**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**FORM 10-Q**

**(MarkOne)**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934.

 

# **For the quarterly period ended December 31, 2006**

# **OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXHANGE ACT OF 1934.

** **

**FOR THE TRANSITION PERIOD                   TO                   .**

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

**ORLEANS HOMEBUILDERS, INC.**

(Exact name of registrant as specified in its charter)
| **Delaware**                    | ** ** | **59-0874323**              |
|---------------------------------|------------|-----------------------------|
| (State or other jurisdiction of |       | (I.R.S. Employer  I.D. No.) |
| incorporation or organization)  |       |                        |

 

**OneGreenwood Square, Suite 101**

**3333Street Road**

**Bensalem,PA 19020**

(Addressof 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 to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes x    No o

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

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act). Yes o     No x

Numberof shares of common stock, par value $0.10 per share, outstanding as of

# February8, 2007:  **18,481,641**

**(excluding 216,490 shares held in Treasury).**

 

 

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

| **PART 1 — FINANCIAL INFORMATION** |   |                                                                                                      |   |
|-----------------------------------------|--------|-----------------------------------------------------------------------------------------------------------|--------|
|                                    |   |                                                                                                      |   |   |   |
| Item 1.                                 |   | Financial Statements (unaudited)                                                                          |   |   |   |
|                                    |   |                                                                                                      |   |   |   |
|                                    |   | Consolidated  Balance Sheets at December 31, 2006 and June 30, 2006                                       |   | 1 |   |
|                                    |   |                                                                                                      |   |   |   |
|                                    |   | Consolidated Statements of Operations for the Three  and Six Months Ended December 31, 2006 and 2005 |   | 2 |   |
|                                    |   |                                                                                                      |   |   |   |
|                                    |   | Consolidated Statements of Shareholders’ Equity for  the Six Months Ended December 31, 2006          |   | 3 |   |
|                                    |   |                                                                                                      |   |   |   |
|                                    |   | Consolidated Statements of Cash Flows for the Six  Months Ended December 31, 2006 and 2005                |   | 4 |   |
|                                    |   |                                                                                                      |   |   |   |
|                                    |   | Notes to Consolidated Financial Statements                                                                |   | 5 |   |
|                                    |   |                                                                                                      |   |   |   |
| Item 2.                                 |   | Management’s Discussion and Analysis of Financial  Condition and Results of Operations               |   | 28 |   |
|                                    |   |                                                                                                      |   |   |   |
| Item 3.                                 |   | Quantitative and Qualitative Disclosures About Market  Risk                                               |   | 63 |   |
|                                    |   |                                                                                                      |   |   |   |
| Item  4.                                |   | Controls  and Procedures                                                                                  |   | 63 |   |
|                                    |   |                                                                                                      |   |   |   |
|                                    |   |                                                                                                      |   |   |   |
|                                    |   |                                                                                                      |   |   |   |
| **PART  II — OTHER INFORMATION**   |   |                                                                                                      |   |
|                                    |   |                                                                                                      |   |   |   |
| Item  1.                                |   | Legal Proceedings                                                                                         |   | 65 |   |
|                                    |   |                                                                                                      |   |   |   |
| Item  1A.                               |   | Risk Factors                                                                                              |   | 65 |   |
|                                    |   |                                                                                                      |   |   |   |
| Item 4.                                 |   | Submission of Matters to a Vote of Secured Holders                                                        |   | 67 |   |
|                                    |   |                                                                                                      |   |   |   |
| Item 6.                                 |   | Exhibits                                                                                                  |   | 69 |   |
|                                         |        |                                                                                                           |        |  |  |  |  |  |  |  |  |

 

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**OrleansHomebuilders, Inc. and Subsidiaries**

**Consolidated Balance Sheets**

**(inthousands, except share amounts)**
| ** **                                                                                                              | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                              | ** ** | **2006**              | ** ** | **2006**          | ** ** |
| ** **                                                                                                              | ** ** | **(Unaudited)**       | ** ** | **(Audited)**     | ** ** |
| Assets                                                                                                                  |       |                  |       |              |       |
| Cash and cash  equivalents                                                                                              |       | $                     | 24,973     |              | $          | 15,964 |   |
| Restricted cash - due  from title company                                                                               |       | 9,106                 |       | 25,304            |       |
| Restricted cash -  customer deposits                                                                                    |       | 8,341                 |       | 9,293             |       |
| Real estate held for  development and sale:                                                                             |       |                  |       |              |       |
| Residential  properties completed or under construction                                                                 |       | 249,642               |       | 272,068           |       |
| Land held for  development or sale and improvements                                                                     |       | 607,600               |       | 544,574           |       |
| Inventory not  owned - Variable Interest Entities                                                                       |       | 91,790                |       | 117,073           |       |
| Property and equipment,  at cost, less accumulated depreciation                                                         |       | 2,860                 |       | 3,344             |       |
| Intangible assets                                                                                                       |       | 4,329                 |       | 4,329             |       |
| Goodwill                                                                                                                |       | 20,514                |       | 20,514            |       |
| Receivables, deferred  charges and other assets                                                                         |       | 21,243                |       | 21,178            |       |
| Land deposits and costs  of future development                                                                          |       | 15,786                |       | 26,862            |       |
| Total Assets                                                                                                            |       | $                     | 1,056,184  |              | $          | 1,060,503 |   |
|                                                                                                                    |       |                  |       |              |       |
|                                                                                                                    |       |                  |       |              |       |
| Liabilities and  Shareholders’ Equity                                                                              |       |                  |       |              |       |
| Liabilities:                                                                                                            |       |                  |       |              |       |
| Accounts payable                                                                                                        |       | $                     | 24,506     |              | $          | 40,796 |   |
| Accrued expenses                                                                                                        |       | 31,605                |       | 73,490            |       |
| Deferred taxes                                                                                                          |       | 697                   |       | 697               |       |
| Customer  deposits                                                                                                      |       | 13,725                |       | 16,209            |       |
| Obligations  related to inventory not owned - Variable Interest Entities                                                |       | 79,016                |       | 103,636           |       |
| Mortgage and  other note obligations                                                                                    |       | 512,117               |       | 422,608           |       |
| Subordinated  notes                                                                                                     |       | 105,000               |       | 105,000           |       |
| Other notes  payable                                                                                                    |       | 851                   |       | 5,885             |       |
| Total  Liabilities                                                                                                      |       | 767,517               |       | 768,321           |       |
|                                                                                                                    |       |                  |       |              |       |
| Commitments and  contingencies (See Note M)                                                                             |       |                  |       |              |       |
|                                                                                                                    |       |                  |       |              |       |
| Redeemable common stock                                                                                                 |       | —                |       | 240               |       |
|                                                                                                                    |       |                  |       |              |       |
| Shareholders’ Equity:                                                                                              |       |                  |       |              |       |
| Common stock, $.10 par,  23,000,000 shares authorized, 18,698,131 shares issued at December 31, 2006 and  June 30, 2006 |       | 1,870                 |       | 1,870             |       |
| Capital in excess of  par value - common stock                                                                          |       | 71,937                |       | 72,624            |       |
| Retained earnings                                                                                                       |       | 217,603               |       | 221,967           |       |
| Treasury stock, at cost  (216,490 and 337,324 shares held at December 31, 2006 and June 30, 2006,  respectively)        |       | (2,743                | )          | (4,519            | )          |
| Total Shareholders’  Equity                                                                                        |       | 288,667               |       | 291,942           |       |
|                                                                                                                    |       |                  |       |              |       |
| Total Liabilities and Shareholders’ Equity                                                                         |       | $                     | 1,056,184  |              | $          | 1,060,503 |   |

 

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

1

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**OrleansHomebuilders, Inc. and Subsidiaries**

**Consolidated Statements of Operations**

**(Unaudited)**

**(inthousands, except per share amounts)**
| ** **                                           | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                           | ** ** | **December 31,**            | ** ** | **December 31,**          | ** ** |
| ** **                                           | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Earned revenues                                      |       |                             |       |                           |       |   |   |   |   |
| Residential properties                               |       | $                                | 153,172    |                           | $          | 220,912 |   | $ | 314,944 |   | $ | 378,875 |   |
| Land sales                                           |       | 1,797                            |       | 1,353                          |       | 2,205 |   | 1,353 |   |
| Other income                                         |       | 2,160                            |       | 2,386                          |       | 5,082 |   | 4,064 |   |
|                                                 |       | 157,129                          |       | 224,651                        |       | 322,231 |   | 384,292 |   |
| Costs and  expenses                                  |       |                             |       |                           |       |   |   |   |   |
| Residential properties                               |       | 135,327                          |       | 169,302                        |       | 266,640 |   | 292,587 |   |
| Land sales                                           |       | 1,231                            |       | 1,150                          |       | 1,605 |   | 1,150 |   |
| Other                                                |       | 1,517                            |       | 1,615                          |       | 3,516 |   | 3,224 |   |
| Selling, general and administrative                  |       | 31,361                           |       | 27,228                         |       | 56,420 |   | 48,575 |   |
| Interest:                                            |       |                             |       |                           |       |   |   |   |   |
| Incurred                                             |       | 12,623                           |       | 8,902                          |       | 24,386 |   | 15,718 |   |
| Less capitalized                                     |       | (12,623                          | )          | (8,902                         | )          | (24,386 | ) | (15,718 | ) |
|                                                 |       | 169,436                          |       | 199,295                        |       | 328,181 |   | 345,536 |   |
|                                                 |       |                             |       |                           |       |   |   |   |   |
| Income / (loss)  from operations before income taxes |       | (12,307                          | )          | 25,356                         |       | (5,950 | ) | 38,756 |   |
| Income tax expense  / (benefit)                      |       | (4,783                           | )          | 9,940                          |       | (2,325 | ) | 15,562 |   |
|                                                 |       |                             |       |                           |       |   |   |   |   |
| Net income /  (loss)                                 |       | $                                | (7,524     | )                              | $          | 15,416 |   | $ | (3,625 | ) | $ | 23,194 |   |
|                                                 |       |                             |       |                           |       |   |   |   |   |
| Basic earnings /  (loss) per share                   |       | $                                | (0.41      | )                              | $          | 0.83 |   | $ | (0.20 | ) | $ | 1.25 |   |
|                                                 |       |                             |       |                           |       |   |   |   |   |
| Diluted earnings  / (loss) per share                 |       | $                                | (0.41      | )                              | $          | 0.82 |   | $ | (0.20 | ) | $ | 1.23 |   |
|                                                 |       |                             |       |                           |       |   |   |   |   |
| Dividends  declared per share                        |       | $                                | 0.02       |                           | $          | 0.02 |   | $ | 0.04 |   | $ | 0.04 |   |
|                                                 |       |                             |       |                           |       |   |   |   |   |
| Basic weighted  average shares outstanding           |       | 18,476                           |       | 18,549                         |       | 18,419 |   | 18,548 |   |
|                                                 |       |                             |       |                           |       |   |   |   |   |
| Diluted weighted  average shares outstanding         |       | 18,476                           |       | 18,888                         |       | 18,419 |   | 18,890 |   |

 

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

2

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**OrleansHomebuilders, Inc. and Subsidiaries**

**Consolidated Statements of Shareholders’ Equity**

**(Unaudited)**

**(dollarsin thousands)**
| ** **                                 | ** ** | ** **            | ** ** | ** **         | ** ** | **Capital in**       | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|--------------------|------------|---------------------------|------------|-------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                 | ** ** | **Common Stock** | ** ** | **Excess of** | ** ** | ** **                | ** ** | **Treasury Stock** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **Shares**            | ** ** | ** **         | ** ** | **Par Value -** | ** ** | **Retained**            | ** ** | **Shares** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **Issued**            | ** ** | **Amount**         | ** ** | **Common Stock**     | ** ** | **Earnings**            | ** ** | **Held**   | ** ** | **Amount** | ** ** | **Total**  | ** ** |
| Balance at June  30, 2006                  |       | 18,698,131            |       | $                  | 1,870      |                      | $          | 72,624                  |       | $          | 221,967    |       | 337,324    |       | $          | (4,519 | ) | $ | 291,942 |   |
|                                       |       |                  |       |               |       |                      |       |                    |       |       |       |       |       |       |       |
| Redeemable  common stock expired           |       |                  |       |               |       | 240                       |       |                    |       |       |       |       |       | 240        |       |
|                                       |       |                  |       |               |       |                      |       |                    |       |       |       |       |       |       |       |
| Shares awarded  under Stock Award Plan     |       |                  |       |               |       | 120                       |       |                    |       |       |       |       |       | 120        |       |
|                                       |       |                  |       |               |       |                      |       |                    |       |       |       |       |       |       |       |
| Fair market  value of stock options issued |       |                  |       |               |       | 730                       |       |                    |       |       |       |       |       | 730        |       |
|                                       |       |                  |       |               |       |                      |       |                    |       |       |       |       |       |       |       |
| Stock options,  net                        |       |                  |       |               |       | (2,725                    | )          |                    |       | (120,834   | )          | 1,776      |       | (949       | )          |
|                                       |       |                  |       |               |       |                      |       |                    |       |       |       |       |       |       |       |
| Tax benefit of  stock option exercises     |       |                  |       |               |       | 948                       |       |                    |       |       |       |       |       | 948        |       |
|                                       |       |                  |       |               |       |                      |       |                    |       |       |       |       |       |       |       |
| Dividends paid  on common stock            |       |                  |       |               |       |                      |       | (739                    | )          |       |       |       |       | (739       | )          |
|                                       |       |                  |       |               |       |                      |       |                    |       |       |       |       |       |       |       |
| Net loss                                   |       |                  |       |               |       |                      |       | (3,625                  | )          |       |       |       |       | (3,625     | )          |
|                                       |       |                  |       |               |       |                      |       |                    |       |       |       |       |       |       |       |
| Balance at December 31,  2006              |       | 18,698,131            |       | $                  | 1,870      |                      | $          | 71,937                  |       | $          | 217,603    |       | 216,490    |       | $          | (2,743 | ) | $ | 288,667 |   |

 

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

3

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**OrleansHomebuilders, Inc. and Subsidiaries**

**Consolidated Statements of Cash Flows**

**(Unaudited)**

**(inthousands)**
| ** **                                                                              | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                              | ** ** | **December 31,**          | ** ** |
| ** **                                                                              | ** ** | **2006**                       | ** ** | **2005** | ** ** |
|                                                                                    |       |                           |       |   |   |
| Cash flows from  operating activities:                                                  |       |                           |       |   |   |
| Net income / (loss)                                                                     |       | $                              | (3,625     | ) | $ | 23,194 |   |
| Adjustments to  reconcile net income / (loss) to net cash used in operating activities: |       |                           |       |   |   |
| Depreciation and amortization                                                           |       | 659                            |       | 729 |   |
| Write-off of real estate held for development and  sale                                 |       | 9,850                          |       | — |   |
| Write-off of land deposits and costs of future  development                             |       | 9,584                          |       | 927 |   |
| Amortization of note discount                                                           |       | 6                              |       | 34 |   |
| Deferred taxes                                                                          |       | —                         |       | (304 | ) |
| Stock based compensation expense                                                        |       | 906                            |       | 267 |   |
| Changes in  operating assets and liabilities:                                           |       |                           |       |   |   |
| Restricted cash - due from title company                                                |       | 16,198                         |       | 19,778 |   |
| Restricted cash - customer deposits                                                     |       | 952                            |       | (2,179 | ) |
| Real estate held for development and sale                                               |       | (50,050                        | )          | (158,170 | ) |
| Receivables, deferred charges and other assets                                          |       | (65                            | )          | (2,809 | ) |
| Land deposits and costs of future developments                                          |       | 2,955                          |       | (6,392 | ) |
| Accounts payable and other liabilities                                                  |       | (59,431                        | )          | (30,491 | ) |
| Customer deposits                                                                       |       | (2,484                         | )          | 3,907 |   |
| Net cash used in  operating activities                                                  |       | (74,545                        | )          | (151,509 | ) |
|                                                                                    |       |                           |       |   |   |
| Cash flows from  investing activities:                                                  |       |                           |       |   |   |
| Purchases of property and equipment                                                     |       | (175                           | )          | (678 | ) |
| Net cash used in  investing activities                                                  |       | (175                           | )          | (678 | ) |
|                                                                                    |       |                           |       |   |   |
| Cash flows from  financing activities:                                                  |       |                           |       |   |   |
| Borrowings from loans secured by real estate assets                                     |       | 108,000                        |       | 124,000 |   |
| Repayment of loans secured by real estate assets                                        |       | (18,491                        | )          | (91,378 | ) |
| Borrowings from subordinated notes                                                      |       | —                         |       | 105,000 |   |
| Repayment of other note obligations                                                     |       | (5,040                         | )          | (3,540 | ) |
| Purchase of treasury stock                                                              |       | (949                           | )          | (1,744 | ) |
| Proceeds from Stock Award Plan                                                          |       | —                         |       | 284 |   |
| Tax benefit from exercise of stock options                                              |       | 948                            |       | — |   |
| Proceeds from stock options exercised                                                   |       | —                         |       | 59 |   |
| Common stock dividend paid                                                              |       | (739                           | )          | (371 | ) |
| Net cash  provided by financing activities                                              |       | 83,729                         |       | 132,310 |   |
|                                                                                    |       |                           |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                   |       | 9,009                          |       | (19,877 | ) |
| Cash and cash  equivalents at beginning of year                                         |       | 15,964                         |       | 62,576 |   |
| Cash and cash  equivalents at end of period                                             |       | $                              | 24,973     |   | $ | 42,699 |   |
|                                                                                    |       |                           |       |   |   |
| Supplemental  disclosure of cash flow activities:                                       |       |                           |       |   |   |
| Interest paid, net of amounts capitalized                                               |       | $                              | —     |   | $ | — |   |
| Income taxes  paid                                                                      |       | $                              | 1,178      |   | $ | 25,112 |   |

 

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

4

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**ORLEANS HOMEBUILDERS, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

(A)              Summary of SignificantAccounting Policies:

The accompanying unauditedconsolidated financial statements are presented in accordance with therequirements for Form 10-Q and do not include all the disclosures required bygenerally accepted accounting principles for complete financialstatements.  Reference is made to Form10-K as of and for the year ended June 30, 2006 for Orleans Homebuilders, Inc.and subsidiaries (the “Company”) for additional disclosures, including asummary of the Company’s accounting policies.

In the opinion ofmanagement, the consolidated financial statements contain all adjustments,consisting of normal recurring accruals, necessary to present fairly theconsolidated financial position of the Company for the periods presented.  The interim operating results of the Companymay not be indicative of operating results for the full year.

***Accounting for financial******statement******misstatements:***

InSeptember 2006, the SEC staff issued Staff Accounting Bulletin No. 108, “Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements” (“SAB 108”). SAB 108 was issued in order toeliminate the diversity of practice surrounding how public companies quantifyfinancial statement misstatements.

Traditionally,there have been two widely-recognized methods for quantifying the effects offinancial statement misstatements: the “roll-over” method and the “iron curtain”method. The roll-over method focuses primarily on the impact of a misstatementon the income statement—including the reversing effect of prior yearmisstatements—but its use can lead to the accumulation of misstatements in thebalance sheet. The iron-curtain method, on the other hand, focuses primarily onthe effect of correcting the period-end balance sheet with less emphasis on thereversing effects of prior year errors on the income statement. The Companycurrently uses the roll-over method for quantifying identified financialstatement misstatements.

5

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InSAB 108, the SEC staff established an approach that requires quantification offinancial statement misstatements based on the effects of the misstatements oneach of the company’s financial statements and the related financial statementdisclosures. This model is commonly referred to as a “dual approach” because itrequires quantification of errors under both the iron curtain and the roll-overmethods.

SAB108 permits existing public companies to initially apply its provisions eitherby (i) restating prior financial statements as if the “dual approach” hadalways been used or (ii) recording the cumulative effect of initially applyingthe “dual approach” as adjustments to the carrying values of assets andliabilities as of January 1, 2006 with an offsetting adjustment recorded to theopening balance of retained earnings. Use of the “cumulative effect” transitionmethod requires detailed disclosure of the nature and amount of each individualerror being corrected through the cumulative adjustment and how and when itarose.

TheCompany will initially apply the provisions of SAB 108 using the cumulativeeffect transition method in connection with the preparation of its annualfinancial statements for the fiscal year ending June 30, 2007.  The Company anticipates that the applicationof SAB 108 will not have a material impact on the Company’s financialstatements.

***Accounting for defined benefit pensions and other postretirementbenefits:***

In September 2006, the FinancialAccounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards No. 158, “Employers’ Accounting for Defined Benefit Pension and OtherPostretirement Plans” (“SFAS 158”).  SFAS 158 requires companies to recognize the overfunded or underfundedstatus of a single-employer defined benefit postretirement plan as an asset orliability in its statement of financial position and to recognize the changesin that funded status in comprehensive income in the year in which the changesoccur.  In addition, SFAS 158 requirescompanies to measure the funded status of a plan as of the date of its year-endstatement of financial position, with limited exceptions.  The effective date for the adoption of SFAS158 for publicly traded companies is as of the end of the fiscal years endingafter December 15, 2006.  The Companywill adopt SFAS 158 as

6

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of June 30, 2007 and itsimpact is to eliminate the Company’s intangible asset that was recognized inconnection with the application of SFAS No. 87, “Employers’ Accounting for  Pensions” (“SFAS No. 87”), reduce the Company’sother comprehensive income, and increase the Company’s accrued expenses.  The Company’s intangible asset related toSFAS No. 87 at December 31, 2006 is approximately $4,329,000.

***Accounting for variable interest entities:***

In January 2003, the FASBissued FASB Interpretation No. 46 “Consolidation of Variable Interest Entities,an interpretation of ARB No. 51” (“FIN 46”). The FASB issued a revised FIN 46 (“FIN 46-R”) in December 2003 whichmodifies and clarifies various aspects of the original interpretations.  A Variable Interest Entity (“VIE”) is createdwhen (i) the equity investment at risk is not sufficient to permit the entityto finance its activities without additional subordinated financial supportfrom other parties or (ii) equity holders either (a) lack direct or indirectability to make decisions about the entity, (b) are not obligated to absorbexpected losses of the entity or (c) do not have the right to receive expected residualreturns of the entity if they occur.  Ifan entity is deemed to be a VIE, pursuant to FIN 46-R, an enterprise thatabsorbs a majority of the expected losses of the VIE is considered the primarybeneficiary and must consolidate the VIE.

Based on the provisions ofFIN 46-R, the Company has concluded that whenever it enters into an optionagreement to acquire land or lots from an entity and pays a significant depositthat is not unconditionally refundable, a VIE is created under condition (ii)(b) of the previous paragraph.  TheCompany has been deemed to have provided subordinated financial support, whichrefers to variable interests that will absorb some or all of an entity’sexpected theoretical losses if they occur. For each VIE created, the Company will compute expected losses andresidual returns based on the probability of future cash flows as outlined inFIN 46-R.  If the Company is deemed to bethe primary beneficiary of the VIE it will consolidate the VIE on its balancesheet.  The fair value of the VIEsinventory will be reported as “Inventory not owned — Variable InterestEntities.”

At December 31, 2006, the Companyconsolidated seventeen VIEs as a result of its options to purchase land or lotsfrom the selling entities.  The Companypaid cash or

7

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issued letters of credit deposits to theseseventeen VIEs totaling $9,303,000 and incurred additional pre-acquisitioncosts totaling $3,471,000.  The Company’sdeposits and any costs incurred prior to acquisition of the land or lotsrepresent the Company’s maximum exposure to loss. The fair value of the VIEsinventory is reported as “Inventory not owned — Variable Interest Entities.”The Company recorded $91,790,000 in Inventory Not Owned — Variable InterestEntities as of December 31, 2006.  Thefair value of the property to be acquired less cash deposits andpre-acquisition costs, which totaled $79,016,000 at December 31, 2006, wasreported on the balance sheet as “Obligations related to inventory not owned —Variable Interest Entities.” Creditors, if any, of these VIEs have no recourseagainst the Company.

The Company willcontinue to secure land and lots using options. Including the deposits and other costs capitalized in connection withthe VIEs discussed in the prior paragraph, the Company had total costs incurredto acquire land and lots at December 31, 2006 of approximately $28,059,000,including $17,091,000 of cash deposits. The total purchase price under thesecancelable contracts or options is approximately $258,431,000. The maximumexposure to loss is limited to the deposits, although some deposits arerefundable, and costs incurred prior to the acquisition of the land or lots.

***Accounting for share based payments***:

InDecember 2004, the FASB revised SFAS No. 123 through the issuance of SFAS No.123-R “Share Based Payment”, revised (“SFAS 123-R”).  SFAS 123-R waseffective for the Company commencing July 1, 2005.  SFAS 123-R, amongother things, eliminates the alternative to use the intrinsic value method ofaccounting for stock based compensation and requires entities to recognize thecost of employee services received in exchange for awards of equity instrumentsbased on the grant-date fair value of those awards.  The fair value basedmethod in SFAS 123-R is similar to the fair-value-based method in SFAS No. 123in most respects, subject to certain key differences.  As the Companypreviously adopted the fair value recognition provisions of SFAS No. 123prospectively for all stock awards granted, commencing on July 1, 2002, theimpact of the modified prospective adoption of SFAS 123-R did not have asignificant impact on the financial position or results of operations of theCompany.  The Company amortizescompensation expense on a straight line basis over the vesting period of eachoption grant.  The Company utilizes

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theBlack-Scholes option pricing model to calculate the compensation expenseassociated with stock options.  For thesix months ended December 31, 2006, the Company recorded pretax compensationexpense associated with stock awards of $906,000.  Total compensation cost related to nonvestedawards not yet recognized of $5,353,000 will be recognized according to vestingschedules through March 2015.  For thesix months ended December 31, 2006, the Company recognized a $948,000 taxbenefit resulting from the exercise of 230,000 non-qualified stock options byMichael T. Vesey, President and Chief Operating Officer and Joseph A.Santangelo, former Chief Financial Officer.

***Accounting for income taxes:***

InJune 2006, the FASB issued FASB Interpretation No. 48, “Accounting forUncertainty in Income Taxes — An interpretation of FASB Statement 109” (“FIN 48”).  FIN 48 prescribes a more-likely than notrecognition threshold as well as a measurement attribute for the financialstatement recognition and measurement of tax positions taken or expected to betaken in a tax return.  FIN 48 iseffective for fiscal years beginning after December 15, 2006.  The Company is currently evaluating theimpact of the adoption of FIN 48.

InDecember 2004, the FASB issued FASB Staff Position No. FAS 109-1, “Applicationof FASB Statement No. 109, Accounting for Income Taxes, for the Tax Deductionon Qualified Production Activities Provided by the American Jobs Creation Actof 2004” (“FSP FAS 109-1”). FSP FAS 109-1 clarifies that the deduction will betreated as a “special deduction” as described in Statement of FinancialAccounting Standards No. 109, “Accounting for Income Taxes.” As such, thespecial deduction has no effect on deferred tax assets and liabilities existingat the date of enactment. The impact of the deduction will be reported in theperiod in which the deduction is claimed.   The Company files aconsolidated return on a calendar year.  Accordingly, the Company beganreflecting the special deduction with respect to its operations effectiveJanuary 1, 2005.  Its impact was to lower the effective tax provision inthe periods in which the deduction was claimed. This benefit will increase as the deduction is phased in under thestatute.

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(B)                                Acquisitions:

***Peachtree Acquisition:***

On December 23, 2004, pursuant to an Asset PurchaseAgreement of the same date, the Company acquired, through a wholly-ownedsubsidiary, the real estate assets described below (the “Assets”) fromPeachtree Residential Properties, LLC, a North Carolina limited liabilitycompany, and Peachtree Townhome Communities, LLC, a North Carolina limitedliability company, which, at the time the Company acquired the assets, werewholly owned subsidiaries of Peachtree Residential Properties, Inc., a Georgiacorporation (collectively, “Peachtree Residential Properties”).

The Assets included: (a) improved and unimproved real property, (b) rights to acquire realestate under options or agreements, (c) equipment, (d) rights under certaincontracts for the sale of homes to be sold and leases for real property, (e)rights to certain tradenames and other intangibles, including contract backlog,(f) homes and other improvements under construction as of the closing, (g)certain plans, drawings, specifications, permits and rights under warrantiesand (h) governmental approvals and books and records associated with, orrelating to the foregoing.

The Company paid $29,300,000 in cash, to acquire theAssets.  The Company also assumed certainliabilities of Peachtree Residential Properties, less $200,000 to be retainedby the Company and applied towards the administration of certain home warrantyclaims.

***Realen Acquisition:***

On July 28, 2004, pursuantto a Purchase Agreement of the same date, the Company completed its acquisitionof all of the issued and outstanding partnership interests in Realen HomesL.P., a Pennsylvania limited partnership (“Realen Homes”), from Realen GeneralPartner, LLC, a Pennsylvania limited liability company, and DB Homes VentureL.P., a Pennsylvania limited partnership. The Company acquired the limitedpartner’s interest in Realen Homes and a subsidiary of the Company, RHGP LLC,acquired the general partner’s interest and serves as the general partner ofRealen Homes.

In accordance with the PurchaseAgreement, the consideration paid by the Company consisted of: (i) $53,348,000in cash delivered at closing, (ii) a promissory note of the

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Company in the aggregateprincipal amount of $5 million, payable over a period of up to two years, withan interest rate of 3% per year and (iii) a warranty holdback of $1.5 millionretained by the Company to be applied toward the administration of any warrantyclaims made against Realen Homes in excess of certain predetermined amounts.  The purchase price was determined based onRealen Homes’ book value at June 30, 2004, its management personnel, itsprofitability, its backlog and its land position.

The Company evaluated the$5,000,000 3% note in accordance with Accounting Principles Board Opinion No.21, “Interest on Receivables and Payables” (“APB 21”) and determined that itwas a below market rate note.  Inaccordance with APB 21, the Company estimated, based on current marketconditions that the Company would likely have been able to obtain similarfixed-rate financing from a third party at approximately 150 basis pointshigher than the note actually obtained. The Company imputed interest on the note at 4.5% and reduced thecarrying value of the note from $5,000,000 to $4,863,000.  The discount of $137,000 was recorded asinterest expense over the life of the note. The Company recorded the remaining $6,000 of the discount to interestexpense during the current fiscal year. The $5,000,000 note was repaid in full during the second quarter offiscal year 2007.

The acquisition included,subject to specified exceptions, all assets and liabilities of Realen Homes,including land owned or under contract, homes under construction but not soldor sold but not delivered, sales offers and reservations, and model homes and furnishings.The acquired assets were used by Realen Homes in the homebuilding business inPennsylvania and Illinois. The Company intends to continue to use the acquiredassets in the homebuilding business.

The Company accounted forthe acquisition as a purchase in accordance with SFAS No. 141, “BusinessCombinations.”  The purchase price wasallocated to goodwill for $13,327,000, which is defined as the fair value ofassets and liabilities acquired in excess of the purchase price, and tointangible assets for $500,000.  Theintangible assets represent the intangible value of the backlog acquired fromRealen Homes.  The intangible value ofthe backlog was amortized into cost of sales as the acquired backlog wasdelivered.  The Company amortized theremaining $6,000 of the

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intangible value of thebacklog acquired from Realen Homes during the three months ended September 30,2005.

***Masterpiece Acquisition:***

On July 28, 2003, theCompany acquired all of the issued and outstanding shares of Masterpiece Homesand entered into an employment agreement with the president of MasterpieceHomes.  Masterpiece Homes is anestablished homebuilder located in Orange City, Florida.  The terms of the stock purchase agreement andemployment agreement are as follows:  (i)$3,900,000 in cash, at closing; and (ii) $2,130,000 payable January 1, 2005(the “Contingent Stock Payment”), unless prior to that date the president isterminated for cause or terminates his employment without good reason, asdefined in the employment agreement; (iii) sale of 30,000 shares of the Company’scommon stock at $8 per share with a put option at the same price, (iv) stockoptions to purchase 45,000 shares of the Company’s common stock at $10.64 pershare vesting equally on December 31, 2004, 2005 and 2006; and (v) contingentpayments representing 25% of the pre-tax profits of Masterpiece Homes for thecalendar years ended December 31, 2004, 2005 and 2006.  The Company also incurred approximately$405,000 in acquisition costs to complete this transaction.  The aforementioned costs are considered partof the purchase price of Masterpiece Homes, except for the following items thatare considered part of, and contingent upon, the employment agreement:  (a) $710,000 of the $2,130,000 paid January 10, 2005; (b) stock options topurchase 45,000 shares of the Company’s common stock at $10.64 per share; and(c) contingent payments representing 25% of the pre-tax profits of MasterpieceHomes for the calendar years ended December 31, 2004, 2005 and 2006.

The Company accounted forthese transactions in accordance with SFAS No. 141, “Business Combinations”,whereby approximately $5,700,000 was considered to be part of the purchaseprice of the business and the remainder part of employee compensation.  That portion related to employee compensationwill be charged to expense over the period to which it relates.  With respect to the amounts allocated to thepurchase, such amounts were allocated to the fair value of assets and liabilitiesacquired with the excess of approximately $3,007,000 allocated to goodwill.

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From July 28, 2003 throughDecember 31, 2006, the Company recorded $338,000 in pretax compensation expenseassociated with the stock options granted pursuant to the employment agreementwith the president of Masterpiece Homes, recognized $3,140,000 in contingentpayments representing 25% of the pre-tax profits of Masterpiece Homes, and paidthe Contingent Stock Payment of $2,130,000 on January 1, 2005 as required underthe terms of the acquisition agreement. See Note (L) below for additionaldiscussion relating to the Company’s employment agreement with the president ofMasterpiece Homes.

(C)                                Certain transactions with related parties:

In November 2006, theCompany entered into an agreement of sale to purchase 23 townhouse lots fromMr. Russell Parker, the president of the Company’s subsidiary, Parker &Lancaster Corporation.  The purchaseprice is calculated at 20% of the net sales price, less lot improvement costs,and is payable on a per lot basis at the time of conveyance of a completed homeon the improved lot to a third party purchaser. The total purchase price of the townhouse lots is approximately $874,000and is considered to approximate fair value of the land.

(D)                               Asset impairments - real estate held fordevelopment and sale:

As a result of increased sales incentives offeredduring fiscal year 2007 and a decrease in anticipated absorption rates atvarious communities, the Company recognized long-lived asset impairment lossestotaling $9,850,000 during the six months ended December 31, 2006.  The Company’s northern region recognized a$3,900,000 impairment loss relating to two communities, while the Company’sFlorida region recognized a $4,800,000 impairment loss relating its scatteredlot inventory.  In addition, the Company’ssouthern region recognized a $900,000 impairment loss, $700,000 of whichrelates to a land parcel it has under an agreement of sale and is expected tosettle in the third quarter of fiscal year 2007.  Further, the Company’s Midwest region recognizeda $250,000 impairment loss relating to one community due to sales incentivesbeing offered to close out the community. The long-lived asset impairment losses were the amounts by which thebook value of the assets described above exceeded their fair values.  The fair value of the assets was determinedbased on the current estimated sales price, less the estimated costs ofconstruction and selling costs to dispose of the assets.  The long-lived asset impairment losses wereincluded in the cost of residential properties on the Consolidated Statementsof Operations.  The

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Company did not have any long-lived assetimpairment losses during the six month period ended December 31, 2005.

(E)                                 Mortgage and other note obligations andsubordinated notes:

The $617,117,000outstanding balance at December 31, 2006 consists of $511,950,000 outstandingunder the Revolving Credit Facility, which is discussed below, $105,000,000outstanding pursuant to the sale and issuance of trust preferred securitiesdiscussed below, and $167,000 under mortgage obligations secured by land heldfor development and sale and improvements. The average month-end balance during the six months ended December 31,2006 was $586,780,000.

***Revolving Credit Facility:***

At December 31, 2006,the Company had approximately $511,950,000 outstanding under the RevolvingCredit Facility.  In addition,approximately $40,724,000 of letters of credit and other assurances of theavailability of funds have been provided under the Revolving Credit Facility.

On January 24, 2006, Greenwood Financial,Inc., a wholly-owned subsidiary of the Company and other wholly-ownedsubsidiaries of the Company, as borrowers, and Orleans Homebuilders, Inc. asguarantor, entered into an Amended and Restated Revolving Credit and LoanAgreement (as amended, the “Amended and Restated Credit Agreement”) for a$650,000,000 Senior Secured Revolving Credit and Letter of Credit Facility (the“Revolving Credit Facility”) with various banks as lenders.  The Amended and Restated Credit Agreement wasamended on November 1, 2006.

Under and subject to the terms of the Amended and Restated CreditAgreement, the borrowers may borrow and re-borrow for the purpose of financingthe acquisition and development of real estate, the construction of homes andimprovements, for investment in joint ventures, for working capital and forsuch other appropriate purposes as may be approved by the lenders.  The Amended and Restated Credit Agreement isprimarily collateralized by real estate held for development and sale.  In addition, in connection with the Amendedand Restated Credit Agreement, the Company entered into an amended and restatedGuaranty Agreement.

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The Revolving Credit Facility has a maturity date of December 20, 2008and may be increased to $750,000,000 under certain circumstances.  Borrowings and advances under the RevolvingCredit Facility bear interest on a per annum basis equal to the LIBOR MarketIndex Rate plus a non-default variable spread ranging from 165 basis points to225 basis points, depending upon the Company’s leverage ratio.  During the term of the Revolving CreditFacility, interest is payable monthly in arrears.  At December 31, 2006, the interest rate was7.45%, which included a 212.5 basis point spread.

The Company is subject to certain financial ratios and customarycovenants as set forth in the Amended and Restated Credit Agreement.  These financial ratios and covenants include,but are not limited to, debt service; consolidated adjusted tangible net worth;leverage; investments in joint ventures, land held for development and sale andspeculative inventory; and limitations on subordinated and purchase moneymortgage debt.  The Amended and RestatedCredit Agreement was amended on November 1, 2006 (“First Amendment to theAmended and Restated Credit Agreement”). As part of the first amendment, the maximum permitted ratio of all landowned which is not subject to a qualifying agreement of sale and on which nounit has been or is being constructed to the Company’s consolidated adjustedtangible net worth was increased from 1.75-to-1.00 to 1.85-to-1.00 as ofSeptember 30, 2006.  At September 30,2006, the Company’s ratio of all land owned which is not subject to aqualifying agreement of sale and on which no unit has been or is beingconstructed to the Company’s consolidated adjusted tangible net worth was1.77-to-1.00.  As a result of FirstAmendment to the Amended and Restated Credit Agreement, the Company was incompliance with all applicable financial ratios and covenants in the Amendedand Restated Credit Agreement as of September 30, 2006.  See below for additional discussion anddisclosure of the First Amendment to the Amended and Restated Credit Agreement.

***First Amendment to the Amended and Restated Credit Agreement:***

On November 1, 2006, the Company’s RevolvingCredit Facility described above was amended as follows:

·                  The required debt service ratio was reducedfrom 2.25-to-1.00 for the entire term of the revolving credit facility to2.25-to-1.00 at September 30, 2006; 2.00-to-1.00 at December 31, 2006;1.65-to-1.00 at March 31, 2007, 1.50-to-1.00 at June 30, 2007 through December31, 2007; 1.65-to-1.00 at March 31, 2008; and 1.80-to-1.00 at June 30, 2008through December 31, 2008. 

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                        In addition, the Company’s debt service ratio must be greater than orequal to 1.75-to-1.00 as of the last day of at least two fiscal quarters ineach rolling period of five consecutive quarters, beginning with the period offive consecutive fiscal quarters ending September 30, 2006.

·                  The definition of debt service included inthe calculation of the debt service ratio was modified to exclude the repaymentof the $5,000,000 note issued to the former owners of Realen Homes.  See Note (B) above for a discussion of theterms of the $5,000,000 note that was issued in connection with the acquisitionof Realen Homes.

·                  The non-default variable interest rate spreadwill be increased by 25 basis points when the Company’s debt service ratio isless than 2.25-to-1.00.

·                  The permitted ratio of all land owned whichis not subject to a qualifying agreement of sale and on which no unit has beenor is being constructed to the  Company’sconsolidated adjusted tangible net worth was reset to 1.85-to-1.00 at September30, 2006 through December 31, 2006; 1.75-to-1.00 at March 31, 2007 through June30, 2007; 1.65-to-1.00 at September 30, 2007 through December 31, 2007; and1.50-to-1.00 from March 31, 2008 through December 31, 2008.

·                  The permitted minimum consolidated tangiblenet worth was reset to 90% of the Company’s consolidated tangible net worth atSeptember 30, 2006 plus an amount equal to 50% of the net income earned duringeach fiscal quarter that ends after September 30, 2006 and all of the netproceeds of equity securities issued by the Company after September 30,2006.  In addition, the definition ofconsolidated tangible net worth was modified to exclude any intangible assetsrecognized in connection with the Company’s supplemental executive retirementplan.  Prior to the First Amendment tothe Amended and Restated Credit Agreement, the permitted minimum consolidatedtangible net worth was defined as $180,000,000 plus an amount equal to 50% ofthe net income earned during each fiscal quarter that ended after December 31,2005 and all of the net proceeds of equity securities issued by the Companyafter December 31, 2005.

The required financial metrics that allow forthe unsecured election provided under the Revolving Credit Facility wererevised to a leverage ratio that is less than or equal 

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to 2.00-to-1.00; a debt service ratio that isgreater than or equal to 2.25-to-1.00; and a ratio of all land owned which isnot subject to a qualifying agreement of sale and on which no unit has been oris being constructed to the Company’s consolidated adjusted tangible net worthis less than or equal to 1.25-to-1.00. If these financial metrics are in place for two consecutive quarters,then the Company may request a release of all collateral under the RevolvingCredit Facility.

***Default under Amended and Restated CreditAgreement:***

As a result of the Company’s inventory impairmentand abandoned project charges, the Company was in violation of its debt serviceratio covenant at December 31, 2006. Subsequent to December 31, 2006 and prior to the filing of the Company’sForm 10-Q for the second quarter of fiscal 2007, the Company entered into aSecond Amendment to the Amended and Restated Credit Agreement (“SecondAmendment to the Amended and Restated Credit Agreement”).  As a result, on February 7, 2007, and as ofDecember 31, 2006, the Company was in compliance with the financial covenantscontained in the Amended and Restated Credit Agreement.  At December 31, 2006, approximately $511,950,000of borrowings and approximately $40,724,000 of letters of credit and otherassurances were outstanding under the Revolving Credit Facility.  See Note (N) Subsequent Events for furtherdetails on the Second Amendment to the Amended and Restated Credit Agreement.

***Trust Preferred Securities:***

On November 23, 2005, the Company issued$75,000,000 of trust preferred securities which mature on January 30, 2036 andare callable, in whole or in part, at par plus accrued interest on or afterJanuary 30, 2011.  For the first tenyears, the securities have a fixed interest rate of 8.61% per annum.  Thereafter, the securities have a floatinginterest rate equal to three-month LIBOR plus 360 basis points per annum,resetting quarterly. In the event the Company fails to meet certain financialcovenants for three consecutive quarters, the applicable rate of interest willbe increased by 300 basis points until such time as the Company is incompliance with the financial covenants, then the interest rate will return toits original amount.  It is an event ofdefault if the increased interest rate is in effect for four consecutivequarters.  The occurrence of an event ofdefault may trigger demand for immediate payment in full of all outstandingamounts, whereupon all outstanding amounts will be immediately due andpayable.  At December 31, 2006 theCompany failed to meet the Interest 

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Coverage Ratio Covenant of 1.75-to-1.00.  Under the indenture, the Interest CoverageRatio is defined as the Company’s Adjusted EBITDA to debt service for thetrailing twelve month period.  This wasthe first quarter the Company failed to meet any financial covenants under thetrust preferred securities. The transaction is treated as debt for financialstatement purposes.  The Company usedproceeds from the sale of these securities to repay outstanding obligationsunder the Revolving Credit Facility discussed above.

On September 20, 2005, the Company issued$30,000,000 of trust preferred securities which mature on September 30, 2035and are callable, in whole or in part, at par plus accrued interest on or afterSeptember 30, 2010.  For the first tenyears, the securities have a fixed interest rate of 8.52% per annum.  Thereafter, the securities have a floatinginterest rate equal to three-month LIBOR plus 380 basis points per annum,resetting quarterly.  The transaction istreated as debt for financial statement purposes.  The Company used proceeds from the sale ofthese securities to fund land purchases and residential construction.  The obligations relating to the trustpreferred securities are subordinated to the Revolving Credit Facility.

(F)                                 Redeemable Common Stock:

In connection with theCompany’s acquisition of Parker and Lancaster Corporation on October 13, 2000,the Company issued 300,000 shares of common stock of the Company to the formershareholders of Parker and Lancaster Corporation.  The former shareholders of Parker andLancaster Corporation had the right to cause the Company to repurchase thecommon stock approximately five years after the closing of the acquisition at aprice of $3.33 per share.  The redemptionfeature of these shares expired during the quarter ended December 31, 2005.

In connection with theCompany’s acquisition of Masterpiece Homes on July 28, 2003, the Company sold30,000 shares of common stock of the Company to the president of MasterpieceHomes at $8 per share.  The president ofMasterpiece Homes has the right to cause the Company to repurchase the commonstock at $8 per share by giving notice to the Company no later than the earlierof December 31, 2006 or 30 days after termination of his employment, asspecified in his employment agreement. The redemption feature of these sharesexpired during the quarter ended 

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December 31, 2006.  See Note (L) below for additional discussionrelating to the Company’s employment agreement with the president ofMasterpiece Homes.

(G)                                Employee Retirement and Deferred CompensationPlans

***Employee Retirement Plan:***

On December 1, 2005, the Company adopted a non-qualified target defined benefit retirement plan, effective as of September 1, 2005, which covers a group of management employees of the Company.  This Supplemental Executive Retirement Plan (the “SERP”) is intended to provide to each participant an annual supplemental retirement benefit based upon their years of service with the Company and highest average compensation for five consecutive years.  The annual supplemental benefit for each participant will be adjusted based on the actual performance of the SERP compared to the target. The benefit is payable for life with a minimum of 10 years guaranteed. In order to qualify for normal retirement benefits, a participant must attain age 65 with at least five years of participation in the SERP. Early retirement will be permitted beginning at age 55, after 5 years of participation in the Plan. Early retirement benefits will be adjusted actuarially to reflect the early retirement date.

If a participant terminates employment with the Company prior to attaining his or her normal retirement date, other than by reason of early retirement, death or disability, the participant will forfeit all benefits under the SERP.

The Company can amend or terminate the SERP at any time. However, no termination will affect the participants’ accrued benefits as determined in accordance with the SERP or delay any payments to a participant beyond the time that such amount would otherwise be payable without regard to the amendment.

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The Company used a 4% annual compensation increase and a 6.16% discount rate in its calculation of the present value of its projected benefit obligation at June 30, 2006.  The discount rate used represented the Moody’s AA bond rate for long-term bonds as of June 2006.  The Company recognized the following costs related to the SERP for the period ended December 31, 2006:

|                                     | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **December 31,**            | ** ** |
| ** **                          | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                          | ** ** | **(Unaudited)**                  | ** ** |
| ** **                          | ** ** | **(in thousands)**          | ** ** |
|                                |       |                             |       |                           |       |   |   |   |   |
| Net periodic  pension cost:         |       |                             |       |                           |       |   |   |   |   |
| Service cost                        |       | $                                | 201,000    |                           | $          | 180,000 |   | $ | 371,000 |   | $ | 180,000 |   |
| Interest cost                       |       | 127,000                          |       | 103,000                        |       | 221,000 |   | 103,000 |   |
| Amortization of  prior service cost |       | 91,000                           |       | 111,000                        |       | 181,000 |   | 111,000 |   |
| Total net  periodic pension cost    |       | $                                | 419,000    |                           | $          | 394,000 |   | $ | 773,000 |   | $ | 394,000 |   |

 

As the SERP was not adopteduntil December 1, 2005, the Company did not recognize any net periodic pensioncosts during the three months ended September 30, 2005.

***Deferred Compensation Plan:***

On December 1, 2005, the Company adopted an Executive Compensation Deferral Plan (the “Deferral Plan”) effective as of June 1, 2005.  Under the Plan, participants will have the ability to defer a portion of their compensation which will be credited to an account maintained by the Company for the participant. Amounts contributed by participants are always vested. Participant deferral accounts will be maintained by the Company for recordkeeping purposes only. Participants will have no interest in any assets which may be set aside by the Company to meet its obligations under the Deferral Plan. At December 31, 2006, the Company had obligations totaling $1,583,000 in connection with the Deferral Plan.  The deferred compensation is included in accrued expenses on the Company’s Consolidated Balance Sheet at December 31, 2006.

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(H)                               Earnings (Loss) Per Share:

The weighted average numberof shares used to compute basic earnings (loss) per common share and dilutedearnings (loss) per common share and a reconciliation of the numerator anddenominator used in the computation for the three and six months ended December31, 2006 and 2005 are shown in the following table:

|                                                                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                            | ** ** | **December 31,**            | ** ** |
| ** **                                                                            | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                            | ** ** | **(Unaudited)**                  | ** ** |
| ** **                                                                            | ** ** | **(in thousands)**          | ** ** |
|                                                                                  |       |                             |       |                           |       |   |   |   |   |
| Weighted average  common shares issued                                                |       | 18,698                           |       | 18,698                         |       | 18,698 |   | 18,698 |   |
| Less: Average  treasury shares Outstanding                                            |       | (222                             | )          | (149                           | )          | (279 | ) | (150 | ) |
| Basic EPS shares                                                                      |       | 18,476                           |       | 18,549                         |       | 18,419 |   | 18,548 |   |
| Effect of  assumed shares issued under  treasury  stock method for stock options |       |                             | (1)        | 339                            |       |   | (1) | 342 |   |
| Diluted EPS  shares                                                                   |       | 18,476                           |       | 18,888                         |       | 18,419 |   | 18,890 |   |
|                                                                                  |       |                             |       |                           |       |   |   |   |   |
| Net income (loss) for  basic and diluted EPS                                          |       | $                                | (7,524     | )                              | $          | 15,416 |   | $ | (3,625 | ) | $ | 23,194 |   |
|                                                                                       |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |

 

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(1)     For the three and six months ended December31, 2006, the Company used basic shares outstanding to compute diluted earningsper common share as the use of the diluted shares outstanding was anti-dilutiveon the diluted earnings per share calculation.

(I)                                    Residential Properties Completed or underConstruction:

Residential properties completed or underconstruction consist of the following:

|                                                               | ** ** | **December 31,   2006** | ** ** | **June 30,   2006** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------|------------|-------------------------------|------------|
| ** **                                                    | ** ** | **(unaudited)**                   | ** ** | **(audited)**                 | ** ** |
| ** **                                                    | ** ** | **(in thousands)**           | ** ** |
| Under contract  for sale (backlog)                            |       | $                                 | 128,400    |                          | $          | 124,073 |   |
| Unsold                                                        |       | 121,242                           |       | 147,995                       |       |
| Total residential  properties completed or under construction |       | $                                 | 249,642    |                          | $          | 272,068 |   |

 

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(J)                                   Segment Reporting:

Statement of Financial Accounting Standards No. 131 “Disclosuresabout Segments of an Enterprise and Related Information” (“SFAS 131”) establishesstandards for the manner in which public enterprises report segment informationabout operating segments.  The Companyhas determined that its operations primarily involve five reportablehomebuilding segments operating in fourteen markets.  The reportable homebuilding segments includeoperations conducting business in the following states:

Northern:  southeastern Pennsylvania, central NewJersey, southern New Jersey, andOrange County, New York

Southern:  Charlotte, Raleigh and Greensboro, North Carolina;Richmond andTidewater, Virginia

Florida: Orlando, Palm Coast, and Palm Bay,Florida

Midwestern:  Chicago, Illinois

Western:  Phoenix, Arizona.

The Company’s evaluation of segment performance isbased on net income. Below is a summary of revenue, net income, and income taxexpense for each reportable segment for the three and six months ended December31, 2006 and 2005:

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| ** **                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                        | ** ** | **December 31,**            | ** ** |
| ** **                        | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                        | ** ** | **(Unaudited)**                  | ** ** |
| ** **                        | ** ** | **(in thousands)**          | ** ** |
|                              |       |                             |       |                           |       |   |   |   |   |
| **Total  Revenue**                | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Northern                          |       | $                                | 47,667     |                           | $          | 90,658 |   | $ | 97,313 |   | $ | 149,954 |   |
| Southern                          |       | 61,944                           |       | 79,123                         |       | 136,057 |   | 138,957 |   |
| Florida                           |       | 22,491                           |       | 19,216                         |       | 40,908 |   | 37,112 |   |
| Midwestern                        |       | 23,448                           |       | 33,902                         |       | 44,874 |   | 55,163 |   |
| Western                           |       | —                           |       | —                         |       | — |   | — |   |
| Corporate and  unallocated (1)    |       | 1,579                            |       | 1,752                          |       | 3,079 |   | 3,106 |   |
| Consolidated  Total               |       | $                                | 157,129    |                           | $          | 224,651 |   | $ | 322,231 |   | $ | 384,292 |   |
|                              |       |                             |       |                           |       |   |   |   |   |
| **Net  Income (Loss)**            |       |                             |       |                           |       |   |   |   |   |
| Northern                          |       | $                                | (4,589     | )                              | $          | 10,249 |   | $ | (3,369 | ) | $ | 15,475 |   |
| Southern                          |       | 1,077                            |       | 4,111                          |       | 5,459 |   | 6,319 |   |
| Florida                           |       | (2,090                           | )          | 738                            |       | (2,669 | ) | 1,497 |   |
| Midwestern                        |       | (831                             | )          | 2,237                          |       | 216 |   | 3,029 |   |
| Western                           |       | (147                             | )          | (6                             | )          | (290 | ) | (6 | ) |
| Corporate and  unallocated (1)    |       | (944                             | )          | (1,913                         | )          | (2,972 | ) | (3,120 | ) |
| Consolidated  Total               |       | $                                | (7,524     | )                              | $          | 15,416 |   | $ | (3,625 | ) | $ | 23,194 |   |
|                              |       |                             |       |                           |       |   |   |   |   |
| **Income  Tax Expense (Benefit)** |       |                             |       |                           |       |   |   |   |   |
| Northern                          |       | $                                | (2,986     | )                              | $          | 6,096 |   | $ | (2,192 | ) | $ | 10,284 |   |
| Southern                          |       | 676                              |       | 2,511                          |       | 3,431 |   | 3,941 |   |
| Florida                           |       | (1,278                           | )          | 429                            |       | (1,634 | ) | 906 |   |
| Midwestern                        |       | (528                             | )          | 1,444                          |       | 137 |   | 1,934 |   |
| Western                           |       | (83                              | )          | —                         |       | (159 | ) | — |   |
| Corporate and  unallocated (1)    |       | (584                             | )          | (540                           | )          | (1,908 | ) | (1,503 | ) |
| Consolidated Total                |       | $                                | (4,783     | )                              | $          | 9,940 |   | $ | (2,325 | ) | $ | 15,562 |   |

 

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(1) Corporate andunallocated includes the revenues and expenses of the Company’s mortgagebrokerage and property management operations as well as corporate levelselling, general and administrative expenses. These selling, general, and administrative expenses are primarilycomprised of corporate salaries, bonuses, and benefits; accounting andconsulting fees; corporate travel expenses; net periodic pension costs; andcompensation expense resulting from the fair valuation of stock options.

23

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Below is as a summary of total assets and goodwillfor each reportable segment at December 31, 2006 and June 30, 2006:

|                                | ** ** | **December 31,**   | ** ** | **June 30,** | ** ** |
|--------------------------------|------------|-------------------------|------------|-------------------|------------|
| ** **                     | ** ** | **2006**                | ** ** | **2006**          | ** ** |
| ** **                     | ** ** | **(Unaudited)**         | ** ** | **(Audited)**     | ** ** |
| ** **                     | ** ** | **(In thousands)** | ** ** |
| **Assets**                     | ** ** | ** **              | ** ** | ** **        | ** ** |
| North                          |       | $                       | 459,986    |              | $          | 437,535 |   |
| South                          |       | 324,829                 |       | 332,965           |       |
| Florida                        |       | 98,171                  |       | 122,809           |       |
| Midwest                        |       | 130,262                 |       | 126,901           |       |
| West                           |       | 37,782                  |       | 34,917            |       |
| Corporate and unallocated  (2) |       | 5,154                   |       | 5,376             |       |
| Consolidated Total             |       | $                       | 1,056,184  |              | $          | 1,060,503 |   |
| ** **                     | ** ** | ** **              | ** ** | ** **        | ** ** |
| **Goodwill**                   | ** ** | ** **              | ** ** | ** **        | ** ** |
| North                          |       | $                       | 7,918      |              | $          | 7,918 |   |
| South                          |       | 4,180                   |       | 4,180             |       |
| Florida                        |       | 3,007                   |       | 3,007             |       |
| Midwest                        |       | 5,409                   |       | 5,409             |       |
| Consolidated Total             |       | $                       | 20,514     |              | $          | 20,514 |   |

 

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(2) Corporate andunallocated includes the intangible asset recorded in connection with theCompany’s supplemental executive retirement plan as well as the carrying value(historical cost less accumulated depreciation) of the Company’s partialownership interests in four corporate jets. See Note (G) for additional discussion and disclosure of thesupplemental executive retirement plan.

(K)                               Litigation:

The Company is currentlyinvolved in three separate actions involving injuries on the job allegedlysuffered by employees of its subcontractors and one wrongful death and survivalaction of which the potential claim and ultimate outcome is currentlyunknown.  The injuries range from variousfractures requiring surgery to low back and neck injuries.  Given the uncertainty surrounding theultimate outcome of the claims, the Company has not recorded any reserve withrespect to these claims at December 31, 2006.  The Company is self-insured up to $2,000,000 for each general liabilityclaim with a $25,000,000 general liability umbrella policy thereafter.  See Note (M) for additional information onthe Company’s self-insurance policy. With respect to these claims, the Company is aggressively pursuing theinsurance and indemnification available to it from its subcontractors.  While the Company currently believes that theultimate outcome of these claims, individually and in the aggregate,

24

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will not have a materialadverse effect on the financial position, operating results or cash flows ofthe Company, litigation is subject to inherent uncertainties.  If an unfavorable outcome were to occur,there exists the possibility of a material adverse impact on the Company’s netincome in the period in which the unfavorable outcome occurs.

In addition, from time totime the Company is named as a defendant in legal actions arising from itsnormal business activities.  Although theamount of liability that could arise with respect to currently pending actionscannot be accurately predicted, in the opinion of the Company any suchliability will not have a material adverse effect on the financial position,operating results or cash flows of the Company.

(L)                                 Restructuring:

During the six months endedDecember 31, 2006, the Company reduced its workforce by approximately 170employees in response to decreased new order activity resulting from weakenedconditions in the U.S. housing market.  The workforce reductions took place in all of the Company’s regions andincluded general and administrative, sales, and construction overheadpositions.  The Company recognizedapproximately $425,000 and $766,000 in severance expenses related to the workforce reductions during the three and six months ended December 31, 2006,respectively.  The costs were included incosts of residential properties and selling, general and administrativeexpenses in the Company’s Consolidated Statement of Operations for the threeand six months ended December 31, 2006. The workforce reductions werecommensurate with the Company’s decreased new order activity and productionlevels.

On October 26, 2006, Mr.Robert Fitzsimmons’s employment as the president of Masterpiece Homes, Inc.ended by mutual agreement.  Mr.Fitzsimmons will receive his base salary and medical benefits through January28, 2007.  In addition, Mr. Fitzsimmonswill receive an amount equal to 25% of certain pre-tax profits attributable tothe operations of Masterpiece Homes for the period January 1, 2006 throughDecember 31, 2006.  Pursuant to hisemployment agreement, Mr. Fitzsimmons acquired options to purchase up to45,000 shares of the Company’s common stock at an exercise price of $10.64 pershare.  On April 4, 2005, Mr. Fitzsimmonsexercised 15,000 of these options.  Anadditional 15,000 options vested 

25

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on December 31, 2005 and theremaining 15,000 options vested on December 31, 2006.  Mr. Fitzsimmons will retain these options.

In November 2006, theCompany terminated the employment of Joel A. Armstrong, Executive VicePresident of the Company.  Under theterms of Mr. Armstrong’s employment agreement, he is entitled to continueto receive his base salary and any bonus to which he is entitled for the nextconsecutive 12 months. For thesix months ended December 31, 2006, the Company recognized approximately$1,100,000 in severance expenses related to Mr. Armstrong’s termination.

(M)                            Commitments and Contingencies:

As of December 31, 2006, theCompany owned or controlled approximately 13,100 building lots.  As part of the aforementioned building lots,the Company had contracted to purchase, or had under option, undeveloped landand improved lots for an aggregate purchase price of approximately $258,431,000which are expected to yield approximately 4,500 building lots.  Generally,the Company structures its land acquisitions so that it has the right to cancelits agreements to purchase undeveloped land and improved lots by forfeiture ofits deposit under the agreement. Furthermore, purchase of the properties isusually contingent upon obtaining all governmental approvals and satisfactionof certain requirements by the Company and the sellers.

Until February 2004, generalliability claims were fully insured, subject to applicable policy limits andexclusions. Thereafter, because of increasing insurance costs, the Companyself-insures the first $2,000,000 of each general liability claim in its North,Midwest and West regions.  The Company’sSouth and Florida regions continue to maintain conventional general liabilitypolicies.  At December 31, 2006 and June30, 2006 the Company has recorded self insurance reserves of $1,199,000 and$1,128,000, respectively.  The reservesinclude an estimate of expected settlements on pending claims, defense costsand a provision for claims incurred but not reported.  These estimates are based on the Company’sassessment of potential liability using an analysis of available informationwith respect to pending claims, historical experience and current cost trends.  The amount of the Company’s ultimateliability in respect of these matters may differ materially from theseestimates.

26

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(N)                               Subsequent Events:

***Second Amendment to******Amended and Restated Credit Agreement:***

On February 7, 2007, the Company’s Amendedand Restated Credit Agreement described in Note (E) above was amended asfollows:

·                  AdjustedEBITDA as defined in the Amended and Restated Credit Agreement was revised forthe debt service ratio covenant.  Forpurposes of the debt service ratio covenant, the revised Adjusted EBITDAincludes add-backs for inventory impairments and abandoned project write-offs,plus certain other non-cash charges and extraordinary losses, minus certainother non-cash credits and extraordinary gains.

·                  The required debt service ratio was reducedfrom 1.65-to-1.00 to 1.50-to-1.00 at March 31, 2007.

·                  The permitted ratio of all land owned whichis not subject to a qualifying agreement of sale and on which no unit has beenor is being constructed to the  Company’sconsolidated adjusted tangible net worth was reset to 1.90-to-1.00 at December31, 2006 and 1.90-to-1.00 at March 31, 2007.

 

27

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**ORLEANSHOMEBUILDERS, INC. AND SUBSIDIARIES**

**Item 2.****                                                          ****Management’s Discussion andAnalysis of Financial Condition and****Results of Operations**

OrleansHomebuilders, Inc. and its subsidiaries (collectively, the “Company”, “OHB” or “Orleans”)develop, build and market high-quality, single-family homes, townhomes andcondominiums to serve various homebuyer segments, including first-time, firstmove-up, second move-up, luxury and active adult.  The Company is currently engaged inresidential real estate development in the following fourteen markets:southeastern Pennsylvania; central New Jersey; southern New Jersey; OrangeCounty, New York; Charlotte, Raleigh and Greensboro, North Carolina; Richmondand Tidewater, Virginia; Orlando, Palm Coast, and Palm Bay Florida; Chicago,Illinois; and Phoenix, Arizona.  TheCompany’s Charlotte, North Carolina market also includes operations in adjacentcounties in South Carolina.  The Companyhas operated in its Pennsylvania and New Jersey markets for over 85 years andbegan operations in its North Carolina and Virginia markets in fiscal 2001through the acquisition of Parker & Lancaster Corporation, a privately-heldresidential homebuilder.  The Companyentered the Orlando and Palm Coast, Florida markets on July 28, 2003 through itsacquisition of Masterpiece Homes, Inc. (“Masterpiece Homes”), a privately-heldresidential homebuilder.  On July 28,2004, the Company entered the Chicago, Illinois market through the acquisitionof Realen Homes, L.P. (“Realen Homes”), an established privately-heldhomebuilder with operations in southeastern Pennsylvania and Chicago,Illinois.  On December 23, 2004, pursuantto an Asset Purchase Agreement of the same date, the Company acquired, througha wholly-owned subsidiary, certain real estate assets from PeachtreeResidential Properties, LLC, a North Carolina limited liability company andPeachtree Townhome Communities, LLC, a North Carolina limited liability companywhich, at the time the Company acquired the assets, were wholly-ownedsubsidiaries of Peachtree Residential Properties, Inc., a Georgia corporation(collectively, “Peachtree Residential Properties”).  In December 2005, the Company entered thePhoenix, Arizona market as a start-up operation via the purchase of anundeveloped parcel of land.

References to a givenfiscal year in this Quarterly Report on Form 10-Q are to the fiscal year endedJune 30th of that year.  For example, thephrases “fiscal 2007” or “2007 fiscal year” refer to the fiscal year ended June30, 2007.  When used in this report, “northernregion” refers to the Company’s markets in Pennsylvania, New Jersey and NewYork, which includes the southeastern Pennsylvania operations of Realen Homesthat were acquired on July 28, 2004; “southern region” refers to the Company’smarkets in North Carolina and Virginia; “Florida region” refers to the Company’smarkets in Florida; 

28

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“midwestern region”refers to the Company’s market in Illinois; and “western region” refers to theCompany’s market in Arizona.

**Results of Operations**

The following table sets forth certain details as to residential salesactivity.  The information provided isfor the three and six months ended December 31, 2006 and 2005 in the case ofresidential revenue earned and new orders, and as of December 31, 2006 and 2005in the case of backlog.

A sales contract or potential sale is classified as a new order and,therefore, becomes a part of backlog, at the time a homebuyer executes acontract to purchase a home from the Company.
| ** **                                    | ** ** | **Six Months Ended December 31,** | ** ** |
|-----------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                              | ** ** | **2005** | ** ** |
| ** **                                    | ** ** | **(Dollars in thousands)**                  | ** ** |
|                                          |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |
| **Northern Region**                           |       | ** **                                            | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** |   |
| Pennsylvania, New  Jersey and New York:       |       | **Amount**                                            | ** ** | **Homes** | ** ** | **Price** | ** ** | **Amount** | ** ** | **Homes** | ** ** | **Price** |   |
| Residential revenue  earned                   |       | $                                                     | 95,322     |   | 196 |   | $ | 486 |   | $ | 149,198 |   | 326 |   | $ | 458 |   |
| New orders                                    |       | 103,059                                               |       | 211 |   | 488 |   | 139,242 |   | 257 |   | 542 |   |
| Backlog                                       |       | 108,260                                               |       | 209 |   | 518 |   | 240,565 |   | 466 |   | 516 |   |
| Net income (loss)                             |       | (3,369                                                | )          | n/a |   | n/a |   | 15,475 |   | n/a |   | n/a |   |
|                                          |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |
| **Southern Region**                           | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| North Carolina, South  Carolina And Virginia: |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |
| Residential revenue  earned                   |       | $                                                     | 135,227    |   | 284 |   | $ | 476 |   | $ | 138,883 |   | 355 |   | $ | 391 |   |
| New orders                                    |       | 105,667                                               |       | 215 |   | 491 |   | 188,967 |   | 430 |   | 439 |   |
| Backlog                                       |       | 124,084                                               |       | 233 |   | 533 |   | 208,375 |   | 448 |   | 465 |   |
| Net income                                    |       | 5,459                                                 |       | n/a |   | n/a |   | 6,319 |   | n/a |   | n/a |   |
|                                          |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |
| **Florida Region**                            | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Residential revenue  earned                   |       | $                                                     | 40,583     |   | 158 |   | $ | 257 |   | $ | 35,727 |   | 151 |   | $ | 237 |   |
| New orders                                    |       | 15,257                                                |       | 85 |   | 179 |   | 49,063 |   | 152 |   | 323 |   |
| Backlog                                       |       | 17,845                                                |       | 65 |   | 275 |   | 99,538 |   | 360 |   | 276 |   |
| Net income (loss)                             |       | (2,669                                                | )          | n/a |   | n/a |   | 1,497 |   | n/a |   | n/a |   |
|                                          |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |
| **Midwestern Region**                         | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Residential revenue  earned                   |       | $                                                     | 43,812     |   | 102 |   | $ | 430 |   | $ | 55,067 |   | 132 |   | $ | 417 |   |
| New orders                                    |       | 46,155                                                |       | 105 |   | 440 |   | 47,493 |   | 111 |   | 428 |   |
| Backlog                                       |       | 39,681                                                |       | 84 |   | 472 |   | 50,649 |   | 118 |   | 429 |   |
| Net income                                    |       | 216                                                   |       | n/a |   | n/a |   | 3,029 |   | n/a |   | n/a |   |
|                                          |       |                                                  |       |   |   |   |   |   |   |   |   |   |   |
| **Western  Region****(1)**                    | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                                      |       | (290                                                  | )          | n/a |   | n/a |   | (6 | ) | n/a |   | n/a |   |
| ** **                                    | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Corporate  and unallocated**                | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                                      |       | (2,972                                                | )          | n/a |   | n/a |   | (3,120 | ) | n/a |   | n/a |   |
| ** **                                    | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Combined  Regions**                         | ** ** | ** **                                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Residential  revenue earned                   |       | $                                                     | 314,944    |   | 740 |   | $ | 426 |   | $ | 378,875 |   | 964 |   | $ | 393 |   |
| New orders                                    |       | 270,138                                               |       | 616 |   | 439 |   | 424,765 |   | 950 |   | 447 |   |
| Backlog                                       |       | 289,870                                               |       | 591 |   | 490 |   | 599,127 |   | 1,392 |   | 430 |   |
| Net income (loss)                             |       | (3,625                                                | )          | n/a |   | n/a |   | 23,194 |   | n/a |   | n/a |   |

----

(1)  Information on net loss is for the periodbeginning December 1, 2005, the date the Company entered this region, throughDecember 31, 2006.  The region did notgenerate residential revenue or new orders for the period beginning December 1,2005, the date the Company entered this region, through December 31, 2006.

29

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| ** **                                          | ** ** | **Three Months Ended December 31,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                          | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| ** **                                          | ** ** | **(Dollars in thousands)**                    | ** ** |
| ** **                                          | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Northern  Region**                                |       | ** **                                              | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** |   |
| Pennsylvania,  New Jersey and New York:             |       | **Amount**                                              | ** ** | **Homes** | ** ** | **Price** | ** ** | **Amount** | ** ** | **Homes** | ** ** | **Price** |   |
| Residential  revenue earned                         |       | $                                                       | 46,731     |   | 100 |   | $ | 467 |   | $ | 90,145 |   | 189 |   | $ | 477 |   |
| New orders                                          |       | 47,567                                                  |       | 96 |   | 495 |   | 47,078 |   | 81 |   | 581 |   |
| Backlog                                             |       | 108,260                                                 |       | 209 |   | 518 |   | 240,565 |   | 466 |   | 516 |   |
| Net income  (loss)                                  |       | (4,589                                                  | )          | n/a |   | n/a |   | 10,249 |   | n/a |   | n/a |   |
|                                                |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| **Southern  Region**                                | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| North Carolina,  South Carolina  and Virginia: |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Residential  revenue earned                         |       | $                                                       | 61,534     |   | 129 |   | $ | 477 |   | $ | 79,083 |   | 199 |   | $ | 397 |   |
| New orders                                          |       | 57,997                                                  |       | 121 |   | 479 |   | 75,307 |   | 172 |   | 438 |   |
| Backlog                                             |       | 124,084                                                 |       | 233 |   | 533 |   | 208,375 |   | 448 |   | 465 |   |
| Net income                                          |       | 1,077                                                   |       | n/a |   | n/a |   | 4,111 |   | n/a |   | n/a |   |
|                                                |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| **Florida  Region**                                 | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Residential  revenue earned                         |       | $                                                       | 22,406     |   | 94 |   | $ | 238 |   | $ | 17,848 |   | 72 |   | $ | 248 |   |
| New orders                                          |       | 17,135                                                  |       | 83 |   | 206 |   | 17,024 |   | 52 |   | 327 |   |
| Backlog                                             |       | 17,845                                                  |       | 65 |   | 275 |   | 99,538 |   | 360 |   | 276 |   |
| Net income  (loss)                                  |       | (2,090                                                  | )          | n/a |   | n/a |   | 738 |   | n/a |   | n/a |   |
|                                                |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| **Midwestern  Region**                              | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Residential  revenue earned                         |       | $                                                       | 22,501     |   | 54 |   | $ | 417 |   | $ | 33,836 |   | 80 |   | $ | 423 |   |
| New orders                                          |       | 29,676                                                  |       | 67 |   | 443 |   | 24,007 |   | 56 |   | 429 |   |
| Backlog                                             |       | 39,681                                                  |       | 84 |   | 472 |   | 50,649 |   | 118 |   | 429 |   |
| Net income (loss)                                   |       | (831                                                    | )          | n/a |   | n/a |   | 2,237 |   | n/a |   | n/a |   |
|                                                |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| **Western  Region****(1)**                          | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                                            |       | (147                                                    | )          | n/a |   | n/a |   | (6 | ) | n/a |   | n/a |   |
|                                                |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| **Corporate  and unallocated**                      | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                                            |       | (944                                                    | )          | n/a |   | n/a |   | (1,913 | ) | n/a |   | n/a |   |
|                                                |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| **Combined  Regions**                               | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Residential  revenue earned                         |       | $                                                       | 153,172    |   | 377 |   | $ | 406 |   | $ | 220,912 |   | 540 |   | $ | 409 |   |
| New orders                                          |       | 152,375                                                 |       | 367 |   | 415 |   | 163,416 |   | 361 |   | 453 |   |
| Backlog                                             |       | 289,870                                                 |       | 591 |   | 490 |   | 599,127 |   | 1,392 |   | 430 |   |
| Net income (loss)                                   |       | (7,524                                                  | )          | n/a |   | n/a |   | 15,416 |   | n/a |   | n/a |   |

----

(1)  Information on net loss is for the periodbeginning December 1, 2005, the date the Company entered this region, throughDecember 31, 2006.  The region did notgenerate residential revenue or new orders for the period beginning December 1,2005, the date the Company entered this region, through December 31, 2006.

**Three and Six Months Ended December 31, 2006**

**Ordersand Backlog**

New orders for the six months ended December 31, 2006 decreased$154,627,000, or 36.4%, to $270,138,000 on 616 homes, compared to $424,765,000on 950 homes for the six months ended December 31, 2005.  The average price per home of new ordersdecreased by approximately 1.8% to $439,000 for the six months ended December31, 2006 compared to $447,000 for the six months ended December 31, 2005.  The Company is currently utilizing and willcontinue to utilize sales incentives in all of its markets in an effort toincrease customer demand and absorption rates, and reduce new home inventorylevels where applicable.

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New orders for the three months ended December 31, 2006 decreased$11,041,000, or 6.8%, to $152,375,000 on 367 homes, compared to $163,416,000 on361 homes for the three months ended December 31, 2005.  The average price per home of new ordersdecreased by approximately 8.4% to $415,000 for the three months ended December31, 2006 compared to $453,000 for the three months ended December 31, 2005.

The significant decrease in the Company’s new orders during the threeand six months ended December 31, 2006 compared to the three and six monthsended December 31, 2005 was attributable to unfavorable market conditions inthe housing industry.  The major factorscontributing to the unfavorable market conditions include a) increased new andresale home inventory levels primarily caused by speculators attempting to selltheir homes, specifically in the Company’s Palm Coast market in the Floridaregion, and b) decreased homebuyer demand due to lower consumer confidence inthe overall housing market.  The decreasein homebuyer demand as a result of lower consumer confidence can be attributedto concerns of prospective buyers of new homes about the direction of homeprices, which has increased general homebuyer uncertainty regarding whether nowis the best time to buy a home.  TheCompany continues to respond to this uncertainty by increasing sales incentivesand offering limited time promotions with the objective of improving new ordersand reducing home inventory levels.  TheCompany believes that the aforementioned market conditions will continue tohave a negative impact on new orders and new order pricing in the near-term,thereby further reducing future revenues, gross margins and net income.

In response to these unfavorable market conditions, the Company reducedits workforce by approximately 170 employees during the six months endedDecember 31, 2006. The workforce reductions took place in all of the Company’sregions and included general and administrative, sales, and constructionoverhead positions.   For the six monthsended December 31, 2006, the Company recognized approximately $766,000 inseverance expenses related to the work force reductions of which approximately$425,000 was recognized in the second quarter of fiscal year 2007.  The majority of severance has been paid outas of December 31, 2006.  The workforcereductions were commensurate with the Company’s decreased new order activityand production levels.  In November 2006,the Company terminated the employment of Joel A. Armstrong, Executive VicePresident of the Company.  Under theterms of Mr. Armstrong’s employment agreement, he is entitled to continue toreceive his base salary and any bonus to which he is entitled for theconsecutive 12 months following his termination. For the six months ended

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December 31, 2006, the Company recognized approximately $1,100,000 inseverance expenses related to Mr. Armstrong’s termination.

The backlog at December 31, 2006 decreased $309,257,000, or 51.6%, to$289,870,000 on 591 homes compared to the backlog at December 31, 2005 of$599,127,000 on 1,392 homes.  Thedecrease in the backlog was attributable to decreases in new orders in all ofthe Company’s regions for the six months ended December 31, 2006.  The average price per home included in theCompany’s backlog increased 14.0% to $490,000 at December 31, 2006 compared to$430,000 at December 31, 2005.  Theincrease in the average price per home in backlog was attributable to a changein product mix of homes in backlog, specifically in the Southern Region.  There were more luxury and second move-uphomes in backlog in the Southern Region at December 31, 2006 when compared toDecember 31, 2005.

The Company experienced a cancellation rate of 27% for the six monthsended December 31, 2006, compared to 18% for the six months ended December 31,2005.   The cancellation rate hasincreased in the majority of regions in which the Company operates whencompared with the six months ended December 31, 2005.  The increase in cancellation rates for thesix months ended December 31, 2006 is primarily attributable to a) speculatorsexiting the Company’s Palm Coast market in the Florida region; b) lowerconsumer confidence in the overall housing market leading to uncertainty bycurrent homebuyers of their ability to sell their existing home and thereby affordthe purchase of a new home; and c) lower consumer confidence in the overallhousing market leading to uncertainty about the direction of home prices andthe value of their new home purchase.

For the three months ended December 31, 2006, the Company experienced acancellation rate of 24% compared to 21% for the three months ended December31, 2005.   The Company believes thatmost speculators buying its homes had exited the market prior to the start ofits second quarter.  Therefore, theCompany believes the increase in  thecancellation rate for the three months ended December 31, 2006 is primarilyattributable to lower consumer confidence in the overall housing market asdescribed above.

***Northern Region:***

New orders for the six months ended December 31, 2006 decreased$36,183,000 to $103,059,000, or 26.0%, on 211 homes, compared to $139,242,000on 257 homes for the six months ended December 31, 2005.  The decrease in new orders was attributableto decreased

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homebuyer demand due to lower consumer confidence in the overallhousing market. The decrease in homebuyer demand as a result of lower consumerconfidence can be attributed to concerns of prospective buyers of new homesabout the direction of home prices, which has increased general uncertainty asto whether now is the best time to buy a home. The Northern Region has approximately 133 inventory homes, in variousstages of completion, available for sale at December 31, 2006.  New home inventory is comprised of modelhomes, completed homes and homes in various stages of construction not subjectto an agreement of sale The Company anticipates reducing this by approximately25% by the end of the current fiscal year. The average price per home of new orders decreased by 10.0% to $488,000for the six months ended December 31, 2006 compared to $542,000 for the sixmonths ended December 31, 2005.  Thedecrease in the average price per home of new orders was impacted by twofactors.  First, the Company experienceda shift in the mix of new orders for the six months ended December 31, 2006compared to the six months ended December 31, 2005.  Specifically, multi-family homes, whichtypically have lower price points than single family homes, comprised a largerpercentage of new orders than single family homes for the six months endedDecember 31, 2006 when compared to the six months ended December 31, 2005.  Second, the Company offered increased salesincentives during the six months ended December 31, 2006 when compared with thesix months ended December 31, 2005 in an effort to increase absorption ratesand convert the Company’s inventory into cash.

New orders for the three months ended December 31, 2006 increased$489,000  to $47,567,000, or 1.0%, on 96homes, compared to $47,078,000 on 81 homes for the three months ended December31, 2005. The increase in new orders was attributable to an increase in salesincentives offered in an effort to increase customer demand in an overallsluggish housing market.  The averageprice per home of new orders decreased by 14.8% to $495,000 for the threemonths ended December 31, 2006 compared to $581,000 for the three months endedDecember 31, 2005.  The decrease in theaverage price per home of new orders was caused primarily by two factors.  First, the Company experienced a shift in themix of new orders for the three months ended December 31, 2006 compared to thethree months ended December 31, 2005. Specifically, multi-family homes, which typically have lower pricepoints than single family homes, comprised a larger percentage of new ordersthan single family homes for the three months ended December 31, 2006 whencompared to the three months ended December 31, 2005.  Second, the Company offered increased salesincentives during the three months ended December 31, 2006 when compared withthe three months ended December 31, 2005 in an effort to increase absorptionrates and convert the Company’s inventory into cash.

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The Company had 38 active selling communities in thenorthern region as of December 31, 2006 compared to 26 active sellingcommunities at December 31, 2005.

***Southern Region:***

New orders for the six months ended December 31, 2006 decreased$83,300,000 to $105,667,000, or 44.1%, on 215 homes compared to $188,967,000 on430 homes for the six months ended December 31, 2005.  The decrease in new orders was attributableto decreased demand in the region which began during the fourth quarter offiscal 2006 and has continued through the second quarter of fiscal 2007.  The decreased demand is primarily due tolower consumer confidence in the overall housing market.  The Southern Region has approximately 154inventory homes, in various stages of completion, available for sale atDecember 31, 2006.  The Companyanticipates reducing this by approximately 60% by the end of the current fiscalyear.  The overall decrease in new orderdollars was partially offset by an increase in the average price per home ofnew orders of 11.9% to $491,000 for the six months ended December 31, 2006compared to $439,000 for the six months ended December 31, 2005. This increasein the average price per home of new orders was attributable to a product mixshift in which second time move-up and luxury homes comprised a largerpercentage of new orders than entry level and first time move-up homes during thesix months ended December 31, 2006 compared to the six months ended December31, 2005.

New orders for the three months ended December 31, 2006 decreased$17,310,000 to $57,997,000, or 23.0%, on 121 homes compared to $75,307,000 on172 homes for the three months ended December 31, 2005.  The decrease in new orders was attributableto decreased demand in the region which began during the fourth quarter offiscal 2006 and has continued through the second quarter of fiscal 2007.  The overall decrease in new order dollars waspartially offset by an increase in the average price per home of new orders of9.4% to $479,000 for the three months ended December 31, 2006 compared to$438,000 for the three months ended December 31, 2005. This increase in theaverage price per home of new orders was attributable to a product mix shift inwhich second time move-up and luxury homes comprised a larger percentage of neworders than entry level and first time move-up homes during the three monthsended December 31, 2006 compared to the three months ended December 31, 2005.

The Company had 45 active selling communities in the southern region asof December 31, 2006 compared to 47 active selling communities as of December31, 2005.

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***Florida Region:***

New orders for the six months ended December 31, 2006 decreased$33,806,000  to $15,257,000, or 68.9%, on85 homes compared to $49,063,000 on 152 homes for the six months ended December31, 2005.  The decrease in new orders wasa result of decreased homebuyer demand due to lower consumer confidence in theoverall housing market and a significant increase in cancellation rates asinvestors continued to exit the Palm Coast market in the Florida Region.  The Company’s Palm Coast market within theFlorida Region accounted for approximately 8% of total new orders in theFlorida Region for the six months ended December 31, 2006 compared with 70% forthe same period in the prior fiscal year. Excluding the Palm Coast market, the Company’s Florida Region new ordersfor the six months ended December 31, 2006 were relatively consistent with thesame period in the prior fiscal year. However, the average sales price per home of new orders, excluding PalmCoast, decreased by approximately 27% to $229,000 for the six months endedDecember 31, 2006 compared to $314,000 for the six months ended December 31,2005, primarily as a result of incentives offered in an effort to increaseabsorption rates in an overall sluggish housing market.  The Company experienced a 50% cancellationrate in the Florida region for the six months ended December 31, 2006, comparedto 30% for the six months ended December 31, 2005.  As a result of the cancellations, the Companyhas offered sales incentives in an effort to increase absorption rates and tofurther decrease its new home inventory levels. As a result of the sales incentives, new home orders increased in thelatter part of the six month period resulting in the Company’s Florida regionnew home inventory level, including model homes, at December 31, 2006,remaining consistent with its December 31, 2005 level of approximately 70homes.  New home inventory is comprisedof model homes, completed homes and homes in various stages of construction notsubject to an agreement of sale.  Theaverage price per home of new orders decreased by 44.6% to $179,000 for the sixmonths ended December 31, 2006 compared to $323,000 for the six months endedDecember 31, 2005.  The decrease inaverage price per home of new orders was primarily a result of product mix andsales incentives being offered by the Company in an effort to decrease it newhome inventory levels.

New orders for the three months ended December 31, 2006 increased$111,000 to $17,135,000, or 0.7%, on 83 homes compared to $17,024,000 on 52homes for the three months ended December 31, 2005.  The increase in new orders was a result ofthe Company offering sales incentives in an effort to decrease its new homeinventory levels.  The Companyexperienced a 25% cancellation rate in the Florida region for the three monthsended December 31, 2006, compared to 38% for the three months ended December31, 2005.  The decreased cancellation

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rate is due to an increase in orders for the period as a result ofincreased sales incentives and the fact that many investors have exited themarket prior to the beginning of the quarter ending December 31, 2006.  The average price per home of new ordersdecreased by 37.0% to $206,000 for the three months ended December 31, 2006compared to $327,000 for the three months ended December 31, 2005.  The decrease in average price per home of neworders was primarily a result of product mix and sales incentives being offeredby the Company in an effort to decrease it new home inventory levels.

The Company had six active selling communities in the Florida region asof December 31, 2006, compared to four active selling communities as ofDecember 31, 2005.

***Midwestern Region:***

New orders for the six months ended December 31, 2006 decreased$1,338,000 to $46,155,000, or 2.8%, on 105 homes compared to $47,493,000 on 111homes for the six months ended December 31, 2005.    The decrease in new orders, which beganduring the fourth quarter of fiscal 2006, primarily was a result of decreasedhomebuyer demand due to lower consumer confidence in the overall housingmarket.  The Company has responded tothis decreased homebuyer demand by increasing sales incentives and offeringlimited time promotions with the objective of improving new orders and reducinghome inventory levels.  As a result ofthe sales incentives, new home orders increased in the latter part of the sixmonth period resulting in a decrease in the Company’s Midwest region new homeinventory level, including model homes, of approximately 25%, at December 31,2006 when compared with December 31, 2005. The Company had approximately 25 homes in inventory, at various stagesof construction, available for sale at December 31, 2006.  The average price per home of new ordersincreased by 2.8% to $440,000 for the six months ended December 31, 2006compared to $428,000 for the six months ended December 31, 2005.

New orders for the three months ended December 31, 2006 increased$5,669,000 to $29,676,000, or 23.6%, on 67 homes compared to $24,007,000 on 56homes for the three months ended December 31, 2005.    The increase in new orders was a result ofthe Company offering sales incentives in an effort to improve new orders andreduce new home inventory levels.  Theaverage price per home of new orders increased by 3.3% to $443,000 for thethree months ended December 31, 2006 compared to $429,000 for the three monthsended December 31, 2005.

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The Company had eightactive selling communities in the midwestern region as of December 31, 2006 and2005, respectively.

# **TotalEarned Revenues**

Total earned revenues for the six months ended December 31, 2006decreased $62,061,000, to $322,231,000, or 16.1%, compared to $384,292,000 forthe six months ended December 31, 2005. Residential revenue earned from the sale of residential homes included740 homes totaling $314,944,000 during the six months ended December 31, 2006,as compared to 964 homes totaling $378,875,000 during the six months endedDecember 31, 2005.  The average sellingprice per home delivered increased by approximately 8.4% to $426,000 for thesix months ended December 31, 2006 compared to $393,000 for the six monthsended December 31, 2005.  Customerdiscounts increased to 6.0% of residential revenue earned for the six monthsended December 31, 2006 compared to 1.9% for the same period in the prioryear.  The decrease in residentialrevenue earned is due to the decrease in new order activity and increase incustomer discounts, as described above.

Total earned revenues for the three months ended December 31, 2006decreased $67,522,000, to $157,129,000, or 30.1%, compared to $224,651,000 forthe three months ended December 31, 2005. Residential revenue earned from the sale of residential homes included377 homes totaling $153,172,000 during the three months ended December 31,2006, as compared to 540 homes totaling $220,912,000 during the three monthsended December 31, 2005.  The averageselling price per home delivered remained relatively consistent at $406,000 forthe three months ended December 31, 2006 compared to $409,000 for the threemonths ended December 31, 2005.  Customerdiscounts increased to 8.7% of residential revenue earned for the three monthsended December 31, 2006 compared to 1.9% for the same period in the prior year.  The decrease in residential revenue earned isdue to the decrease in new order activity and increase in customer discounts asoutlined above.

***Northern Region:***

Residential revenue earned for the six months ended December 31, 2006decreased $53,876,000  to $95,322,000, or36.1%, on 196 homes delivered as compared to $149,198,000 on 326 homesdelivered during the six months ended December 31, 2005. The decrease inresidential revenue earned primarily was a result of reduced new order activityin the region which began during the second quarter of fiscal 2006 and hascontinued through the second quarter of fiscal 2007.  The decrease was partially offset by anincrease in the average selling price per home delivered of 

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6.1% to $486,000 for the six months ended December 31, 2006 from$458,000 for the six months ended December 31, 2005 as a result of a shift inthe product mix of homes delivered. Specifically, in the region the Companydelivered a larger percentage of luxury homes during the six months endedDecember 31, 2006 when compared to the same period in the prior fiscalyear.  Customer discounts increased to5.8% of residential revenue earned for the six months ended December 31, 2006compared to 1.5% for the same period in the prior year.  The decrease in new order activity andincrease in customer discounts contributed to the decrease in residentialrevenue earned.

Residential revenue earned for the three months ended December 31, 2006decreased $43,414,000 to $46,731,000, or 48.2%, on 100 homes delivered ascompared to $90,145,000 on 189 homes delivered during the three months endedDecember 31, 2005. The decrease in residential revenue earned was primarily aresult of reduced new order activity in the region which began during thesecond quarter of fiscal 2006 and has continued through the second quarter offiscal 2007.  The decrease was alsoattributable to a decrease in the average selling price per home delivered of2.1%, to $467,000 for the three months ended December 31, 2006 from $477,000for the three months ended December 31, 2005 as a result of a shift in theproduct mix of homes delivered and an increase in customer discounts.  Customer discounts increased to 7.3% ofresidential revenue earned for the three months ended December 31, 2006 comparedto 1.6% for the same period in the prior year. The decrease in residential revenue earned is due to the decrease in neworder activity and average selling price and an increase in customer discountsas outlined above.

***Southern Region:***

Residential revenue earned for the six months ended December 31, 2006decreased $3,656,000 to $135,227,000, or 2.6%, on 284 homes delivered ascompared to $138,883,000 on 355 homes delivered during the six months endedDecember 31, 2005.  The decrease inresidential revenue earned was a result of reduced new order activity in theregion which began during the fourth quarter of fiscal 2006 and has continuedthrough the second quarter of fiscal 2007. The decrease was partially offset by an increase in the average sellingprice per home delivered of 21.7% to $476,000 for the six months ended December31, 2006 from $391,000 for the six months ended December 31, 2005. The increasein the average price per home delivered was attributable to a change in theproduct mix of homes delivered during the six months ended December 31, 2006compared to the six months ended December 31, 2005.  Specifically, in the region, the Companydelivered a larger percentage of luxury and second move-up homes during the sixmonths ended

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December 31, 2006 than the six months ended December 31, 2005.  Customer discounts increased to 4.2% ofresidential revenue earned for the six months ended December 31, 2006 comparedto 3.1% for the same period in the prior year. The increase in customer incentives also contributed to the decrease inresidential revenue earned.

Residential revenue earned for the three months ended December 31, 2006decreased $17,549,000 to $61,534,000, or 22.2%, on 129 homes delivered ascompared to $79,083,000 on 199 homes delivered during the three months endedDecember 31, 2005.  The decrease inresidential revenue earned was a result of reduced new order activity in theregion which began during the fourth quarter of fiscal 2006 and has continuedthrough the second quarter of fiscal 2007. The decrease was partially offset by an increase in the average sellingprice per home delivered of 20.1% to $477,000 for the three months endedDecember 31, 2006 from $397,000 for the three months ended December 31, 2005.The increase in the average price per home delivered was attributable to achange in the product mix of homes delivered during the three months endedDecember 31, 2006 compared to the three months ended December 31, 2005.  Specifically, in the region, the Companydelivered a larger percentage of luxury and second move-up homes during thethree months ended December 31, 2006 than the three months ended December 31,2005.  Customer discounts increased to5.8% of residential revenue earned for the three months ended December 31, 2006compared to 3.0% for the same period in the prior year.  The increase in customer incentives alsocontributed to the decrease in residential revenue earned.

***Florida Region:***

Residentialrevenue earned for the six months ended December 31, 2006 increased $4,856,000to $40,583,000, or 13.6%, on 158 homes, compared to $35,727,000 on 151 homesfor the six months ended December 31, 2005. The increase in residential revenue earned was primarily attributable tothe Company offering sales incentives on its new home inventory in an effort todecrease its new home inventory levels. The Company’s Palm Coast market comprised approximately 44% of theresidential revenue earned for the six months ended December 31, 2006 comparedwith approximately 58% for the same period in the prior fiscal year.  The Company anticipates the Palm Coast marketto become a less significant portion of its residential revenue earned in thefuture.  Customer discounts increased to12.2% of residential revenue earned for the six months ended December 31, 2006compared to 0.3% for the same period in the prior year.  The average selling price per home increased8.4% to $257,000 for the six months ended December 31, 2006 from $237,000 forthe six months ended December 31, 2005. The

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increasein average selling price per home is primarily a result of product mix,specifically related to one community that did not generate residential revenuein the prior fiscal year period.

Residentialrevenue earned for the three months ended December 31, 2006 increased$4,558,000 to $22,406,000, or 25.5%, on 94 homes, compared to $17,848,000 on 72homes for the three months ended December 31, 2005.  The increase in residential revenue earnedwas primarily attributable to the Company offering sales incentives to increasesalens and decrease its new home inventory levels.  Customer discounts increased to 18.0% ofresidential revenue earned for the three months ended December 31, 2006compared to 0.3% for the same period in the prior year.  The average selling price per home decreased4.0% to $238,000 for the three months ended December 31, 2006 from $248,000 forthe three months ended December 31, 2005. The decrease in average selling price per home is primarily a result ofthe increase in customer discounts.

***Midwestern Region:***

Residential revenue earned for the six months ended December 31, 2006decreased $11,255,000 to $43,812,000, or 20.4%, on 102 homes, compared to$55,067,000 on 132 homes for the six months ended December 31, 2005.  The decrease in residential revenue earnedprimarily was a result of reduced new order activity in the region which beganduring the fourth quarter of fiscal 2006 and has continued for the first sixmonths of fiscal 2007.  The decrease waspartially offset by an increase in the average selling price per home deliveredof 3.1% to $430,000 for the six months ended December 31, 2006 from $417,000for the six months ended December 31, 2005. Customer discounts increased to5.8% of residential revenue earned for the six months ended December 31, 2006compared to 0.7% for the same period in the prior year.  The increase in customer discounts alsocontributed to the decrease in residential revenue earned.

Residential revenue earned for the three months ended December 31, 2006decreased $11,335,000 to $22,501,000, or 33.5%, on 54 homes, compared to$33,836,000 on 80 homes for the three months ended December 31, 2005.  The average selling price per home delivereddecreased 1.4% to $417,000 for the three months ended December 31, 2006compared to $423,000 for the three months ended December 31, 2005.  The decrease in residential revenue earnedprimarily was a result of reduced new order activity in the region which beganduring the fourth quarter of fiscal 2006 and has continued for the first sixmonths of fiscal 2007.  Customerdiscounts increased to 9.1% of residential revenue earned for the three monthsended December 31, 2006 compared to 0.6% for the same period in the prioryear.  The increase in customer discountsalso contributed to the decrease in residential revenue earned.

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**Other Income**

Other income consists primarily of property management fees andmortgage processing income.  Other incomefor the six months ended December 31, 2006 increased $1,018,000 to $5,082,000,or 25.0%, compared to $4,064,000 for the six months ended December 31,2005.  The increase in other income wasprimarily attributable to increases in mortgage processing revenue, propertymanagement revenue and miscellaneous income during the six months endedDecember 31, 2006 compared to the six months ended December 31, 2005.  The Company recognized miscellaneous incomeof $550,000 in Other Income in connection with the settlement of outstandingissues relating to a parcel of land in the Company’s northern region that waspreviously under agreement of sale.

Other income for the three months ended December 31, 2006 decreased$226,000 to $2,160,000, or 9.5%, compared to $2,386,000 for the three monthsended December 31, 2005.  The decrease inother income was primarily attributable to decreases in forfeited customerdeposits, interest income earned and mortgage processing revenue during thethree months ended December 31, 2006 compared to the three months endedDecember 31, 2005.

# **Costsand Expenses**

***Cost of Residential Properties:***

The cost of residential properties, including inventory impairments of$9,850,000, for the six months ended December 31, 2006 decreased $25,947,000 to$266,640,000, or 8.9%, when compared with the six months ended December 31,2005.  The decrease in the cost ofresidential properties was primarily attributable to a decrease in residentialproperties revenue, offset by inventory impairment charges and increases ininterest and construction costs.

The cost of residential properties, including inventory impairments of$6,650,000, for the three months ended December 31, 2006 decreased $33,975,000to $135,327,000, or 20.1%, when compared with the three months ended December31, 2005.  The decrease in the cost ofresidential properties was primarily attributable to a decrease in residentialproperties revenue, offset by inventory impairment charges and increases ininterest, land and construction costs.

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***Inventory Impairments:***

As a result of increased sales incentives offeredduring fiscal year 2007 and a decrease in anticipated absorption rates atvarious communities, theCompany recorded impairments to residential properties completed or underconstruction and land held for development or sale and improvement for the sixmonths ended December 31, 2006, in the amounts of $1,750,000 and $8,100,000,respectively.  The Company had no suchcharge in the previous year period. These impairments were charged to the cost of residential properties andwere recorded in various homebuilding segments, most notably with respect tocommunities in the Florida region, and also communities in the Northern regionand Southern region.  The impairment losses recognized represent theamounts by which the book values of the residential properties and land heldfor development and sale exceeded the estimated fair value of the assets.  The inventory impairments wererecorded as a result of a slower than anticipated pace of new orders andincreases in sales incentives required to generate new home orders.

As a result of increased sales incentives offeredduring the second quarter of fiscal year 2007 and a decrease in anticipatedabsorption rates at various communities, the Company recorded impairments to residential properties completed orunder construction and land held for development or sale and improvement forthe three months ended December 31, 2006, in the amounts of $250,000 and$6,400,000, respectively.  The Companyhad no such charge in the previous year period. These impairments were charged to the cost of residential properties andwere recorded in various homebuilding segments, most notably with respect tocommunities in the Florida region, and also communities in the Northern regionand Southern region.

The Company will continue to assess its residential propertiescompleted or under construction and land held for development or sale andimprovement considering changing market conditions.  Continued deterioration in demand and marketconditions could result in a reevaluation of the Company’s inventory, which mayresult in additional impairments to residential properties and land held fordevelopment or sale and improvements. See Liquidity and Capital Resources section below for discussion on theeffect of inventory impairments on the Company’s liquidity.

***Gross Profit Margin:***

The Company’s consolidated gross profit margins were 11.7% and 15.3%during the second quarter and first six months of fiscal 2007, respectively,compared with 23.4% and 22.8% during the same periods in fiscal 2006.

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The Company’s consolidated gross profit margins, excluding inventoryimpairments, were 16.0% and 18.5% during the second quarter and first sixmonths of fiscal 2007, respectively, compared with 23.4% and 22.8% during thesame periods in fiscal 2006.

The decrease in Company’s consolidated gross profit margins, excludinginventory impairments,  was primarilyattributable to reduced gross profit margins in the Company’s Northern, Floridaand Midwest regions that were partially offset by an increase in gross profitmargins in the Company’s Southern region. These decreases primarily resulted from offering higher sales incentivesin order to generate new orders and reduce new home inventory, as well asincreases in  interest, the cost of landand construction materials used in building new homes.

In addition, the Company sells a variety of home types in variouscommunities and regions, each yielding a different gross profit margin.  As a result, depending on the mix of bothcommunities and of home types delivered, the consolidated gross profit marginmay fluctuate up or down on a periodic basis and periodic profit margins maynot be representative of the consolidated gross profit margin for future years.

***Interest Included in Cost of Residential Properties:***

Interest included in the costs and expenses of residential propertieswas $4,292,000 and $7,799,000 during the second quarter and first six months offiscal 2007, respectively, compared with $3,211,000 and $5,430,000 during thesame periods in fiscal 2006.  Theincrease in interest included in the costs and expenses of residentialproperties was attributable to increased interest rates on the Company’svariable rate debt during fiscal 2006 and fiscal 2007 coupled with interestpayments on the Company’s subordinated notes issued in fiscal 2006.  The Company’s subordinated notes have higherinterest rates than the Company’s other debt. The interest incurred during the construction periods is capitalized toinventory and then expensed to the cost of residential properties in the periodin which the home settles.  

**Selling, General & Administrative Expenses:**

The Company’s Selling,General and Administrative Expenses include selling and advertising costs,commissions and other general and administrative costs.  For the six months ended December 31, 2006,selling, general and administrative expenses increased $7,845,000 to$56,420,000, or 16.2%, when compared with the six months ended December 31,2005.  The increase was attributable toincreases in selling and advertising costs, abandoned projects and severancecompensation, partially offset by a decrease in commissions and other incentive

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compensation.  Selling, general and administrative expensesas a percentage of residential revenue earned for the six months ended December31, 2006 increased to 17.9% compared to 12.8% in the same period in the priorfiscal year.  Selling, general andadministrative expenses, excluding abandoned projects and severancecompensation, as a percentage of residential revenue earned for the six monthsended December 31, 2006 increased to 14.6% compared to 12.6% in the same periodin the prior fiscal year.

For the three months ended December 31, 2006, selling, general andadministrative expenses increased $4,133,000 to $31,361,000, or 15.2%, whencompared with the three months ended December 31, 2005.  The increase was attributable to increases inselling and advertising costs, abandoned projects and severance compensation,partially offset by a decrease in commissions and other incentivecompensation.  Selling, general andadministrative expenses as a percentage of residential revenue earned for thethree months ended December 31, 2006 increased to 20.5% compared to 12.3% inthe same period in the prior fiscal year. Selling, general and administrative expenses, excluding abandonedprojects and severance compensation, as a percentage of residential revenueearned for the three months ended December 31, 2006 increased to 14.6% comparedto 11.9% in the same period in the prior fiscal year.

***Selling and Advertising:***

For the six months ended December 31, 2006, selling and advertising costsincreased $3,314,000 to $16,116,000, or 25.9%, when compared with the sixmonths ended December 31, 2005.  Sellingand advertising costs includes advertising, community sales office expense,model home expense, amortization of deferred marketing costs and other sellingcosts.  The increase in selling andadvertising was primarily due to an increase in advertising costs in an effortto generate homebuyer traffic; an increase in landscaping expense in an effortto make the communities more attractive to homebuyers; an increase inmaintenance costs due to the increase in inventory homes; and an increase inthe amortization of deferred marketing costs and other sales office expensesprimarily attributable to an increase in communities open when compared with thesame period in the prior fiscal year.

For the three months ended December 31, 2006, selling and advertisingcosts increased $2,553,000 to $9,079,000, or 39.1%, when compared with thethree months ended December 31, 2005. The increase in selling and advertising was primarily due to an increasein advertising costs in an effort to generate homebuyer traffic; an increase inlandscaping expense in an effort to make the communities more attractive tohomebuyers; an increase in maintenance costs due to the 

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increase in inventory homes; and an increase in the amortization ofdeferred marketing costs and other sales office expenses primarily attributableto an increase in communities open when compared with the same period in theprior fiscal year.

***Commissions:***

The Company’s commission expense was $6,117,000 and $12,143,000 duringthe second quarter and first six months of fiscal 2007, respectively, comparedwith $7,601,000 and $13,506,000 during the same periods in fiscal 2006.  The Company’s commission expense as apercentage of residential revenue earned was 4.0% and 3.9% during the secondquarter and first six months of fiscal 2007, respectively, compared with 3.4%and 3.6% during the same periods in fiscal 2006.

The fiscal 2007 second quarter and year-to-date decrease in commissionexpense is related to the decrease in residential property revenue whencompared with the same periods in the prior fiscal year.  The increase in commissions as a percentageof residential revenue earned is a result of added incentives in an attempt toincrease new home orders.

***General and Administrative:***

At the end of fiscal year 2006 and the beginning of fiscal year 2007,the Company’s backlog began to decline due to the unfavorable market conditionsin the homebuilding industry.  Inaddition, the Company’s cancellations began to increase resulting in anincrease in homes in inventory.  As aresult, the Company began to increase sales incentives in an effort to increasenew orders and backlog and reduce inventory. As a result of these unfavorable conditions in the homebuildingindustry, the Company also began to review its land under option and agreementsof sale to determine if the economics of the transaction were acceptable to theCompany given the state of the market in the homebuilding industry.  For those agreements deemed unfavorable, theCompany attempted to renegotiate the transaction.  If the transaction could not be renegotiatedon terms favorable to the Company, the option or agreement of sale wasterminated resulting in the abandoned project write-off described above.

The Company will continue to assess its land under option and agreementof sale considering changing market conditions. Continued deterioration in demand and market conditions could result ina reevaluation of the Company’s remaining land and lots under option andagreements of sale, which may result in additional abandoned projectwrite-offs.  See Liquidity and CapitalResources section below for discussion on the effect of abandoned projectwrite-offs on the Company’s liquidity.

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For the six months ended December 31, 2006, general and administrativecosts increased $5,894,000 to $28,161,000, or 26.5%, when compared with the sixmonths ended December 31, 2005.  Theincrease in general and administrative costs was primarily due to a) anincrease of $8,648,000 in abandoned project write-offs, which represents duediligence costs and deposits on land projects under option which the Companyelected not to pursue; b) an increase of $1,066,000 for severance compensation; c) an increase of $975,000 incharges for a supplemental executive retirement plan, which was adopted duringthe second quarter of fiscal 2006, and expenses associated with the issuance ofstock options, as a result of the addition of one senior executive in June2006; d) an increase of $431,000 in connection with the Company’s start-upoperation in its West Region, offset by; e) a decrease in salaries andincentive compensation.

For the three months ended December 31, 2006, general and administrativecosts increased $3,064,000 to $16,165,000, or 23.4%, when compared with thethree months ended December 31, 2005. The increase in general and administrative costs was primarily due to a)an increase of $7,187,000 in abandoned project write-offs, which represents duediligence costs and deposits on land projects under option which the Companyelected not to pursue; b) an increase of $1,066,000 for severance compensation; c) an increase of $278,000 incharges for a supplemental executive retirement plan, which was adopted duringthe second quarter of fiscal 2006, and expenses associated with the issuance ofstock options, as a result of the addition of one senior executive in June2006; d) an increase of $217,000 in connection with the Company’s start-upoperation in its West Region, offset by; e) a decrease in salaries andincentive compensation.

# **IncomeTax Expense / (Benefit):**

Income tax expense for the six months ended December 31, 2006 decreased$17,887,000 to an income tax benefit of $2,325,000 for the six months endedDecember 31, 2006.  The decrease inincome tax expense was primarily attributable to a decrease in income fromoperations before income taxes for the six months ended December 31, 2006compared to the six months ended December 31, 2005.

Income tax expense for the three months ended December 31, 2006decreased $14,723,000 to an income tax benefit of $4,783,000 for the threemonths ended December 31, 2006.  Thedecrease in income tax expense was primarily attributable to a decrease in incomefrom operations before income taxes for the three months ended December 31,2006 compared to the three months ended December 31, 2005.

 

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The Company’s consolidated tax rate fluctuates slightly depending uponthe shift in the mix of income from operations before income taxes earned ineach of the Company’s regions.  TheCompany’s effective tax rate was 38.9% and 39.1% during the second quarter andfirst six months of fiscal 2007, respectively, compared with 39.2% and 40.2%during the same periods in fiscal 2006.  The Company’s overall effective tax rate decreased for the three and sixmonths ended December 31, 2006 compared to the three and six months endedDecember 31, 2005 as a result of a decrease in unfavorable permanentdifferences resulting from stock option activity as well as increased taxbenefits resulting from the tax deduction on qualified production activitiesprovided by the American Jobs Creation Act of 2004.

# **N****et Income / Loss:**

The Company reported a net loss of $3,625,000 for the six months endedDecember 31, 2006 compared with net income of $23,194,000 for the six monthsended December 31, 2005.  The net loss isprimarily attributable to reduced gross profit margins due to increased salesincentives in an effort to increase new home orders; inventory impairments ofapproximately $6,009,000, net of tax and an increase in abandoned projectwrite-offs of approximately $5,840,000, net of tax for the six months endedDecember 31, 2006.

The Company reported a net loss of $7,524,000 for the three monthsended December 31, 2006 compared with net income of $15,416,000 for the threemonths ended December 31, 2005.  The netloss is primarily attributable to reduced gross profit margins due to increasedsales incentives in an effort to increase new home orders; inventoryimpairments of approximately $4,057,000, net of tax, and an increase inabandoned project write-offs of approximately $4,912,000, net of tax, for thesix months ended December 31, 2006.

***Northern Region:***

The Northern Region net loss was $3,369,000 for the first six months offiscal 2007 compared with net income of $15,475,000 for the same period infiscal 2006.  The Northern Region netloss was $4,589,000 for the second quarter of fiscal 2007 compared with netincome of $10,249,000   for the sameperiod in fiscal 2006.  The decrease innet income of $14,838,000 and $18,844,000 for the three months and six monthsended December 31, 2006 when compared with the prior year is primarily due tounfavorable market conditions in the housing industry, as described above,resulting in a decrease in residential revenue earned and gross profit margin.In addition, due to unfavorable market conditions, the Company recordedinventory impairments of

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$2,379,000, net of tax, in the Northern Region as a result of a slowerthan anticipated pace of new orders and increases in sales incentives.  Further,the Company recorded abandoned project write-offs of $3,980,000, net oftax, which represents due diligence costs and deposits on land projects underoption which the Company elected not to pursue. The aforementioned items negatively impacted net income in the NorthernRegion for the three and six months ended December 31, 2006 when compared withthe same periods in the prior fiscal year.

***Southern Region:***

The Southern Region net income was $5,459,000 for the first six monthsof fiscal 2007 compared with $6,319,000 for the same period in fiscal 2006.  The Southern Region net income was $1,077,000for the second quarter of fiscal 2007 compared $4,111,000 for the same periodin the prior fiscal year.  The decreasein net income of $3,034,000 and $860,000 for the three months and six monthsended December 31, 2006 when compared with the prior year is primarily due tounfavorable market conditions in the housing industry, as described above,resulting in a decrease in residential revenue earned and gross profit.  In addition, the Company recorded inventory impairmentsof $549,000, net of tax, in the Southern Region.  Further,the Company recorded abandoned project write-offs of $808,000, net oftax, which represents due diligence costs and deposits on land projects underoption which the Company elected not to pursue. The aforementioned items negatively impacted net income in the SouthernRegion for the three and six months ended December 31, 2006 when compared withthe same periods in the prior fiscal year.

***Florida Region:***

The Florida Region net loss was $2,669,000 for the first six months offiscal 2007 compared with net income of $1,497,000 for the same period infiscal 2006.  The Florida Region net losswas $2,090,000 for the second quarter of fiscal 2007 compared with net incomeof $738,000 for the same period in fiscal 2006. The decrease in net income of$2,828,000 and $4,166,000 for the three months and six months ended December31, 2006 when compared with the prior year is primarily due to unfavorablemarket conditions in the housing industry, as described above, resulting in adecrease in gross profit margin.  Specifically in the Florida Region, the Company experienced high neworder cancellation rates as investors continued to exit various markets in theFlorida region.  This resulted in anincrease in new home inventory levels, causing the Company to increase salesincentives in an effort to decrease its new home inventory levels.  The increased sales incentives led to adecrease in gross profit margins thereby negatively impacting net income in theFlorida Region.  The slower thananticipated pace of new orders and increased

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sales incentives resulted in an inventory impairment charge of$2,928,000, net of tax, further reducing net income in the Florida Region forthe six months ended December 31, 2006. The aforementioned items negativelyimpacted net income in the Florida Region for the three and six months endedDecember 31, 2006 when compared with the same periods in the prior fiscal year.

***Midwestern Region:***

The Midwest Region net income was $216,000 for the first six months offiscal 2007 compared with $3,029,000 for the same period in fiscal 2006.  The Midwest Region net loss was $831,000 forthe second quarter of fiscal 2007 compared with net income of $2,237,000 forthe same period in the prior fiscal year. The decrease in net income of $3,068,000 and $2,813,000 for the threemonths and six months ended December 31, 2006 when compared with the prior yearis primarily due to unfavorable market conditions in the housing industry, asdescribed above, resulting in a decrease in residential revenue earned andgross profit margin.  In addition, due tounfavorable market conditions, the Company recorded inventory impairments of$153,000, net of tax, in the Midwestern Region as a result of a slower than anticipatedpace of new orders and increases in sales incentives.  Further,the Company recorded abandoned project write-offs of $916,000, net oftax, which represents due diligence costs and deposits on land projects underoption which the Company elected not to pursue. The aforementioned itemsnegatively impacted net income in the Midwestern Region for the three and sixmonths ended December 31, 2006 when compared with the same periods in the priorfiscal year.

**Liquidityand Capital Resources**

On an ongoing basis, the Company requires capital to purchase anddevelop land, to construct homes, to fund related carrying costs and overheadand to fund various advertising and marketing programs to facilitatesales.  These expenditures include sitepreparation, roads, water and sewer lines, impact fees and earthwork, as wellas the construction costs of the homes and amenities.  The Company’s sources of capital includefunds derived from operations, sales of assets and various borrowings, most ofwhich are secured.  During the secondquarter of fiscal year 2007, the Company repaid the $5,000,000 note outstandingin connection with the Realen acquisition. In January 2007, the Company entered into an agreement of sale to sell aparcel of land in its Southern Region for approximately $13,600,000.  The Company expects to complete this sale inearly February 2007 and to net approximately $10,000,000 in available cash fromthis transaction.  With the proceeds fromthis transaction, the Company expects to repay outstanding obligations underits Revolving Credit Facility described below. The Company believes that cash on hand, funds generated from operationsand financial commitments from available lenders will provide

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sufficient capital for the Company to meet its existing operating needsthrough June 30, 2007.  However, for adiscussion of a projected debt covenant violation at June 30, 2007, see theDefault under Revolving Credit Facility section below.

***Default under Revolving CreditFacility:***

As a result of the Company’s inventory impairment andabandoned project charges, the Company was in violation of its debt serviceratio covenant at December 31, 2006.  Thedebt service ratio is the Company’s Adjusted EBITDA to debt service, as definedin the Amended and Restated Credit Agreement described below.  Each component, Adjusted EBITDA and debtservice, is comprised of the trailing twelve month’s activity.  Subsequent to December 31, 2006 and prior tothe filing of the Company’s Form 10-Q for the second quarter of fiscal 2007,the Company entered into an amendment to the Amended and Restated CreditAgreement (“Second Amendment to the Amended and Restated Credit Agreement”).  As a result, on February 7, 2007, and as ofDecember 31, 2006, the Company was in compliance with the covenants containedin the Amended and Restated Credit Agreement, as amended.  At December 31, 2006, approximately$511,950,000 of borrowings and approximately $40,724,000 of letters of creditand other assurances were outstanding under the Revolving Credit Facility.  See details of the Second Amendment to theAmended and Restated Credit Agreement below.

During the course of completing its projected debtcovenant compliance calculations for the remainder of the fiscal year, and dueto current unfavorable conditions in the homebuilding industry, the Companydetermined that it is unlikely that it will meet its debt service ratiocovenant at June 30, 2007.  A violationof this covenant, unless waived by the lenders or otherwise cured, wouldconstitute an event of default under the Revolving Credit Facility, giving thelenders the right to terminate their obligations to make additional loans underthe Revolving Credit Facility, demand immediate payment in full of all amountsoutstanding, foreclose on collateral and exercise other rights and remediesgranted under the Revolving Credit Facility and related loan documents and asmay be available pursuant to applicable law. The Company is currently in discussions with its lenders with respect tothe potential violation of its debt service covenant with a view towardobtaining an amendment or waiver of the covenant so as to be incompliance.  While the Company believesit can negotiate an acceptable resolution, there can be no assurance that theCompany will be able to negotiate an amendment or waiver or that such amendmentor waiver will be on terms acceptable to the Company.  If the Company is unable to obtain a waiverfrom its lenders, it could have a material adverse effect on the Company’sfinancial position.

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***Revolving Credit Facility:***

At December 31, 2006, theCompany had $97,326,000 of borrowing capacity under its secured revolvingcredit facility discussed below, of which $3,536,000 was available to be drawnbased upon the Company’s borrowing base. A majority of the Company’s debt is variable rate, primarily based on30-day LIBOR, and therefore, the Company is exposed to market risk inconnection with interest rate changes. At December 31, 2006, the 30-day LIBOR rate of interest was 5.32%.

OnJanuary 24, 2006, Greenwood Financial, Inc., a wholly-owned subsidiary of theCompany and other wholly-owned subsidiaries of the Company, as borrowers, andOrleans Homebuilders, Inc. as guarantor, entered into an Amended and RestatedRevolving Credit and Loan Agreement (as amended, the “Amended and RestatedCredit Agreement”) for a $650,000,000 Senior Secured Revolving Credit andLetter of Credit Facility (the “Revolving Credit Facility”) with various banksas lenders.  The Amended and RestatedCredit Agreement was amended on November 1, 2006 (“First Amendment to theAmended and Restated Credit Agreement”).

Underand subject to the terms of the Revolving Credit Facility, the borrowers mayborrow and re-borrow for the purpose of financing the acquisition anddevelopment of real estate, the construction of homes and improvements, forinvestment in joint ventures, for working capital and for such otherappropriate purposes as may be approved by the lenders.  The Revolving Credit Facility is primarilycollateralized by real estate held for development and sale.  In addition, in connection with the Amendedand Restated Credit Agreement, the Company entered into an amended and restatedGuaranty Agreement.

TheRevolving Credit Facility has a maturity date of December 20, 2008 and may beincreased to $750,000,000 under certain circumstances.  Borrowings and advances under the RevolvingCredit Facility bear interest on a per annum basis equal to the LIBOR MarketIndex Rate plus a non-default variable spread ranging from 165 basis points to225 basis points, depending upon the Company’s leverage ratio.  During the term of the Revolving CreditFacility, interest is payable monthly in arrears.  At December 31, 2006, the interest rate was7.45%, which included a 212.5 basis point spread.

TheCompany is subject to certain financial ratios and customary covenants as setforth in the Amended and Restated Credit Agreement.  These financial ratios and covenants include,but are

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notlimited to, debt service; consolidated adjustable tangible net worth; leverage;investments in joint ventures, land held for development and sale andspeculative inventory; and limitations on subordinated and purchase moneymortgage debt.  As described below, theAmended and Restated Credit Agreement was amended on November 1, 2006 andFebruary 7, 2007.  As a result of theNovember 1, 2006 and February 7, 2007 amendments, the Company was in compliancewith all applicable financial ratios and covenants in the Amended and RestatedCredit Agreement as of September 30, 2006 and December 31, 2006, respectively.

***First Amendment to the Amendedand Restated Credit Agreement dated November 1, 2006:***

On November 1, 2006, theCompany’s Amended and Restated Credit Agreement described above was amended asfollows:

·                  The required debt service ratio was reducedfrom 2.25-to-1.00 for the entire term of the revolving credit facility to2.25-to-1.00 at September 30, 2006; 2.00-to-1.00 at December 31, 2006;1.65-to-1.00 at March 31, 2007, 1.50-to-1.00 at June 30, 2007 through December31, 2007; 1.65-to-1.00 at March 31, 2008; and 1.80-to-1.00 at June 30, 2008through December 31, 2008.  In addition,the Company’s debt service ratio must be greater than or equal to 1.75-to-1.00as of the last day of at least two fiscal quarters in each rolling period offive consecutive quarters, beginning with the period of five consecutive fiscalquarters ending September 30, 2006.

·                  The definition of debt service included inthe calculation of the debt service ratio was modified to exclude the repaymentof the $5,000,000 note issued to the former owners of Realen Homes.  See Note (B) in the Notes to the ConsolidatedFinancial Statements for a discussion of the terms of the $5,000,000 note thatwas issued in connection with the acquisition of Realen Homes.

·                  The non-default variable interest rate spreadwill be increased by 25 basis points when the Company’s debt service ratio isless than 2.25-to-1.00.

·                  The permitted ratio of all land owned whichis not subject to a qualifying agreement of sale and on which no unit has beenor is being constructed to the Company’s consolidated adjusted tangible networth was reset to 1.85-to-1.00 at September 30, 2006 through December 31,2006; 1.75-to-1.00 at March 31, 2007 through June 30, 2007; 1.65-to-1.00 atSeptember 30, 2007 through December 31, 2007; and 1.50-to-1.00 from March 31,2008 through December 31, 2008.

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·                  The permitted minimum consolidated tangiblenet worth was reset to 90% of the Company’s consolidated tangible net worth atSeptember 30, 2006 plus an amount equal to 50% of the net income earned duringeach fiscal quarter that ends after September 30, 2006 and all of the netproceeds of equity securities issued by the Company after September 30,2006.  In addition, the definition ofconsolidated tangible net worth was modified to exclude any intangible assetsrecognized in connection with the Company’s supplemental executive retirementplan.  Prior to the amendment to theAmended and Restated Credit Agreement, the permitted minimum consolidatedtangible net worth was defined as $180,000,000 plus an amount equal to 50% ofthe net income earned during each fiscal quarter that ended after December 31,2005 and all of the net proceeds of equity securities issued by the Companyafter December 31, 2005.

·                  The required financial metrics that allow forthe unsecured election provided under the Revolving Credit Facility wererevised to a leverage ratio that is less than or equal to 2.00-to-1.00; a debtservice ratio that is greater than or equal to 2.25-to-1.00; and a ratio of allland owned which is not subject to a qualifying agreement of sale and on whichno unit has been or is being constructed to the Company’s consolidated adjustedtangible net worth is less than or equal to 1.25-to-1.00. If these financialmetrics are in place for two consecutive quarters, then the Company may requesta release of all collateral under the Revolving Credit Facility.

***Second Amendment to the Amendedand Restated Credit Agreement dated February 7, 2007:***

OnFebruary 7, 2007, the Company’s Amended and Restated Credit Agreement wasfurther amended as follows:

·                  Adjusted EBITDA as defined in the Amended andRestated Credit Agreement was revised for the debt service ratio covenant.  The revised Adjusted EBITDA used for the debtservice ratio covenant was revised to include add-backs for inventoryimpairments and abandoned project write-offs, plus certain other non-cashcharges and extraordinary losses, and deductions for certain other non-cashcredits and extraordinary gains.  Withoutthis adjustment the Company’s debt service ratio would have been 1.61 to 1.00at December 31, 2006

·                  The required debt service ratio was reducedfrom 1.65-to-1.00 to 1.50-to-1.00 at March 31, 2007.

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·                  The permitted ratio of all land owned whichis not subject to a qualifying agreement of sale and on which no unit has beenor is being constructed to the Company’s consolidated adjusted tangible networth was reset from 1.85-to-1.00 to 1.90-to-1.00 at December 31, 2006 and from1.75-to-1.00 to 1.90-to-1.00 at March 31, 2007. At December 31, 2006 this ratio was 1.85-to-1.00

***Trust Preferred Securities:***

OnNovember 23, 2005, the Company issued $75,000,000 of trust preferred securitieswhich mature on January 30, 2036 and are callable, in whole or in part, at parplus accrued interest on or after January 30, 2011.  For the first ten years, the securities havea fixed interest rate of 8.61% per annum. Thereafter, the securities have a floating interest rate equal tothree-month LIBOR plus 360 basis points per annum, resetting quarterly. In theevent the Company fails to meet certain financial covenants for threeconsecutive quarters, the applicable rate of interest will be increased by 300basis points until such time as the Company is in compliance with the financialcovenants, then the interest rate will return to its original amount.  It is an event of default if the increasedinterest rate is in effect for four consecutive quarters.  The occurrence of an event of default, maytrigger demand for immediate payment in full of all amounts outstanding,whereupon all outstanding amounts will be immediately due and payable.  At December 31, 2006 the Company failed tomeet the Interest Coverage Ratio Covenant of 1.75-to-1.00.  Under the indenture, the Interest CoverageRatio is defined as the Company’s Adjusted EBITDA to debt service for thetrailing twelve month period.  This wasthe first quarter the Company failed to meet any financial covenants under thetrust preferred securities.  Thetransaction is treated as debt for financial statement purposes.  The Company used proceeds from the sale ofthese securities to repay outstanding obligations under the Revolving CreditFacility discussed above.

OnSeptember 20, 2005, the Company issued $30,000,000 of trust preferredsecurities which mature on September 30, 2035 and are callable, in whole or inpart, at par plus accrued interest on or after September 30, 2010.  For the first ten years, the securities havea fixed interest rate of 8.52% per annum. Thereafter, the securities have a floating interest rate equal tothree-month LIBOR plus 380 basis points per annum, resetting quarterly.  The transaction is treated as debt forfinancial statement purposes.  TheCompany used proceeds from the sale of these securities to fund land purchasesand residential construction.  Theobligations relating to the trust preferred securities are subordinated to theRevolving Credit Facility.

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***Employee Retirement Plan:***

On December 1, 2005, the Company adopted a non-qualified target defined benefit retirement plan, effective as of September 1, 2005, which covers a group of management employees of the Company.  This Supplemental Executive Retirement Plan (the “SERP”) is intended to provide to each participant an annual supplemental retirement benefit based upon their years of service with the Company and highest average compensation for five consecutive years.  The annual supplemental benefit for each participant will be adjusted based on the actual performance of the SERP compared to the target. The benefit is payable for life with a minimum of 10 years guaranteed. In order to qualify for normal retirement benefits, a participant must attain age 65 with at least five years of participation in the SERP. Early retirement will be permitted beginning at age 55, after 5 years of participation in the Plan. Early retirement benefits will be adjusted actuarially to reflect the early retirement date.

If a participant terminates employment with the Company prior to attaining his or her normal retirement date, other than by reason of early retirement, death or disability, the participant will forfeit all benefits under the SERP.

The Company can amend or terminate the SERP at any time. However, no termination will affect the participants’ accrued benefits as determined in accordance with the SERP or delay any payments to a participant beyond the time that such amount would otherwise be payable without regard to the amendment.

The Company used a 4% annual compensation increase and a 6.16% discount rate in its calculation of the present value of its projected benefit obligation at June 30, 2006.  The discount rate used represented the Moody’s AA bond rate for long-term bonds as of June 30, 2006.  The Company recognized the following costs related to the SERP for the period ended December 31, 2006:

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|                                     | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **December 31,**            | ** ** |
| ** **                          | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                          | ** ** | **(Unaudited)**                  | ** ** |
| ** **                          | ** ** | **(in thousands)**          | ** ** |
| Net periodic  pension cost:         |       |                             |       |                           |       |   |   |   |   |
| Service cost                        |       | $                                | 201,000    |                           | $          | 180,000 |   | $ | 371,000 |   | $ | 180,000 |   |
| Interest cost                       |       | 127,000                          |       | 103,000                        |       | 221,000 |   | 103,000 |   |
| Amortization of  prior service cost |       | 91,000                           |       | 111,000                        |       | 181,000 |   | 111,000 |   |
| Total net periodic  pension cost    |       | $                                | 419,000    |                           | $          | 394,000 |   | $ | 773,000 |   | $ | 394,000 |   |

 

As the SERP was not adopted until December 1, 2005, the Company did notrecognize any net periodic pension costs during the three months endedSeptember 30, 2005.

***Deferred Compensation Plan:***

On December 1, 2005, the Company adopted an Executive Compensation Deferral Plan (the “Deferral Plan”) effective as of June 1, 2005.  Under the Plan, participants will have the ability to defer a portion of their compensation which will be credited to an account maintained by the Company for the participant. Amounts contributed by participants are always vested. Participant deferral accounts will be maintained by the Company for recordkeeping purposes only. Participants will have no interest in any assets which may be set aside by the Company to meet its obligations under the Deferral Plan.  At December 31, 2006, the Company had obligations totaling $1,583,000 in connection with the Deferral Plan.  The deferred compensation is included in accrued expenses on the Company’s Consolidated Balance Sheet at December 31, 2006.

***Share Repurchase Program:***

In September 2005, the Board of Directors authorized the repurchase ofup to one million shares of the Company’s common stock.  The repurchases, which represent up to 5% ofthe Company’s 18.7 million shares of common stock currently outstanding, willbe made from time to time through open market purchases or privately negotiatedtransactions at the Company’s discretion and in accordance with the rules ofthe Securities and Exchange Commission. The amount and timing of the repurchases will depend on marketconditions and other factors.

TheCompany did not repurchase any shares under the share repurchase program duringthe six months ended December 31, 2006.

 

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***Cash Flow Statement:***

Net cash used in operating activities for the six months ended December31, 2006 was $74,545,000, compared to net cash used in operating activities forthe prior year six month period of $151,509,000.  The decrease was primarily attributable to adecrease in cash used for real estate held for development and sale relating tosite improvement costs for land previously acquired and land acquisitions. Thedecrease in cash used for land deposits and costs of future development coupledwith decreased net income and increased write-offs associated with real estateheld for development and sale and land deposits and costs of future developmentalso contributed to the decrease in cash used in operating activities. Net cashused in investing activities for the six months ended December 31, 2006 was$175,000, compared to $678,000 for the prior fiscal period.  This decrease was attributable to a decreasein fixed asset additions.  Net cashprovided by financing activities for the six months ended December 31, 2006 was$83,729,000, compared to $132,310,000 for the prior fiscal period.  The majority of this decrease relates to adecrease in net borrowings for the six months ended December 31, 2006 whencompared with the same period in the prior fiscal year.

Cash dividends are approved on a quarterly basis by the Company’s Boardof Directors, subject to its discretion. Net cash provided by operating activities is used to pay cash dividends.

**LotPositions**

As of December 31, 2006, the Company owned or controlled approximately13,100 building lots.  Included in theaforementioned lots, the Company had contracted to purchase, or has underoption, undeveloped land and improved building lots for an aggregate purchaseprice of approximately $258,257,000 that are expected to yield approximately4,500 building lots.

***Undeveloped Land Acquisitions:***

In recent years, the process of acquiring desirable undeveloped landhas become extremely competitive, particularly in the northern region, mostlydue to the lack 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, the Companystructures its land acquisitions so that it has the right to cancel itsagreements to purchase undeveloped land by forfeiture of its deposit under theagreement.  For the six months endedDecember 31, 2006, the Company forfeited $2,908,000 of land deposits andexpensed an additional $6,701,000 of pre-acquisition costs related to thecancellation of purchase agreements.  TheCompany will continue to assess its 

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investment in land deposits and costs of future development consideringchanging market conditions.  Continueddeterioration in demand and market conditions could result in a decision towalk away from additional land and lot options and a reevaluation of theCompany’s investment in land deposits and costs of future development which mayresult in additional write-offs. Included in the balance sheet captions “Inventorynot owned — Variable Interest Entities” and “Land deposits and costs of futuredevelopment,” at December 31, 2006, the Company had $25,078,000 invested in 33parcels of undeveloped land, of which $14,368,000 was deposits, a portion ofwhich is non-refundable.  At December 31,2006, overall undeveloped parcels of land under contract had an aggregatepurchase price of approximately $197,996,000 and were expected to yieldapproximately 3,855 building lots.

The Company attempts to further mitigate the risks involved inacquiring undeveloped land by structuring its undeveloped land acquisitions sothat the deposits required under the agreements coincide with certainbenchmarks in the governmental approval process, thereby limiting the amount atrisk.  This process allows the Company toperiodically review the approval process and make a decision on the viabilityof developing the acquired parcel based upon expected profitability.  In some circumstances the Company may berequired to make deposits solely due to the passage of time.  This structure still provides the Company anopportunity to periodically review the viability of developing the parcel ofland.  In addition, the Company primarilystructures its agreements to purchase undeveloped land to be contingent uponobtaining all governmental approvals necessary for construction.  Under most agreements, the Company securesthe responsibility for obtaining the required governmental approvals as theCompany believes that it has significant expertise in this area.  The Company intends to complete theacquisition of undeveloped land after all governmental approvals are in place.  In certain circumstances, however, when allextensions have been exhausted, the Company must make a decision on whether toproceed with the purchase even though all governmental approvals have not yetbeen received.  In these circumstances,the Company performs reasonable due diligence to ascertain the likelihood thatthe necessary governmental approvals will be granted.

***Improved Lot Acquisitions:***

The process of acquiring improved building lots from developers isextremely competitive.  The Companycompetes with many national homebuilders to acquire improved building lots,some of which have greater financial resources than the Company.  The acquisition of improved lots is usuallyless risky than the acquisition of undeveloped land as the contingencies andrisks involved 

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in the land development process are borne by the developer.  In addition, governmental approvals aregenerally in place when the improved building lots are acquired.

At December 31, 2006, the Company had contracted to purchase or hadunder option approximately 651 improved building lots for an aggregate purchaseprice of approximately $60,261,000.  AtDecember 31, 2006, the Company had $2,981,000 invested in these improvedbuilding lots, of which $2,723,000 is deposits. There were no deposits forfeited during the six months ended December31, 2006 with respect to improved building lots.

TheCompany expects to utilize primarily the Revolving Credit Facility as describedabove as well as other existing capital resources, to finance the acquisitionsof undeveloped land and improved lots described above.  The Company anticipates completing a majorityof these acquisitions during the next several years.

**CriticalAccounting Policies**

For a discussion of the Company’s critical accounting policies, see “CriticalAccounting Policies” under Item 7 of the Company’s Annual Report on Form 10-Kfor fiscal year ended June 30, 2006 filed with the Securities and ExchangeCommission on September 11, 2006.

# **Recent AccountingPronouncements**

***Accounting for financial statement misstatements:***

InSeptember 2006, the SEC staff issued Staff Accounting Bulletin No. 108, “Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements” (“SAB 108”). SAB 108 was issued in order toeliminate the diversity of practice surrounding how public companies quantifyfinancial statement misstatements.

Traditionally,there have been two widely-recognized methods for quantifying the effects offinancial statement misstatements: the “roll-over” method and the “iron curtain”method. The roll-over method focuses primarily on the impact of a misstatementon the income statement—including the reversing effect of prior yearmisstatements—but its use can lead to the accumulation of misstatements in thebalance sheet. The iron-curtain method, on the other hand, focuses primarily onthe effect of correcting the period-end balance sheet with less emphasis on thereversing effects of prior year errors on the income statement. The Companycurrently uses the roll-over method for quantifying identified financialstatement misstatements.

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InSAB 108, the SEC staff established an approach that requires quantification offinancial statement misstatements based on the effects of the misstatements oneach of the company’s financial statements and the related financial statementdisclosures. This model is commonly referred to as a “dual approach” because itrequires quantification of errors under both the iron curtain and the roll-overmethods.

SAB108 permits existing public companies to initially apply its provisions eitherby (i) restating prior financial statements as if the “dual approach” hadalways been used or (ii) recording the cumulative effect of initially applyingthe “dual approach” as adjustments to the carrying values of assets andliabilities as of January 1, 2006 with an offsetting adjustment recorded to theopening balance of retained earnings. Use of the “cumulative effect” transitionmethod requires detailed disclosure of the nature and amount of each individualerror being corrected through the cumulative adjustment and how and when itarose.

TheCompany will initially apply the provisions of SAB 108 using the cumulativeeffect transition method in connection with the preparation of its annualfinancial statements for the fiscal year ending June 30, 2006.  The application of SAB 108 will not have amaterial impact on the Company’s financial statements.

***Accounting for defined benefit pensions and other postretirementbenefits:***In September2006, the Financial Accounting Standards Board (“FASB”) issued Statement ofFinancial Accounting Standards No. 158, “Employers’ Accounting for DefinedBenefit Pension and Other Postretirement Plans” (“SFAS 158”).   SFAS 158 requires companies to recognize theoverfunded or underfunded status of a single-employer defined benefitpostretirement plan as an asset or liability in its statement of financialposition and to recognize the changes in that funded status in comprehensiveincome in the year in which the changes occur. In addition, SFAS 158 requires companies to measure the funded status ofa plan as of the date of its year-end statement of financial position, withlimited exceptions.  The effective datefor the adoption of SFAS 158 for publicly traded companies is as of the end ofthe fiscal years ending after December 15, 2006.  The Company will adopt SFAS 158 as of June30, 2007 and its impact is to eliminate the Company’s intangible asset that wasrecognized in connection with the application of SFAS No. 87, “Employers’Accounting for  Pensions” (“SFAS 87”), reducethe Company’s other comprehensive income, and increase the Company’s accruedexpenses.

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***Accounting for share based payments:***In December 2004,the FASB revised SFAS No. 123 through the issuance of SFAS No. 123-R “ShareBased Payment”, revised (“SFAS 123-R”).  SFAS 123-R was effective for theCompany commencing July 1, 2005.  SFAS 123-R, among other things,eliminates the alternative to use the intrinsic value method of accounting forstock based compensation and requires entities to recognize the cost ofemployee services received in exchange for awards of equity instruments basedon the grant-date fair value of those awards.  The fair value based methodin SFAS 123-R is similar to the fair-value-based method in SFAS No. 123 in mostrespects, subject to certain key differences.  As the Company previouslyadopted the fair value recognition provisions of SFAS No. 123 prospectively forall stock awards granted, commencing on July 1, 2002, the impact of themodified prospective adoption of SFAS 123-R did not have a significant impacton the financial position or results of operations of the Company.  The Company amortizes compensation expense ona straight line basis over the vesting period of each option grant.  The Company utilizes the Black-Scholes optionpricing model to calculate the compensation expense associated with stockoptions.  For the six months endedDecember 31, 2006, the Company recorded pretax compensation expense associatedwith stock awards of $906,000.  Totalcompensation cost related to nonvested awards not yet recognized of $5,353,000will be recognized according to vesting schedules through March 2015.  For the six months ended December 31, 2006,the Company recognized a $948,000 tax benefit resulting from the exercise of230,000 non-qualified stock options by Michael T. Vesey, President and ChiefOperating Officer and Joseph A. Santangelo, former Chief Financial Officer.

***Accounting for income taxes:***In June 2006, theFASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes — An interpretation of FASB Statement 109” (“FIN 48”).  FIN 48 prescribes a more-likely than notrecognition threshold as well as a measurement attribute for the financialstatement recognition and measurement of tax positions taken or expected to betaken in a tax return, FIN 48 is effective for fiscal years beginning afterDecember 15, 2006.  The Company iscurrently evaluating the impact of the adoption of FIN 48.

In December 2004, the FASB issued FASB StaffPosition No. FAS 109-1, “Application of FASB Statement No. 109, Accounting forIncome Taxes, for the Tax Deduction on Qualified Production Activities Providedby the American Jobs Creation Act of 2004” (“FSP FAS 109-1”). FSP FAS 109-1clarifies that the deduction will be treated as a “special deduction” asdescribed in Statement of Financial Accounting Standards No. 109, “Accountingfor Income Taxes.” As such, 

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the special deduction has no effect on deferred taxassets and liabilities existing at the date of enactment. The impact of the deductionwill be reported in the period in which the deduction is claimed. The Companyfiles a consolidated return on a calendar year. Accordingly, the Company beganreflecting the special deduction with respect to its operations effectiveJanuary 1, 2005.  Its impact was to lower the effective tax provision inthe periods in which the deduction was claimed and that this benefit willincrease as the deduction is phased in under the statute.

CautionaryStatement for Purposes of the “Safe Harbor” Provisions of the PrivateSecurities Litigation Reform Act of 1995

In addition to historical information, this report contains statementsrelating to future events or our future results.  These statements are forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933 andSection 21E of the Securities Exchange Act of 1934, as amended (the “ExchangeAct”), and are subject to the Safe Harbor provisions created by statute.  Generally words such as “may”, “will”, “should”,“could”, “anticipate”, “expect”, “intend”, “estimate”, “plan”, “continue”, and “believe”or the negative of or other variation on these and other similar expressionsidentify forward-looking statements. These forward-looking statements including, without limitation, statementswith respect to potential liabilities relating to litigation currently pendingagainst us, anticipated reductions in inventory, market conditions, anticipatedfuture dividends, anticipated delivery of homes in backlog, expected warrantycosts, future land acquisitions, the direction of the housing market 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 for the fiscal year endedJune 30, 2006.

Forward-looking statements are based on current expectationsand involve risks and uncertainties and our future results could differsignificantly from those expressed or implied by our forward-lookingstatements.

Many factors could cause our actual consolidated results to differmaterially from those expressed in any of our forward-looking statements.

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**Item 3.****                    Quantitative and QualitativeDisclosures About Market Risk**

Market risk represents the risk of loss that may impact the financialposition, results of operations or cash flows of the Company, due to adversechanges in financial 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 or the prime rate,and, therefore, affected by changes in market interest rates.  Based on current operations, an increase ordecrease in interest rates of 100 basis points will result in a correspondingincrease or decrease in cost of sales and interest charges incurred by theCompany of approximately $5,120,000 in a fiscal year, a portion of which willbe capitalized and included in cost of sales as homes are delivered.  The Company believes that reasonably possiblenear-term interest rate changes will not result in a material negative effecton future earnings, fair values or cash flows of the Company.  Generally, the Company has been able torecover any increased costs of borrowing through increased selling prices;however, there is no assurance the Company will be able to continue to increaseselling prices to cover the effects of any increase in near-term interestrates.

Changes in the prices of commodities that are a significant componentof home construction costs, particularly lumber, may result in unexpected shortterm increases in construction costs. Since the sales price of the Company’s homes is fixed at the time thebuyer enters into a contract to acquire a home and because the Companygenerally contracts to sell its homes before construction begins, any increasein costs in excess of those anticipated may result in gross margins lower thananticipated for the homes in the Company’s backlog.  The Company attempts to mitigate the marketrisks of price fluctuation of commodities by entering into fixed-pricecontracts with its subcontractors and material suppliers for a specified periodof time, generally commensurate with the building cycle.

There have been no material adverse changes to the Company’s (1)exposure to market risk and (2) management of these risks, since June 30, 2006.

**Item 4.****          ****                Controlsand Procedures**

The Company’s management, with the participation of the Company’s ChiefExecutive Officer, President and Chief Operating Officer, and Acting ChiefFinancial Officer, evaluated the effectiveness of the Company’s disclosure controlsand procedures as of the end of the period covered by this report.  Based upon that evaluation, the ChiefExecutive Officer, President and Chief Operating Officer and Acting ChiefFinancial Officer concluded that the Company’s disclosure controls andprocedures are functioning effectively to provide reasonable assurance 

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that information required to be disclosed by the Company in reportsfiled under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time periods specified in the Security andExchange Commission’s rules and forms and also to ensure information requiredto be disclosed is accumulated and communicated to management.  There has been no change in the Company’sinternal control over financial reporting during the Company’s most recentfiscal quarter that has materially affected, or is reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

 

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**PART II.  OTHERINFORMATION**

**Item 1.****                                                          ****Legal Proceedings.**

TheCompany is currently involved in three separate actions involving injuries onthe job allegedly suffered by employees of its subcontractors and one wrongfuldeath and survival action of which the potential claim and ultimate outcome iscurrently unknown.  The injuries rangefrom various fractures requiring surgery to low back and neck injuries.  Given the uncertainty surrounding theultimate outcome of the claims, the Company has not recorded any reserve withrespect to these claims at December 31, 2006.  The Company is self-insured up to $2,000,000 for each general liabilityclaim with a $25,000,000 general liability umbrella policy thereafter.  See Note (M) for additional information onthe Company’s self-insurance policy. With respect to these claims, the Company is aggressively pursuing theinsurance and indemnification available to it from its subcontractors.  While the Company currently believes that theultimate outcome of these claims, individually and in the aggregate, will nothave a material adverse effect on the financial position, operating results orcash flows of the Company, litigation is subject to inherentuncertainties.  If an unfavorable outcomewere to occur, there exists the possibility of a material adverse impact on theCompany’s net income in the period in which the unfavorable outcome occurs.

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

**Item 1A.****                                                 ****Risk Factors.**

Set forth below isa discussion of the material changes in our risk factors as previouslydisclosed in Item 1A of Part I of our Annual Report on Form 10-K forthe fiscal year ended June 30, 2006 (“2006 Form 10-K”).

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The informationpresented below updates, and should be read in conjunction with, the riskfactors and other information disclosed in our 2006 Form 10-K.

***Deterioration of market conditions in the homebuildingindustry and customer demand could adversely affect our results of operations.***

During the quarterended December 31, 2006, we decided not to pursue development of certainparcels of land on which we had option agreements and the acquisition ofcertain lots on which we had options resulting in write-offs of land depositsand pre-acquisition costs.  In addition,we recorded significant impairments to residential properties completed orunder construction and land held for development or sale and improvements.  The impairments were primarily due to aslower than anticipated pace of new orders and increases in sales incentivesrequired to generate new home orders. These write-offs and impairments adversely affected our results ofoperations during the quarter ended December 31, 2006.    If market conditions in the homebuildingindustry or customer demand continue to deteriorate or do not improve in futureperiods, we may decide not to pursue development of additional parcels of landor the acquisition of additional lots on which we have option agreements, andthe value of existing land holdings and residential properties may continue todecline.  This would lead to furtherwrite-offs of deposits and pre-acquisition costs and impairments to residentialproperties and land held for development or sale and improvements.

***We believe it is unlikely that we will be able to satisfy certainfinancial covenants in our******Amended and Restated CreditAgreement******as of June 30, 2007. If we are not able tosatisfy these covenants, obtain waivers of or amendments to the covenants, ornegotiate a new facility without these terms prior to this time, our lenderscould declare a default and demand repayment.***

Our Amended andRestated Credit Agreement required us to maintain a certain “Debt Service Ratio”of 2:00-to-1:00 at December 31, 2006. Generally, the Debt Service Ratio was the ratio of the Company’s “AdjustedEBITDA” to “Debt Service” (each as defined in the Amended and Restated CreditAgreement). ** **Asof December 31, 2006, our Debt Service Ratio was 1:61-to-1:00.  Our Amended and

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Restated CreditAgreement, was further amended by a Second Amendment to Amended and RestatedRevolving Credit Loan Agreement dated as of February 7, 2007 (the “SecondAmendment”).  The Second Amendmentamended the calculation of the Debt Service Ratio to add inventory impairmentand abandoned project charges, and certain other non-cash charges, back toAdjusted EBITDA for purposes of calculation our Debt Service Ratio, whichresulted in the Company being in compliance with the Debt Service Ratio covenantas of December 31, 2006.  The SecondAmendment also revised certain financial covenants as of March 31, 2007, butdid not adjust any financial covenants as of June 30, 2007 or later.

We have determinedit is unlikely that we will meet the existing Debt Service Ratio covenant atJune 30, 2007 as set forth in the Second Amendment.  A violation of this covenant, unless waivedby the lenders or otherwise cured, would constitute an event of default underthe Amended and Restated Credit Agreement, giving the lenders the right toterminate their obligations to make additional loans under the Amended andRestated Credit Agreement, demand immediate payment in full of all amountsoutstanding, foreclose on collateral and exercise other rights and remedies grantedunder the Amended and Restated Credit Agreement and related loan documents andas may be available pursuant to applicable law. We are currently in discussions with our lenders with respect to thepotential violation of the Debt Service Ratio covenant with a view towardobtaining an amendment or waiver of the covenant so as to be in compliance atJune 30, 2007.  We may not be able tonegotiate an amendment or waiver or other acceptable resolution or any suchwaiver, amendment or other resolution may not be on terms acceptable to theCompany.  If we are unable to negotiate aresolution and are in breach of the Debt Service Ratio covenant or any othercovenant as of June 30, 2007 and our lenders declared a default, there is noassurance that we would be able to obtain financing to pay amounts owed underthe Amended and Restated Credit Agreement or to continue to fund on-goingoperations.

**Item 4.****                                                          ****Submission of Matters to a Voteof Security Holders.**

On December 7, 2006, the Company held itsAnnual Meeting of Stockholders pursuant to a notice dated October 27,2006.  Definitive proxy materials werefiled with the Securities and Exchange Commission prior to the meeting.  A total

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of 17,998,056 shares were voted at themeeting, constituting 97.5% of the 18,462,984 shares entitled to vote.

At the Annual Meeting, theten nominees (Benjamin D. Goldman, Jerome S. Goodman, Robert N. Goodman, AndrewN. Heine, David Kaplan, Lewis Katz, Jeffrey P. Orleans, Robert M. Segal, JohnW. Temple and Michael T.Vesey) for election to the Company’s Board of Directorswere all elected. The results of the vote were as follows:

|                      | ** ** | **Share Voted For** | ** ** | **Shares for Which  Vote was Withheld** | ** ** |
|----------------------|------------|-------------------------------|------------|-------------------------------------------------------------|------------|
|                 |       |                          |       |                                                        |       |
| Benjamin D.  Goldman |       | 17,320,032                    |       | 678,024                                                     |       |
| Jerome S.  Goodman   |       | 15,956,854                    |       | 2,041,202                                                   |       |
| Robert N.  Goodman   |       | 17,320,492                    |       | 677,564                                                     |       |
| Andrew N. Heine      |       | 17,320,492                    |       | 677,564                                                     |       |
| David Kaplan         |       | 17,320,292                    |       | 677,764                                                     |       |
| Lewis Katz           |       | 17,315,112                    |       | 682,944                                                     |       |
| Jeffrey P.  Orleans  |       | 17,320,253                    |       | 677,803                                                     |       |
| Robert M. Segal      |       | 17,315,171                    |       | 682,885                                                     |       |
| John W. Temple       |       | 17,315,012                    |       | 683,044                                                     |       |
| Michael T. Vesey     |       | 17,319,795                    |       | 678,261                                                     |       |

 

At the Annual Meeting, the Amended andRestated Orleans Homebuilders, Inc. 2004 Omnibus Stock Incentive Plan (the “Amendedand Restated Plan”) was approved with 15,167,669 votes for the Amended andRestated Plan, 745,367 votes against the Amended and Restated Plan and 2,427abstentions.  The Amended and RestatedPlan increased the number of shares of common stock authorized for issuanceunder the Orleans Homebuilders, Inc. 2004 Omnibus Stock Incentive Plan by350,000 shares to 400,000 shares and increased the per person fiscal year grantlimitation to 250,000 shares.

Also at the Annual Meeting, the OrleansHomebuilders, Inc. Cash Bonus Plan for C. Dean Amann II (the “Amann Cash BonusPlan”) was approved with 15,073,062 votes for the Amann Cash Bonus Plan,834,399 votes against the Amann Cash Bonus Plan and 8,001 abstentions.  The Amann Cash Bonus Plan provides for a cashbonus to be paid to Mr. Amann in any plan year, which is the same as theCompany’s fiscal year, in which there are net pre-tax profits for the Company’sNorthern and Midwestern Divisions.  Netpre-tax profits for the Amann Cash Bonus Plan means the net profits for theCompany’s Northern and

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Midwestern Divisions, determined on a pre-taxbasis, after taking into account accrual and/or payment of employee bonuses,including with out limitation, under the Company’s Amended and Restated Plan(to the extent such expenses are allocable to the Company’s Northern andMidwestern Divisions and excluding any bonus payable pursuant to the Amann CashBonus Plan), and without taking into account nonrecurring items, income or lossarising from discontinued operations or other extraordinary events ortransactions.  Net pre-tax profits for the Amann Cash Bonus Plan asdescribed above are determined by applying generally accepted accountingprinciples.  If there are no pre-taxprofits for the Company’s Northern and Midwestern Divisions in a given planyear, no cash bonus will be paid pursuant to the Amann Cash Bonus Plan.

**Item 6***.**                                                          *Exhibits.
|        | 10.1   |   | First Amendment to Amended and Restated Revolving  Credit Loan Agreement, dated November 1, 2006 (incorporated by reference to  Exhibit 10.1 to the Company’s Form 8-K filed with the Securities and Exchange  Commission on November 3, 2006).                  |
|--------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                  |
|   | 10.2** |   | Amended and Restated Orleans Homebuilders, Inc. 2004  Omnibus Stock Incentive Plan (incorporated by reference to Appendix A to  the Company’s Proxy Statement on Schedule 14A filed with the Securities and  Exchange Commission on October 27, 2006). |
|   |   |   |                                                                                                                                                                                                                                                                  |
|   | 10.3** |   | Orleans Homebuilders, Inc. Cash Bonus Plan for C.  Dean Amann, II (incorporated by reference to Appendix B to the Company’s  Proxy Statement on Schedule 14A filed with the Securities and Exchange  Commission on October 27, 2006).                  |
|   |   |   |                                                                                                                                                                                                                                                                  |
|   | 10.4*  |   | Second Amendment to the Amended and Restated  Revolving Credit Loan Agreement, dated February 7, 2007.                                                                                                                                                                |
|   |   |   |                                                                                                                                                                                                                                                                  |
|   | 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 James W. Thompson pursuant to  Section 302 Sarbanes-Oxley Act of 2002.                                                                                                                                                                               |
|   |   |   |                                                                                                                                                                                                                                                                  |
|   | 32.1*  |   | Certification of Jeffrey P. Orleans pursuant to  Section 906 Sarbanes-Oxley Act of 2002.                                                                                                                                                                              |
|   |   |   |                                                                                                                                                                                                                                                                  |
|   | 32.2*  |   | Certification of Michael T. Vesey pursuant to  Section 906 Sarbanes-Oxley Act of 2002.                                                                                                                                                                                |
|   |   |   |                                                                                                                                                                                                                                                                  |
|   | 32.3*  |   | Certification of James W. Thompson pursuant to Section  906 Sarbanes-Oxley Act of 2002.                                                                                                                                                                               |

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* Exhibits filed herewithelectronically.

** Management contract orcompensatory plan or arrangement.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.
|        |                  | ORLEANS  HOMEBUILDERS, INC.           |
|--------|------------------|---------------------------------------|
|   |             | (Registrant)                          |
|   |             |                                  |
|   | February 9, 2007 | Michael T. Vesey                      |
|   |             | Michael T. Vesey                      |
|   |             | President and Chief Operating Officer |
|   |             |                                  |
|   | February 9, 2007 | James W. Thompson                     |
|   |             | James W. Thompson                     |
|   |             | Acting Chief Financial Officer        |

 

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**EXHIBIT INDEX**
| 10.4*  |   | Second Amendment to the Amended and Restated  Revolving Credit Loan Agreement, dated February 7, 2007. |
|--------|--------|--------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                   |
| 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 James W. Thompson pursuant to  Section 302 Sarbanes-Oxley Act of 2002.                |
|   |   |                                                                                                   |
| 32.1*  |   | Certification of Jeffrey P. Orleans pursuant to  Section 906 Sarbanes-Oxley Act of 2002.               |
|   |   |                                                                                                   |
| 32.2*  |   | Certification of Michael T. Vesey pursuant to  Section 906 Sarbanes-Oxley Act of 2002.                 |
|   |   |                                                                                                   |
| 32.3*  |   | Certification of James W. Thompson pursuant to  Section 906 Sarbanes-Oxley Act of 2002.                |

 

 

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* Exhibits filed herewithelectronically.

 

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