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** **

 

** **

**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, 2008** |
| ** **     | ** ** |
| ** **     | **OR** |
| ** **     | ** ** |
| **o**          | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXHANGE  ACT OF 1934** |

** **

**For the transitionperiod                    to**

** **

#### **CommissionFile 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 Identification. 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, including area 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

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See the definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

| Large  accelerated filer o                                              |   | Accelerated  filer o    |
|------------------------------------------------------------------------------|--------|------------------------------|
|                                                                         |   |                         |
| Non-accelerated  filer o (Do not check if a smaller reporting  company) |   | Smaller  reporting company x |

 

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 common stock, par value$0.10 per share, outstanding as ofFebruary 13, 2009:             19,089,141

(excluding 98,990 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, 2008 and June 30, 2008                                                       | 1          |
|        |                                                                                                                                          |       |
|        | Condensed Consolidated  Statements of Operations for the Three and Six Months Ended December 31,  2008 and 2007                          | 2          |
|        |                                                                                                                                          |       |
|        | Condensed Consolidated  Statements of Shareholders’ Equity and Total Comprehensive Loss for the Six  Months Ended December 31, 2008 | 3          |
|        |                                                                                                                                          |       |
|        | Condensed Consolidated Statements of  Cash Flows for the Six Months Ended December 31, 2008 and 2007                                     | 4          |
|        |                                                                                                                                          |       |
|        | Notes to Condensed  Consolidated Financial Statements                                                                                         | 5          |
|        |                                                                                                                                          |       |
| Item 2.     | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                                                   | 25         |
|        |                                                                                                                                          |       |
| Item 3.     | Quantitative  and Qualitative Disclosures About Market Risk                                                                                   | 47         |
|        |                                                                                                                                          |       |
| Item  4.    | Controls and  Procedures                                                                                                                      | 47         |
|        |                                                                                                                                          |       |
|        | **PART II — OTHER INFORMATION**                                                                                                     |       |
|        |                                                                                                                                          |       |
| Item 1A.    | Risk Factors                                                                                                                                  | 47         |
|        |                                                                                                                                          |       |
| Item 4.     | Submission of  Matters to a Vote of Security Holders                                                                                          | 48         |
|        |                                                                                                                                          |       |
| **Item 6.** | **Exhibits**                                                                                                                                  | **49**     |

 

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** **

**OrleansHomebuilders, Inc. and Subsidiaries**

**Condensed Consolidated BalanceSheets**

**(Unaudited)**

**(dollarsin thousands, except per share amounts)**

** **

 
| ** **                                                                                                                                                      | ** ** | **December 31,  2008** | ** ** | **June 30,  2008** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| Assets                                                                                                                                                          |       |                        |       |                    |       |
| Cash and cash equivalents                                                                                                                                       |       | $                           | 10,795     |                    | $          | 72,341 |   |
| Restricted cash - due from title company                                                                                                                        |       | 1,911                       |       | 19,269                  |       |
| Restricted cash - customer deposits                                                                                                                             |       | 6,288                       |       | 8,264                   |       |
| Marketable securities                                                                                                                                           |       | 17,318                      |       | —                  |       |
| Real estate held for development and sale:                                                                                                                      |       |                        |       |                    |       |
| Residential properties completed or under construction                                                                                                          |       | 192,729                     |       | 193,257                 |       |
| Land held for development or sale and improvements                                                                                                              |       | 340,055                     |       | 359,555                 |       |
| Inventory not owned - variable interest entities                                                                                                                |       | 10,668                      |       | 13,050                  |       |
| Inventory not owned - other financial interests                                                                                                                 |       | 12,158                      |       | 12,171                  |       |
| Property and equipment, at cost, less accumulated depreciation                                                                                                  |       | 897                         |       | 1,491                   |       |
| Goodwill                                                                                                                                                        |       | —                      |       | 4,180                   |       |
| Receivables, deferred charges and other assets                                                                                                                  |       | 21,704                      |       | 22,154                  |       |
| Land deposits and costs of future development                                                                                                                   |       | 10,486                      |       | 10,380                  |       |
| Total Assets                                                                                                                                                    |       | $                           | 625,009    |                    | $          | 716,112 |   |
|                                                                                                                                                            |       |                        |       |                    |       |
| Liabilities and Shareholders’ Equity                                                                                                                       |       |                        |       |                    |       |
| Liabilities:                                                                                                                                                    |       |                        |       |                    |       |
| Accounts payable                                                                                                                                                |       | $                           | 37,133     |                    | $          | 44,916 |   |
| Accrued expenses                                                                                                                                                |       | 40,464                      |       | 51,768                  |       |
| Deferred revenue                                                                                                                                                |       | 214                         |       | 274                     |       |
| Customer deposits                                                                                                                                               |       | 8,737                       |       | 11,856                  |       |
| Obligations related to inventory not owned - variable interest  entities                                                                                        |       | 10,235                      |       | 10,875                  |       |
| Obligations related to inventory not owned - other financial  interests                                                                                         |       | 12,058                      |       | 12,071                  |       |
| Mortgage and other note obligations                                                                                                                             |       | 365,409                     |       | 396,133                 |       |
| Subordinated notes                                                                                                                                              |       | 105,000                     |       | 105,000                 |       |
| Other notes payable                                                                                                                                             |       | —                      |       | 718                     |       |
| Total Liabilities                                                                                                                                               |       | 579,250                     |       | 633,611                 |       |
|                                                                                                                                                            |       |                        |       |                    |       |
| Commitments and contingencies (See note 14)                                                                                                                     |       |                        |       |                    |       |
|                                                                                                                                                            |       |                        |       |                    |       |
| Shareholders’ Equity:                                                                                                                                      |       |                        |       |                    |       |
| Common stock, $0.10 par, 23,000,000 shares authorized, 19,188,131 and  18,938,131 shares issued at December 31, 2008 and June 30, 2008,  respectively |       | 1,919                       |       | 1,894                   |       |
| Capital in excess of par value - common stock                                                                                                                   |       | 76,072                      |       | 75,204                  |       |
| Accumulated other comprehensive loss                                                                                                                            |       | (894                        | )          | (816                    | )          |
| (Accumulated deficit) retained earnings                                                                                                                         |       | (30,084                     | )          | 7,473                   |       |
| Treasury stock, at cost (98,990 shares held at December 31, 2008  and June 30, 2008)                                                                  |       | (1,254                      | )          | (1,254                  | )          |
| Total Shareholders’ Equity                                                                                                                                 |       | 45,759                      |       | 82,501                  |       |
|                                                                                                                                                            |       |                        |       |                    |       |
| Total Liabilities and Shareholders’ Equity                                                                                                                 |       | $                           | 625,009    |                    | $          | 716,112 |   |

 

See accompanying notes which are an integral part of the consolidatedfinancial statements.

 

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**OrleansHomebuilders, Inc. and Subsidiaries**

**Condensed Consolidated Statements ofOperations**

**(Unaudited)**

**(inthousands, except per share amounts)**

 
| ** **                                          | ** ** | **Three months ended December 31,** | ** ** | **Six months ended December 31,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------|------------|
| ** **                                          | ** ** | **2008**                                 | ** ** | **2007**                               | ** ** | **2008** | ** ** | **2007** | ** ** |
| Earned revenue                                      |       |                                     |       |                                   |       |   |   |   |   |
| Residential properties                              |       | $                                        | 87,753     |                                   | $          | 144,490 |   | $ | 176,355 |   | $ | 263,847 |   |
| Land sales                                          |       | —                                   |       | 8,224                                  |       | 58 |   | 9,410 |   |
| Other income                                        |       | 2,475                                    |       | 2,229                                  |       | 4,136 |   | 4,562 |   |
|                                                |       | 90,228                                   |       | 154,943                                |       | 180,549 |   | 277,819 |   |
| Costs and expenses                                  |       |                                     |       |                                   |       |   |   |   |   |
| Residential properties                              |       | 87,248                                   |       | 147,425                                |       | 174,955 |   | 250,378 |   |
| Land sales                                          |       | 2                                        |       | 44,784                                 |       | 26 |   | 46,042 |   |
| Other                                               |       | 1,856                                    |       | 1,441                                  |       | 3,640 |   | 3,435 |   |
| Selling, general and administrative                 |       | 16,121                                   |       | 24,588                                 |       | 32,699 |   | 42,863 |   |
| Impairment of goodwill                              |       | —                                   |       | —                                 |       | 4,180 |   | — |   |
| Interest:                                           |       |                                     |       |                                   |       |   |   |   |   |
| Incurred                                            |       | 11,018                                   |       | 13,035                                 |       | 22,006 |   | 25,704 |   |
| Less capitalized                                    |       | (9,999                                   | )          | (13,035                                | )          | (19,123 | ) | (25,704 | ) |
|                                                |       | 106,246                                  |       | 218,238                                |       | 218,383 |   | 342,718 |   |
|                                                |       |                                     |       |                                   |       |   |   |   |   |
| Loss from continuing operations before income taxes |       | (16,018                                  | )          | (63,295                                | )          | (37,834 | ) | (64,899 | ) |
| Income tax benefit                                  |       | (397                                     | )          | (24,688                                | )          | (277 | ) | (24,529 | ) |
|                                                |       |                                     |       |                                   |       |   |   |   |   |
| Loss from continuing operations                     |       | (15,621                                  | )          | (38,607                                | )          | (37,557 | ) | (40,370 | ) |
|                                                |       |                                     |       |                                   |       |   |   |   |   |
| Discontinued operations:                            |       |                                     |       |                                   |       |   |   |   |   |
| Loss from discontinued operations, net of taxes     |       | —                                   |       | (12,778                                | )          | — |   | (13,070 | ) |
|                                                |       |                                     |       |                                   |       |   |   |   |   |
| Net loss                                            |       | $                                        | (15,621    | )                                      | $          | (51,385 | ) | $ | (37,557 | ) | $ | (53,440 | ) |
|                                                |       |                                     |       |                                   |       |   |   |   |   |
| Basic loss per share                                |       |                                     |       |                                   |       |   |   |   |   |
| Continuing operations                               |       | $                                        | (0.84      | )                                      | $          | (2.09 | ) | $ | (2.03 | ) | $ | (2.18 | ) |
| Discontinued operations                             |       | $                                        | —     |                                   | $          | (0.69 | ) | $ | — |   | $ | (0.71 | ) |
| Loss per share                                      |       | $                                        | (0.84      | )                                      | $          | (2.78 | ) | $ | (2.03 | ) | $ | (2.89 | ) |
|                                                |       |                                     |       |                                   |       |   |   |   |   |
| Diluted loss per share                              |       |                                     |       |                                   |       |   |   |   |   |
| Continuing operations                               |       | $                                        | (0.84      | )                                      | $          | (2.09 | ) | $ | (2.03 | ) | $ | (2.18 | ) |
| Discontinued operations                             |       | $                                        | —     |                                   | $          | (0.69 | ) | $ | — |   | $ | (0.71 | ) |
| Loss per share                                      |       | $                                        | (0.84      | )                                      | $          | (2.78 | ) | $ | (2.03 | ) | $ | (2.89 | ) |
|                                                |       |                                     |       |                                   |       |   |   |   |   |
| Dividends declared per share                        |       | $                                        | —     |                                   | $          | 0.02 |   | $ | — |   | $ | 0.04 |   |
|                                                |       |                                     |       |                                   |       |   |   |   |   |
| Basic weighted average shares outstanding           |       | 18,518                                   |       | 18,502                                 |       | 18,511 |   | 18,502 |   |
|                                                |       |                                     |       |                                   |       |   |   |   |   |
| Diluted weighted average shares outstanding         |       | 18,518                                   |       | 18,502                                 |       | 18,511 |   | 18,502 |   |

 

See accompanying notes which are an integral part ofthe consolidated financial statements.

 

 

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**OrleansHomebuilders, Inc. and Subsidiaries**

**Condensed Consolidated Statements ofChanges in Shareholders’ Equity**

**AndTotal Comprehensive (Loss) Income**

**(Unaudited)**

**(dollarsin thousands)**

 
| ** **                                  | ** ** | **Six months ended  December 31, 2008** | ** ** |
|---------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                  | ** ** | **Shares**                                   | ** ** | **Amount** | ** ** |
| **Common Stock**                            | ** ** | ** **                                   | ** ** | ** ** | ** ** |
| Beginning balance                           |       | 18,938,131                                   |       | $ | 1,894 |   |
| Restricted stock award                      |       | 250,000                                      |       | 25 |   |
| Ending balance                              |       | 19,188,131                                   |       | $ | 1,919 |   |
|                                        |       |                                         |       |   |   |
| **Additional Paid in Capital**              | ** ** | ** **                                   | ** ** | ** ** | ** ** |
| Beginning balance                           |       |                                         |       | $ | 75,204 |   |
| Fair market value of stock options issued   |       |                                         |       | 665 |   |
| Shares awarded under Stock award plan       |       |                                         |       | 228 |   |
| Restricted stock award                      |       |                                         |       | (25 | ) |
| Ending balance                              |       |                                         |       | $ | 76,072 |   |
|                                        |       |                                         |       |   |   |
| **(Accumulated Deficit) Retained Earnings** | ** ** | ** **                                   | ** ** | ** ** | ** ** |
| Beginning balance                           |       |                                         |       | $ | 7,473 |   |
| Net loss                                    |       |                                         |       | (37,557 | ) |
| Ending balance                              |       |                                         |       | $ | (30,084 | ) |
|                                        |       |                                         |       |   |   |
| **Accumulated Other Comprehensive Loss**    | ** ** | ** **                                   | ** ** | ** ** | ** ** |
| Beginning balance                           |       |                                         |       | $ | (816 | ) |
| Net unrealized loss on investments          |       |                                         |       | (78 | ) |
| Ending balance                              |       |                                         |       | $ | (894 | ) |
|                                        |       |                                         |       |   |   |
| **Treasury Stock**                          | ** ** | ** **                                   | ** ** | ** ** | ** ** |
| Beginning and ending balance                |       | 98,990                                       |       | $ | (1,254 | ) |
|                                        |       |                                         |       |   |   |
| **Total Comprehensive Loss**                | ** ** | ** **                                   | ** ** | ** ** | ** ** |
| Net loss                                    |       |                                         |       | $ | (37,557 | ) |
| Unrealized loss on investments              |       |                                         |       | (78 | ) |
| **Total Comprehensive loss**                |       |                                         |       | $ | (37,635 | ) |

 

See accompanyingnotes, which are an integral part of the consolidated financial statements

 

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**OrleansHomebuilders, Inc. and Subsidiaries**

**Condensed Consolidated Statements ofCash Flows**

**(Unaudited)**

**(dollarsin thousands)**

 
| ** **                                                                                 | ** ** | **Six months ended  December 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                 | ** ** | **2008**                                | ** ** | **2007** | ** ** |
|                                                                                       |       |                                    |       |   |   |
| Cash flows from operating activities:                                                      |       |                                    |       |   |   |
| Net loss                                                                                   |       | $                                       | (37,557    | ) | $ | (53,440 | ) |
| Adjustments to reconcile net loss to net cash (used in) provided by  operating activities: |       |                                    |       |   |   |
| Depreciation and amortization                                                              |       | 3,394                                   |       | 1,552 |   |
| Gain on sale of fixed assets                                                               |       | (906                                    | )          | — |   |
| Gain on sale of marketable securities                                                      |       | (27                                     | )          | — |   |
| Write-off of real estate held for development and sale                                     |       | 18,088                                  |       | 80,901 |   |
| Write-off of land deposits and costs of future development                                 |       | 1,798                                   |       | 862 |   |
| Write-off of goodwill                                                                      |       | 4,180                                   |       | — |   |
| Deferred taxes                                                                             |       | —                                  |       | (10,641 | ) |
| Stock based compensation expense                                                           |       | 961                                     |       | 1,095 |   |
| Changes in operating assets and liabilities:                                               |       |                                    |       |   |   |
| Restricted cash - due from title company                                                   |       | 17,358                                  |       | 16,358 |   |
| Restricted cash - customer deposits                                                        |       | 1,976                                   |       | 1,950 |   |
| Real estate held for development and sale                                                  |       | 1,940                                   |       | 18,060 |   |
| Receivables, deferred charges and other assets                                             |       | (175                                    | )          | (33,805 | ) |
| Land deposits and costs of future developments                                             |       | 379                                     |       | (12,483 | ) |
| Accounts payable and other liabilities                                                     |       | (19,212                                 | )          | 32,056 |   |
| Customer deposits                                                                          |       | (3,119                                  | )          | (127 | ) |
| Net cash (used in) provided by operating activities                                        |       | (10,922                                 | )          | 42,338 |   |
|                                                                                       |       |                                    |       |   |   |
| Cash flows from investing activities:                                                      |       |                                    |       |   |   |
| Purchases of marketable securities                                                         |       | (34,021                                 | )          | (40 | ) |
| Sales and maturities of marketable securities                                              |       | 16,652                                  |       | — |   |
| Proceeds from sale of fixed assets                                                         |       | 996                                     |       | — |   |
| Proceeds from disposition of business                                                      |       | —                                  |       | 11,300 |   |
| Net cash (used in) provided by investing activities                                        |       | (16,373                                 | )          | 11,260 |   |
|                                                                                       |       |                                    |       |   |   |
| Cash flows from financing activities:                                                      |       |                                    |       |   |   |
| Borrowings from loans collateralized by real estate assets                                 |       | 78,059                                  |       | 25,000 |   |
| Repayment of loans collateralized by real estate assets                                    |       | (108,786                                | )          | (74,994 | ) |
| Repayment of other note obligations                                                        |       | (718                                    | )          | (32 | ) |
| Financing costs of long-term debt                                                          |       | (2,265                                  | )          | (4,482 | ) |
| Liability associated with other financial interests                                        |       | —                                  |       | 13,425 |   |
| Payments on liabilities associated with other financial interests                          |       | (541                                    | )          | — |   |
| Common stock cash dividend paid                                                            |       | —                                  |       | (740 | ) |
| Net cash used in financing activities                                                      |       | (34,251                                 | )          | (41,823 | ) |
|                                                                                       |       |                                    |       |   |   |
| Net (decrease) increase in cash and cash equivalents                                       |       | (61,546                                 | )          | 11,775 |   |
| Cash and cash equivalents at beginning of period                                           |       | 72,341                                  |       | 19,991 |   |
| Cash and cash equivalents at end of period                                                 |       | $                                       | 10,795     |   | $ | 31,766 |   |

 

See accompanyingnotes which are an integral part of the consolidated financial statements.

 

 

 

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** **

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

 

 

**1.****             ****BASISOF PRESENTATION AND SUMMARY OF 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 various typesof homebuyers, including move-up, luxury, empty nester, active adult andfirst-time homebuyers.  The Company alsogenerates revenue from the sale of land.

 

***Interim FinancialInformation***

 

Thesecondensed financial statements have been prepared in accordance with the rules ofthe Securities and Exchange Commission for interim financial statements and donot include all annual disclosures required by accounting principles generallyaccepted in the United States.  Thesefinancial statements should be read in conjunction with the auditedconsolidated financial statements and notes thereto included in the Company’s Form 10-Kfor the fiscal year ended June 30, 2008. The June 30, 2008, amounts were derived from the Company’s auditedfinancial statements, but do not include all disclosures required by accountingprinciples generally accepted in the United States of America.  The condensed financial information as of December 31,2008, and for the three and six months ended December 31, 2008 and 2007,is unaudited, but in the opinion of management includes all adjustments,consisting of normal recurring accruals, that management considers necessaryfor a fair presentation of the Company’s consolidated results of operations,financial position and cash flows.  Resultsfor the three and six months ended December 31, 2008, are not necessarilyindicative of results to be expected for the full fiscal year 2009 or any otherfuture periods.

 

OnDecember 31, 2007, the Company specifically committed to exiting itsArizona market and, in connection with this decision, on that date, it disposedof its entire land position and its related work-in-process homes in Arizona,which constituted substantially all of its assets in Arizona.  The Company has historically reported this businessas the western region operating segment. The disposed work-in-process inventory and land assets constitutedsubstantially all of the Company’s assets in the western region.  As such, all charges associated with thewestern region are included as a discontinued operation.

 

InSeptember 2006, the Financial Accounting Standards Board (“FASB”) issued Statement ofFinancial Accounting Standard (“SFAS”) No. 157, “FairValue Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework formeasuring fair value in Generally Accepted Accounting Principles (“GAAP”), andexpands disclosures about fair value measurements.  SFAS No. 157 is effective for financialassets and financial liabilities in fiscal years beginning after November 15,2007 and for certain nonfinancial assets and certain nonfinancial liabilitiesin fiscal years beginning after November 15, 2008.  Effective July 1, 2008, the Company hasadopted the provisions of SFAS No. 157 that relate to its financial assetsand financial liabilities.  See note 15,Fair Value Disclosures.

 

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 No. 159). This Statement permits entities to choose to measure many financialinstruments and certain other items at fair value and report unrealized gainsand losses on these instruments in earnings. SFAS No. 159 was effective July 1, 2008.  The Company did not adopt the fair valueoption.

 

Certainprior year amounts have been reclassified to conform to the fiscal year 2009presentation, with no effect on previously reported net loss or shareholders’equity.

 

**2.****             ****RECENT ACCOUNTING PRONOUNCEMENTS**

 

InDecember 2007, the FASB issued SFAS No. 160, “NoncontrollingInterests in Consolidated Financial Statements—an amendment of ARB No. 51”(“SFAS No. 160”). SFAS No. 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 calls for consistency in the mannerof reporting changes in the parent’s ownership interest and requires fair valuemeasurement of any noncontrolling equity investment retained in adeconsolidation.  SFAS No. 160is effective for fiscal year ending June 30, 2010.  The Company is evaluating the impact theadoption of SFAS 160 will have on its consolidated financial statements.

 

InDecember 2007, the FASB issued SFAS No. 141 (revised 2007), “BusinessCombinations” (“SFAS No. 141(R)”). SFAS No. 141(R) broadensthe guidance of SFAS No. 141, extending its applicability to alltransactions and other events in which one entity obtains control over one ormore other businesses.  It broadens thefair value measurement and recognition of assets acquired, 

 

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liabilitiesassumed, and interests transferred as a result of business combinations.  SFAS No. 141(R) expands onrequired disclosures to improve the statement users’ abilities to evaluate thenature and financial effects of business combinations.  SFAS No. 141(R) is effectivefor fiscal year ending June 30, 2010. The Company is evaluating the impact the adoption of SFAS No. 141(R) willhave on its consolidated financial statements.

 

InMarch 2008, the FASB issued SFAS No. 161, “Disclosures about DerivativeInstruments and Hedging Activities, an amendment of FASB Statement No. 133.”  This statement requires enhanced disclosuresabout an entity’s derivative and hedging activities and thereby improves thetransparency of financial reporting.  TheStatement is effective for financial statements for fiscal years and interimperiods beginning after November 15, 2008 and is not expected to have animpact on the Company’s financial statements.

 

InJune 2008, the FASB issued FASB Staff Position (“FSP”) Emerging IssuesTask Force 03-6-1, “Determining Whether Instruments Granted in Share-BasedPayment Transactions Are Participating Securities.” Under the FSP, unvestedshare-based payment awards that contain non-forfeitable rights to dividends ordividend equivalents are participating securities and, therefore, are includedin computing earnings per share pursuant to the two-class method.  The two-class method determines earnings pershare for each class of common stock and participating securities according to dividendsor dividend equivalents and their respective participation rights inundistributed earnings.  The Company’soutstanding restricted stock awards will be considered participating securitiesunder this FSP. The FSP is effective for the Company’s fiscal year beginning July 1,2009 and requires retrospective application. The Company does not expect the adoption of the FSP to have a materialimpact on its reported earnings per share.

 

InDecember 2008, the FASB issued FSP No. FAS 140-4 and FIN 46(R)-8, “Disclosuresby Public Entities (Enterprises) about Transfers of Financial Assets andInterests in Variable Interest Entities.” The staff position amends SFAS No. 140,“Accounting for Transfers and Servicing of Financial Assets and Extinguishmentsof Liabilities,” to require public entities to provide additional disclosuresabout transfers of financial assets. It also amends FIN 46(R) to requirepublic enterprises, including sponsors that have a variable interest in avariable interest entity, to provide additional disclosures about theirinvolvement with variable interest entities. This position is effective forfinancial statements issued for interim periods and fiscal years ending after December 15,2008.  The adoption of thispronouncement, which is related to disclosure only, did not have a materialimpact on the Company’s financial statements.

 

**3.****             ****CASH AND CASH EQUIVALENTS**

 

Cashand cash equivalents consisted of the following at December 31, 2008 and June 30,2008:

 
| ** **                                                                           | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                           | ** ** | **2008**              | ** ** | **2008**          | ** ** |
| Cash and money market funds                                                          |       | $                     | 9,168      |              | $          | 72,341 |   |
| Treasury securities - with maturities of less than three months at  time of purchase |       | 1,627                 |       | —            |       |
|                                                                                 |       | $                     | 10,795     |              | $          | 72,341 |   |

 

**4.****             ****MARKETABLE SECURITIES**

 

Inaccordance with SFAS No. 115, “Accounting for Certain Investments in Debtand Equity Securities”, securities are classified into three categories:held-to-maturity, available-for-sale and trading.  The Company’s marketable securities consistof United States Treasury securities classified as available-for-salesecurities.  Accordingly, they arecarried at fair value in accordance with SFAS No. 115.  Further, according to SFAS No. 115 theunrealized holding gains and losses for available-for-sales securities areexcluded from earnings and reported, net of deferred income taxes, inaccumulated other comprehensive loss, unless the loss is classified as otherthan a temporary decline in market value. At December 31, 2008, the amortized cost, gross unrealized gains(losses) and fair value of available-for-sale securities by major security typeand class of security were as follows:

 
| ** **                                                                       | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | ** **     | ** ** |
|----------------------------------------------------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|----------------|------------|
| ** **                                                                       | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Fair Value** | ** ** |
| Treasury securities - with maturities of less than one year at time  of purchase |       | $             | 17,396     |           | $          | 6              |       | $              | (84        | ) | $ | 17,318 |   |
|                                                                                  |            |               |            |                |            |                |            |                |            |  |  |  |  |

 

The treasury bills and treasury notes described abovehave maturities that range from three months to six months.

 

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**5****.****             ****RESIDENTIAL PROPERTIES COMPLETEDOR UNDER CONSTRUCTION**

 

Residentialproperties completed or under construction consist of the following:

 
| ** **                                                 | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                 | ** ** | **2008**              | ** ** | **2008**          | ** ** |
| Under contract for sale                                    |       | $                     | 92,954     |              | $          | 109,980 |   |
| Unsold                                                     |       | 99,775                |       | 83,277            |       |
| Total residential property completed or under construction |       | $                     | 192,729    |              | $          | 193,257 |   |

 

**6**.              **MORTGAGE AND OTHER NOTE OBLIGATIONS ANDSUBORDINATED NOTES**

 

The$365,409 outstanding balance in mortgage and other note obligations at December 31,2008, consists of $365,223 outstanding under the Revolving Credit Facility,which is discussed below, and $186 under mortgage obligations collateralized byland held for development and sale and improvements.  The average daily balance of the RevolvingCredit Facility during the six months ended December 31, 2008, was$377,535.

 

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

 

***Revolving Credit Facility***

 

On December 22,2004, Greenwood Financial, Inc., a wholly-owned subsidiary of the Company,and other wholly-owned subsidiaries of the Company, as borrowers, and OrleansHomebuilders, Inc., as guarantor, entered into a Revolving Credit LoanAgreement for a Senior Secured Revolving Credit and Letter of Credit Facilitywith various banks as lenders (as amended and restated and further amended, the“Revolving Credit Facility”). The Revolving Credit Loan Agreement was amendedon January 24, 2006, via the Amended and Restated Revolving Credit LoanAgreement (the “Amended Credit Agreement”). In connection with the Amended Credit Agreement, Orleans Homebuilders, Inc.executed a Guaranty, which was amended on September 6, 2007 and amendedand restated on September 30, 2008. The Amended and Restated CreditAgreement was amended on November 1, 2006, February 7, 2007, May 8,2007, September 6, 2007, December 21, 2007, May 9, 2008 by alimited waiver to the Amended Credit Agreement, which was extended on September 15,2008, and amended and restated in the Second Amended and Restated RevolvingCredit Loan Agreement, dated September 30, 2008 (the “Second AmendedCredit Agreement”).  The Second AmendedCredit Agreement was subsequently amended by a limited waiver letter dated January 30,2009 (the “waiver letter”) and the First Amendment to Second Amended andRestated Revolving Credit Loan Agreement and First Amendment to SecurityAgreement dated February 11, 2009 (the “First Amendment”).

 

***Waiver Letter***

 

Absent the waiver letterdescribed below, the Company would have continued to be in default of itsobligation to, on or before January 23, 2009, make a principal repaymentin an amount necessary to reduce the outstanding principal balance of the loansto the borrowing base availability (the “Repayment Covenant”).  The failure to make the repayment in fullwithin the proscribed period constituted an event of default under the SecondAmended Credit Agreement, of which the Company provided notice to the Lenders.  In addition, Wachovia Bank, N.A. (“Wachovia”)asserted that the borrowers breached the liquidity covenant in the SecondAmended Credit Agreement (the “Liquidity Covenant”) for the quarter ended December 31,2008.  The borrowers disagree withWachovia’s assertion that the borrowers breached the Liquidity Covenant andhave notified Wachovia of their disagreement.

 

The second waiver lettertemporarily waived compliance with the Repayment Covenant and the LiquidityCovenant generally from December 31, 2008 through and including February 6,2009, unless another event of default occurred.  With the termination ofwaiver period without the First Amendment described below having been enteredinto, the failure of the Company to have complied with the Repayment Covenanton or before that date, the Company was again in breach of the RepaymentCovenant and, to the extent there had been a breach of the Liquidity Covenantas asserted by Wachovia (an assertion with which the Company disagrees), theCompany was also in breach of that covenant.  Any such breaches were,however, cured by the First Amendment described below.

 

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***First Amendment to the Second Amended Credit Agreement andSecurity Agreement:***

 

On February 11,2009, the Company entered into the First Amendment to the Second Amended CreditAgreement which provides, among other things, that:

 

·                  The categoryreductions applicable to the determination of borrowing base availability wereadjusted so that the maximum borrowing base availability attributable to assetclass (ii) (units not subject to a qualifying agreement of sale)determined on the basis of any borrowing base certificate that is deliveredbefore July 31, 2009, was increased to a maximum of 58% of the aggregateborrowing base availability attributable to asset classes (i) (unitssubject to a qualifying agreement of sale) and (ii) (units not subject toa qualifying agreement of sale) as shown on the borrowing base certificate.  For borrowing base certificates delivered onor after July 31, 2009, the maximum percentage remains unchanged at 45%.

·                  The categoryreductions applicable to the determination of the borrowing base availabilitywere adjusted so that the maximum borrowing base availability attributable toasset classes (iii) (lots part of improved land not subject to aqualifying agreement of sale), (iv) (lots part of land under development)and (v) (lots part of land approved for development), based on borrowingbase certificates delivered before July 31, 2009, was increased to amaximum of 65% of the total borrowing base availability as shown on theborrowing base certificate.  Forborrowing base certificates delivered on or after July 31, 2009, themaximum percentage is 55%.    The maximumdollar value of borrowing base availability attributable to asset classes(iii), (iv) and (v) were also adjusted to the following (with suchlimitations to be reduced dollar for dollar at the time and in the amounts ofany impairments with respect to assets in asset classes (iii), (iv) and (v) andincluded in the borrowing base taken by borrowers):

(i)                                     Beginning with the BorrowingBase Certificate delivered on or after the effective date of the FirstAmendment: $235,000;

 

(ii)                                  Beginning with the BorrowingBase Certificate delivered on or after July 31, 2009: $200,000; and

 

(iii)                               Beginning with the BorrowingBase Certificate delivered after September 30, 2009: $190,000.

·                  Under the FirstAmendment, the aggregate effect of (i) the modification of the borrowingbase category reductions applicable to units not subject to a qualifyingagreement of sale (described above); (ii) the modification of theborrowing base category reductions for land under development (describedabove); and (iii)  the inventory impairments during the second fiscalquarter of approximately $8,670, was an increase in net borrowing baseavailability of $16,065 as of December 31, 2008, from a negative $14,567to a positive $1,498.

·                  The amount ofthe Revolving Credit Facility was reduced from $440,000 to $405,000, exceptthat the amount of the Revolving Credit Facility will be reduced to $375,000beginning on July 16, 2009 and through maturity, unless otherwisepermanently reduced as a result of certain prepayments required by theRevolving Credit Facility.  The letter ofcredit sublimit was reduced to $30,000 from $60,000, and the financial letterof credit sublimit was reduced to $15,000 from $25,000. The amount actuallyavailable under the Revolving Credit Facility is also subject to the borrowingbase availability requirements in the Revolving Credit Facility.

·                  In the eventthere is one or more defaulting lenders, so long as there is no event ofdefault has occurred and is continuing, pro-rata principal payments shall notbe made to such defaulting lender, but instead shall be paid over to the masterborrower.

·                  The minimumconsolidated tangible net worth level was adjusted to a minimum of at least$25,000 (1) reduced by the sum of (a) any impairments or othercharges under GAAP on assets in the borrowing base taken by the Company andrecorded in respect of the financial quarters ended December 31, 2008 and March 31,2009, plus (b)  any deferred tax assets valuation allowance reservesrecorded in respect of the fiscal quarters ended December 31, 2008 and March 31,2009, plus (c) any impairments or write-offs relating to tangible assetsor pre-acquisition costs not contained in the borrowing base recorded inrespect of the fiscal quarters ended December 31, 2008 and March 31,2009****(provided, however, that the aggregatecovenant level reduction pursuant to this clause (1) shall not exceed$15,000), and (2) increased by the sum of (x) any favorableadjustment to the deferred tax asset valuation allowance recorded in respect ofthe fiscal quarters ended December 31, 2008 and March 31, 2009, plus (y) 50%of positive quarterly net income after March 31, 2008.

·                  The definitionof liquidity was revised to provide that negative borrowing base availabilityis deducted from cash and cash equivalents when determining liquidity and theminimum required liquidity covenant was reduced from $15,000 to $10,000.  A five business day cure period in the eventof a breach of the minimum liquidity covenant was also added.

·                  The maximumamount of cash or cash equivalents (excluding cash in transit at titlecompanies) that the Company is allowed to maintain was set at a maximum of$15,000 for any consecutive five-day period.

·                  The cash flowfrom operations covenant ratio was adjusted downward for the quarter ending June 30, 2009 to 0.50:1.00 and for the quarter ending September 30, 2009 andthereafter to 0.65:1.00.

·                  The Company’sability to purchase up to $8,000 of unimproved real estate is no longeravailable; however, the Company’s ability to acquire lots though optiontake-downs remains unchanged.  Theprovision specifically allowing the Company to make new joint venture investmentsup to certain specified amounts was also eliminated.

·                  The interestrate was increased by 25 basis points, to the LIBOR interest rate plus 5.25%.

 

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·                  Generally, theability to obtain letters of credit for general working capital or corporatepurposes and the ability to obtain letters of credit in connection withprojects outside the borrowing base were eliminated (provided, however, thatexisting letters of credit can be renewed, subject to the other terms of theLoan Agreement).

·                  Provisions wereadded providing that no letter of credit will be issued or renewed and that notri-party agreement will be executed or maintained while any lender is adefaulting lender, except if the Borrowers have delivered to Agent cashcollateral equal to the defaulting lenders’ pro rata share of the letter ofcredit or tri-party agreement.  The cashcollateral is to be used to reimburse lenders in the event of draws underletters of credit or tri-party agreements.

·                  Letter ofcredit advances (that is, payments pursuant to a letter of credit that resultin the making of a loan to Borrowers in excess of the then available borrowingbase) must be repaid within five business days, or earlier under certaincircumstances.

·                  Provisions wereadded to the Second Amended Credit Agreement and related Security Agreementproviding that, in the event of receipt of any tax refund by any obligor thatconstitutes collateral, the amount received must be used to prepay the loansunder the facility.  Any such collateralreceived by the agent will likewise be applied to the outstandingindebtedness.  However, such reduction ofthe outstanding indebtedness would have the effect of then increasing the netborrowing base availability immediately thereafter.

·                  Additionalprovisions were added with respect to the allocation among the lenders ofburdens and risks associated with defaulting lenders.

·                  Inconsideration of entering into the First Amendment to the Second Amended CreditAgreement, the Company paid a fee equal to 0.25% of such approving lenders’reduced commitments effective on the closing of the amendment.

 

***Terms of the Revolving Credit Facility:***

 

The borrowing limit underthe Revolving Credit Facility is $405,000, except that the amount of the RevolvingCredit Facility will be reduced to $375,000 beginning July 16, 2009,unless otherwise permanently reduced as a result of certain requiredprepayments. The total amount of loans and advances outstanding at any timeunder the Revolving Credit Facility may not exceed the lesser of thethen-current borrowing base availability or the revolving sublimit as definedin the Revolving Credit Facility. The borrowing base availability is based onthe lesser of the appraised value or cost of real estate owned by the Companythat has been admitted to the borrowing base and is subject to variouslimitations and qualifications set forth in the Revolving Credit Agreement.

 

From October 1, 2008to February 10, 2009, borrowings and advances under the Revolving CreditFacility bear interest on a per annum basis equal to the LIBOR Market IndexRate plus 500 basis points.  Beginning onFebruary 11, 2009, the interest rate increased to the LIBOR Market IndexRate plus 525 basis points.  Prior to October 1,2008, the applicable spread had been 400 basis points. During the term of theRevolving Credit Facility, interest is payable monthly in arrears.  At December 31, 2008, the interest ratewas 5.44%, which included a 500 basis point spread.

 

A fee will be earned andpayable on September 15, 2009 equal to 8.0% per annum, calculated on adaily basis, of the difference between $250,000 and the aggregate level of thelenders’ lending commitments under the Revolving Credit Facility as they existfrom time to time between September 30, 2008 and the earlier of September 15,2009 and the date the commitments are permanently reduced to $250,000; howeverthis fee will be reduced by 80% if the aggregate level of commitments on orbefore September 15, 2009 have been permanently reduced to $250,000. Underthis provision, the Company currently estimates that the minimum it will berequired to pay is $0 and the maximum is $9,150. The Company expects that itwill pay no amounts under this provision as it intends to refinance the debtbefore the payment is due and payable. There can be no assurance that suchrefinancing will occur. In addition, if all indebtedness under the RevolvingCredit Facility is not fully repaid by December 20, 2009, a separate feewill be earned and payable on December 20, 2009 equal to 8.0% per annum ofthe amount by which the aggregate commitments under the Revolving CreditFacility that exist from time to time after September 15, 2009 exceed$250,000, calculated on a daily basis. Under this provision, the Company currently estimates that the minimumit will be required to pay is $0 and the maximum is $2,630. The Company expectsthat it will pay no amounts under this provision as it intends to refinance thedebt before the payment is due and payable. There can be no assurance that suchrefinancing will occur.

 

In addition to anyinterest that may be payable with respect to amounts advanced by the lenderspursuant to a letter of credit, the Company will be required to pay to thelender(s) issuing letters of credit an issuance fee of 0.125% of theamount of the letters of credit.

 

Under and subject to theterms of the Revolving Credit Facility, the borrowers may borrow and re-borrowfor the purpose of financing the acquisition and development of real estate,the construction of homes and improvements, for working capital and for suchother appropriate corporate purposes as may be approved by the lenders. Underthe Revolving Credit Facility, each lender is generally obligated to fund onlyits pro rata portion of each requested loan or advance.  As a result, if any lender refuses, or isunable, to fund its 

 

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pro rata portion of arequested loan or advance, the Company may be unable to borrow the entireamount of the requested loan or advance despite the fact that if there aredefaulting lenders, the Company is permitted to submit additional borrowingrequests in an effort to make-up any borrowing shortfall caused by a defaultinglender failing to fund.  In addition, solong as no event of default has occurred and is continuing, pro-rate principalpayments shall not be made to any defaulting lender, but instead shall be paidover to the master borrower.  TheRevolving Credit Facility also provides for certain burden sharing measures toallocate among the lenders the burdens and risks associated with defaultinglenders in the event there are defaulting lenders.

 

Approximately 35% of theCompany’s collateral assets have been reappraised pursuant to the terms of thewaiver letter and the Company and approximately one third of the assets in theborrowing base with a book value in excess of $4,000 that have not yet beenre-appraised are currently being re-appraised. The re-appraisals that have beendone to date have not had a material impact on the Company’s borrowing baseavailability, but there can be no assurance that future reappraisals will notreduce borrowing base availability.

 

Various conditions mustbe satisfied in order for real estate to be admitted to the borrowing base,including that a mortgage in favor of lenders has been delivered to the agentfor lenders and that all governmental approvals necessary to begin developmentof for-sale residential housing, other than building permits and certain otherpermits borrower in good faith believes will be issued within 120 days,have been obtained. Depending on the stage of development of the real estate,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. Based onthese ranges, the Company is restricted as to the type of land it can have invarious stages of development as well as the dollar value of land underdevelopment.

 

As security for allobligations of borrowers to lenders under the Revolving Credit Facility,lenders continue to have a first priority mortgage lien on all real estateowned by the Company or any borrower and included in the borrowing base underthe Revolving Credit Facility. As further security, pursuant to the SecondAmended Credit Facility, the Company has also agreed to grant to the lenders asecurity interest in and assignment of all future tax refunds and proceedsthereof received or payable to the borrowers or the Company after the closingof the Second Amended Credit Agreement, mortgages in favor of lenders withrespect to all real property owned by the borrowers or the Company that is notalready subject to a lien in favor of the lenders under the Revolving CreditFacility and a security interest in inter-company debt.  Pursuant to the First Amendment, all such taxrefunds must be paid over to the lenders within one business day and will be usedto prepay any indebtedness under the Revolving Credit facility.  Orleans Homebuilders, Inc. hasguaranteed the obligations of the borrowers to lenders pursuant to a Guarantyexecuted by Orleans Homebuilders, Inc. on January 26, 2006, amendedon September 6, 2007 and amended and restated on September 30,2008.  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. However, the Company and its subsidiaries maintain a majorityof the cash, cash equivalents and marketable securities available to them inaccounts and as treasury securities outside of the lenders under the RevolvingCredit Facility.

 

The Revolving CreditFacility contains customary covenants that, subject to certain exceptions,limit or eliminate the ability of the Company to (among other things):

 

·                  Incur or assume other indebtedness,except certain permitted indebtedness and possible second lien indebtedness ifappropriately approved;

·                  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 disposeof all or substantially all of its assets;

·                  Enter into any transaction with anaffiliate that is not a borrower or a guarantor under the Revolving CreditFacility, or a subsidiary of either;

·                  Pay any dividends;

·                  Redeem any stock or subordinated debt;and

·                  Invest in joint ventures or otherentities that are not obligors under the Revolving Credit Facility.

 

In addition, under theRevolving Credit Facility, all real property sales must be accomplished througha title company, with the net proceeds of such a sale going directly to theagent bank for application to the outstanding balance under the RevolvingCredit Facility. Any purchases of real estate must be done through a titlecompany through advances under the Revolving Credit Facility and all suchacquisitions must be subject to mortgages in favor of the lenders; and, at thetime of any such advance, the Company will be required to provide an estimateof the portion of the borrowing that will be used for construction needs.However, the Company may make additional draws from time-to-time pursuant tothe terms of the Revolving Credit Facility.

 

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The Revolving CreditFacility also contains various financial covenants. Among other things, thefinancial covenants, as amended, require that:

 

·                  The Company must maintain a minimumconsolidated tangible net worth of at least $25,000  (1) reduced by the sum of (a) anyimpairments or other charges under GAAP on assets in the borrowing base takenby the Company and recorded in respect of the financial quarters ended December 31,2008 and March 31, 2009, plus (b)  any deferred tax assets valuationallowance reserves recorded in respect of the fiscal quarters ended December 31,2008 and March 31, 2009, plus (c) any impairments or write-offsrelating to tangible assets or pre-acquisition costs not contained in theborrowing base recorded in respect of the fiscal quarters ended December 31,2008 and March 31, 2009****(provided,however, that the aggregate covenant level reduction pursuant to this clause (1) shallnot exceed $15,000), and (2) increased by the sum of (x) anyfavorable adjustment to the deferred tax asset valuation allowance recorded inrespect of the fiscal quarters ended December 31, 2008 and March 31,2009, plus (y) 50% of positive quarterly net income after March 31,2008.

·                  The Company must maintain a requiredliquidity level based on cash plus borrowing base availability of at least$10,000 of cash and cash equivalents (including cash held at a title company)on a consolidated basis at all times, minus the amount by which thethen-outstanding principal balance of the Company’s loans plus any swing lineloans exceeds the then-current borrowing base availability.

·                  The Company’s minimum cash flow fromoperations ratio based on cash flow from operations to interest incurred covenant,must exceed 1.25-to-1.00 for the quarter ending December 31, 2008;0.40-to-1.00 for the quarter ending March 31, 2009; 0.50-to-1.00 for thequarter ending June 30, 2009; and 0.65-to-1.00 for the quarter ending September 30,2009 and thereafter. Cash flow from operations is calculated based on the lasttwelve months cash flow from operations, adjusted for interest paid (excludingany amortized deferred financing costs related to all amendments to the AmendedCredit Agreement, the Second Amended Credit Agreement and the trust preferredsecurities and any future amendments to any of the foregoing), 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, and interest income.

·                  The maximum amount of cash or cashequivalents (excluding cash at title companies) the Company is allowed tomaintain for any consecutive five-day period is $15,000.

·                  The Company may purchase improvedland (i.e., finished lot takedowns and/or controlled rolling lot options)purchased by the borrowers in the normal course of business, consistent withthe projections provided to the Lenders, but otherwise limits the Company’sability to purchase improved and unimproved land.

 

At the fiscal quartersended September 30, 2006, December 31, 2006, March 31, 2007, June 30,2007, March 31, 2008, June 30, 2008 and December 31, 2008, theCompany would have been in violation of certain financial covenants in theAmended and Restated Credit Agreement if not for the First Amendment, SecondAmendment, Third Amendment, Fourth Amendment, waiver letter, the Second AmendedCredit Agreement, the second waiver letter and the First Amendment to theSecond Amended Credit Agreement, respectively.

 

The Revolving CreditFacility provides that, subject to any applicable notice and cure 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 orperform any promise, covenant, warranty, obligation, representation oragreement under the Revolving Credit Facility or any other loan document;

·                  Bankruptcy and other insolvency eventswith respect to any borrower or the Company;

·                  Dissolution or reorganization of anyborrower or the Company;

·                  The entry of a judgment or judgmentsagainst borrower(s) or the Company: (i) in an aggregate amount thatis at least $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 within30 days; or the issuance of any writs of attachment, execution orgarnishment against any borrower or the Company;

·                  Any material adverse change in thefinancial condition of a borrower or the Company which causes the lenders, ingood faith, to believe that the performance of any of the obligations under theRevolving Credit Facility is impaired or doubtful for any reason; and

·                  Specified cross defaults.

 

Upon the occurrence andcontinuation of an event of default, after completion of any applicable graceor cure period, lenders may demand immediate payment in full of allindebtedness outstanding under the Revolving Credit Facility, terminate theirobligations to make any loans or advances or issue any letter of credit, setoff and apply any and all deposits held by any lender for the credit or accountof 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. A defaultunder the Company’s Revolving Credit Facility could also prevent the Companyfrom making required payments under the Company’s trust preferred securities,which would cause a default under those securities.

 

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If the Company does notmeet its forecast in its budgets, the Company could violate its debt covenantsand, absent a waiver or amendment from its lenders, the Company could be in defaultunder its Revolving Credit Facility and, as a result, its debt could become duewhich would have a material adverse effect on the Company’s financial positionand results of operations.

 

As of December 31,2008, after giving effect to the First Amendment, the Company was in compliancewith all of its financial covenants under the Second Amended Credit Agreement,as amended.

 

***Trust Preferred Securities:***

 

On November 23,2005, the Company issued $75,000 of trust preferred securities which mature on January 30,2036 and are callable, in whole or in part, at par plus accrued interest on orafter January 30, 2011. For the first ten years, the securities have afixed interest rate of 8.61% per annum, provided that certain covenant levelsare maintained. Thereafter, the securities have a floating interest rate equalto three-month LIBOR plus 360 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 repayoutstanding obligations under the Revolving Credit Facility discussed above.

 

The trust’s preferred andcommon securities require quarterly distributions of interest by the trust tothe holders of the trust securities at a fixed interest rate equal to 8.61% perannum through January 30, 2016 and, after January 30, 2016, at avariable interest rate (reset quarterly) equal to the three-month LondonInterbank Offered Rate (“LIBOR”) plus 360 basis points.  Since the Company failed to meet both thedebt service ratio and minimum tangible net worth requirement set forth in the August 13,2007 supplemental indenture as of the end of a fiscal quarter for at leastthree of the last four consecutive fiscal quarters ended on June 30, 2008,the applicable rate of interest was increased by 300 basis points. The Companybegan accruing for this increased interest rate on July 31, 2008, whichwas paid to holders for the first time with the coupon payable on October 31,2008. The interest rate will return to the regularly applicable rate once theCompany is in compliance with the debt service ratio and minimum tangible networth requirements as of the end of any fiscal quarter.  The terms of the trust securities aregoverned by an Amended and Restated Trust Agreement, dated November 23,2005, among OHI Financing, Inc., (“OHI Financing”) as depositor, JPMorganChase Bank, National Association, as property trustee, Chase Bank USA, NationalAssociation, as the Delaware trustee, and the administrative trustees namedtherein.

 

The trust used theproceeds from the sale of the trust’s securities to purchase $77,320 inaggregate principal amount of unsecured junior subordinated notes due January 30,2036 issued by OHI Financing, which includes $2,300 of inter-company issuances.The junior subordinated notes were issued pursuant to a Junior SubordinatedIndenture, dated November 23, 2005, as amended by a Supplemental Indenturedated August 13, 2007, collectively referred to herein as the “Indenture,”among OHI Financing, as issuer, and JPMorgan Chase Bank, National Association,as trustee. The terms of the junior subordinated notes are substantially thesame as the terms of the trust’s preferred securities. The interest payments onthe junior subordinated notes paid by OHI Financing, Inc. will be used bythe trust to pay the quarterly distributions to the holders of the trust’spreferred and common securities. Pursuant to the parent guarantee agreementdated November 23, 2005 by and between the Company and JPMorgan ChaseBank, National Association, as trustee, the Company has unconditionallyguaranteed OHI Financing, Inc.’s payment and other obligations under theindenture and the junior subordinated notes. The Company used the proceeds fromthe issuance and sale of the trust preferred securities and the subsequentpurchase of the junior subordinated notes to partially repay indebtedness.

 

The Indenture permits OHIFinancing to redeem the junior subordinated notes at par, plus accrued intereston or after January 30, 2011. If OHI Financing redeems any amount of thejunior subordinated notes, the Trust Agreement requires the trust to redeem alike amount of the trust securities. Under certain circumstances relating tothe tax treatment of the trust or the interest payments made on the juniorsubordinated notes or the classification of the trust as an “investment company”under the Investment Company Act of 1940, as amended, OHI Financing may alsoredeem the junior subordinated notes prior to January 30, 2011 at a 7.5%premium.

 

With certain exceptionsrelating to debt to a trust, partnership or other entity affiliated with theCompany that is a financing vehicle for the Company, the junior subordinatednotes and the Company’s obligations under the parent guarantee are expresslysubordinate to all of the Company’s existing and future debt unless it isprovided in the instrument creating or evidencing such debt, or pursuant towhich such debt is outstanding, that such debt is not superior in right topayment of the junior subordinated notes or the obligations under the parentcompany’s guarantee, as the case may be.

 

Under the Indenture, OHIFinancing will generally have to make eight consecutive Adjusted Interest Ratecoupon payments (other than the eight consecutive Adjusted Interest Rate couponpayments that could be made on each of the coupon payment dates from October 30,2008 to and including July 30, 2010) to cause an event of default underthe Indenture (or in some cases six consecutive coupon payments). More specifically,the Indenture provides that the earliest an event of default could occur as aresult of the payment of the Adjusted Interest Rate is (i) upon thepayment of the Adjusted Interest Rate coupon for October 30, 2010, ifapplicable, provided there have been eight prior consecutive Adjusted InterestRate coupons paid by OHI Financing; (ii) on either the fiscal quarterended March 31, 2010 or the fiscal year ended June 30, 2010, if ateither date both the trailing twelve months’ interest coverage ratio is lessthan 1.25 to 1, and OHI Financing has made the six prior consecutive AdjustedInterest Rate coupon payments; or (iii) on

 

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the fiscal quarter ended September 30,2010, if at such time both the trailing twelve months’ interest coverage ratiois less than 1.75 to 1, and OHI Financing has made the eight prior consecutiveAdjusted Interest Rate coupon payments. The Adjusted Interest Rate must be paidfor eight (or in some instances six) consecutive coupons in order to trigger anevent of default. If the interest coverage ratio test and the minimumconsolidated tangible net worth test, are both met, OHI Financing would makethe payment of the Regular Interest Rate for the next coupon, and the AdjustedInterest Rate test “resets” requiring OHI Financing to make eight (or in someinstances six) new consecutive coupon payments at the Adjusted Interest Ratebefore triggering an event of default. The interest coverage ratio and minimumconsolidated tangible net worth measure are not traditional financialmaintenance covenants; they are only utilized in determining if the AdjustedInterest Rate or the Regular Interest Rate is applicable.

 

The junior subordinatednotes and the trust securities could become immediately payable upon an eventof default. Under the terms of the Trust Agreement and the Indenture, subjectto any applicable cure period, an event of default generally occurs upon:

 

·                  non-payment of any interest on the juniorsubordinated notes when it becomes due and payable, and continuance of thedefault for a period of 30 days;

·                  non-payment of the principal of, or anypremium on, the junior subordinated notes at their maturity;

·                  default in the performance, or breach, ofany covenant or warranty made by OHI Financing, Inc., in the indenture andthe continuance of the default or breach for a period of 30 days afterwritten notice to OHI Financing, Inc.;

·                  non-payment of any distribution on thetrust’s securities when it becomes due and payable, and continuance of thedefault for a period of 30 days;

·                  non-payment of the redemption price ofany trust’s security when it becomes due and payable;

·                  default in the performance, or breach, inany material respect of any covenant or warranty of any of the trustees in theTrust Agreement, which default or breach continues for a period of 30 daysafter written notice to the trustees and OHI Financing, Inc.;

·                  default in the performance, or breach(which default or breach must be material in certain cases), of any covenant orwarranty made by OHI Financing, Inc. In the purchase agreement pursuant towhich the trust securities and the junior subordinated notes were sold andpurchased and the continuation of such default or breach for a period of30 days after written notice to OHI Financing, Inc.;

·                  bankruptcy, insolvency or liquidation ofthe property trustee, if a successor property trustee has not been appointedwithin 90 days thereafter;

·                  the bankruptcy or insolvency of OHIFinancing, Inc.; or

·                  certain dissolutions or liquidations, orterminations of the business or existence, of the trust.

 

Pursuant to the August 13,2007 Supplemental Indenture, OHI Financing established a $5,000 reserve fund inSeptember 2007 for the benefit of the holders of the trust preferredsecurities by posting a letter of credit with the trustee. If the adjustedinterest rate is in effect for the four consecutive coupon payments ending July 30,2009, this reserve fund must be increased by $2,500. Under certain events ofdefault, this reserve fund may be drawn by the trustee and used in respect ofthe trust preferred obligations. The reserve fund may be released upon theearlier of compliance with the applicable interest coverage ratio resulting inOHI Financing paying interest at the regular interest rate rather than theadjusted interest rate, or redemption or defeasance of the notes in accordancewith the terms of the Indenture.

 

On September 20,2005, the Company issued $30,000 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. The Company 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.

 

**7.****             ****ASSETIMPAIRMENTS — REAL ESTATE HELD 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 No. 144”). SFAS No. 144 requires that long-lived assets be reviewed forimpairment whenever events or changes in circumstances indicate that thecarrying value of the asset may not be recoverable.  Recoverability of real estate held fordevelopment and sale is measured by comparing the carrying value to the futureundiscounted net cash flows expected to be generated by the asset.  The impairment loss is the difference betweenthe book value of the assets and the discounted future cash flows generatedfrom expected revenue of the assets, less the associated cost to complete anddirect costs to sell.  Estimated cashflows are discounted at a rate commensurate with the inherent risk of theassets and cash flows, which approximates fair value.  The estimates used in the determination ofthe estimated cash flows and fair value of the asset are based on 

 

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factorsknown to us at the time such estimates are made and our expectations of futureoperations.  These estimates of cashflows are significantly impacted by estimates of the amounts and timing ofrevenues and costs and other factors, which, in turn, are impacted by localmarket economic conditions and the actions 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 or other assets.

 

Asof December 31, 2008, there were a number of parcels which were tested forimpairment as a trigger was identified. Some of these parcels included those that had previously been impaired.In some cases, the undiscounted cash flow analysis prepared by management didnot indicate an impairment.  However,these cash flows are subject to significant estimates and assumptions made bymanagement. In some cases, the results of whether an impairment is indicatedfrom the undiscounted cash flow analysis is highly sensitive to changes inassumptions. These parcels could suffer impairment in the future, and suchimpairment amounts could be material to the Company’s results of operations andfinancial position.  In conducting our review for indicatorsof impairment on a community level, we evaluate, among other things, themargins on homes that have been delivered, margins under sales contracts inbacklog, projected margins with regard to future home sales over the life ofthe community, and the fair value of the land itself.  Inventory impairments are recorded inresidential properties cost and expenses.

 

Whenimpairment is indicated, the Company estimates the fair value of inventoryunder SFAS No. 144 based on current market conditions and currentassumptions made by management, which may differ materially from actual resultsif market conditions change. For example, further market deterioration may leadthe Company to incur additional impairment charges on previously impairedinventory, as well as on inventory not currently impaired but for whichindicators of impairment may arise if further market deterioration occurs.

 

Inconducting the review for indicators of impairment on a community level, theCompany evaluates, among other things, the margins on homes that have beendelivered, margins under sales contracts in backlog, projected margins withregard to future home sales over the life of the community, and the estimatedfair value of the land itself.

 

Indetermining the recoverability of the carrying value of the assets in acommunity that the Company has evaluated as requiring a test for impairment,significant quantitative and qualitative assumptions are made relative to thefuture home sales prices, sales incentives, direct and indirect costs(including interest expected to be capitalized) of home construction and landdevelopment and the pace of new home orders. In addition, these assumptions aredependent on the specific market conditions and competitive factors for thecommunity being tested. The Company’s estimates are made using informationavailable at the date of the recoverability test. However, as facts and circumstancesmay change in future reporting periods, the estimates of recoverability aresubject to change. When impairment is indicated, the Company estimates the fairvalue of its communities using a discounted cash flow model.  The determination of fair value also requiresdiscounting the estimated cash flows at a rate commensurate with the inherentrisks associated with the assets and related estimated cash flow streams.

 

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Thefollowing table represents inventory impairments by region for continuingoperations for the three and six months ended December 31, 2008 and 2007:

 
| ** ** | ** ** | **Three months ended December 31,** | ** ** |
|------------|------------|------------------------------------------|------------|
| ** ** | ** ** | **2008**                                 | ** ** | **2007** | ** ** |
| ** ** | ** ** | **Communities**                          | ** ** | **Impairment** | ** ** | **Communities** | ** ** | **Impairment** | ** ** |
| Northern   |       | 11                                       |       | $ | 6,005 |   | 5 |   | $ | 5,654 |   |
| Southern   |       | 8                                        |       | 2,598 |   | 5 |   | 5,200 |   |
| Midwestern |       | —                                   |       | — |   | 5 |   | 9,668 |   |
| Florida    |       | 1                                        |       | 67 |   | 3 |   | 2,395 |   |
| Total      |       | 20                                       |       | $ | 8,670 |   | 18 |   | $ | 22,917 |   |

 
| ** ** | ** ** | **Six months ended December 31,** | ** ** |
|------------|------------|----------------------------------------|------------|
| ** ** | ** ** | **2008**                               | ** ** | **2007** | ** ** |
| ** ** | ** ** | **Communities**                        | ** ** | **Impairment** | ** ** | **Communities** | ** ** | **Impairment** | ** ** |
| Northern   |       | 13                                     |       | $ | 10,904 |   | 5 |   | $ | 6,366 |   |
| Southern   |       | 8                                      |       | 2,695 |   | 5 |   | 5,200 |   |
| Midwestern |       | 3                                      |       | 3,907 |   | 5 |   | 9,668 |   |
| Florida    |       | 2                                      |       | 582 |   | 3 |   | 2,395 |   |
| Total      |       | 26                                     |       | $ | 18,088 |   | 18 |   | $ | 23,629 |   |

 

During the three and sixmonths ended December 31, 2007, the Company specifically identifiedparcels of land to sell and negotiated contracts with potential buyers.  Prior to the closing of the land saletransactions, the Company recorded asset impairments on the land to be sold of$36,556 for the three and six months ended December 31, 2007.  The Company’s midwestern region recordedimpairments of $23,163 related to the sale of two parcels.  The Company’s Florida region recordedimpairments of $8,385 related to the sale of four parcels.  The Company’s southern region recordedimpairments of $5,008 related to the sale of two parcels.

 

Additionally, the Companyrecorded an impairment charge of $20,706 related to the sale of its landposition in the western region in the three and six months ended December 31,2007. This impairment charge is included in loss from discontinued operations.

 

These impairment chargesrepresent the amounts by which the carrying value of the assets sold exceededtheir fair values less costs to sell. The fair value of the assets was determined based on the contractedsales price.  These impairment chargeswere included in the cost of land sales on the Consolidated Statements ofOperations.

** **

**8.     STOCK BASED COMPENSATION**

** **

TheCompany follows the provision of SFAS No. 123 (revised 2004) “Share-BasedPayment” (“SFAS No. 123(R)”), which establishes the financial accountingand reporting standards for stock-based compensation plans.  SFAS No. 123(R) requires themeasurement and recognition of compensation expense for all stock-based awardsmade to employees and directors, including stock options and restrictedstock.  Under the provisions of SFAS No. 123(R),stock-based compensation cost is measured at the grant date, based on the calculatedfair value of the award, and is recognized as an expense over the requisiteservice period of the entire award (generally the vesting period of theaward).  The fair value based method inSFAS No. 123(R) is similar to the fair-value-based method in SFAS No. 123in most respects, subject to certain 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 orresults of operations of the Company.

 

***Stock Option Plans***

 

OnAugust 26, 2004, the Company’s Board of Directors 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 AwardPlan.  On December 6, 2007, the stockholders of theCompany approved the second amendment and restatement of the 2004 StockIncentive Plan to increase the number of shares of the Company’s common stockauthorized for issuance under the plan from 400,000 to 2,000,000 shares.

 

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Duringthe three months ended December 31, 2008 and 2007, the Company recognized$337 and $492, respectively, of stock based compensation expense related tostock options.

 

Duringthe six months ended December 31, 2008 and 2007, the Company recognized$659 and $966, respectively, of stock based compensation expense related tostock options.

 

Thefollowing summarizes stock option activity for the Company’s stock option plansduring the six months ended December 31, 2008:

 
| ** **                       | ** ** | **Number  of Options** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|----------------------------------|------------|------------------------|------------|---------------------------------------|------------|
| Outstanding, beginning of period |       | 752,500                |       | $                                     | 9.01       |   |
| Granted                          |       | 250,000                |       | 2.20                                  |       |
| Exercised                        |       | —                 |       | —                                |       |
| Outstanding, end of period       |       | 1,002,500              |       | $                                     | 7.32       |   |
| Exercisable, end of period       |       | 266,500                |       | $                                     | 12.14      |   |

 

Therewere no options exercisable at December 31, 2008 that had a strike pricebelow the market value of the underlying shares of stock.

 

Duringthe three and six months ended December 31, 2008, the Company grantedoptions to acquire 250,000 shares. During the three and six months ended December 31, 2007, theCompany granted options to acquire 180,000 shares.  In addition, during the three and six monthsended December 31, 2007, options to acquire 240,000 shares at $15.60 were repriced to$4.65.

 

Nooptions were exercised during the three and six months ended December 31,2008 or the three and six months ended December 31, 2007.

 

Thefollowing table summarizes information about the Company’s stock options at December 31,2008:

 
| ** **                         | ** ** | **Options Outstanding**                 | ** ** | **Options Exercisable**                        | ** ** |
|------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Outstanding at  December 31,   2008** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Exercisable at  December 31,  2008** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $2.20  **-**$2.20                  |       | 250,000                                      |       | 9.9                                                 |       | $ | 2.20 |   | — |   | N/A |   | N/A |   |
| 4.03  **-**4.85                    |       | 445,000                                      |       | 9.0                                                 |       | 4.41 |   | 84,000 |   | 9.0 |   | 4.38 |   |
| 10.64  **-**10.64                  |       | 30,000                                       |       | 4.6                                                 |       | 10.64 |   | 30,000 |   | 4.6 |   | 10.64 |   |
| 15.63  **-**15.63                  |       | 250,000                                      |       | 7.5                                                 |       | 15.63 |   | 125,000 |   | 7.5 |   | 15.63 |   |
| 21.60  **-**21.60                  |       | 27,500                                       |       | 5.7                                                 |       | 21.60 |   | 27,500 |   | 5.7 |   | 21.60 |   |
| ** **                         |       | 1,002,500                                    |       | 8.6                                                 |       | $ | 7.32 |   | 266,500 |   | 7.4 |   | $ | 12.14 |   |
|                                    |            |                                              |            |                                                     |            |  |  |  |  |  |  |  |  |  |  |

 

Theaggregate intrinsic value as of December 31, 2008 for outstanding stockoptions and for stock options that are exercisable was $0 and $0, respectively.

 

TheCompany uses the Black-Scholes option pricing model to determine the aggregatefair value of the stock options granted. The aggregate fair value of the Company’s stock option grants areamortized to compensation expense over their respective vesting periods andincluded in selling, general and administrative expenses on the ConsolidatedStatements of Operations.  The Companytypically issues shares of common stock from treasury stock upon the exerciseof stock options, but such shares may also be newly issued.

 

Asof December 31, 2008, there was a total of $1,762 of unrecognizedcompensation expense related to time based non-vested stock options.  That cost is expected to be recognized over aweighted average period of 3.3 years.

 

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*** ***

***Stock Award Plans***

 

InOctober 2003, the Board of Directors adopted the Orleans Homebuilders, Inc.Stock Award Plan (the “Stock Award Plan”), which provided grant of stock awardsof up to an aggregate of 400,000 shares of the Company’s common stock.  On October 17, 2008, the Board ofDirectors approved an increase in the number of shares authorized for issuanceunder the Stock Award Plan from 400,000 shares to 1,000,000 shares, which wasapproved at the Company’s Annual Meeting on December 4, 2008.  The Stock Award Plan allows for the payment ofall or a portion of the incentive compensation awarded under the Company’sbonus compensation plans to be paid by means of a transfer of shares of commonstock.  The plan has a ten year life andis open to all employees of the Company and its subsidiaries.  The value of time based restricted stockawards are determined by their intrinsic value (as if the underlying shareswere vested and issued) on the grant date. During the three and six month ended December 31, 2008 and 2007,the company awarded 250,000 and 240,000 shares of restricted stock to anexecutive officer.  The restricted stockawarded during the three and six months ended December 31, 2008 was issuedunder of the 2004 Stock Incentive Plan. At December 31, 2008, the Company had awarded 395,904 shares ofcommon stock under the Stock Award Plan and had 604,096 shares of the commonstock available to issue under the Stock Award Plan.

 

Duringthe three months ended December 31, 2008 and 2007, the Company recognized$135 and $108, respectively, of stock based compensation expense related tostock awards.

 

Duringthe six months ended December 31, 2008 and 2007, the Company recognized$296 and $193, respectively, of stock based compensation expense related tostock awards.

 

Asof December 31, 2008, there was a total of $4,700 of unrecognizedcompensation expense related to time based non-vested restricted stockawards.  That cost is expected to berecognized over a weighted average period of 5.3 years.

 

***Cash Bonus Plan***

*** ***

On December 4,2008, The Company’s Compensation Committee adopted a cash bonus plan for anexecutive officer (the “Plan”).  The Plan provides for a cash bonus of$375 to be paid to the executive officer in the event the Company achievescertain performance targets as determined by the Compensation Committee, whichmay generally include targets relating to: (i) capital structureinitiatives; (ii) refinancing the Company’s outstanding debt (such as bythe issuance of new debt, equity or equity-linked securities by the Company ora joint venture in which the Company is a participant); or (iii) theCompany entering into a new or modified credit facility (such as a modifiedcredit facility extending the maturity date of the Company’s revolving creditfacility).  The maximum amount payable pursuant to the Plan is $750,provided the Company achieves at least two of such performance targets. In the event the executive officer is awarded a cash bonus pursuant to thePlan, he will be given the option of using up to 50% of that cash bonus at thetime of the award to purchase restricted shares of the Company’s stock at apurchase price of $2.75 per share (or up to 136,363 shares of fully vestedcommon stock will be issued to Participant if all awards are earned under thePlan and the executive officer elects to have all such awards payable inCompany common stock).  The Company isaccounting for the Plan as a combination award in accordance with SFAS No. 123(R).  Based on Company estimates, the Company willbe accruing $375 during the period of December 2008 through March 2009;accruing $375 during the period of December 2008 through September 2009;and expensing $60 relating to the option to purchase restricted shares duringthe period of December 2009 through September 2009.  During the three and six months ended December 31,2008, the Company recognized $137 of compensation expense related to the Plan.

 

**9.     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 Retirement Plan (“SERP”). ThisSERP, which was amended on March 13, 2006 and September 27, 2007, isintended to provide the participants with an annual supplemental retirementbenefit based upon their years of service with the Company and highest averagecompensation for five consecutive years. The annual supplemental benefit foreach participant will be adjusted based on the actual performance of the SERPcompared to the target. The benefit is payable for life with a minimum of tenyears guaranteed.  In order to qualifyfor normal retirement benefits, a participant must attain age 65 with at leastfive years of participation in the SERP. Early retirement will be permitted beginning at age 55, afterfive years of participation in the SERP. Early retirement benefits will beadjusted actuarially to reflect the early retirement date.

 

If a participantterminates employment with the Company prior to attaining his or her normalretirement date, other than by reason of early retirement, death or disability,the participant will forfeit all benefits under the SERP, provided that certainterminations occurring after a change in control will not result in aforfeiture.  The Company can amend orterminate the SERP at any time. However, no amendment or termination willaffect the participants’ accrued benefits as determined in accordance with theSERP or delay any payments to a participant beyond the time that such amountwould otherwise be payable without regard to the amendment.

 

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TheCompany used a 4% annual compensation increase and a 6.1% discount rate in itscalculation of the present value of its projected benefit obligation.  The discount rate used represented the Moody’sAA bond rate for long-term bonds as of June 2008.

 

TheCompany recognized the following costs related to the SERP for the three andsix months ended December 31, 2008 and 2007:

 
| ** **                                                   | ** ** | **Three months ended December 31,** | ** ** | **Six months ended December 31,** | ** ** |
|--------------------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                   | ** ** | **2008**                                 | ** ** | **2007**                               | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net periodic pension cost:                                   |       |                                     |       |                                   |       |   |   |   |   |
| Service cost                                                 |       | $                                        | 129        |                                   | $          | 153 |   | $ | 259 |   | $ | 306 |   |
| Interest cost                                                |       | 85                                       |       | 85                                     |       | 170 |   | 170 |   |
| Amortization of prior service cost                           |       | 104                                      |       | 104                                    |       | 209 |   | 207 |   |
| Amortization of actuarial gain                               |       | (69                                      | )          | (46                                    | )          | (136 | ) | (92 | ) |
| Total net periodic pension cost                              |       | $                                        | 249        |                                   | $          | 296 |   | $ | 502 |   | $ | 591 |   |
|                                                         |       |                                     |       |                                   |       |   |   |   |   |
| Assumptions used for determining net periodic pension costs: |       |                                     |       |                                   |       |   |   |   |   |
|                                                         |       |                                     |       |                                   |       |   |   |   |   |
| Discount rate                                                |       | 6.10                                     | %          | 6.10                                   | %          | 6.10 | % | 6.10 | % |
| Salary scale                                                 |       | 4.00                                     | %          | 4.00                                   | %          | 4.00 | % | 4.00 | % |

 

**10.  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 31,2008 and 2007 are shown in the following table:

 
| ** **                                                         | ** ** | **Three months ended December 31,** | ** ** | **Six months ended  December 31,** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                         | ** ** | **2008**                                 | ** ** | **2007**                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| Numerator:                                                         |       |                                     |       |                                    |       |   |   |   |   |
| Loss from continuing operations for basic and diluted EPS          |       | $                                        | (15,621    | )                                       | $          | (38,607 | ) | $ | (37,557 | ) | $ | (40,370 | ) |
|                                                               |       |                                     |       |                                    |       |   |   |   |   |
| Denominator                                                        |       |                                     |       |                                    |       |   |   |   |   |
| Weighted average common shares outstanding (in thousands)          |       | 18,518                                   |       | 18,502                                  |       | 18,511 |   | 18,502 |   |
|                                                               |       |                                     |       |                                    |       |   |   |   |   |
| Basic and diluted loss per common share from continuing operations |       | $                                        | (0.84      | )                                       | $          | (2.09 | ) | $ | (2.03 | ) | $ | (2.18 | ) |

 

Assumedshares (in thousands) under the treasury stock method for stock options of 0and 92 for the three months ended December 31, 2008 and 2007,respectively, and 0 and 91 for the six months ended December 31, 2008 and2007, respectively, were not included in the computation of diluted earnings pershare because the impact was anti-dilutive for those periods.

 

**11.  INCOME TAXES**

** **

The Company’s income taxbenefit from continuing operations for the six months ended December 31,2008 was $277 compared to $24,529 in the corresponding prior year period.  These amounts represent effective tax ratesfor the six months ended December 31, 2008 and 2007 of 0.8% and 37.8%,respectively.  The significant changes inthe Company’s effective tax rate resulted primarily from the recording of a$13,826 net valuation reserve in the first six months of fiscal year 2009 ascompared with no valuation reserve in the comparable period of the previousfiscal year.  SFAS No. 109 — “Accountingfor Income Taxes” (“SFAS No. 109”) requires that companies assess whethera valuation allowance should be established based on the consideration of allavailable evidence using a “more likely than not” standard.  In making such judgments, significant weightis given to evidence that can be objectively verified.  SFAS No. 109 provides that a cumulativeloss in recent years is significant negative evidence in considering whetherdeferred tax assets are realizable and also restricts the amount of reliance onprojections of future taxable income to support the recovery of deferred taxassets.  The ultimate realization ofthese deferred tax assets is dependent upon the generation of future taxableincome 

 

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during the periods inwhich those temporary differences become deductible.  Changes in existing tax laws could alsoaffect actual tax results and the valuation of deferred tax assets over time.  The income tax benefit for the six monthsended December 31, 2008 reflects the impact of a reduction in a prior yeartax contingency of approximately $324, as a result of the favorable settlementof the related contingency, partially offset by separate company state incometax expense.  The income tax expense forthe six months ended December 31, 2007 include the impact of a revision toa prior year tax contingency reserve of approximately $520 as well as a prioryear income tax return-to-accrual adjustment of approximately $228.

 

At December 31, 2008and June 30, 2008, the Company had net deferred income tax assets of$68,084 and $53,642, respectively, offset by full valuation allowances of$68,084 and $53,642, respectively.

 

The Company is currentlyunder examination by various taxing jurisdictions and anticipates finalizingthe examinations with certain jurisdictions within the next twelve months.  The final outcome of these examinations isnot yet determinable.  The statute oflimitations for the Company’s major tax jurisdictions remains open forexamination for tax years 2005-2007.

 

**12.  DISCONTINUED OPERATIONS**

** **

OnDecember 31, 2007, the Company specifically committed to exiting itsArizona market and, in connection with this decision, on that date, it disposedof its entire land position and its related work-in-process homes in Arizona,which constituted substantially all of its assets in Arizona.  The Company has historically reported thisbusiness as the western region operating segment.  The disposed work-in-process inventory andland assets constituted substantially all of the Company’s assets in thewestern region.  As such, all chargesassociated with the western region are included as a discontinued operation.

 

Asthe western region represented a component of the Company’s business, theconsolidated financial statements have been reclassified for all periodspresented to present this business as discontinued operations.  Summarized financial information for thewestern region is set forth below:

 
| ** **                            | ** ** | **Three months ended   December 31,** | ** ** | **Six months ended December 31,** | ** ** |
|---------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------|------------|
| ** **                            | ** ** | **2007**                                        | ** ** | **2007**                               | ** ** |
| Operating loss                        |       | $                                               | (21,092    | )                                      | $          | (21,574 | ) |
| Tax benefit                           |       | (8,314                                          | )          | (8,504                                 | )          |
| Net loss from discontinued operations |       | $                                               | (12,778    | )                                      | $          | (13,070 | ) |

 

Discontinuedoperations have not been segregated in the condensed consolidated statement ofcash flows. Therefore amounts for certain captions will not agree withrespective data in the condensed consolidated statement of operations.

 

**13.  SEGMENT REPORTING**

** **

SFAS No. 131 “Disclosuresabout Segments of an Enterprise and Related Information” (“SFAS No. 131”)establishes standards for the manner in which public enterprises report segmentinformation about operating segments. The Company has determined that its operations primarily involve fourreportable homebuilding segments operating in 11 markets.  Revenues are primarily derived from the saleof homes which the Company constructs. The segments reported have been determined to have similar economiccharacteristics including similar historical and expected future operatingperformance, employment trends, land acquisitions and land constraints,municipality behavior and met the other aggregation criteria in SFAS No. 131.  The reportable homebuilding segments includeoperations conducting business in the following markets:

 

Northern region:

 

·                  Southeastern Pennsylvania;

·                  Central New Jersey;

·                  Southern New Jersey; and

·                  Orange County, New York

 

Southern region:

 

·                  Charlotte, North Carolina (including adjacent counties in SouthCarolina);

·                  Richmond, Virginia;

·                  Raleigh, North Carolina;

 

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·                  Greensboro, North Carolina; and

·                  Tidewater, Virginia

 

Midwestern region:

 

·                  Chicago, Illinois

 

Florida region:

 

·                  Orlando, Florida

 

During the fiscal yearended June 30, 2008, the Company exited from the Phoenix, Arizonamarket.  See note 12, DiscontinuedOperations.

 

 

The Company’s evaluationof segment performance is based on (loss) income from continuing operationsbefore taxes.  During fiscal year 2008,the allocation of corporate and unallocated (loss) income from continuingoperations before taxes to the segments was a fixed amount, which left aportion of the loss unallocated.  Duringfiscal year 2009, corporate (loss) income from continuing operations is fullyallocated to the segments based on budgeted revenue.  The fiscal year 2009 allocation includes theCompany’s mortgage brokerage and property management subsidiaries.  Below is a summary of revenue and (loss)income from continuing operations before taxes for each reportable segment forthe three and six months ended December 31, 2008 and 2007:

 
| ** **                                   | ** ** | **Three Months Ended December 31,** | ** ** | **Six Months Ended  December 31,** | ** ** |
|----------------------------------------------|------------|------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                   | ** ** | **2008**                                 | ** ** | **2007**                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Total Revenue**                            | ** ** | ** **                               | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Northern                                     |       | $                                        | 33,222     |                                    | $          | 55,137 |   | $ | 80,102 |   | $ | 106,277 |   |
| Southern                                     |       | 44,289                                   |       | 62,600                                  |       | 71,594 |   | 111,105 |   |
| Midwestern                                   |       | 9,198                                    |       | 16,581                                  |       | 20,688 |   | 30,119 |   |
| Florida                                      |       | 1,239                                    |       | 16,686                                  |       | 4,429 |   | 24,955 |   |
| Corporate and unallocated(1)                 |       | 2,280                                    |       | 3,939                                   |       | 3,736 |   | 5,363 |   |
| Consolidated Total                           |       | $                                        | 90,228     |                                    | $          | 154,943 |   | $ | 180,549 |   | $ | 277,819 |   |
|                                         |       |                                     |       |                                    |       |   |   |   |   |
| **(Loss) Income from Continuing Operations** | ** ** | ** **                               | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Before Taxes**                             | ** ** | ** **                               | ** ** | ** **                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Northern                                     |       | $                                        | (8,043     | )                                       | $          | (10,414 | ) | $ | (13,888 | ) | $ | (11,092 | ) |
| Southern                                     |       | (5,746                                   | )          | (10,090                                 | )          | (15,182 | ) | (10,511 | ) |
| Midwestern                                   |       | (1,656                                   | )          | (35,867                                 | )          | (7,168 | ) | (37,391 | ) |
| Florida                                      |       | (573                                     | )          | (12,867                                 | )          | (1,596 | ) | (13,988 | ) |
| Corporate and unallocated                    |       | —                                   |       | 5,943                                   |       | — |   | 8,083 |   |
| Consolidated Total                           |       | $                                        | (16,018    | )                                       | $          | (63,295 | ) | $ | (37,834 | ) | $ | (64,899 | ) |

----

(1) Corporateand unallocated includes the revenue of the Company’s mortgage brokerage andproperty management.

 

**14.  COMMITMENTS AND CONTINGENCIES**

** **

AtDecember 31, 2008, the Company had outstanding bank letters of credit,surety bonds and financial security agreements amounting to $101,928 ascollateral for completion of improvements at various developments of theCompany.

 

Asof December 31, 2008, the Company owned or controlled approximately 6,387building lots.  As part of theaforementioned building lots, the Company has contracted to purchase, or hadunder option, undeveloped land and improved lots for an aggregate purchaseprice of $99,781, which are expected to yield approximately 1,353 buildinglots.  Generally, the Company structuresits land acquisitions so that it has the right to cancel its agreements topurchase undeveloped land and improved lots by forfeiture of its deposit underthe agreement.  Furthermore, purchase ofthe properties is usually contingent upon obtaining all governmental approvalsand satisfaction of certain requirements by the Company and the sellers.

 

Fromtime to time, the Company is named as a defendant in legal actions arising fromits normal business activities.  Althoughthe amount of any liability that could arise with respect to currently pendingactions cannot be accurately predicted, in the opinion of the Company any suchliability will not have a material adverse effect on the financial position oroperating results of the Company.

 

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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 inestimate.  Any significant materialdefects are generally under warranty with the Company’s supplier.  The Company has not historically incurred anysignificant litigation requiring additional specific reserves for its productofferings (e.g., mold litigation).

 

Generally,the Company provides all of its homebuyers with a limited one year warranty asto workmanship. Under certain circumstances, this warranty may be extended totwo years. 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 and actual costs incurred are paid for by the third party provider.

 

The Company’s warrantyand customer satisfaction costs are charged to cost of sales at the time eachhome is closed and title and possession have been transferred to the homebuyer.The amount charged to additions represents warranty and customer satisfactioncosts factored into the cost of each home. The amount recorded as chargesincurred represents the actual warranty and customer satisfaction cost incurredfor the period presented. Certain costs to complete, not included as warrantycosts, have been excluded from the rollforward below:

 
| ** **                     | ** ** | **Six months ended December 31,** | ** ** |
|--------------------------------|------------|----------------------------------------|------------|
| ** **                     | ** ** | **2008**                               | ** ** | **2007** | ** ** |
| Balance at beginning of period |       | $                                      | 3,353      |   | $ | 2,908 |   |
| Warranty costs accrued         |       | 834                                    |       | 1,399 |   |
| Actual warranty costs incurred |       | (1,402                                 | )          | (1,477 | ) |
| Balance at end of period       |       | $                                      | 2,785      |   | $ | 2,830 |   |

 

**15.  FAIR VALUE DISCLOSURES**

** **

Effective July 1,2008, the Company adopted SFAS No. 157, “ Fair Value Measurements” (“SFAS No. 157”)as amended by FASB Staff Position SFAS No. 157-1, “ Application of FASBStatement No. 157 to FASB Statement No. 13 and Other AccountingPronouncements That Address Fair Value Measurements for Purposes of LeaseClassification or Measurement under Statement 13” (“FSP FAS No. 157-1”)and FASB Staff Position SFAS No. 157-2, “ Effective Date of FASB StatementNo. 157” (“FSP FAS No. 157-2”). SFAS No. 157 defines fair value,establishes a framework for measuring fair value in GAAP and provides forexpanded disclosure about fair value measurements.  SFAS No. 157 is applied prospectively,including to all other accounting pronouncements that require or permit fairvalue measurements.  FSP FAS No. 157-1amends SFAS No. 157 to exclude from the scope of SFAS No. 157 certainleasing transactions accounted for under SFAS No. 13, “Accounting forLeases” for purposes of measurements and classifications.  FSP FAS No. 157-2 amends SFAS No. 157to defer the effective date of SFAS No. 157 for all non-financial assetsand non-financial liabilities except those that are recognized or disclosed atfair value in the financial statements on a recurring basis to fiscal yearsbeginning after November 15, 2008.

 

SFAS No. 157 definesfair value as the exchange price that would be received for an asset or paid totransfer a liability (an exit price) in the principal or most advantageousmarket for the asset or liability in an orderly transaction between marketparticipants on the measurement date. SFAS No. 157 also establishes a fairvalue hierarchy which requires an entity to maximize the use of observableinputs and minimize the use of unobservable inputs when measuring fairvalue.  The standard describes threelevels of inputs that may be used to measure fair value.  Financial assets and liabilities arecategorized based on the inputs to the valuation techniques as follows:

 

Level 1   Fair value determined based on quoted pricesin active markets for identical assets.

 

Level 2   Fair value determined using significantother observable inputs.

 

Level 3   Fair values determined using significantunobservable inputs.

 

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The Company’s financialinstruments measured at fair value on a recurring basis are summarized below:

 
| ** **                | ** ** | ** **               | ** ** | **Fair Value at**          | ** ** |
|---------------------------|------------|--------------------------|------------|----------------------------|------------|
| **Financial Instruments** | ** ** | **Fair Value Hierarchy** | ** ** | **December 31, 2008** | ** ** |
| Marketable securities     |       | Level  1                 |       | $                          | 17,318     |   |
|                           |            |                          |            |                            |            |  |

 

The partial adoption ofSFAS No. 157 under FSP FAS No. 157-2 did not have a material impacton the Company’s financial assets and liabilities.  Management is evaluating the impact that SFASNo. 157 will have on its non-financial assets and non-financialliabilities since the application of SFAS No. 157 for such items wasdeferred to July 1, 2009.  TheCompany believes that the impact of these items will not be material to itsconsolidated financial statements.

 

**16.  GOODWILL**

** **

During the six monthsended December 31, 2008, the Company recorded an impairment charge relatedto the goodwill that arose from the Parker & LancasterCorporationacquisition.  This assessment wasperformed in accordance with SFAS No. 142. Management evaluated the recoverability of the goodwill by comparing thecarrying value of the Company’s southern reporting unit to its fair value.  Fair value was determined based on thediscounted future cash flows.  These cashflows are significantly impacted by estimates related to current and futureeconomic conditions, including absorption rates and margins reflective ofslowing demand, as well as anticipated future demand and timing thereof.  The amounts included in the discounted cashflow analysis are based on management’s best estimate of future results.  This estimate considered increased risk anduncertainty associated with current market and economic conditions as reflectedwithin the discount rate used to present value future cash flows and lowerexpected pricing over the projection period due to decreased consumer demand inthe near term over the projection period. The deteriorating market conditions in the Southern Region in whichParker & Lancaster operates are the result of continued economicturmoil, uncertainty in the credit and financial markets, decreased consumerdemand and increased mortgage underwriting standards. Discount rates were basedon the Company’s weighted average cost of capital adjusted for theaforementioned business risks.  Theamount of the goodwill impairment was $4,180 and was recorded in the Company’ssouthern reporting segment.  As a resultof this impairment charge, the Company has no goodwill on its Balance Sheet at December 31,2008.  No impairment charge related togoodwill was taken during the three and six months ended December 31,2007.

 

**17.  VARIABLE INTEREST ENTITIES**

** **

AVariable Interest Entity (“VIE”) is created when (i) the equity investmentat risk is not sufficient to permit the entity to finance its activitieswithout additional subordinated financial support from other parties or (ii) equityholders either (a) lack direct or indirect ability to make decisions aboutthe entity, (b) are protected from absorbing expected losses of the entityor (c) do not have the right to receive expected residual returns of theentity if they occur.  If an entity isdeemed to be a VIE, pursuant to FIN 46-R, an enterprise that absorbs amajority of the expected losses of the VIE is considered the primarybeneficiary and must consolidate the VIE.

 

Basedon the provisions of FIN 46-R, the Company has concluded that whenever itenters into an option agreement to acquire land or lots from an entity and paysa significant deposit that is not unconditionally refundable, a VIE is createdunder condition (ii) (b) of the previous paragraph.  The Company has been deemed to have providedsubordinated financial support, which refers to variable Interests that willabsorb some or all of an entity’s expected theoretical losses if theyoccur.  For each VIE created, the Companyperforms an analysis of the expected losses and residual returns based on theprobability of future cash flows based on the expected variability as outlinedin FIN 46-R.  If the Company isdeemed to be the primary beneficiary of the VIE it will consolidate the VIE onits balance sheet.  The fair value of theVIEs inventory, generally believed to be the purchase price of the land underoption, will be reported as “Inventory not owned—Variable Interest Entities.”

 

AtDecember 31, 2008, the Company consolidated three VIEs as a result of itsoptions to purchase land or lots from the selling entities.  The Company paid cash of $412 and issuedletters of credit of $100 to these VIEs and incurred additional pre-acquisitioncosts totaling $21.  The Company’sdeposits and any costs incurred prior to acquisition of the land or lots representthe Company’s maximum exposure to loss. The fair value of the VIEs inventory, determined as of the date ofconsolidation, is reported as “Inventory not owned—Variable Interest Entities.”  The Company recorded $10,668 in Inventory NotOwned—Variable Interest Entities as of December 31, 2008.  The fair value of the property to be acquiredless cash deposits and pre-acquisition costs, which totaled $10,235 at December 31,2008, was reported on the balance sheet as “Obligations related to inventorynot owned—Variable Interest Entities.” Creditors, if any, of these VIEs have norecourse against the Company.

 

TheCompany will continue to secure land and lots using options.  Excluding the deposits and other costscapitalized in connection with the VIEs discussed in the prior paragraph, theCompany had total costs incurred to acquire land and lots at December 31,2008 of approximately $10,486, including $3,771 of cash deposits.

 

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**18.SUBSEQUENT EVENT**

 

***Waiver Letter***

 

Absent the waiver letterdescribed below, the Company would have continued to be in default of itsobligation to, on or before January 23, 2009, make a principal repaymentin an amount necessary to reduce the outstanding principal balance of the loansto the borrowing base availability (the “Repayment Covenant”).  The failure to make the repayment in fullwithin the proscribed period constituted an event of default under the SecondAmended Credit Agreement, of which the Company provided notice to theLenders.  In addition, Wachovia Bank,N.A. (“Wachovia”) asserted that the borrowers breached the liquidity covenantin the Second Amended Credit Agreement (the “Liquidity Covenant”) for thequarter ended December 31, 2008. The borrowers disagree with Wachovia’s assertion that the borrowersbreached the Liquidity Covenant and have notified Wachovia of theirdisagreement.

 

The second waiver lettertemporarily waived compliance with the Repayment Covenant and the LiquidityCovenant generally from December 31, 2008 through and including February 6,2009, unless another event of default occurred.  With the termination ofwaiver period without the First Amendment described below having been enteredinto, the failure of the Company to have complied with the Repayment Covenanton or before that date, the Company was again in breach of the RepaymentCovenant and, to the extent there had been a breach of the Liquidity Covenantas asserted by Wachovia (an assertion with which the Company disagrees), theCompany was also in breach of that covenant.  Any such breaches were,however, cured by the First Amendment described below.

 

***First Amendment to the Second Amended Credit Agreement andSecurity Agreement:***

 

On February 11,2009, the Company entered into the First Amendment to the Second Amended CreditAgreement which provides, among other things, that:

 

·                  The categoryreductions applicable to the determination of borrowing base availability wereadjusted so that the maximum borrowing base availability attributable to assetclass (ii) (units not subject to a qualifying agreement of sale)determined on the basis of any borrowing base certificate that is deliveredbefore July 31, 2009, was increased to a maximum of 58% of the aggregateborrowing base availability attributable to asset classes (i) (unitssubject to a qualifying agreement of sale) and (ii) (units not subject toa qualifying agreement of sale) as shown on the borrowing basecertificate.  For borrowing basecertificates delivered on or after July 31, 2009, the maximum percentageremains unchanged at 45%.

·                  The categoryreductions applicable to the determination of the borrowing base availabilitywere adjusted so that the maximum borrowing base availability attributable toasset classes (iii) (lots part of improved land not subject to aqualifying agreement of sale), (iv) (lots part of land under development)and (v) (lots part of land approved for development), based on borrowingbase certificates delivered before July 31, 2009, was increased to amaximum of 65% of the total borrowing base availability as shown on theborrowing base certificate.  Forborrowing base certificates delivered on or after July 31, 2009, themaximum percentage is 55%.    The maximumdollar value of borrowing base availability attributable to asset classes(iii), (iv) and (v) were also adjusted to the following (with suchlimitations to be reduced dollar for dollar at the time and in the amounts ofany impairments with respect to assets in asset classes (iii), (iv) and (v) andincluded in the borrowing base taken by borrowers):

(i)                                     Beginning with the BorrowingBase Certificate delivered on or after the effective date of the FirstAmendment: $235,000;

(ii)                                  Beginning with the BorrowingBase Certificate delivered on or after July 31, 2009: $200,000; and

(iii)                               Beginning with the BorrowingBase Certificate delivered after September 30, 2009: $190,000.

·                  Under the FirstAmendment, the aggregate effect of (i) the modification of the borrowingbase category reductions applicable to units not subject to a qualifyingagreement of sale (described above); (ii) the modification of theborrowing base category reductions for land under development (describedabove); and (iii)  the inventory impairments during the second fiscalquarter of approximately $8,670, was an increase in net borrowing base availabilityof $16,065 as of December 31, 2008, from a negative $14,567 to a positive$1,498.

·                  The amount ofthe Revolving Credit Facility was reduced from $440,000 to $405,000, exceptthat the amount of the Revolving Credit Facility will be reduced to $375,000beginning on July 16, 2009 and through maturity, unless otherwisepermanently reduced as a result of certain prepayments required by theRevolving Credit Facility.  The letter ofcredit sublimit was reduced to $30,000 from $60,000, and the financial letterof credit sublimit was reduced to $15,000 from $25,000. The amount actuallyavailable under the Revolving Credit Facility is also subject to the borrowingbase availability requirements in the Revolving Credit Facility.

·                  In the eventthere is one or more defaulting lenders, so long as there is no event ofdefault has occurred and is continuing, pro-rata principal payments shall notbe made to such defaulting lender, but instead shall be paid over to the masterborrower.

 

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·                  The minimumconsolidated tangible net worth level was adjusted to a minimum of at least$25,000 (1) reduced by the sum of (a) any impairments or othercharges under GAAP on assets in the borrowing base taken by the Company andrecorded in respect of the financial quarters ended December 31, 2008 and March 31,2009, plus (b)  any deferred tax assets valuation allowance reservesrecorded in respect of the fiscal quarters ended December 31, 2008 and March 31,2009, plus (c) any impairments or write-offs relating to tangible assetsor pre-acquisition costs not contained in the borrowing base recorded inrespect of the fiscal quarters ended December 31, 2008 and March 31,2009****(provided, however, that the aggregatecovenant level reduction pursuant to this clause (1) shall not exceed$15,000), and (2) increased by the sum of (x) any favorableadjustment to the deferred tax asset valuation allowance recorded in respect ofthe fiscal quarters ended December 31, 2008 and March 31, 2009, plus (y) 50%of positive quarterly net income after March 31, 2008.

·                  The definitionof liquidity was revised to provide that negative borrowing base availabilityis deducted from cash and cash equivalents when determining liquidity and theminimum required liquidity covenant was reduced from $15,000 to $10,000.  A five business day cure period in the eventof a breach of the minimum liquidity covenant was also added.

·                  The maximumamount of cash or cash equivalents (excluding cash in transit at titlecompanies) that the Company is allowed to maintain was set at a maximum of$15,000 for any consecutive five-day period.

·                  The cash flowfrom operations covenant ratio was adjusted downward for the quarter ending June 30, 2009 to 0.50:1.00 and for the quarter ending September 30, 2009 andthereafter to 0.65:1.00.

·                  The Company’sability to purchase up to $8,000 of unimproved real estate is no longeravailable; however, the Company’s ability to acquire lots though optiontake-downs remains unchanged.  Theprovision specifically allowing the Company to make new joint venture investmentsup to certain specified amounts was also eliminated.

·                  The interestrate was increased by 25 basis points, to the LIBOR interest rate plus 5.25%.

·                  Generally, theability to obtain letters of credit for general working capital or corporatepurposes and the ability to obtain letters of credit in connection withprojects outside the borrowing base were eliminated (provided, however, thatexisting letters of credit can be renewed, subject to the other terms of theLoan Agreement).

·                  Provisions wereadded providing that no letter of credit will be issued or renewed and that notri-party agreement will be executed or maintained while any lender is adefaulting lender, except if the Borrowers have delivered to Agent cashcollateral equal to the defaulting lenders’ pro rata share of the letter ofcredit or tri-party agreement.  The cashcollateral is to be used to reimburse lenders in the event of draws underletters of credit or tri-party agreements.

·                  Letter ofcredit advances (that is, payments pursuant to a letter of credit that resultin the making of a loan to Borrowers in excess of the then available borrowingbase) must be repaid within five business days, or earlier under certaincircumstances.

·                  Provisions wereadded to the Second Amended Credit Agreement and related Security Agreementproviding that, in the event of receipt of any tax refund by any obligor thatconstitutes collateral, the amount received must be used to prepay the loansunder the facility.  Any such collateralreceived by the agent will likewise be applied to the outstandingindebtedness.  However, such reduction ofthe outstanding indebtedness would have the effect of then increasing the netborrowing base availability immediately thereafter.

·                  Additionalprovisions were added with respect to the allocation among the lenders ofburdens and risks associated with defaulting lenders.

·                  Inconsideration of entering into the First Amendment to the Second Amended CreditAgreement, the Company paid a fee equal to 0.25% of such approving lenders’reduced commitments effective on the closing of the amendment.

 

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| **ITEM 2.** | ** ** | **MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL****CONDITION AND RESULTS OF  OPERATIONS****(Dollars in thousands, except  per share data)** |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|

 

OrleansHomebuilders, Inc., a Delaware corporation, and its subsidiaries(collectively, the “Company”, “OHB”, “Orleans”, “we”, “us” or “our”) market,develop and build high-quality, single-family homes, townhomes and condominiumsto serve various types of homebuyers, including move-up, luxury, empty nester,active adult, first-time move-up and first-time homebuyers. The Companybelieves this broad range of home designs gives it flexibility to addresseconomic and demographic trends within its markets.  The Company has been in operation since 1918and is currently engaged in residential real estate development in eight statesin the following 11 markets: Southeastern Pennsylvania; Central New Jersey;Southern New Jersey; Orange County, New York; Charlotte, Raleigh andGreensboro, North Carolina; Richmond and Tidewater, Virginia; Chicago,Illinois; and Orlando, Florida.  TheCompany’s Charlotte, North Carolina market also includes operations in adjacentcounties in South Carolina.  On December 31,2007, the Company committed to exiting the Phoenix, Arizona market and, inconnection with that decision, on that date disposed of its entire landposition and its related work-in-process homes in Phoenix, which constitutedsubstantially all of its assets in the western region.  The Consolidated Financial Statements havebeen reclassified for all prior periods presented to reflect this business as adiscontinued operation.  SeeNote 12, Discontinued Operations.

 

Referencesto a given fiscal year in this Quarterly Report on Form 10-Q is to thefiscal year ended June 30th of that year. For example, the phrases “fiscal 2009”, “2009 fiscal year” or “yearended June 30, 2009” refer to the fiscal year ending June 30,2009.  When used in this report, the “northernregion” segment refers to our markets in Pennsylvania, New Jersey and New York;the “southern region” segment refers to our markets in North Carolina andVirginia, as well as the adjacent counties in South Carolina; the “midwesternregion” segment refers to our market in Illinois; the “Florida region” segmentrefers to our market in Florida; and the “western region” segment refers to ourformer market in Arizona.

 

**Results of Operations**

 

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

 

Sincethe latter part of fiscal year 2006, we and the entire housing industry havefaced several significant challenges in the housing and mortgage markets as awhole.  These challenges have increasedsignificantly during the three and six months ended December 31, 2008 asthese difficulties which previously were confined to certain segments of theeconomy (including homebuilding) have expanded to a greater portion of theUnited States and global economy. Economic reports show that the United States economy is suffering fromfalling wages, rising inflation, weak consumer spending, job losses, tightcredit, a lingering malaise in the real estate industry and the worst financialcrisis since the 1930s.  During thequarter, it was announced that the United States economy had been in arecession since December 2007. As a result, we believe that overalleconomic conditions and conditions in the housing and mortgage markets willremain difficult and these conditions may continue to have a negative impact onnew orders, new order pricing and consumer confidence related to housing in thenear term, thereby further reducing revenues, gross margins and net income.  We are continuing to respond 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.  Furtherdecreases in demand for our homes may require us to further increase the use ofsales incentives and to take other steps to reduce expenditures and expenses,which could result in future inventory impairments.

 

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Forthe tables below setting forth certain details as to residential salesactivities, the information is provided for the three and six months ended December 31,2008 and 2007 in the case of residential revenue earned and new orders, and asof December 31, 2008 and 2007 in the case of backlog.  We consider a sales contract or a potentialsale to be classified as a new order and, therefore, become a part of backlog, at the timea homebuyer executes a contract to purchase a home from the Company.  Sales contracts are usually accompanied by asales deposit.  In some instances,purchasers are permitted to cancel sales contracts if they are unable to closeon the sale of their existing home or fail to qualify for financing and undercertain other circumstances.

 
| ** **                     | ** ** | **Three months ended December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|---------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **2008**                                                | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **New orders**                 | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 41,234     |       | $          | 114,687    |       | $ | (73,453 | ) | (64.0 | )% |
| Units                          |       | 113                                                     |       | 284        |       | (171       | )          | (60.2 | )% |
| Average sales price            |       | $                                                       | 365        |       | $          | 404        |       | $ | (39 | ) | (9.7 | )% |
|                           |       |                                                    |       |       |       |       |       |   |   |
| **Residential revenue earned** | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 87,753     |       | $          | 144,490    |       | $ | (56,737 | ) | (39.3 | )% |
| Units                          |       | 199                                                     |       | 323        |       | (124       | )          | (38.4 | )% |
| Average sales price            |       | $                                                       | 441        |       | $          | 447        |       | $ | (6 | ) | (1.3 | )% |

 
| ** **                     | ** ** | **Six months ended December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|-------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **2008**                                              | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **New orders**                 | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                     | 94,864     |       | $          | 247,263    |       | $ | (152,399 | ) | (61.6 | )% |
| Units                          |       | 248                                                   |       | 587        |       | (339       | )          | (57.8 | )% |
| Average sales price            |       | $                                                     | 383        |       | $          | 421        |       | $ | (38 | ) | (9.0 | )% |
|                           |       |                                                  |       |       |       |       |       |   |   |
| **Residential revenue earned** | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                     | 176,355    |       | $          | 263,847    |       | $ | (87,492 | ) | (33.2 | )% |
| Units                          |       | 399                                                   |       | 586        |       | (187       | )          | (31.9 | )% |
| Average sales price            |       | $                                                     | 442        |       | $          | 450        |       | $ | (8 | ) | (1.8 | )% |

 
| ** **          | ** ** | **As of  December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------|------------|------------------------------|------------|------------|------------|------------|------------|
| ** **          | ** ** | **2008**                     | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **          | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Backlog**         | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars             |       | $                            | 156,818    |       | $          | 301,329    |       | $ | (144,511 | ) | (48.0 | )% |
| Units               |       | 335                          |       | 610        |       | (275       | )          | (45.1 | )% |
| Average sales price |       | $                            | 468        |       | $          | 494        |       | $ | (26 | ) | (5.3 | )% |

 

Neworders for the three months ended December 31, 2008 decreased $73,453 or64.0%, to $41,234 on 113 homes, compared to $114,687 on 284 homes for the threemonths ended December 31, 2007.  Theaverage price per home decreased by approximately 9.7% to $365 for the threemonths ended December 31, 2008 compared to $404 for the three months endedDecember 31, 2007.

 

Neworders for the six months ended December 31, 2008 decreased $152,399 or61.6%, to $94,864 on 248 homes, compared to $247,263 on 587 homes for the sixmonths ended December 31, 2007.  Theaverage price per home decreased by approximately 9.0% to $383 for the sixmonths ended December 31, 2008 compared to $421 for the six months ended December 31,2007.

 

Thedecrease in new orders for the three and six months ended December 31,2008 is attributable to the continued deterioration in the overall housing andmortgage markets during the period, significant turmoil in the capital markets,weaker employment statistics and decreased consumer confidence.  The decrease in the average sales price onnew orders generally represents a response to the deterioration in marketconditions by us in an effort to increase absorption through the use of marketingincentives and price reductions.

 

Residentialrevenues earned for the three months ended December 31, 2008 decreased$56,737, or 39.3%, to $87,753 on 199 homes,

 

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comparedto $144,490 on 323 homes for the three months ended December 31,2007.  The average price per homedecreased by approximately 1.3% to $441 for the three months ended December 31,2008 compared to $447 for the three months ended December 31, 2007.

 

Residentialrevenues earned for the six months ended December 31, 2008 decreased$87,492, or 33.2%, to $176,355 on 399 homes, compared to $263,847 on 586 homesfor the six months ended December 31, 2007.  The average price per home decreased byapproximately 1.8% to $442 for the six months ended December 31, 2008compared to $450 for the six months ended December 31, 2007.

 

Thedecrease in residential revenues earned for the three and six months ended December 31,2008 is also attributable to the continued deterioration in the overall housingand mortgage markets during the period, significant turmoil in the capitalmarkets, weaker employment statistics and decreased consumer confidence.

 

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

 

Cancellationrates for the three and six months ended December 31, 2008 were 30.7% and33.7% of new orders compared to 26.0% and 23.7% for the three and six monthsended December 31, 2007.  Thisincrease is the result of the deteriorating economy, which is reflected in thelower gross orders in all regions. Cancellations declined from 182 in the six months ended December 31,2007 to 126 in the six months ended December 31, 2008.

 

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*** ***

***Northern Region:***

*** ***
| ** **                     | ** ** | **Three months ended December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|---------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **2008**                                                | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **New orders**                 | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 16,505     |       | $          | 45,890     |       | $ | (29,385 | ) | (64.0 | )% |
| Units                          |       | 41                                                      |       | 109        |       | (68        | )          | (62.4 | )% |
| Average sales price            |       | $                                                       | 403        |       | $          | 421        |       | $ | (18 | ) | (4.3 | )% |
|                           |       |                                                    |       |       |       |       |       |   |   |
| **Residential revenue earned** | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 33,102     |       | $          | 57,024     |       | $ | (23,922 | ) | (42.0 | )% |
| Units                          |       | 73                                                      |       | 118        |       | (45        | )          | (38.1 | )% |
| Average sales price            |       | $                                                       | 453        |       | $          | 483        |       | $ | (30 | ) | (6.2 | )% |
|                           |       |                                                    |       |       |       |       |       |   |   |
| ** **                     | ** ** | **Six months ended December 31,**   | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **2008**                                                | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **New orders**                 | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 41,959     |       | $          | 99,472     |       | $ | (57,513 | ) | (57.8 | )% |
| Units                          |       | 96                                                      |       | 222        |       | (126       | )          | (56.8 | )% |
| Average sales price            |       | $                                                       | 437        |       | $          | 448        |       | $ | (11 | ) | (2.5 | )% |
|                           |       |                                                    |       |       |       |       |       |   |   |
| **Residential revenue earned** | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 79,827     |       | $          | 108,050    |       | $ | (28,223 | ) | (26.1 | )% |
| Units                          |       | 170                                                     |       | 223        |       | (53        | )          | (23.8 | )% |
| Average sales price            |       | $                                                       | 470        |       | $          | 485        |       | $ | (15 | ) | (3.1 | )% |
|                           |       |                                                    |       |       |       |       |       |   |   |
| ** **                     | ** ** | **As of  December 31,**                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **2008**                                                | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Backlog**                    | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 71,950     |       | $          | 136,057    |       | $ | (64,107 | ) | (47.1 | )% |
| Units                          |       | 136                                                     |       | 254        |       | (118       | )          | (46.5 | )% |
| Average sales price            |       | $                                                       | 529        |       | $          | 536        |       | $ | (7 | ) | (1.3 | )% |

 

Ournorthern region is comprised of our Southeastern Pennsylvania; Central NewJersey; Southern New Jersey and Orange County, New York markets.  We believe that our geographic mix in thismarket allows us to compete better than if we were situated in one or twoconcentrated markets.  In the northernregion, we currently build homes primarily targeted toward move-up, luxury,empty nester and active adult homebuyers.

 

Thedecrease in new orders for the northern region noted above for the three andsix months ended December 31, 2008, is the result of a large decrease inthe number of units sold, coupled with a slight decline in the average salesprice.  The decrease in the number ofunits is primarily the result of deteriorating market conditions.  The decrease in residential revenue earnedfor the three and six months ended December 31, 2008, was also the resultof both decreases in the units sold and the average sale price.

 

Wehave introduced new smaller-value oriented product in the region and we havealso seen a shift in mix to our multi-family townhome products as well as lowerpriced single family communities.

 

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***Southern Region:***

*** ***
| ** **                     | ** ** | **Three months ended December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|---------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **2008**                                                | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **New orders**                 | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 17,472     |       | $          | 50,183     |       | $ | (32,711 | ) | (65.2 | )% |
| Units                          |       | 52                                                      |       | 119        |       | (67        | )          | (56.3 | )% |
| Average sales price            |       | $                                                       | 336        |       | $          | 422        |       | $ | (86 | ) | (20.4 | )% |
|                           |       |                                                    |       |       |       |       |       |   |   |
| **Residential revenue earned** | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 44,227     |       | $          | 61,827     |       | $ | (17,600 | ) | (28.5 | )% |
| Units                          |       | 100                                                     |       | 127        |       | (27        | )          | (21.3 | )% |
| Average sales price            |       | $                                                       | 442        |       | $          | 487        |       | $ | (45 | ) | (9.2 | )% |
|                           |       |                                                    |       |       |       |       |       |   |   |
| ** **                     | ** ** | **Six months ended December 31,**   | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **2008**                                                | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **New orders**                 | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 35,697     |       | $          | 108,765    |       | $ | (73,068 | ) | (67.2 | )% |
| Units                          |       | 103                                                     |       | 240        |       | (137       | )          | (57.1 | )% |
| Average sales price            |       | $                                                       | 347        |       | $          | 453        |       | $ | (106 | ) | (23.4 | )% |
|                           |       |                                                    |       |       |       |       |       |   |   |
| **Residential revenue earned** | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 71,505     |       | $          | 110,200    |       | $ | (38,695 | ) | (35.1 | )% |
| Units                          |       | 164                                                     |       | 227        |       | (63        | )          | (27.8 | )% |
| Average sales price            |       | $                                                       | 436        |       | $          | 485        |       | $ | (49 | ) | (10.1 | )% |
|                           |       |                                                    |       |       |       |       |       |   |   |
| ** **                     | ** ** | **As of  December 31,**                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **2008**                                                | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Backlog**                    | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 67,951     |       | $          | 129,093    |       | $ | (61,142 | ) | (47.4 | )% |
| Units                          |       | 155                                                     |       | 256        |       | (101       | )          | (39.5 | )% |
| Average sales price            |       | $                                                       | 438        |       | $          | 504        |       | $ | (66 | ) | (13.1 | )% |

 

Oursouthern region is comprised of our Charlotte, Raleigh and Greensboro, NorthCarolina and the Richmond and Tidewater, Virginia markets.  The Charlotte, North Carolina market alsoincludes operations in adjacent counties in South Carolina.  The Company in its southern region currentlybuilds homes targeted toward move-up and luxury homebuyers.

 

Thedecrease in new orders for the three and six months ended December 31,2008, compared to the three and six months ended December 31, 2007, is theresult of significant decreases in both the number of units sold and theaverage price per unit.  The decrease inresidential revenues earned for the three and six months ended December 31,2008, compared to the three and six months ended December 31, 2007, isalso due to significant decreases in the number of units sold and the averagesale price per unit.  These decreases arethe result of decreases in our luxury product — particularly in the Richmondarea.

 

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***Midwestern Region:***

 
| ** **                     | ** ** | **Three months ended December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|---------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **2008**                                                | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **New orders**                 | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 6,767      |       | $          | 13,532     |       | $ | (6,765 | ) | (50.0 | )% |
| Units                          |       | 17                                                      |       | 33         |       | (16        | )          | (48.5 | )% |
| Average sales price            |       | $                                                       | 398        |       | $          | 410        |       | $ | (12 | ) | (2.9 | )% |
|                           |       |                                                    |       |       |       |       |       |   |   |
| **Residential revenue earned** | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 9,198      |       | $          | 15,725     |       | $ | (6,527 | ) | (41.5 | )% |
| Units                          |       | 20                                                      |       | 34         |       | (14        | )          | (41.2 | )% |
| Average sales price            |       | $                                                       | 460        |       | $          | 463        |       | $ | (3 | ) | (0.6 | )% |
|                           |       |                                                    |       |       |       |       |       |   |   |
| ** **                     | ** ** | **Six months ended December 31,**   | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **2008**                                                | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **New orders**                 | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 14,927     |       | $          | 26,968     |       | $ | (12,041 | ) | (44.6 | )% |
| Units                          |       | 38                                                      |       | 73         |       | (35        | )          | (47.9 | )% |
| Average sales price            |       | $                                                       | 393        |       | $          | 369        |       | $ | 24 |   | 6.5 | % |
|                           |       |                                                    |       |       |       |       |       |   |   |
| **Residential revenue earned** | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 20,676     |       | $          | 28,561     |       | $ | (7,885 | ) | (27.6 | )% |
| Units                          |       | 48                                                      |       | 62         |       | (14        | )          | (22.6 | )% |
| Average sales price            |       | $                                                       | 431        |       | $          | 461        |       | $ | (30 | ) | (6.5 | )% |
|                           |       |                                                    |       |       |       |       |       |   |   |
| ** **                     | ** ** | **As of  December 31,**                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **2008**                                                | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Backlog**                    | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 15,335     |       | $          | 26,339     |       | $ | (11,004 | ) | (41.8 | )% |
| Units                          |       | 38                                                      |       | 66         |       | (28        | )          | (42.4 | )% |
| Average sales price            |       | $                                                       | 404        |       | $          | 399        |       | $ | 5 |   | 1.3 | % |

 

Inour midwestern region, we have operations in the Chicago area.  The Company in its midwestern regioncurrently builds homes primarily targeted toward the move-up homebuyer.

 

Duringthe three and six months ended December 31, 2008, 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 notedabove.  Average sales price was downslightly during the three months ended December 31, 2008, but increasedduring the six months ended December 31, 2008.  During our first quarter of fiscal year 2008,market prices of new homes in the Chicago market declined significantly.  This increase was due to the significantprice declines that occurred during the early part of fiscal year 2008.  The decrease in residential revenues earnedduring the three and six months ended December 31, 2008, was due todeclines in units sold and average sale price.

 

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***Florida Region:***

 
| ** **                     | ** ** | **Three months ended December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|---------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **2008**                                                | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **New orders**                 | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 490        |       | $          | 5,082      |       | $ | (4,592 | ) | (90.4 | )% |
| Units                          |       | 3                                                       |       | 23         |       | (20        | )          | (87.0 | )% |
| Average sales price            |       | $                                                       | 163        |       | $          | 221        |       | $ | (58 | ) | (26.2 | )% |
|                           |       |                                                    |       |       |       |       |       |   |   |
| **Residential revenue earned** | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 1,226      |       | $          | 9,914      |       | $ | (8,688 | ) | (87.6 | )% |
| Units                          |       | 6                                                       |       | 44         |       | (38        | )          | (86.4 | )% |
| Average sales price            |       | $                                                       | 204        |       | $          | 225        |       | $ | (21 | ) | (9.3 | )% |
|                           |       |                                                    |       |       |       |       |       |   |   |
| ** **                     | ** ** | **Six months ended December 31,**   | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **2008**                                                | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **New orders**                 | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 2,281      |       | $          | 12,058     |       | $ | (9,777 | ) | (81.1 | )% |
| Units                          |       | 11                                                      |       | 52         |       | (41        | )          | (78.8 | )% |
| Average sales price            |       | $                                                       | 207        |       | $          | 232        |       | $ | (25 | ) | (10.8 | )% |
|                           |       |                                                    |       |       |       |       |       |   |   |
| **Residential revenue earned** | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 4,347      |       | $          | 17,036     |       | $ | (12,689 | ) | (74.5 | )% |
| Units                          |       | 17                                                      |       | 74         |       | (57        | )          | (77.0 | )% |
| Average sales price            |       | $                                                       | 256        |       | $          | 230        |       | $ | 26 |   | 11.3 | % |
|                           |       |                                                    |       |       |       |       |       |   |   |
| ** **                     | ** ** | **As of  December 31,**                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **2008**                                                | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Backlog**                    | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dollars                        |       | $                                                       | 1,582      |       | $          | 9,840      |       | $ | (8,258 | ) | (83.9 | )% |
| Units                          |       | 6                                                       |       | 34         |       | (28        | )          | (82.4 | )% |
| Average sales price            |       | $                                                       | 264        |       | $          | 289        |       | $ | (25 | ) | (8.7 | )% |

 

Theabove table reflects results from our Florida region for the three and sixmonths ended December 31, 2008 and 2007. In the Florida region, we have operations in the Orlando market.  The six months ended December 31, 2007,also reflects results from the Palm Bay market from which we substantiallyexited during the first quarter of fiscal 2008. The three and six months ended December 31, 2007, also reflectsresults from the Palm Coast market from which we substantially exited duringthe second quarter of fiscal 2008.  TheCompany in the Florida region currently builds homes primarily targeted towardfirst-time, move-up and entry level homebuyers.

 

Thedecrease in new orders for the three and six months ended December 31,2008, as compared to the three and six months ended December 31, 2007, isprimarily the result of the continued deterioration of market conditions inthis region.  New orders were also negativelyimpacted by our exit from the Palm Bay and Palm Coast markets, as notedabove.  The decline in residentialrevenue earned is also the result of the overall decline in market conditions,as well as our exit from the Palm Bay and Palm Coast markets, as noted above.

 

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***Costs and Expenses:***

 

***Residential Properties:***

 
| ** **                     | ** ** | **Three months ended December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------|------------|---------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                     | ** ** | **2008**                                                | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Residential Properties**     | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Earned revenue                 |       | $                                                       | 87,753     |       | $          | 144,490    |       | $ | (56,737 | ) | (39.3 | )% |
| Cost of residential properties |       | 87,248                                                  |       | 147,425    |       | (60,177    | )          | (40.8 | )% |
| Gross profit margin            |       | $                                                       | 505        |       | $          | (2,935     | )          | $ | 3,440 |   | (117.2 | )% |
| Gross profit margin %          |       | 0.6                                                     | %          | (2.0       | )%         |       |       |   |   |
|                           |       |                                                    |       |       |       |       |       |   |   |
| ** **                     | ** ** | **Six months ended December 31,**   | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **2008**                                                | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                     | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Residential Properties**     | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Earned revenue                 |       | $                                                       | 176,355    |       | $          | 263,847    |       | $ | (87,492 | ) | (33.2 | )% |
| Cost of residential properties |       | 174,955                                                 |       | 250,378    |       | (75,423    | )          | (30.1 | )% |
| Gross profit margin            |       | $                                                       | 1,400      |       | $          | 13,469     |       | $ | (12,069 | ) | (89.6 | )% |
| Gross profit margin %          |       | 0.8                                                     | %          | 5.1        | %          |       |       |   |   |

 

Thecosts of residential properties for the three and six months ended December 31,2008, compared to the three and six months ended December 31, 2007decreased primarily as a result of decreased residential revenue earned.  Impairments of residential property in theamount of $8,670 and $22,917 were recorded in the three months ended December 31,2008 and 2007, respectively.  Impairmentsof residential property in the amount of $18,088 and $23,629 were recorded inthe six months ended December 31, 2008 and 2007, respectively.  Gross profit percentage for the three and sixmonths ended December 31, 2008 was 0.6% and 0.8%, as compared to (2.0)%and 5.1% for the three and six months ended December 31, 2007.  Without recording the impairments, the grossprofit percentage would have been 10.5% and 11.1% for the three and six monthsended December 31, 2008, as compared to 13.8% and 14.1% for the three andsix months ended December 31, 2007.

 

Wesell a variety of home types in various communities and regions, each yieldinga different gross profit margin. As a result, depending on the mix of bothcommunities and home types delivered, the consolidated gross profit margin mayfluctuate up and down on a periodic basis and periodic profit margins may notbe representative of the consolidated gross profit margin for the entire yearor future years.

 

Wecapitalize interest costs to inventory during development andconstruction.  Capitalized interest ischarged to cost of sales as the related inventory is delivered to thebuyer.  Historically, our inventoryeligible for interest capitalization exceeded our debt levels.  As a result of our reduction of inventoriesin recent quarters the Company’s active inventory has been lower than its debtlevel; therefore, a portion of the interest incurred during those periods wasexpensed directly to interest expense. As all interest incurred is ultimately expensed, this occurrence onlyaccelerated the expense recognition of the interest incurred during theperiod.  Interest included in the costsand expenses of residential properties and land sold for the three months endedDecember 31, 2008 and December 31, 2007 was $4,535 and $5,114,respectively. Interest included in the costs and expenses of residentialproperties and land sold for the six months ended December 31, 2008 and December 31,2007 was $8,679 and $8,923, respectively. Interest charged directly to interest expense during the three and sixmonths ended December 31, 2008 was $1,019 and $2,883, respectively.  Included in interest expense during the sixmonths ended December 31, 2008, was the write-off of debt acquisitioncosts in the amount of $784.  This chargewas recognized due to the decrease in borrowing capacity as a result of the September 30,2008 amendment to the Revolving Credit Facility.  There was no interest charged directly tointerest expense during the three and six months ended December 31, 2007.

 

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***Selling, General and Administrative:***

 
| ** **                              | ** ** | **Three months ended December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                              | ** ** | **2008**                                                | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                              | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Selling, General and Administrative** | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Selling and advertising                 |       | $                                                       | 4,665      |       | $          | 8,219      |       | $ | (3,554 | ) | (43.2 | )% |
| Commissions                             |       | 3,537                                                   |       | 5,644      |       | (2,107     | )          | (37.3 | )% |
| General and administrative              |       | 7,919                                                   |       | 10,725     |       | (2,806     | )          | (26.2 | )% |
| Total                                   |       | $                                                       | 16,121     |       | $          | 24,588     |       | $ | (8,467 | ) | (34.4 | )% |

 
| ** **                              | ** ** | **Six months ended December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|-------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                              | ** ** | **2008**                                              | ** ** | **2007**   | ** ** | **Change** | ** ** | **% Change** | ** ** |
| ** **                              | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Selling, General and Administrative** | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Selling and advertising                 |       | $                                                     | 9,798      |       | $          | 14,674     |       | $ | (4,876 | ) | (33.2 | )% |
| Commissions                             |       | 7,094                                                 |       | 9,921      |       | (2,827     | )          | (28.5 | )% |
| General and administrative              |       | 15,807                                                |       | 18,268     |       | (2,461     | )          | (13.5 | )% |
| Total                                   |       | $                                                     | 32,699     |       | $          | 42,863     |       | $ | (10,164 | ) | (23.7 | )% |

 

Sellingand advertising costs include amortization of deferred marketing costs andother selling costs.  These costsdecreased primarily as a result of reduced sales office headcount, as part ofheadcount reductions that took place during the latter half of fiscal year 2008and the first half of fiscal year 2009. During the first seven months of fiscal year 2009, the Company has hadthree headcount reductions, which have reduced the total number of employees atthe Company from 544 at June 30, 2008 to 376 at January 31, 2009, areduction of 31%.  From June 30,2006 to January 31, 2009, headcount has been reduced from 988 to 376, areduction of 62%.

 

Thedecrease in commission expense is primarily attributable to the decrease inresidential revenues as noted above. Commission expense as a percentage of residential revenue increased to4.0% and 4.0% for the three and six months ended December 31, 2008 from3.9% and 3.8% for the three and six months ended December 31, 2007.  The increased rate is due to increasedincentives to the Company’s sales force.

 

Thedecrease in general and administrative costs was due to the aforementionedheadcount reductions.  Write-offs ofabandoned projects and other pre-acquisition costs were $1,641 and $1,798 forthe three and six months ended December 31, 2008 as compared to $462 and$862 for the three and six months ended December 31, 2007.

 

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

 
| ** **                 | ** ** | **Three months ended December 31,** | ** ** | ** ** | ** ** |
|----------------------------|------------|---------------------------------------------------------|------------|------------|------------|
| ** **                 | ** ** | **2008**                                                | ** ** | **2007**   | ** ** | **Change** | ** ** |
| ** **                 | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Land sales**             | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Earned revenue             |       | $                                                       | —     |       | $          | 8,224 |   | $ | (8,224 | ) |
| Costs and expenses         |       | 2                                                       |       | 44,784     |       | (44,782 | ) |
| Gross profit (loss)        |       | $                                                       | (2         | )          | $          | (36,560 | ) | $ | 36,558 |   |
|                       |       |                                                    |       |       |       |   |   |
| **Other income (expense)** | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Other income               |       | $                                                       | 2,475      |       | $          | 2,229 |   | $ | 246 |   |
| Other expense              |       | $                                                       | 1,856      |       | $          | 1,441 |   | $ | 415 |   |

 
| ** **                 | ** ** | **Six months ended December 31,** | ** ** | ** ** | ** ** |
|----------------------------|------------|-------------------------------------------------------|------------|------------|------------|
| ** **                 | ** ** | **2008**                                              | ** ** | **2007**   | ** ** | **Change** | ** ** |
| ** **                 | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Land sales**             | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Earned revenue             |       | $                                                     | 58         |       | $          | 9,410 |   | $ | (9,352 | ) |
| Costs and expenses         |       | 26                                                    |       | 46,042     |       | (46,016 | ) |
| Gross profit (loss)        |       | $                                                     | 32         |       | $          | (36,632 | ) | $ | 36,664 |   |
|                       |       |                                                  |       |       |       |   |   |
| **Other income (expense)** | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Other income               |       | $                                                     | 4,136      |       | $          | 4,562 |   | $ | (426 | ) |
| Other expense              |       | $                                                     | 3,640      |       | $          | 3,435 |   | $ | 205 |   |

 

TheCompany had land sales revenue of $0 and $58 during the three and six monthsended December 31, 2008 as compared to $8,224 and $9,410 during the threeand six month ended December 31, 2007.

 

During the three monthsended December 31, 2007, we closed nine separate land sale transactions,disposing of approximately 1,400 lots.  Included in those 1,400 lots, were267 lots that comprised our entire work-in-process inventory and land positionsin the Phoenix, Arizona market.  We have historically reported thisbusiness as our western region operating segment.  The disposedwork-in-process inventory and land positions constituted substantially all ofour assets and operations in the western region.  Accordingly, all chargesassociated with the western region are included as discontinued operations.

 

Including the lots soldin the western region, approximately 94% of the lots sold were in ourmidwestern, Florida and western regions.  Approximately 6% of the lotssold were in our southern region.  No lots were sold in the northernregion during the three months ended December 31, 2007.

 

We received proceeds onthe nine dispositions in the amount of $32,949, inclusive of proceeds relatedto the western region, of which $8,224 was recognized as land sales revenuefrom continuing operations during the three months ended December 31,2007.  An additional $13,425 of proceeds relates to two parcels of landthat were sold, but for accounting purposes were treated as a financingobligation because they were subject to option agreements.  These separateoption agreements generally provided us with the option, but not theobligation, to purchase lots on an individual basis through periodic lot optionacquisition schedules.  The remaining $11,300 million relates to thewestern region and is included in loss from discontinued operations discussedbelow.

 

Prior to the completionof the land sales discussed above, we recorded asset impairments on the land tobe sold.  The total impairment charge related to these land sales were$36,556 for the three months ended December 31, 2007.  These assetimpairment losses are included in the costs of land sales.

 

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.

 

Ourmortgage processing business assists homebuyers in obtaining financing directlyfrom unaffiliated lenders.  We do notfund or service the mortgage loans, nor do we assume any credit or interestrate risk in connection with originating the mortgages.

 

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

*** ***
| ** **                                  | ** ** | **Three months ended December 31,** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|---------------------------------------------------------|------------|------------|------------|
| ** **                                  | ** ** | **2008**                                                | ** ** | **2007**   | ** ** | **Change** | ** ** |
| ** **                                  | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Pre-tax loss from continuing operations     |       | $                                                       | (16,018    | )          | $          | (63,295 | ) | $ | 47,277 |   |
| Income tax benefit                          |       | (397                                                    | )          | (24,688    | )          | 24,291 |   |
| Loss from continuing operations, net of tax |       | $                                                       | (15,621    | )          | $          | (38,607 | ) | $ | 22,986 |   |

 
| ** **                                  | ** ** | **Six months ended December 31,** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------------|------------|------------|------------|
| ** **                                  | ** ** | **2008**                                              | ** ** | **2007**   | ** ** | **Change** | ** ** |
| ** **                                  | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Pre-tax loss from continuing operations     |       | $                                                     | (37,834    | )          | $          | (64,899 | ) | $ | 27,065 |   |
| Income tax benefit                          |       | (277                                                  | )          | (24,529    | )          | 24,252 |   |
| Loss from continuing operations, net of tax |       | $                                                     | (37,557    | )          | $          | (40,370 | ) | $ | 2,813 |   |

 

Theeffective income tax rate was 0.7% for the six months ended December 31,2008 as compared to 37.8% for the six months ended December 31, 2007.  The significant change in the Company’s taxrate was a result of the additional valuation allowance against the deferred tax assets due to thelack of objectively verifiable evidence regarding the realization of theseassets in the foreseeable future.  Therewas no valuation allowance booked during the six months ended December 31,2007.  As of December 31, 2008, thevaluation allowance amounted to $68,084. Of this amount $14,442 was booked during the six months ended December 31,2008.

 

***Loss from Discontinued Operations:***

 

OnDecember 31, 2007, the Company specifically committed to exiting itsArizona market and, in connection with this decision, on that date, it disposedof its entire land position and its related work-in-process homes inArizona.  We have historically reportedthis business as the western region operating segment.  The disposed work-in-process inventory andland assets constituted substantially all of our assets in the western region.  As such, all charges associated with thewestern region are included as a discontinued operation.

 

Lossfrom discontinued operations was $12,778 and 13,070, or a loss of $0.69 pershare and $0.71 per share for the three and six months ended December 31,2007.  See Note 12 to our consolidatedfinancial statements in Item 1 of this Part 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.

 

Asof December 31, 2008, we had $50,198 of borrowing capacity under oursecured revolving credit facility discussed below, subject to borrowing baseavailability.  At December 31, 2008,after taking into account the first amendment described below, we had creditfacility availability of $1,498.  At December 31,2008, the 30-day LIBOR rate of interest was 0.44%.

 

Duringthe six months ended December 31, 2008, our liquidity decreased by $39,677as shown in the table below:

 
| ** **                                 | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                 | ** ** | **2008**              | ** ** | **2008**          | ** ** |
| Cash and cash equivalents                  |       | $                     | 10,795     |              | $          | 72,341 |   |
| Restricted cash - due from title companies |       | 1,911                 |       | 19,269            |       |
| Marketable securities                      |       | 17,318                |       | —            |       |
| Net borrowing base availability            |       | 1,498                 |       | (20,411           | )          |
| Liquidity                                  |       | $                     | 31,522     |              | $          | 71,199 |   |

 

The decrease in liquidity is primarily due tocash used for operations, lower backlog, which has the impact of reducing ourgross borrowing base and inventory impairments during the six months endedDecember 31, 2008, which decreased our borrowing base availability.  These items decreasing our liquidity werepartially offset by adjustments made in the calculation of the borrowing basepursuant to the First Amendment to the Second Amended Credit Agreement, aplanned increase in our accounts payable aging, and decreases in acquisitionsof land.   

 

 

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Oursources of capital include, but are not limited to, funds derived fromoperations, sales of various assets, reductions in speculative inventory levelsthrough completed home deliveries and reductions in speculative starts,borrowings under our Revolving Credit Facility, the issuance of debt or equitysecurities, and other external sources of capital.  Our short-term and long-term liquidity dependprimarily upon the net cash recovery of our land investment upon completed homedeliveries, working capital management (cash, accounts receivable, inventory ofunits under construction, accounts payable and other liabilities), bankborrowings, land related expenditures, net new orders and deliveries.  In an effort to increase liquidity, we maypursue sales of parcels of land, model homes and other assets, amendments toour Revolving Credit Facility, or we may pursue sales of debt or equitysecurities, or seek other external sources of funds.  However, we can offer no assurances as towhether or when such transactions will occur or whether the transactions willbe on terms advantageous to us.

 

Asthe downturn in the housing industry has continued, we have rationalized thesize of our business through lot count reductions for both owned and controlledlots, the abandonment or renegotiation of land option contracts, the reductionin the total number of existing speculative units, limited construction of newspeculative units in order to maintain reasonable speculative unit levelsrelative to lower new orders, and actively shifted our speculative unit mixwherever possible to price and products that are in better relative demandtoday.  We have also significantlyreduced our land expenditures and land expenditure budgets, including, giventhe most recent market conditions, significantly reducing these expendituresfor the balance of the fiscal year in order to minimize the impacts of lowernet new orders on cash flow generated. Pursuant to the First Amendment to the Second Amended Credit Agreement,the Company’s ability to purchase unimproved real estate is no longeravailable; however, the Company continues to be able to acquire lots thoughoption take-downs.  Further, we havesignificantly reduced our workforce, with headcount reduction through January 31,2009 of over 30% in the current fiscal year and over 60% since June 30,2006.

 

FromJanuary 1, 2007 to December 31, 2008, we have reduced our net debt levelsby $143,504, or 25% (where net debt is defined for each period as totalmortgage and other note obligations plus subordinated notes less the aggregateof cash and cash equivalents, marketable securities, restricted cash — due fromtitle company, but excluding restricted cash — customer deposits).  During this same period, the aggregate amountof our work-in-process and owned land inventories have decreased by $324,458(from $857,242 to $532,784), which impacts our gross borrowing base availability.  A significant portion of the inventorydecrease is due to impairments of $200,939 (including discontinued operations)recorded during this period, although a portion of previously impairedinventory has since been sold, either through land sales or normal operations.  During this same period, our total liquidity(as defined above) decreased by $6,093, from $37,615 to $31,522.  The net debt reduction from January 1, 2007 toDecember 31, 2008 described above has been generated through variousmeans, including operations, the reduction in the total number of speculativeunits, offering incentives to buyers in order to help keep orders anddeliveries at higher relative levels notwithstanding challenging industryconditions, selective lands sales, decreases in land acquisitions and otherland expenditures, the abandonment or renegotiation of land option contracts,income tax refunds and a planned increase in our accounts payable aging.

 

Wecontinue to focus on cash generation and preservation to allow sufficient liquidityto be available to fund our operations. We currently believe that the cash andcash equivalents and marketable securities on hand, funds generated fromoperations and anticipated availability under our Revolving Credit Facilitywill provide sufficient capital for us to meet our existing operatingneeds.  However, any material variancefrom our internally projected operating results (including net new orders,cancellations, backlog and deliveries), material declines in the value of ourreal estate held for development and sale (which may lead to additionalinventory impairments), or significant declines in the bank appraised valuerelative to existing appraisals for certain of our assets to be appraised onbehalf of the banks in the coming quarters, could result in a reduction inavailable borrowing capacity under our Revolving Credit Facility.  Such a reduction in available borrowingcapacity could constrain liquidity and require us to seek additional amendmentsand/or waivers under our Revolving Credit Facility.  We can make no assurances that our businesswill generate sufficient cash flow from operations or that future borrowingswill be available to us in an amount sufficient to enable us to pay ourindebtedness, or to fund our other liquidity needs.  In addition, our Revolving Credit Facilitymatures on December 20, 2009, and while we currently anticipate that wewill be able to refinance our Revolving Credit Facility before that time, canoffer no assurance that we will be able to do so, or be able to do so oncommercially reasonable terms.  In theevent that we are not successful in executing our plans discussed above, we mayneed to consider alternative sources of capital to finance our operations.

 

***Revolving Credit Facility***

 

On December 22, 2004,Greenwood Financial, Inc., a wholly-owned subsidiary of the Company, andother wholly-owned subsidiaries of the Company, as borrowers, and OrleansHomebuilders, Inc., as guarantor, entered into a Revolving Credit LoanAgreement for a Senior Secured Revolving Credit and Letter of Credit Facilitywith various banks as lenders (as amended and restated and further amended, the“Revolving Credit Facility”). The Revolving Credit Loan Agreement was amendedon January 24, 2006,

 

 

 

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via the Amended andRestated Revolving Credit Loan Agreement (the “Amended Credit Agreement”).  In connection with the Amended CreditAgreement, Orleans Homebuilders, Inc. executed a Guaranty, which wasamended on September 6, 2007 and amended and restated on September 30,2008. The Amended and Restated Credit Agreement was amended on November 1,2006, February 7, 2007, May 8, 2007, September 6, 2007, December 21,2007, May 9, 2008 by a limited waiver to the Amended Credit Agreement,which was extended on September 15, 2008, and amended and restated in theSecond Amended and Restated Revolving Credit Loan Agreement, dated September 30,2008 (the “Second Amended Credit Agreement”). The Second Amended Credit Agreement was subsequently amended by alimited waiver letter dated January 30, 2009 (the “waiver letter”) and theFirst Amendment to Second Amended and Restated Revolving Credit Loan Agreement andFirst Amendment to Security Agreement dated February 11, 2009 (the “FirstAmendment”).

 

***Waiver Letter***

 

Absent the waiver letterdescribed below, the Company would have continued to be in default of itsobligation to, on or before January 23, 2009, make a principal repaymentin an amount necessary to reduce the outstanding principal balance of the loansto the borrowing base availability (the “Repayment Covenant”).  The failure to make the repayment in fullwithin the proscribed period constituted an event of default under the SecondAmended Credit Agreement, of which the Company provided notice to theLenders.  In addition, Wachovia Bank,N.A. (“Wachovia”) asserted that the borrowers breached the liquidity covenantin the Second Amended Credit Agreement (the “Liquidity Covenant”) for thequarter ended December 31, 2008. The borrowers disagree with Wachovia’s assertion that the borrowersbreached the Liquidity Covenant and have notified Wachovia of theirdisagreement.

 

The second waiver lettertemporarily waived compliance with the Repayment Covenant and the LiquidityCovenant generally from December 31, 2008 through and including February 6,2009, unless another event of default occurred.  With the termination ofwaiver period without the First Amendment described below having been enteredinto, the failure of the Company to have complied with the Repayment Covenanton or before that date, the Company was again in breach of the RepaymentCovenant and, to the extent there had been a breach of the Liquidity Covenantas asserted by Wachovia (an assertion with which the Company disagrees), theCompany was also in breach of that covenant.  Any such breaches were,however, cured by the First Amendment described below.

 

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*** ***

***First Amendment to the Second Amended Credit Agreement and SecurityAgreement:***

 

On February 11,2009, the Company entered into the First Amendment to the Second Amended CreditAgreement which provides, among other things, that:

 

·                  The categoryreductions applicable to the determination of borrowing base availability wereadjusted so that the maximum borrowing base availability attributable to assetclass (ii) (units not subject to a qualifying agreement of sale)determined on the basis of any borrowing base certificate that is deliveredbefore July 31, 2009, was increased to a maximum of 58% of the aggregateborrowing base availability attributable to asset classes (i) (unitssubject to a qualifying agreement of sale) and (ii) (units not subject toa qualifying agreement of sale) as shown on the borrowing basecertificate.  For borrowing basecertificates delivered on or after July 31, 2009, the maximum percentageremains unchanged at 45%.

·                  The categoryreductions applicable to the determination of the borrowing base availabilitywere adjusted so that the maximum borrowing base availability attributable toasset classes (iii) (lots part of improved land not subject to aqualifying agreement of sale), (iv) (lots part of land under development)and (v) (lots part of land approved for development), based on borrowingbase certificates delivered before July 31, 2009, was increased to amaximum of 65% of the total borrowing base availability as shown on theborrowing base certificate.  Forborrowing base certificates delivered on or after July 31, 2009, themaximum percentage is 55%.    The maximumdollar value of borrowing base availability attributable to asset classes(iii), (iv) and (v) were also adjusted to the following (with suchlimitations to be reduced dollar for dollar at the time and in the amounts ofany impairments with respect to assets in asset classes (iii), (iv) and (v) andincluded in the borrowing base taken by borrowers):

(i)                                     Beginning with the BorrowingBase Certificate delivered on or after the effective date of the FirstAmendment: $235,000;

(ii)                                  Beginning with the BorrowingBase Certificate delivered on or after July 31, 2009: $200,000; and

(iii)                               Beginning with the BorrowingBase Certificate delivered after September 30, 2009: $190,000.

·                  Under the FirstAmendment, the aggregate effect of (i) the modification of the borrowingbase category reductions applicable to units not subject to a qualifyingagreement of sale (described above); (ii) the modification of theborrowing base category reductions for land under development (describedabove); and (iii)  the inventory impairments during the second fiscalquarter of approximately $8,670, was an increase in net borrowing base availabilityof $16,065 as of December 31, 2008, from a negative $14,567 to a positive$1,498.

·                  The amount ofthe Revolving Credit Facility was reduced from $440,000 to $405,000, exceptthat the amount of the Revolving Credit Facility will be reduced to $375,000beginning on July 16, 2009 and through maturity, unless otherwisepermanently reduced as a result of certain prepayments required by theRevolving Credit Facility.  The letter ofcredit sublimit was reduced to $30,000 from $60,000, and the financial letterof credit sublimit was reduced to $15,000 from $25,000. The amount actuallyavailable under the Revolving Credit Facility is also subject to the borrowingbase availability requirements in the Revolving Credit Facility.

·                  In the eventthere is one or more defaulting lenders, so long as there is no event ofdefault has occurred and is continuing, pro-rata principal payments shall notbe made to such defaulting lender, but instead shall be paid over to the masterborrower.

·                  The minimumconsolidated tangible net worth level was adjusted to a minimum of at least$25,000 (1) reduced by the sum of (a) any impairments or othercharges under GAAP on assets in the borrowing base taken by the Company andrecorded in respect of the financial quarters ended December 31, 2008 and March 31,2009, plus (b)  any deferred tax assets valuation allowance reservesrecorded in respect of the fiscal quarters ended December 31, 2008 and March 31,2009, plus (c) any impairments or write-offs relating to tangible assetsor pre-acquisition costs not contained in the borrowing base recorded inrespect of the fiscal quarters ended December 31, 2008 and March 31,2009****(provided, however, that the aggregatecovenant level reduction pursuant to this clause (1) shall not exceed$15,000), and (2) increased by the sum of (x) any favorableadjustment to the deferred tax asset valuation allowance recorded in respect ofthe fiscal quarters ended December 31, 2008 and March 31, 2009, plus (y) 50%of positive quarterly net income after March 31, 2008.

·                  The definitionof liquidity was revised to provide that negative borrowing base availabilityis deducted from cash and cash equivalents when determining liquidity and theminimum required liquidity covenant was reduced from $15,000 to $10,000.  A five business day cure period in the eventof a breach of the minimum liquidity covenant was also added.

·                  The maximumamount of cash or cash equivalents (excluding cash in transit at titlecompanies) that the Company is allowed to maintain was set at a maximum of$15,000 for any consecutive five-day period.

·                  The cash flowfrom operations covenant ratio was adjusted downward for the quarter ending June 30, 2009 to 0.50:1.00 and for the quarter ending September 30, 2009 andthereafter to 0.65:1.00.

 

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·                  The Company’sability to purchase up to $8,000 of unimproved real estate is no longeravailable; however, the Company’s ability to acquire lots though optiontake-downs remains unchanged.  Theprovision specifically allowing the Company to make new joint ventureinvestments up to certain specified amounts was also eliminated.

·                  The interestrate was increased by 25 basis points, to the LIBOR interest rate plus 5.25%.

·                  Generally, theability to obtain letters of credit for general working capital or corporatepurposes and the ability to obtain letters of credit in connection withprojects outside the borrowing base were eliminated (provided, however, thatexisting letters of credit can be renewed, subject to the other terms of theLoan Agreement).

·                  Provisions wereadded providing that no letter of credit will be issued or renewed and that notri-party agreement will be executed or maintained while any lender is adefaulting lender, except if the Borrowers have delivered to Agent cashcollateral equal to the defaulting lenders’ pro rata share of the letter ofcredit or tri-party agreement.  The cashcollateral is to be used to reimburse lenders in the event of draws underletters of credit or tri-party agreements.

·                  Letter ofcredit advances (that is, payments pursuant to a letter of credit that resultin the making of a loan to Borrowers in excess of the then available borrowingbase) must be repaid within five business days, or earlier under certaincircumstances.

·                  Provisions wereadded to the Second Amended Credit Agreement and related Security Agreementproviding that, in the event of receipt of any tax refund by any obligor thatconstitutes collateral, the amount received must be used to prepay the loansunder the facility.  Any such collateralreceived by the agent will likewise be applied to the outstandingindebtedness.  However, such reduction ofthe outstanding indebtedness would have the effect of then increasing the netborrowing base availability immediately thereafter.

·                  Additionalprovisions were added with respect to the allocation among the lenders ofburdens and risks associated with defaulting lenders.

·                  Inconsideration of entering into the First Amendment to the Second Amended CreditAgreement, the Company paid a fee equal to 0.25% of such approving lenders’reduced commitments effective on the closing of the amendment.

 

***Terms of the Revolving Credit Facility:***

 

The borrowing limit underthe Revolving Credit Facility is $405,000, except that the amount of the RevolvingCredit Facility will be reduced to $375,000 beginning July 16, 2009,unless otherwise permanently reduced as a result of certain requiredprepayments. The total amount of loans and advances outstanding at any timeunder the Revolving Credit Facility may not exceed the lesser of thethen-current borrowing base availability or the revolving sublimit as definedin the Revolving Credit Facility. The borrowing base availability is based onthe lesser of the appraised value or cost of real estate owned by the Companythat has been admitted to the borrowing base and is subject to variouslimitations and qualifications set forth in the Revolving Credit Agreement.

 

From October 1, 2008to February 10, 2009, borrowings and advances under the Revolving CreditFacility bear interest on a per annum basis equal to the LIBOR Market IndexRate plus 500 basis points.  Beginning onFebruary 11, 2009, the interest rate increased to the LIBOR Market IndexRate plus 525 basis points.  Prior to October 1,2008, the applicable spread had been 400 basis points. During the term of theRevolving Credit Facility, interest is payable monthly in arrears.  At December 31, 2008, the interest ratewas 5.44%, which included a 500 basis point spread.

 

A fee will be earned andpayable on September 15, 2009 equal to 8.0% per annum, calculated on adaily basis, of the difference between $250,000 and the aggregate level of thelenders’ lending commitments under the Revolving Credit Facility as they existfrom time to time between September 30, 2008 and the earlier of September 15,2009 and the date the commitments are permanently reduced to $250,000; howeverthis fee will be reduced by 80% if the aggregate level of commitments on orbefore September 15, 2009 have been permanently reduced to $250,000. Underthis provision, the Company currently estimates that the minimum it will berequired to pay is $0 and the maximum is $9,150. The Company expects that itwill pay no amounts under this provision as it intends to refinance the debtbefore the payment is due and payable. There can be no assurance that suchrefinancing will occur. In addition, if all indebtedness under the RevolvingCredit Facility is not fully repaid by December 20, 2009, a separate feewill be earned and payable on December 20, 2009 equal to 8.0% per annum ofthe amount by which the aggregate commitments under the Revolving CreditFacility that exist from time to time after September 15, 2009 exceed$250,000, calculated on a daily basis. Under this provision, the Company currently estimates that the minimumit will be required to pay is $0 and the maximum is $2,630. The Company expectsthat it will pay no amounts under this provision as it intends to refinance thedebt before the payment is due and payable. There can be no assurance that suchrefinancing will occur.

 

In addition to anyinterest that may be payable with respect to amounts advanced by the lenderspursuant to a letter of credit, the Company will be required to pay to thelender(s) issuing letters of credit an issuance fee of 0.125% of theamount of the letters of credit.

 

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Under and subject to theterms of the Revolving Credit Facility, the borrowers may borrow and re-borrowfor the purpose of financing the acquisition and development of real estate,the construction of homes and improvements, for working capital and for suchother appropriate corporate purposes as may be approved by the lenders. Underthe Revolving Credit Facility, each lender is generally obligated to fund onlyits pro rata portion of each requested loan or advance.  As a result, if any lender refuses, or isunable, to fund its pro rata portion of a requested loan or advance, theCompany may be unable to borrow the entire amount of the requested loan oradvance despite the fact that if there are defaulting lenders, the Company ispermitted to submit additional borrowing requests in an effort to make-up anyborrowing shortfall caused by a defaulting lender failing to fund.  In addition, so long as no event of defaulthas occurred and is continuing, pro-rate principal payments shall not be madeto any defaulting lender, but instead shall be paid over to the master borrower.  The Revolving Credit Facility also providesfor certain burden sharing measures to allocate among the lenders the burdensand risks associated with defaulting lenders in the event there are defaultinglenders.

 

Approximately 35% of theCompany’s collateral assets have been reappraised pursuant to the terms of thewaiver letter and the Company and approximately one third of the assets in theborrowing base with a book value in excess of $4,000 that have not yet beenre-appraised are currently being re-appraised. The re-appraisals that have beendone to date have not had a material impact on the Company’s borrowing baseavailability, but there can be no assurance that future reappraisals will notreduce borrowing base availability.

 

Various conditions mustbe satisfied in order for real estate to be admitted to the borrowing base,including that a mortgage in favor of lenders has been delivered to the agentfor lenders and that all governmental approvals necessary to begin developmentof for-sale residential housing, other than building permits and certain otherpermits borrower in good faith believes will be issued within 120 days,have been obtained. Depending on the stage of development of the real estate,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. Based onthese ranges, the Company is restricted as to the type of land it can have invarious stages of development as well as the dollar value of land underdevelopment.

 

As security for allobligations of borrowers to lenders under the Revolving Credit Facility,lenders continue to have a first priority mortgage lien on all real estateowned by the Company or any borrower and included in the borrowing base underthe Revolving Credit Facility. As further security, pursuant to the SecondAmended Credit Facility, the Company has also agreed to grant to the lenders asecurity interest in and assignment of all future tax refunds and proceedsthereof received or payable to the borrowers or the Company after the closingof the Second Amended Credit Agreement, mortgages in favor of lenders withrespect to all real property owned by the borrowers or the Company that is notalready subject to a lien in favor of the lenders under the Revolving CreditFacility and a security interest in inter-company debt.  Pursuant to the First Amendment, all such taxrefunds must be paid over to the lenders within one business day and will be usedto prepay any indebtedness under the Revolving Credit facility.  Orleans Homebuilders, Inc. hasguaranteed the obligations of the borrowers to lenders pursuant to a Guarantyexecuted by Orleans Homebuilders, Inc. on January 26, 2006, amendedon September 6, 2007 and amended and restated on September 30,2008.  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. However, the Company and its subsidiaries maintain a majorityof the cash, cash equivalents and marketable securities available to them inaccounts and as treasury securities outside of the lenders under the RevolvingCredit Facility.

 

The Revolving CreditFacility contains customary covenants that, subject to certain exceptions,limit or eliminate the ability of the Company to (among other things):

 

·                  Incur or assume other indebtedness,except certain permitted indebtedness and possible second lien indebtedness ifappropriately approved;

·                  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 disposeof all or substantially all of its assets;

·                  Enter into any transaction with anaffiliate that is not a borrower or a guarantor under the Revolving CreditFacility, or a subsidiary of either;

·                  Pay any dividends;

·                  Redeem any stock or subordinated debt;and

·                  Invest in joint ventures or otherentities that are not obligors under the Revolving Credit Facility.

 

In addition, under theRevolving Credit Facility, all real property sales must be accomplished througha title company, with the net proceeds of such a sale going directly to theagent bank for application to the outstanding balance under the RevolvingCredit Facility. Any purchases of real estate must be done through a titlecompany through advances under the Revolving Credit Facility and all suchacquisitions must be subject to mortgages in favor of the lenders; and, at thetime of any such advance, the Company will be required to provide an estimateof the portion of the borrowing that will be used for construction needs.However, the Company may make additional draws from time-to-time pursuant tothe terms of the Revolving Credit Facility.

 

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The Revolving CreditFacility also contains various financial covenants. Among other things, thefinancial covenants, as amended, require that:

 

·                  The Company must maintain a minimumconsolidated tangible net worth of at least $25,000  (1) reduced by the sum of (a) anyimpairments or other charges under GAAP on assets in the borrowing base takenby the Company and recorded in respect of the financial quarters ended December 31,2008 and March 31, 2009, plus (b)  any deferred tax assets valuationallowance reserves recorded in respect of the fiscal quarters ended December 31,2008 and March 31, 2009, plus (c) any impairments or write-offsrelating to tangible assets or pre-acquisition costs not contained in theborrowing base recorded in respect of the fiscal quarters ended December 31,2008 and March 31, 2009****(provided,however, that the aggregate covenant level reduction pursuant to this clause (1) shallnot exceed $15,000), and (2) increased by the sum of (x) anyfavorable adjustment to the deferred tax asset valuation allowance recorded inrespect of the fiscal quarters ended December 31, 2008 and March 31,2009, plus (y) 50% of positive quarterly net income after March 31,2008.

·                  The Company must maintain a requiredliquidity level based on cash plus borrowing base availability of at least$10,000 of cash and cash equivalents (including cash held at a title company)on a consolidated basis at all times, minus the amount by which thethen-outstanding principal balance of the Company’s loans plus any swing lineloans exceeds the then-current borrowing base availability.

·                  The Company’s minimum cash flow fromoperations ratio based on cash flow from operations to interest incurred covenant,must exceed 1.25-to-1.00 for the quarter ending December 31, 2008;0.40-to-1.00 for the quarter ending March 31, 2009; 0.50-to-1.00 for thequarter ending June 30, 2009; and 0.65-to-1.00 for the quarter ending September 30,2009 and thereafter. Cash flow from operations is calculated based on the lasttwelve months cash flow from operations, adjusted for interest paid (excludingany amortized deferred financing costs related to all amendments to the AmendedCredit Agreement, the Second Amended Credit Agreement and the trust preferredsecurities and any future amendments to any of the foregoing), 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, and interest income.

·                  The maximum amount of cash or cashequivalents (excluding cash at title companies) the Company is allowed tomaintain for any consecutive five-day period is $15,000.

·                  The Company may purchase improvedland (i.e., finished lot takedowns and/or controlled rolling lot options)purchased by the borrowers in the normal course of business, consistent withthe projections provided to the Lenders, but otherwise limits the Company’sability to purchase improved and unimproved land.

 

At the fiscal quartersended September 30, 2006, December 31, 2006, March 31, 2007, June 30,2007, March 31, 2008, June 30, 2008 and December 31, 2008, theCompany would have been in violation of certain financial covenants in theAmended and Restated Credit Agreement if not for the First Amendment, SecondAmendment, Third Amendment, Fourth Amendment, waiver letter, the Second AmendedCredit Agreement, the second waiver letter and the First Amendment to theSecond Amended Credit Agreement, respectively.

 

The Revolving CreditFacility provides that, subject to any applicable notice and cure 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 orperform any promise, covenant, warranty, obligation, representation oragreement under the Revolving Credit Facility or any other loan document;

·                  Bankruptcy and other insolvency eventswith respect to any borrower or the Company;

·                  Dissolution or reorganization of anyborrower or the Company;

·                  The entry of a judgment or judgmentsagainst borrower(s) or the Company: (i) in an aggregate amount thatis at least $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 within30 days; or the issuance of any writs of attachment, execution orgarnishment against any borrower or the Company;

·                  Any material adverse change in thefinancial condition of a borrower or the Company which causes the lenders, ingood faith, to believe that the performance of any of the obligations under theRevolving Credit Facility is impaired or doubtful for any reason; and

·                  Specified cross defaults.

 

Upon the occurrence andcontinuation of an event of default, after completion of any applicable graceor cure period, lenders may demand immediate payment in full of allindebtedness outstanding under the Revolving Credit Facility, terminate theirobligations to make any loans or advances or issue any letter of credit, setoff and apply any and all deposits held by any lender for the credit or accountof any borrower. In addition, upon the occurrence of certain events ofbankruptcy or other insolvency events with respect to 

 

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any borrower or theCompany, all indebtedness outstanding under the Revolving Credit Facility shallbe immediately due and payable without any act or action by lenders. A defaultunder the Company’s Revolving Credit Facility could also prevent the Companyfrom making required payments under the Company’s trust preferred securities,which would cause a default under those securities.

 

If the Company does notmeet its forecast in its budgets, the Company could violate its debt covenantsand, absent a waiver or amendment from its lenders, the Company could be indefault under its Revolving Credit Facility and, as a result, its debt couldbecome due which would have a material adverse effect on the Company’sfinancial position and results of operations.

 

As of December 31,2008, after giving effect to the First Amendment, the Company was in compliancewith all of its financial covenants under the Second Amended Credit Agreement,as amended.

 

 

***Trust Preferred Securities:***

 

On November 23,2005, the Company issued $75,000 of trust preferred securities which mature on January 30,2036 and are callable, in whole or in part, at par plus accrued interest on orafter January 30, 2011. For the first ten years, the securities have afixed interest rate of 8.61% per annum, provided that certain covenant levelsare maintained. Thereafter, the securities have a floating interest rate equalto three-month LIBOR plus 360 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 repayoutstanding obligations under the Revolving Credit Facility discussed above.

 

The trust’s preferred andcommon securities require quarterly distributions of interest by the trust tothe holders of the trust securities at a fixed interest rate equal to 8.61% perannum through January 30, 2016 and, after January 30, 2016, at avariable interest rate (reset quarterly) equal to the three-month LondonInterbank Offered Rate (“LIBOR”) plus 360 basis points.  Since the Company failed to meet both thedebt service ratio and minimum tangible net worth requirement set forth in the August 13,2007 supplemental indenture as of the end of a fiscal quarter for at leastthree of the last four consecutive fiscal quarters ending on June 30, 2008,the applicable rate of interest was increased by 300 basis points. We beganaccruing for this increased interest rate on July 31, 2008, which was paidto holders for the first time with the coupon payable on October 31, 2008.The interest rate will return to the regularly applicable rate once the Companyis in compliance with the debt service ratio and minimum tangible net worthrequirements as of the end of any fiscal quarter. The terms of the trustsecurities are governed by an Amended and Restated Trust Agreement, dated November 23,2005, among OHI Financing, Inc., (“OHI Financing”) as depositor, JPMorganChase Bank, National Association, as property trustee, Chase Bank USA, NationalAssociation, as the Delaware trustee, and the administrative trustees namedtherein.

 

The trust used theproceeds from the sale of the trust’s securities to purchase $77,320 inaggregate principal amount of unsecured junior subordinated notes due January 30,2036 issued by OHI Financing, which includes $2,300 of inter-company issuances.The junior subordinated notes were issued pursuant to a Junior SubordinatedIndenture, dated November 23, 2005, as amended by a Supplemental Indenturedated August 13, 2007, collectively referred to herein as the “Indenture,”among OHI Financing, as issuer, and JPMorgan Chase Bank, National Association,as trustee. The terms of the junior subordinated notes are substantially thesame as the terms of the trust’s preferred securities. The interest payments onthe junior subordinated notes paid by OHI Financing, Inc. will be used bythe trust to pay the quarterly distributions to the holders of the trust’spreferred and common securities. Pursuant to the parent guarantee agreementdated November 23, 2005 by and between the Company and JPMorgan ChaseBank, National Association, as trustee, the Company has unconditionallyguaranteed OHI Financing, Inc.’s payment and other obligations under theindenture and the junior subordinated notes. The Company used the proceeds fromthe issuance and sale of the trust preferred securities and the subsequentpurchase of the junior subordinated notes to partially repay indebtedness.

 

The Indenture permits OHIFinancing to redeem the junior subordinated notes at par, plus accrued intereston or after January 30, 2011. If OHI Financing redeems any amount of thejunior subordinated notes, the Trust Agreement requires the trust to redeem alike amount of the trust securities. Under certain circumstances relating tothe tax treatment of the trust or the interest payments made on the juniorsubordinated notes or the classification of the trust as an “investment company”under the Investment Company Act of 1940, as amended, OHI Financing may alsoredeem the junior subordinated notes prior to January 30, 2011 at a 7.5%premium.

 

With certain exceptionsrelating to debt to a trust, partnership or other entity affiliated with theCompany that is a financing vehicle for the Company, the junior subordinatednotes and the Company’s obligations under the parent guarantee are expresslysubordinate to all of the Company’s existing and future debt unless it isprovided in the instrument creating or evidencing such debt, or pursuant towhich such debt is outstanding, that such debt is not superior in right topayment of the junior subordinated notes or the obligations under the parentcompany’s guarantee, as the case may be.

 

Under the Indenture, OHIFinancing will generally have to make eight consecutive Adjusted Interest Ratecoupon payments (other than the eight consecutive Adjusted Interest Rate couponpayments that could be made on each of the coupon payment dates from 

 

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October 30, 2008 toand including July 30, 2010) to cause an event of default under theIndenture (or in some cases six consecutive coupon payments). Morespecifically, the Indenture provides that the earliest an event of defaultcould occur as a result of the payment of the Adjusted Interest Rate is (i) uponthe payment of the Adjusted Interest Rate coupon for October 30, 2010, ifapplicable, provided there have been eight prior consecutive Adjusted InterestRate coupons paid by OHI Financing; (ii) on either the fiscal quarterended March 31, 2010 or the fiscal year ended June 30, 2010, if ateither date both the trailing twelve months’ interest coverage ratio is lessthan 1.25 to 1, and OHI Financing has made the six prior consecutive AdjustedInterest Rate coupon payments; or (iii) on the fiscal quarter ended September 30,2010, if at such time both the trailing twelve months’ interest coverage ratiois less than 1.75 to 1, and OHI Financing has made the eight prior consecutiveAdjusted Interest Rate coupon payments. The Adjusted Interest Rate must be paidfor eight (or in some instances six) consecutive coupons in order to trigger anevent of default. If the interest coverage ratio test and the minimumconsolidated tangible net worth test, are both met, OHI Financing would makethe payment of the Regular Interest Rate for the next coupon, and the AdjustedInterest Rate test “resets” requiring OHI Financing to make eight (or in someinstances six) new consecutive coupon payments at the Adjusted Interest Ratebefore triggering an event of default. The interest coverage ratio and minimumconsolidated tangible net worth measure are not traditional financialmaintenance covenants; they are only utilized in determining if the AdjustedInterest Rate or the Regular Interest Rate is applicable.

 

The junior subordinatednotes and the trust securities could become immediately payable upon an eventof default. Under the terms of the Trust Agreement and the Indenture, subjectto any applicable cure period, an event of default generally occurs upon:

 

·                  non-payment of any interest on the junior subordinated notes when itbecomes due and payable, and continuance of the default for a period of30 days;

·                  non-payment of the principal of, or any premium on, the juniorsubordinated notes at their maturity;

·                  default in the performance, or breach, of any covenant or warranty madeby OHI Financing, Inc., in the indenture and the continuance of thedefault or breach for a period of 30 days after written notice to OHIFinancing, Inc.;

·                  non-payment of any distribution on the trust’s securities when itbecomes due and payable, and continuance of the default for a period of30 days;

·                  non-payment of the redemption price of any trust’s security when itbecomes due and payable;

·                  default in the performance, or breach, in any material respect of anycovenant or warranty of any of the trustees in the Trust Agreement, whichdefault or breach continues for a period of 30 days after written noticeto the trustees and OHI Financing, Inc.;

·                  default in the performance, or breach (which default or breach must bematerial in certain cases), of any covenant or warranty made by OHI Financing, Inc.In the purchase agreement pursuant to which the trust securities and the juniorsubordinated notes were sold and purchased and the continuation of such defaultor breach for a period of 30 days after written notice to OHI Financing, Inc.;

·                  bankruptcy, insolvency or liquidation of the property trustee, if a successorproperty trustee has not been appointed within 90 days thereafter;

·                  the bankruptcy or insolvency of OHI Financing, Inc.; or

·                  certain dissolutions or liquidations, or terminations of the businessor existence, of the trust.

 

Pursuant to the August 13,2008 Supplemental Indenture, OHI Financing established a $5,000 reserve fund inSeptember 2007 for the benefit of the holders of the trust preferredsecurities by posting a letter of credit with the trustee. If the adjustedinterest rate is in effect for the four consecutive coupon payments ending July 30,2009, this reserve fund must be increased by $2,500. Under certain events ofdefault, this reserve fund may be drawn by the trustee and used in respect ofthe trust preferred obligations. The reserve fund may be released upon theearlier of compliance with the applicable interest coverage ratio resulting inOHI Financing paying interest at the regular interest rate rather than theadjusted interest rate, or redemption or defeasance of the notes in accordancewith the terms of the Indenture.

 

On September 20,2005, the Company issued $30,000 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. The Company 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.

 

***Cash Flow Statement***

 

Netcash used by operating activities for the six months ended December 31,2008 was $10,922, compared to net cash provided by operating activities of$42,338 for the six months ended December 31, 2007.  The change was primarily due to a loss in thecurrent 

 

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fiscalyear prior to taking into account non-cash charges as compared to income in theprior fiscal year before non-cash charges.

 

Netcash used in investing activities for the six months ended December 31,2008 was $16,373.  This was related tonet purchases of short-term marketable securities — primarily treasury billsand treasury notes - during the first six months of fiscal year 2009.  In the six months ended December 31,2007, the Company proceeds of $11,300 related to the sale of the Westernregion.

 

Netcash used in financing activities for the six months ended December 31,2008 was $34,251, compared to $41,823 for the six months ended December 31,2007.  Cash used in financing activitiesprimarily relates to net paydowns on our credit facility during the six monthsended December 31, 2008 and 2007.

 

**Lot Positions**

 

Asof December 31, 2008, we owned or controlled approximately 6,387 buildinglots.  Included in the aforementionedlots, we had contracted to purchase, or have under option, undeveloped land andimproved building lots for an aggregate purchase price of approximately $99,781that are expected to yield approximately 1,353 building lots.  The table below shows our lots by region:

 
| **Region** | ** ** | **Lots owned** | ** ** | **Percent of lots owned** | ** ** | **Lots under options of agreement of sale** | ** ** | **Percent of lots controlled** | ** ** | **Total lots owned or  controlled** | ** ** | **Percent of total** | ** ** |
|------------|------------|----------------|------------|---------------------------|------------|---------------------------------------------|------------|--------------------------------|------------|------------------------------------------|------------|----------------------|------------|
| Northern   |       | 2,645          |       | 52.5                      | %          | 639                                         |       | 47.2                           | %          | 3,284                                    |       | 51.4                 | %          |
| Southern   |       | 1,817          |       | 36.1                      | %          | 456                                         |       | 33.8                           | %          | 2,273                                    |       | 35.6                 | %          |
| Midwestern |       | 330            |       | 6.6                       | %          | 228                                         |       | 16.9                           | %          | 558                                      |       | 8.7                  | %          |
| Florida    |       | 242            |       | 4.8                       | %          | 30                                          |       | 2.2                            | %          | 272                                      |       | 4.3                  | %          |
| Total      |       | 5,034          |       | 100.0                     | %          | 1,353                                       |       | 100.1                          | %          | 6,387                                    |       | 100.0                | %          |

 

Asnoted above in our discussion of our Revolving Credit Facility, pursuant to theterms of the First Amendment to the Second Amended Credit Agreement, we cannotpurchase any of real estate with the exception of improved land (i.e. finishedlost takedowns and/or controlled rolling lot options) purchased in the normalcourse of business consistent with the projections provided to our lenders.

 

***Undeveloped LandAcquisitions***

 

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 of regulation in thehousing industry has increased the time it takes to acquire undeveloped landwith all of the necessary governmental approvals required to beginconstruction.  Generally, we structureour land acquisitions so that we have the right to cancel our agreements topurchase undeveloped land by forfeiture of our deposit under theagreement.  Included in the balance sheetcaptions “Inventory not owned — Variable Interest Entities” and “Land depositsand costs of future development,” at December 31, 2008 we had $9,757invested in 8 parcels of undeveloped land, of which $3,063 is cash deposits, aportion of which is non-refundable.  At December 31,2008, overall undeveloped parcels of land under contract had an aggregatepurchase price of approximately $44,092 and were expected to yieldapproximately 659 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 us to periodically reviewthe approval process and make a decision on the viability of developing theparcel to be acquired based upon expected profitability.  In some circumstances we may be required tomake deposits solely due to the passage of time.  This structure still provides us anopportunity to periodically review the viability of developing the parcel ofland.  In addition, we primarilystructure our agreements to purchase undeveloped land to be contingent uponobtaining all governmental approvals necessary for construction.  Under most agreements, we secure theresponsibility for obtaining the required governmental approvals as we believethat we have significant expertise in this area.  We intend to complete the acquisition ofundeveloped land only after all governmental approvals are in place.  In certain rare circumstances, however, whenall extensions have been exhausted, we must make a decision on whether toproceed with the purchase even though all governmental approvals have not yetbeen received.  In these circumstances,we perform reasonable due diligence to ascertain the likelihood that thenecessary governmental approvals will be granted.

 

 

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*** ***

***Improved Lot Acquisitions:***

 

Theprocess of acquiring improved building lots from developers is extremelycompetitive.  We compete with manynational homebuilders to acquire improved building lots, some of which havegreater 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 aregenerally in place when the improved building lots are acquired.

 

AtDecember 31, 2008, we had contracted to purchase or had under optionapproximately 694 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 $55,689.  At December 31,2008, we had $1,000 invested, of which $978 is cash deposits, invested in theseimproved building lots.

 

Subjectto the restrictions in our Revolving Credit Facility, we expect to utilizeprimarily the Revolving Credit Facility as described above as well as otherexisting capital resources, to finance the acquisitions of undeveloped land andimproved lots described above.  Thetiming of these acquisitions will depend on market conditions.  We have substantially reduced our land expendituresboth to-date and our planned expenditures for the next several quarters toreflect current market conditions.

 

**Recent Accounting Pronouncements**

 

InDecember 2007, the Financial Accounting Standard Board (“FASB”) issuedStatement of Financial Accounting Standard (“SFAS”) No. 160, “NoncontrollingInterests in Consolidated Financial Statements—an amendment of ARB No. 51”(“SFAS No. 160”). SFAS No. 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 calls for consistency in the mannerof reporting changes in the parent’s ownership interest and requires fair valuemeasurement of any noncontrolling equity investment retained in adeconsolidation.  SFAS No. 160is effective for fiscal year ending June 30, 2010.  The Company is evaluating the impact theadoption of SFAS 160 will have on its consolidated financial statements.

 

InDecember 2007, the FASB issued SFAS No. 141 (revised 2007), “BusinessCombinations” (“SFAS No. 141(R)”). SFAS No. 141(R) broadensthe guidance of SFAS No. 141, extending its applicability to alltransactions and other events in which one entity obtains control over one ormore other businesses.  It broadens thefair value measurement and recognition of assets acquired, liabilities assumed,and interests transferred as a result of business combinations.  SFAS No. 141(R) expands onrequired disclosures to improve the statement users’ abilities to evaluate thenature and financial effects of business combinations.  SFAS No. 141(R) is effectivefor fiscal year ending June 30, 2010. The Company is evaluating the impactthe adoption of SFAS No. 141(R) will have on its consolidatedfinancial statements.

 

InMarch 2008, the FASB issued SFAS No. 161, “Disclosures aboutDerivative Instruments and Hedging Activities, an amendment ofFASB Statement No. 133.”  Thisstatement requires enhanced disclosures about an entity’s derivative andhedging activities and thereby improves the transparency of financialreporting.  The Statement is effectivefor financial statements for fiscal years and interim periods beginning after November 15,2008 and is not expected to have an impact on the Company’s financial statements.

 

InJune 2008, the FASB issued FASB Staff Position (“FSP”) Emerging IssuesTask Force 03-6-1, “Determining Whether Instruments Granted in Share-BasedPayment Transactions Are Participating Securities.” Under the FSP, unvestedshare-based payment awards that contain non-forfeitable rights to dividends ordividend equivalents are participating securities and, therefore, are includedin computing earnings per share pursuant to the two-class method.  The two-class method determines earnings pershare for each class of common stock and participating securities according todividends or dividend equivalents and their respective participation rights inundistributed earnings.  The Company’soutstanding restricted stock awards will be considered participating securitiesunder this FSP. The FSP is effective for the Company’s fiscal year beginning July 1,2009 and requires retrospective application. The Company does not expect the adoption of the FSP to have a materialimpact on its reported earnings per share.

 

InDecember 2008, the FASB issued FSP No. FAS 140-4 and FIN 46(R)-8, “Disclosuresby Public Entities (Enterprises) about Transfers of Financial Assets andInterests in Variable Interest Entities.” The staff position amends SFAS No. 140,“Accounting for Transfers and Servicing of Financial Assets and Extinguishmentsof Liabilities,” to require public entities to provide additional disclosuresabout transfers of financial assets. It also amends FIN 46(R) to requirepublic enterprises, including sponsors that have a variable interest in avariable interest entity, to provide additional disclosures about theirinvolvement with variable interest entities. This position is effective forfinancial statements issued for interim periods and fiscal years ending after December 15,2008.  The adoption of thispronouncement, which is related to disclosure only, did not have a materialimpact on the Company’s financial statements.

 

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Cautionary Statement forPurposes of the “Safe Harbor” Provisions of the Private Securities LitigationReform Act of 1995

 

In addition to historicalinformation, this report contains statements relating to future events or ourfuture results. These statements are forward-looking statements within themeaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and aresubject 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 the negative of or other variation on these and other similarexpressions identify forward-looking statements.  These forward-looking statements including,without limitation, statements with respect to the downturn in the homebuildingindustry; changes in consumer confidence and cancellation rates; the Company’ssignificant level of debt and anticipated defaults under our revolving creditfacility; the Company’s intention to refinance its bank debt, anticipatedrealization of deferred tax assets; anticipated reappraisals of assets in ourborrowing base; the substantial elimination of the possibility of certaindefaults under the Company’s $75,000 issue of trust preferred securities untilat least September 2010; anticipated tax refunds; potential effects ofchanges in financial and commodity market prices and interest rates; potentialliabilities relating to litigation currently pending against us; anticipateddelivery of homes in backlog; fluctuations in market conditions;appropriateness of completed home inventory levels; the overall direction of thehousing market; expected warranty costs; future land acquisitions; and theavailability of sufficient capital for us to meet our operating needs are madeonly as of the date of this report.  Wedo not undertake to update or revise the forward-looking statements, whether asa result of new information, future events or otherwise.  For additional information on some potentialrisks, see the Company’s Annual Report on Form 10-K/A for the fiscal yearended June 30, 2008.

 

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.

 

Many factors could causeour actual consolidated results to differ materially from those expressed inany of our forward-looking statements.

 

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**ITEM 3.****                            ****QUANTITATIVEAND QUALITATIVE DISCLOSURES 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’s principal market risk exposurecontinues to be interest rate risk.  Amajority of the Company’s debt is variable based on LIBOR, and, therefore,affected by changes in market interest rates. Based on current operations, an increase or decrease in interest ratesof 100 basis points will result in a corresponding increase or decreaseinterest charges incurred by the Company of approximately $3,654,000 in afiscal year, a portion of which may be capitalized and included in cost ofsales as homes are delivered.

 

Changesin the prices of commodities that are a significant component of homeconstruction costs, particularly lumber, may result in unexpected short termincreases in construction costs.  Sincethe sale price of the Company’s homes is fixed at the time the buyer entersinto a contract to acquire a home and because the Company generally contractsto sell its homes before construction begins, any increase in costs in excessof those anticipated may result in gross margins lower than anticipated for thehomes in the Company’s backlog.  TheCompany 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, 2008.

 

**ITEM 4.****                            ****CONTROLSAND PROCEDURES**

 

TheCompany’s management, with the participation of the Company’s Chief ExecutiveOfficer, President and Chief Operating Officer, Executive Vice President andChief Financial Officer and Vice President and Corporate Controller evaluatedthe effectiveness of the Company’s disclosure controls and procedures as of theend of the period covered by this report. Based upon that evaluation, the Chief Executive Officer, President andChief Operating Officer, Executive Vice President and Chief Financial Officerand Vice President and Corporate Controller concluded that the Company’sdisclosure controls and procedures are functioning effectively to providereasonable assurance that information required to be disclosed by the Companyin reports filed under the Securities Exchange Act of 1934 is recorded,processed, summarized and reported within the time periods specified in theSecurity and Exchange Commission’s rules and forms and also to ensureinformation required to be disclosed is accumulated and communicated tomanagement including the Chief Executive Officer, President and Chief OperatingOfficer, Executive Vice President and Chief Financial Officer and VicePresident and Corporate Controller as appropriate to allow timely decisionsregarding required disclosure.

 

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.

 

**PART II. OTHERINFORMATION**

 

**ITEM1A.****                   ****RISKFACTORS**

 

Therehas been no material changes in our risk factors during the six months ended December 31,2008.  For additional informationregarding risk factors, see our Annual Report on Form 10-K for the yearended June 30, 2008.

 

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**ITEM 4.****                            ****SUBMISSION OF MATTERS TOA VOTE OF SECURITY HOLDERS**

 

On December 4, 2008,the Company held its Annual Meeting of Stockholders pursuant to a notice dated October 28,2008.  Definitive proxy materials were filed with the Securities andExchange Commission prior to the meeting.  A total of 17,692,179 shareswere voted at the meeting, constituting 93.9% of the 18,839,141 shares entitledto vote.

 

**Proposal 1.**

 

At the 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 to the Company’s Board ofDirectors were all elected.

 
| ** **          | ** ** | ** **           | ** ** | **Shares for Which**  | ** ** |
|---------------------|------------|----------------------|------------|-----------------------|------------|
| ** **          | ** ** | **Shares Voted For** | ** ** | **Vote was Withheld** | ** ** |
|                |       |                 |       |                  |       |
| Benjamin D. Goldman |       | 17,622,822           |       | 69,357                |       |
|                |       |                 |       |                  |       |
| Jerome S. Goodman   |       | 17,622,612           |       | 69,567                |       |
|                |       |                 |       |                  |       |
| Robert N. Goodman   |       | 17,619,182           |       | 72,997                |       |
|                |       |                 |       |                  |       |
| Andrew N. Heine     |       | 17,621,773           |       | 70,406                |       |
|                |       |                 |       |                  |       |
| David Kaplan        |       | 17,614,882           |       | 77,297                |       |
|                |       |                 |       |                  |       |
| Lewis Katz          |       | 17,622,067           |       | 70,112                |       |
|                |       |                 |       |                  |       |
| Jeffrey P. Orleans  |       | 17,622,668           |       | 69,511                |       |
|                |       |                 |       |                  |       |
| Robert M. Segal     |       | 17,618,303           |       | 73,876                |       |
|                |       |                 |       |                  |       |
| John W. Temple      |       | 17,615,287           |       | 76,892                |       |
|                |       |                 |       |                  |       |
| Michael T. Vesey    |       | 17,619,587           |       | 72,592                |       |

 

**Proposal 2.**

 

At the Annual Meeting,the stockholders approved increasing the number of shares authorized in theOrleans Homebuilders, Inc. Amended and Restated Stock Award Plan from400,000 shares to 1,000,000 shares.  Thevote was as follows:

 
| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker non-votes** | ** ** |
|------------|------------|-------------|------------|-------------|------------|----------------------|------------|
|       |       |        |       |        |       |                 |       |
| 15,196,203 |       | 186,177     |       | 3,803       |       | 2,305,996            |       |

 

A plurality of the votes cast was required to electthe directors in proposal 1.  Theaffirmative vote of the majority of the votes cast was required to passproposal 2.  Fewer shares were voted onProposal 2 than on Proposal 1.  “Brokernon-votes” accounted for this difference in voted shares, and are notconsidered “votes cast” for purposes of Section 216 of the DelawareGeneral Corporation Law.  For certaintypes of “non-routine” proposals, such as Proposal 2, brokers do not have thediscretionary authority to vote their clients’ shares, and therefore they mustrefrain from voting on such proposals in the absence of instructions from theirclients.

 

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

 
| ** **                | ** ** | ** **                                                                                                                                                                                                                                                                                                                                               | ** ** | **Incorporated by Reference** | ** ** | ** ** |
|---------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|------------|
| **Exhibit********Number** | ** ** | **Exhibit Description**                                                                                                                                                                                                                                                                                                                             | ** ** | **Form**                      | ** ** | **Date**   | ** ** | **Exhibit********Number** | ** ** | **Filed********Herewith** |
| 10.1                      |       | Orleans  Homebuilders, Inc. Amended and Restated Stock Award Plan                                                                                                                                                                                                                                                                                   |       | 8-K                           |       | 12/4/08    |   | 10.1 |   |   |
| 10.2                      |       | Amendment to  Orleans Homebuilders, Inc. Supplemental Executive Retirement Plan                                                                                                                                                                                                                                                                     |       | 8-K                           |       | 12/4/08    |   | 10.2 |   |   |
| 10.3                      |       | Amendment to  Orleans Homebuilders, Inc. Executive Compensation Deferral Plan                                                                                                                                                                                                                                                                       |       | 8-K                           |       | 12/4/08    |   | 10.3 |   |   |
| 10.4                      |       | Letter Agreement  between Garry P. Herdler and Orleans Homebuilders, Inc., dated  December 4, 2008                                                                                                                                                                                                                                             |       | 8-K                           |       | 12/4/08    |   | 10.4 |   |   |
| 10.5                      |       | First Amendment  to Employment Agreement between Orleans Homebuilders, Inc. and Garry P.  Herdler, dated December 4, 2008                                                                                                                                                                                                                      |       | 8-K                           |       | 12/4/08    |   | 10.5 |   |   |
| 10.6                      |       | Second Amendment  to Employment Contract between Jeffrey P. Orleans and Orleans  Homebuilders, Inc., dated December 4, 2008                                                                                                                                                                                                                    |       | 8-K                           |       | 12/4/08    |   | 10.6 |   |   |
| 10.7                      |       | Form of  Non-Qualified Stock Option for Employees                                                                                                                                                                                                                                                                                                   |       | 8-K                           |       | 12/4/08    |   | 10.7 |   |   |
| 10.8                      |       | Orleans Homebuilders, Inc. Cash Bonus Plan for Garry P. Herdler                                                                                                                                                                                                                                                                                     |       |                          |       |       |   |   |   | X |
| 10.9                      |       | First Amendment  to Second Amended and Restated Revolving Credit Loan Agreement and First  Amendment to Security Agreement dated as of February 11, 2009, by  and among Greenwood Financial, Inc. and certain affiliates, Orleans  Homebuilders, Inc., Wachovia Bank, National Association and various  other lenders party thereto. |       | 8-K                           |       | 2/7/09     |   | 10.1 |   |   |
| 31.1                      |       | Certification of Jeffrey P. Orleans pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                     |       |                          |       |       |   |   |   | X |
| 31.2                      |       | Certification of Michael T. Vesey pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                  |       |                          |       |       |   |   |   | X |
| 31.3                      |       | Certification of Garry P. Herdler pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                       |       |                          |       |       |   |   |   | X |
| 32.1                      |       | Certification of Jeffrey P. Orleans pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                     |       |                          |       |       |   |   |   | X |
| 32.2                      |       | Certification of Michael T. Vesey pursuant to Section 906  of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                  |       |                          |       |       |   |   |   | X |
| 32.3                      |       | Certification of Garry P. Herdler pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                       |       |                          |       |       |   |   |   | X |

 

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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 17, 2009 | Jeffrey P. Orleans                    |   |
|                   | Jeffrey P. Orleans                    |   |
|                   | Chairman of the Board and Chief       |   |
|                   | Executive Officer                     |   |
|                   | (Principal Executive Officer)         |   |
|                   |                                  |   |
| February 17, 2009 | Michael T. Vesey                      |   |
|                   | Michael T. Vesey                      |   |
|                   | President and Chief Operating Officer |   |
|                   |                                  |   |
| February 17, 2009 | Garry P. Herdler                      |   |
|                   | Garry P. Herdler                      |   |
|                   | Executive Vice President and          |   |
|                   | Chief Financial Officer               |   |
|                   | (Principal Financial Officer)         |   |
|                   |                                  |   |
| February 17, 2009 | Mark D. Weaver                        |   |
|                   | Mark D. Weaver                        |   |
|                   | Vice President and                    |   |
|                   | Corporate Controller                  |   |
|                   | (Principal Accounting Officer)        |   |

 

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**EXHIBIT INDEX**

 
| 10.8 |   | Orleans Homebuilders, Inc. Cash Bonus Plan for Garry P. Herdler                                    |
|------|--------|---------------------------------------------------------------------------------------------------------|
| 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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