.

 

AtDecember 31, 2007, the Company had $418,950 outstanding and $133,571 ofborrowing capacity under its secured revolving credit facility discussed below,of which, $19,557 was available to be drawn based on the Company’s monthlyborrowing base certificate as of December 31, 2007. In addition,approximately $32,479 of letters of credit and other assurances of the availabilityof funds have been provided under the Revolving Credit Facility, as definedbelow.

 

***Terms of the Revolving CreditFacility:***

 

OnDecember 22, 2004, Greenwood Financial, Inc., a wholly-ownedsubsidiary of the Company and other wholly-owned subsidiaries of the Company,as borrowers, and Orleans Homebuilders, Inc., as guarantor, entered into aRevolving Credit and Loan Agreement for a $500,000 Senior Secured RevolvingCredit and Letter of Credit Facility with various banks as lenders (as amendedand restated and further amended, the “Revolving Credit Facility”). TheRevolving Credit and Loan Agreement was amended on January 24, 2006 viathe Amended and Restated Revolving Credit and Loan Agreement (the 

 

6

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“AmendedCredit Agreement”). In connection with the Amended Credit Agreement, OrleansHomebuilders, Inc. entered into an amended Guaranty agreement, which wasamended on September 6, 2007 by the First Amendment to Guaranty. TheAmended and Restated Credit Agreement was amended on November 1, 2006 (the“First Amendment”), February 7, 2007 (the “Second Amendment”), May 8,2007 (the “Third Amendment”), September 6, 2007 (the “Fourth Amendment”)and December 21, 2007 (the “Fifth Amendment”).

 

Theborrowing limit under the Revolving Credit Facility is $585,000, subject toincrease if certain conditions are met. Under and subject to the terms of theRevolving Credit Facility, the borrowers may borrow and re-borrow for thepurpose of financing the acquisition and development of real estate, theconstruction of homes and improvements, for investment in joint ventures, forworking capital and for such other appropriate corporate purposes as may beapproved by the lenders. Capitalized terms used below and not otherwise definedhave the meanings set forth in the Amended and Restated Credit Agreement.

 

Pursuantto the Fourth Amendment, and subject to the terms of the Revolving CreditFacility, approximately $121,000 of the $585,000 Revolving Credit Facility hasa maturity date of December 20, 2008 and the remaining $464,000 has amaturity date of December 20, 2009. Borrowings and advances under theRevolving Credit Facility bear interest on a per annum basis equal to the LIBORMarket Index Rate plus a non-default variable spread ranging from 250 basispoints to 400 basis points, depending upon the Company’s leverage ratio. Duringthe term of the Revolving Credit Facility, interest is payable monthly inarrears. At December 31, 2007, the interest rate was 7.350%, which includeda 275 basis point spread.

 

Thetotal amount of loans and advances outstanding at any time under the RevolvingCredit Facility may not exceed the lesser of the then-current borrowing baseavailability or the revolving sublimit as defined in the Revolving CreditFacility. Pursuant to the Fourth Amendment, the revolving sublimit is $585,000,subject to reduction on December 20, 2008. The borrowing base availabilityis based on the lesser of the appraised value or cost of real estate owned bythe Company that has been admitted to the borrowing base. Various conditionsmust be satisfied in order for real estate to be admitted to the borrowingbase, including that a mortgage in favor of lenders has been delivered to theagent for lenders and that all governmental approvals necessary to begindevelopment of for-sale residential housing, other than building permits andcertain other permits borrower in good faith believes will be issued within 120days, have been obtained. Depending on the stage of development of the realestate, the loan to value or loan to cost advance rate in the borrowing base rangesfrom 50% to 95% of the appraised value or cost of the real estate.

 

Assecurity for all obligations of borrowers to lenders under the Revolving CreditFacility, lenders have a first priority mortgage lien on all real estateadmitted to the borrowing base. In addition, Orleans Homebuilders, Inc.has guaranteed the obligations of the borrowers to lenders pursuant to anamended Guaranty executed by Orleans Homebuilders, Inc. on January 26,2006 and amended on September 6, 2007. Under the Guaranty, OrleansHomebuilders, Inc. granted lenders a security interest in any balance orassets in any deposit or other account that Orleans Homebuilders, Inc. haswith any lender.

 

TheRevolving Credit Facility contains customary covenants that, subject to certainexceptions, limit the ability of the Company to (among other things):

 

**·**                 Incur or assume other indebtedness, exceptcertain permitted indebtedness;

·                  Grant or permit to exist any lien, exceptcertain permitted liens;

·                  Enter into any merger, consolidation oracquisition of all or substantially all the assets of another entity;

·                  Sell, assign, lease or otherwise dispose ofall or substantially all of its assets;

·                  Enter into any transaction with an affiliatethat is not a borrower or a guarantor under the Revolving Credit Facility, or asubsidiary of either;

·                  Pay dividends in excess of $0.02 per shareper quarter; or

·                  Redeem any stock.

 

TheRevolving Credit Facility also contains various financial covenants. Amongother things, the financial covenants, as amended, require that:

 

·                  As of the last day of each fiscal quarter,the ratio of the Company’s Adjusted EBITDA to debt service for the prior fourfiscal quarters cannot be not less than 0.20-to-1.00 for the period ending June 30,2008; 0.50-to-1.00 for the period ending September 30, 2008; 0.65-to-1.00for the period ending December 31, 2008, March 31, 2009 and June 30,2009; and 1.00-to-1.00 for the period ending September 30, 2009. As aresult of the Fourth and Fifth Amendments, the Adjusted EBITDA to debt servicecovenant was waived for the periods ending June 30, 2007, 

 

7

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September 30, 2007, December 31, 2007 and March 31,2008.

·                  The Company must maintain a minimumconsolidated tangible net worth of at least $192,000 plus 50% of the positivenet income earned after June 30, 2007 and all of the net proceeds ofequity securities issued by the Company after June 30, 2007. In addition,the minimum consolidated adjusted tangible net worth shall be reduced by after-taxinventory impairments up to a maximum aggregate amount of $35,000 and after-taxland sales impairments up to a maximum aggregate amount of $50,000, provided thatthe minimum consolidated tangible net worth is at least $130,000 at all times.

·                  As of the last day of each fiscal quarter,the Company’s leverage ratio cannot exceed 4.00-to-1.00 for any fiscal quartersending on or after December 31, 2007. In addition, as of the last day ofeach fiscal quarter ending on or after December 31, 2007, the Company’sleverage ratio, excluding the effect of inventory impairments and land salesimpairments, cannot exceed 3.00-to-1.00.

·                  As of the last day of each fiscal quarter,the ratio of the book value of all land that is not subject to a qualifyingagreement of sale and on which no unit has been or is being constructed to theCompany’s consolidated adjusted tangible net worth cannot exceed 2.00-to-1.00at December 31, 2007 and March 31, 2008; 1.85-to-1.00 at June 30,2008, September 30, 2008 and December 31, 2008; and 1.75-to-1.00 at March 31,2009 through maturity.

·                  The Company must maintain a requiredliquidity level based on cash plus borrowing base availability and under thiscovenant, the Company must have (i) at least $10,000 of cash and cashequivalents (as defined) as of the reporting date of each borrowing basecertificate, and (ii) at least $15,000 of liquidity (as defined andincluding cash and cash equivalents) as of the date of each borrowing basecertificate, through July 31, 2008. Starting August 31, 2008, theCompany must have (i) at least $15,000 of cash and cash equivalents (asdefined) as of the reporting date of each borrowing base certificate, and (ii) atleast $20,000 of liquidity (as defined and including cash and cash equivalents)as of the date of each borrowing base certificate.

·                  Under a minimum cash flow from operationsratio based on cash flow from operations to interest incurred covenant, which isapplicable starting with the twelve-month period ending December 31, 2007,if the interest coverage ratio is less than 1.25-to-1.00, the Company must havea cash flow from operations to interest incurred ratio (as defined) of at least1.50-to-1.00. During the first four quarterly periods during which thiscovenant is applicable, even if the interest coverage ratio is less than1.25-to-1.00, the cash flow from operations ratio may be less than 1.50-to-1.00during any one period, so long as it is greater than 1.00-to-1.00. Cash flowfrom operations is calculated based on the last twelve months cash flow fromoperations and adjusted for interest expense and includes any amounts from thedisposition of model homes that are subject to a sale-leaseback transaction tothe extent such amounts are not otherwise included in net cash provided byoperating activities.

 

Inaddition, the Revolving Credit Facility contains various financial covenantswith respect to the value of land in certain stages of development that may beowned by the Company, a borrower or any subsidiary of the Company and limitsthe number of units which are not subject to a bona-fide agreement of sale thatmay be in the inventory of any borrower, the Company or any subsidiary of theCompany.

 

Atthe fiscal quarters ended September 30, 2006, December 31, 2006, March 31,2007 and June 30, 2007, the Company would have been in violation ofcertain financial covenants in the Amended and Restated Credit Agreement if notfor the First Amendment, Second Amendment, Third Amendment and FourthAmendment, respectively, notwithstanding the fact that as of September 6,2007 (the date of the Fourth Amendment), the Company was in compliance with allof its covenants as they existed immediately prior to the Fourth Amendment.

 

TheRevolving Credit Facility provides that, subject to any applicable notice andcure provisions, each of the following (among others) is an event of default:

 

·                  Failure by borrowers to pay when due anyamounts owing under the Revolving Credit Facility;

·                  Failure by the Company to observe or performany promise, covenant, warranty, obligation, representation or agreement underthe Revolving Credit Facility or any other loan document;

·                  Bankruptcy and other insolvency events withrespect to any borrower or the Company;

·                  Dissolution or reorganization of any borroweror the Company;

·                  The entry of a judgment or judgments againstborrower(s) or the Company: (i) in an aggregate amount that is atleast $500 in excess of available insurance proceeds, if such judgment orjudgments are not dismissed or bonded within 30 days; or (ii) thatprevents borrowers from conveying lots and units in the ordinary course ofbusiness if such judgment or judgments are not dismissed or bonded within 30days; or the issuance of any writs of attachment, execution or garnishmentagainst any borrower or the Company;

·                  Any material adverse change in the financialcondition of a borrower or the Company which causes the lenders, in 

 

8

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good faith, to believe that the performance of anyof the obligations under the Revolving Credit Facility is impaired or doubtfulfor any reason; and

·                  Specified cross defaults.

 

Uponthe occurrence and continuation of an event of default, after completion of anyapplicable grace or cure period, lenders may demand immediate payment in fullof all indebtedness outstanding under the Revolving Credit Facility, terminatetheir obligations to make any loans or advances or issue any letter of credit,set off and apply any and all deposits held by any lender for the credit oraccount of any borrower. In addition, upon the occurrence of certain events ofbankruptcy or other insolvency events with respect to any borrower or theCompany, all indebtedness outstanding under the Revolving Credit Facility shallbe immediately due and payable without any act or action by lenders.

 

***Trust Preferred Securities***

 

OnNovember 23, 2005, the Company issued $75,000 of trust preferredsecurities which mature on January 30, 2036 and are callable, in whole orin part, at par plus accrued interest on or after January 30, 2011. Forthe first ten years, the securities have a fixed interest rate of 8.61% perannum, provided that certain covenant levels are maintained. Thereafter, the securitieshave a floating interest rate equal to three-month LIBOR plus 360 basis pointsper annum, resetting quarterly.

 

Pursuant to the original Indenture, in the event theCompany fails to meet certain financial ratios for three of four consecutivequarters, the applicable rate of interest will be increased by 300 basis pointsuntil the Company is in compliance with the financial ratios, at which time theinterest rate will return to its original amount. On August 13, 2007, theCompany entered into Supplemental Indenture No. 1 (the “SupplementalIndenture”), which amended the terms of the securities by deferring thepotential start of this increased rate of interest for at least four quarters. Butfor the Supplemental Indenture, the Company would have been subject to theincreased rate of interest starting with the first quarter of fiscal 2008. Pursuantto the Supplemental Indenture, it is an event of default if the increasedinterest rate is in effect for eight consecutive interest payment periods,starting with the quarterly interest payment due on October 30,2008.  The occurrence of an event of default may trigger demand forimmediate payment in full of all outstanding amounts.  An uncured event ofdefault under the trust preferred securities also constitutes an event ofdefault under the Amended and Restated Credit Agreement.  At December 31,2006, March 31, 2007, June 30, 2007, September 30, 2007 and December 31,2007 the Company failed to meet the interest coverage ratio. The interestcoverage ratio is the ratio of Adjusted EBITDA to Debt Service, as defined inthe Supplemental Indenture, for the relevant accounting period.  TheCompany anticipates that it will not meet the interest coverage ratio for thequarter ending March 31, 2008. As a result, the Company anticipates thatit will begin to pay the increased rate of interest under the $75,000 of trustpreferred securities starting with the quarterly interest payment due on October 30,2008.

 

To allow the Supplemental Indenture to becomeeffective, OHI Financing, Inc. established a $5,000 reserve fund for thebenefit of the holders of the trust preferred securities by posting a letter ofcredit with the trustee under the Supplemental Indenture, which is subject toincrease and may be drawn by the trustee and used in respect of the trustpreferred obligations.

 

Thesecurities are treated as debt obligations for financial statement purposes.The Company used proceeds from the sale of these securities to repayoutstanding obligations under the Revolving Credit Facility discussed above.

 

OnSeptember 20, 2005, the Company issued $30,000 of trust preferredsecurities which mature on September 30, 2035 and are callable, in wholeor in part, at par plus accrued interest on or after September 30, 2010.For the first ten years, the securities have a fixed interest rate of 8.52% perannum. Thereafter, the securities have a floating interest rate equal tothree-month LIBOR plus 380 basis points per annum, resetting quarterly. Thesecurities are treated as debt obligations for financial statement purposes.The Company used proceeds from the sale of these securities to fund landpurchases and residential construction. The obligations relating to the trustpreferred securities are subordinated to the Revolving Credit Facility.

 

**4.****             ****LAND SALES**

 

Duringthe three months ended December 31, 2007, the Company identified parcelsof land to sell and negotiated contracts with potential buyers on these parcels.During December 2007, the Company closed on nine separate land sale transactions,disposing of approximately 1,400 lots. Included in the approximately 1,400 lotsdisposed, were 267 lots that comprised the Company’s entire work-in-processinventory and land positions in its Phoenix, Arizona market. The Company hashistorically reported this business as its western region operating segment. Thedisposed work-in-process inventory and land positions constituted substantiallyall of the Company’s assets and operations in the western region. Accordingly,all charges associated with the western region are included as a discontinuedoperation (see note 12 – ‘Discontinued Operations’).

 

9

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TheCompany received proceeds on the sale in the amount of $32,949, of which,$8,224 was recognized as land sales revenue during the three months ended December 31,2007, exclusive of $11,300 of proceeds related to the sale of land in theCompany’s western region, as discussed above. The remaining $13,425 of proceedsrelates to two parcels of land that were sold and subsequently subject to anoption agreement (see note 5 – ‘Inventory Not Owned – Other Financial Interests’).

 

Duringthe six months ended December 31, 2007, the Company received proceeds onthe sale of land in the amount of $34,135, of which, $9,410 was recognized asland sales revenue during the six months ended December 31, 2007.

 

Inaddition, the Company anticipates receiving approximately $25,000 of federalincome tax refunds directly or indirectly as a result of these transactionsbefore its fiscal year ended June 30, 2008.

 

**5.****             ****INVENTORY NOT OWNED – OTHERFINANCIAL INTERESTS**

 

Soldland that is subject to an option agreement is accounted for using the financemethod of accounting.  The optionprovides the company with the option, but not the obligation, to reacquireindividual lots on a periodic lot takedown schedule.  Detailsof the financing method are described below:

 
    - The costs     associated with the land parcel at the time it is sold are reported in     ‘Inventory not owned – Other Financial Interests’ on the Company’s     condensed consolidated balance sheet.
    - The cash     received from the buyer is reported as a liability within ‘Obligations     related to inventory not owned – Other Financial Interests’ on the     Company’s condensed consolidated balance sheet.  The liability is accreted at an interest     rate consistent with the Company’s effective borrowing rate over the life     of the option.  The Company will     report interest incurred in connection with the accretion of the     liability.  Interest incurred will     be subject to capitalization into land and improvements costs.
    - The lot     purchase price under the option includes both the amount to repurchase the     land sold at its original cost to the buyer plus interest, as well as     improvements made by the buyer subsequent to his purchase and prior to the     Company’s repurchase.  Upon exercise     of the option, the amount of the lot purchase price attributable to the     original cost to the buyer plus interest will be applied to the accreted     liability. The amount of the lot purchase price in excess of the accreted     liability represents reimbursement to the buyer for lot improvement costs     and will be capitalized within land held for development or sale and     improvements.   The cost of the lot     within land held for development or sale and improvements will be expensed     through cost of residential properties and land sold in accordance with     the Company’s policy.
    - Upon     termination or expiration of the option, we will recognize land sales     revenue and cost of land sales.

 

**6.****             ****ASSET IMPAIRMENTS – REAL ESTATEHELD FOR DEVELOPMENT AND SALE**

 

TheCompany accounts for its real estate held for development and sale inaccordance with SFAS No. 144, “Accounting for the Impairment or Disposalof Long-Lived Assets” (“SFAS 144”). SFAS 144 requires that long-lived assets bereviewed for impairment whenever events or changes in circumstances indicatethat the carrying value of the asset may not be recoverable. Recoverability of realestate held for development and sale is measured by comparing the carryingvalue to the future undiscounted net cash flows expected to be generated by theasset. The impairment loss is the difference between the book value of theassets and the discounted future cash flows generated from expected revenue ofthe assets, less the associated cost to complete and direct costs to sell,which approximates fair value. The estimates used in the determination of theestimated cash flows and fair value of the asset are based on factors known tous at the time such estimates are made and our expectations of futureoperations. These estimates of cash flows are significantly impacted byestimates of the amounts and timing of revenues and costs and other factors,which, in turn, are impacted by local market economic conditions and theactions of competitors. Should the estimates or expectations used indetermining estimated cash flows or fair value decrease or differ from currentestimates in the future, we may be required to recognize additional impairmentsrelated to these assets.

 

*Land Sale Impairment Losses*

 

Asdiscussed in note 4 - ‘Land Sales’, during the three months ended December 31,2007, the Company specifically identified parcels of land to sell andnegotiated contracts with potential buyers. Prior to the closing of the landsale transactions, the Company recorded asset impairments on the land to besold of $36,556 for the three and six months ended December 31, 2007. TheCompany’s midwestern region recorded impairments of $23,163 related to the saleof two parcels. The Company’s Florida region recorded impairments of $8,385related to the sale of four parcels. The Company’s southern region recordedimpairments of $5,008 related to the sale of two parcels.

 

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Additionally,the Company recorded an impairment charge of $20,706 related to the sale of itsland position in the western region. This impairment charge is included in lossfrom discontinued operations.

 

Theseimpairment charges represent the amounts by which the carrying value of theassets sold exceeded their fair values less costs to sell. The fair value ofthe assets was determined based on the contracted sales price. These impairmentcharges were included in the cost of land sales on the Consolidated Statementsof Operations.

 

*Long-lived Asset Impairment Losses*

 

Inaddition to the impairment charges recognized prior to the land sales, theCompany recognized long-lived asset impairment losses totaling $22,917 and$23,629 for the three and six months ended December 31, 2007,respectively, due to increased sales incentives and continued deterioration inoverall market conditions in all regions. This further market deterioration inthe homebuilding market along with the disruption in the credit markets in thesecond quarter of fiscal 2008, have significantly adversely impacted the valueof this inventory beyond previous expectations causing the Company to re-assessits projects for impairment at December 31, 2007. Specifically, theCompany’s midwestern region recognized an impairment loss of $9,668 during thethree and six months ended December 31, 2007, relating to five communitiesas a result of an overall decline in the demand for new homes, increased pricecompetition as well as lower consumer confidence and slower economic activityin this market. The Company’s northern region recognized an impairment loss of$5,654 and $6,366 during the three and six months ended December 31, 2007,respectively, relating to five communities as a result of increased pricecompetition and slowing sales in the resale home market. Additionally, theCompany’s southern region recognized an impairment loss of $5,200 during thethree and six months ended December 31, 2007, relating to five communitiesas a result of market conditions similar to that of the northern region. TheCompany’s Florida region recognized an impairment loss of $2,395 during thethree and six months ended December 31, 2007, relating to threecommunities primarily due to the increased supply of existing home inventory,lower consumer confidence and slower economic activity in this market..

 

Asa result of increased sales incentives offered during fiscal year 2007 and adecrease in anticipated absorption rates at various communities, the Companyrecognized long-lived asset impairment losses totaling $9,850 during the sixmonths ended December 31, 2006.  The Company’s northern regionrecognized a $3,900 impairment loss relating to two communities, while theCompany’s Florida region recognized a $4,800 impairment loss relating itsscattered lot inventory.  In addition, the Company’s southern regionrecognized a $900 impairment loss.  Further, the Company’s Midwest regionrecognized a $250 impairment loss relating to one community due to salesincentives being offered to close out the community.

 

Asa result of the continued deterioration of market conditions during the secondquarter, the Company performed a review of outstanding land positions, as wellas absorption, pricing and gross profit to determine if an impairment chargewas necessary. The long-lived asset impairment losses recorded were the amountsby which the carrying value of the assets described above exceeded their fairvalues. The long-lived asset impairment losses were included in the cost ofresidential properties on the consolidated statements of operations.

 

**7.****             ****STOCK BASED COMPENSATION**

 

***Stock Option Plans***

 

OnAugust 26, 2004, the board of directors of the Company adopted the OrleansHomebuilders, Inc. 2004 Omnibus Stock Incentive Plan (as subsequentlyamended, the “2004 Stock Incentive Plan”), which is intended to function as anamendment, restatement and combination of all stock option and award plans ofthe Company other than the Orleans Homebuilders, Inc. Stock Award Plan.

 

OnDecember 6, 2007, the stockholders of the Company approved the secondamendment and restatement of the 2004 Stock Incentive Plan to increase thenumber of shares of the Company’s common stock authorized for issuance underthe plan from 400,000 to 2,000,000 shares.

 

InDecember 2004, the FASB revised SFAS No. 123 through the issuance ofSFAS No. 123-R “Share-Based Payment”, 

 

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revised(“SFAS 123-R”). SFAS 123-R was effective for the Company commencing July 1,2005. SFAS 123-R, among other things, eliminates the alternative to use theintrinsic value method of accounting for stock based compensation and requiresentities to recognize the cost of employee services received in exchange forawards of equity instruments based on the grant-date fair value of those awards(with limited exceptions). The fair value based method in SFAS 123-R is similarto the fair-value-based method in SFAS No. 123 in most respects, subjectto certain key differences. The Company previously adopted the fair valuerecognition provisions of SFAS No. 123 prospectively for all stock awardsgranted and, as such, the impact of the modified prospective adoption of SFAS123-R did not have a significant impact on the financial position or results ofoperations of the Company.

 

Duringthe three months ended December 31, 2007 and 2006, the Company recognized$492 and $365, respectively, of stock based compensation expense related tostock options. During the six months ended December 31, 2007 and 2006, theCompany recognized $966 and $730, respectively, of stock based compensationexpense related to stock options

 

Thefollowing summarizes stock option activity for the Company’s stock option plansduring the six months ended December 31, 2007:

 
| ** **                                | ** ** | ** ** | ** ** | **Weighted**           | ** **  |
|-------------------------------------------|------------|------------|------------|------------------------|-------------|
| ** **                                | ** ** | **Shares** | ** ** | **Average Price** | ** **  |
| Outstanding at June 30,  2007        | ** ** | 645,000    |       | $                      |  13.46 | ** ** |
| Granted                                   |       | 180,000    |       | 4.03                   |        |
| Exercised                                 |       | —     |       | N/A                    |        |
| Repricing adjustment(1)                   |       | —     |       | (10.95                 | )           |
| Cancelled                                 |       | —     |       | N/A                    |        |
| Outstanding  at December 31, 2007    |       | 825,000    |       | $                      | 8.22        |   |
|                                      |       |       |       |                   |        |
| Exercisable  at December 31, 2007(2) |       | 217,500    |       | $                      | 9.23        |   |

 

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(1) Optionsto acquire 240,000 shares at $15.60 were repriced to $4.65 during the sixmonths ended December 31, 2007.

(2) 120,000of the 217,500 options exercisable at December 31, 2007 have a marketvalue in excess of the strike price.

 

Nostock options were exercised during the three and six months ended December 31,2007. The intrinsic value of stock options exercised during the three monthsand six months ended December 31 2006, was $2,046 and $2,371,respectively.

 

During the three and six months ended December 31, 2007, theCompany repriced an option to acquire 240,000 shares and granted options toacquire an additional 180,000 shares.

 

Thefollowing table summarizes information about the Company’s stock options at December 31,2007:

 
| ** **              | **Options Outstanding** | ** **                    | **Options Exercisable** | ** **      |
|-------------------------|------------------------------|-------------------------------|------------------------------|-----------------|
| ** **              | ** **                   | ** **                    | ** **                   | **Weighted**    | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **              | ** **                   | **Outstanding**               | ** **                   | **Average**     | ** ** | **Average** | ** ** | **Exercisable** | ** ** | **Average** | ** ** |
| **Range of**       |                         | **at December 31,** |                         | **Contractual** |   | **Exercise** |   | **at December 31,** |   | **Exercise** |   |
| **Exercise Price** |                         | **2007**                      |                         | **Life**        |   | **Price** |   | **2007** |   | **Price** |   |
| $                       |  1.19                   |                          | 95,000                       |            | 0.3 |   | $ | 1.19 |   | 95,000 |   | $ | 1.19 |   |
| 2.06                    |                         | 2,500                         |                         | 0.9             |   | 2.06 |   | 2,500 |   | 2.06 |   |
| 4.03                    |                         | 180,000                       |                         | 10.0            |   | 4.03 |   | — |   | N/A |   |
| 4.65                    |                         | 240,000                       |                         | 9.2             |   | 4.65 |   | — |   | N/A |   |
| 10.64                   |                         | 30,000                        |                         | 5.6             |   | 10.64 |   | 30,000 |   | 10.64 |   |
| 15.63                   |                         | 250,000                       |                         | 8.5             |   | 15.63 |   | 62,500 |   | 15.63 |   |
| 21.60                   |                         | 27,500                        |                         | 6.7             |   | 21.60 |   | 27,500 |   | 21.60 |   |
|                    |                         | 825,000                       |                         | 7.9             |   | $ | 8.22 |   | 217,500 |   | $ | 9.23 |   |
|                         |                              |                               |                              |                 |  |  |  |  |  |  |  |  |  |  |  |  |

 

Theaggregate intrinsic value for outstanding stock options and for stock optionsthat are exercisable as of  December 31,2007 was $230 and $230, respectively.

 

TheCompany uses the Black-Scholes option pricing model to determine the aggregatefair value of the stock options granted. The aggregate fair value of theCompany’s stock option grants are amortized to compensation expense over theirrespective 

 

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vestingperiods and included in selling, general and administrative expenses on theConsolidated Statements of Operations. The Company typically issues shares ofcommon stock from treasury stock upon the exercise of stock options, but suchshares may also be newly issued.

 

Asof December 31, 2007, there was a total of $3,045 of unrecognizedcompensation expense related to time based non-vested stock options.

 

***Stock Award Plans***

 

InOctober 2003, the Board of Directors adopted the Orleans Homebuilders, Inc.Stock Award Plan (the “Stock Award Plan”). The Stock Award Plan provides forthe grant of stock awards of up to an aggregate of 400,000 shares of theCompany’s common stock. The Stock Award Plan allows for the payment of all or aportion of the incentive compensation awarded under the Company’s bonuscompensation plans to be paid by means of a transfer of shares of common stock.The plan has a ten year life and is open to all employees of the Company andits subsidiaries. The value of time based restricted stock awards is determinedby their intrinsic value (as if the underlying shares were vested and issued)on the grant date. At December 31, 2007, the Company had awarded 395,904shares of common stock under the Stock Award Plan and the Company had 4,096shares of the common stock available to issue under the Stock Award Plan.

 

Duringthe three and six months ended December 31, 2007, the Company granted, butdid not issue, stock awards for 240,000 shares. During the three and six monthsended December 31, 2006, the Company did not grant any stock awards.

 

Duringthe three months ended December 31, 2007 and 2006, the Company recognized$108 and $85, respectively, of stock based compensation expense related tostock awards. During the six months ended December 31, 2007 and 2006, theCompany recognized $193 and $176, respectively, of stock based compensationexpense related to stock awards.

 

Asof December 31, 2007, there was a total of $4,668 of unrecognizedcompensation expense related to time based non-vested restricted stock awards. Thatcost is expected to be recognized over a weighted average period of 6.5 years.

 

**8.****             ****EMPLOYEE RETIREMENT PLAN**

 

OnDecember 1, 2005, the Company adopted an unfunded, non-qualified targetdefined benefit retirement plan, effective as of September 1, 2005, whichcovers a group of management employees of the Company. The Company owns lifeinsurance policies on all participants in the Supplemental Executive RetirementPlan (“SERP”). This SERP, which was amended on March 13, 2006 and again onSeptember 27, 2007, is intended to provide the participants with an annualsupplemental retirement benefit based upon their years of service with theCompany and highest average compensation for five consecutive years. The annualsupplemental benefit for each participant will be adjusted based on the actualperformance of the SERP compared to the target.

 

TheCompany adopted SFAS No. 158, “Employers’ Accounting for Defined BenefitPension and Other Postretirement Plans” (“SFAS 158”) effective June 30,2007. SFAS 158 requires companies to recognize the overfunded or underfundedstatus of a single-employer defined benefit postretirement plan as an asset orliability in its statement of financial position and to recognize changes inthat funded status in comprehensive income in the year in which the changesoccur. In addition, SFAS 158 requires companies to measure the funded status ofa plan as of the date of its year-end statement of financial position, withlimited exceptions.

 

TheCompany used a 4% annual compensation increase and a 6.10% discount rate in itscalculation of the present value of its projected benefit obligation. Thediscount rate used represented the Moody’s AA bond rate for long-term bonds asof June 2007.

 

TheCompany recognized the following costs related to the SERP for the three andsix months ended December 31, 2007 and 2006:

 
| ** **                          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------|------------|------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **December 31**   | ** ** | **December 31,**          | ** ** |
| ** **                          | ** ** | **2007**               | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net periodic  pension cost:         |       |                   |       |                           |       |   |   |   |   |
| Service cost                        |       | $                      | 153        |                           | $          | 201 |   | $ | 306 |   | $ | 371 |   |
| Interest  cost                      |       | 85                     |       | 127                            |       | 170 |   | 221 |   |
| Amortization  of prior service cost |       | 104                    |       | 91                             |       | 207 |   | 181 |   |
| Amortization  of actuarial gain     |       | (46                    | )          | —                         |       | (92 | ) | — |   |
| Total net  periodic pension cost    |       | $                      | 296        |                           | $          | 419 |   | $ | 591 |   | $ | 773 |   |

 

13

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**9.****             ****LOSS PER SHARE**

 

Theweighted average number of shares used to compute basic loss per common shareand diluted loss per common share and a reconciliation of the numerator anddenominator used in the computation for the three and six months ended December 31,2007 are shown in the following table:

 
| ** **                                                                 | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------|------------|--------------------------------|------------|
| ** **                                                                 | ** ** | **December 31,**  | ** ** | **December 31,**          | ** ** |
| ** **                                                                 | ** ** | **(in thousands)**     | ** ** |
| ** **                                                                 | ** ** | **2007**               | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Weighted average common  shares issued                                     |       | 18,698                 |       | 18,698                         |       | 18,698 |   | 18,698 |   |
| Less:  Average treasury shares outstanding                                 |       | (196                   | )          | (222                           | )          | (196 | ) | (279 | ) |
| Basic EPS  shares                                                          |       | 18,502                 |       | 18,476                         |       | 18,502 |   | 18,419 |   |
| Effect of assumed shares under treasury  stock method for stock options(1) |       | —                 |       | —                         |       | — |   | — |   |
| Diluted EPS  shares                                                        |       | 18,502                 |       | 18,476                         |       | 18,502 |   | 18,419 |   |
|                                                                       |       |                   |       |                           |       |   |   |   |   |
| Loss from  continuing operations for basic and diluted EPS                 |       | $                      | (38,607    | )                              | $          | (7,029 | ) | $ | (40,370 | ) | $ | (2,987 | ) |
| Loss from  discontinued operations for basic and diluted EPS               |       | (12,778                | )          | (495                           | )          | (13,070 | ) | (638 | ) |
| Net loss for  basic and diluted EPS                                        |       | $                      | (51,385    | )                              | $          | (7,524 | ) | $ | (53,440 | ) | $ | (3,625 | ) |

 

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(1)          For the three and six months ended December 31, 2007 and December 31,2006, the Company used basic shares outstanding to compute diluted earnings percommon share as the use of the diluted shares outstanding was anti-dilutive onthe diluted earnings per common share calculation.

 

Assumedshares under treasury stock method for stock options of 92 and 121 for thethree months ended December 31, 2007 and 2006, respectively, and 91 and216 for the six months ended December 31, 2007 and 2006, respectively,were not included in the computation of diluted earnings per share because theimpact was anti-dilutive for those periods.

 

**10.****      ****COMPREHENSIVE LOSS**

 

Forthe three and six months ended December 31, 2007 and 2006, totalcomprehensive loss equals net loss.

 

**11.****      ****INCOME TAXES**

 

TheCompany recorded an income tax benefit from continuing operations of $24,688and $4,515 for the three months ended December 31, 2007 and 2006,respectively.  For the six months ended December 31, 2007 and 2006,the Company recorded an income tax benefit from continuing operations of$24,529 and $1,981, respectively. The Company no longer believes thatit can reliably estimate its projected effective tax rate for the year. Theincome tax benefit for the six months ended December 31,2007 exceeded the amount that would have resulted from theapplication of the federal statutory tax rate primarily as a result of theeffect of state income taxes, net of the associated federal tax benefit, partlyoffset by two discrete items that had the impact oflowering the total income tax benefit: a revision to a prior year taxcontingency reserve of approximately $600 and the prior year income taxreturn-to-accrual adjustment of $****474****.  Similarly, theincome tax benefit for the six months ended December 31, 2006 exceeded theamount that would have resulted from the application of the federal statutorytax rate primarily as a result of the effect of state income taxes, net of theassociated federal tax benefit, partly offset by the impact of the prioryear income tax return-to-accrual adjustment.

 

Asdiscussed in Note 1 above, in June 2006, the FASB issued FIN 48. FIN 48prescribes a recognition threshold and measurement attribute for tax positionstaken or expected to be taken in a tax return. This interpretation alsoprovides guidance on de-recognition, classification, interest and penalties,accounting in interim periods, disclosure and transition. The evaluation of atax position in accordance with this interpretation is a two-step process. Inthe first step, recognition, the Company determines whether it ismore-likely-than-not that a tax position will be sustained upon examination,including resolution of any related appeals or litigation processes, based onthe technical merits of the position. The second step addresses measurement ofa tax position that meets the more-likely-than-not criteria. The tax positionis measured at the largest amount of benefit that is more than 50 percentlikely to be realized upon ultimate settlement. Differences between taxpositions taken in a tax return and amounts recognized in the financialstatements will generally result in (a) an 

 

14

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increasein a liability for income taxes payable or a reduction of an income tax refundreceivable, (b) a reduction in a deferred tax asset or an increase in adeferred tax liability or (c) both (a) and (b). Tax positions thatpreviously failed to meet the more-likely-than-not recognition threshold shouldbe recognized in the first subsequent financial reporting period in which thatthreshold is met. Previously recognized tax positions that no longer meet themore-likely-than-not recognition threshold should be de-recognized in the firstsubsequent financial reporting period in which that threshold is no longer met.Use of a valuation allowance as described in SFAS 109 is not an appropriatesubstitute for the de-recognition of a tax position. The requirement to assessthe need for a valuation allowance for deferred tax assets based on sufficiencyof future taxable income is unchanged by this interpretation.

 

Asof July 1, 2007, the Company adopted the provisions of FIN 48. The Companyrecognized the cumulative effect of applying its provisions by reducing its July 1,2007 retained earnings opening balance by $715 with a corresponding increase tothe appropriate tax liability accounts. The amount of unrecognized tax benefitas of July 1, 2007 after the FIN 48 adjustment was $2,535. This amountrelates to unrecognized tax positions that, if recognized, would affect theannual effective tax rate of the Company.

 

TheCompany’s unrecognized tax liability results primarily from the varyingapplication of statutes, regulations and interpretations including recent statetax cases regarding similar issues. The Company anticipates that it will paysubstantially all of the balance associated with its uncertain tax positionswithin the next three months as it has entered into a voluntary disclosure agreementto resolve an issue.

 

TheCompany files income tax returns at the U.S. federal level and in various stateand local jurisdictions. The Company is no longer subject to U.S. federal,state or local income tax examinations by tax authorities for calendar yearsbefore 2002.

 

TheCompany recognizes interest and penalties accrued in relation to unrecognizedtax benefits in tax expense. At July 1, 2007, the Company had accruedapproximately $1,300 for the payment of interest and penalties.

 

Theimpact of the adoption of FIN 48 on retained earnings as of July 1, 2007is as follows (in thousands):

 
| Retained  earning as of June 30, 2007                                 |   | $    | 154,003 |   |
|----------------------------------------------------------------------------|--------|------|---------|--------|
| Impact of  adoption of FIN 48 on retained earnings as of July 1, 2007 |   | (715 | )       |
| Retained  earnings as of July 1, 2007                                 |   | $    | 153,288 |   |

 

**12.****      ****DISCONTINUED OPERATIONS**

 

During the three months ended December 31, 2007, the Companydetermined that its operating strategy no longer supported maintaining apresence in the Phoenix, Arizona market. Accordingly, the Company disposed ofits entire balance of work-in-process inventory and land in a singletransaction with a single buyer for $11,300 of proceeds. The Company shut downall operations that supported the western region and terminated employeesassociated with that region. The Company has historically reported thisbusiness as its western region operating segment. The disposed work-in-processinventory and land assets constituted substantially all of the Company’s assetsand operations in the western region.

 

As the western region represented a component of the Company’sbusiness, the consolidated financial statements have been reclassified for allperiods presented to present this business as discontinued operations. Prior tothe sale, during the second quarter of fiscal 2008, an impairment charge of$20,706 was recognized to reduce the carrying value of the land andwork-in-process sold to its fair value less costs to sell. Costs and expensesdirectly associated with this business have been reclassified as discontinuedoperations on the consolidated statement of operations. Corporate expenses suchas general corporate overhead have not been allocated to discontinuedoperations. Summarized financial information for the western region is setforth below:

 
| ** **                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------|------------|------------------------|------------|--------------------------------|------------|
| ** **                             | ** ** | **December 31,**  | ** ** | **December 31,**          | ** ** |
| ** **                             | ** ** | **2007**               | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Operating  loss                        |       | $                      | (21,092    | )                              | $          | (763 | ) | $ | (21,574 | ) | $ | (982 | ) |
| Tax benefit                            |       | 8,314                  |       | 268                            |       | 8,504 |   | 344 |   |
| Net loss  from discontinued operations |       | $                      | (12,778    | )                              | $          | (495 | ) | $ | (13,070 | ) | $ | (638 | ) |

 

Discontinued operations have not been segregated in the consolidatedstatement of cash flows. Therefore amounts for certain captions will not agreewith respective data in the consolidated statement of operations.

 

15

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**13.****      ****SEGMENT REPORTING**

 

SFASNo. 131 “Disclosures about Segments of an Enterprise and RelatedInformation” establishes standards for the manner in which public enterprisesreport segment information about operating segments. The Company has determinedthat its operations primarily involve four reportable homebuilding segmentsoperating in eleven markets. Revenues are primarily derived from the sale ofhomes which the Company constructs. The segments reported have been determinedto have similar economic characteristics including similar historical andexpected future operating performance, employment trends, land acquisitions andland constraints, municipality behavior and met the other aggregation criteriain SFAS 131. The reportable homebuilding segments include operations conductingbusiness in the following states:

 
| Northern: southeastern Pennsylvania, central New Jersey, southern New  Jersey |
|-------------------------------------------------------------------------------|
| and Orange County, New  York                                                  |
| Southern: Charlotte, Raleigh and Greensboro, North Carolina, Richmond         |
| and Tidewater, Virginia                                                       |
| Midwestern: Chicago, Illinois                                                 |
| Florida: Orlando, Florida                                                     |

 

TheCompany’s evaluation of segment performance is based on income from continuingoperations. Below is a summary of revenue and income (loss) from continuingoperations for each reportable segment for the three and six months ended December 31,2007 and 2006:

 
| ** **                                    | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|--------------------------------|------------|
| ** **                                    | ** ** | **December 31,**  | ** ** | **December 31,**          | ** ** |
| ** **                                    | ** ** | **2007**               | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Total  Revenue**                            |       |                   |       |                           |       |   |   |   |   |
| Northern                                      |       | $                      | 56,233     |                           | $          | 47,667 |   | $ | 106,277 |   | $ | 97,313 |   |
| Southern                                      |       | 62,600                 |       | 61,944                         |       | 111,105 |   | 136,057 |   |
| Midwestern                                    |       | 16,581                 |       | 22,491                         |       | 30,119 |   | 40,908 |   |
| Florida                                       |       | 16,686                 |       | 23,448                         |       | 24,955 |   | 44,874 |   |
| Corporate  and unallocated(1)                 |       | 2,843                  |       | 1,578                          |       | 5,363 |   | 3,078 |   |
| Consolidated  Total                           |       | $                      | 154,943    |                           | $          | 157,128 |   | $ | 277,819 |   | $ | 322,230 |   |
|                                          |       |                   |       |                           |       |   |   |   |   |
| **Income  (Loss) from Continuing Operations** |       |                   |       |                           |       |   |   |   |   |
| Northern                                      |       | $                      | (5,037     | )                              | $          | (4,589 | ) | $ | (8,273 | ) | $ | (3,369 | ) |
| Southern                                      |       | (6,133                 | )          | 1,077                          |       | (6,525 | ) | 5,459 |   |
| Midwestern                                    |       | (21,613                | )          | (2,090                         | )          | (22,531 | ) | (2,669 | ) |
| Florida                                       |       | (7,905                 | )          | (831                           | )          | (8,594 | ) | 216 |   |
| Corporate  and unallocated(1)                 |       | 2,081                  |       | (596                           | )          | 5,553 |   | (2,624 | ) |
| Consolidated  Total                           |       | $                      | (38,607    | )                              | $          | (7,029 | ) | $ | (40,370 | ) | $ | (2,987 | ) |

 

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(1) Corporateand unallocated include the revenues and expenses of the Company’s mortgagebrokerage and property management operations as well as corporate levelselling, general, administrative expenses. These selling, general, andadministrative expenses are primarily comprised of corporate salaries, bonuses,and benefits; accounting and consulting fees; corporate travel expenses; netperiodic pension costs; and compensation expense resulting from the fairvaluation of stock options.

 

**14.****      ****COMMITMENTS AND CONTINGENCIES**

 

AtDecember 31, 2007, the Company had outstanding bank letters of credit,surety bonds and financial security agreements amounting to $132,425 ascollateral for completion of improvements at various developments of theCompany.

 

Asof December 31, 2007, the Company owned or controlled approximately 8,525building lots. As part of the aforementioned building lots, the Company hascontracted to purchase, or had under option, undeveloped land and improved lotsfor an aggregate purchase price of $161,021, which are expected to yieldapproximately 2,550 building lots. Generally, the Company structures its landacquisitions so that it has the right to cancel its agreements to purchaseundeveloped land and improved lots by forfeiture of its deposit under theagreement. Furthermore, purchase of the properties is usually contingent uponobtaining all governmental approvals and satisfaction of certain requirementsby the Company and the sellers.

 

16

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Fromtime to time, the Company is named as defendant in legal actions arising fromits normal business activities. Although the amount of any liability that couldarise with respect to currently pending actions cannot be accurately predicted,in the opinion of the Company any such liability will not have a materialadverse effect on the financial position or operating results of the Company.

 

TheCompany accrues the cost for warranty and customer satisfaction into the costof its homes as a liability at closing for each unit based on the Company’sindividual budget per unit. These liabilities are reviewed on a quarterly basisand generally closed to earnings within nine to 12 months for unusedamounts with any excess amounts expensed as identified as a change in estimate.

 

Any significant materialdefects are generally under warranty with the Company’s supplier. The Companyhas not historically incurred any significant litigation requiring additionalspecific reserves for its product offerings (e.g., mold litigation).

 

Generally, the Companyprovides all of its homebuyers with a limited one year warranty as toworkmanship. Under certain circumstances, this warranty may be extended to twoyears. In practice, the Company may extend this warranty period with theultimate goal of satisfying the customer. In addition, the Company enrolls allof its homes in a limited warranty program with a third party provider (withthe premium paid for this program included in the individual unit budgetsdescribed above). This limited warranty program generally covers certaindefects for periods of one to two years and major structural defects for up toten years. Actual costs incurred are paid for by the third party provider.

 

TheCompany’s warranty and customer satisfaction costs are charged to cost of salesat the time each home is closed and title and possession have been transferredto the homebuyer. The amount charged to additions represents warranty andcustomer satisfaction costs factored into the cost of each home. The amountrecorded as charges incurred represents the actual warranty and customersatisfaction cost incurred for the period presented. Certain costs to complete,not included as warranty costs, have been excluded from the rollforward below:

 
| ** **                      | ** ** | **For the six months ended** | ** ** |
|---------------------------------|------------|------------------------------|------------|
| ** **                      | ** ** | **December 31,**        | ** ** |
| ** **                      | ** ** | **2007**                     | ** ** | **2006** | ** ** |
| Balance at June 30         |       | $                            | 2,908      |   | $ | 2,188 | ** ** |
| Warranty costs accrued          |       | 1,399                        |       | 1,922 | ** ** |
| Actual  warranty costs incurred |       | (1,477                       | )          | (2,081 | ) |
| Balance at  December 31    |       | $                            | 2,830      |   | $ | 2,029 |   |

 
| **ITEM 2.** | ** ** | **MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|-------------|------------|-------------------------------------------------------------------------------------------------|

 

OrleansHomebuilders, Inc., a Delaware corporation, and its subsidiaries (collectively,the “Company”, “OHB”, “Orleans”, “we”, “us” or “our”) market, develop and buildhigh-quality, single-family homes, townhomes and condominiums to serve varioustypes of homebuyers, including move-up, luxury, empty nester, active adult andfirst-time homebuyers. We believe this broad range of home designs gives itflexibility to address economic and demographic trends within our markets. TheCompany has been in operation since 1918 and is currently engaged inresidential real estate development in the following eleven markets:southeastern Pennsylvania; central New Jersey; southern New Jersey; OrangeCounty, New York; Charlotte, Raleigh and Greensboro, North Carolina; Richmondand Tidewater, Virginia; Chicago, Illinois; and Orlando, Florida. The Company’sCharlotte, North Carolina market also includes operations in adjacent countiesin South Carolina. The Company has operated in the Pennsylvania and New Jerseymarkets for nearly 90 years and began operations in the North Carolina andVirginia markets in fiscal 2001 through the acquisition of Parker &Lancaster Corporation (“PLC”), a privately-held residential homebuilder. Weentered the Orlando, Florida market on July 28, 2003 through ouracquisition of Masterpiece Homes, Inc., now Masterpiece Homes, LLC (“MasterpieceHomes”), a privately-held residential homebuilder. On July 28, 2004, weentered the Chicago, Illinois market through the acquisition of Realen Homes,L.P. (“Realen Homes”), an established privately-held homebuilder withoperations in Chicago, Illinois and southeastern Pennsylvania. On December 23,2004, pursuant to an Asset Purchase Agreement of the same date, we acquired,through a wholly-owned subsidiary, certain real estate assets from PeachtreeResidential Properties, LLC, a North Carolina limited liability company andPeachtree Townhome Communities, LLC, a North Carolina limited liability companywhich, at the time we acquired the assets, were wholly-owned subsidiaries ofPeachtree Residential Properties, Inc., a Georgia corporation (collectively,“Peachtree Residential Properties”).

 

17

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Referencesto a given fiscal year in this Quarterly Report on Form 10-Q are to thefiscal year ended June 30th of that year. For example, the phrases “fiscal2008”, “2008 fiscal year” or “year ended June 30, 2008” refer to thefiscal year ending June 30, 2008. When used in this report, the “northernregion” segment refers to our markets in Pennsylvania, New Jersey and New York,which includes the southeastern Pennsylvania operations of Realen Homes thatwere acquired on July 28, 2004; the “southern region” segment refers toour markets in North Carolina and Virginia, as well as the adjacent counties inSouth Carolina; the “midwestern region” segment refers to our market inIllinois; the “Florida region” segment refers to our market in Florida; and the“western region” segment refers to our former market in Arizona.

 

**Critical Accounting Policies**

 

The preparation of financialstatements and related disclosures in conformity with accounting principlesgenerally accepted in the United States requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities, thedisclosure of contingent assets and liabilities at the date of the financialstatements and revenues and expenses during the period reported. The followingaccounting policies involve a “critical accounting estimate” because they areparticularly dependent on estimates and assumptions made by management aboutmatters that are highly uncertain at the time the accounting estimates are made.See Item 7 - “Management’s Discussion and Analysis of Financial Condition andResults of Operations - Critical Accounting Policies” in our Annual Report on Form 10-Kfor the fiscal year ended June 30, 2007, for other critical accountingpolicies.

 

*Valuation of Deferred Tax Assets*

 

We record income taxes underthe asset and liability method, whereby deferred tax assets and liabilities arerecognized based on the future tax consequences attributable to temporarydifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases and attributable to operatingloss and tax credit carryforwards. Deferred tax assets and liabilities aremeasured using enacted tax rates expected to apply in the years in which thetemporary differences are expected to be recovered or paid. The effect ondeferred tax assets and liabilities of a change in tax rates is recognized inearnings in the period when the changes are enacted.

 

SFAS 109, *Accounting for Income Taxes,*(“SFAS 109”)requires a reduction of the carrying amounts of deferred tax assets by avaluation allowance if, based on the available evidence, it is more likely thannot that such assets will not be realized. Accordingly, the need to establish avaluation allowance against deferred tax assets is assessed periodically basedon the SFAS 109 more-likely-than-not realization threshold criterion. In theassessment for a valuation allowance, appropriate consideration is given to allpositive and negative evidence related to the realization of the deferred taxassets. This assessment considers, among other matters, the nature, frequencyand severity of current and cumulative losses, forecasts of futureprofitability, excess of appreciated asset value over the tax basis of netassets, the duration of statutory carryforward periods, our experience withoperating loss and tax credit carryforwards not expiring unused, and taxplanning alternatives.

 

Our analysis of the need fora valuation allowance recognizes that we have incurred a cumulative loss overthe evaluation period (three years for the period ending December 31,2007), including a substantial loss during the 2007 calendar year. A majorityof the current loss was the result of the difficult current market conditions,as well as losses and impairment charges incurred on the nine asset sales thattook place during December 2007, that led to the impairments of certain realestate held for development or sale as well as goodwill. We believe we willgenerate taxable earnings in our combined primary markets. Consideration hasalso been given to the period over which these net deferred tax assets can berealized, and our history of not having Federal tax loss carryforwards expireunused.

 

We believe that theaccounting estimate for the valuation of deferred tax assets is a criticalaccounting estimate because judgment is required in assessing the likely futuretax consequences of events that have been recognized in our financialstatements or tax returns. We based our estimate of deferred tax assets andliabilities on current tax laws and rates and, in certain cases, business plansand other expectations about future outcomes. Changes in existing tax laws orrates could affect actual tax results and future business results, includingfurther market deterioration, may affect the amount of deferred tax liabilitiesor the valuation of deferred tax assets over time. Our accounting for deferredtax consequences represents our best estimate of future events. Changes thatare not anticipated in our current estimates could have a materialperiod-to-period impact on our financial position or results of operations.

 

At December 31, 2007and June 30, 2007, our net deferred tax asset was $34.1 million and $23.5million, respectively. Based on our assessment, it appears more likely than notthat the net deferred tax asset will be realized through future taxableearnings and the excess of appreciated asset value over the tax basis of ournet assets. Accordingly, no valuation allowance has been established for ournet deferred tax asset. We will continue to assess the need for a valuationallowance in the future.

 

18

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If future results are less than projected particularly in the Company’sprimary markets, tax planning alternatives no longer are viable, or there is notexcess appreciated asset value over the tax basis of net assets, a valuationallowance may be required to reduce the deferred tax assets, which could have amaterial impact on our results of operations in the period in which it isrecorded.

 

**Results of Operations**

 

***New Orders, Residential Revenues and Backlog:***

 

Duringthe second half of fiscal 2006 and all of fiscal 2007, we and the entirehousing industry have faced several significant challenges in the housing andmortgage markets as a whole. These challenges continued throughout the sixmonths ended December 31, 2007 and include decreased homebuyer demand dueto lower consumer confidence in the overall housing market, increaseduncertainty in the overall mortgage market, increased underwriting standardsand an increase in foreclosures.  Webelieve that overall economic conditions will remain difficult in the near termand these conditions may continue to have a negative impact on new orders andnew order pricing, thereby further reducing revenues, gross margins and netincome.  We are responding to theseunfavorable market conditions by attempting to maintain absorption levelsthrough the use of sales incentives, reevaluating our individual land holdings,reducing our land expenditures and emphasizing cost reductions to adjust forlower levels of production.  Further decreasesin demand for our homes may require us to further increase the use of salesincentives.

 

Forthe tables below setting forth certain details as to residential salesactivities, the information is provided for the three and six months ended December 31,2007 and 2006 in the case of residential revenue earned and new orders, and asof December 31, 2007 and 2006 in the case of backlog. We consider a salescontract or a potential sale to be classified as a new order.

 
| ** **                      | ** ** | **Three months ended December 31** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|--------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **2007**                                               | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                      | ** ** | **(dollars in thousands)**                   | ** ** |
| **New orders**                  |       |                                                   |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                      | 114,687    |       | $          | 152,375    |       | $ | (37,688 | ) | (24.7 | )% |
| Units                           |       | 284                                                    |       | 367        |       | (83        | )          | (22.6 | )% |
| Average sales price             |       | $                                                      | 404        |       | $          | 415        |       | $ | (11 | ) | (2.7 | )% |
|                            |       |                                                   |       |       |       |       |       |   |   |
| **Residential revenues earned** |       |                                                   |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                      | 144,490    |       | $          | 153,172    |       | $ | (8,682 | ) | (5.7 | )% |
| Units                           |       | 323                                                    |       | 377        |       | (54        | )          | (14.3 | )% |
| Average sales price             |       | $                                                      | 447        |       | $          | 406        |       | $ | 41 |   | 10.1 | % |

 
| ** **                      | ** ** | **Six months ended December 31** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **2007**                                             | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                      | ** ** | **(dollars in thousands)**                 | ** ** |
| **New orders**                  |       |                                                 |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                    | 247,263    |       | $          | 270,138    |       | $ | (22,875 | ) | (8.5 | )% |
| Units                           |       | 587                                                  |       | 616        |       | (29        | )          | (4.7 | )% |
| Average sales price             |       | $                                                    | 421        |       | $          | 439        |       | $ | (18 | ) | (3.9 | )% |
|                            |       |                                                 |       |       |       |       |       |   |   |
| **Residential revenues earned** |       |                                                 |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                    | 263,847    |       | $          | 314,944    |       | $ | (51,097 | ) | (16.2 | )% |
| Units                           |       | 586                                                  |       | 740        |       | (154       | )          | (20.8 | )% |
| Average sales price             |       | $                                                    | 450        |       | $          | 426        |       | $ | 24 |   | 5.8 | % |

 
| ** **          | ** ** | **December 31,**                | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------|------------|--------------------------------------|------------|------------|------------|------------|------------|
| ** **          | ** ** | **2007**                             | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **          | ** ** | **(dollars in thousands)** | ** ** |
| **Backlog**         |       |                                 |       |       |       |       |       |   |   |
| Dollars             |       | $                                    | 301,329    |       | $          | 289,870    |       | $ | 11,459 |   | 4.0 | % |
| Units               |       | 610                                  |       | 591        |       | 19         |       | 3.2 | % |
| Average sales price |       | $                                    | 494        |       | $          | 490        |       | $ | 4 |   | 0.7 | % |

 

19

----

 

New orders for the three months ended December 31, 2007 decreased$37.7 million, or 24.7%, to $114.7 million on 284 homes, compared to $152.4million on 367 homes for the three months ended December 31, 2006.  The average price per home decreased byapproximately 2.7% to $404 thousand for the three months ended December 31,2007 compared to $415 thousand for the three months ended December 31,2006.

 

Neworders for the six months ended December 31, 2007 decreased $22.9 million,or 8.5%, to $247.3 million on 587 homes, compared to $270.1 million on 616homes for the six months ended December 31, 2006. The average price perhome of new orders decreased by approximately 3.9% to $421 thousand for the sixmonths ended December 31, 2007 compared to $439 thousand for the sixmonths ended December 31, 2006.

 

Thedecrease in new orders for the three and six months ended December 31,2007 is attributable to the continued deterioration in the overall housingmarket during the period.  Additionally,during the three and six months ended December 31, 2006, we madesignificant efforts to reduce inventory levels which led to an unusual increasein new orders during the prior year period. The decrease in the average sales price on new orders represents aresponse to the deterioration in market conditions by us in an effort toincrease absorption through the use of marketing incentives and pricereductions.

 

Residential revenues earned for the three months ended December 31,2007 decreased $8.7 million, or 5.7%, to $144.5 million on 323 homes, comparedto $153.2 million on 377 homes for the three months ended December 31,2006.  Residential revenues earned for the six months ended December 31,2007 decreased $51.1 million, or 16.2%, to $263.8 million on 586 homes,compared to $314.9 million on 740 homes for the six months ended December 31,2006.

 

Thedecrease in residential revenues earned is primarily the result of effortstaken by us to reduce inventory levels during the prior year period, as notedabove.  We offered significant pricediscounts in order to drive the sales of standing inventory, most of which wasdelivered during the six months ended December 31, 2006.  We believe that we have reduced our completedhome inventory levels to appropriate levels given the current market conditionsin which it operates.

 

Changesin backlog are the net result of changes in net new orders and residentialrevenues earned.

 

Cancellationsfor the six months ending December 31, 2007 were 24% of new orderscompared to 27% for the six months ended December 31, 2006. This decreaseis primarily the result of abnormally high cancellations during the six monthsended December 31, 2006 in our Florida region, which resulted from theexit of investors in this region. We believe that cancellation rates havestabilized and believe that most of the backlog at December 31, 2007 willbe delivered during fiscal year 2008.

 

***Northern Region:***

*** ***
| ** **                      | ** ** | **Three months ended December 31** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|--------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **2007**                                               | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                      | ** ** | **(dollars in thousands)**                   | ** ** |
| **New orders**                  |       |                                                   |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                      | 45,890     |       | $          | 47,567     |       | $ | (1,677 | ) | (3.5 | )% |
| Units                           |       | 109                                                    |       | 96         |       | 13         |       | 13.5 | % |
| Average sales price             |       | $                                                      | 421        |       | $          | 495        |       | $ | (74 | ) | (14.9 | )% |
|                            |       |                                                   |       |       |       |       |       |   |   |
| **Residential revenues earned** |       |                                                   |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                      | 57,024     |       | $          | 46,731     |       | $ | 10,293 |   | 22.0 | % |
| Units                           |       | 118                                                    |       | 100        |       | 18         |       | 18.0 | % |
| Average sales price             |       | $                                                      | 483        |       | $          | 467        |       | $ | 16 |   | 3.4 | % |

*** ***
| ** **                      | ** ** | **Six months ended December 31** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **2007**                                             | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                      | ** ** | **(dollars in thousands)**                 | ** ** |
| **New orders**                  |       |                                                 |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                    | 99,472     |       | $          | 103,059    |       | $ | (3,587 | ) | (3.5 | )% |
| Units                           |       | 222                                                  |       | 211        |       | 11         |       | 5.2 | % |
| Average sales price             |       | $                                                    | 448        |       | $          | 488        |       | $ | (40 | ) | (8.3 | )% |
|                            |       |                                                 |       |       |       |       |       |   |   |   |   |   |
| **Residential revenues earned** |       |                                                 |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                    | 108,050    |       | $          | 95,322     |       | $ | 12,728 |   | 13.4 | % |
| Units                           |       | 223                                                  |       | 196        |       | 27         |       | 13.8 | % |
| Average sales price             |       | $                                                    | 485        |       | $          | 486        |       | $ | (1 | ) | (0.4 | )% |

 

20

----

 
| ** **          | ** ** | **December 31,**                | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------|------------|--------------------------------------|------------|------------|------------|------------|------------|
| ** **          | ** ** | **2007**                             | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **          | ** ** | **(dollars in thousands)** | ** ** |
| **Backlog**         |       |                                 |       |       |       |       |       |   |   |
| Dollars             |       | $                                    | 136,057    |       | $          | 108,260    |       | $ | 27,797 |   | 25.7 | % |
| Units               |       | 254                                  |       | 209        |       | 45         |       | 21.5 | % |
| Average sales price |       | $                                    | 536        |       | $          | 518        |       | $ | 18 |   | 3.4 | % |
|                     |            |                                      |            |            |            |            |            |  |  |  |  |  |  |  |  |  |

 

Ournorthern region is comprised of the Southeastern Pennsylvania, Central NewJersey, Southern New Jersey and Orange County, New York markets. We believethat our geographic mix in this market allows us to compete better than if wewere situated in one or two concentrated markets. In the northern region, we currentlybuild homes primarily targeted toward move-up, luxury, empty nester and activeadult homebuyers.

 

Thedecrease in new orders for the northern region noted above is primarily theresult of decreases in the average sales price, partially offset by an increasein the number of units.  The decrease inaverage sales price is the result of product mix and increases in salesincentives offered in order to increase orders. Additionally, during the three and six months ended December 31,2006, we took specific efforts to reduce inventory levels, thereby increasingnew orders for that period.

 

Theincrease in residential revenues earned is primarily the result of newcommunities that were open during the six months ended December 31, 2007that were not open or were in the early sales stage and did not have closingsduring the six months ended December 31, 2006.

 

***Southern Region:***

 
| ** **                      | ** ** | **Three months ended December 31** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|--------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **2007**                                               | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                      | ** ** | **(dollars in thousands)**                   | ** ** |
| **New orders**                  |       |                                                   |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                      | 50,183     |       | $          | 57,997     |       | $ | (7,814 | ) | (13.5 | )% |
| Units                           |       | 119                                                    |       | 121        |       | (2         | )          | (1.7 | )% |
| Average sales price             |       | $                                                      | 422        |       | $          | 479        |       | $ | (57 | ) | (12.0 | )% |
|                            |       |                                                   |       |       |       |       |       |   |   |   |   |   |
| **Residential revenues earned** |       |                                                   |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                      | 61,827     |       | $          | 61,534     |       | $ | 293 |   | 0.5 | % |
| Units                           |       | 127                                                    |       | 129        |       | (2         | )          | (1.6 | )% |
| Average sales price             |       | $                                                      | 487        |       | $          | 477        |       | $ | 10 |   | 2.1 | % |

 
| ** **                      | ** ** | **Six months ended December 31** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **2007**                                             | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                      | ** ** | **(dollars in thousands)**                 | ** ** |
| **New orders**                  |       |                                                 |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                    | 108,765    |       | $          | 105,667    |       | $ | 3,098 |   | 2.9 | % |
| Units                           |       | 240                                                  |       | 215        |       | 25         |       | 11.6 | % |
| Average sales price             |       | $                                                    | 453        |       | $          | 491        |       | $ | (38 | ) | (7.8 | )% |
|                            |       |                                                 |       |       |       |       |       |   |   |
| **Residential revenues earned** |       |                                                 |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                    | 110,200    |       | $          | 135,227    |       | $ | (25,027 | ) | (18.5 | )% |
| Units                           |       | 227                                                  |       | 284        |       | (57        | )          | (20.1 | )% |
| Average sales price             |       | $                                                    | 485        |       | $          | 476        |       | $ | 9 |   | 2.0 | % |

 

21

----

 
| ** **          | ** ** | **December 31,**                | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------|------------|--------------------------------------|------------|------------|------------|------------|------------|
| ** **          | ** ** | **2007**                             | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **          | ** ** | **(dollars in thousands)** | ** ** |
| **Backlog**         |       |                                 |       |       |       |       |       |   |   |
| Dollars             |       | $                                    | 129,093    |       | $          | 124,084    |       | $ | 5,009 |   | 4.0 | % |
| Units               |       | 256                                  |       | 233        |       | 23         |       | 9.9 | % |
| Average sales price |       | $                                    | 504        |       | $          | 533        |       | $ | (29 | ) | (5.3 | )% |

 

Oursouthern region is comprised of the Charlotte, Raleigh and Greensboro, NorthCarolina and the Richmond and Tidewater, Virginia markets. The Charlotte, NorthCarolina market also includes operations in adjacent counties in SouthCarolina. The Company in the southern region currently builds homes targetedtoward move-up and luxury homebuyers.

 

Thedecrease in new orders for the three months ended December 31, 2007compared to the three months ended December 31, 2006 is primarily drivenby the deteriorating market conditions, particularly in our Charlotteregion.  The increase in new orders forthe six months ended December 31, 2007 compared to the six months ended December 31,2006 is primarily the result of new communities that were open during the sixmonths ended December 31, 2007 that were not open during the six monthsended December 31, 2006, partially offset by the deteriorating marketconditions noted above. These new communities, on average, had a lower averageselling price, which resulted in the decrease in selling price noted above.Additionally, our southern region increased sales incentives in existingcommunities in an effort to drive sales growth, which negatively impactedaverage sales price.

 

Residentialrevenues earned were virtually flat for the three months ended December 31,2007 compared to the three months ended December 31, 2006.  The decrease in residential revenues earnedfor the six months ended December 31, 2007 compared to the six monthsended December 31, 2006 is primarily the result of the decline in marketconditions for this region during the second half of fiscal 2007 and into thefirst half of fiscal 2008.

 

***Midwestern Region:***

 
| ** **                      | ** ** | **Three months ended December 31** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|--------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **2007**                                               | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                      | ** ** | **(dollars in thousands)**                   | ** ** |
| **New orders**                  |       |                                                   |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                      | 13,532     |       | $          | 29,676     |       | $ | (16,144 | ) | (54.4 | )% |
| Units                           |       | 33                                                     |       | 67         |       | (34        | )          | (50.7 | )% |
| Average sales price             |       | $                                                      | 410        |       | $          | 443        |       | $ | (33 | ) | (7.4 | )% |
|                            |       |                                                   |       |       |       |       |       |   |   |
| **Residential revenues earned** |       |                                                   |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                      | 15,725     |       | $          | 22,501     |       | $ | (6,776 | ) | (30.1 | )% |
| Units                           |       | 34                                                     |       | 54         |       | (20        | )          | (37.0 | )% |
| Average sales price             |       | $                                                      | 463        |       | $          | 417        |       | $ | 46 |   | 11.0 | % |

 
| ** **                      | ** ** | **Six months ended December 31** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **2007**                                             | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                      | ** ** | **(dollars in thousands)**                 | ** ** |
| **New orders**                  |       |                                                 |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                    | 26,968     |       | $          | 46,155     |       | $ | (19,187 | ) | (41.6 | )% |
| Units                           |       | 73                                                   |       | 105        |       | (32        | )          | (30.5 | )% |
| Average sales price             |       | $                                                    | 369        |       | $          | 440        |       | $ | (71 | ) | (16.0 | )% |
|                            |       |                                                 |       |       |       |       |       |   |   |
| **Residential revenues earned** |       |                                                 |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                    | 28,561     |       | $          | 43,812     |       | $ | (15,251 | ) | (34.8 | )% |
| Units                           |       | 62                                                   |       | 102        |       | (40        | )          | (39.2 | )% |
| Average sales price             |       | $                                                    | 461        |       | $          | 430        |       | $ | 31 |   | 7.2 | % |

 
| ** **          | ** ** | **December 31,**                | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------|------------|--------------------------------------|------------|------------|------------|------------|------------|
| ** **          | ** ** | **2007**                             | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **          | ** ** | **(dollars in thousands)** | ** ** |
| **Backlog**         |       |                                 |       |       |       |       |       |   |   |
| Dollars             |       | $                                    | 26,339     |       | $          | 39,681     |       | $ | (13,342 | ) | (33.6 | )% |
| Units               |       | 66                                   |       | 84         |       | (18        | )          | (21.4 | )% |
| Average sales price |       | $                                    | 399        |       | $          | 472        |       | $ | (73 | ) | (15.5 | )% |

 

22

----

 

Inour midwestern region, we have operations in the Chicago area. The Company inthe midwestern region currently builds homes primarily targeted toward themove-up homebuyer.  The midwestern regionhas experienced an overall decline in the demand for new homes, increased pricecompetition as well as lower consumer confidence and slower economic activityin this market.  The Company hasresponded to the market conditions in this region by offering larger salesincentives than are offered in our other markets.

 

Duringthe three and six months ended December 31, 2007, both new order dollarsand the number of units sold decreased as compared to the same periods in theprior year.  This decrease is primarilythe result of the deteriorating economic and market conditions noted above andreduced inventory levels.  Additionally,we closed out of three communities during fiscal 2007 and the first half offiscal 2008, which contributed little to no new orders for the three and sixmonths ended December 31, 2007, partially offset by the opening of threenew communities. The decrease in the average selling price is primarily the resultof increased sales incentives offered in an effort to drive sales growth andimprove absorption, as well as a change in product mix as a result of theclosed communities noted above.

 

Thedecrease in residential revenues earned is primarily the result of the overalldecline in market conditions in this region.

 

***Florida Region:***

 
| ** **                      | ** ** | **Three months ended December 31** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|--------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **2007**                                               | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                      | ** ** | **(dollars in thousands)**                   | ** ** |
| **New orders**                  |       |                                                   |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                      | 5,082      |       | $          | 17,135     |       | $ | (12,053 | ) | (70.3 | )% |
| Units                           |       | 23                                                     |       | 83         |       | (60        | )          | (72.3 | )% |
| Average sales price             |       | $                                                      | 221        |       | 206        |       | 15         |   | 7.0 | % |
|                            |       |                                                   |       |       |       |       |       |   |   |
| **Residential revenues earned** |       |                                                   |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                      | 9,914      |       | $          | 22,406     |       | $ | (12,492 | ) | (55.8 | )% |
| Units                           |       | 44                                                     |       | 94         |       | (50        | )          | (53.2 | )% |
| Average sales price             |       | $                                                      | 225        |       | $          | 238        |       | $ | (13 | ) | (5.5 | )% |

 
| ** **                      | ** ** | **Six months ended December 31** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | **2007**                                             | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                      | ** ** | **(dollars in thousands)**                 | ** ** |
| **New orders**                  |       |                                                 |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                    | 12,058     |       | $          | 15,257     |       | $ | (3,199 | ) | (21.0 | )% |
| Units                           |       | 52                                                   |       | 85         |       | (33        | )          | (38.8 | )% |
| Average sales price             |       | $                                                    | 232        |       | 179        |       | 53         |   | 29.2 | % |
|                            |       |                                                 |       |       |       |       |       |   |   |
| **Residential revenues earned** |       |                                                 |       |       |       |       |       |   |   |
| Dollars                         |       | $                                                    | 17,036     |       | $          | 40,583     |       | $ | (23,547 | ) | (58.0 | )% |
| Units                           |       | 74                                                   |       | 158        |       | (84        | )          | (53.2 | )% |
| Average sales price             |       | $                                                    | 230        |       | $          | 257        |       | $ | (27 | ) | (10.4 | )% |

 
| ** **          | ** ** | **December 31,**                | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------|------------|--------------------------------------|------------|------------|------------|------------|------------|
| ** **          | ** ** | **2007**                             | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **          | ** ** | **(dollars in thousands)** | ** ** |
| **Backlog**         |       |                                 |       |       |       |       |       |   |   |
| Dollars             |       | $                                    | 9,840      |       | $          | 17,845     |       | $ | (8,005 | ) | (44.9 | )% |
| Units               |       | 34                                   |       | 65         |       | (31        | )          | (47.7 | )% |
| Average sales price |       | $                                    | 289        |       | $          | 275        |       | $ | 14 |   | 5.4 | % |

 

Theabove table reflects results from our Florida region for the three and sixmonths ended December 31, 2007 and 2006. In the Florida region, we haveoperations in the Orlando market. The current and prior year periods alsoreflect results from the Palm Bay market from which we substantially exitedduring the first quarter of fiscal 2008 and the Palm Coast market from which wesubstantially exited during the second quarter of fiscal 2008. The Company inthe Florida region currently builds homes primarily targeted toward first-timemove-up and entry level homebuyers.

 

23

----

 

Thedecrease in new orders for the three and six months ended December 31,2007, as compared to the three and six months ended December 31, 2006, isprimarily the result of the continued deterioration of market conditions inthis region.  New orders were alsonegatively impacted by our exit from the Palm Bay and Palm Coast markets, asnoted above.  During the three and sixmonths ended December 31, 2006, we offered increased sales incentives inan effort to reduce excess inventory levels. The average sales price for the three and six months ended December 31,2007, has increased as we have successfully reduced these inventory levels.

 

Thedecline in residential revenues earned is primarily the result of the overalldecline in market conditions, as well as our exit from the Palm Bay and PalmCoast markets, as noted above.

 

Additionally,demand in the Florida region for first-time buyers has decreased due to thetightening of the mortgage markets and the inability of a large portion of thedemographic to obtain financing for new home purchases. As the average salesprice in the Florida region is significantly less than the average sales pricein our other regions, we believe that the targeted demographic in this regionis more prone to uncertainties in the mortgage markets, especially thesub-prime mortgage market.

 

***Costs and Expenses:***

 

***Residential Properties:***

 
| ** **                     | ** ** | **Three months ended December 31** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|--------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **2007**                                               | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | **(dollars in thousands)**                   | ** ** |
| **Residential Properties**     |       |                                                   |       |       |       |       |       |   |   |
| Earned revenues                |       | $                                                      | 144,490    |       | $          | 153,172    |       | $ | (8,682 | ) | (5.7 | )% |
| Cost of residential properties |       | 147,425                                                |       | 135,327    |       | 12,098     |       | 8.9 | % |
| Gross profit margin            |       | $                                                      | (2,935     | )          | $          | 17,845     |       | $ | (20,780 | ) | (116.4 | )% |
| Gross profit margin %          |       | (2.0                                                   | )%         | 11.7       | %          |       |       |   |   |

 
| ** **                     | ** ** | **Six months ended December 31** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **2007**                                             | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | **(dollars in thousands)**                 | ** ** |
| **Residential Properties**     |       |                                                 |       |       |       |       |       |   |   |
| Earned revenues                |       | $                                                    | 263,847    |       | $          | 314,944    |       | $ | (51,097 | ) | (16.2 | )% |
| Cost of residential properties |       | 250,378                                              |       | 266,640    |       | (16,262    | )          | (6.1 | )% |
| Gross profit margin            |       | $                                                    | 13,469     |       | $          | 48,304     |       | $ | (34,835 | ) | (72.1 | )% |
| Gross profit margin %          |       | 5.1                                                  | %          | 15.3       | %          |       |       |   |   |

 

Thecosts of residential properties for the three months ended December 31,2007 compared to the three months ended December 31, 2006 increasedprimarily as a result of long-lived asset impairment losses recorded during thethree months ended December 31, 2007. These long-lived asset impairment losses of $22.9 million were recordedin each of our regions.  Gross profitpercentage for the three months ended December 31, 2007 was (2.0)%, whichwas a decrease from 11.7% for the three months ended December 31, 2006.

 

Thecosts of residential properties for the six months ended December 31, 2007compared to the six months ended December 31, 2006 decreased primarily asa result of decreased residential revenues earned offset by long-lived assetimpairment losses recorded during the six months ended December 31,2007.  Long-lived asset impairment lossesof $23.6 million were recorded in each of our regions.  Gross profit percentage for the six monthsended December 31, 2007 was 5.1%, which was a decrease from 15.3% for thesix months ended December 31, 2006.

 

Inaddition, we sell a variety of home types in various communities and regions,each yielding a different gross profit margin. As a result, depending on themix of both communities and home types delivered, the consolidated gross profitmargin may fluctuate up and down on a periodic basis and periodic profit marginsmay not be representative of the consolidated gross profit margin for futureyears.

 

Interestincluded in the costs and expenses of residential properties and land sold forthe three and six months ended December 31, 2007 were $5,114 and $8,923,respectively.  Interest included in thecosts and expenses of residential 

 

24

----

 

propertiesand land sold for the three and six months ended December 31, 2006 were$4,293 and $7,800, respectively.  Theinterest incurred during the construction period is capitalized to inventoryand then expensed to the cost of residential properties in the period in whichthe home settles.

 

***Selling, General andAdministrative:***

 
| ** **                              | ** ** | **Three months ended December 31** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                              | ** ** | **2007**                                               | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                              | ** ** | **(dollars in thousands)**                   | ** ** |
| **Selling, General and Administrative** |       |                                                   |       |       |       |       |       |   |   |
| Selling and advertising                 |       | $                                                      | 8,219      |       | $          | 9,073      |       | $ | (854 | ) | (9.4 | )% |
| Commissions                             |       | 5,644                                                  |       | 6,117      |       | (473       | )          | (7.7 | )% |
| General and administrative              |       | 10,725                                                 |       | 15,409     |       | (4,684     | )          | (30.4 | )% |
| Total                                   |       | $                                                      | 24,588     |       | $          | 30,599     |       | $ | (6,011 | ) | (19.6 | )% |

 
| ** **                              | ** ** | **Six months ended December 31** | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|------------------------------------------------------|------------|------------|------------|
| ** **                              | ** ** | **2007**                                             | ** ** | **2006**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                              | ** ** | **(dollars in thousands)**                 | ** ** |
| **Selling, General and Administrative** |       |                                                 |       |       |       |   |   |   |   |
| Selling and advertising                 |       | $                                                    | 14,674     |       | $          | 16,108 |   | $ | (1,434 | ) | (8.9 | )% |
| Commissions                             |       | 9,921                                                |       | 12,143     |       | (2,222 | ) | (18.3 | )% |
| General and administrative              |       | 18,268                                               |       | 27,191     |       | (8,923 | ) | (32.8 | )% |
| Total                                   |       | $                                                    | 42,863     |       | $          | 55,442 |   | $ | (12,579 | ) | (22.7 | )% |

 

Sellingand advertising costs include amortization of deferred marketing costs andother selling costs. These costs decreased primarily as a result of reducedsales office headcount, as part of headcount reductions that took place in July 2007.

 

Thedecrease in commission expense is primarily attributable to the decrease inresidential revenues as noted above. Commission expense as a percentage ofresidential revenue decreased to 3.9% and 3.8% for the three and six monthsended December 31, 2007, respectively, and from 4.0% and 3.9% for thethree and six months ended December 31, 2006, respectively.

 

Thedecrease in general and administrative costs is attributable to decreases inpayroll expense, relating to the headcount reductions that were completed in July 2007and overall decreases in controllable costs as we adjusted to the decline inmarket conditions. Included in general and administrative costs for the threemonths ended December 31, 2007 and 2006 were $0.5 million and $8.1million, respectively, related to the write-off of abandoned projects and otherpre-acquisition costs.  Write-off ofabandoned projects and other pre-acquisition costs were $0.9 million and $9.4million for the six months ended December 31, 2007 and 2006, respectively.

 

DuringJuly, 2007, we completed a round of headcount reductions. The headcountreductions were taken in several stages throughout the prior and current fiscalyear and across all of our regions in response to the general downturn in thehomebuilding industry.  Additionally, wecompleted another round of headcount reductions, subsequent to December 31,2007.  Severance costs of $0.5 millionwere accrued in the three months ended December 31, 2007 relating to theseheadcount reductions.  This most recentheadcount reduction affected all of our regions and represented a 14% decreasein total employee count.

 

Duringthe three months ended December 31, 2007, we reviewed our land underoption and agreements of sale and other pre-acquisition costs to determine ifthe anticipated economics of the transaction remained acceptable to us given thestate of the homebuilding industry. For those agreements deemed unfavorable, weattempted to renegotiate the transaction to more favorable terms. In thosesituations where the contract could not be renegotiated on terms we believedwere favorable to us, the option or agreement of sale was written-off,resulting in the write-off of abandoned projects and other-pre-acquisitioncosts noted above.

 

25

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***Land Sales and Other Income:***

 
| ** **                 | ** ** | **Three months ended December 31** | ** ** | ** ** | ** ** |
|----------------------------|------------|--------------------------------------------------------|------------|------------|------------|
| ** **                 | ** ** | **2007**                                               | ** ** | **2006**   | ** ** | **Change** | ** ** |
| ** **                 | ** ** | **(dollars in thousands)**                   | ** ** |
| **Land sales**             |       |                                                   |       |       |       |   |   |
| Earned revenues            |       | $                                                      | 8,224      |       | $          | 1,797 |   | $ | 6,427 |   |
| Costs and expenses         |       | 44,784                                                 |       | 1,231      |       | 43,553 |   |
| Gross (loss) profit        |       | $                                                      | (36,560    | )          | $          | 566 |   | $ | (37,126 | ) |
|                       |       |                                                   |       |       |       |   |   |
| **Other income (expense)** |       |                                                   |       |       |       |   |   |
| Other income               |       | $                                                      | 2,229      |       | $          | 2,159 |   | $ | 70 |   |
| Other expense              |       | 1,441                                                  |       | 1,515      |       | (74 | ) |

 
| ** **                 | ** ** | **Six months ended December 31** | ** ** | ** ** | ** ** |
|----------------------------|------------|------------------------------------------------------|------------|------------|------------|
| ** **                 | ** ** | **2007**                                             | ** ** | **2006**   | ** ** | **Change** | ** ** |
| ** **                 | ** ** | **(dollars in thousands)**                 | ** ** |
| **Land sales**             |       |                                                 |       |       |       |   |   |
| Earned revenues            |       | $                                                    | 9,410      |       | $          | 2,205 |   | $ | 7,205 |   |
| Costs and expenses         |       | 46,042                                               |       | 1,605      |       | 44,437 |   |
| Gross (loss) profit        |       | $                                                    | (36,632    | )          | $          | 600 |   | $ | (37,232 | ) |
|                       |       |                                                 |       |       |       |   |   |
| **Other income (expense)** |       |                                                 |       |       |       |   |   |
| Other income               |       | $                                                    | 4,562      |       | $          | 5,081 |   | $ | (519 | ) |
| Other expense              |       | 3,435                                                |       | 3,511      |       | (76 | ) |

 

Duringthe three months ended December 31, 2007 in response to the overalldeterioration in market conditions, we closed nine separate land saletransactions, disposing of approximately 1,400 lots.  Included in those 1,400 lots, were 267 lotsthat comprised our entire work-in-process inventory and land positions in thePhoenix, Arizona market.  We havehistorically reported this business as our western region operatingsegment.  The disposed work-in-processinventory and land positions constituted substantially all of our assets andoperations in the western region. Accordingly, all charges associated with the western region are includedas discontinued operations.

 

Includingthe lots sold in the western region, approximately 94% of the lots sold were inour midwestern, Florida and western regions. Approximately 6% of the lots sold were in our southern region.  No lots were sold in the northern regionduring the three months ended December 31, 2007.

 

Wereceived proceeds on the nine dispositions in the amount of $32.9 million, inclusiveof proceeds related to the western region, of which $8.2 million was recognizedas land sales revenue from continuing operations during the three and sixmonths ended December 31, 2007.  Anadditional $13.4 million of proceeds relates to two parcels of land that weresold, but for accounting purposes are treated as a financing obligation becausethey are subject to an option agreement. These separate option agreements generally provide us with the option,but not the obligation, to purchase lots on an individual basis throughperiodic lot option acquisition schedules. The remaining $11.3 million relates to the western region and isincluded in loss from discontinued operations discussed below.

 

Priorto the completion of the land sales discussed above, we recorded assetimpairments on the land to be sold.  Thetotal impairment charge related to these land sales were $36.6 million for thethree months ended December 31, 2007. These asset impairment losses are included in the costs of landsales.  Additionally, we recorded animpairment charge of $20.7 million related to the sale of assets in the westernregion.  This impairment charges isincluded in net loss from discontinued operations discussed below.

 

Otherincome consists primarily of property management fees and mortgage processingincome, while other expense consists primarily of the costs of propertymanagement and mortgage processing, along with depreciation expense for theCompany. The decrease in other income is primarily attributable to decreases inproperty management fees and interest income earned. The decrease in otherexpenses is primarily related to decreased costs associated with the mortgageprocessing business.

 

Ourmortgage processing business assists homebuyers in obtaining financing directlyfrom unaffiliated lenders. We do not fund or service the mortgage loans, nordoes it assume any credit or interest rate risk in connection with originatingthe mortgages.

 

26

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***Income Taxes and Loss from Continuing Operations:***

 
| ** **                                  | ** ** | **Three months ended December 31** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|--------------------------------------------------------|------------|------------|------------|
| ** **                                  | ** ** | **2007**                                               | ** ** | **2006**   | ** ** | **Change** | ** ** |
| ** **                                  | ** ** | **(dollars in thousands)**                   | ** ** |
| Pre-tax loss from continuing operations     |       | $                                                      | (63,295    | )          | $          | (11,544 | ) | $ | (51,751 | ) |
| Income tax benefit                          |       | (24,688                                                | )          | (4,515     | )          | (20,173 | ) |
| Loss from continuing operations, net of tax |       | $                                                      | (38,607    | )          | $          | (7,029 | ) | $ | (31,578 | ) |

 
| ** **                                  | ** ** | **Six months ended December 31** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------|------------|------------|------------|
| ** **                                  | ** ** | **2007**                                             | ** ** | **2006**   | ** ** | **Change** | ** ** |
| ** **                                  | ** ** | **(dollars in thousands)**                 | ** ** |
| Pre-tax loss from continuing operations     |       | $                                                    | (64,899    | )          | $          | (4,968 | ) | $ | (59,931 | ) |
| Income tax benefit                          |       | (24,529                                              | )          | (1,981     | )          | (22,548 | ) |
| Loss from continuing operations, net of tax |       | $                                                    | (40,370    | )          | $          | (2,987 | ) | $ | (37,383 | ) |

 

Inall of our regions, the increase in net loss from continuing operations isprimarily the result of asset impairment charges recorded during the three andsix months ended December 31, 2007. During the three and six months ended December 31, 2007, werecorded land sale impairment charges of $22.1 million, net of tax.  During the three and six months ended December 31,2007, we recorded long-lived asset impairment charges of $13.9 million and$14.3 million, respectively, net of taxes.

 

Theeffective income tax rate has decreased to 37.8% for the six months ended December 31,2007 from 39.9% for the six months ended December 31, 2006. The currentyear period also includes the impact of a revision to a prior year taxcontingency reserve of approximately $0.6 million and a prior year income taxreturn-to-accrual adjustment of approximately $0.5 million.

 

***Loss from Discontinued Operations:***

 

During the three months ended December 31, 2007, we determinedthat our operating strategy no longer supported maintaining a presence in thePhoenix, Arizona market.  Accordingly, wedisposed of our entire balance of work-in-process inventory and land in asingle transaction with a single buyer. We have historically reported this business as the western regionoperating segment.  The disposedwork-in-process inventory and land assets constituted substantially all of ourassets in the western region.  As such,all charges associated with the western region are included as a discontinuedoperation.

 

Loss from discontinued operations was $12.8 million or a loss of $0.69per share for the three months ended December 31, 2007 compared to a lossof $0.5 million or $0.03 per share for the three months ended December 31,2006.  For the six months ended December 31,2007, the loss from discontinued operations was $13.1 million or $0.71 pershare compared to a loss of $0.6 million or $0.03 per share for the six monthsended December 31, 2006.  Theadditional loss in both current fiscal year periods is principally due toimpairment charges to reduce the carrying value of the land prior to beingsold.  See Note 12 to our consolidatedfinancial statements in Item 1.

 

**Liquidity and Capital Resources**

 

Onan ongoing basis, we require capital for expenditures to purchase and developland, to construct homes, to fund related carrying costs and overhead and tofund various advertising and marketing programs to facilitate sales. These expenditures include site preparation, roads, water and sewer lines,impact fees and earthwork, as well as the construction costs of the homes andamenities.  Our sources of capital include funds derived from operations,sales of assets and various borrowings, most of which are secured.  In aneffort to increase liquidity, we may pursue sales on parcels of land, as wellas alternatives for selling a portion of our model home portfolio and otherassets; however, we can offer no assurances as to whether or when suchtransactions will occur or whether the transactions will be on termsadvantageous to us.

 

Weregularly monitor our land positions in an effort to identify potential landsales and improve our liquidity. Subsequent to December 31, 2007, we completed one additional landsale of approximately 20 lots that yielded net proceeds of approximately $2.0million and net gain of approximately $0.5 million.  We do not currently have any plans to sellany additional parcels of land, but circumstances may change which could resultin our taking advantage of such sales in the future.

 

Asof December 31, 2007, we had $133.6 million of borrowing capacity underour secured revolving credit facility discussed below, of which approximately$19.6 million was available to be drawn based upon our monthly borrowing basecertificate 

 

27

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asof December 31, 2007. A majority of our debt is variable rate, based onthe 30-day LIBOR rate, and therefore, we are exposed to market risk inconnection with interest rate changes. At December 31, 2007, the 30-dayLIBOR rate of interest was 4.600%.

 

TheCompany anticipates receiving approximately $25 million of federal income taxrefunds directly or indirectly as a result of certain land sale transactionsthat were completed during the three months ended December 31, 2007.  We expect to receive this refund prior theend of our fiscal year ended June 30, 2008; however, we can offer noassurances as to the amount of the refund or when it will be received.

 

Webelieve that cash on hand, funds generated from operations and financialcommitments from available lenders will provide sufficient capital for us tomeet our existing operating needs. Furthermore, we believe that we will continue to meet the covenantrequirements of the Revolving Credit Facility; however, we can make noassurances that it will be able to comply with the covenants or be able toobtain waivers or amendments of the covenants upon acceptable terms or at all.

 

***Revolving Credit Facility***

 

OnDecember 22, 2004, Greenwood Financial, Inc., a wholly-ownedsubsidiary of the Company and other wholly-owned subsidiaries of the Company,as borrowers, and Orleans Homebuilders, Inc., as guarantor, entered into aRevolving Credit and Loan Agreement for a $500.0 million Senior SecuredRevolving Credit and Letter of Credit Facility with various banks as lenders(as amended and restated and further amended, the “Revolving Credit Facility”).The Revolving Credit and Loan Agreement was amended on January 24, 2006via the Amended and Restated Revolving Credit and Loan Agreement (the “AmendedCredit Agreement”). In connection with the Amended Credit Agreement, OrleansHomebuilders, Inc. entered into an amended Guaranty agreement, which wasamended on September 6, 2007 by the First Amendment to Guaranty. TheAmended and Restated Credit Agreement was amended on November 1, 2006 (the“First Amendment”), February 7, 2007 (the “Second Amendment”), May 8,2007 (the “Third Amendment”), September 6, 2007 (the “Fourth Amendment”)and December 21, 2007 (the “Fifth Amendment”).

 

Theborrowing limit under the Revolving Credit Facility is $585.0 million, subjectto increase if certain conditions are met. Under and subject to the terms ofthe Revolving Credit Facility, the borrowers may borrow and re-borrow for thepurpose of financing the acquisition and development of real estate, theconstruction of homes and improvements, for investment in joint ventures, forworking capital and for such other appropriate corporate purposes as may beapproved by the lenders. Capitalized terms used below and not otherwise definedhave the meanings set forth in the Amended and Restated Credit Agreement.

 

Pursuantto the Fourth Amendment, and subject to the terms of the Revolving CreditFacility, approximately $464.0 million of the $585.0 million Revolving CreditFacility has a maturity date of December 20, 2009 and the remaining $121.0million has a maturity date of December 20, 2008.  Borrowings and advances under the Revolving CreditFacility bear interest on a per annum basis equal to the LIBOR Market IndexRate plus a non-default variable spread ranging from 250 basis points to 400basis points, depending upon our leverage ratio. During the term of theRevolving Credit Facility, interest is payable monthly in arrears. At December 31,2007, the interest rate was 7.350%, which included a 275 basis point spread.

 

Thetotal amount of loans and advances outstanding at any time under the RevolvingCredit Facility may not exceed the lesser of the then-current borrowing baseavailability or the revolving sublimit as defined in the Revolving CreditFacility. Pursuant to the Fourth Amendment, the revolving sublimit is $585.0million, subject to reduction on December 20, 2008. The borrowing baseavailability is based on the lesser of the appraised value or cost of realestate owned by us that has been admitted to the borrowing base. Variousconditions must be satisfied in order for real estate to be admitted to theborrowing base, including that a mortgage in favor of lenders has beendelivered to the agent for lenders and that all governmental approvalsnecessary to begin development of for-sale residential housing, other thanbuilding permits and certain other permits borrower in good faith believes willbe issued within 120 days, have been obtained. Depending on the stage ofdevelopment of the real estate, the loan to value or loan to cost advance ratein the borrowing base ranges from 50% to 95% of the appraised value or cost ofthe real estate.

 

Assecurity for all obligations of borrowers to lenders under the Revolving CreditFacility, lenders have a first priority mortgage lien on all real estateadmitted to the borrowing base. In addition, Orleans Homebuilders, Inc.has guaranteed the obligations of the borrowers to lenders pursuant to anamended Guaranty executed by Orleans Homebuilders, Inc. on January 26,2006 and amended on September 6, 2007. Under the Guaranty, OrleansHomebuilders, Inc. granted lenders a security interest in any balance orassets in any deposit or other account that Orleans Homebuilders, Inc. haswith any lender.

 

28

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TheRevolving Credit Facility contains customary covenants that, subject to certainexceptions, limit the ability of the Company to (among other things):

 

·                  Incuror assume other indebtedness, except certain permitted indebtedness;

·                  Grantor permit to exist any lien, except certain permitted liens;

·                  Enterinto any merger, consolidation or acquisition of all or substantially all theassets of another entity;

·                  Sell,assign, lease or otherwise dispose of all or substantially all of its assets;

·                  Enterinto any transaction with an affiliate that is not a borrower or a guarantorunder the Revolving Credit Facility, or a subsidiary of either;

·                  Paydividends in excess of $0.02 per share per quarter; or

·                  Redeemany stock.

 

TheRevolving Credit Facility also contains various financial covenants. Amongother things, the financial covenants, as amended, require that:

 

·                  Asof the last day of each fiscal quarter, the ratio of our Adjusted EBITDA todebt service for the prior four fiscal quarters cannot be not less than0.20-to-1.00 for the period ending June 30, 2008; 0.50-to-1.00 for theperiod ending September 30, 2008; 0.65-to-1.00 for the period ending December 31,2008, March 31, 2009 and June 30, 2009; and 1.00-to-1.00 for theperiod ending September 30, 2009. As a result of the Fourth and FifthAmendments, the Adjusted EBITDA to debt service covenant was waived for theperiods ending June 30, 2007, September 30, 2007, December 31,2007 and March 31, 2008.

·                  Wemust maintain a minimum consolidated tangible net worth of at least $192.0million plus 50% of the positive net income earned after June 30, 2007 andall of the net proceeds of equity securities issued by us after June 30,2007.  In addition, the minimumconsolidated adjusted tangible net worth shall be reduced by after-tax inventoryimpairments up to a maximum aggregate amount of $35.0 million and after-tax landsales impairments up to a maximum aggregate amount of $50.0 million, providedthat the minimum consolidated tangible net worth is at least $130.0 million atall times.

·                  Asof the last day of each fiscal quarter, our leverage ratio cannot exceed4.00-to-1.00 for any fiscal quarters ending on or after December 31,2007.  In addition, as of the last day ofeach fiscal quarter ending on or after December 31, 2007, our leverageratio, excluding the effect of inventory impairments and land salesimpairments, cannot exceed 3.00-to-1.00.

·                  Asof the last day of each fiscal quarter, the ratio of the book value of all landthat is not subject to a qualifying agreement of sale and on which no unit hasbeen or is being constructed to our consolidated adjusted tangible net worthcannot exceed  2.00-to-1.00 at December 31,2007 and March 31, 2008; 1.85-to-1.00 at June 30, 2008, September 30,2008 and December 31, 2008; and 1.75-to-1.00 at March 31, 2009through maturity.

·                  Wemust maintain a required liquidity level based on cash plus borrowing baseavailability and under this covenant, we must have (i) at least $10.0million of cash and cash equivalents (as defined) as of the reporting date ofeach borrowing base certificate, and (ii) at least $15.0 million ofliquidity (as defined and including cash and cash equivalents) as of the dateof each borrowing base certificate, through July 31, 2008.  Starting August 31, 2008, we must have (i) atleast $15.0 million of cash and cash equivalents (as defined) as of thereporting date of each borrowing base certificate, and (ii) at least $20.0million of liquidity (as defined and including cash and cash equivalents) as ofthe date of each borrowing base certificate.

·                  Undera minimum cash flow from operations ratio based on cash flow from operations tointerest incurred covenant, which is applicable starting with the twelve-monthperiod ending December 31, 2007, if the interest coverage ratio is lessthan 1.25-to-1.00, we must have a cash flow from operations to interestincurred ratio (as defined) of at least 1.50-to-1.00. During the first fourquarterly  periods during which thiscovenant is applicable, even if the interest coverage ratio is less than1.25-to-1.00, the cash flow from operations ratio may be less than 1.50-to-1.00during any one period, so long as it is greater than 1.00-to-1.00. Cash flowfrom operations is calculated based on the last twelve months cash flow fromoperations and adjusted for interest expense and includes any amounts from thedisposition of model homes that are subject to a sale-leaseback transaction tothe extent such amounts are not otherwise included in net cash provided byoperating activities.

 

Inaddition, the Revolving Credit Facility contains various financial covenantswith respect to the value of land in certain stages of development that may beowned by us, a borrower or any subsidiary of the Company and limits the numberof units which are not subject to a bona-fide agreement of sale that may be inthe inventory of any borrower, the Company or any subsidiary of the Company.

 

29

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Atthe fiscal quarters ended September 30, 2006, December 31, 2006, March 31,2007 and June 30, 2007, we would have been in violation of certainfinancial covenants in the Amended and Restated Credit Agreement if not for theFirst Amendment, Second Amendment, Third Amendment and Fourth Amendment,respectively, notwithstanding the fact that as of September 6, 2007 (thedate of the Fourth Amendment), we were in compliance with all of our covenantsas they existed immediately prior to the Fourth Amendment.

 

TheRevolving Credit Facility provides that, subject to any applicable notice andcure provisions, each of the following (among others) is an event of default:

 

·                  Failureby borrowers to pay when due any amounts owing under the Revolving CreditFacility;

·                  Failureby the Company to observe or perform any promise, covenant, warranty,obligation, representation or agreement under the Revolving Credit Facility orany other loan document;

·                  Bankruptcyand other insolvency events with respect to any borrower or the Company;

·                  Dissolutionor reorganization of any borrower or the Company;

·                  Theentry of a judgment or judgments against borrower(s) or the Company: (i) inan aggregate amount that is at least $0.5 million in excess of availableinsurance proceeds, if such judgment or judgments are not dismissed or bondedwithin 30 days; or (ii) that prevents borrowers from conveying lots andunits in the ordinary course of business if such judgment or judgments are notdismissed or bonded within 30 days; or the issuance of any writs of attachment,execution or garnishment against any borrower or the Company;

·                  Anymaterial adverse change in the financial condition of a borrower or the Companywhich causes the lenders, in good faith, to believe that the performance of anyof the obligations under the Revolving Credit Facility is impaired or doubtfulfor any reason; and

·                  Specifiedcross defaults.

 

Uponthe occurrence and continuation of an event of default, after completion of anyapplicable grace or cure period, lenders may demand immediate payment in fullof all indebtedness outstanding under the Revolving Credit Facility, terminatetheir obligations to make any loans or advances or issue any letter of credit,set off and apply any and all deposits held by any lender for the credit oraccount of any borrower. In addition, upon the occurrence of certain events ofbankruptcy or other insolvency events with respect to any borrower or theCompany, all indebtedness outstanding under the Revolving Credit Facility shallbe immediately due and payable without any act or action by lenders.

 

***Trust Preferred Securities***

 

OnNovember 23, 2005, we issued $75.0 million of trust preferred securitieswhich mature on January 30, 2036 and are callable, in whole or in part, atpar plus accrued interest on or after January 30, 2011. For the first tenyears, the securities have a fixed interest rate of 8.61% per annum, providedthat certain covenant levels are maintained. Thereafter, the securities have afloating interest rate equal to three-month LIBOR plus 360 basis points perannum, resetting quarterly.

 

Pursuantto the original Indenture, in the event we fail to meet certain financialratios for three of four consecutive quarters, the applicable rate of interestwill be increased by 300 basis points until we are in compliance with thefinancial ratios, at which time the interest rate will return to its originalamount.   On August 13, 2007, weentered into Supplemental Indenture No. 1 (the “Supplemental Indenture”),which amended the terms of the securities by deferring the potential start ofthis increased rate of interest for at least four quarters.  But for the Supplemental Indenture, we wouldhave been subject to the increased rate of interest starting with the firstquarter of fiscal 2008.  Pursuant to theSupplemental Indenture, it is an event of default if the increased interestrate is in effect for eight consecutive interest payment periods, starting withthe quarterly interest payment due on October 30, 2008.  Theoccurrence of an event of default may trigger demand for immediate payment infull of all outstanding amounts.  An uncured event of default under thetrust preferred securities also constitutes an event of default under theAmended and Restated Credit Agreement.  At December 31, 2006, March 31,2007, June 30, 2007, September 30, 2007 and December 31, 2007 wefailed to meet the interest coverage ratio. The interest coverage ratio is the ratio of Adjusted EBITDA to DebtService, as defined in the Supplemental Indenture, for the relevant accountingperiod.  We anticipate that we will not meet the interest coverage ratiofor the quarter ending March 31, 2008. As a result, we anticipate that we will begin to pay the increased rateof interest under the $75.0 million of trust preferred securities starting withthe quarterly interest payment due on October 30, 2008.  We believe that the Supplemental Indenturehas substantially eliminated the possibility for an event of default as aresult of making eight consecutive increased interest rate payments under theTrust Preferred Securities until at least September 2010.

 

30

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Toallow the Supplemental Indenture to become effective, OHI Financing, Inc.established a $5.0 million reserve fund for the benefit of the holders of thetrust preferred securities by posting a letter of credit with the trustee underthe Supplemental Indenture, which is subject to increase and may be drawn bythe trustee and used in respect of the trust preferred obligations.

 

Thesecurities are treated as debt obligations for financial statement purposes. Weused proceeds from the sale of these securities to repay outstandingobligations under the Revolving Credit Facility discussed above.

 

OnSeptember 20, 2005, we issued $30.0 million of trust preferred securities which mature on September 30,2035 and are callable, in whole or in part, at par plus accrued interest on orafter September 30, 2010. For the first ten years, the securities have afixed interest rate of 8.52% per annum. Thereafter, the securities have afloating interest rate equal to three-month LIBOR plus 380 basis points perannum, resetting quarterly. The securities are treated as debt obligations forfinancial statement purposes. We used proceeds from the sale of thesesecurities to fund land purchases and residential construction. The obligationsrelating to the trust preferred securities are subordinated to the RevolvingCredit Facility.

 

***Employee Retirement Plan***

 

OnDecember 1, 2005, we adopted an unfunded, non-qualified target definedbenefit retirement plan, effective as of September 1, 2005, which covers agroup of management employees of the Company. We own life insurance policies onall participants in the Supplemental Executive Retirement Plan (“SERP”). ThisSERP, which was amended and restated on September 27, 2007, is intended toprovide the participants with an annual supplemental retirement benefit basedupon their years of service with us and highest average compensation for fiveconsecutive years. The annual supplemental benefit for each participant will beadjusted based on the actual performance of the SERP compared to the target.The benefit is payable for life with a minimum of 10 years guaranteed. In orderto qualify for normal retirement benefits, a participant must attain age 65with at least five years of participation in the SERP. Early retirement will bepermitted beginning at age 55, after 5 years of participation in the SERP.Early retirement benefits will be adjusted actuarially to reflect the earlyretirement date.

 

Ifa participant terminates employment with us prior to attaining his or hernormal retirement age, other than by reason of early retirement, death ordisability, the participant generally will forfeit all benefits under the SERP.

 

Wecan amend or terminate the SERP at any time. However, no amendment or terminationwill affect the participants’ accrued benefits as determined in accordance withthe SERP or delay any payments to a participant beyond the time that suchamount would otherwise be payable without regard to the amendment.

 

***Cash Flow Statement***

 

Netcash provided by operating activities for the six months ended December 31,2007 was $37.9 million, compared to net cash used in operating activities forthe six months ended December 31, 2006 of $74.5 million. The primarydrivers of cash provided by operating activities were the sale of land duringthe six months ended December 31, 2007 and an increase in the accountpayable balances.

 

Netcash provided by investing activities for the six months ended December 31,2007 was $11.3 million, compared to net cash used in investing activities of$0.2 million for the six months ended December 31, 2006. Net cash providedby investing activities for the six months ended December 31, 2007 relatedto the disposition of assets related to the western region, partially offset bypurchase of property and equipment.

 

Netcash used in financing activities for the six months ended December 31,2007 was $37.3 million, compared to net cash provided by financing activitiesof $83.7 million for the six months ended December 31, 2006.  Cash used in financing activities primarilyrelates to net paydowns on our credit facility during the six months ended December 31,2007.  The paydown is the result of thecash provided by operating activities noted above.

 

***Summary of Outstanding Obligations***

 

Thefollowing table summarizes our outstanding obligations as of December 31,2007 and the effect such obligations are expected to have on our liquidity andcash flow in future periods. For mortgage and other note obligations, paymentsdue by period are shown based on the expiration date of the loan.

 

31

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| ** **                            | ** ** | **Payments due during fiscal year ending June 30,** | ** ** |
|---------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                            | ** ** | **Total**                                                                              | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **Thereafter** | ** ** |
| Obligations:                          |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Mortgage and other note   obligations |       | $                                                                                      | 524,884    |   | $ | 250 |   | $ | 684 |   | $ | 418,950 |   | $ | — |   | $ | — |   | $ | 105,000 |   |
| Operating leases                      |       | 3,846                                                                                  |       | 855 |   | 1,282 |   | 602 |   | 472 |   | 359 |   | 276 |   |
| Affordable housing contributions      |       | 225                                                                                    |       | 50 |   | 100 |   | 75 |   | — |   | — |   | — |   |
| Tax obligation                        |       | 2,535                                                                                  |       | 2,535 |   | — |   | — |   | — |   | — |   | — |   |
| Total obligations                     |       | $                                                                                      | 531,490    |   | $ | 3,690 |   | $ | 2,066 |   | $ | 419,627 |   | $ | 472 |   | $ | 359 |   | $ | 105,276 |   |

 

**Lot Positions**

 

Asof December 31, 2007, we owned or controlled approximately 8,525 buildinglots. Included in the aforementioned lots, we had contracted to purchase, orhas under option, undeveloped land and improved building lots for an aggregatepurchase price of approximately $161.0 million that are expected to yieldapproximately 2,550 building lots. Approximately 88% of the owned or controlled lots are in our northernand southern regions.  An additional 8%of the owned or controlled lots are in our midwestern region, while our Floridaregion has 4% of the owned or controlled lot position.

 

***Undeveloped Land Acquisitions:***

 

Inrecent years, the process of acquiring desirable undeveloped land has beenextremely competitive, particularly in the northern region, mostly due to thelack of available parcels suitable for development. In addition, expansion ofregulation in the housing industry has increased the time it takes to acquireundeveloped land with all of the necessary governmental approvals required tobegin construction. Generally, we structure our land acquisitions so that wehave the right to cancel our agreements to purchase undeveloped land byforfeiture of our deposit under the agreement. As of December 31, 2007,all but one of our agreements to purchase undeveloped land was structured inthis manner. Included in the balance sheet captions “Inventory not owned –Variable Interest Entities” and “Land deposits and costs of future development,”at December 31, 2007 we had $8.0 million invested in 14 parcels ofundeveloped land, of which $7.1 million is cash deposits, a portion of which isnon-refundable. At December 31, 2007, overall undeveloped parcels of landunder contract had an aggregate purchase price of approximately $88.5 millionand were expected to yield approximately 1,650 building lots.

 

Weattempt to further mitigate the risks involved in acquiring undeveloped land bystructuring our undeveloped land acquisitions so that the deposits requiredunder the agreements coincide with certain benchmarks in the governmentalapproval process, thereby limiting the amount at risk. This process allows usto periodically review the approval process and make a decision on theviability of developing the parcel to be acquired based upon expectedprofitability. In some circumstances we may be required to make deposits solelydue to the passage of time. This structure still provides us an opportunity toperiodically review the viability of developing the parcel of land. Inaddition, we primarily structure our agreements to purchase undeveloped land tobe contingent upon obtaining all governmental approvals necessary forconstruction. Under most agreements, we secure the responsibility for obtainingthe required governmental approvals as we believe that we have significantexpertise in this area. We intend to complete the acquisition of undevelopedland only after all governmental approvals are in place. In certain rarecircumstances, however, when all extensions have been exhausted, we must make adecision on whether to proceed with the purchase even though all governmentalapprovals have not yet been received. In these circumstances, we performreasonable due diligence to ascertain the likelihood that the necessarygovernmental approvals will be granted.

 

***Improved Lot Acquisitions:***

 

Theprocess of acquiring improved building lots from developers is extremelycompetitive. We compete with many national homebuilders to acquire improvedbuilding lots, some of which have greater financial resources than us. Theacquisition of improved lots is usually less risky than the acquisition ofundeveloped land as the contingencies and risks involved in the landdevelopment process are borne by the developer rather than us. In addition,governmental approvals are generally in place when the improved building lotsare acquired.

 

AtDecember 31, 2007, we had contracted to purchase or had under optionapproximately 900 improved building lots, which include lots that were sold,but for accounting purposes are treated as a financing obligation because theyare subject to an option agreement, for an aggregate purchase price ofapproximately $72.5 million. At December 31, 2007, we had $2.7 million,all of which are deposits, invested in these improved building lots. There wereno deposits forfeited during the three and six months ended December 31,2007 with respect to improved building lots.

 

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Weexpect to utilize primarily the Revolving Credit Facility as described above aswell as other existing capital resources, to finance the acquisitions ofundeveloped land and improved lots described above. We anticipate completing amajority of these acquisitions during the next several years.

 

**Recent Accounting Pronouncements**

 

InSeptember 2006, the FASB issued SFAS No. 157, “Fair ValueMeasurements” (“SFAS 157”). SFAS 157 provides guidance for using fair value tomeasure assets and liabilities. SFAS 157 will be effective for our fiscal yearending June 30, 2009. The Company is currently evaluating this standardand has not yet determined what impact it would have on our consolidatedfinancial statements.

 

InFebruary 2007, the FASB issued SFAS No. 159, “The Fair Value Optionfor Financial Assets and Financial Liabilities — Including an Amendment of FASBStatement No. 115” (“SFAS 159”). SFAS 159 provides an entity with theoption to measure many financial instruments and certain other items at fairvalue. Under the fair value option, an entity will report unrealized gains andlosses on those items at each subsequent reporting date. SFAS 159 is effectivefor fiscal years beginning after November 15, 2007, which for the Companyis the fiscal year ending June 30, 2009. We are currently evaluating thisstandard and have not yet determined what impact, if any, the fair value optionwould have on our consolidated financial statements.

 

InDecember 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—anamendment of ARB No. 51” (“SFAS 160”). SFAS 160 requires that anoncontrolling interest in a subsidiary be reported as equity and the amount ofconsolidated net income specifically attributable to the noncontrollinginterest be identified in the consolidated financial statements. It also callsfor consistency in the manner of reporting changes in the parent’s ownershipinterest and requires fair value measurement of any noncontrolling equityinvestment retained in a deconsolidation. SFAS 160 is effective for our fiscalyear ending June 30, 2010.  We areevaluating the impact the adoption of SFAS 160 will have on our consolidatedfinancial statements.

 

InDecember 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”).SFAS 141R broadens the guidance of SFAS 141, extending its applicability to alltransactions and other events in which one entity obtains control over one ormore other businesses. It broadens the fair value measurement and recognitionof assets acquired, liabilities assumed, and interests transferred as a resultof business combinations. SFAS 141R expands on required disclosures to improvethe statement users’ abilities to evaluate the nature and financial effects ofbusiness combinations. SFAS 141R is effective for our fiscal year ending June 30,2010. We are evaluating the impact the adoption of SFAS 141R will have on ourconsolidated financial statements.

 

Cautionary Statement for Purposes of the “Safe Harbor” Provisions ofthe Private Securities Litigation Reform Act of 1995

 

Inaddition to historical information, this report contains statements relating tofuture events or our future results. These statements are forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933and Section 21E of the Securities Exchange Act of 1934, as amended (the “ExchangeAct”), and are subject to the Safe Harbor provisions created by statute.Generally words such as “may”, “will”, “should”, “could”, “would”, “anticipate”,“expect”, “intend”, “estimate”, “plan”, “continue” and “believe” or thenegative of or other variation on these and other similar expressions identifyforward-looking statements. These forward-looking statements including, withoutlimitation, statements with respect to anticipated realization of deferred taxassets, the substantial elimination of the possibility of certain defaultsunder the Company’s $75 million issue of trust preferred securities until atleast September 2010, anticipated tax refunds, potential liabilities relatingto litigation currently pending against us, anticipated future dividends,anticipated delivery of homes in backlog, future market conditions, anticipateddelivery of backlog, appropriateness of completed home inventory levels and theoverall direction of the housing market, expected warranty costs, future landacquisitions and the availability of sufficient capital for us to meet ouroperating needs are made only as of the date of this report. We do notundertake to update or revise the forward-looking statements, whether as aresult of new information, future events or otherwise. For additionalinformation on some potential risks, see the Company’s Annual Report on Form 10-Kfor the fiscal year ended June 30, 2007.

 

Forward-lookingstatements are based on current expectations and involve risks anduncertainties and our future results could differ significantly from thoseexpressed or implied by our forward-looking statements.

 

Manyfactors could cause our actual consolidated results to differ materially fromthose expressed in any of our forward-looking statements.

 

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**ITEM 3.****                            ****QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

Marketrisk represents the risk of loss that may impact the financial position,results of operations or cash flows of the Company, due to adverse changes infinancial and commodity market prices and interest rates. The Company’sprincipal market risk exposure continues to be interest rate risk. A majorityof the Company’s debt is variable based on LIBOR, and, therefore, affected bychanges in market interest rates. Based on current operations, an increase ordecrease in interest rates of 100 basis points will result in a correspondingincrease or decrease in cost of sales and interest charges incurred by theCompany of approximately $4.2 million in a fiscal year, a portion of which willbe capitalized and included in cost of sales as homes are delivered. TheCompany believes that reasonably possible near-term interest rate changes willnot result in a material negative effect on future earnings, fair values orcash flows of the Company.

 

Changesin the prices of commodities that are a significant component of homeconstruction costs, particularly lumber, may result in unexpected short termincreases in construction costs. Since the sales price of the Company’s homesis fixed at the time the buyer enters into a contract to acquire a home andbecause the Company generally contracts to sell its homes before constructionbegins, any increase in costs in excess of those anticipated may result ingross margins lower than anticipated for the homes in the Company’s backlog.The Company attempts to mitigate the market risks of price fluctuation ofcommodities by entering into fixed-price contracts with its subcontractors andmaterial suppliers for a specified period of time, generally commensurate withthe building cycle.

 

Therehave been no material adverse changes to the Company’s (i) exposure tomarket risk and (ii) management of these risks, since June 30, 2007.

 

**ITEM 4.****                            ****CONTROLS AND PROCEDURES**

 

TheCompany’s management, with the participation of the Company’s Chief ExecutiveOfficer, Executive Vice President and Chief Financial Officer and VicePresident and Controller evaluated the effectiveness of the Company’sdisclosure controls and procedures as of the end of the period covered by thisreport. Based upon that evaluation, the Chief Executive Officer, President andChief Operating Officer, Executive Vice President and Chief Financial Officerand Vice President and Controller concluded that the Company’s disclosurecontrols and procedures are functioning effectively to provide reasonableassurance that information required to be disclosed by the Company in reportsfiled under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time periods specified in the Security andExchange Commission’s rules and forms and also to ensure informationrequired to be disclosed is accumulated and communicated to management. Therehas been no change in the Company’s internal control over financial reportingduring the Company’s most recent fiscal quarter that has materially affected,or is reasonably likely to materially affect, the Company’s internal controlover financial reporting.

 

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** **

**PART II. OTHERINFORMATION**

 

**ITEM1A.****                   ****RISK FACTORS**

 

Therehas been no material changes in our market risks during the three and sixmonths ended December 31, 2007, except as noted below. For additionalinformation regarding market risk, see our Annual Report on Form 10-K forthe year ended June 30, 2007.

 

***We may not be able to utilize all of our deferred tax assets.***

 

We currently believe that weare likely to have taxable income in the future sufficient to realize thebenefit of all of our deferred tax assets (consisting primarily of inventoryvaluation adjustments, reserves and accruals that are not currently deductiblefor tax purposes, as well as net operating loss carryforwards from losses weincurred during fiscal 2007). However, some or all of these deferred tax assetscould expire unused if we are unable to generate taxable income in the futuresufficient to utilize them or we enter into transactions that limit our rightto use them. If it becomes more likely than not that our deferred tax assetswill expire unused, we will have to recognize a valuation allowance, which maymaterially increase our income tax expense, and therefore adversely affect ourresults of operations and tangible net worth in the period in which it isrecorded.

 

**ITEM 4.      SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

OnDecember 6, 2007, the Company held its Annual Meeting of Stockholderspursuant to a notice dated October 26, 2007.  Definitive proxymaterials were filed with the Securities and Exchange Commission prior to themeeting.  A total of 11,998,698 shares were voted at the meeting,constituting 64.9% of the 18,501,641 shares entitled to vote.

 

Atthe Annual Meeting, the ten nominees (Benjamin D. Goldman, Jerome S. Goodman,Robert N. Goodman, Andrew N. Heine, David Kaplan, Lewis Katz, Jeffrey P.Orleans, Robert M. Segal, John W. Temple and Michael T. Vesey) for election tothe Company’s Board of Directors were all elected.

 
| ** **           | ** ** | **SharesVoted For** | ** ** | **Shares for Which    Vote was Withheld** |
|----------------------|------------|--------------------------|------------|---------------------------------------------------------------|
| ** **           | ** ** | ** **               | ** ** | ** **                                                    |
| Benjamin  D. Goldman |       | 11,998,698               |       | 0                                                             |
|                 |       |                     |       |                                                          |
| Jerome  S. Goodman   |       | 11,998,698               |       | 0                                                             |
|                 |       |                     |       |                                                          |
| Robert  N. Goodman   |       | 11,998,698               |       | 0                                                             |
|                 |       |                     |       |                                                          |
| Andrew  N. Heine     |       | 11,998,698               |       | 0                                                             |
|                 |       |                     |       |                                                          |
| David  Kaplan        |       | 11,998,698               |       | 0                                                             |
|                 |       |                     |       |                                                          |
| Lewis  Katz          |       | 11,998,698               |       | 0                                                             |
|                 |       |                     |       |                                                          |
| Jeffrey  P. Orleans  |       | 11,998,648               |       | 50                                                            |
|                 |       |                     |       |                                                          |
| Robert  M. Segal     |       | 11,998,698               |       | 0                                                             |
|                 |       |                     |       |                                                          |
| John  W. Temple      |       | 11,998,698               |       | 0                                                             |
|                 |       |                     |       |                                                          |
| Michael  T. Vesey    |       | 11,998,698               |       | 0                                                             |

 

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Atthe Annual Meeting, the Second Amended and Restated Orleans Homebuilders, Inc.2004 Omnibus Stock Incentive Plan (the “Amended and Restated Plan”) wasapproved with 11,996,274 votes for the Amended and Restated Plan, 2,212 votesagainst the Amended and Restated Plan and 212 abstentions.  The Amendedand Restated Plan increased the number of shares of common stock authorized forissuance under the Orleans Homebuilders, Inc. 2004 Omnibus Stock IncentivePlan by 1,600,000 shares to 2,000,000 and to permit the Company to modify theexercise price of options without further stockholder approval.

 

Alsoat the Annual Meeting, the Orleans Homebuilders, Inc. Cash Bonus Plan forGarry Herdler (the “Herdler Cash Bonus Plan”) was approved with 11,996,174 votes for the Herdler CashBonus Plan, 2,312 votes againstthe Herdler Cash Bonus Plan and 212 abstentions.  The Herdler Cash BonusPlan provides for a cash bonus to be paid to Mr. Herdler in any plan year,which is the same as the Company’s fiscal year, in which there is pre-tax,pre-bonus consolidated income for the Company.  Pre-tax, pre-bonusconsolidated income means the net income for the Company plus (a) accrualand/or payment of senior executive bonuses pursuant to the Company’s OrleansHomebuilders, Inc. Incentive Compensation Plan; (b) all state,federal, city, municipal, capital and other similar taxes, and (c) write-downsor similar expenses related to the Company’s inventory of owned or controlledlots, land, option contracts, homes, works in progress and/or other similaritems.  Pre-tax, pre-bonus consolidatedincome for the Herdler Cash Bonus Plan is determined in a manner consistentwith bonus calculations pursuant to the Incentive Compensation Plan and theaudited financial statements of the Company for the periods in question. Ifthere is no pre-tax, pre-bonus consolidated income for the Company in a givenplan year, no cash bonus will be paid pursuant to the Herdler Cash Bonus Plan.  If there is pre-tax, pre-bonus consolidatedincome for the Company in a given plan year, then the cash bonus amount payableto Mr. Herdler will be equal to the positive difference, if any, between thesum of: (i) 0.75% of the first $100 million of pre-tax, pre-bonus consolidatedincome for the applicable plan year, and (ii) 0.50% of the pre-tax, pre-bonusconsolidated income in excess of $100 million for the applicable plan year.

 

**ITEM 6.****                            ****EXHIBITS**

 

3.1           Amended and Restated By-laws ofOrleans Homebuilders, Inc. (incorporated by reference to Exhibit 3.1to the Company’s Form 8-K filed with the Securities and ExchangeCommission on December 11, 2007).

 

10.1         Second Amended and Restated OrleansHomebuilders, Inc. Omnibus Stock Incentive Plan (incorporated by referenceto Appendix D of the Company’s Proxy Statement with respect to its 2007 AnnualMeeting of Stockholders).

 

10.2         Orleans Homebuilders, Inc. CashBonus Plan for Garry Herdler (incorporated by reference to Appendix E of theCompany’s Proxy Statement with respect to its 2007 Annual Meeting ofStockholders).

 

10.3         Orleans Homebuilders, Inc.Restricted Stock Award Agreement (incorporated by reference to Exhibit 10.3to the Company’s Form 8-K filed with the Securities and ExchangeCommission on December 11, 2007).

 

10.4         Letter Agreement between OrleansHomebuilders, Inc. and Garry P. Herdler (incorporated by reference to Exhibit 10.4to the Company’s Form 8-K filed with the Securities and Exchange Commissionon December 11, 2007).

 

10.5         Orleans Homebuilders, Inc.Amendment to Non-Qualified Stock Option (incorporated by reference to Exhibit 10.5to the Company’s Form 8-K filed with the Securities and ExchangeCommission on December 11, 2007).

 

10.6         Fifth Amendment to Amended and RestatedRevolving Credit Loan Agreement, dated as of December 21, 2007 andeffective as of December 1, 2007, by and among Greenwood Financial, Inc.and certain affiliates, Orleans Homebuilders, Inc., Wachovia Bank,National Association and various other lenders party thereto (incorporated byreference to Exhibit 10.1 to the Company’s Form 8-K filed with theSecurities and Exchange Commission on December 28, 2007).

 

31.1*                    Certification of Jeffrey P. Orleans pursuant to Section 302 of theSarbanes-Oxley Act of 2002.

 

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31.2*                    Certification of Michael T. Veseypursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.3*                    Certification of Garry P. Herdler pursuant toSection 302 of the Sarbanes-Oxley Act of 2002.

 

32.1*                    Certification of Jeffrey P. Orleans pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

32.2*                    Certification of Michael T. Veseypursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

32.3*                    Certification of Garry P. Herdler pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

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*Exhibits filed herewith electronically

 

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SIGNATURES

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                  | ORLEANS HOMEBUILDERS, INC.   |
|-----------------------|------------------------------|
|                  | (Registrant)                 |
|                  |                         |
|                  |                         |
| February 7, 2008 | Jeffrey P. Orleans           |   |
|                  | Jeffrey P. Orleans           |   |
|                  | Chief Executive Officer      |   |
|                  |                         |   |
| February 7, 2008 | Garry P. Herdler             |   |
|                  | Garry P. Herdler             |   |
|                  | Executive Vice President and |   |
|                  | Chief Financial Officer      |   |
|                  |                         |   |
| February 7, 2008 | Mark D. Weaver               |   |
|                  | Mark D. Weaver               |   |
|                  | Vice President and           |   |
|                  | Controller                   |   |

 

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**EXHIBIT INDEX**

 
| 31.1* |   | Certification of Jeffrey P. Orleans pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.    |
|-------|--------|---------------------------------------------------------------------------------------------------------|
| 31.2* |   | Certification of Michael T. Vesey pursuant to Section 302  of the Sarbanes-Oxley Act of 2002. |
| 31.3* |   | Certification of Garry P. Herdler pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.      |
| 32.1* |   | Certification of Jeffrey P. Orleans pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002.    |
| 32.2* |   | Certification of Michael T. Vesey pursuant to Section 906  of the Sarbanes-Oxley Act of 2002. |
| 32.3* |   | Certification of Garry P. Herdler pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.      |

 

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*Exhibits filed herewith electronically

 

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