**United States**

**Securities andExchange Commission**

**Washington, D.C. 20549**

**Form 10-K**
| **x**      | ** ** | **Annual Report Pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended (the  “Exchange Act”)** |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                            |
|       |       | **For the fiscal  year ended December 31, 2006**                                                                                      |
|       |       | ** **                                                                                                                            |
|       |       | **or**                                                                                                                                |
|       |       | ** **                                                                                                                            |
| **o**      | ** ** | **Transition Report Pursuant to Section 13 or 15(d) of the Exchange Act**                                                             |

 

**For thetransition period from              to              **

**Commission File Number 001-08029**

**The RylandGroup, Inc.**

(Exact name of registrant as specified in its charter)

| **Maryland**                       | ** ** | **52-0849948**                        |
|------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction      |       | (I.R.S. Employer  Identification No.) |
| of incorporation  or organization) |       |                                  |

 

**24025 Park Sorrento, Suite 400, Calabasas, California 91302**(Address of principal executive offices)

Registrant’s telephone number,including area code: **(818) 223-7500**

Securities registered pursuantto Section 12(b) of the Exchange Act:
| **Title of each class**                 | ** ** | **Name of each exchange on which registered** |
|-----------------------------------------|------------|-----------------------------------------------|
| Common stock, par value $1.00 per share |       | New York Stock Exchange                       |

 

Securities registered pursuantto Section 12(g) of the Exchange Act: **None**

Indicate by check mark if the registrant isa well-known seasoned issuer, as defined in Rule 405 of the Securities Act of1933, as amended (the “Securities Act”).

Yes  x   No  o

Indicate by check mark if the registrant isnot required to file reports pursuant to Section 13 or Section 15(d) of theExchange Act.

Yes  o   No  x

Indicate by check mark whether theregistrant: (1) has filed all reports required to be filed by Section 13 or15(d) of the Exchange Act during the preceding 12 months (or for such shorterperiod that the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

Yes  x   No  o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements  incorporated by reference in Part III of thisForm 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether theregistrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.   See definitionof “accelerated filer and large accelerated filer” in Rule 12b-2 of theExchange Act.
| Large accelerated filer  x |   | Accelerated filer  o |   | Non-accelerated filer   o |
|---------------------------------|--------|---------------------------|--------|--------------------------------|

 

Indicate by check mark whetherthe registrant is a shell company (as defined in Rule 12b-2 of the ExchangeAct).Yes  o   No  x

The aggregate market value ofthe common stock of The Ryland Group, Inc. held by nonaffiliates of theregistrant (43,509,472 shares) at June 30, 2006, was $1,895,707,695.

The number of shares of commonstock of The Ryland Group, Inc. outstanding on February 12, 2007, was42,572,875.

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**Documents Incorporated byReference**
| NAME  OF DOCUMENT                                              |       | LOCATION IN REPORT   |
|----------------------------------------------------------------|------------|----------------------|
|                                                           |       |                 |
| *Proxy Statement for the 2007 Annual Meeting of  Stockholders* | ** ** | **Parts I, II, III** |

 

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**The Ryland Group, Inc.**Form 10-KIndex
| ITEM NO.          | ** **                                                                                            | ** ** |
|-------------------|-------------------------------------------------------------------------------------------------------|------------|
|              |                                                                                                  |       |   |
| **Part I**        |                                                                                                  |
| Item  1.          | Business                                                                                              | 4          |
| Item  1A.         | Risk  Factors                                                                                         | 11         |
| Item 1B.          | Unresolved Staff  Comments                                                                            | 13         |
| Item  2.          | Properties                                                                                            | 13         |
| Item  3.          | Legal  Proceedings                                                                                    | 13         |
| Item 4.           | Submission of  Matters to a Vote of Security Holders                                                  | 13         |
|              |                                                                                                  |       |
| **Part II**       |                                                                                                  |       |
| Item 5.           | Market for  Registrant’s Common Equity and Related Stockholder Matters                           | 15         |
| Item 6.           | Selected Financial  Data                                                                              | 17         |
| Item 7.           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations           | 19         |
| Item 7A.          | Quantitative  and Qualitative Disclosures About Market Risk                                           | 34         |
| Item 8.           | Financial Statements  and Supplementary Data                                                          | 35         |
| Item 9.           | Changes in and  Disagreements With Accountants on Accounting and Financial Disclosure                 | 66         |
| Item 9A.          | Controls and  Procedures                                                                              | 66         |
| Item 9B.          | Other Information                                                                                     | 66         |
|              |                                                                                                  |       |
| **Part III**      |                                                                                                  |       |
| Item 10.          | Directors,  Executive Officers and Corporate Governance                                               | 67         |
| Item 11.          | Executive  Compensation                                                                               | 67         |
| Item 12.     | Security  Ownership of Certain Beneficial Owners andManagement and Related Stockholder Matters   | 67         |
| Item 13.          | Certain  Relationships and Related Transactions, and Director Independence                            | 67         |
| Item 14.          | Principal  Accountant Fees and Services                                                               | 67         |
|              |                                                                                                  |       |
| **Part IV**       |                                                                                                  |       |
| Item 15.          | Exhibits and  Financial Statement Schedules                                                           | 68         |
|              |                                                                                                  |       |
| Signatures        | 72                                                                                                    |
|              |                                                                                                  |
| Index of Exhibits | 73                                                                                                    |
|                   |                                                                                                       |            |  |  |

 

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**Part I****                ****Item 1.****          ****Business**

With headquarters inSouthern California, The Ryland Group, Inc., a Maryland corporation (the “Company”),is one of the nation’s largest homebuilders and a leading mortgage-financecompany. It is a Fortune 500 company and is traded on the New York StockExchange under the symbol “RYL.” Founded in 1967, the Company has built morethan 265,000 homes. In addition, Ryland Mortgage Company and its subsidiaries (“RMC”)has provided mortgage financing and related services for more than 225,000homebuyers. The Company consists of six segments: fourgeographically-determined homebuilding regions, financial services, andcorporate.

The Company’s operationsspan all significant aspects of the homebuying process—from design,construction and sale to mortgage origination, title insurance, escrow andinsurance services. The homebuilding operations are, by far, the mostsubstantial part of its business, comprising approximately 98 percent ofconsolidated revenues in 2006. The homebuilding segments generate nearly all oftheir revenues from the sale of completed homes, with a lesser amount from thesale of land and lots. In addition to building single-family detached homes,the homebuilding segments also build attached homes, such as town homes and condominiums,including some mid-rise buildings, which share common walls and roofs. TheCompany builds homes for entry-level buyers, as well as for first- andsecond-time move-up buyers. The Company’s prices range from $98,000 to morethan $800,000, with the average price of a home closed during 2006 being$295,000. The financial services segment offers mortgage, title, escrow andinsurance services to its homeowners and subcontractors.

Over the last 13 years,the Company has concentrated on expanding its operations by investing itsavailable capital into both existing and new markets. It has believed thatmeasured “organic” growth avoids the risk, debt, intangible assets anddistractions associated with external acquisitions. The Company focuses onachieving a high return on invested capital and establishing profitableoperations in each of its markets. New communities are evaluated based onreturn and profitability benchmarks, and both senior and local management areincentivized based on their ability to achieve such returns. Managementcontinually monitors the land acquisition process, sales revenues, margins andreturns achieved in each of the Company’s markets as part of its capitalevaluation process.

The Company is highlydiversified throughout the United States, with no more than 10 percent of itsdeployed capital allocated to any given market. It believes diversification notonly minimizes its exposure to economic and market fluctuations, but alsoenhances its growth potential. Capital is strategically allocated to avoidconcentration in any given geographic area and to circumvent the accompanyingrisk associated with excessive dependence on local market anomalies. Subject tomacroeconomic and local market conditions, the Company plans to either manage itsexposure or to expand its presence in its existing markets in an effort to beamong the largest builders in each of those markets. It also intends tocontinue diversification by selectively entering new markets, primarily throughestablishing start-up or satellite operations in markets near its existingdivisions.

The Company’s nationalscale has provided increased opportunities for negotiation of volume discountsand rebates from material suppliers. Additionally, it has greater access to alower cost of capital due to the strength of its balance sheet, as well as toits lending and capital markets relationships. The Company’s economies of scaleand diversification have contributed to significant improvements in itsoperating margins during periods of growth and mitigated its overall risk inperiods of declining housing demand.

Committed to productinnovation, the Company conducts ongoing research into consumer preferences andtrends. It is constantly adapting and improving its house plans, designfeatures, customized options and mortgage programs. It strives to offer value,selection, location and quality to all homebuyers.

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The Company is dedicatedto building quality homes and customer relationships. With customersatisfaction as a major priority, it continues to make innovative enhancementsdesigned to attract homebuyers. During 2006, the Company launched a newexpanded Web site to include online systems for tracking requests, processingissues and improving customer interaction. In addition, the Company uses athird party to analyze customer feedback and to better serve its homebuyers’needs.

The Company enters intoland development joint ventures, from time to time, as a means of building lotpositions, reducing its risk profile and enhancing its return on capital. Itoccasionally partners with developers, other homebuilders or financialinvestors to develop finished lots for sale to the joint ventures’ members orother third parties.

Aside from being anadded value to customers, the financial services segment greatly enhances theCompany’s profitability while limiting its risk. A competitively high capturerate for mortgage financing and other services allows the homebuilder tomonitor its backlog and closing process. Risk is further reduced because substantiallyall loans are sold to a third party within one day of the date they close. Thethird party then services and manages the loans and assumes the credit risk ofborrower default.

**Homebuilding**

*General*

The Company’s homes arebuilt on-site and marketed in four major geographic regions, or segments. AtDecember 31, 2006, the Company operated in the following metropolitan areas:
| REGION/SEGMENT |   | MAJOR MARKETS SERVED                                                                                                                               |
|----------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------|
| NORTH          |   | Baltimore,  Chicago, Cincinnati, Delaware, Indianapolis, Minneapolis and Washington, D.C.                                                          |
|           |   |                                                                                                                                               |
| SOUTHEAST      |   | Atlanta,  Charleston, Charlotte, Fort Myers, Greensboro, Greenville, Jacksonville, Myrtle  Beach, Orlando and Tampa                                |
|           |   |                                                                                                                                               |
| TEXAS          |   | Austin, Dallas,  Houston and San Antonio                                                                                                           |
|           |   |                                                                                                                                               |
| WEST           |   | California’s  Central Valley, California’s Coachella Valley, California’s Inland Empire,  Denver, Las Vegas, Phoenix and Sacramento |

 

The Company hasdecentralized operations to provide more flexibility to its local divisionpresidents and management teams. Each of its 22 homebuilding divisions acrossthe country generally consists of a division president, a controller and othermanagement personnel focused on land entitlement, acquisition and development;sales, construction, customer service, and purchasing; as well as accountingand administrative personnel. The Company’s operations in each of itshomebuilding markets may differ due to a number of market-specific factors.These factors include regional economic conditions and job growth; landavailability and local land development; consumer preferences; competition fromother homebuilders; and home resale activity. The Company not only considerseach of these factors upon entering into new markets, but also in determiningthe extent of its operations and capital allocation in existing markets. TheCompany’s local management teams are familiar with these factors, and theirmarket experience and expertise are critical in making decisions regardinglocal operations.

The Company providesoversight and centralizes key elements of its homebuilding business through itscorporate and regional offices. The Company has four regional offices, eachgenerally consisting of a region president; a chief financial officer; realestate legal counsel; and additional management personnel focused on human resources,marketing and operations. Regional offices provide oversight 

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and standardizationwhere appropriate. The staff in each of these offices monitors activities byusing various operational metrics in order to achieve Company returnbenchmarks.

The Company marketsattached and detached single-family homes, which are generally targeted toentry-level and first- and second-time move-up buyers. Its diverse product lineis tailored to the local styles and preferences found in each of its geographicmarkets. The product line offered in a particular community is determined inconjunction with the land acquisition process and is dependent upon a number offactors, including consumer preferences, competitive product offerings anddevelopment costs. Architectural services are generally outsourced to increasecreativity and to ensure that the Company’s home designs are consistent withlocal market trends.

Homebuyers are able tocustomize certain features of their homes by selecting from numerous options andupgrades displayed in the Company’s model homes and design centers. Thesedesign centers, which are conveniently located in most of the Company’smarkets, also represent an increasing source of additional revenue and profitfor the Company. Custom options contributed approximately 12 percent ofrevenues in 2006 and resulted in significantly higher margins in comparison tobase homes.

*LandAcquisition and Development*

The Company’s objectiveis to control a portfolio of building lots sufficient to meet its anticipatedhomebuilding requirements for a period of approximately four to five years. TheCompany acquires land only after completing due diligence and feasibilitystudies. The land acquisition process is controlled by a corporate landapproval committee to help ensure that transactions meet the Company’sstandards for financial performance and risk. In the ordinary course of itshomebuilding business, the Company utilizes both direct acquisition and optioncontracts to control building lots for use in the sale and construction ofhomes. The Company’s direct land acquisition activities include the bulkpurchase of finished lots from developers and the purchase of undevelopedentitled land from third parties. The Company generally does not purchaseunentitled or unzoned land.

Although control of lotinventory through the use of option contracts minimizes the Company’sinvestment, such a strategy is not viable in certain markets due to the absenceof third-party land developers. In other markets, competitive conditions mayprevent the Company from controlling quality lots solely through the use ofoption contracts. In such situations, the Company may acquire undevelopedentitled land and/or finished lots on a bulk basis. The Company utilizes theselective development of land to gain access to prime locations, increasemargins and position itself as a leader in the area through its influence overa community’s character, layout and amenities. After determining the size,style, price range, density, layout and overall design of a community, theCompany obtains governmental and other approvals necessary to begin thedevelopment process. Land is then graded; roads, utilities, amenities and otherinfrastructures are installed; and the individual home sites are created.

At December 31, 2006,the Company had cash deposits and outstanding letters of credit totaling $187.8million in connection with option agreements and land purchase contracts havinga total purchase price of $1.5 billion. These options and commitments expire atvarious dates through 2018.

*MaterialsCosts*

Substantially allmaterials used in construction are available from a number of sources, but may fluctuatein price due to various factors. In order to increase purchasing efficiencies,the Company not only standardizes certain building materials and products, butalso acquires such products through national supply contracts. The Company has,on occasion, experienced shortages of certain materials. If shortages were tooccur in the future, such shortages could result in longer construction timesand higher costs than those experienced in the past.

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*Construction*

Substantially allon-site construction is performed for a fixed price by independentsubcontractors selected on a competitive-bid basis. The Company generallyrequires a minimum of three competitive bids for each phase of construction.Construction activities are supervised by the Company’s production team, whichschedules and coordinates subcontractor work, monitors quality, and ensurescompliance with local zoning and building codes. The Company requiressubstantially all of its subcontractors to have general liability insurance(including construction defect coverage) and workmans compensation insurance.Construction time for homes depends on weather, availability of labor orsubcontractors, materials, home size, geological conditions and other factors.The duration of the home construction process is generally between three andsix months. The Company has an integrated financial and homebuilding managementsystem that assists in scheduling production and controlling costs. Throughthis system, the Company monitors construction status and job costs incurredfor each home during each phase of construction. The system provides fordetailed budgeting and allows the Company to track and control actual costs,versus construction bids, for each community and subcontractor. The Companyhas, on occasion, experienced shortages of skilled labor in certain markets. Ifshortages were to occur in the future, such shortages could result in longerconstruction times and higher costs than those experienced in the past.

The Company, itssubcontractors and its suppliers maintain insurance, subject to deductibles andself-insured amounts, to protect against various risks associated withhomebuilding activities, including, among others, general liability, “all-risk”property, workmans compensation, automobile and employee fidelity. The Companyaccrues for its expected costs associated with the deductibles and self-insuredamounts.

*Marketing*

The Company generallymarkets its homes to entry-level and first- and second-time move-up buyersthrough targeted product offerings in each of the communities in which itoperates. The Company’s marketing strategy is determined during the land acquisitionand feasibility stage of a community’s development. Employees and independentreal estate brokers sell the Company’s homes, generally by showing furnishedmodels. A new order is reported when a customer’s sales contract has beensigned by the homebuyer and approved by the Company, subject to cancellation.The Company normally starts construction of a home when a customer has selecteda lot, chosen a floor plan and received preliminary mortgage approval. However,construction may begin prior to this in order to satisfy market demand forcompleted homes and to facilitate construction scheduling and/or cost savings.Homebuilding revenues are recognized when home sales are closed, title andpossession are transferred to the buyer and there is no significant continuinginvolvement.

The Company advertisesin newspapers and trade publications, as well as with marketing brochures andnewsletters. It also uses billboards, radio and television advertising, and itsWeb site to market the location, price range and availability of its homes. TheCompany also attempts to operate in conspicuously located communities thatpermit it to take advantage of local traffic patterns. Model homes play a significantrole in the Company’s marketing efforts by creating an attractive atmosphereand displaying options and upgrades.

The Company’s salescontracts typically require an earnest money deposit. The amount of earnestmoney required varies between markets and communities. Additionally, buyers aregenerally required to pay additional deposits when they select options orupgrades for their homes. Most of the Company’s sales contracts stipulate thatwhen homebuyers cancel the homebuyers’ contracts with the Company, it has theright to retain the homebuyers’ earnest money and option deposits; however, itsoperating divisions may choose to refund part or all of such deposits. TheCompany’s sales contracts may also include contingencies that permit homebuyersto cancel and receive a refund of their deposits if they cannot obtain mortgagefinancing at prevailing or specified interest rates within a specified timeperiod. The Company’s contracts may also include other contingencies, such 

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as the sale of anexisting home. The length of time between the signing of a sales contract for ahome and delivery of the home to the buyer may vary, depending on customerpreferences, permit approval and construction cycles.

*CustomerService and Warranties*

The Company’s operatingdivisions are responsible for pre-closing quality control inspections andresponding to homebuyers’ post-closing needs. The Company believes that promptand courteous acknowledgment of its homebuyers’ needs during and afterconstruction reduces post-closing repair costs, enhances its reputation forquality and service, and ultimately leads to repeat and referral business. Thesubcontractors, who perform most of the actual construction, also providewarranties on workmanship.

The Company provideseach homeowner with product warranties covering workmanship and materials forone year, certain mechanical systems for two years and structural systems forten years from the time of closing. The Company believes its warranty programmeets or exceeds terms customarily offered in the homebuilding industry.

*Seasonality*

The Company experiencesseasonal variations in its quarterly operating results and capitalrequirements. Historically, new order activity is higher during the spring andsummer months. This is primarily due to the preference of many homebuyers toact during those periods. As a result, it typically has more homes underconstruction, closes more homes, and has greater revenues and operating incomein the third and fourth quarters of the year.

**Financial Services**

The Company’s financialservices segment provides mortgage-related products and services, as well asinsurance services, to its homebuyers and subcontractors. The Company’s financialservices segment includes RMC, Ryland Homes Insurance Company (“RHIC”), LPSHoldings Corporation and its subsidiaries (“LPS”) and Columbia National RiskRetention Group, Inc. (“CNRRG”). By aligning its operations with the Company’shomebuilding segments, the financial services segment leverages thisrelationship to provide lending services to homebuyers. In addition to being avaluable asset to customers, the financial services segment greatly enhancesthe Company’s profitability. Providing mortgage financing and other services toits customers allows the homebuilding segments to better monitor their backlogand closing process. Substantially all loans are sold to a third party withinone business day of the date they close. The third party then services andmanages the loans and assumes the credit risk of borrower default. Insuranceservices provide subcontractors with construction-related insurance in thewestern markets. Additionally, the financial services segment providesinsurance for liability risks, specifically homeowners’ warranty coverage,arising in connection with the homebuilding business of the Company.

*LoanOrigination*

In 2006, RMC’s mortgageorigination operations consisted primarily of loans, which were originated inconnection with the sale of the Company’s homes. During the year, mortgageoperations originated 11,744 loans, totaling $3.0 billion, of which 99.7percent was for purchases of homes built by the Company and the remainingamount was for either purchases of homes built by others, purchases of existinghomes or the refinancing of existing mortgage loans.

RMC arranges varioustypes of mortgage financing, including conventional, Federal HousingAdministration (“FHA”) and Veterans Administration (“VA”) mortgages, withvarious fixed- and adjustable-rate features. RMC is approved to originate loansthat conform to the guidelines established by the Federal Home Loan MortgageCorporation (“FHLMC”) and the Federal National Mortgage Association (“FNMA”).RMC sells the loans it originates, along with the related servicing rights, toothers.

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*Titleand Escrow Services*

Cornerstone TitleCompany, a wholly-owned subsidiary of RMC, doing business as Ryland TitleCompany, provides title services and acts as a title insurance agent primarilyfor the Company’s homebuyers. At December 31, 2006, it provided title servicesin Arizona, Colorado, Florida, Georgia, Illinois, Indiana, Maryland, Minnesota,Nevada, North Carolina, Ohio, South Carolina, Texas and Virginia. The Companyalso operates Ryland Escrow Company, which performs escrow and closingfunctions for the Company’s homebuyers in California. During 2006, Ryland TitleCompany and Ryland Escrow Company provided these services to 96.3 percent ofthe Company’s homebuyers in the markets in which they operate, compared to 96.9percent during 2005.

LPS is a wholly-ownedsubsidiary of the Company and was formed to operate certain limited purposesubsidiaries, including Ryland Escrow Company.

*InsuranceServices*

Ryland InsuranceServices (“RIS”), a wholly-owned subsidiary of RMC, provides insurance servicesto the Company’s homebuyers. At December 31, 2006, RIS was licensed to operatein all of the states in which the Company’s homebuilding segments operate.During 2006, it provided insurance services to 62.4 percent of the Company’shomebuyers, compared to 60.4 percent during 2005.

RHIC is a wholly-ownedsubsidiary of the Company that provides insurance services to the homebuildingsegments’ subcontractors in certain markets.

CNRRG is a wholly-ownedsubsidiary of the Company. CNRRG was established to directly insure liabilityrisks, specifically homeowners’ warranty coverage, arising in connection withthe homebuilding business of the Company.

**Corporate**

Corporate is anon-operating business segment whose purpose is to support operations.Corporate departments are responsible for establishing operational policies andinternal control standards; implementing strategic initiatives; and monitoringcompliance with policies and controls throughout the Company’s operations.Corporate acts as an internal source of capital and provides financial, humanresources, information technology, insurance, legal, marketing, nationalpurchasing and tax compliance services. In addition, it performs administrativefunctions associated with a publicly traded entity.

**Real Estate and Economic Conditions**

The Company is significantlyaffected by fluctuations in economic activity, interest rates and levels ofconsumer confidence. The effects of these fluctuations differ among the variousgeographic markets in which the Company operates. Higher interest rates mayaffect the ability of buyers to qualify for mortgage financing and decreasedemand for new homes. As a result, rising interest rates generally willdecrease the Company’s home sales and mortgage originations. The Company’sbusiness is also affected by local economic conditions, such as employmentrates and housing demand, in the markets in which it operates. Some of thesemarkets have, at times, experienced a significant decline in housing demand.

Inventory risk can besubstantial for homebuilders. The market value of land, lots and housinginventories fluctuates as a result of changing market and economic conditions.The Company must continuously locate and acquire land not only for expansioninto new markets, but also for replacement and expansion of land inventorywithin current markets. The Company employs various measures, including acorporate land approval process and a continuous review by senior management,designed to control inventory risk. However, it cannot assure that thesemeasures will avoid or eliminate this risk.

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**Competition**

The Company competes ineach of its markets with a large number of national, regional and localhomebuilding companies. Some of these national companies are larger than theCompany and most have greater financial resources than in the past. Thestrength and expanded presence of national homebuilders, plus the continuedviability of regional and local homebuilders, has increased competition in manymarkets. This competition could make it more difficult to acquire suitable landat acceptable prices, force an increase in selling incentives or decreasesales. Any of these could have an adverse impact on the Company’s financialperformance or results of operations. The Company also competes with otherhousing alternatives, including existing homes and rental properties. Principalcompetitive factors in the homebuilding industry include price; design;quality; reputation; relationship with developers; accessibility ofsubcontractors; availability and location of lots; and availability of customerfinancing.

The Company’s financialservices segment competes with other mortgage bankers to arrange financing forhomebuyers. Principal competitive factors include interest rates and otherfeatures of mortgage loan products available to the consumer.

**Regulatory and Environmental Matters**

The homebuildingsegments are subject to various local, state and federal laws, ordinances,rules and regulations pertaining to zoning, building design, construction,stormwater permitting and discharge, and similar matters, as well as to openspace, wetlands and environmentally protected areas. These include localregulations that impose restrictive zoning and density requirements to limitthe number of homes that can be built within the boundaries of a particulararea, as well as other municipal or city planning issues. The Company may alsoexperience periodic delays in homebuilding projects due to regulatorycompliance, municipal appeals and other governmental planning processes in anyof the areas in which it operates.

RMC is subject to therules and regulations of FHA, FHLMC, FNMA, VA and the Department of Housing andUrban Development (“HUD”) with respect to originating, processing and sellingmortgage loans. In addition, there are other federal and state laws andregulations that affect not only these activities, but also RMC’s title, escrowand insurance brokerage operations. These rules and regulations prohibitdiscrimination and establish underwriting guidelines that include provisionsfor inspections and appraisals; require credit reports on prospectiveborrowers; and fix maximum loan amounts. RMC is required to submit audited financialstatements to various regulatory agencies annually, and each regulatory entityhas its own financial requirements. The Company’s affairs are also subject toexamination by these regulatory agencies and by state agencies, at all times,to assure compliance with applicable regulations, policies and procedures.Mortgage origination activities are subject to the Equal Credit OpportunityAct, the Federal Truth-in-Lending Act and the Real Estate Settlement ProceduresAct (“RESPA”), as well as to associated regulations that prohibitdiscrimination and require the disclosure of certain information to mortgagorsconcerning credit and settlement costs.

RHIC is registered andlicensed under Section 431, Article 19 of the Hawaii Revised Statutes and isrequired to meet certain minimum capital and surplus requirements.Additionally, no dividends may be paid without prior approval of the HawaiiInsurance Commissioner.

**Employees**

At December 31, 2006,the Company had 2,810 employees. The Company considers its employee relationsto be good. No employees are represented by a collective bargaining agreement.

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**Web Site Access to Reports**

The Company filesannual, quarterly and special reports; proxy statements; and other informationwith the U.S. Securities and Exchange Commission (“SEC”) under the ExchangeAct. Any document the Company files may be read at the SEC’s public referenceroom, Room 1580 at 100 F Street, NE, Washington, D.C. 20549. Please call theSEC toll-free at 1-800-SEC-0330 for information regarding its public referenceroom. The Company files information electronically with the SEC. The Company’sSEC filings are available from the SEC’s Web site at *www.sec.gov*.Reports, proxy and information statements, and other information regardingissuers that file electronically are readily obtainable there.

Stockholders, securitiesanalysts and others seeking information about the Company’s business operationsand financial performance can receive copies of its 2006 Annual Report on Form10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, allamendments to those reports and other publications filed with the SEC inWashington, D.C., without charge, by contacting the treasurer’s office at (818)223-7677; by writing to The Ryland Group, Inc., Investor Relations, 24025 ParkSorrento, Suite 400, Calabasas, California 91302; or via e-mail at *investors@ryland.com*. In addition, all filings with the SEC,news releases and quarterly earnings announcements, including live audio andreplays of the most recent quarterly earnings conference calls, can be accessedfree of charge on the Company’s Web site at *www.ryland.com*.Information on the Company’s Web site is not part of this report. The Companymakes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, CurrentReports on Form 8-K and amendments to those reports filed or furnished pursuantto Section 13(a) or 15(d) of the Exchange Act available on its Web site as soonas possible after it electronically files such material with, or furnishes itto, the SEC. To retrieve any of this information, visit *www.ryland.com*,select “Investors” and scroll down the page to “SEC Filings.”

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

*If real estateand economic conditions deteriorate, the Company’s revenue and profit maydecrease.*

The Company can be significantlyaffected by the cyclical nature of the homebuilding industry, which issensitive to fluctuations in general and local economic conditions, interestrates, housing demand, employment levels, availability of financing and levelsof consumer confidence. The effects of these fluctuations differ among thevarious geographic markets in which it operates. Sales of new homes areaffected by market conditions for resale homes and rental properties. Itsbusiness is also affected by local economic conditions, such as employmentrates and housing demand in the markets in which the Company builds homes. Themarkets in which it operates can experience mild to significant declines inhousing demand. The Company is currently experiencing a decline in marketdemand in many of its markets.

*If market demandsignificantly changes, the Company is subject to inventory risk.*

Inventory risk can besubstantial for homebuilders. The market value of the Company’s land, buildinglots and housing inventories fluctuates as a result of changing market andeconomic conditions. In addition, inventory carrying costs can result in lossesin poorly performing projects or markets. In the event of significant changesin economic or market conditions, the Company may dispose of land or housinginventories on a basis that may result in a loss or may be required to writedown or reduce the carrying value of its inventory. In the course of itsbusiness, the Company continuously seeks and makes acquisitions of land forexpansion into new markets, as well as for replacement and expansion of landinventory within its current markets. Although it employs various measures,including its land approval process and continued review by senior managementdesigned to manage inventory risks, the Company cannot assure that thesemeasures will enable it to avoid or eliminate its inventory risk.

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*Constructioncosts can fluctuate and impact the Company’s margins.*

The homebuilding industryhas, from time to time, experienced significant difficulties, including:shortages of qualified trades people; reliance on local subcontractors who maybe inadequately capitalized; shortages of materials; and volatile increases inthe cost of materials, particularly increases in the price of lumber, drywalland cement, which are significant components of home construction costs. TheCompany may not be able to recapture increased costs by raising prices eitherbecause of market conditions or because the Company fixes its prices at thetime home sales contracts are signed.

*If interestrates rise further, then the Company’s business may decline and profitabilitymay be reduced.*

Interest rates can significantlyaffect the Company’s lines of business. Higher interest rates affect theability of buyers to qualify for mortgage financing and decrease demand for newhomes. As a result, rising interest rates can decrease its home sales andmortgage originations. Further, the level and expected direction of interestrates can adversely affect the profitability of sales. Any of these factorscould have an adverse impact on the Company’s results of operations or financialposition.

*Because theCompany’s industry is competitive, the business practices of other homebuilderscan have an impact on the Company’s financial results and cause these resultsto decline.*

The residential housingindustry is highly competitive. The Company competes in each of its marketswith a large number of national, regional and local homebuilding companies.This competition could make it more difficult to acquire suitable land atacceptable prices, force it to increase selling incentives or lower its salesper community. Any of these could have an adverse impact on the Company’s financialperformance or results of operations. It also competes with other housingalternatives, including existing homes and rental housing. Principalcompetitive factors in homebuilding are home price, design, quality,reputation, relationship with developers, accessibility of subcontractors,availability and location of lots, and availability of customer financing.

The Company’s financialservices segment competes with other mortgage bankers to arrange financing forhomebuyers. Principal competitive factors include interest rates and otherfeatures of mortgage loan products available to the consumer.

*Because theCompany’s business is subject to various regulatory and environmentallimitations, it may not be able to conduct its business as planned.*

The Company’s homebuildingsegments are subject to various local, state and federal laws, statutes,ordinances, rules and regulations concerning zoning, building design,construction, stormwater permitting and discharge and similar matters, as wellas open space, wetlands and environmentally protected areas. These includelocal regulations that impose restrictive zoning and density requirements inorder to limit the number of homes that can be built within the boundaries of aparticular area, as well as other municipal or city land planning restrictions,requirements or limitations. The Company may also experience periodic delays inhomebuilding projects due to regulatory compliance, municipal appeals and othergovernment planning processes in any of the areas in which it operates.

The Company’s financialservices segment is subject to the rules and regulations of FHA, FHLMC, FNMA,VA and HUD with respect to originating, processing, selling and servicingmortgage loans. Mortgage origination activities are further subject to the EqualCredit Opportunity Act, Federal Truth-in-Lending Act and RESPA and theirassociated regulations. These and other federal and state statutes andregulations, among other things, prohibit discrimination and establishunderwriting guidelines which include provisions for audits, inspections andappraisals, require credit reports on prospective borrowers, fix maximum loanamounts and require the disclosure of certain information concerning credit andsettlement costs. The Company is required to submit audited financialstatements annually, and each agency or other entity has its own financialrequirements. The Company’s affairs are also subject to examination by theseentities at all times to assure compliance with applicable regulations,policies and procedures.

12

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*Naturaldisasters may have a significant impact on the Company’s business.*

The climates and geologyof many of the states in which the Company operates present increased risks ofnatural disasters. To the extent that hurricanes, severe storms, earthquakes,droughts, floods, wildfires or other natural disasters or similar events occur,its business in those states may be adversely affected.

*Because thisreport contains forward-looking statements, it may not prove to be accurate.*

This report and other Companyreleases and filings with the SEC may contain forward-looking statements. TheCompany generally identifies forward-looking statements using words like “believe,”“intend,” “expect,” “may,” “should,” “plan,” “project,” “contemplate,” “anticipate,”“target,” “estimate,” “foresee,” “goal,” “likely,” “will” or similarstatements. Because these statements reflect its current views concerningfuture events, these statements involve risks, uncertainties and assumption,including the risks and uncertainties identified in this report. Actual resultsmay differ significantly from the results discussed in these forward-lookingstatements. The Company does not undertake to update its forward-lookingstatements or risk factors to reflect future events or circumstances.

**Item 1****B****. Unresolved Staff Comments**

None.

**Item 2.****          ****Properties**

The Company leases officespace for its corporate headquarters in Calabasas, California and for its ITDepartment and RMC’s operations center in Scottsdale, Arizona. In addition, theCompany leases office space in the various markets in which it operates.

**Item 3.****          ****Legal Proceedings**

Contingent liabilitiesmay arise from obligations incurred in the ordinary course of business or fromthe usual obligations of on-site housing producers for the completion ofcontracts.

On January 15, 2004, asecurities class action was filed against the Company and two of its officersin the United States District Court for the Northern District of Texas. Theaction alleges violations of the federal securities laws in connection with thedisclosure by the Company of new home sales for the fourth quarter of 2003. InSeptember 2005, the Court dismissed the action because the lead plaintiffpreviously selected by the Court had failed to state a claim upon which reliefcould be granted. As a result, the Court also dismissed the class actioncomplaint. Subsequently, a different member of the purported class asked to besubstituted as a new lead plaintiff. In June 2006, the Court granted thatrequest and reinstated the action. The Company and the individual defendantsintend to vigorously defend themselves.

The Company is party tovarious other legal proceedings generally incidental to its businesses. Basedon evaluation of these matters and discussions with counsel, managementbelieves that liabilities arising from these matters will not have a materialadverse effect on the financial condition of the Company.

**Item 4.****          ****Submission of Matters to a Vote of SecurityHolders**

No matters weresubmitted to a vote of security holders during the fourth quarter of the yearended December 31, 2006.

13

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**Executive Officers of the Company**

The following sets forthcertain information regarding the executive officers of the Company:
|                               |   |   |   | POSITION *(date elected to  position)*                                                                                                                                                                                                               |
|-------------------------------|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| NAME                          |   | AGE    |   | PRIOR BUSINESS EXPERIENCE                                                                                                                                                                                                                            |
| R. CHAD DREIER 

        |   | 59     |   | Chairman of the  Board of Directors (since 1994);

President and  Chief Executive Officer of the

Company (since  1993)

                                                                                                                       |
| KIPLING W. SCOTT              |   | 52     |   | Chief Operating  Officer of the Company (since 2006);

Executive Vice  President of the Company (since 2003); President of the North Central Region  of Ryland Homes (1997–2006); Senior Vice President of the Company (1995–2003)

  |
| GORDON A. MILNE               |   | 55     |   | Executive Vice  President and Chief Financial Officer of the Company (since 2002); Senior  Vice President and Chief Financial Officer of the Company (2000–2002)

                                                                         |
| MARK L.  BEISSWANGER 

  |   | 46     |   | Senior Vice  President of the Company and President of the West Region of Ryland Homes  (since 2000)

                                                                                                                                          |
| ROBERT J. CUNNION, III        |   | 51     |   | Senior Vice  President, Human Resources of the Company (since 1999)

                                                                                                                                                                           |
| ERIC E. ELDER 

         |   | 49     |   | Senior Vice  President, Marketing and Communications of the Company (since 2000)

                                                                                                                                                              |
| DAVID L. FRISTOE              |   | 50     |   | Senior Vice President, Controller and Chief Accounting  Officer of the Company (since 2004); Senior Vice President, Controller, Chief  Accounting Officer and Chief Information Officer of the Company (2000–2004)                              |
|                          |   |   |   |                                                                                                                                                                                                                                                 |
| TIMOTHY J.  GECKLE 

    |   | 54     |   | Senior Vice  President, General Counsel and Secretary of the Company (since 1997)

                                                                                                                                                             |
| LARRY T.  NICHOLSON 

   |   | 49     |   | Senior Vice  President of the Company and President of the Southeast Region of Ryland  Homes (since 2004); President of the Orlando Division of Ryland Homes  (1999–2004)

                                                                |
| DANIEL G.  SCHREINER 

  |   | 49     |   | Senior Vice  President of the Company (since 1999); President of Ryland Mortgage Company  (since 1998)

                                                                                                                                        |
| PETER G. SKELLY 

       |   | 43     |   | Senior Vice  President of the Company and President of the North Region of Ryland Homes  (since 2006); President of the Chicago Division of Ryland Homes (1999–2006)

                                                                     |
| KEN L. TRAINER 

        |   | 41     |   | Senior Vice  President of the Company and President of the Texas Region of Ryland Homes  (since 2006); President of the Austin/San Antonio Division of Ryland Homes  (2002–2006)

                                                         |

 

14

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The Board of Directorselects all officers.

There are no familyrelationships between any director or executive officer, or arrangements orunderstandings pursuant to which the officers listed above were elected. Seethe Company’s *Proxy Statement for the 2007 Annual Meetingof Stockholders* (the “*2007 Proxy Statement*”)for a description of the Company’s employment and severance arrangements withcertain of its executive officers, which is filed pursuant to Regulation 14Aunder the Exchange Act.

**Part II****            ****Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters**

**Market for Common Equity, Common Stock Prices and Dividends**

The Company lists itscommon shares on the NYSE, trading under the symbol “RYL.”

The latest reported saleprice of the Company’s common stock on February 12, 2007, was $53.51, and therewere approximately 1,652 common stockholders of record.

The table below presentshigh and low market prices and dividend information for the Company.
|                | ** ** | ** ** | ** ** | ** ** | ** ** | **DIVIDENDS**      | ** ** | ** **      | ** ** | ** ** | ** **     | ** ** | ** ** | **DIVIDENDS**      | ** ** |
|----------------|------------|------------|------------|------------|------------|--------------------|------------|-----------------|------------|------------|----------------|------------|------------|--------------------|------------|
| ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | **DECLARED**       | ** ** | ** **      | ** ** | ** ** | ** **     | ** ** | ** ** | **DECLARED**       | ** ** |
| **2006**       | ** ** | **HIGH**   | ** ** | **LOW**    | ** ** | **PER SHARE** | ** ** | **2005**        | ** ** | **HIGH**   | ** **     | **LOW**    | ** ** | **PER SHARE** | ** ** |
| First quarter  |       | **$**      | **82.37**  | ** ** | **$**      | **64.83**          | ** ** | **$**           | **0.12**   |       | First  quarter |       | $          | 71.81              |       | $ | 53.97 |   | $ | 0.06 |   |
| Second quarter |       | **73.24**  | ** ** | **41.64**  | ** ** | **0.12**           |       | Second  quarter |       | 76.37      |           | 58.06      |       | 0.06               |       |
| Third quarter  |       | **46.16**  | ** ** | **34.82**  | ** ** | **0.12**           |       | Third  quarter  |       | 83.13      |           | 65.97      |       | 0.06               |       |
| Fourth quarter |       | **56.48**  | ** ** | **42.69**  | ** ** | **0.12**           |       | Fourth quarter  |       | 76.97      |           | 62.25      |       | 0.12               |       |
|                |            |            |            |            |            |                    |            |                 |            |            |                |            |            |                    |            |  |  |  |  |  |  |

**Issuer****Purchases of Equity Securities**

The following tablesummarizes the Company’s purchases of its own equity securities during the 12months ended December 31, 2006:
| (in  thousands, except share data) | ** ** | ** **                   | ** ** | ** **              | ** ** | ** **                             | ** ** |
|------------------------------------|------------|------------------------------|------------|-------------------------|------------|----------------------------------------|------------|
| ** **                         | ** ** | ** **                   | ** ** | ** **              | ** ** | **TOTAL NUMBER OF**          | ** ** | **APPROXIMATE DOLLAR** | ** ** |
| ** **                         | ** ** | ** **                   | ** ** | ** **              | ** ** | **SHARES PURCHASED**              | ** ** | **VALUE OF SHARES** | ** ** |
| ** **                         | ** ** | ** **                   | ** ** | ** **              | ** ** | **AS PART OF PUBLICLY** | ** ** | **THAT MAY YET BE** | ** ** |
| ** **                         | ** ** | **TOTAL NUMBER**        | ** ** | **AVERAGE PRICE**       | ** ** | **ANNOUNCED PLANS**               | ** ** | **PURCHASED UNDER THE** | ** ** |
| **PERIOD**                         | ** ** | **OF SHARES PURCHASED** | ** ** | **PAID PER SHARE** | ** ** | **OR PROGRAMS**                   | ** ** | **PLANS OR PROGRAMS** | ** ** |
|                               |       |                         |       |                    |       |                                   |       |   |   |
| January 1–31                  |       | 110,000                      |       | $                       | 72.85      |                                   | 110,000    |   | $ | 268,691 |   |
| February 1–28                 |       | 600,000                      |       | 69.11                   |       | 600,000                                |       | 227,226 |   |
| March 1–31                    |       | 325,000                      |       | 68.87                   |       | 325,000                                |       | 204,842 |   |
| April 1–30                    |       | 300,000                      |       | 65.63                   |       | 300,000                                |       | 185,154 |   |
| May 1–31                      |       | 1,315,000                    |       | 55.84                   |       | 1,315,000                              |       | 111,727 |   |
| June 1–30                     |       | 200,000                      |       | 50.01                   |       | 200,000                                |       | 101,724 |   |
| July 1–31                     |       | 800,000                      |       | 38.80                   |       | 800,000                                |       | 70,687 |   |
| August 1–31                   |       | 1,050,000                    |       | 42.00                   |       | 1,050,000                              |       | 26,587 |   |
| September 1–30                |       | -                            |       | -                       |       | -                                      |       | 26,587 |   |
| October 1–31                  |       | -                            |       | -                       |       | -                                      |       | 26,587 |   |
| November 1–30                 |       | -                            |       | -                       |       | -                                      |       | 26,587 |   |
| December 1–31                 |       | -                            |       | -                       |       | -                                      |       | 201,587 |   |
| Total                              |       | 4,700,000                    |       | $                       | 53.22      |                                   | 4,700,000  |   |   |   |
|                                    |            |                              |            |                         |            |                                        |            |  |  |  |  |

 

On December 12, 2005,the Company announced that it had received authorization from its Board of Directorsto purchase shares totaling $250.0 million, or approximately 3.5 millionshares, based on the Company’s stock price on that date. At December 31, 2006,there were approximately 487,000 shares

15

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availablefor purchase in accordance with this authorization based on the Company’s stockprice on that date. This authorization does not have an expiration date.

On December 6, 2006, theCompany announced that it had received authorization from its Board ofDirectors to purchase shares totaling $175.0 million, or approximately 3.1million shares, based on the Company’s stock price on that date. As of December31, 2006, no shares had been purchased in accordance with this authorization.This authorization does not have an expiration date.

**PerformanceGraph**The following performance graph and related informationshall not be deemed “soliciting material” or be “filed” with the SEC, nor shallsuch information be incorporated by reference into any future filing under theSecurities Act or the Exchange Act, except to the extent that the Company specificallyincorporates it by reference into such filing.

**COMPARISON OFFIVE-YEAR CUMULATIVE TOTAL RETURN***

Among The Ryland Group, Inc., the S & P 500Index and the Dow Jones U.S. Home Construction IndexCalendar year ending December 31.

**$100 invested on 12/31/01 instock or index-including reinvestment of dividends.*

**SecuritiesAuthorized for Issuance Under Equity Compensation Plans**The information required by Item 201(d) of Regulation S-K isincorporated by reference from the *2007 Proxy Statement*.

16

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**Item 6.****          ****Selected Financial Data**
| *(in millions, except share data) unaudited*  |   | **2006**   | ** ** | 2005       |                                                                                                                                | 2004   |                                                                                                                                                                   | 2003   |                                                                                                                                | 2002   |                                                                                      |
|-----------------------------------------------|--------|------------|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------|
| **ANNUAL RESULTS**                            |   | ** ** | ** ** |       |                                                                                                                                |   |                                                                                                                                                                   |   |                                                                                                                                |   |                                                                                      |
| REVENUES                                      |   | ** ** | ** ** |       |                                                                                                                                |   |                                                                                                                                                                   |   |                                                                                                                                |   |                                                                                      |
| Homebuilding                                  |   | **$**      | **4,654**  | ** ** | $             4,726                                                     |   | $             3,867                                                                                        |   | $             3,355                                                     |   | $      2,805                                                     |   |
| Financial services                            |   | **103**    | ** ** | 92         |                                                                                                                                | 85     |                                                                                                                                                                   | 89     |                                                                                                                                | 72     |                                                                                      |
| TOTAL REVENUES                                |   | **4,757**  | ** ** | 4,818      |                                                                                                                                | 3,952  |                                                                                                                                                                   | 3,444  |                                                                                                                                | 2,877  |                                                                                      |
| Cost of sales                                 |   | **3,640**  | ** ** | 3,538      |                                                                                                                                | 2,964  |                                                                                                                                                                   | 2,616  |                                                                                                                                | 2,216  |                                                                                      |
| Selling, general  and administrative expenses |   | **542**    | ** ** | 551        |                                                                                                                                | 467    |                                                                                                                                                                   | 427    |                                                                                                                                | 352    |                                                                                      |
| Expenses related  to early retirement of debt |   | **8**      | ** ** | 8          |                                                                                                                                | -      |                                                                                                                                                                   | 5      |                                                                                                                                | -      |                                                                                      |
| Earnings before  taxes                        |   | **567**    | ** ** | 721        |                                                                                                                                | 521    |                                                                                                                                                                   | 396    |                                                                                                                                | 309    |                                                                                      |
| Tax expense                                   |   | **207**    | ** ** | 274        |                                                                                                                                | 201    |                                                                                                                                                                   | 154    |                                                                                                                                | 124    |                                                                                      |
| NET EARNINGS                                  |   | **$**      | **360**    | ** ** | $                      447 |   | $                      320                                    |   | $                      242 |   | $               185 |   |
| **YEAR-END POSITION**                         |   | ** ** | ** ** |       |                                                                                                                                |   |                                                                                                                                                                   |   |                                                                                                                                |   |                                                                                      |
| ASSETS                                        |   | ** ** | ** ** |       |                                                                                                                                |   |                                                                                                                                                                   |   |                                                                                                                                |   |                                                                                      |
| Cash and cash equivalents                     |   | **$**      | **215**    | ** ** | $                      461 |   | $                            88 |   | $                      317 |   | $               269 |   |
| Housing inventories                           |   | **2,772**  | ** ** | 2,580      |                                                                                                                                | 2,024  |                                                                                                                                                                   | 1,397  |                                                                                                                                | 1,100  |                                                                                      |
| Other assets                                  |   | **430**    | ** ** | 346        |                                                                                                                                | 313    |                                                                                                                                                                   | 294    |                                                                                                                                | 289    |                                                                                      |
| TOTAL ASSETS                                  |   | **3,417**  | ** ** | 3,387      |                                                                                                                                | 2,425  |                                                                                                                                                                   | 2,008  |                                                                                                                                | 1,658  |                                                                                      |
| LIABILITIES                                   |   | ** ** | ** ** |       |                                                                                                                                |   |                                                                                                                                                                   |   |                                                                                                                                |   |                                                                                      |
| Debt                                          |   | **950**    | ** ** | 922        |                                                                                                                                | 559    |                                                                                                                                                                   | 574    |                                                                                                                                | 537    |                                                                                      |
| Other liabilities and minority interest       |   | **956**    | ** ** | 1,089      |                                                                                                                                | 809    |                                                                                                                                                                   | 609    |                                                                                                                                | 441    |                                                                                      |
| TOTAL LIABILITIES                             |   | **1,906**  | ** ** | 2,011      |                                                                                                                                | 1,368  |                                                                                                                                                                   | 1,183  |                                                                                                                                | 978    |                                                                                      |
| STOCKHOLDERS’ EQUITY                     |   | **$**      | **1,511**  | ** ** | $             1,376                                                     |   | $             1,057                                                                                        |   | $                      825 |   | $               680 |   |
| **PER COMMON SHARE DATA**                     |   | ** ** | ** ** |       |                                                                                                                                |   |                                                                                                                                                                   |   |                                                                                                                                |   |                                                                                      |
| NET EARNINGS                                  |   | ** ** | ** ** |       |                                                                                                                                |   |                                                                                                                                                                   |   |                                                                                                                                |   |                                                                                      |
| Basic                                         |   | **$**      | **8.14**   | ** ** | $                   9.52                  |   | $                   6.72                                                     |   | $                   4.86                  |   | $            3.51                  |   |
| Diluted                                       |   | **7.83**   | ** ** | 9.03       |                                                                                                                                | 6.36   |                                                                                                                                                                   | 4.56   |                                                                                                                                | 3.32   |                                                                                      |
| DIVIDENDS DECLARED                            |   | **$**      | **0.48**   | ** ** | $                   0.30                  |   | $                   0.21                                                     |   | $                   0.08                  |   | $            0.04                  |   |
| STOCKHOLDERS’ EQUITY PER SHARE           |   | **$**      | **35.46**  | ** ** | $             29.68                                                     |   | $             22.32                                                                                        |   | $             16.98                                                     |   | $      13.46                                                     |   |
| **OTHER FINANCIAL DATA**                      |   | ** ** | ** ** |       |                                                                                                                                |   |                                                                                                                                                                   |   |                                                                                                                                |   |                                                                                      |
| EBITDA1                                       |   | **$**      | **663**    | ** ** | $                      810 |   | $                      603                                    |   | $                      478 |   | $               384 |   |
| EBITDA/interest  incurred2                    |   | **9.2**    | **x**      | 12.2       | x                                                                                                                                   | 11.3   | x                                                                                                                                                                      | 9.5    | x                                                                                                                                   | 7.8    | x                                                                                         |
| Return on  beginning equity3                  |   | **26.2**   | **%**      | 42.3       | %                                                                                                                                   | 38.9   | %                                                                                                                                                                      | 35.5   | %                                                                                                                                   | 33.0   | %                                                                                         |
| Debt-to-total capital4                        |   | **38.6**   | **%**      | 40.1       | %                                                                                                                                   | 34.6   | %                                                                                                                                                                      | 41.0   | %                                                                                                                                   | 44.1   | %                                                                                         |

 

1*Earnings before interest, taxes, depreciation andamortization (“EBITDA”) is a measure commonly used in the homebuilding industryand is presented to assist in understanding the ability of the operations ofthe Company to generate cash beyond that which is needed to service existinginterest requirements and ongoing tax obligations. EBITDA equals net earningsbefore (a) interest expense; (b) previously capitalized interest amortized tocost of sales; (c) income taxes; and (d) depreciation and amortization. EBITDAis not a financial measure recognized in accordance with generally acceptedaccounting principles (“GAAP”). EBITDA should neither be considered analternative to net earnings determined in accordance with GAAP as an indicatorof operating performance nor an alternative to cash flows from operatingactivities determined in accordance with GAAP as a measure of liquidity.*

2*EBITDA/interest incurred is calculated as EBITDA(defined above) divided by total interest incurred, which is the sum ofinterest expense and capitalized interest for the period.*

3*Return on beginning equity is calculated as netearnings divided by total stockholders’ equity at the beginning of the period.*

4*Debt-to-total capital is calculated as debt dividedby the sum of debt and total stockholders’ equity.*

17

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The following table setsforth the computation of EBITDA for each period presented.
|                                                  |   | YEAR ENDED DECEMBER 31, |        |
|--------------------------------------------------|--------|-------------------------|-------------|
| *(in  thousands)*                                |   | **2006**                |        | 2005 |   | 2004 |   | 2003 |   | 2002 |   |
| Earnings before  taxes                           |   | **$**                   | **567,108** |   | $ | 721,051 |   | $    521,212 |   | $    396,217 |   | $  309,340 |   |
| Interest expense                                 |   | **205**                 |        | 738 |   | 1,227 |   | 7,523 |   | 9,391 |   |
| Capitalized  interest amortized to cost of sales |   | **48,708**              |        | 45,483 |   | 41,764 |   | 38,263 |   | 32,162 |   |
| Depreciation and  amortization                   |   | **46,731**              |        | 43,166 |   | 38,519 |   | 36,436 |   | 32,670 |   |
| EBITDA                                           |   | **$**                   | **662,752** |   | $ | 810,438 |   | $    602,722 |   | $    478,439 |   | $  383,563 |   |

 

A reconciliation ofEBITDA to net cash provided by operations, the most directly comparable GAAPmeasure, is provided below for each period presented.
|                                                                               |   | YEAR ENDED DECEMBER 31, |        |
|-------------------------------------------------------------------------------|--------|-------------------------|-------------|
| *(in  thousands)*                                                             |   | **2006**                |        | 2005 |   | 2004 |   | 2003 |   | 2002 |   |
| Net cash  provided by (used for) operating activities                         |   | **$**                   | **14,637**  |   | $  216,264 |   | $   (78,471 | ) | $  139,471 |   | $   87,715 |   |
| Increase in  inventory                                                        |   | **182,679**             |        | 490,971 |   | 585,562 |   | 239,989 |   | 200,623 |   |
| Tax expense                                                                   |   | **207,166**             |        | 273,999 |   | 200,667 |   | 154,525 |   | 123,736 |   |
| Interest expense                                                              |   | **205**                 |        | 738 |   | 1,227 |   | 7,523 |   | 9,391 |   |
| Capitalized  interest amortized   to cost of sales                            |   | **48,708**              |        | 45,483 |   | 41,764 |   | 38,263 |   | 32,162 |   |
| Net change in  other assets, payables and other liabilities                   |   | **216,939**             |        | (175,358 | ) | (104,424 | ) | (67,248 | ) | (43,033 | ) |
| Stock-based  compensation expense                                             |   | **(25,593**             | **)**       | (18,862 | ) | (15,208 | ) | (16,051 | ) | (9,833 | ) |
| Tax benefit from  exercise of stock options   and vesting of restricted stock |   | **14,632**              |        | (30,505 | ) | (17,475 | ) | (17,120 | ) | (12,103 | ) |
| Other operating  activities, net                                              |   | **3,379**               |        | 7,708 |   | (10,920 | ) | (913 | ) | (5,095 | ) |
| EBITDA                                                                        |   | **$**                   | **662,752** |   | $ | 810,438 |   | $  602,722 |   | $  478,439 |   | $ 383,563 |   |
|                                                                               |        |                         |             |  |  |  |  |  |  |  |  |  |  |

 

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**Item 7.****          ****Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

**Forward-Looking Statements**

*Note: Certain statements in this annual report maybe regarded as “forward-looking statements” within the meaning of the PrivateSecurities Litigation Reform Act of 1995, and may qualify for the safe harborprovided for in Section 21E of the Securities Exchange Act of 1934, as amended.These forward-looking statements represent the Company’s expectations andbeliefs concerning future events, and no assurance can be given that theresults described in this annual report will be achieved. These forward-lookingstatements can generally be identified by the use of statements that includewords such as “anticipate,” “believe,” “estimate,” “expect,” “foresee,” “goal,”“intend,” “likely,” “may,” “plan,” “project,” “should,” “target,” “will” or othersimilar words or phrases. All forward-looking statements contained herein arebased upon information available to the Company on the date of this annualreport. Except as may be required under applicable law, the Company does notundertake any obligation to update or revise any forward-looking statements,whether as a result of new information, future events or otherwise.*

*These forward-looking statements are subject torisks, uncertainties and other factors, many of which are outside of theCompany’s control, that could cause actual results to differ materially fromthe results discussed in the forward-looking statements. The factors andassumptions upon which any forward-looking statements herein are based aresubject to risks and uncertainties which include, among others:*

·    *economic changes nationally or inthe Company’s local markets, including volatility and increases in interestrates, inflation, changes in consumer demand and confidence levels and thestate of the market for homes in general;*

·    *the availability and cost ofland;*

·    *increased land development costson projects under development;*

·    *shortages of skilled labor or rawmaterials used in the production of houses;*

·    *increased prices for labor, landand raw materials used in the production of houses;*

·    *increased competition;*

·    *failure to anticipate or react tochanging consumer preferences in home design;*

·    *increased costs and delays inland development or home construction resulting from adverse weatherconditions;*

·    *potential delays or increasedcosts in obtaining necessary permits as a result of changes to laws,regulations or governmental policies (including those that affect zoning,density, building standards and the environment);*

·    *delays in obtaining approvalsfrom applicable regulatory agencies and others in connection with the Company’scommunities and land activities;*

·    *the risk factors set forth inthis Form 10-K; and*

·    *other factors over which theCompany has little or no control.*

19

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**Overview/Results of Operations**

During 2006, thehomebuilding industry continued to experience a softening of demand for newhomes. Over the last several years, the price appreciation of homes wasrelatively high in most markets and, in turn, attracted speculation. As priceappreciation slowed, consumer confidence and demand declined causing nationalhomebuilders to experience increasing inventories, which resulted in a dramaticrise in the number of homes available for sale. The Company experienced adecrease in sales orders due to this lower demand, as well as to an increase insales contract cancellations. As a result, the Company modified its operatingstrategy to compete in this changing environment by increasing advertising,sales price discounts and other incentives to generate sales; by striving toreduce inventory and commitments to purchase land in the future throughcontract renegotiations and cancellations; by decreasing its overhead expenseto more closely match projected volume levels; and by renegotiating contractswith subcontractors and suppliers.

Despite this challengingenvironment, the Company’s earnings, revenues and deliveries of homesrepresented the second-best year in the Company’s history. Although resultswere indicative of the more challenging economic climate, they also reflectedthe Company’s ability to deliver strong returns through geographic diversificationwhile managing risk in uncertain conditions. The Company also achievedadditional economies as a result of its variable-cost structure, consolidationof operations and cost-saving initiatives. It improved its Fortune 500 rankingand maintained its investment-grade rating while lowering leverage and theaverage interest rate on its debt. The Company continues to make investments innew marketing initiatives, product development, customer service, training andtechnology, all of which are critical to capturing market share while improvingthe customer’s experience and streamlining processes.

The Company reportedconsolidated net earnings of $359.9 million, or $7.83 per diluted share, for2006, compared to $447.1 million, or $9.03 per diluted share, for 2005 and $320.5million, or $6.36 per diluted share, for 2004. The net earnings decrease for2006, compared to 2005, resulted from a broad trend toward softening demand inresidential housing and a more competitive sales environment in most markets,as well as from inventory valuation adjustments and write-offs of deposits andpreacquisition costs that accompanied selective local market weakness. The risein the Company’s net earnings from 2004 to 2005 was primarily due to higherrevenues, increased operating margins and decreased expenses for itshomebuilding operations.

Total revenues for 2006were $4.8 billion, a decrease of $60.4 million or 1.3 percent, from 2005 thatresulted from a decline in closing volume, partially offset by an increase inaverage sales price. Total revenues for 2005 exceeded 2004 levels by $865.7million, or 21.9 percent. Homebuilding pretax operating margins were 12.3percent for 2006, compared to 15.8 percent for 2005 and 13.6 percent for 2004.The decrease in margins in 2006 from 2005 was due to increased priceconcessions and sales incentives in most markets, inventory valuationadjustments and option deposit write-offs.

EBITDA was $662.8million for the year ended December 31, 2006, compared to $810.4 million and $602.7million for the same period in 2005 and 2004, respectively. The Company’s ratioof EBITDA to interest incurred was 9.2 for the year ended December 31, 2006,compared to 12.2 for 2005 and 11.3 for 2004.

In an effort to positionitself for competitive industry conditions in 2007, the Company generated cash flowsin 2006 from its operations by maintaining profitability, while reducing landacquisition and construction activity. The Company had 15,353 fewer lots undercontrol, or a 20.3 percent decrease at December 31, 2006, versus year-end 2005,as a result of terminating marginal option contracts. Inventory growth was moremoderate during 2006 in order to balance lower order volume with an ability togain market share in the event of stabilizing demand. Goodwill of $18.2 millionremained unchanged in 2006 from 2005 and was among the lowest in the industry.The Company’s debt-to-capital ratio was 38.6 percent at December 31, 2006, ascompared to 40.1 percent for the

20

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same period in 2005. Theweighted-average rate of interest for the Company’s debt was 5.8 percent and6.3 percent at December 31, 2006 and 2005, respectively.
| STOCKHOLDERS’ |       |
|--------------------|------------|
| RETURN ON EQUITY   |       | RETURN ON CAPITAL |   | EQUITY PER SHARE |   |
| 2004               |       | 38.9 | % | 24.8 | % | $ 22.32 |   |
| 2005               |       | 42.3 | % | 29.4 | % | $ 29.68 |   |
| **2006**           | ** ** | **26.2** | **%** | **17.0** | **%** | **$ 35.46** | ** ** |
|                    |            |  |  |  |  |  |  |  |

 

Stockholders’ equityincreased 9.8 percent, or $135.1 million, during 2006, compared to an increaseof 30.2 percent, or $319.2 million, during 2005. As a result of balancing cashoutlays with inventory management, leverage objectives and common stockrepurchases, stockholders’ equity per share increased 19.5 percent to $35.46 in2006, compared to $29.68 in 2005. The Company’s book value at December 31,2006, was 98.8 percent tangible. The Company is not a significant participantin off-balance sheet financing outside of traditional option contracts withland developers and its investments in joint ventures represent less than onepercent of its total assets. Its balance sheet continues to reflect the Company’sstrength, low-risk strategy and transparency.

During 2006, the Companycontinued to deliver solid returns to stockholders while maintaining itsstrategically low-risk model. In addition, it has focused on realigning thebusiness to prepare for a prolonged downturn, should it occur, and developingcompetitive advantages through training and technology initiatives. Return onbeginning equity was 26.2 percent, return on beginning capital1 was 17.0 percent andinventory was turned 1.3 times. The Company’s cost of capital has declined.Despite a challenging industry environment, the Company’s stockholder returnsremained among the highest in the industry and Fortune 500 companies.

**Homebuilding**

The Company’shomebuilding operations consist of four geographically-determined regionalreporting segments: North, Southeast, Texas and West.

New orders representsales contracts that have been signed by the homebuyer and approved by the Company,subject to cancellation. The dollar value of new order contracts decreased $1.9billion, or 37.5 percent, to $3.2 billion for the year ended December 31, 2006,from $5.1 billion for the year ended December 31, 2005, and $4.4 billion forthe same period in 2004 due to slowing demand and to increases in cancellationrates. Unit orders decreased 36.4 percent in 2006 and increased 3.8 percent in2005. Cancellation rates totaled 37.1 percent and 22.3 percent for the yearsended December 31, 2006 and 2005, respectively.

The combinedhomebuilding operations reported pretax earnings of $573.1 million for 2006,compared to $744.2 million for 2005 and $525.5 million for 2004. Homebuildingresults in 2006 decreased from 2005 primarily due to an environment of slowingdemand that resulted in declining prices and valuations, which in turn led to adecline in gross profit margins and closing volume, offset by a 6.1 percentincrease in average closing price. Homebuilding results in 2005 increased from2004 due to higher average closing prices, gross profit margins and closingvolume.

Homebuilding revenuesfell 1.5 percent for 2006, compared to 2005, due to a 7.7 percent decrease inclosings, partially offset by a 6.1 percent increase in average closing price.The decline in closings in 2006 was due to slowing market trends and a morecompetitive sales environment in most markets. The increase in the averageclosing price was primarily due to the delivery of homes in 2006 that were soldin 2005 under more favorable market conditions than currently exist.Homebuilding revenues increased 22.2 percent for 2005, compared to 2004, due toa 10.4 percent rise in closings and a

1*Returnon beginning capital is calculated by dividing net earnings before tax-affectedinterest by the sum of beginning debt and total stockholders’ equity.*

21

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10.8 percent increase inaverage closing price. The rise in closings in 2005 was due to a higher backlogat the beginning of the year and a 3.8 percent increase in new home ordersduring the year.

Consistent with itspolicy of managing land investments according to return and risk targets, theCompany executed several land and lot sales during the year. Homebuildingrevenues for the year ended December 31, 2006, included $94.3 million from landand lot sales, compared to $96.9 million for 2005 and $74.2 million for 2004,which contributed net gains of $24.8 million, $23.9 million and $25.2 millionto pretax earnings in 2006, 2005 and 2004, respectively.
| GROSS PROFIT MARGIN |       | SG&A EXPENSE |   | PRETAX  EARNINGS MARGIN |   |
|---------------------|------------|------------------|--------|-------------------------|--------|
| 2004                |       | 23.2             | %      | 9.8                     | %      | 13.6 | % |
| 2005                |       | 25.2             | %      | 9.4                     | %      | 15.8 | % |
| **2006**            | ** ** | **21.8**         | **%**  | **9.5**                 | **%**  | **12.3** | **%** |

 

Gross profit margins from home salesaveraged 21.8 percent for 2006, a decrease from 25.2 percent for 2005 and 23.2percent for 2004. The decline was primarily attributable to a more competitivemarket that resulted in an increase in price concessions and sales incentives;inventory valuation adjustments; and deposit write-offs during the year. Priceconcessions and sales incentives totaled 7.1 percent for the year endedDecember 31, 2006, versus 4.8 percent for the same period in 2005. The Companyevaluates its land and housing inventory in accordance with the provisions ofStatement of Financial Accounting Standards No. 144 (“SFAS 144”), “Accountingfor the Impairment or Disposal of Long-Lived Assets” on a quarterly basis andmore frequently if impairment indicators exist. In certain markets whereconditions have deteriorated due to decreased demand and increased competitionfor fewer buyers, selective land or inventory positions have declined in valueand become impaired. The Company has written down certain impaired inventoriesby $62.9 million and $800,000 during 2006 and 2005, respectively, to theirestimated fair values. From time to time, a community’s projected profitabilitymay not produce returns commensurate with the Company’s requirements, and theCompany cancels the option and writes off the deposit. During 2006, the Companywrote off residential land option deposits totaling $10.9 million. Impairmentadjustments and deposit write-offs primarily impacted the West region and wereincluded in “Cost of goods sold.” (See “Housing Inventories” within Note A, “Summaryof Significant Accounting Policies.”) The Company generated the strongest grossmargins in its Baltimore, Charleston, Jacksonville, Las Vegas, Orlando,Phoenix, Tampa and Washington, D.C., markets, while its Denver, Fort Myers andOhio Valley markets were the most challenging.

Selling, general andadministrative expenses, as a percentage of revenue, were 9.5 percent for 2006,9.4 percent for 2005 and 9.8 percent for 2004. Selling, general andadministrative expenses, as a percentage of revenue, remained relatively flatfrom the prior year due to cost reduction efforts in the face of decliningrevenues in various markets and a decrease in compensation that wascommensurate with lower earnings, partially offset by $6.9 million infeasibility cost write-offs, resulting from the abandonment of certainprojects. The decrease in selling, general and administrative expenses, as apercentage of revenue, in 2005 compared to 2004, was primarily attributable toleverage obtained through a substantial rise in closings in the Atlanta,Charlotte, Inland Empire, Jacksonville, Las Vegas, Phoenix and Texas markets,which was accompanied by more moderate increases in marketing and general andadministrative expenses, partially offset by higher incentive compensationexpense due to improved earnings.

In 2006 and 2005, thehomebuilding segments capitalized all interest incurred. The rise incapitalized interest resulted from increased development activity relative tohomebuilding construction activity.

22

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**Homebuilding Segments**

New orders for 2006decreased 31.1 percent in the North, 43.8 percent in the Southeast, 12.6percent in Texas and 54.7 percent in the West. In 2006, the decline in neworders was primarily due to a softening in demand in most markets and a morecompetitive sales environment. Market uncertainty and heightened pricingcompetition among homebuilders led to rising cancellation rates by homebuyersand were a major factor in this order decline. New orders for 2005 increased12.4 percent in the Southeast and 12.2 percent in Texas, but decreased 1.9percent in the North and 7.2 percent in the West. In 2005, new order trendswere generally driven by historically low interest rates and expansion plans,but they declined slightly in the fourth quarter in the North and West due, inpart, to the moderating effect increased price appreciation had on consumerdemand and to product shortages in Las Vegas that resulted, in part, fromdelays in development, processing and approval times for new projects.

**NEW ORDERS**
|                             |     | YEAR ENDED DECEMBER 31, |       |
|-----------------------------|----------|-------------------------|------------|
|                        |     | **2006**                | ** ** | 2005 |   | 2004 |   |
| UNITS/*Percentage of total* |     | ** **              | ** ** |   |   |   |   |
| North                       |     | **2,987**               | ** ** | 4,333 |   | 4,419 |   |
| * *                    | * * | ***26.8***              | ***%***    | *24.7* | *%* | *26.2* | *%* |
| Southeast                   |     | **3,164**               | ** ** | 5,630 |   | 5,009 |   |
| * *                    | * * | ***28.4***              | ***%***    | *32.2* | *%* | *29.7* | *%* |
| Texas                       |     | **3,237**               | ** ** | 3,702 |   | 3,299 |   |
| * *                    | * * | ***29.1***              | ***%***    | *21.1* | *%* | *19.5* | *%* |
| West                        |     | **1,746**               | ** ** | 3,852 |   | 4,153 |   |
| * *                    | * * | ***15.7***              | ***%***    | *22.0* | *%* | *24.6* | *%* |
| Total                       |     | **11,134**              | ** ** | 17,517 |   | 16,880 |   |
|                        |     | ** **              | ** ** |   |   |   |   |
| DOLLARS *(in millions)*     |     | ** **              | ** ** |   |   |   |   |
| North                       |     | **$**                   | **970**    | ** ** | $ | 1,355 |   | $ | 1,318 |   |
| Southeast                   |     | **921**                 | ** ** | 1,621 |   | 1,222 |   |
| Texas                       |     | **653**                 | ** ** | 680 |   | 546 |   |
| West                        |     | **666**                 | ** ** | 1,480 |   | 1,347 |   |
| Total                       |     | **$**                   | **3,210**  | ** ** | $ | 5,136 |   | $ | 4,433 |   |
|                        |     | ** **              | ** ** |   |   |   |   |
| CANCELLATION  PERCENTAGE    |     | ** **              | ** ** |   |   |   |   |
| North                       |     | **31.5**                | **%**      | 19.7 | % | 17.5 | % |
| Southeast                   |     | **39.0**                | ** ** | 17.6 |   | 19.3 |   |
| Texas                       |     | **32.2**                | ** ** | 28.4 |   | 30.6 |   |
| West                        |     | **48.3**                | ** ** | 25.3 |   | 18.9 |   |
| Total                       |     | **37.1**                | **%**      | 22.3 | % | 21.2 | % |

 

The increase incancellation rates was highest in the western and Florida markets, whichexperienced more extreme price appreciation in recent years.

The Company experiencesseasonal variations in its quarterly operating results and capitalrequirements. Historically, new order activity is higher in the spring andsummer months. As a result, it typically has more homes under construction,closes more homes, and has greater revenues and operating income in the thirdand fourth quarters of the year. This is primarily due to the preference ofmany homebuyers to act during those periods.

23

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**CLOSINGS******
|                                         |     | YEAR ENDED DECEMBER 31, |       |
|-----------------------------------------|----------|-------------------------|------------|
|                                    |     | **2006**                | ** ** | 2005 |   | 2004 |   |
| UNITS/*Percentage of total*             |     | ** **              | ** ** |   |   |   |   |
| North                                   |     | **3,604**               | ** ** | 4,367 |   | 4,349 |   |
| * *                                | * * | ***23.4***              | ***%***    | *26.2* | *%* | *28.8* | *%* |
| Southeast                               |     | **5,126**               | ** ** | 4,887 |   | 4,374 |   |
| * *                                | * * | ***33.3***              | ***%***    | *29.3* | *%* | *29.0* | *%* |
| Texas                                   |     | **3,546**               | ** ** | 3,365 |   | 3,116 |   |
| * *                                | * * | ***23.0***              | ***%***    | *20.2* | *%* | *20.6* | *%* |
| West                                    |     | **3,116**               | ** ** | 4,054 |   | 3,262 |   |
| * *                                | * * | ***20.3***              | ***%***    | *24.3* | *%* | *21.6* | *%* |
| Total                                   |     | **15,392**              | ** ** | 16,673 |   | 15,101 |   |
|                                    |     | ** **              | ** ** |   |   |   |   |
| AVERAGE CLOSING  PRICE *(in thousands)* |     | ** **              | ** ** |   |   |   |   |
| North                                   |     | **$**                   | **320**    | ** ** | $ | 310 |   | $ | 288 |   |
| Southeast                               |     | **293**                 | ** ** | 254 |   | 230 |   |
| Texas                                   |     | **193**                 | ** ** | 177 |   | 165 |   |
| West                                    |     | **385**                 | ** ** | 356 |   | 312 |   |
| Total                                   |     | **$**                   | **295**    | ** ** | $ | 278 |   | $ | 251 |   |

 

Outstanding contracts denote the Company’sbacklog of homes sold but not closed, which are generally built and closed,subject to cancellation, over the subsequent two quarters. The Company hadoutstanding contracts for 4,206 units at December 31, 2006. The $1.3 billionvalue of outstanding contracts at December 31, 2006, represents a decrease of50.6 percent from December 31, 2005, due to a 50.3 percent decline in unitorders. Average sales price increases resulted, in part, from a change in mixthat was weighted toward higher-priced homes. Outstanding contracts at December31, 2006, represented approximately 35 percent of 2007 targeted closings.

**OUTSTANDING CONTRACTS**
|                                |   | DECEMBER 31,                                                         |       |
|--------------------------------|--------|----------------------------------------------------------------------|------------|
|                           |   | **2006**                                                             | ** ** | 2005 |   | 2004 |   |
| UNITS                          |   | ** **                                                           | ** ** |   |   |   |   |
| North                          |   | **1,157**                                                            | ** ** | 1,774 |   | 1,808 |   |
| Southeast                      |   | **1,639**                                                            | ** ** | 3,601 |   | 2,858 |   |
| Texas                          |   | **1,020**                                                            | ** ** | 1,329 |   | 992 |   |
| West                           |   | **390**                                                              | ** ** | 1,760 |   | 1,962 |   |
| Total                          |   | **4,206**                                                            | ** ** | 8,464 |   | 7,620 |   |
|                           |   | ** **                                                           | ** ** |   |   |   |   |
| DOLLARS *(in  millions)*       |   | ** **                                                           | ** ** |   |   |   |   |
| North                          |   | **$          387** | ** ** | $     571 |   | $     568 |   |
| Southeast                      |   | **526**                                                              | ** ** | 1,106 |   | 725 |   |
| Texas                          |   | **228**                                                              | ** ** | 259 |   | 173 |   |
| West                           |   | **153**                                                              | ** ** | 686 |   | 649 |   |
| Total                          |   | **$       1,294**                 | ** ** | $  2,622 |   | $  2,115 |   |
|                           |   | ** **                                                           | ** ** |   |   |   |   |
| AVERAGE PRICE *(in thousands)* |   | ** **                                                           | ** ** |   |   |   |   |
| North                          |   | **$          334** | ** ** | $     322 |   | $     314 |   |
| Southeast                      |   | **321**                                                              | ** ** | 307 |   | 254 |   |
| Texas                          |   | **224**                                                              | ** ** | 195 |   | 175 |   |
| West                           |   | **391**                                                              | ** ** | 390 |   | 331 |   |
| Total                          |   | **$          308** | ** ** | $     310 |   | $     278 |   |

 

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**STATEMENTS OF EARNINGS**
|                                              |   | YEAR  ENDED DECEMBER  31, |          |
|----------------------------------------------|--------|---------------------------|---------------|
| *(in  thousands)*                            |   | **2006**                  | ** **    | 2005 |   | 2004 |   |
| NORTH                                        |   | ** **                | ** **    |   |   |   |   |
| Revenues                                     |   | **$**                     | **1,196,335** | ** ** | $     1,388,208 |   | $  1,284,361 |   |
| Expenses                                     |   | ** **                | ** **    |   |   |   |   |
| Cost of sales                                |   | **917,804**               | ** **    | 1,023,752 |   | 938,045 |   |
| Selling, general and administrative expenses |   | **107,895**               | ** **    | 123,273 |   | 111,925 |   |
| Total expenses                               |   | **1,025,699**             | ** **    | 1,147,025 |   | 1,049,970 |   |
| Pretax earnings                              |   | **$**                     | **170,636**   | ** ** | $        241,183 |   | $     234,391 |   |
|                                         |   | ** **                | ** **    |   |   |   |   |
| SOUTHEAST                                    |   | ** **                | ** **    |   |   |   |   |
| Revenues                                     |   | **$**                     | **1,522,123** | ** ** | $     1,258,373 |   | $  1,011,494 |   |
| Expenses                                     |   | ** **                | ** **    |   |   |   |   |
| Cost of sales                                |   | **1,128,421**             | ** **    | 962,634 |   | 796,071 |   |
| Selling, general and administrative expenses |   | **140,582**               | ** **    | 116,497 |   | 106,459 |   |
| Total expenses                               |   | **1,269,003**             | ** **    | 1,079,131 |   | 902,530 |   |
| Pretax earnings                              |   | **$**                     | **253,120**   | ** ** | $        179,242 |   | $     108,964 |   |
|                                         |   | ** **                | ** **    |   |   |   |   |
| TEXAS                                        |   | ** **                | ** **    |   |   |   |   |
| Revenues                                     |   | **$**                     | **695,356**   | ** ** | $        619,332 |   | $     533,276 |   |
| Expenses                                     |   | ** **                | ** **    |   |   |   |   |
| Cost of sales                                |   | **564,003**               | ** **    | 509,818 |   | 438,238 |   |
| Selling, general and administrative expenses |   | **71,499**                | ** **    | 65,206 |   | 58,171 |   |
| Total expenses                               |   | **635,502**               | ** **    | 575,024 |   | 496,409 |   |
| Pretax earnings                              |   | **$**                     | **59,854**    | ** ** | $          44,308 |   | $       36,867 |   |
|                                         |   | ** **                | ** **    |   |   |   |   |
| WEST                                         |   | ** **                | ** **    |   |   |   |   |
| Revenues                                     |   | **$**                     | **1,240,106** | ** ** | $     1,459,838 |   | $  1,037,955 |   |
| Expenses                                     |   | ** **                | ** **    |   |   |   |   |
| Cost of sales                                |   | **1,029,847**             | ** **    | 1,041,399 |   | 791,733 |   |
| Selling, general and administrative expenses |   | **120,726**               | ** **    | 138,962 |   | 100,990 |   |
| Total expenses                               |   | **1,150,573**             | ** **    | 1,180,361 |   | 892,723 |   |
| Pretax earnings                              |   | **$**                     | **89,533**    | ** ** | $        279,477 |   | $     145,232 |   |
|                                         |   | ** **                | ** **    |   |   |   |   |
| TOTAL                                        |   | ** **                | ** **    |   |   |   |   |
| Revenues                                     |   | **$**                     | **4,653,920** | ** ** | $     4,725,751 |   | $  3,867,086 |   |
| Expenses                                     |   | ** **                | ** **    |   |   |   |   |
| Cost of sales                                |   | **3,640,075**             | ** **    | 3,537,603 |   | 2,964,087 |   |
| Selling, general and administrative expenses |   | **440,702**               | ** **    | 443,938 |   | 377,545 |   |
| Total expenses                               |   | **4,080,777**             | ** **    | 3,981,541 |   | 3,341,632 |   |
| Pretax earnings                              |   | **$**                     | **573,143**   | ** ** | $        744,210 |   | $     525,454 |   |
|                                         |   | ** **                | ** **    |   |   |   |   |
| HOUSING GROSS PROFIT MARGINS                 |   | ** **                | ** **    |   |   |   |   |
| North                                        |   | **23.4**                  | **%**         | 26.5 | % | 26.6 | % |
| Southeast                                    |   | **25.9**                  | ** **    | 23.4 |   | 21.3 |   |
| Texas                                        |   | **18.5**                  | ** **    | 17.9 |   | 17.6 |   |
| West                                         |   | **16.8**                  | ** **    | 28.4 |   | 23.6 |   |
| Total                                        |   | **21.8**                  | **%**         | 25.2 | % | 23.2 | % |

 

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**Homebuilding Segments 2006 versus 2005**

*North*– Homebuilding revenues decreased by 13.8 percent to $1.2 billion in 2006 from$1.4 billion in 2005 primarily due to a 17.5 percent decline in the number ofhomes delivered in all of the markets in this segment, partially offset by a3.2 percent increase in average closing price. Gross margins from home saleswere 23.4 percent in 2006, compared to 26.5 percent in 2005. Gross margins onhome sales decreased in 2006 primarily due to increased price concessions andsales incentives totaling 7.9 percent in 2006, versus 5.9 percent in 2005.

*Southeast*–  Homebuilding revenues were $1.5billion in 2006, compared to $1.3 billion in 2005, an increase of 21.0 percent,primarily due to a 4.9 percent rise in the number of homes delivered and a 15.4percent increase in the average sales price of homes delivered. Gross marginson home sales were 25.9 percent in 2006, compared to 23.4 percent in 2005.Gross margins on home sales increased in 2006 primarily due to a 15.4 percentrise in average sales price and to a change in mix in prices and profitabilityof homes delivered, partially offset by an increase in price concessions andsales incentives.  Price concessions andsales incentives for the year ended December 31, 2006 and 2005 were 5.6 percentand 3.4 percent, respectively.

*Texas*–  Homebuilding revenues increased by12.3 percent to $695.4 million in 2006 from $619.3 million in 2005 primarilydue to a 5.4 percent increase in the number of homes delivered and a 9.0percent increase in the average sales price of homes delivered. Gross marginson home sales were 18.5 percent in 2006, compared to 17.9 percent in 2005.

*West*–  Homebuilding revenues decreased $219.7million, or 15.1 percent, to $1.2 billion in 2006, compared to $1.5 billion in2005, primarily due to a 23.1 percent decline in the number of homes delivered,partially offset by an 8.1 percent increase in average closing price. Grossmargins from home sales were 16.8 percent in 2006, compared to 28.4 percent in2005. Gross margins on home sales decreased in 2006 due to an increase in salesincentives, inventory valuation adjustments and deposit write-offs. Priceconcessions and sales incentives for the year ended December 31, 2006 and 2005were 8.7 percent and 3.5 percent, respectively.

**Homebuilding Segments 2005 versus 2004**

*North*–  Homebuilding revenues increased by 8.1percent to $1.4 billion in 2005 from $1.3 billion in 2004 primarily due to anincrease in the number of homes delivered in the Twin Cities market and anincrease in the average sales price of homes delivered in all of the markets inthis segment.

*Southeast*–  Homebuilding revenues were $1.3billion in 2005, compared to $1.0 billion in 2004, an increase of 24.4 percent,primarily due to a rise in the number of homes delivered and a 10.4 percentincrease in the average sales price of homes delivered. Gross margins on homesales were 23.4 percent in 2005, compared to 21.3 percent in 2004. Grossmargins on home sales increased in 2005 primarily due to rising demand andsales prices.

*Texas*–  Homebuilding revenues increased by16.1 percent to $619.3 million in 2005 from $533.3 million in 2004 primarilydue to a rise in the number of homes delivered and an increase in the averagesales price of homes delivered. Gross margins on home sales were 17.9 percentin 2005, compared to 17.6 percent in 2004.

*West*–  Homebuilding revenues increased $421.9million, or 40.6 percent, to $1.5 billion in 2005, compared to $1.0 billion in2004, primarily due to a rise in the number of homes delivered in the InlandEmpire, Las Vegas and Phoenix markets, plus a 14.1 percent increase in theaverage sales price of homes delivered. Gross margins from home sales were 28.4percent in 2005, compared to 23.6 percent in 2004. This increase was due to asignificant rise in price appreciation.

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**Financial Services**

The Company’s financialservices segment provides mortgage-related products and services, as well asinsurance services to its homebuyers and subcontractors. By aligning itsoperations with the Company’s homebuilding segments, the financial servicessegment leverages this relationship to provide lending services to homebuyers.In addition to being a valuable asset to customers, the financial servicessegment greatly enhances the Company’s profitability. Providing mortgage financingand other services to its customers allows the homebuilder to better monitorits backlog and closing process. Substantially all loans are sold to a thirdparty within one business day of the date they close. The third party thenservices and manages the loans and assumes the credit risk of borrower default.Insurance services provide subcontractors with construction-related insurancein the western markets. Additionally, the financial services segment providesinsurance for liability risks, specifically homeowners’ warranty coverage,arising in connection with the homebuilding business of the Company.

**FINANCIAL SERVICES STATEMENT OF EARNINGS**
|                                                                  |   | YEAR ENDED DECEMBER 31, |       |
|------------------------------------------------------------------|--------|-------------------------|------------|
| *(in  thousands)*                                                |   | **2006**                | ** ** | 2005 |   | 2004 |   |
| * *                                                         |   | ** **              | ** ** |   |   |   |   |
| REVENUES                                                         |   | ** **              | ** ** |   |   |   |   |
| Net gains on sales of mortgages and mortgage  servicing rights   |   | **$**                   | **44,231** | ** ** | $  45,918 |   | $ 45,040 |   |
| Title/escrow/insurance                                           |   | **41,086**              | ** ** | 28,489 |   | 23,740 |   |
| Net origination fees                                             |   | **16,552**              | ** ** | 15,032 |   | 10,768 |   |
| Interest and other                                               |   | **1,427**               | ** ** | 2,376 |   | 5,187 |   |
| TOTAL REVENUES                                                   |   | **103,296**             | ** ** | 91,815 |   | 84,735 |   |
|                                                             |   | ** **              | ** ** |   |   |   |   |
| GENERAL AND ADMINISTRATIVE EXPENSES                              |   | **35,601**              | ** ** | 32,442 |   | 28,033 |   |
| PRETAX EARNINGS                                                  |   | **$**                   | **67,695** | ** ** | $  59,373 |   | $ 56,702 |   |
| Ryland Homes  origination capture rate                           |   | **81.9**                | **%**      | 81.9 | % | 84.2 | % |
| Mortgage-backed  securities and notes receivable average balance |   | **$**                   | **1,707**  | ** ** | $    7,365 |   | $ 18,603 |   |

 

In 2006, RMC’s mortgageorigination operations consisted primarily of mortgage loans originated inconnection with the sale of the Company’s homes. The number of mortgageoriginations was 11,744 for 2006, compared to 12,774 for 2005 and 11,920 for2004. During 2006, total dollar originations were $3.0 billion, of which 99.7percent was for purchases of homes built by the Company and the remainingamount was for either purchases of homes built by others, purchases of existinghomes or the refinancing of existing mortgage loans. The capture rate ofmortgages originated for customers of the Company’s homebuilding operations was81.9 percent in 2006 and 2005, compared to 84.2 percent in 2004.

The financial servicessegment reported pretax earnings of $67.7 million for 2006, compared to $59.4million for 2005 and $56.7 million for 2004. The increase in 2006 was primarilydue to increased income from insurance services and a 6.5 percent rise inaverage loan size, offset by an 8.1 percent decrease in loans originated. Theincrease in 2005 versus 2004 was primarily due to a 7.2 percent increase inloans originated and a rise in average loan size, as well as increased profitabilityfrom title, escrow and insurance operations.

Revenues for the financialservices segment were $103.3 million for 2006, compared to $91.8 million for2005. This rise was attributable to a $12.6 million increase in title, escrowand insurance revenues, partially offset by reduced interest income from adeclining investment portfolio and reduced revenue from the sales of mortgagesand mortgage servicing rights. In 2005, revenues for the financial servicessegment increased 8.4 percent to $91.8 million from $84.7 million in 2004 dueto increased revenues from loan origination activities and title, escrow andinsurance operations, partially offset by reduced interest income from thedeclining investment portfolio.

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General and administrativeexpenses increased for the year ended December 31, 2006, compared to 2005,primarily as a result of additional expenses incurred in the Company’sinsurance operations. General and administrative expenses rose for the yearended December 31, 2005, compared to 2004, primarily as a result of additionalexpenses incurred in both the Company’s mortgage operations and its title andinsurance operations.

Interest expensedecreased 72.2 percent for the year ended December 31, 2006, compared to 2005, dueto continued runoff and redemption of the Company’s mortage-backed securitiesportfolio. In 2005, interest expense decreased 27.4 percent, compared to 2004,primarily as a result of a continued decline in bonds payable and short-termnotes payable, which resulted from continued runoff of the underlyingcollateral and from the sale and redemption of portions of the Company’smortgage-backed securities portfolio.

**Corporate**

Corporate expenses were$66.0 million for 2006, $74.3 million for 2005 and $60.9 million for 2004.Excluding stock option expense required by a change in accounting principle,corporate expense was $60.8 million for the year ended December 31, 2006.Corporate expense for 2006, as compared to 2005, declined primarily due tolower executive compensation expense that resulted from a decline in earningsand stock price. Corporate expense for 2005, as compared to 2004, roseprimarily as a result of an increase in support and training costs that wascommensurate with anticipated growth; a rise in incentive compensation, whichwas due to increases in the Company’s results and financial performance; andcosts incurred as a result of the Company’s compliance with Section 404 of theSarbanes-Oxley Act of 2002.

The Company ended theyear with $215.0 million in cash, no borrowings against its revolving creditfacility and a lower cost of funds.

In 2006, the Companyrecorded an expense of approximately $7.7 million associated with the earlyredemption of $150.0 million of its 9.1 percent senior subordinated notes dueJune 2011, of which it owned $6.5 million, at a stated call price of 104.6percent of the principal amount.

In 2005, the Companyrecorded an expense of approximately $8.3 million associated with the earlyredemption of $150.0 million of its 9.8 percent senior notes due September2010, of which it owned $3.0 million, at a stated call price of 104.9 percentof the principal amount.

**Investments in Joint Ventures**

At December 31, 2006,the Company had an interest in 12 active joint ventures in the Atlanta, Austin,Chicago, Dallas, Denver, Las Vegas, Orlando and Phoenix markets, three of whichwere consolidated. These joint ventures exist for the purpose of acquisitionand co-development of lots, which are then sold to the Company, its joint venturepartners or others, at market prices. Depending on the number of joint venturesand the level of activity in the entities, annual earnings from the Company’sinvestment in joint ventures will vary significantly. The Company’sproportionate share of losses from unconsolidated joint ventures in 2006,totaled $260,000, compared to earnings of $315,000 in 2005 and $5.8 million in2004. The earnings in 2004 were primarily attributable to a $5.4 million gainon the sale of land to a third party in one joint venture in Atlanta. TheCompany’s investment in unconsolidated joint ventures was $13.5 million atDecember 31, 2006, compared to $10.2 million at December 31, 2005. (See “Investmentsin Joint Ventures” within Note A, “Summary of Significant Accounting Policies.”)

**Income Taxes**

Income taxes for fiscalyears 2006, 2005 and 2004 were provided at effective tax rates of 36.5 percent,38.0 percent and 38.5 percent, respectively. The decrease in the effective taxrate for 2006, as compared to 2005, was primarily attributable to prior years’tax provisions no longer required due 

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to the expiration ofvarious tax statutes. The decrease in the effective tax rate for 2005 and 2004was primarily attributable to a new tax deduction on qualified productionactivities created by the American Jobs Creation Act of 2004. (See Note H, “IncomeTaxes.”)

**Financial Condition and Liquidity**

Cash requirements forthe Company are generally provided from internally generated funds and outsideborrowings.

Net earnings providedcash flows of $359.9 million in 2006, $447.1 million in 2005 and $320.5 millionin 2004. New debt was issued during the year ended December 31, 2006, thatprovided cash flows of $250.0 million, compared to $500.0 million for the sameperiod in 2005. Repayment of senior and senior subordinated notes used $243.5million and $147.0 million for the years ended December 31, 2006 and 2005,respectively. Additionally, net changes in other assets, payables and otherliabilities used $216.9 million in 2006; and provided cash flows of $175.4million in 2005 and $104.4 million in 2004. The cash provided was investedprincipally in inventory of $182.7 million, $491.0 million and $585.6 millionin 2006, 2005 and 2004, respectively; as well as in stock repurchases of $250.1million, $176.2 million and $118.3 million for the same periods in 2006, 2005and 2004. Dividends totaled $0.48, $0.30 and $0.21 per share for the annualperiods ended December 31, 2006, 2005 and 2004, respectively. During 2006,stockholders’ equity rose $135.1 million, while debt increased $28.1 million,decreasing the Company’s leverage.
| STOCKHOLDERS’ EQUITY |       | DEBT             |       | DEBT-TO-CAPITAL |       |
|---------------------------|------------|------------------|------------|-----------------|------------|
| *(in millions)*           |       | *(in millions)*  |       | RATIO           |       |
| 2004                      |       | $ 1,057     |       | $ 559      |       | 34.6 | % |
| 2005                      |       | $ 1,376     |       | $ 922      |       | 40.1 | % |
| **2006**                  | ** ** | **$ 1,511** | ** ** | **$ 950**  | ** ** | **38.6** | **%** |

 

Consolidated inventoriesowned by the Company increased to $2.5 billion at December 31, 2006, from $2.3billion at December 31, 2005. The Company attempts to maintain a projectedfour- to five-year supply of land, with nearly half controlled through options.At December 31, 2006, the Company controlled 60,318 lots, with 31,251 lotsowned and 29,067 lots, or 48.2 percent, under option. The Company hashistorically funded the acquisition of land and the exercise of land optionsthrough a combination of operating cash flows, capital transactions andborrowings under its revolving credit facility. The Company expects thesesources to continue to be adequate to fund future obligations with regard tothe acquisition of land and the exercise of land options; therefore, it doesnot anticipate that the exercise of land options will have a material adverseeffect on its liquidity. In an effort to increase liquidity, models have beensold and leased back on a selective basis for generally three to eighteenmonths. The Company owned 66.9 percent and 80.7 percent of its model homes atDecember 31, 2006 and 2005, respectively.

The homebuildingsegments’ borrowings include senior notes, an unsecured revolving creditfacility and nonrecourse secured notes payable. Senior notes outstandingtotaled $900.0 million at December 31, 2006. Senior and senior subordinatednotes outstanding totaled $893.5 million at December 31, 2005.

In 2006, the Companyredeemed $150.0 million of its 9.1 percent senior subordinated notes due June2011, of which it owned $6.5 million. The redemption price was 104.6 percent ofthe principal amount of the notes outstanding, plus accrued interest as of theredemption date. The Company recognized a $7.7 million loss related to the earlyretirement of these senior subordinated notes in the third quarter of 2006.Additionally, the Company’s 8.0 percent senior notes, which totaled $100.0million, matured in August 2006.

In January 2006, theCompany replaced its $500.0 million revolving credit facility with a new $750.0million revolving credit facility. In November 2006, the Company increased thisrevolving 

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credit facility from$750.0 million to $1.1 billion through its accordion feature. The creditagreement, which matures in January 2011, also provides access to an additional$366.5 million of financing through an accordion feature under which theaggregate commitment may be increased up to $1.5 billion, subject to theavailability of additional lending commitments. The $1.1 billion revolvingcredit facility includes a $75.0 million swing-line facility and a $600.0million sublimit for issuance of standby letters of credit. Amounts borrowedunder the credit agreement are guaranteed on a joint and several basis bysubstantially all of the Company’s wholly-owned homebuilding subsidiaries. Suchguarantees are full and unconditional. Interest rates on outstanding borrowingsare determined either by reference to LIBOR, with margins determined based onchanges in its leverage ratio and credit ratings, or by reference to analternate base rate. The credit agreement contains various customary affirmative,negative and financial covenants. The Company was in compliance with thesecovenants at December 31, 2006. (See Note F, “Debt.”)

The Company uses itsunsecured revolving credit facility to finance increases in its homebuildinginventory and working capital, when necessary. There were no borrowingsoutstanding under the current or previous agreements at December 31, 2006 or2005, respectively. Under the respective agreements, the Company had letters ofcredit outstanding that totaled $192.9 million at December 31, 2006, and $185.6million at December 31, 2005. Unused borrowing capacity under the respectivefacilities totaled $940.6 million and $314.4 million at December 31, 2006 and2005, respectively.

The $150.0 million of5.4 percent senior notes due June 2008; the $250.0 million of 5.4 percentsenior notes due May 2012; the $250.0 million of 6.9 percent senior notes dueJune 2013; and the $250.0 million of 5.4 percent senior notes due January 2015are subject to certain covenants that include, among other things, restrictionson additional secured debt and the sale of assets. At December 31, 2006, theCompany was in compliance with these covenants.

In 2006, the Companyterminated its treasury interest rate locks (“treasury locks”), which wereentered into in 2005 to facilitate the replacement of some of its higher-ratesenior and senior subordinated debt. (See Note D, “Derivative Instruments.”)

To finance its landpurchases, the Company may also use seller-financed nonrecourse secured notespayable. At December 31, 2006, such notes payable outstanding amounted to $50.1million, compared to $28.5 million at December 31, 2005.

In 2005, the Companyredeemed $150.0 million of its 9.8 percent senior notes due September 2010, ofwhich it owned $3.0 million. The notes were redeemed at a stated call price of104.9 percent of the principal amount, plus accrued and unpaid interest. TheCompany recorded an expense of $8.3 million related to the early retirement ofthis debt.

Although the Company nolonger issues mortgage-backed securities and mortgage-participation securities,some of its limited-purpose subsidiaries continued to hold collateral forpreviously issued mortgage-backed bonds in which the Company maintained aresidual interest. Revenues, expenses and portfolio balances declined asmortgage collateral pledged to secure the bonds decreased due to scheduledpayments and prepayments, as well as to the sale and redemption of a majorityof the investment portfolio during 2005 and 2004.

The Company filed ashelf registration statement with the SEC for up to $1.0 billion of its debtand equity securities on April 11, 2005. At December 31, 2006, $600.0 millionremained available under this registration statement due to the issuance of$250.0 million of senior notes in May 2005, of which $100.0 million was appliedto a previous shelf registration statement, and the issuance of $250.0 millionof senior notes in May 2006. The registration statement provides thatsecurities may be offered, from time to time, in one or more series and in theform of senior, subordinated or con-

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vertible debt; preferredstock; preferred stock represented by depository shares; common stock; stockpurchase contracts; stock purchase units; and warrants to purchase both debtand equity securities. In the future, the Company intends to continue tomaintain effective shelf registration statements that will facilitate access tothe capital markets. The timing and amount of future offerings, if any, willdepend on market and general business conditions.

During 2006, the Companyrepurchased 4.7 million shares of its common stock at a cost of $250.1 million.In December, the Company’s Board of Directors authorized the purchase ofadditional shares totaling $175.0 million. At December 31, 2006, the Companyhad existing authorization from its Board of Directors to purchase a total ofapproximately 3.7 million shares at a cost of $201.6 million, based on theCompany’s stock price on that date. Outstanding shares at December 31, 2006,were 42,612,525, versus 46,368,143 for December 31, 2005, a decrease of 8.1percent.

The Company grantedfewer stock options in 2006 that, when combined with common stock repurchasesand lower stock prices, lowered dilution.

The following tableprovides a summary of the Company’s contractual cash obligations and commercialcommitments at December 31, 2006, and the effect such obligations are expectedto have on liquidity and cash flow in future periods.
|                             |   | CONTRACTUAL PAYMENTS  DUE BY PERIOD |        |
|-----------------------------|--------|-------------------------------------|-------------|
| *(in thousands)*            |   | TOTAL                               |        | 2007 |   | 2008-2009 |   | 2010-2011 |   | AFTER 2011 |   |
| Debt, principle  maturities |   | **$**                               | **950,117** | ** ** | **$** | **25,980** | ** ** | **$** | **170,893** | ** ** | **$** | **3,244** | ** ** | **$** | **750,000** | ** ** |
| Interest on debt            |   | **302,713**                         | ** **  | **52,125** | ** ** | **91,485** | ** ** | **88,126** | ** ** | **70,977** | ** ** |
| Operating leases            |   | **59,572**                          | ** **  | **14,052** | ** ** | **22,766** | ** ** | **13,909** | ** ** | **8,845** | ** ** |
| Land option  contracts1     |   | **33,645**                          | ** **  | **26,393** | ** ** | **7,252** | ** ** | **-** | ** ** | **-** | ** ** |
| Total at December 31,  2006 |   | **$ 1,346,047**                | ** **  | **$ 118,550** | ** ** | **$   292,396** | ** ** | **$       105,279** | ** ** | **$       829,822** | ** ** |
|                             |        |                                     |             |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

1*Represents obligations under option contracts withspecific performance provisions, net of cash deposits.*

The Company believes that its current cashposition, cash generation capabilities, amounts available under its revolvingcredit facility and ability to access the capital markets in a timely mannerwith its existing shelf registration statement are adequate to meet its cashneeds for the foreseeable future.

**Off–Balance Sheet Arrangements**

In the ordinary courseof business, the Company enters into land and lot option purchase contracts inorder to procure land or lots for the construction of homes. Land and lotoption purchase contracts enable the Company to control significant lotpositions with a minimal capital investment and substantially reduce the risksassociated with land ownership and development. The Company had $187.8 millionin cash deposits and letters of credit to purchase land and lots with a totalpurchase price of $1.5 billion at December 31, 2006. Only $34.2 million of the $1.5billion in land and lot option purchase contracts contain specific performanceprovisions. Additionally, the Company’s liability is generally limited toforfeiture of the nonrefundable deposits, letters of credit and othernonrefundable amounts incurred.

Pursuant toInterpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities,”the Company consolidated $263.9 million of inventory not owned at December 31,2006, $186.0 million of which pertained to land and lot option purchasecontracts and $77.9 million of which pertained to three of the Company’shomebuilding joint ventures. (See “Variable Interest Entities” and “Investmentsin Joint Ventures” within Note A, “Summary of Significant Accounting Policies.”)

At December 31, 2006,the Company had outstanding letters of credit totaling $192.9 million anddevelopment or performance bonds totaling $482.2 million, issued by thirdparties, to secure performance under various contracts and obligations relatingto land or municipal improvement. The 

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Company expects that theobligations secured by these letters of credit and performance bonds willgenerally be satisfied in the ordinary course of business and in accordancewith applicable contractual terms. To the extent that the obligations are fulfilled,the related letters of credit and performance bonds will be released, and theCompany will not have any continuing obligations.

The Company has nomaterial third-party guarantees other than those associated with its $1.1billion revolving credit facility, its senior notes and its investments injoint ventures. (See “Investments in Joint Ventures” within Note A, “Summary ofSignificant Accounting Policies;” and Note K, “Supplemental GuarantorInformation.”)

**Critical Accounting Policies**

Preparation of theCompany’s consolidated financial statements requires the use of judgment in theapplication of accounting policies and estimates of inherently uncertainmatters. Listed below are those policies that management believes are criticaland require the use of complex judgment in their application.

Management has discussedthe critical accounting policies with the Audit Committee of its Board ofDirectors and the Audit Committee has reviewed the disclosure. There are itemswithin the financial statements that require estimation, but are not consideredcritical.

*Share-BasedPayments*

On January 1, 2006, theCompany adopted the provisions of Statement of Financial Accounting StandardsNo. 123(R) (“SFAS 123(R)”) “Share-Based Payment,” which requires that compensationexpense be measured and recognized at an amount equal to the fair value ofshare-based payments granted under compensation arrangements. The Companycalculates the fair value of stock options by using the Black-Scholes-Mertonoption-pricing model. The determination of the fair value of share-based awardsat the grant date requires judgment in developing assumptions, which involve anumber of variables. These variables include, but are not limited to, theexpected stock-price volatility over the term of the awards, the expecteddividend yield and the expected stock option exercise behavior. Additionally,judgment is also required in estimating the number of share-based awards thatare expected to forfeit. If actual results differ significantly from theseestimates, stock-based compensation expense and the Company’s consolidatedresults of operations could be materially impacted. The Company believes theaccounting for stock-based compensation is a critical accounting policy becauseit requires the use of complex judgment in its application.

*Useof Estimates*

In budgeting landacquisitions, development and homebuilding construction costs associated withreal estate projects, the Company evaluates market conditions; material andlabor costs; buyer preferences; construction timing; and provisions forinsurance and warranty obligations. The Company accrues its best estimate ofthe probable cost for resolution of legal claims. Estimates, which are based onhistorical experience and other assumptions, are reviewed continually, updatedwhen necessary and believed to be reasonable under the circumstances.Management believes that the timing and scope of its evaluation procedures areproper and adequate. Changes in assumptions relating to such factors, however,could have a material effect on the Company’s results of operations for aparticular quarterly or annual period.

*IncomeRecognition*

Revenues and cost ofsales are recorded at the time each home or lot is closed, title and possessionare transferred to the buyer and there is no significant continuing involvementin accordance with Statement of Financial Accounting Standards No. 66 (“SFAS 66”),“Accounting for Sales of Real Estate.” In order to match revenues with relatedexpenses, land, land development, interest, taxes and other related costs (bothincurred and estimated to be incurred in the future) are allocated to the costof 

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homes closed, based uponthe relative sales value basis of the total number of homes to be constructedin each community, in accordance with Statement of Financial AccountingStandards No. 67 (“SFAS 67”), “Accounting for Costs and Initial RentalOperations of Real Estate Projects.” Estimated land, common area developmentand related costs of planned communities (including the cost of amenities) areallocated to individual parcels or communities on a relative sales value basis.Changes to estimated costs, subsequent to the commencement of the delivery ofhomes, are allocated to the remaining undelivered homes in the community. Homeconstruction and related costs are charged to the cost of homes closed underthe specific-identification method.

*InventoryValuation*

Housing projects andland held for development (inventory) and sale are stated at either the lowerof cost or net realizable value. Inventory includes land and development costs;direct construction costs; capitalized indirect construction costs; capitalizedinterest; and real estate taxes. It may take one to three years to develop,sell and deliver all of the homes in a typical community. The Company assessesthese assets for recoverability in accordance with the provisions of Statementof Financial Accounting Standards No. 144 (“SFAS 144”), “Accounting for theImpairment or Disposal of Long-Lived Assets.” SFAS 144 requires that long-livedassets and assets held-for-sale be reviewed for impairment whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable. Recoverability of housing inventories is measured by comparingthe carrying amount of an asset to future undiscounted net cash flows expectedto be generated by that asset or by the sales of comparable assets. Assetsheld-for-sale are carried at the lower of cost or fair value, less sellingcosts. These evaluations for impairment are significantly impacted by estimatesof revenues, costs and expenses, as well as by other factors. In addition,land, or costs related to future communities, whether owned or under option, isreviewed to determine if the Company will proceed with development and if allrelated costs are recoverable. If these assets are considered to be impaired,the impairment loss is measured as the amount by which the carrying amount ofthe assets exceeds the fair value of the assets and is recognized within thesame period that it is identified. Management believes its processes aredesigned to properly assess market and carrying values of assets.

*VariableInterest Entities*

FIN 46 requires avariable interest entity to be consolidated by a company if that company is subjectto the majority of the entity’s expected losses and/or receives a majority ofthe entity’s expected returns as a result of ownership, contractual agreementsor other financial interests in the entity. FIN 46 also requires disclosureabout variable interest entities (“VIEs”) that the Company is not required toconsolidate but in which it has a significant, though not primary, variableinterest. The Company enters into joint ventures, from time to time, for thepurpose of acquisition and co-development of land parcels and lots. Itsinvestment in these joint ventures may create a variable interest in a VIE,depending on the contractual terms of the arrangement. Additionally, in theordinary course of business, the Company enters into lot option purchase contractsin order to procure land for the construction of homes. Under such lot optionpurchase contracts, the Company funds stated deposits in consideration for theright to purchase lots at a future point in time, usually at predeterminedprices. In accordance with the requirements of FIN 46, certain of the Company’slot option purchase contracts may result in the creation of a variable interestin a VIE. The Company believes the accounting for joint ventures and landoption purchase contracts using the variable interest consolidation methodologyis a critical accounting policy because compliance with FIN 46 requires the useof complex judgment in its application.

*IncomeTaxes*

The Company calculates aprovision for its income taxes by using the asset and liability method, underwhich deferred tax assets and liabilities are recognized by identifying thetemporary differences arising from the different treatment of items for tax andaccounting purposes. In determining the tax consequences of events that have beenrecognized in the Company’s financial statements or tax 

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returns, judgment isrequired. Differences between the amounts recognized in its financialstatements or tax returns and actual outcomes may arise upon issuance ofregulations and final guidance from federal and state taxing authorities andcould have a material impact on the Company’s consolidated results ofoperations or financial position.

**Outlook**

In 2006, the Companyexperienced a decline in sales orders for new homes, compared to 2005. The Companycontinues to believe its sales orders in late 2006 and early 2007 reflectbroader market trends of a softening in demand for residential housing. Nearlyall markets have been affected by reduced demand and higher cancellation rates,leading to a buildup of new and resale home inventories. At December 31, 2006,the Company’s backlog of orders for new homes totaled 4,206 units, or aprojected dollar value of $1.3 billion, reflecting a 50.6 percent decline indollar value from December 31, 2005. As a result of these trends, the Companyprojects its diluted earnings per share will be between $3.75 and $4.25 for theyear ending December 31, 2007.

**Item 7****A****. Quantitativeand Qualitative Disclosures About Market Risk**

**Market Risk Summary**

The following table providesinformation about the Company’s significant financial instruments that aresensitive to changes in interest rates. For debt obligations, the tablepresents principal cash flows and related weighted-average interest rates byexpected maturity dates. For the other financial instruments, weighted-averagerates are based on implied forward rates as of the reporting date.

**Interest Rate Sensitivity**

**Principal Amount by ExpectedMaturity**
|                              |   |       |        |       |        |       |       |       |       |        |       | FAIR        |        |
|------------------------------|--------|------------|-------------|------------|-------------|------------|------------|------------|------------|-------------|------------|-------------|-------------|
|                         |   |       |        |       |        |       |       | THERE-     |       |        |       | VALUE       |        |
| *(in  thousands)*            |   | 2007       |        | 2008       |        | 2009-2011  |       | AFTER      |       | TOTAL       |       | 12/31/06    |        |
| Senior notes (fixed  rate)   |   | ** ** | ** **  | **$**      | **150,000** | ** ** | ** ** | ** ** | **$**      | **750,000** | ** ** | **$**       | **900,000** | ** ** | **$** | **891,695** | ** ** |
| Average interest rate        |   | ** ** | ** **  | **5.4**    | **%**       | ** ** | ** ** | **5.9**    | **%**      | **5.8**     | **%**      | ** **  | ** **  |
| Other financial  instruments |   | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** **  | ** ** | ** **  | ** **  |
| Forward-delivery contracts:  |   | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** **  | ** ** | ** **  | ** **  |
| Notional amount              |   | **$**      | **41,000**  | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** **  | **$**      | **41,000**  | ** **  | **$** | **152** | ** ** |
| Average interest rate        |   | **5.5**    | **%**       | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | **5.5**     | **%**      | ** **  | ** **  |
| Mortgage interest rate       |   | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** **  | ** ** | ** **  | ** **  |
| lock commitments:            |   | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** **  | ** ** | ** **  | ** **  |
| Notional amount              |   | **$**      | **124,927** | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** **  | **$**      | **124,927** | ** **  | **$** | **598** | ** ** |
| Average interest  rate       |   | **6.3**    | **%**       | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | **6.3**     | **%**      | ** **  | ** **  |
|                              |        |            |             |            |             |            |            |            |            |             |            |             |             |  |  |  |  |  |

 

Interest rate risk is aprimary market risk facing the Company. Interest rate risk not only arisesprincipally in the Company’s financial services segment, but also in respect tothe homebuilding segments’ revolving credit facility. The Company enters intoforward-delivery contracts and may, at times, use other hedging contracts tomitigate its exposure to movements in interest rates on mortgage interest ratelock commitments (“IRLCs”) and mortgage loans held-for-sale. In managing interestrate risk, the Company does not speculate on the direction of interest rates.

34

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**Item 8.    Financial Statements and Supplementary Data**

**CONSOLIDATED STATEMENTS OF EARNINGS**
|                                              |   | YEAR  ENDED DECEMBER 31,                                                                |          |
|----------------------------------------------|--------|-----------------------------------------------------------------------------------------|---------------|
| *(in  thousands, except share data)*         |   | **2006**                                                                                | ** **    | 2005 |   | 2004 |   |
| REVENUES                                     |   | ** **                                                                              | ** **    |   |   |   |   |
| Homebuilding                                 |   | **$**                                                                                   | **4,653,920** | ** ** | $  4,725,751 |   | $   3,867,086 |   |
| Financial services                           |   | **103,296**                                                                             | ** **    | 91,815 |   | 84,735 |   |
| TOTAL REVENUES                               |   | **4,757,216**                                                                           | ** **    | 4,817,566 |   | 3,951,821 |   |
|                                         |   | ** **                                                                              | ** **    |   |   |   |   |
| EXPENSES                                     |   | ** **                                                                              | ** **    |   |   |   |   |
| Cost of sales                                |   | **3,640,075**                                                                           | ** **    | 3,537,603 |   | 2,964,087 |   |
| Selling, general and administrative          |   | **440,702**                                                                             | ** **    | 443,938 |   | 377,545 |   |
| Financial services                           |   | **35,601**                                                                              | ** **    | 32,442 |   | 28,033 |   |
| Corporate                                    |   | **66,035**                                                                              | ** **    | 74,255 |   | 60,944 |   |
| Expenses related to early retirement of debt |   | **7,695**                                                                               | ** **    | 8,277 |   | - |   |
| TOTAL EXPENSES                               |   | **4,190,108**                                                                           | ** **    | 4,096,515 |   | 3,430,609 |   |
|                                         |   | ** **                                                                              | ** **    |   |   |   |   |
| EARNINGS                                     |   | ** **                                                                              | ** **    |   |   |   |   |
| Earnings before taxes                        |   | **567,108**                                                                             | ** **    | 721,051 |   | 521,212 |   |
| Tax expense                                  |   | **207,166**                                                                             | ** **    | 273,999 |   | 200,667 |   |
| NET EARNINGS                                 |   | **$**                                                                                   | **359,942**   | ** ** | $     447,052 |   | $      320,545 |   |
| NET EARNINGS PER COMMON SHARE                |   | ** **                                                                              | ** **    |   |   |   |   |
| Basic                                        |   | **$             8.14** | ** **    | $           9.52 |   | $            6.72 |   |
| Diluted                                      |   | **7.83**                                                                                | ** **    | 9.03 |   | 6.36 |   |
|                                         |   | ** **                                                                              | ** **    |   |   |   |   |
| AVERAGE COMMON SHARES OUTSTANDING            |   | ** **                                                                              | ** **    |   |   |   |   |
| Basic                                        |   | **44,228,502**                                                                          | ** **    | 46,966,317 |   | 47,678,887 |   |
| Diluted                                      |   | **45,944,448**                                                                          | ** **    | 49,490,887 |   | 50,378,840 |   |
| DIVIDENDS  DECLARED PER COMMON SHARE         |   | **$**                                                                                   | **0.48**      | ** ** | $           0.30 |   | $            0.21 |   |

 

*See Notes to ConsolidatedFinancial Statements.*

35

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**CONSOLIDATED BALANCE SHEETS**
|                                                    |   | DECEMBER 31,             |          |
|----------------------------------------------------|--------|--------------------------|---------------|
| *(in  thousands, except share data)*               |   | **2006**                 | ** **    | 2005 |   |
| ASSETS                                             |   | ** **               | ** **    |   |   |
| Cash and cash equivalents                          |   | **$  215,037** | ** **    | $ | 461,383 |   |
| Housing inventories                                |   | ** **               | ** **    |   |   |
| Homes under construction                           |   | **1,079,702**            | ** **    | 1,253,460 |   |
| Land under development and improved lots           |   | **1,427,930**            | ** **    | 1,087,016 |   |
| Consolidated inventory not owned                   |   | **263,853**              | ** **    | 239,191 |   |
| Total inventories                                  |   | **2,771,485**            | ** **    | 2,579,667 |   |
| Property, plant and equipment                      |   | **76,887**               | ** **    | 65,980 |   |
| Net deferred taxes                                 |   | **84,199**               | ** **    | 50,099 |   |
| Purchase price in excess of net assets acquired    |   | **18,185**               | ** **    | 18,185 |   |
| Other                                              |   | **250,904**              | ** **    | 211,559 |   |
| TOTAL ASSETS                                       |   | **3,416,697**            | ** **    | 3,386,873 |   |
|                                               |   | ** **               | ** **    |   |   |
| LIABILITIES                                        |   | ** **               | ** **    |   |   |
| Accounts payable                                   |   | **186,868**              | ** **    | 249,539 |   |
| Accrued and other liabilities                      |   | **586,797**              | ** **    | 664,691 |   |
| Debt                                               |   | **950,117**              | ** **    | 921,970 |   |
| TOTAL LIABILITIES                                  |   | **1,723,782**            | ** **    | 1,836,200 |   |
|                                               |   | ** **               | ** **    |   |   |
| MINORITY INTEREST                                  |   | **181,749**              | ** **    | 174,652 |   |
|                                               |   | ** **               | ** **    |   |   |
| STOCKHOLDERS’ EQUITY                          |   | ** **               | ** **    |   |   |
| Common stock, $1.00 par value:                     |   | ** **               | ** **    |   |   |
| Authorized—200,000,000 shares                 |   | ** **               | ** **    |   |   |
| Issued—42,612,525 shares at December 31, 2006 |   | ** **               | ** **    |   |   |
| (46,368,143 shares at December 31, 2005)           |   | **42,612**               | ** **    | 46,368 |   |
| Retained earnings                                  |   | **1,463,727**            | ** **    | 1,326,689 |   |
| Accumulated other comprehensive income             |   | **4,827**                | ** **    | 2,964 |   |
| TOTAL STOCKHOLDERS’ EQUITY                    |   | **1,511,166**            | ** **    | 1,376,021 |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY    |   | **$**                    | **3,416,697** | ** ** | $ | 3,386,873 |   |
|                                                    |        |                          |               |  |  |  |  |

 

*See Notes to ConsolidatedFinancial Statements.*

36

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**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**
|                                                                                                                          | ** ** | ** ** | ** ** | ** **  | ** ** | ** **   | ** ** | **ACCUMULATED**   | ** ** | ** **             | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|-------------|------------|--------------|------------|-------------------|------------|------------------------|------------|
| ** **                                                                                                               | ** ** | ** ** | ** ** | ** **  | ** ** | ** **   | ** ** | **OTHER**         | ** ** | **TOTAL**              | ** ** |
| ** **                                                                                                               | ** ** | **COMMON** | ** ** | **PAID-IN** | ** ** | **RETAINED** | ** ** | **COMPREHENSIVE** | ** ** | **STOCKHOLDERS’** | ** ** |
| ***(in thousands, except share data)***                                                              | ** ** | **STOCK**  | ** ** | **CAPITAL** | ** ** | **EARNINGS** | ** ** | **INCOME**        | ** ** | **EQUITY**             | ** ** |
| BALANCE AT  JANUARY 1, 2004                                                                                              |       | $          | 48,552     |        | $          | -            |       | $                 | 774,859    |                   | $          | 1,131 |   | $ | 824,542 |   |
| Comprehensive  income:                                                                                                   |       |       |       |        |       |         |       |              |       |                   |       |
| Net earnings                                                                                                             |       |       |       |        |       | 320,545      |       |              |       | 320,545                |       |
| Other comprehensive income, net of tax:                                                                                  |       |       |       |        |       |         |       |              |       |                   |       |
| Change in net unrealized gain  on mortgage-backed securities,  net of taxes of $542                                      |       |       |       |        |       |         |       | (887              | )          | (887                   | )          |
| Total comprehensive income                                                                                               |       |       |       |        |       |         |       |              |       | 319,658                |       |
| Common stock  dividends (per share $0.21)                                                                                |       |       |       |        |       | (10,064      | )          |              |       | (10,064                | )          |
| Repurchase of  common stock                                                                                              |       | (2,939     | )          | (39,259     | )          | (76,098      | )          |              |       | (118,296               | )          |
| Employee stock  plans and related  income tax benefit                                                                    |       | 1,735      |       | 39,259      |       |         |       |              |       | 40,994                 |       |
| BALANCE AT  DECEMBER 31, 2004                                                                                            |       | 47,348     |       | -           |       | 1,009,242    |       | 244               |       | 1,056,834              |       |
| Comprehensive  income:                                                                                                   |       |       |       |        |       |         |       |              |       |                   |       |
| Net earnings                                                                                                             |       |       |       |        |       | 447,052      |       |              |       | 447,052                |       |
| Other comprehensive income, net of tax:                                                                                  |       |       |       |        |       |         |       |              |       |                   |       |
| Change in net unrealized gain on  cash flow hedging instruments  and mortgage-backed securities,  net of taxes of $1,685 |       |       |       |        |       |         |       | 2,720             |       | 2,720                  |       |
| Total comprehensive income                                                                                               |       |       |       |        |       |         |       |              |       | 449,772                |       |
| Common stock  dividends (per share $0.30)                                                                                |       |       |       |        |       | (14,138      | )          |              |       | (14,138                | )          |
| Repurchase of  common stock                                                                                              |       | (2,558     | )          | (58,189     | )          | (115,467     | )          |              |       | (176,214               | )          |
| Employee stock  plans and related  income tax benefit                                                                    |       | 1,578      |       | 58,189      |       |         |       |              |       | 59,767                 |       |
| BALANCE AT  DECEMBER 31, 2005                                                                                            |       | 46,368     |       | -           |       | 1,326,689    |       | 2,964             |       | 1,376,021              |       |
| Comprehensive  income:                                                                                                   |       |       |       |        |       |         |       |              |       |                   |       |
| Net earnings                                                                                                             |       |       |       |        |       | 359,942      |       |              |       | 359,942                |       |
| Other comprehensive income, net of tax:                                                                                  |       |       |       |        |       |         |       |              |       |                   |       |
| Change in net unrealized gain on  cash flow hedging instruments  and mortgage-backed securities,  net of taxes of $1,154 |       |       |       |        |       |         |       | 1,863             |       | 1,863                  |       |
| Total comprehensive income                                                                                               |       |       |       |        |       |         |       |              |       | 361,805                |       |
| Common stock  dividends (per share $0.48)                                                                                |       |       |       |        |       | (21,214      | )          |              |       | (21,214                | )          |
| Repurchase of  common stock                                                                                              |       | (4,700     | )          | (43,728     | )          | (201,690     | )          |              |       | (250,118               | )          |
| Employee stock  plans and related  income tax benefit                                                                    |       | 944        |       | 43,728      |       |         |       |              |       | 44,672                 |       |
| BALANCE AT  DECEMBER 31, 2006                                                                                            |       | $          | 42,612     |        | $          | -            |       | $                 | 1,463,727  |                   | $          | 4,827 |   | $ | 1,511,166 |   |

 

*See Notes to ConsolidatedFinancial Statements.*

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**CONSOLIDATED STATEMENTS OF CASH FLOWS**
|                                                                       |   | YEAR  ENDED DECEMBER  31, |        |
|-----------------------------------------------------------------------|--------|---------------------------|-------------|
| *(in  thousands)*                                                     |   | **2006**                  | ** **  | 2005 |   | 2004 |   |
| CASH FLOWS FROM OPERATING ACTIVITIES                                  |   | ** **                | ** **  |   |   |   |   |
| Net earnings                                                          |   | **$**                     | **359,942** | ** ** | $  447,052 |   | $  320,545 |   |
| Adjustments to reconcile net earnings to net cash  provided           |   | ** **                | ** **  |   |   |   |   |
| by operating  activities:                                             |   | ** **                | ** **  |   |   |   |   |
| Depreciation and amortization                                         |   | **46,731**                | ** **  | 43,166 |   | 38,519 |   |
| Stock-based compensation expense                                      |   | **25,593**                | ** **  | 18,862 |   | 15,208 |   |
| Changes in assets and liabilities:                                    |   | ** **                | ** **  |   |   |   |   |
| Increase in inventories                                               |   | **(182,679**              | **)**       | (490,971 | ) | (585,562 | ) |
| Net change in other assets, payables and other  liabilities           |   | **(216,939**              | **)**       | 175,358 |   | 104,424 |   |
| Tax benefit from exercise of stock options                            |   | ** **                | ** **  |   |   |   |   |
| and vesting of  restricted stock                                      |   | **-**                     | ** **  | 30,505 |   | 17,475 |   |
| Excess tax benefits from stock-based compensation                     |   | **(14,632**               | **)**       | - |   | - |   |
| Other operating activities, net                                       |   | **(3,379**                | **)**       | (7,708 | ) | 10,920 |   |
| Net cash provided by (used for) operating activities                  |   | **14,637**                | ** **  | 216,264 |   | (78,471 | ) |
|                                                                  |   | ** **                | ** **  |   |   |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                                  |   | ** **                | ** **  |   |   |   |   |
| Net additions to property, plant and equipment                        |   | **(53,839**               | **)**       | (55,127 | ) | (47,131 | ) |
| Principal reduction of mortgage-backed securities,                    |   | ** **                | ** **  |   |   |   |   |
| notes receivable  and mortgage collateral                             |   | **2,250**                 | ** **  | 12,561 |   | 19,336 |   |
| Net cash used for investing activities                                |   | **(51,589**               | **)**       | (42,566 | ) | (27,795 | ) |
|                                                                  |   | ** **                | ** **  |   |   |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES                                  |   | ** **                | ** **  |   |   |   |   |
| Cash proceeds of long-term debt                                       |   | **250,000**               | ** **  | 500,000 |   | - |   |
| Repayment of long-term debt                                           |   | **(243,500**              | **)**       | (147,000 | ) | - |   |
| Increase (decrease) in short-term borrowings                          |   | **21,647**                | ** **  | 10,028 |   | (14,934 | ) |
| Common stock dividends                                                |   | **(21,666**               | **)**       | (11,383 | ) | (9,661 | ) |
| Common stock repurchases                                              |   | **(250,118**              | **)**       | (176,214 | ) | (118,296 | ) |
| Issuance of common stock under stock-based  compensation              |   | **19,659**                | ** **  | 29,262 |   | 23,519 |   |
| Excess tax benefits from stock-based compensation                     |   | **14,632**                | ** **  | - |   | - |   |
| Other financing activities, net                                       |   | **(48**                   | **)**       | (5,396 | ) | (2,678 | ) |
| Net cash (used for) provided by financing activities                  |   | **(209,394**              | **)**       | 199,297 |   | (122,050 | ) |
| Net (decrease) increase in cash and cash equivalents                  |   | **(246,346**              | **)**       | 372,995 |   | (228,316 | ) |
| Cash and cash equivalents at beginning of year                        |   | **461,383**               | ** **  | 88,388 |   | 316,704 |   |
| CASH AND CASH EQUIVALENTS AT END OF YEAR                              |   | **$**                     | **215,037** | ** ** | $ | 461,383 |   | $    88,388 |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION                     |   | ** **                | ** **  |   |   |   |   |
| Cash paid for interest (net of capitalized interest)                  |   | **$**                     | **1,295**   | ** ** | $ | 1,846 |   | $ | 763 |   |
| Cash paid for income taxes                                            |   | **258,205**               | ** **  | 230,291 |   | 177,449 |   |
| SUPPLEMENTAL DISCLOSURES OF NONCASH ACTIVITIES                        |   | ** **                | ** **  |   |   |   |   |
| Increase in  consolidated inventory not owned related to land options |   | **$**                     | **9,139**   | ** ** | $ | 64,563 |   | $    41,919 |   |
|                                                                       |        |                           |             |  |  |  |  |  |  |  |

 

*See Notes to ConsolidatedFinancial Statements.*

38

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**Note A: Summary of SignificantAccounting Policies**

*Basisof Presentation*

The consolidated financialstatements include the accounts of The Ryland Group, Inc. and its wholly-ownedsubsidiaries. Intercompany transactions have been eliminated in consolidation.Certain prior year amounts have been reclassified to conform to the 2006presentation.

*Useof Estimates*

The preparation of financial statements, in conformity withaccounting principles generally accepted in the United States, requiresmanagement to make estimates and assumptions that affect the amounts reportedin the financial statements and accompanying notes. Actual results could differfrom these estimates.

*Cashand Cash Equivalents*

The Company considersall highly liquid short-term investments and cash held in escrow to be cashequivalents. Cash equivalents totaled $187.0 million and $440.7 million atDecember 31, 2006 and 2005, respectively.

*PerShare Data*

Basic net earnings percommon share is computed by dividing net earnings by the weighted-averagenumber of common shares outstanding. Additionally, diluted net earnings percommon share give effect to dilutive common stock equivalent shares.

*Stock-Based Compensation*

Prior to January 1,2006, the Company accounted for stock options granted in accordance with TheRyland Group, Inc. 2005 Equity Incentive Plan (the “Plan”) and The RylandGroup, Inc. 2006 Non-Employee Director Stock Plan (the “Director Plan”) byadhering to the provisions and related interpretation of Accounting PrinciplesBoard Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees,” aspermitted by Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accountingfor Stock-Based Compensation,” as amended. Therefore, except for costs relatedto restricted stock units, no stock-based employee compensation cost wasrecognized in net earnings, as all options granted under those plans had anexercise price equal to the market value of the underlying common stock on thedate of grant.

Effective January 1,2006, the Company adopted the fair value recognition provisions of SFAS 123(R)by using the modified prospective transition method. Under that transitionmethod, compensation cost recognized in 2006 includes: *(a)*compensation cost for all share-based payments granted prior to January 1,2006, but not yet vested, based on the grant-date fair value estimated inaccordance with the original provisions of SFAS 123; and *(b)*compensation cost for all share-based payments granted subsequent to January 1,2006, based on the grant-date fair value estimated in accordance with theprovisions of SFAS 123(R). Results for prior periods have not been restated.

*StockSplit*

In October 2004, theCompany’s Board of Directors approved a two-for-one stock split of its commonstock, which was affected in the form of a stock dividend. Records holders ofthe Company’s common stock at the close of business on November 15, 2004, wereentitled to one additional share for each share held at that time. The newshares were distributed on November 30, 2004. All references in theconsolidated financial statements to common shares, share prices, per shareamounts and stock plans have been retroactively restated for the 2004two-for-one stock split.

*HomebuildingRevenues*

Homebuilding revenuesare recognized when home and lot sales are closed, title and possession aretransferred to the buyer and there is no significant continuing involvement inaccordance with SFAS 66. Sales incentives offset revenues and are expensed whenhomes are closed.

39

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*HousingInventories*

Housing inventoriesconsist principally of homes under construction, land under development and improvedlots. Inventory includes land and development costs; direct construction costs;capitalized indirect construction costs; capitalized interest; and real estatetaxes. Inventories to be held and used are stated at cost unless a community isdetermined to be impaired, in which case the impaired inventories are writtendown to fair value. Long-lived assets are reviewed for impairment wheneverevents or changes in circumstances indicate that the carrying amount of anasset may not be recoverable. Recoverability of assets is measured by comparingthe carrying amount of an asset to future undiscounted net cash flows expectedto be generated by that asset or by the sales of comparable assets. Inventoriesto be disposed of are stated at either the lower of cost or fair value, lesscost to sell, and are reported net of valuation reserves. Write-downs ofimpaired inventories to fair value are recorded as adjustments to the costbasis of the respective inventory. Valuation reserves related to inventories tobe disposed of amounted to $59.7 million at December 31, 2006, and $486,000 atDecember 31, 2005. The net carrying values of the related inventories amountedto $124.3 million and $1.2 million at December 31, 2006 and 2005, respectively.

Costs of inventory includedirect costs of land and land development; material acquisition; and homeconstruction expenses. The costs of acquiring and developing land andconstructing certain related amenities are allocated to the parcels to whichthese costs relate. Interest and taxes are capitalized during the landdevelopment stage.

The following table is asummary of capitalized interest:
| *(in thousands)*                     |   | **2006**          | ** ** | 2005    |   |
|--------------------------------------|--------|-------------------|------------|---------|--------|
| Capitalized  interest at January 1   |   | **$ 75,890** | ** ** | $       | 55,414 |   |
| Interest  capitalized                |   | **71,750**        | ** ** | 65,959  |   |
| Interest  amortized to cost of sales |   | **(48,708**       | **)**      | (45,483 | )      |
| Capitalized interest at  December 31 |   | **$ 98,932** | ** ** | $       | 75,890 |   |

 

The following tablesummarizes each reporting segment’s total number of lots owned and lotscontrolled under option agreements:
|                                    |   | DECEMBER 31, |       |
|------------------------------------|--------|--------------|------------|
|                               |   | **2006**     | ** ** | 2005 |   |
| LOTS OWNED                         |   | ** **   | ** ** |   |   |
| North                              |   | **5,880**    | ** ** | 6,190 |   |
| Southeast                          |   | **11,016**   | ** ** | 10,421 |   |
| Texas                              |   | **6,760**    | ** ** | 5,321 |   |
| West                               |   | **7,595**    | ** ** | 8,269 |   |
| Total lots owned                   |   | **31,251**   | ** ** | 30,201 |   |
| LOTS CONTROLLED UNDER OPTION       |   | ** **   | ** ** |   |   |
| North                              |   | **10,747**   | ** ** | 13,613 |   |
| Southeast                          |   | **10,192**   | ** ** | 17,186 |   |
| Texas                              |   | **5,430**    | ** ** | 7,873 |   |
| West                               |   | **2,698**    | ** ** | 6,798 |   |
| Total lots controlled under option |   | **29,067**   | ** ** | 45,470 |   |
| TOTAL  LOTS OWNED AND CONTROLLED   |   | **60,318**   | ** ** | 75,671 |   |

 

40

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*VariableInterest Entities*

FIN 46 requires a VIE tobe consolidated by a company if that company is subject to a majority of therisk of loss from the VIE’s activities and/or entitled to receive a majority ofthe VIE’s residual returns. FIN 46 also requires disclosures about VIEs thatthe Company is not obligated to consolidate but in which it has a significant,though not primary, variable interest.

The Company enters intojoint ventures, from time to time, for the purpose of acquisition andco-development of land parcels and lots. Its investment in these joint venturesmay create a variable interest in a VIE, depending on the contractual terms ofthe arrangement. Additionally, in the ordinary course of business, the Companyenters into lot option purchase contracts in order to procure land for theconstruction of homes. Under such lot option purchase contracts the Companyfunds stated deposits in consideration for the right to purchase lots at afuture point in time, usually at predetermined prices. In accordance with therequirements of FIN 46, certain of the Company’s lot option purchase contractsmay result in the creation of a variable interest in a VIE.

In compliance with theprovisions of FIN 46, the Company consolidated $263.9 million of inventory notowned at December 31, 2006, $186.0 million of which pertained to land and lotoption purchase contracts representing the fair value of the optioned propertyand $77.9 million of which pertained to three of the Company’s homebuildingjoint ventures. (See further discussion that follows under “Investments inJoint Ventures.”) While the Company may not have had legal title to theoptioned land or guaranteed the seller’s debt associated with that property,under FIN 46 it had the primary variable interest and was required toconsolidate the particular VIE’s assets under option at fair value.Additionally, to reflect the fair value of the inventory consolidated under FIN46, the Company eliminated $13.7 million of its related cash deposits for lotoption purchase contracts, which are included in consolidated inventory notowned. Minority interest totaling $172.3 million was recorded with respect tothe consolidation of these contracts, representing the selling entities’ownership interests in these VIEs. At December 31, 2006, the Company had cashdeposits and letters of credit totaling $34.9 million relating to lot optionpurchase contracts that were consolidated, representing its current maximumexposure to loss. Creditors of these VIEs, if any, have no recourse against theCompany. At December 31, 2006, the Company had cash deposits and/or letters ofcredit totaling $83.0 million that were associated with lot option purchasecontracts having an aggregate purchase price of $850.1 million and that wererelated to VIEs in which it did not have a primary variable interest.

*ServiceLiabilities*

Service, warranty andcompletion costs are estimated and accrued at the time a home closes andupdated as experience requires.

*Investmentsin Joint Ventures*

The Company enters intojoint ventures, from time to time, for the purpose of acquisition and co-developmentof land parcels and lots. Currently, the Company participates in 12homebuilding joint ventures in the Atlanta, Austin, Chicago, Dallas, Denver,Las Vegas, Orlando and Phoenix markets. The Company participates in a number ofjoint ventures in which it has less than a controlling interest. At December31, 2006 and 2005, the Company’s investments in its unconsolidated jointventures totaled $13.5 million and $10.2 million, respectively, and were classifiedin the consolidated balance sheets under “Other” assets. The Company recognizesits share of the respective joint ventures’ earnings from the sale of lots toother homebuilders. It does not, however, recognize earnings from lots that itpurchases from the joint ventures. Instead, it reduces its cost basis in theselots by its share of the earnings from the lots. The Company’s equity in lossesof its unconsolidated joint ventures totaled $260,000 for the year endedDecember 31, 2006, compared to earnings of $315,000 and $5.8 million for thesame periods in 2005 and 2004, respectively.

The aggregate assets ofthe unconsolidated joint ventures in which the Company participated were $649.2million and $581.4 million at December 31, 2006 and 2005, respectively. Theaggregate debt 

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of the unconsolidatedjoint ventures in which the Company participated totaled $429.0 million and$394.0 million at December 31, 2006 and 2005, respectively.

The Company’s jointventure assets and debt include one joint venture that had total assets of$599.0 million and debt of $407.2 million at December 31, 2006. In this jointventure, the Company and its partners provided guarantees of debt on a pro ratabasis. The Company has a 3.3 percent pro rata interest on the debt, or $13.5million, and a completion guarantee related to project development. At December31, 2005, this joint venture had total assets of $554.1 million and debt of$375.5 million, of which the Company’s pro rata interest on the debt was $12.5million. The guarantees apply if a partner defaults on its loan arrangement andthe fair value of the collateral (land and improvements) is less than the loanbalance.

The following tablesummarizes the total estimated number of lots owned and controlled by theCompany under its joint venture agreements:
|                                    |   | DECEMBER 31, |       |
|------------------------------------|--------|--------------|------------|
|                               |   | **2006**     | ** ** | 2005 |   |
| LOTS OWNED                         |   | ** **   | ** ** |   |   |
| North                              |   | **856**      | ** ** | 986 |   |
| Southeast                          |   | **358**      | ** ** | 363 |   |
| Texas                              |   | **203**      | ** ** | 61 |   |
| West                               |   | **441**      | ** ** | 570 |   |
| Total lots owned                   |   | **1,858**    | ** ** | 1,980 |   |
| LOTS CONTROLLED UNDER OPTION       |   | ** **   | ** ** |   |   |
| West                               |   | **1,209**    | ** ** | 1,209 |   |
| Total lots controlled under option |   | **1,209**    | ** ** | 1,209 |   |
| TOTAL  LOTS OWNED AND CONTROLLED   |   | **3,067**    | ** ** | 3,189 |   |

 

In 2006 and 2005, threeof the joint ventures in which the Company participated were consolidated inaccordance with the provisions of FIN 46, as the Company was determined to havethe primary variable interest in the entities. In association with theseconsolidated joint ventures, the Company recorded pretax earnings of $685,000and $7,000 for 2006 and 2005, respectively. Total assets of $78.3 million and$63.7 million (including consolidated inventory not owned), total liabilitiesof $60.5 million and $43.3 million, and minority interest of $9.5 million and$11.5 million were consolidated at December 31, 2006 and 2005, respectively.Additionally, the Company has guaranteed up to 50.0 percent of a $55.0 millionrevolving credit facility for one of its consolidated joint ventures. AtDecember 31, 2006, the actual borrowings against the revolving credit facilityfor this consolidated joint venture was $53.8 million, of which the Company’spro rata share of the debt was $26.9 million.

*Property,Plant and Equipment*

Property, plant andequipment, which included model home furnishings of $69.4 million and $56.3million at December 31, 2006 and 2005, respectively, are carried at cost lessaccumulated depreciation and amortization. Depreciation is provided for,principally, by the straight-line method over the estimated useful lives of theassets. Model home furnishings, which are amortized over the life of thecommunity as homes are closed, are included in cost of sales.

*PurchasePrice in Excess of Net Assets Acquired*

Statement of FinancialAccounting Standards No. 142 (“SFAS 142”), “Goodwill and Other IntangibleAssets,” requires that goodwill and certain intangible assets no longer beamortized but be reviewed for impairment at least annually. Intangible assetswith finite lives will continue to be amortized over their estimated usefullives. Additionally, SFAS 142 requires that goodwill included in the carryingvalue of equity-method investments no longer be amortized.

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The Company adopted theprovisions of SFAS 142 on January 1, 2002, and performs impairment tests of itsgoodwill annually as of March 31. The Company tests goodwill for impairment byusing the two-step process prescribed in SFAS 142. The first step identifiespotential impairment, while the second step measures the amount of impairment.In December 2006, the Company tested goodwill for impairment due to possibleimpairment indicators. The Company had no impairment in the years ended December31, 2006 or 2005.

As a result of theCompany’s application of the nonamortization provisions of SFAS 142, noamortization of goodwill was recorded in 2006, 2005 or 2004.

Goodwill is allocated tothe reporting unit from which it originates. At December 31, 2006, goodwill wasprimarily attributable to the Company’s West region homebuilding segment andwas $18.2 million, net of $24.9 million of accumulated amortization.

*IncomeTaxes*

The Company files aconsolidated federal income tax return. Certain items of income and expense areincluded in one period for financial reporting purposes and in another forincome tax purposes. Deferred income taxes are provided in recognition of thesedifferences. Deferred tax assets and liabilities are determined based on enactedtax rates and are subsequently adjusted for changes in these rates. A change indeferred tax assets or liabilities results in a charge or credit to deferredtax expense.

*LoanOrigination Fees, Costs, Mortgage Discounts and Loan Sales*

Loan origination fees,net of related direct origination costs and loan discount points, arerecognized in current earnings upon the sale of related mortgage loans. Gainsor losses on the sale of mortgage loans and related servicing rights arerecognized when the Company transfers title to the purchaser, in accordancewith Statement of Financial Accounting Standards No. 140 (“SFAS 140”), “Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities.”

*DerivativeInstruments*

In the normal course ofbusiness and pursuant to its risk-management policy, the Company enters, as anend user, into derivative instruments, including forward-delivery contracts forloans; options on forward-delivery contracts; futures contracts; and options onfutures contracts, to minimize the impact of movements in market interest rateson IRLCs. Major factors influencing the use of various hedging contractsinclude general market conditions, interest rates, types of mortgagesoriginated and the percentage of IRLCs expected to fund. The Company is exposedto credit-related losses in the event of nonperformance by counterparties tocertain hedging contracts. Credit risk is limited to those instances where theCompany is in a net unrealized gain position. It manages this credit risk byentering into agreements with counterparties meeting its credit standards andby monitoring position limits. The Company elected not to use hedge accountingtreatment with respect to its economic hedging activities. Accordingly, allderivative instruments used as economic hedges are carried in the consolidatedbalance sheets in “Other” assets or “Accrued and other liabilities” at fairvalue, with changes in value recorded in current earnings. The Company’smortgage pipeline includes IRLCs, which represent commitments that have beenextended by the Company to those borrowers who have applied for loan fundingand have met certain defined credit and underwriting criteria. The Companydetermined that its IRLCs meet the definition of derivatives under Statement ofFinancial Accounting Standards No. 133 (“SFAS 133”), “Accounting for DerivativeInstruments and Hedging Activities,” as amended.

In 2005, the Companyentered into two treasury locks, which terminated in 2006, to facilitate thereplacement of higher-rate senior and senior subordinated debt in 2006. (SeeNote D, “Derivative Instruments.”)

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*AdvertisingCosts*

The Company expenses advertising costs as theyare incurred. Advertising costs totaled $34.9 million, $25.3 million and $21.6million in 2006, 2005 and 2004, respectively.

*ComprehensiveIncome*

Comprehensive incomeconsists of net income and the increase or decrease in unrealized gains orlosses on the Company’s available-for-sale securities, as well as the increaseor decrease in unrealized gains or losses associated with the treasury locks,net of applicable taxes. Comprehensive income totaled $361.8 million, $449.8million and $319.7 million for the years ended December 31, 2006, 2005 and2004, respectively.

*NewAccounting Pronouncements*

*SFAS157*

In September 2006, theFASB issued Statement of Financial Accounting Standards No. 157 (“SFAS 157”), “Fair-ValueMeasurements.” SFAS 157 defines fair value, establishes a framework formeasuring fair value in generally accepted accounting principles and expandsdisclosures about fair-value measurements. SFAS 157 is effective for financialstatements issued for fiscal years beginning after November 15, 2007, andinterim periods within those fiscal years. The Company is currently reviewingthis statement and has not yet determined the impact on its consolidated financialstatements.

*SFAS158*

In September 2006, theFASB issued Statement of Financial Accounting Standards No. 158 (“SFAS 158”), “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans—anamendment of FASB Statements No. 87, 88, 106 and 132(R).” SFAS 158 requires thatthe funded status of defined benefit pension plans and other postretirementplans be recognized in the balance sheet, along with a corresponding after-taxadjustment to stockholders’ equity. The recognition of the funded statusprovision of SFAS 158 applies prospectively and is effective December 31, 2006.SFAS 158 also requires measurement of plan assets and benefit obligations atthe entity’s fiscal year-end, effective December 31, 2008. SFAS 158 did nothave a material effect on the Company’s financial condition or results ofoperations.

*SAB108*

In September 2006, theSEC issued Staff Accounting Bulletin No. 108 (“SAB 108”), “Considering theEffects of Prior Year Misstatements when Quantifying Misstatements in CurrentYear Financial Statements.” SAB 108 addresses how the effects of prior yearuncorrected financial statement misstatements should be considered in currentyear financial statements. SAB 108 requires registrants to quantifymisstatements by using both balance sheet and income statement approaches andto evaluate those results in light of relative quantitative and qualitativefactors. SAB 108 is effective for annual financial statements covering the firstfiscal year ending after November 15, 2006.

*FIN48*

In July 2006, the FASBissued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in IncomeTaxes—an interpretation of FASB Statement No. 109.” In accordance withStatement of Financial Accounting Standards No. 109 (“SFAS 109”), “Accountingfor Income Taxes,” FIN 48 clarifies the accounting for uncertainty in incometaxes recognized in an enterprise’s financial statements. FIN 48 alsoprescribes a recognition threshold and measurement attribute for a tax positiontaken or expected to be taken in a tax return. The new FASB pronouncement alsoprovides guidance on derecognition; classification; interest and penalties;accounting in interim periods; disclosure; and transition. The provisions ofFIN 48 are effective for the Company in the first quarter of 2007. Theimplementation of FIN 48 is not expected to have a material effect on theCompany’s financial condition or results of operations.

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**Note B: Segment Information**

The Company is a leadingnational homebuilder and mortgage-related financial services firm. As one ofthe largest single-family on-site homebuilders in the United States, it buildshomes in 28 markets. The Company consists of six segments: fourgeographically-determined homebuilding regions, financial services, andcorporate. The Company’s homebuilding operations consists of four regionalreporting segments, referred to as North, Southeast, Texas and West. Thehomebuilding segments specialize in the sale and construction of single-familyattached and detached housing. Its financial services segment includes RMC,RHIC, LPS and CNRRG. The Company’s financial services segment provides loanorigination and offers mortgage, title, escrow and insurance services.Corporate is a non-operating business segment with the sole purpose ofsupporting operations. Certain corporate expenses are allocated to thehomebuilding and financial services segments and certain assets relating toemployee benefit plans have been reclassified to other segments in order tobest reflect the Company’s financial position and results of operations.

The Company evaluatesperformance and allocates resources to segments based on a number of factors,including segment pretax earnings. The accounting policies of the segments arethe same as those described in Note A, “Summary of Significant AccountingPolicies.”

**SELECTED SEGMENT INFORMATION**
|                               |   | YEAR  ENDEDDECEMBER 31, |          |
|-------------------------------|--------|-------------------------|---------------|
| *(in  thousands)*             |   | **2006**                |          | 2005 |   | 2004 |   |
| REVENUES                      |   | ** **              | ** **    |   |   |   |   |
| Homebuilding                  |   | ** **              | ** **    |   |   |   |   |
| North                         |   | **$**                   | **1,196,335** | ** ** | $ | 1,388,208 |   | $ | 1,284,361 |   |
| Southeast                     |   | **1,522,123**           | ** **    | 1,258,373 |   | 1,011,494 |   |
| Texas                         |   | **695,356**             | ** **    | 619,332 |   | 533,276 |   |
| West                          |   | **1,240,106**           | ** **    | 1,459,838 |   | 1,037,955 |   |
| Financial services            |   | **103,296**             | ** **    | 91,815 |   | 84,735 |   |
| Total                         |   | **$**                   | **4,757,216** | ** ** | $ | 4,817,566 |   | $ | 3,951,821 |   |
| PRETAX EARNINGS               |   | ** **              | ** **    |   |   |   |   |
| Homebuilding                  |   | ** **              | ** **    |   |   |   |   |
| North                         |   | **$**                   | **170,636**   | ** ** | $ | 241,183 |   | $ | 234,391 |   |
| Southeast                     |   | **253,120**             | ** **    | 179,242 |   | 108,964 |   |
| Texas                         |   | **59,854**              | ** **    | 44,308 |   | 36,867 |   |
| West                          |   | **89,533**              | ** **    | 279,477 |   | 145,232 |   |
| Financial services            |   | **67,695**              | ** **    | 59,373 |   | 56,702 |   |
| Corporate and unallocated     |   | **(73,730**             | **)**         | (82,532 | ) | (60,944 | ) |
| Total                         |   | **$**                   | **567,108**   | ** ** | $ | 721,051 |   | $ | 521,212 |   |
| DEPRECIATION AND AMORTIZATION |   | ** **              | ** **    |   |   |   |   |
| Homebuilding                  |   | ** **              | ** **    |   |   |   |   |
| North                         |   | **$**                   | **9,620**     | ** ** | $ | 10,800 |   | $ | 8,525 |   |
| Southeast                     |   | **10,913**              | ** **    | 9,083 |   | 8,151 |   |
| Texas                         |   | **7,366**               | ** **    | 6,049 |   | 4,897 |   |
| West                          |   | **15,981**              | ** **    | 14,598 |   | 14,004 |   |
| Financial services            |   | **1,225**               | ** **    | 1,119 |   | 623 |   |
| Corporate and unallocated     |   | **1,626**               | ** **    | 1,517 |   | 2,319 |   |
| Total                         |   | **$**                   | **46,731**    | ** ** | $ | 43,166 |   | $ | 38,519 |   |

 

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|                           |   | DECEMBER 31, |          |
|---------------------------|--------|--------------|---------------|
| *(in  thousands)*         |   | **2006**     |          | 2005 |   | 2004 |   |
| IDENTIFIABLE  ASSETS      |   | ** **   |          |   |   |   |   |
| Homebuilding              |   | ** **   |          |   |   |   |   |
| North                     |   | **$**        | **941,791**   |   | $ | 950,636 |   | $ | 681,753 |   |
| Southeast                 |   | **931,275**  |          | 865,886 |   | 525,786 |   |
| Texas                     |   | **446,743**  |          | 420,689 |   | 322,514 |   |
| West                      |   | **864,040**  |          | 974,479 |   | 718,810 |   |
| Financial services        |   | **81,540**   |          | 69,415 |   | 78,040 |   |
| Corporate and unallocated |   | **151,308**  |          | 105,768 |   | 98,067 |   |
| Total                     |   | **$**        | **3,416,697** |   | $ | 3,386,873 |   | $ | 2,424,970 |   |

 

**Note C: Earnings per ShareReconciliation**

The following table setsforth the computation of basic and diluted earnings per share:
|                                                                                            |   | YEAR ENDED DECEMBER 31,                                                     |   |
|--------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------|--------|
| *(in thousands, except share data)*                                                        |   | **2006**                                                                    |   | 2005 |   | 2004 |   |
| NUMERATOR                                                                                  |   | ** **                                                                  |   |   |   |   |   |
| Net earnings                                                                               |   | **$    359,942**                                        |   | $      447,052 |   | $      320,545 |   |
| DENOMINATOR                                                                                |   | ** **                                                                  |   |   |   |   |   |
| Basic earnings per share—weighted-average shares                                      |   | **44,228,502**                                                              |   | 46,966,317 |   | 47,678,887 |   |
| Effect of dilutive securities:                                                             |   | ** **                                                                  |   |   |   |   |   |
| Stock options                                                                              |   | **1,294,237**                                                               |   | 2,140,200 |   | 2,282,812 |   |
| Equity incentive plan                                                                      |   | **421,709**                                                                 |   | 384,370 |   | 417,141 |   |
| Dilutive potential of common shares                                                        |   | **1,715,946**                                                               |   | 2,524,570 |   | 2,699,953 |   |
| Dilutive earnings per share—adjusted  weighted-average shares and assumed conversions |   | **45,944,448**                                                              |   | 49,490,887 |   | 50,378,840 |   |
| NET EARNINGS PER COMMON SHARE                                                              |   | ** **                                                                  |   |   |   |   |   |
| Basic                                                                                      |   | **$           8.14** |   | $            9.52 |   | $            6.72 |   |
| Diluted                                                                                    |   | **7.83**                                                                    |   | 9.03 |   | 6.36 |   |

 

Options to purchase 1.1million shares, 205,000 shares and 420,000 shares of common stock at variousprices were outstanding at December 31, 2006, 2005 and 2004, respectively, butwere not included in the computation of diluted earnings per share for thoseannual periods because their effect would have been antidilutive since theirexercise prices were greater than the average market price of the commonshares.

**Note D: Derivative Instruments**

The Company, which usesderivative financial instruments in its normal course of operations, has noderivative financial instruments that are held for trading purposes.

The contract or notionalamounts of these financial instruments at December 31 were as follows:
| *(in thousands)*                         |   | **2006**                                                                             |   | 2005    |    |
|------------------------------------------|--------|--------------------------------------------------------------------------------------|--------|---------|---------|
| Mortgage  interest rate lock commitments |   | **$ 124,927**                                                                   |   | $       | 344,398 |   |
| Hedging  contracts:                      |   | ** **                                                                           |   |    |    |
| Treasury interest rate locks             |   | **$             -** |   | $       | 250,000 |   |
| Forward-delivery  contracts              |   | **41,000**                                                                           |   | 134,050 |    |

 

IRLCs represent loancommitments with customers at market rates generally up to 180 days beforesettlement. IRLCs expose the Company to market risk as a result of increases inmortgage interest

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rates. IRLCs hadinterest rates generally ranging from 5 percent to 10 percent at December 31,2006, and 4 percent to 10 percent at December 31, 2005.

Hedging contracts areregularly entered into by the Company for the purpose of mitigating itsexposure to movements in interest rates on IRLCs. The selection of thesehedging contracts is based upon the Company’s secondary marketing strategy,which establishes a risk-tolerance level. Major factors influencing the use ofvarious hedging contracts include general market conditions, interest rates,types of mortgages originated and the percentage of IRLCs expected to fund. Themarket risk assumed while holding the hedging contracts generally mitigates themarket risk associated with IRLCs and mortgage loans held-for-sale.

The Company is exposedto credit-related losses in the event of nonperformance by counterparties tocertain hedging contracts. Credit risk is limited to those instances where theCompany is in a net unrealized gain position. The Company manages this creditrisk by entering into agreements with counterparties meeting its creditstandards and by monitoring position limits.

During the secondquarter of 2006, the Company terminated its $100.0 million treasury lock at 4.2percent and its $150.0 million treasury lock at 4.1 percent. These hedges wereentered into in 2005 to facilitate the replacement of higher-rate senior andsenior subordinated debt in 2006. The hedges were evaluated and deemed to behighly effective at the inception of the contracts. The Company accounted forthe treasury locks as cash flow hedges, in accordance with SFAS 133. As aresult of changes in the timing of the Company’s debt issuance and in the termof debt issued in the second quarter of 2006, a gain of $9.2 million wasrecognized during that period, reflecting the ineffective portion of those cashflow hedges. The $8.4 million effective portion of the settlement value of the$150.0 million treasury lock was recorded, net of income tax effect, in “AccumulatedOther Comprehensive Income” and will be amortized over the seven-year life ofthe related debt instrument. For the year ended December 31, 2006, the Companyrecognized pretax gains of $9.9 million from the termination of these locks.

**Note E: Fair Values of Financial Instruments**

The Company’s financialinstruments are held for purposes other than trading. The fair values of these financialinstruments are based on quoted market prices, where available, or areestimated by using either present value or other valuation techniques.Estimated fair values are significantly affected by the assumptions used, includingdiscount rates and estimates of cash flows. In that regard, derived fair valueestimates cannot always be substantiated by comparison to independent marketsand, in some cases, cannot be realized in the immediate settlement of theinstruments.

The table below setsforth the carrying values and fair values of the Company’s financialinstruments at December 31. It excludes nonfinancial instruments, and,accordingly, the aggregate fair value amounts presented do not represent theunderlying value of the Company.
|                                         |   | **2006**     |        | 2005       |   |
|-----------------------------------------|--------|--------------|-------------|------------|--------|
|                                    |   | **CARRYING** | ** **  | **FAIR**   |   | CARRYING |   | FAIR |   |
| *(in  thousands)*                       |   | **VALUE**    | ** **  | **VALUE**  |   | VALUE |   | VALUE |   |
| OTHER ASSETS                            |   | ** **   | ** **  | ** ** |   |   |   |   |   |
| Mortgage loans held-for-sale            |   | **$**        | **11,767**  | ** ** | **$**  | **11,959** |   | $ | 15,188 |   | $ | 15,401 |   |
| DEBT                                    |   | ** **   | ** **  | ** ** |   |   |   |   |   |
| Senior notes                            |   | **$**        | **900,000** | ** ** | **$**  | **891,695** |   | $ | 750,000 |   | $ | 741,340 |   |
| Senior subordinated notes               |   | **-**        | ** **  | **-**      |   | 143,500 |   | 152,124 |   |
| OTHER FINANCIAL  INSTRUMENTS            |   | ** **   | ** **  | ** ** |   |   |   |   |   |
| Treasury interest rate locks            |   | **$**        | **-**       | ** ** | **$**  | **-** |   | $ | 4,785 |   | $ | 4,785 |   |
| Mortgage interest rate lock commitments |   | **598**      | ** **  | **598**    |   | 1,952 |   | 1,952 |   |
| Forward-delivery  contracts             |   | **152**      | ** **  | **152**    |   | (109 | ) | (109 | ) |

 

 

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The carrying amounts ofcash and cash equivalents and secured notes payable are reported in the balancesheet and approximate their fair values. The fair values of the senior notes;senior subordinated notes; mortgage loans held-for-sale; forward-deliverycontracts; treasury locks and IRLCs are based on either quoted market prices ormarket prices for similar financial instruments.

**Note F: Debt**

Debt consists of thefollowing at December 31:
| *(in thousands)*           |   | **2006**   |        | 2005    |   |
|----------------------------|--------|------------|-------------|---------|--------|
| Senior notes               |   | **$**      | **900,000** |    | $      | 750,000 |   |
| Senior  subordinated notes |   | **-**      |        | 143,500 |   |
| Secured notes  payable     |   | **50,117** |        | 28,470  |   |
| Total                      |   | **$**      | **950,117** |    | $      | 921,970 |   |

 

Maturities of debt arescheduled as follows:
| *(in thousands)* |   |        |        |
|------------------|--------|-------------|-------------|
| 2007             |   | **$**       | **25,980**  |   |
| 2008             |   | **161,817** |        |
| 2009             |   | **9,076**   |        |
| 2010             |   | **3,244**   |        |
| After 2010       |   | **750,000** |        |
| Total debt       |   | **$**       | **950,117** |   |

 

At December 31, 2006,the Company had outstanding *(a)* $150.0million of 5.4 percent senior notes due June 2008; *(b)*$250.0 million of 5.4 percent senior notes due May 2012; *(c)*$250.0 million of 6.9 percent senior notes due June 2013; and *(d)* $250.0 million of 5.4 percent senior notes due January2015. Each of the senior notes pay interest semiannually and may be redeemed ata stated redemption price, at the option of the Company, in whole or in part,at any time.

In January 2006, theCompany entered into a $750.0 million unsecured revolving credit facility. Thecredit agreement, which matures in January 2011, also provides access to anadditional $750.0 million of financing through an accordion feature under whichthe aggregate commitment may be increased up to $1.5 billion, subject to theavailability of additional lending commitments. The revolving credit facilityincludes a $75.0 million swing-line facility and a $600.0 million sublimit forissuance of standby letters of credit. Amounts borrowed under the creditagreement are guaranteed on a joint and several basis by substantially all ofthe Company’s wholly-owned homebuilding subsidiaries. Such guarantees are fulland unconditional. Interest rates on outstanding borrowings are determinedeither by reference to LIBOR, with margins determined based on changes in theCompany’s leverage ratio and credit ratings, or by reference to an alternatebase rate. The credit agreement replaces the Company’s prior $500.0 millionrevolving credit facility and has been and is intended to be used for generalcorporate purposes. In November 2006, the Company expanded its revolving creditfacility to $1.1 billion through its accordion feature. The credit agreementcontains various customary affirmative, negative and financial covenants. TheCompany was in compliance with these covenants at December 31, 2006. There wereno borrowings outstanding under this agreement at December 31, 2006, or underthe Company’s prior $500.0 million revolving credit facility at December 31,2005. Letters of credit aggregating $192.9 million and $185.6 million wereoutstanding under the respective agreements at December 31, 2006 and 2005,respectively. Unused borrowing capacity under the respective facilities totaled$940.6 million and $314.4 million at December 31, 2006 and 2005, respectively.

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In 2006, the Companyredeemed $150.0 million of its 9.1 percent senior subordinated notes due June2011, of which it owned $6.5 million. The Company recorded an expense of $7.7million related to the early retirement of debt for the year ended December 31,2006. Additionally, the Company’s 8.0 percent senior notes, which totaled$100.0 million, matured in August 2006. (See “Financial Condition and Liquidity”within “Management’s Discussion and Analysis of Financial Condition and Resultsof Operations.”)

Also, in 2006, theCompany terminated its treasury locks to facilitate the replacement ofhigher-rate senior and senior subordinated debt in 2006. The Company recognizedgains of $9.9 million for the year ended December 31, 2006, related to thetermination of these locks. (See Note D, “Derivative Instruments.”)

In 2005, the Companyredeemed $150.0 million of its 9.8 percent senior notes due September 2010, ofwhich it owned $3.0 million at the time of redemption, and also recorded anexpense of $8.3 million related to the early retirement of this debt.

At December 31, 2006,the Company’s obligations to pay principal, premium, if any, and interest underits $1.1 billion unsecured revolving credit facility; 5.4 percent senior notesdue June 2008; 5.4 percent senior notes due May 2012; 6.9 percent senior notesdue June 2013; and 5.4 percent senior notes due January 2015 are guaranteed ona joint and several basis by substantially all of its wholly-owned homebuildingsubsidiaries. Such guarantees are full and unconditional. (See Note K, “SupplementalGuarantor Information.”)

The senior notes andindenture agreements are subject to certain covenants, that include among otherthings, restrictions on additional secured debt and the sale of assets. TheCompany was in compliance with these covenants at December 31, 2006.

To finance its land purchases,the Company may also use seller-financed nonrecourse secured notes payable. AtDecember 31, 2006 and 2005, outstanding seller-financed nonrecourse notespayable were $50.1 million and $28.5 million, respectively.

**Note G: Employee Incentive and StockPlans**

*RetirementSavings Opportunity Plan (“RSOP”)*

All full-time employeesare eligible to participate in the RSOP following 30 days of employment.Part-time employees are eligible to participate in the RSOP following thecompletion of 1,000 hours of service within the first 12 months of employmentor within any plan year after the date of hire. Pursuant to Section 401(k) ofthe Internal Revenue Code, the plan permits deferral of a portion of aparticipant’s income into a variety of investment options. Total compensationexpense related to the Company’s matching contributions for this plan amountedto $12.0 million, $11.0 million and $9.3 million in 2006, 2005 and 2004,respectively.

*EmployeeStock Purchase Plan (“ESPP”)*

All full-time employeesof the Company, with the exception of its executive officers, are eligible toparticipate in the ESPP. Eligible employees authorize payroll deductions to bemade for the purchase of shares. The Company matches a portion of the employee’scontribution by donating an additional 20.0 percent of the employee’s payrolldeduction. Stock is purchased by a plan administrator on a regular monthlybasis. All brokerage and transaction fees for purchasing the stock are paid forby the Company. The Company’s expense related to its matching contribution forthis plan was $495,000, $514,000 and $390,000 in 2006, 2005 and 2004,respectively.

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*Supplemental Executive Retirement Plans*

The Company hassupplemental nonqualified retirement plans, which vest over five-year periodsbeginning in 2003, pursuant to which the Company will pay supplemental pensionbenefits to key employees upon retirement. In connection with these plans, theCompany has purchased cost-recovery life insurance on the lives of certainemployees. Insurance contracts associated with the plans are held by trustsestablished as part of the plans to implement and carry out their provisionsand finance their related benefits. The trusts are owners and beneficiaries ofsuch contracts. The amount of coverage is designed to provide sufficientrevenue to cover all costs of the plans if assumptions made as to employmentterm, mortality experience, policy earnings and other factors are realized. AtDecember 31, 2006 and 2005, the cash surrender value of these contracts was$24.8 million and $19.2 million, respectively and is included in “Other”assets. The net periodic benefit cost of these plans for the year endedDecember 31, 2006, was $3.3 million, which included service costs of $4.3million, interest costs of $1.1 million and investment earnings of $2.1million. The net periodic benefit cost of these plans for the year endedDecember 31, 2005, was $2.8 million, which included service costs of $3.1million, interest costs of $117,000 and investment earnings of $423,000. The$18.0 million and $12.6 million projected benefit obligations at December 31,2006 and 2005, respectively, were equal to the net liability recognized in thebalance sheet at those dates. For the years ended December 31, 2006 and 2005,the weighted-average discount rates used for the plans were 7.7 percent and 7.5percent, respectively.

**Note H: Income Taxes**

The Company’s expensefor income taxes is summarized as follows:
|                           | ** ** | **YEAR ENDED DECEMBER 31,** | ** **  |
|---------------------------|------------|--------------------------------------------|-------------|
| ***(in thousands)*** | ** ** | **2006**                                   | ** **  | **2005** | ** ** | **2004** | ** ** |
| CURRENT                   | ** ** | ** **                                 |        |   |   |   |   |
| Federal                   | ** ** | **$**                                      | **206,635** |   | $ | 243,220 |   | $ | 181,426 |   |
| State                     | ** ** | **32,799**                                 |        | 36,852 |   | 27,079 |   |
| Total current             | ** ** | **239,434**                                |        | 280,072 |   | 208,505 |   |
| DEFERRED                  | ** ** | ** **                                 |        |   |   |   |   |
| Federal                   | ** ** | **(27,848**                                | **)**       | (5,274 | ) | (6,820 | ) |
| State                     | ** ** | **(4,420**                                 | **)**       | (799 | ) | (1,018 | ) |
| Total deferred            | ** ** | **(32,268**                                | **)**       | (6,073 | ) | (7,838 | ) |
| Total expense             | ** ** | **$**                                      | **207,166** |   | $ | 273,999 |   | $ | 200,667 |   |

 

The following tablereconciles the statutory federal income tax rate to the Company’s effectiveincome tax rate:
|                                         | ** ** | **YEAR ENDED DECEMBER 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **                              | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Income taxes at  federal statutory rate | ** ** | **35.0**                                   | **%**      | 35.0 | % | 35.0 | % |
| State income  taxes, net of federal tax | ** ** | **3.2**                                    |       | 3.2 |   | 3.2 |   |
| Domestic  production activity deduction | ** ** | **(0.9**                                   | **)**      | (0.8 | ) | - |   |
| Resolution of  tax contingency          | ** ** | **(1.0**                                   | **)**      | - |   | - |   |
| Other                                   | ** ** | **0.2**                                    |       | 0.6 |   | 0.3 |   |
| Effective rate                          | ** ** | **36.5**                                   | **%**      | 38.0 | % | 38.5 | % |

 

 

Deferred income taxes reflectthe net tax effects of temporary differences between the carrying amounts ofassets and liabilities for financial reporting purposes and the amounts usedfor income tax purposes.

50

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Significant components ofthe Company’s deferred tax assets and liabilities at December 31 were asfollows:
| *(in thousands)*                                   |   | **2006**    | ** ** | 2005       |   |
|----------------------------------------------------|--------|-------------|------------|------------|--------|
| DEFERRED TAX  ASSETS                               |   | ** **  | ** ** |       |   |
| Warranty, legal and other accruals                 |   | **$**       | **29,029** | ** ** | $      | 33,032 |   |
| Employee benefits                                  |   | **51,427**  | ** ** | 39,297     |   |
| Noncash charge for impairment of long-lived assets |   | **23,105**  | ** ** | -          |   |
| Other                                              |   | **8,411**   | ** ** | 2,277      |   |
| Total deferred tax assets                          |   | **111,972** | ** ** | 74,606     |   |
| DEFERRED TAX  LIABILITIES                          |   | ** **  | ** ** |       |   |
| Deferred recognition of income and gains           |   | **(4,037**  | **)**      | (6,870     | )      |
| Capitalized expenses                               |   | **(19,183** | **)**      | (13,738    | )      |
| Other                                              |   | **(4,553**  | **)**      | (3,899     | )      |
| Total deferred tax liabilities                     |   | **(27,773** | **)**      | (24,507    | )      |
| NET DEFERRED TAX ASSET                             |   | **$**       | **84,199** | ** ** | $      | 50,099 |   |

 

The Company determinedthat no valuation allowance for the deferred tax asset was required at December31, 2006 or 2005. The Company had a total net current tax liability of $36.4million and $67.1 million at December 31, 2006 and 2005, respectively. Theseamounts are reported in the consolidated balance sheets in “Accrued and otherliabilities.”

**Note I:Stock-Based Compensation**

The Plan permits thegranting of stock options, stock appreciation rights, restricted orunrestricted stock awards, stock units or any combination of the foregoing toemployees. Stock options granted in accordance with the Plan generally have amaximum term of five years and vest in equal annual installments over threeyears. Outstanding stock options granted under previous plans generally have amaximum term of ten years and vest over three years. At December 31, 2006 and2005, stock options or other awards or units available for grant totaled240,645 and 659,263, respectively.

The Director Planprovides for a stock award of 3,000 shares to each non-employee director on May1 of each year. New non-employee directors will receive a pro-rata stock award30 days after their date of appointment or election based on the remainingportion of the plan year (May 1 to April 30) in which they are appointed orelected. Stock awards are fully vested and non-forfeitable on their applicableaward date. At December 31, 2006, 120,000 stock awards were available forfuture grant in accordance with the Director Plan.

Previously, The RylandGroup, Inc. 2004 Non-Employee Director Equity Plan (the “Predecessor DirectorPlan”) provided for automatic grants of non-statutory stock options todirectors for the purchase of shares at prices not less than the fair marketvalue of the shares at the date of grant. Stock options fully vested, becameexercisable six months after the date of grant and had a maximum term of tenyears. The stock options expire three years after the date of termination ofservice on the Board of Directors, regardless of their stated expiration dates.Upon approval of the Director Plan, stock options available for future grantunder the Predecessor Director Plan were canceled.

All outstanding stockoptions, stock awards and restricted stock awards have been granted inaccordance with the terms of the Plan, the Director Plan and their respectivepredecessor plans, all of which were approved by the Company’s stockholders.Certain option and share awards provide for accelerated vesting if there is achange in control (as defined in the plans).

The fair value of each ofthe Company’s stock option awards is estimated on the date of grant by usingthe Black-Scholes-Merton option-pricing formula, which requires inputassumptions for the Company’s expected dividend yield, expected volatility,risk-free interest rate and the expected

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option life. Expectedvolatility is based upon the historical volatility of the Company’s commonstock. The expected dividend yield is based on an annual dividend rate of $0.48per common share. The risk-free interest rate for periods within thecontractual life of the stock option award is based upon the zero-coupon U.S.Treasury bond issued on the date the stock option is granted with a maturityequal to the expected option life for the stock option granted. The expectedoption life is derived from historical experience under the Company’sshare-based payment plans and represents the period of time that stock optionawards granted are expected to be outstanding.

Prior to the adoption ofSFAS 123(R), the Company presented all tax benefits of deductions resultingfrom the exercise of stock options as operating cash flows in the ConsolidatedStatements of Cash Flows. SFAS 123(R) requires cash flows attributable to taxbenefits resulting from tax deductions in excess of compensation costrecognized for those stock options (“excess tax benefits”) to be classified as financingcash flows. Had the Company not adopted SFAS 123(R), the $14.6 million excesstax benefit classified as a financing cash inflow would have been classified asan operating cash inflow.

Net earnings for the yearended December 31, 2006, includes $25.6 million, or $0.35 per diluted share ofstock-based compensation expense, before income tax benefits of $9.4 million.Stock-based compensation expenses have been allocated to the Company’sreportable segments and are disclosed in “Corporate,” “Financial services” and “Selling,general and administrative” expenses.

The following tableillustrates the effect on net earnings and earnings per share had the Companyapplied the fair value recognition provisions of SFAS 123 to stock optionsgranted under its equity-based compensation plans in the years ended December31, 2005 and 2004. For purposes of this pro forma disclosure, the grant-datefair value of the Company’s stock options was estimated by using aBlack-Scholes-Merton option-pricing formula and amortized to expense over thestock options’ vesting periods.
| *(in thousands, except share data)*                                                                                                      |   | 2005    |    | 2004    |   |
|------------------------------------------------------------------------------------------------------------------------------------------|--------|---------|---------|---------|--------|
| Net earnings, as  reported                                                                                                               |   | $       | 447,052 |    | $      | 320,545 |   |
| Add: Stock-based  employee compensation expense included in   reported net earnings, net of related tax effects1                         |   | 11,695  |    | 9,353   |   |
| Deduct: Total  stock-based employee compensation expense   determined under fair value method for all awards, net of related tax effects |   | (17,652 | )       | (15,015 | )      |
| Pro forma net  earnings                                                                                                                  |   | $       | 441,095 |    | $      | 314,883 |   |
| Earnings per  share:                                                                                                                     |   |    |    |    |   |
| Basic – as reported                                                                                                                 |   | $       | 9.52    |    | $      | 6.72 |   |
| Basic – pro forma                                                                                                                   |   | 9.39    |    | 6.60    |   |
| Diluted – as reported                                                                                                               |   | 9.03    |    | 6.36    |   |
| Diluted – pro  forma                                                                                                                |   | 8.91    |    | 6.25    |   |

*1Amount representsthe Company’s net stock-based compensation expense associated with restrictedstock units.*

The Company recordedstock-based compensation related to stock options of $10.4 million for the yearended December 31, 2006.

The Company has determined the grant-datefair value of stock options using the Black-Scholes-Merton formula. Theweighted-average inputs used and fair values determined for stock optionsgranted during the years ended December 31, 2006, 2005 and 2004, are presentedbelow:
|                                         |   | **2006** | ** ** | 2005       |   | 2004  |   |
|-----------------------------------------|--------|----------|------------|------------|--------|-------|--------|
| Expected  volatility                    |   | **38.0** | **%**      | 38.4       | %      | 38.4  | %      |
| Expected  dividend yield                |   | **0.8**  | **%**      | 0.5        | %      | 0.5   | %      |
| Expected term (*in years*)              |   | **3.2**  | ** ** | 3.0        |   | 3.0   |   |
| Risk-free rate                          |   | **5.0**  | **%**      | 4.0        | %      | 2.4   | %      |
| Weighted-average grant  date fair value |   | **$**    | **19.17**  | ** ** | $      | 18.99 |   | $ | 11.65 |   |
|                                         |        |          |            |            |        |       |        |  |  |  |

 

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A summary of stock option activity inaccordance with the Company’s plans as of December 31, 2006, 2005 and 2004, andchanges for the years then ended follows:
|                                           |   |          |       |             |       | WEIGHTED-         |       |               |   |
|-------------------------------------------|--------|---------------|------------|------------------|------------|-------------------|------------|--------------------|--------|
|                                      |   |          |       | WEIGHTED-        |       | AVERAGE           |       | AGGREGATE          |   |
|                                      |   |          |       | AVERAGE          |       | REMAINING         |       | INTRINSIC          |   |
|                                      |   |          |       | EXERCISE         |       | CONTRACTUAL       |       | VALUE              |   |
|                                      |   | SHARES        |       | PRICE            |       | LIFE *(in years)* |       | *(in thousands)*   |   |
| Options  outstanding at January 1, 2004   |   | 6,012,876     |       | $ 13.11     |       | 6.62              |       |               |   |
| Granted                                   |   | 1,016,400     |       | 43.45            |       |              |       |               |   |
| Exercised                                 |   | (1,452,654    | )          | 10.95            |       |              |       |               |   |
| Forfeited                                 |   | (41,224       | )          | 25.13            |       |              |       |               |   |
| Options  outstanding at December 31, 2004 |   | 5,535,398     |       | $ 19.15     |       | 6.38              |       | $ 212,473     |   |
| Available for  future grant               |   | 1,918,608     |       |             |       |              |       |               |   |
| Total shares  reserved                    |   | 7,454,006     |       |             |       |              |       |               |   |
| Options  exercisable at December 31, 2004 |   | 3,676,991     |       | $ 12.11     |       | 5.27              |       | $ 167,031     |   |
| Options  outstanding at January 1, 2005   |   | 5,535,398     |       | $ 19.15     |       | 6.38              |       |               |   |
| Granted                                   |   | 569,750       |       | 65.36            |       |              |       |               |   |
| Exercised                                 |   | (1,408,973    | )          | 14.84            |       |              |       |               |   |
| Forfeited                                 |   | (41,605       | )          | 42.52            |       |              |       |               |   |
| Options  outstanding at December 31, 2005 |   | 4,654,570     |       | $ 25.91     |       | 5.71              |       | $ 215,199     |   |
| Available for  future grant               |   | 1,612,463     |       |             |       |              |       |               |   |
| Total shares  reserved                    |   | 6,267,033     |       |             |       |              |       |               |   |
| Options  exercisable at December 31, 2005 |   | 3,360,535     |       | $ 17.62     |       | 5.13              |       | $ 183,191     |   |
| Options  outstanding at January 1, 2006   |   | **4,654,570** | ** ** | **$ 25.91** | ** ** | **5.71**          | ** ** | ** **         |   |
| Granted                                   |   | **374,500**   | ** ** | **62.31**        | ** ** | ** **        | ** ** | ** **         |   |
| Exercised                                 |   | **(798,218**  | **)**      | **12.34**        | ** ** | ** **        | ** ** | ** **         |   |
| Forfeited                                 |   | **(66,710**   | **)**      | **56.83**        | ** ** | ** **        | ** ** | ** **         |   |
| Options  outstanding at December 31, 2006 |   | **4,164,142** | ** ** | **$ 31.29** | ** ** | **5.02**          | ** ** | **$ 106,250** |   |
| Available for  future grant               |   | **360,645**   | ** ** | ** **       | ** ** | ** **        | ** ** | ** **         |   |
| Total shares  reserved                    |   | **4,524,787** | ** ** | ** **       | ** ** | ** **        | ** ** | ** **         |   |
| Options exercisable at  December 31, 2006 |   | **3,365,335** | ** ** | **$ 25.54** | ** ** | **5.04**          | ** ** | **$ 102,729** |   |

 

A summary of stock options outstanding andexercisable at December 31, 2006, follows:
|                       | ** ** | **OPTIONS OUTSTANDING** | ** **   | **OPTIONS EXERCISABLE** | ** ** |
|-----------------------|------------|------------------------------|--------------|------------------------------|------------|
| ** **            | ** ** | ** **                   | ** **   | **WEIGHTED-**                | ** ** | **WEIGHTED-** | ** ** | ** ** | ** ** | **WEIGHTED-** | ** ** |
| **RANGE OF**     | ** ** | ** **                   | ** **   | **AVERAGE**                  | ** ** | **AVERAGE** | ** ** | ** ** | ** ** | **AVERAGE** | ** ** |
| **EXERCISE**          | ** ** | **NUMBER**                   | ** **   | **REMAINING**                | ** ** | **EXERCISE** | ** ** | **NUMBER** | ** ** | **EXERCISE** | ** ** |
| **PRICES**            | ** ** | **OUTSTANDING**              | *** *** | **LIFE *(years)***      | ** ** | **PRICE** | ** ** | **EXERCISABLE** | ** ** | **PRICE** | ** ** |
| **$3.19  to $6.38**   | ** ** | **1,117,352**                | ** **   | **2.44**                     | ** ** | **$** | **6.09** | ** ** | **1,117,352** | ** ** | **$** | **6.09** | ** ** |
| **$10.19  to $24.44** | ** ** | **1,144,217**                | ** **   | **5.50**                     | ** ** | **19.21** | ** ** | **1,144,217** | ** ** | **19.21** | ** ** |
| **$34.70  to $57.54** | ** ** | **1,025,989**                | ** **   | **7.27**                     | ** ** | **43.91** | ** ** | **785,173** | ** ** | **45.11** | ** ** |
| **$61.40 to $83.13**  | ** ** | **876,584**                  | ** **   | **5.03**                     | ** ** | **64.38** | ** ** | **318,593** | ** ** | **68.25** | ** ** |
|                       |            |                              |              |                              |            |  |  |  |  |  |  |  |  |

** **

The total intrinsic valueof stock options exercised during the years ended December 31, 2006, 2005 and2004 were $38.5 million, $77.7 million and $46.1 million, respectively. Theintrinsic value of a stock option is the amount by which the market value ofthe underlying stock exceeds the exercise price of the option.

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A summary of the Company’snonvested options as of and for the years ended December 31, 2006, 2005 and2004 follows:
|                                               | ** ** | **2006**   | ** ** | **2005**            | ** ** | **2004**   | ** ** |
|-----------------------------------------------|------------|------------|------------|---------------------|------------|------------|------------|
| ** **                                    | ** ** | ** ** | ** ** | **WEIGHTED-**       | ** ** | ** ** | ** ** | **WEIGHTED-** | ** ** | ** ** | ** ** | **WEIGHTED-** | ** ** |
| ** **                                    | ** ** | ** ** | ** ** | **AVERAGE**         | ** ** | ** ** | ** ** | **AVERAGE** | ** ** | ** ** | ** ** | **AVERAGE** | ** ** |
| ** **                                    | ** ** | ** ** | ** ** | **GRANT-DATE**      | ** ** | ** ** | ** ** | **GRANT-DATE** | ** ** | ** ** | ** ** | **GRANT-DATE** | ** ** |
| ** **                                    | ** ** | **SHARES** | ** ** | **FAIR VALUE** | ** ** | **SHARES** | ** ** | **FAIR VALUE** | ** ** | **SHARES** | ** ** | **FAIR VALUE** | ** ** |
| Nonvested  options outstanding at January 1   |       | 1,294,035  |       | $                   | 13.40      |       | 1,858,407  |   | $ | 9.19 |   | 2,224,748 |   | $ | 6.53 |   |
| Granted                                       |       | 374,500    |       | 19.17               |       | 569,750    |       | 18.99 |   | 1,016,400 |   | 11.76 |   |
| Vested                                        |       | (803,018   | )          | 12.82               |       | (1,092,517 | )          | 9.21 |   | (1,341,517 | ) | 6.79 |   |
| Forfeited                                     |       | (66,710    | )          | 16.82               |       | (41,605    | )          | 12.05 |   | (41,224 | ) | 7.29 |   |
| Nonvested options  outstanding at December 31 |       | 798,807    |       | $                   | 16.40      |       | 1,294,035  |   | $ | 13.40 |   | 1,858,407 |   | $ | 9.19 |   |

 

As of December 31, 2006,there was $7.7 million of total unrecognized compensation cost related tononvested stock option awards granted under the Company’s plans, which isexpected to be recognized over the next 2.6 years.

The Company has madeseveral restricted stock awards to senior executives under the Plan and itspredecessor plans. Compensation expense recognized for such awards was $13.3million, $18.8 million and $14.3 million for the years ended December 31, 2006,2005 and 2004, respectively.

The following is asummary of activity relating to restricted stock awards:
|                                   |   | **2006**     | ** ** | 2005     |   | 2004     |   |
|-----------------------------------|--------|--------------|------------|----------|--------|----------|--------|
| Restricted  shares at January 1   |   | **441,000**  | ** ** | 356,800  |   | 638,600  |   |
| Shares awarded                    |   | **133,000**  | ** ** | 253,000  |   | —   |   |
| Shares vested                     |   | **(138,336** | **)**      | (168,800 | )      | (281,800 | )      |
| Restricted shares at  December 31 |   | **435,664**  | ** ** | 441,000  |   | 356,800  |   |

 

At December 31, 2006, theoutstanding restricted shares are scheduled to vest as follows: 2007—182,664; 2008—128,664;2009—84,336; and 2010—40,000.

The Company granted anaggregate stock award of 30,000 shares to its ten non-employee directors on May1, 2006, pursuant to the terms of the Director Plan. The Company recordedstock-based compensation expense related to this grant in the amount of $1.9million during the year ended December 31, 2006.

**Note J:Commitments and Contingencies**

*Commitments*

In the normal course ofbusiness, the Company acquires rights under option agreements to purchase landor lots for use in future homebuilding operations. At December 31, 2006, it hadrelated cash deposits and letters of credit outstanding that totaled $187.8million for land options pertaining to land purchase contracts with anaggregate purchase price of $1.5 billion. At December 31, 2006, the Company hadcommitments with respect to option contracts having specific performanceprovisions of approximately $34.2 million, compared to $60.5 million atDecember 31, 2005.

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Rent expense primarilyrelates to officefacilities, model homes, furniture and equipment.
|                             |   | YEAR ENDED DECEMBER 31, |       |
|-----------------------------|--------|----------------------------------------|------------|
| *(in thousands)*       |   | **2006**                               | ** ** | 2005 |   | 2004 |   |
| Total rent  expense         |   | **$ 23,232**                      | ** ** | $ 17,050 |   | $ 16,934 |   |
| Less income from  subleases |   | **(950**                               | **)**      | (312 | ) | (295) |   |
| Net rent expense            |   | **$ 22,282**                      | ** ** | $ 16,738 |   | $ 16,639 |   |

 

Future minimum rentalcommitments under noncancelable leases with remaining terms in excess of oneyear are as follows:
| *(in thousands)*        |   |       |       |
|-------------------------|--------|------------|------------|
| 2007                    |   | **$**      | **14,052** | ** ** |
| 2008                    |   | **12,645** | ** ** |
| 2009                    |   | **10,121** | ** ** |
| 2010                    |   | **8,166**  | ** ** |
| 2011                    |   | **5,743**  | ** ** |
| Thereafter              |   | **8,845**  | ** ** |
| Less sublease  income   |   | **(276)**  | ** ** |
| Total lease commitments |   | **$**      | **59,296** | ** ** |

 

RMC purchases optionalcommitments from its investors for the purpose of mitigating its exposure tomovements in interest rates on customer-financing commitments. RMC pays the investor a fixed one-time premium for thesecommitments. In return, RMC receives the option of selling a loan at a fixed rate in the commitment for astipulated period of time. Optional commitments with investors arenon-transferable and RMC’s risk is limited to the initial premium paid. Fairvalues of optional commitments are estimated based on the premium paid andamortized over the duration of the commitment. The outstanding commitments atDecember 31, 2006 had a notional amount of $183.6 million with a fair value of$12,000.

*Contingencies*

As an on-site housingproducer, the Company is often required by some municipalities to obtaindevelopment or performance bonds and letters of credit in support of itscontractual obligations. At December 31, 2006, total development bonds were$482.2 million, while total related deposits and letters of credit were $74.0million. In the event that any such bonds or letters of credit are called, theCompany would be required to reimburse the issuer; however, it does not expectthat any currently outstanding bonds or letters of credit will be called.

At December 31, 2006 and2005, one of the joint ventures in which the Company participates had debt of$407.2 million and $375.5 million, respectively. In this joint venture, theCompany and its partners provided guarantees of debt on a pro rata basis. TheCompany had a 3.3 percent pro rata interest on the debt, or $13.5 million and$12.5 million at December 31, 2006 and 2005, respectively and a completionguarantee related to project development. The guarantees apply if a partnerdefaults on its loan arrangement and the fair value of the collateral (land andimprovements) is less than the loan balance. In another of its joint ventures,the Company has guaranteed up to 50.0 percent of a $55.0 million revolvingcredit facility. At December 31, 2006, the actual borrowings against therevolving credit facility for this consolidated joint venture was $53.8million, of which the Company’s pro rata share of debt was $26.9 million.

IRLCs represent loancommitments with customers at market rates generally up to 180 days beforesettlement. At December 31, 2006, the Company had outstanding IRLCs totaling$124.9 million. Hedging contracts are utilized to mitigate the risk associatedwith interest rate fluctuations on IRLCs. (See Note D, “Derivative Instruments.”)

55

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The Company providesproduct warranties covering workmanship and materials for one year, certainmechanical systems for two years and structural systems for ten years. TheCompany estimates and records warranty liabilities based upon historicalexperience and known risks at the time a home closes, and in the case ofunexpected claims, upon identification and quantificationof the obligations. Actual future warranty costs could differ from currentestimates.

Changes in the Company’sproduct liability reserve during the period are as follows:
| *(in thousands)*       |   | **2006**    | ** ** | 2005       |   |
|------------------------|--------|-------------|------------|------------|--------|
| Balance at  January 1  |   | **$**       | **41,647** | ** ** | $      | 33,090 |   |
| Warranties  issued     |   | **29,828**  | ** ** | 32,815     |   |
| Settlements made       |   | **(27,373** | **)**      | (24,258    | )      |
| Balance at December 31 |   | **$**       | **44,102** | ** ** | $      | 41,647 |   |

 

The Company requiressubstantially all of its subcontractors to have general liability insurance(including construction defect coverage) and workmans compensation insurance.These insurance policies protect the Company against a portion of its risk ofloss from claims, subject to certain self-insured retentions, deductibles andother coverage limits. However, with fewer insurers participating, generalliability insurance for the homebuilding industry has become more difficultto obtain over the past several years. As a result, RHIC provides insuranceservices to the homebuilding segments’ subcontractors in certain markets. AtDecember 31, 2006, RHIC had $28.9 million in cash and cash equivalents and$22.5 million in subcontractor product liability reserves, which are includedin the consolidated balance sheet under “Cash and cash equivalents” and “Accruedand other liabilities,” respectively. At December 31, 2005, RHIC had $16.3million in cash and cash equivalents and  $16.9 million in subcontractor productliability reserves, which are included in the consolidated balance sheet.

Changes in the Company’ssubcontractor product liability reserves during the period are as follows:
| *(in thousands)*         |   | **2006**  |       | 2005   |   |
|-------------------------------|--------|-----------|------------|--------|--------|
| Balance at  January 1         |   | **$**     | **16,907** |   | $      | 8,446 |   |
| Insurance  expense provisions |   | **5,614** |       | 8,461  |   |
| Balance at December 31        |   | **$**     | **22,521** |   | $      | 16,907 |   |

 

The Company is party tovarious legal proceedings generally incidental to its businesses. Litigationreserves have been established based on discussions with counsel and theCompany’s analysis of historical claims. The Company has, and requires themajority of its subcontractors to have, general liability insurance to protectit against a portion of its risk of loss and cover it againstconstruction-related claims. The Company establishes reserves to cover itsself-insured retentions and deductible amounts under those policies. Due to thehigh degree of judgment required in determining these estimated reserveamounts, actual future litigation costs could differ from the Company’s currentestimates. At December 31, 2006 and 2005, the Company had legal reserves of$21.0 million and $21.6 million, respectively. (See Item 3. “Legal Proceedings.”)

**Note K: Supplemental GuarantorInformation**

The Company’s obligationsto pay principal, premium, if any, and interest under its $1.1 billionunsecured revolving credit facility; 5.4 percent senior notes due June 2008;5.4 percent senior notes due May 2012; 6.9 percent senior notes due June 2013;and 5.4 percent senior notes due January 2015 are guaranteed on a joint andseveral basis by substantially all of its 100 percent owned homebuildingsubsidiaries (the “Guarantor Subsidiaries”). Such guarantees are full andunconditional.

56

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In lieu of providingseparate financialstatements for the Guarantor Subsidiaries, the accompanying condensedconsolidating financialstatements have been included. Management does not believe that separate financial statements for the GuarantorSubsidiaries are material to investors and are, therefore, not presented.

The following informationpresents the consolidating statements of earnings, financial position and cash flows for *(a)* the parent company and issuer, The Ryland Group, Inc. (“TRG,Inc.”); *(b)* the Guarantor Subsidiaries; *(c)* the non-guarantor subsidiaries; and *(d)*the consolidation eliminations used to arrive at the consolidated informationfor The Ryland Group, Inc. and subsidiaries.

**CONSOLIDATING STATEMENTS OFEARNINGS**
|                                               | ** ** | ** **         | ** **    | ** **       | ** ** | ** **       | ** ** | **YEAR ENDED DECEMBER 31, 2006** | ** **  |
|-----------------------------------------------|------------|--------------------|---------------|------------------|------------|------------------|------------|------------------------------------------------------|-------------|
| ** **                                    | ** ** | ** **         | ** **    | ** **       | ** ** | **NON-**         | ** ** | ** **                                           | ** **  | ** ** | ** ** |
| ** **                                    | ** ** | ** **         | ** **    | **GUARANTOR**    | ** ** | **GUARANTOR**    | ** ** | **CONSOLIDATING**                                    | ** **  | **CONSOLIDATED** | ** ** |
| ***(in thousands)***                     | ** ** | **TRG, INC.** | ** **    | **SUBSIDIARIES** | ** ** | **SUBSIDIARIES** | ** ** | **ELIMINATIONS**                                     | ** **  | **TOTAL** | ** ** |
| REVENUES                                      | ** ** | **$**              | **2,859,744** | ** **       | **$**      | **1,908,416**    | ** ** | **$**                                                | **117,342** | ** ** | **$** | **(128,286** | **)** | **$** | **4,757,216** | ** ** |
| EXPENSES                                      | ** ** | ** **         | ** **    | ** **       | ** ** | ** **       | ** ** | ** **                                           | ** **  | ** ** | ** ** |
| Corporate, general and  administrative        | ** ** | **2,450,382**      | ** **    | **1,810,670**    | ** ** | **49,647**       | ** ** | **(128,286**                                         | **)**       | **4,182,413** | ** ** |
| Expenses related to early  retirement of debt | ** ** | **7,695**          | ** **    | **-**            | ** ** | **-**            | ** ** | **-**                                                | ** **  | **7,695** | ** ** |
| TOTAL EXPENSES                                | ** ** | **2,458,077**      | ** **    | **1,810,670**    | ** ** | **49,647**       | ** ** | **(128,286**                                         | **)**       | **4,190,108** | ** ** |
| Earnings before  taxes                        | ** ** | **401,667**        | ** **    | **97,746**       | ** ** | **67,695**       | ** ** | **-**                                                | ** **  | **567,108** | ** ** |
| Tax expense                                   | ** ** | **145,125**        | ** **    | **36,655**       | ** ** | **25,386**       | ** ** | **-**                                                | ** **  | **207,166** | ** ** |
| Equity in net  earnings of subsidiaries       | ** ** | **103,400**        | ** **    | **-**            | ** ** | **-**            | ** ** | **(103,400**                                         | **)**       | **-** | ** ** |
| NET EARNINGS                                  | ** ** | **$**              | **359,942**   | ** **       | **$**      | **61,091**       | ** ** | **$**                                                | **42,309**  | ** ** | **$** | **(103,400** | **)** | **$** | **359,942** | ** ** |

 

 
|                                                | ** ** | ** **         | ** ** | ** **       | ** ** | ** **       | ** ** | **YEAR ENDED DECEMBER 31, 2005** | ** ** |
|------------------------------------------------|------------|--------------------|------------|------------------|------------|------------------|------------|------------------------------------------------------|------------|
| ** **                                     | ** ** | ** **         | ** ** | ** **       | ** ** | **NON-**         | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | ** **         | ** ** | **GUARANTOR**    | ** ** | **GUARANTOR**    | ** ** | **CONSOLIDATING**                                    | ** ** | **CONSOLIDATED** | ** ** |
| ***(in thousands)***                      | ** ** | **TRG, INC.** | ** ** | **SUBSIDIARIES** | ** ** | **SUBSIDIARIES** | ** ** | **ELIMINATIONS**                                     | ** ** | **TOTAL** | ** ** |
| REVENUES                                       |       | $                  | 2,777,565  |             | $          | 2,064,488        |       | $                                                    | 91,815     |   | $ | (116,302 | ) | $ | 4,817,566 |   |
| EXPENSES                                       |       |               |       |             |       |             |       |                                                 |       |   |   |
| Corporate,  general and  administrative        |       | 2,374,722          |       | 1,797,376        |       | 32,442           |       | (116,302                                             | )          | 4,088,238 |   |
| Expenses  related to early  retirement of debt |       | 8,277              |       | -                |       | -                |       | -                                                    |       | 8,277 |   |
| TOTAL  EXPENSES                                |       | 2,382,999          |       | 1,797,376        |       | 32,442           |       | (116,302                                             | )          | 4,096,515 |   |
| Earnings before taxes                          |       | 394,566            |       | 267,112          |       | 59,373           |       | -                                                    |       | 721,051 |   |
| Tax expense                                    |       | 150,106            |       | 101,502          |       | 22,391           |       | -                                                    |       | 273,999 |   |
| Equity in net earnings  of subsidiaries        |       | 202,592            |       | -                |       | -                |       | (202,592                                             | )          | - |   |
| NET EARNINGS                                   |       | $                  | 447,052    |             | $          | 165,610          |       | $                                                    | 36,982     |   | $ | (202,592 | ) | $ | 447,052 |   |

 

 
|                                         | ** ** | ** **         | ** ** | ** **       | ** ** | ** **       | ** ** | **YEAR ENDED DECEMBER 31, 2004** | ** ** |
|-----------------------------------------|------------|--------------------|------------|------------------|------------|------------------|------------|------------------------------------------------------|------------|
|                                         | ** ** | ** **         | ** ** | ** **       | ** ** | **NON-**         | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| ** **                              | ** ** | ** **         | ** ** | **GUARANTOR**    | ** ** | **GUARANTOR**    | ** ** | **CONSOLIDATING**                                    | ** ** | **CONSOLIDATING** | ** ** |
| ***(in thousands)***               | ** ** | **TRG, INC.** | ** ** | **SUBSIDIARIES** | ** ** | **SUBSIDIARIES** | ** ** | **ELIMINATIONS**                                     | ** ** | **TOTAL** | ** ** |
| REVENUES                                |       | $                  | 2,403,614  |             | $          | 1,551,529        |       | $                                                    | 86,076     |   | $ | (89,398 | ) | $ | 3,951,821 |   |
| EXPENSES                                |       |               |       |             |       |             |       |                                                 |       |   |   |
| Corporate,  general and  administrative |       | 2,065,629          |       | 1,425,004        |       | 29,374           |       | (89,398                                              | )          | 3,430,609 |   |
| TOTAL  EXPENSES                         |       | 2,065,629          |       | 1,425,004        |       | 29,374           |       | (89,398                                              | )          | 3,430,609 |   |
| Earnings before taxes                   |       | 337,985            |       | 126,525          |       | 56,702           |       | -                                                    |       | 521,212 |   |
| Tax expense                             |       | 130,280            |       | 48,713           |       | 21,674           |       | -                                                    |       | 200,667 |   |
| Equity in net earnings  of subsidiaries |       | 112,840            |       | -                |       | -                |       | (112,840                                             | )          | - |   |
| NET EARNINGS                            |       | $                  | 320,545    |             | $          | 77,812           |       | $                                                    | 35,028     |   | $ | (112,840 | ) | $ | 320,545 |   |

 

57

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**CONSOLIDATING BALANCE SHEETS**

 
|                                                   | ** ** | ** **         | ** **    | ** **       | ** ** | ** **       | ** ** | **DECEMBER 31, 2006** | ** **  |
|---------------------------------------------------|------------|--------------------|---------------|------------------|------------|------------------|------------|---------------------------------|-------------|
|                                                   | ** ** | ** **         | ** **    | ** **       | ** ** | **NON-**         | ** ** | ** **                      | ** **  | ** ** | ** ** |
| ** **                                        | ** ** | ** **         | ** **    | **GUARANTOR**    | ** ** | **GUARANTOR**    | ** ** | **CONSOLIDATING**               | ** **  | **CONSOLIDATED** | ** ** |
| ***(in thousands)***                         | ** ** | **TRG, INC.** | ** **    | **SUBSIDIARIES** | ** ** | **SUBSIDIARIES** | ** ** | **ELIMINATIONS**                | ** **  | **TOTAL** | ** ** |
| ASSETS                                            |       |               |          |             |       |             |       |                            |        |   |   |
| Cash  and cash equivalents                        |       | **$**              | **43,129**    | ** **       | **$**      | **129,079**      | ** ** | **$**                           | **42,829**  | ** ** | **$** | **-** | ** ** | **$** | **215,037** | ** ** |
| Consolidated  inventories owned                   |       | **1,563,246**      | ** **    | **944,386**      | ** ** | **-**            | ** ** | **-**                           | ** **  | **2,507,632** | ** ** |
| Consolidated  inventories not owned               |       | **5,655**          | ** **    | **8,059**        | ** ** | **250,139**      | ** ** | **-**                           | ** **  | **263,853** | ** ** |
| Total  inventories                                |       | **1,568,901**      | ** **    | **952,445**      | ** ** | **250,139**      | ** ** | **-**                           | ** **  | **2,771,485** | ** ** |
| Purchase  price in excess of net assets  acquired |       | **15,383**         | ** **    | **2,802**        | ** ** | **-**            | ** ** | **-**                           | ** **  | **18,185** | ** ** |
| Investment  in subsidiaries/                      |       | ** **         | ** **    | ** **       | ** ** | ** **       | ** ** | ** **                      | ** **  | ** ** | ** ** |
| intercompany  receivables                         |       | **1,023,975**      | ** **    | **-**            | ** ** | **12,178**       | ** ** | **(1,036,153**                  | **)**       | **-** | ** ** |
| Other  assets                                     |       | **281,688**        | ** **    | **97,979**       | ** ** | **32,323**       | ** ** | **-**                           | ** **  | **411,990** | ** ** |
| TOTAL  ASSETS                                     |       | **2,933,076**      | ** **    | **1,182,305**    | ** ** | **337,469**      | ** ** | **(1,036,153**                  | **)**       | **3,416,697** | ** ** |
| LIABILITIES                                       |       | ** **         | ** **    | ** **       | ** ** | ** **       | ** ** | ** **                      | ** **  | ** ** | ** ** |
| Accounts  payable and other accrued  liabilities  |       | **480,811**        | ** **    | **162,758**      | ** ** | **130,096**      | ** ** | **-**                           | ** **  | **773,665** | ** ** |
| Debt                                              |       | **941,099**        | ** **    | **9,018**        | ** ** | **-**            | ** ** | **-**                           | ** **  | **950,117** | ** ** |
| Intercompany  payables                            |       | **-**              | ** **    | **370,858**      | ** ** | **-**            | ** ** | **(370,858**                    | **)**       | **-** | ** ** |
| TOTAL  LIABILITIES                                |       | **1,421,910**      | ** **    | **542,634**      | ** ** | **130,096**      | ** ** | **(370,858**                    | **)**       | **1,723,782** | ** ** |
| MINORITY INTEREST                                 |       | **-**              | ** **    | **-**            | ** ** | **181,749**      | ** ** | **-**                           | ** **  | **181,749** | ** ** |
| STOCKHOLDERS’ EQUITY                         |       | **1,511,166**      | ** **    | **639,671**      | ** ** | **25,624**       | ** ** | **(665,295**                    | **)**       | **1,511,166** | ** ** |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY  |       | **$**              | **2,933,076** | ** **       | **$**      | **1,182,305**    | ** ** | **$**                           | **337,469** | ** ** | **$** | **(1,036,153** | **)** | **$** | **3,416,697** | ** ** |

 

 

 
|                                                   | ** ** | ** **         | ** ** | ** **       | ** ** | ** **       | ** ** | **DECEMBER 31, 2005** | ** ** |
|---------------------------------------------------|------------|--------------------|------------|------------------|------------|------------------|------------|---------------------------------|------------|
|                                                   | ** ** | ** **         | ** ** | ** **       | ** ** | **NON-**         | ** ** | ** **                      | ** ** | ** ** | ** ** |
| ** **                                        | ** ** | ** **         | ** ** | **GUARANTOR**    | ** ** | **GUARANTOR**    | ** ** | **CONSOLIDATING**               | ** ** | **CONSOLIDATING** | ** ** |
| ***(in thousands) ***                   | ** ** | **TRG, INC.** | ** ** | **SUBSIDIARIES** | ** ** | **SUBSIDIARIES** | ** ** | **ELIMINATIONS**                | ** ** | **TOTAL** | ** ** |
| ASSETS                                            |       |               |       |             |       |             |       |                            |       |   |   |
| Cash  and cash equivalents                        |       | $                  | 81,895     |             | $          | 359,709          |       | $                               | 19,779     |   | $ | - |   | $ | 461,383 |   |
| Consolidated  inventories owned                   |       | 1,382,900          |       | 957,576          |       | -                |       | -                               |       | 2,340,476 |   |
| Consolidated  inventories not owned               |       | 6,681              |       | 6,576            |       | 225,934          |       | -                               |       | 239,191 |   |
| Total  inventories                                |       | 1,389,581          |       | 964,152          |       | 225,934          |       | -                               |       | 2,579,667 |   |
| Purchase  price in excess of net assets  acquired |       | 15,383             |       | 2,802            |       | -                |       | -                               |       | 18,185 |   |
| Investment  in subsidiaries/                      |       |               |       |             |       |             |       |                            |       |   |   |
| intercompany receivables                          |       | 1,169,987          |       | -                |       | 23,259           |       | (1,193,246                      | )          | - |   |
| Other  assets                                     |       | 216,190            |       | 66,208           |       | 45,240           |       | -                               |       | 327,638 |   |
| TOTAL  ASSETS                                     |       | 2,873,036          |       | 1,392,871        |       | 314,212          |       | (1,193,246                      | )          | 3,386,873 |   |
| LIABILITIES                                       |       |               |       |             |       |             |       |                            |       |   |   |
| Accounts  payable and other accrued  liabilities  |       | 589,279            |       | 205,985          |       | 118,966          |       | -                               |       | 914,230 |   |
| Debt                                              |       | 907,736            |       | 14,234           |       | -                |       | -                               |       | 921,970 |   |
| Intercompany  payables                            |       | -                  |       | 594,071          |       | -                |       | (594,071                        | )          | - |   |
| TOTAL  LIABILITIES                                |       | 1,497,015          |       | 814,290          |       | 118,966          |       | (594,071                        | )          | 1,836,200 |   |
| MINORITY INTEREST                                 |       | -                  |       | -                |       | 174,652          |       | -                               |       | 174,652 |   |
| STOCKHOLDERS’ EQUITY                         |       | 1,376,021          |       | 578,581          |       | 20,594           |       | (599,175                        | )          | 1,376,021 |   |
| TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY  |       | $                  | 2,873,036  |             | $          | 1,392,871        |       | $                               | 314,212    |   | $ | (1,193,246 | ) | $ | 3,386,873 |   |

 

58

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**CONSOLIDATING STATEMENT OF CASHFLOWS**
| ** **                                                                                    | ** ** | ** **               | ** **  | ** **             | ** ** | ** **             | ** ** | **YEAR ENDED DECEMBER 31, 2006** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|--------------------------|-------------|------------------------|------------|------------------------|------------|------------------------------------------------------|------------|
|                                                                                               | ** ** | ** **               | ** **  | ** **             | ** ** | **NON-**               | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| ** **                                                                                    | ** ** | ** **               | ** **  | **GUARANTOR**          | ** ** | **GUARANTOR**          | ** ** | **CONSOLIDATING**                                    | ** ** | **CONSOLIDATING** | ** ** |
| ***(in thousands) ***                                                               | ** ** | **TRG, INC. ** | ** **  | **SUBSIDIARIES ** | ** ** | **SUBSIDIARIES ** | ** ** | **ELIMINATIONS **                               | ** ** | **TOTAL** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES                                                         |       |                     |        |                   |       |                   |       |                                                 |       |   |   |
| Net earnings                                                                                  |       | **$**                    | **359,942** | ** **             | **$**      | **61,091**             | ** ** | **$**                                                | **42,309** | ** ** | **$** | **(103,400** | **)** | **$** | **359,942** | ** ** |
| Adjustments to reconcile net earnings  to net cash provided  by operating activities:         |       | ** **               | ** **  | ** **             | ** ** | ** **             | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Depreciation and  amortization                                                                |       | **27,808**               | ** **  | **17,698**             | ** ** | **1,225**              | ** ** | **-**                                                | ** ** | **46,731** | ** ** |
| Stock-based  compensation expense                                                             |       | **15,376**               | ** **  | **9,450**              | ** ** | **767**                | ** ** | **-**                                                | ** ** | **25,593** | ** ** |
| Changes in assets  and liabilities:                                                           |       | ** **               | ** **  | ** **             | ** ** | ** **             | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| (Increase)  decrease in inventories                                                           |       | **(179,320**             | **)**       | **11,707**             | ** ** | **(15,066**            | **)**      | **-**                                                | ** ** | **(182,679** | **)** |
| Net change in  other assets, payables  and other liabilities                                  |       | **(9,151**               | **)**       | **(303,988**           | **)**      | **(7,200**             | **)**      | **103,400**                                          | ** ** | **(216,939** | **)** |
| Excess tax benefits  from stock-based compensation                                            |       | **(14,632**              | **)**       | **-**                  | ** ** | **-**                  | ** ** | **-**                                                | ** ** | **(14,632** | **)** |
| Other operating  activities, net                                                              |       | **(3,379**               | **)**       | **-**                  | ** ** | **-**                  | ** ** | **-**                                                | ** ** | **(3,379** | **)** |
| Net cash provided  by (used for)  operating activities                                        |       | **196,644**              | ** **  | **(204,042**           | **)**      | **22,035**             | ** ** | **-**                                                | ** ** | **14,637** | ** ** |
| CASH FLOWS FROM  INVESTING ACTIVITIES                                                         |       | ** **               | ** **  | ** **             | ** ** | ** **             | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Net additions to  property, plant  and equipment                                              |       | **(31,280**              | **)**       | **(21,372**            | **)**      | **(1,187**             | **)**      | **-**                                                | ** ** | **(53,839** | **)** |
| Principal  reduction of mortgage-backed securities, notes receivable and  mortgage collateral |       | **-**                    | ** **  | **-**                  | ** ** | **2,250**              | ** ** | **-**                                                | ** ** | **2,250** | ** ** |
| Net cash (used  for) provided by  investing activities                                        |       | **(31,280**              | **)**       | **(21,372**            | **)**      | **1,063**              | ** ** | **-**                                                | ** ** | **(51,589** | **)** |
| CASH FLOWS FROM  FINANCING ACTIVITIES                                                         |       | ** **               | ** **  | ** **             | ** ** | ** **             | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Cash proceeds of  long-term debt                                                              |       | **250,000**              | ** **  | **-**                  | ** ** | **-**                  | ** ** | **-**                                                | ** ** | **250,000** | ** ** |
| Repayment of  long-term debt                                                                  |       | **(243,500**             | **)**       | **-**                  | ** ** | **-**                  | ** ** | **-**                                                | ** ** | **(243,500** | **)** |
| Increase  (decrease) in short-term  borrowings                                                |       | **26,863**               | ** **  | **(5,216**             | **)**      | **-**                  | ** ** | **-**                                                | ** ** | **21,647** | ** ** |
| Common stock  dividends                                                                       |       | **(21,666**              | **)**       | **-**                  | ** ** | **-**                  | ** ** | **-**                                                | ** ** | **(21,666** | **)** |
| Common stock  repurchases                                                                     |       | **(250,118**             | **)**       | **-**                  | ** ** | **-**                  | ** ** | **-**                                                | ** ** | **(250,118** | **)** |
| Issuance of  common stock under  stock-based compensation                                     |       | **19,659**               | ** **  | **-**                  | ** ** | **-**                  | ** ** | **-**                                                | ** ** | **19,659** | ** ** |
| Excess tax benefits  from stock-based compensation                                            |       | **14,632**               | ** **  | **-**                  | ** ** | **-**                  | ** ** | **-**                                                | ** ** | **14,632** | ** ** |
| Other financing  activities, net                                                              |       | **-**                    | ** **  | **-**                  | ** ** | **(48**                | **)**      | **-**                                                | ** ** | **(48** | **)** |
| Net cash used for  financing activities                                                       |       | **(204,130**             | **)**       | **(5,216**             | **)**      | **(48**                | **)**      | **-**                                                | ** ** | **(209,394** | **)** |
| Net (decrease)  increase in cash and  cash equivalents                                        |       | **(38,766**              | **)**       | **(230,630**           | **)**      | **23,050**             | ** ** | **-**                                                | ** ** | **(246,346** | **)** |
| Cash and cash  equivalents at  beginning of year                                              |       | **81,895**               | ** **  | **359,709**            | ** ** | **19,779**             | ** ** | **-**                                                | ** ** | **461,383** | ** ** |
| CASH AND CASH EQUIVALENTS  AT END OF YEAR                                                     |       | **$**                    | **43,129**  | ** **             | **$**      | **129,079**            | ** ** | **$**                                                | **42,829** | ** ** | **$** | **-** | ** ** | **$** | **215,037** | ** ** |

 

59

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**CONSOLIDATING STATEMENT OF CASH FLOWS**

 
|                                                                                              | ** ** | ** **               | ** ** | ** **             | ** ** | ** **             | ** ** | **YEAR ENDED DECEMBER 31, 2005** | ** ** |
|----------------------------------------------------------------------------------------------|------------|--------------------------|------------|------------------------|------------|------------------------|------------|------------------------------------------------------|------------|
|                                                                                              | ** ** | ** **               | ** ** | ** **             | ** ** | **NON-**               | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| ** **                                                                                   | ** ** | ** **               | ** ** | **GUARANTOR **    | ** ** | **GUARANTOR **    | ** ** | **CONSOLIDATING **                              | ** ** | **CONSOLIDATED** | ** ** |
| ***(in thousands) ***                                                              | ** ** | **TRG, INC. ** | ** ** | **SUBSIDIARIES ** | ** ** | **SUBSIDIARIES ** | ** ** | **ELIMINATIONS **                               | ** ** | **TOTAL** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES                                                         |       |                     |       |                   |       |                   |       |                                                 |       |   |   |
| Net earnings                                                                                 |       | $                        | 447,052    |                   | $          | 165,610                |       | $                                                    | 36,982     |   | $ | (202,592 | ) | $ | 447,052 |   |
| Adjustments to reconcile net earnings  to net cash provided by operating activities:         |       |                     |       |                   |       |                   |       |                                                 |       |   |   |
| Depreciation and amortization                                                                |       | 25,880                   |       | 16,167                 |       | 1,119                  |       | -                                                    |       | 43,166 |   |
| Stock-based compensation expense                                                             |       | 15,039                   |       | 3,430                  |       | 393                    |       | -                                                    |       | 18,862 |   |
| Changes in assets and liabilities:                                                           |       |                     |       |                   |       |                   |       |                                                 |       |   |   |
| Increase in inventories                                                                      |       | (269,121                 | )          | (192,901               | )          | (28,949                | )          | -                                                    |       | (490,971 | ) |
| Net change in other assets, payables  and other liabilities                                  |       | (370,135                 | )          | 349,505                |       | (6,604                 | )          | 202,592                                              |       | 175,358 |   |
| Tax benefit from exercise of stock  options and vesting of restricted stock                  |       | 30,505                   |       | -                      |       | -                      |       | -                                                    |       | 30,505 |   |
| Other operating activities, net                                                              |       | (7,708                   | )          | -                      |       | -                      |       | -                                                    |       | (7,708 | ) |
| Net cash (used for) provided by operating activities                                         |       | (128,488                 | )          | 341,811                |       | 2,941                  |       | -                                                    |       | 216,264 |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                                                         |       |                     |       |                   |       |                   |       |                                                 |       |   |   |
| Net additions to property, plant  and equipment                                              |       | (27,496                  | )          | (26,886                | )          | (745                   | )          | -                                                    |       | (55,127 | ) |
| Principal reduction of mortgage-backed securities,  notes receivable and mortgage collateral |       | -                        |       | -                      |       | 12,561                 |       | -                                                    |       | 12,561 |   |
| Net cash (used for) provided by  investing activities                                        |       | (27,496                  | )          | (26,886                | )          | 11,816                 |       | -                                                    |       | (42,566 | ) |
| CASH FLOWS FROM  FINANCING ACTIVITIES                                                        |       |                     |       |                   |       |                   |       |                                                 |       |   |   |
| Cash proceeds of long-term debt                                                              |       | 500,000                  |       | -                      |       | -                      |       | -                                                    |       | 500,000 |   |
| Repayment of long-term debt                                                                  |       | (147,000                 | )          | -                      |       | -                      |       | -                                                    |       | (147,000 | ) |
| Increase (decrease) in short-term borrowings                                                 |       | 7,124                    |       | 13,394                 |       | (10,490                | )          | -                                                    |       | 10,028 |   |
| Common stock dividends                                                                       |       | (11,383                  | )          | -                      |       | -                      |       | -                                                    |       | (11,383 | ) |
| Common stock repurchases                                                                     |       | (176,214                 | )          | -                      |       | -                      |       | -                                                    |       | (176,214 | ) |
| Issuance of common stock under  stock-based compensation                                     |       | 29,262                   |       | -                      |       | -                      |       | -                                                    |       | 29,262 |   |
| Other financing activities, net                                                              |       | -                        |       | -                      |       | (5,396                 | )          | -                                                    |       | (5,396 | ) |
| Net cash provided by (used for)  financing activities                                        |       | 201,789                  |       | 13,394                 |       | (15,886                | )          | -                                                    |       | 199,297 |   |
| Net increase (decrease) in cash and  cash equivalents                                        |       | 45,805                   |       | 328,319                |       | (1,129                 | )          | -                                                    |       | 372,995 |   |
| Cash and cash equivalents at   eginning of year                                              |       | 36,090                   |       | 31,390                 |       | 20,908                 |       | -                                                    |       | 88,388 |   |
| CASH AND CASH  EQUIVALENTS  AT END OF YEAR                                                   |       | $                        | 81,895     |                   | $          | 359,709                |       | $                                                    | 19,779     |   | $ | - |   | $ | 461,383 |   |

 

60

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**CONSOLIDATING STATEMENT OF CASHFLOWS**
|                                                                                               | ** ** | ** **         | ** ** | ** **       | ** ** | ** **       | ** ** | **YEAR ENDED DECEMBER 31, 2004** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------|------------|------------------|------------|------------------------------------------------------|------------|
|                                                                                               | ** ** | ** **         | ** ** | ** **       | ** ** | **NON-**         | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| ** **                                                                                    | ** ** | ** **         | ** ** | **GUARANTOR**    | ** ** | **GUARANTOR**    | ** ** | **CONSOLIDATING**                                    | ** ** | **CONSOLIDATED** | ** ** |
| ** **                                                                                    | ** ** | **TRG, INC.** | ** ** | **SUBSIDIARIES** | ** ** | **SUBSIDIARIES** | ** ** | **ELIMINATIONS**                                     | ** ** | **TOTAL** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES                                                         |       |               |       |             |       |             |       |                                                 |       |   |   |
| Net earnings                                                                                  |       | $                  | 320,545    |             | $          | 77,812           |       | $                                                    | 35,028     |   | $ | (112,840) |   | $ | 320,545 |   |
| Adjustments to reconcile net earnings  to net cash provided by operating activities:          |       |               |       |             |       |             |       |                                                 |       |   |   |
| Depreciation and amortization                                                                 |       | 23,287             |       | 14,609           |       | 623              |       | -                                                    |       | 38,519 |   |
| Stock-based compensation expense                                                              |       | 11,134             |       | 3,688            |       | 386              |       | -                                                    |       | 15,208 |   |
| Changes in assets and liabilities:                                                            |       |               |       |             |       |             |       |                                                 |       |   |   |
| Increase in inventories                                                                       |       | (298,489           | )          | (253,221         | )          | (33,852          | )          | -                                                    |       | (585,562 | ) |
| Net change in other assets, payables  and other liabilities                                   |       | 45,933             |       | (69,968          | )          | 15,619           |       | 112,840                                              |       | 104,424 |   |
| Tax benefit from exercise of stock  options and vesting of restricted stock                   |       | 17,475             |       | -                |       | -                |       | -                                                    |       | 17,475 |   |
| Other operating activities, net                                                               |       | 10,920             |       | -                |       | -                |       | -                                                    |       | 10,920 |   |
| Net cash provided by (used for)  operating activities                                         |       | 130,805            |       | (227,080         | )          | 17,804           |       | -                                                    |       | (78,471 | ) |
| CASH FLOWS FROM  INVESTING ACTIVITIES                                                         |       |               |       |             |       |             |       |                                                 |       |   |   |
| Net additions to property, plant  and equipment                                               |       | (26,370            | )          | (19,468          | )          | (1,293           | )          | -                                                    |       | (47,131 | ) |
| Principal reduction of mortgage-backed securities,  notes receivable and  mortgage collateral |       | -                  |       | -                |       | 19,336           |       | -                                                    |       | 19,336 |   |
| Net cash (used for) provided by  investing activities                                         |       | (26,370            | )          | (19,468          | )          | 18,043           |       | -                                                    |       | (27,795 | ) |
| CASH FLOWS FROM FINANCING  ACTIVITIES                                                         |       |               |       |             |       |             |       |                                                 |       |   |   |
| Increase (decrease) in short-term  borrowings                                                 |       | 1,659              |       | (829             | )          | (15,764          | )          | -                                                    |       | (14,934 | ) |
| Common stock dividends                                                                        |       | (9,661             | )          | -                |       | -                |       | -                                                    |       | (9,661 | ) |
| Common stock repurchases                                                                      |       | (118,296           | )          | -                |       | -                |       | -                                                    |       | (118,296 | ) |
| Issuance of common stock under  stock-based compensation                                      |       | 23,519             |       | -                |       | -                |       | -                                                    |       | 23,519 |   |
| Other financing activities, net                                                               |       | -                  |       | -                |       | (2,678           | )          | -                                                    |       | (2,678 | ) |
| Net cash used for financing activities                                                        |       | (102,779           | )          | (829             | )          | (18,442          | )          | -                                                    |       | (122,050 | ) |
| Net increase (decrease) in cash and  cash equivalents                                         |       | 1,656              |       | (247,377         | )          | 17,405           |       | -                                                    |       | (228,316 | ) |
| Cash and cash equivalents at  beginning of year                                               |       | 34,434             |       | 278,767          |       | 3,503            |       | -                                                    |       | 316,704 |   |
| CASH AND CASH EQUIVALENTS  AT END OF YEAR                                                     |       | $                  | 36,090     |             | $          | 31,390           |       | $                                                    | 20,908     |   | $  | - |   | $ | 88,388 |   |

 

61

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**Supplementary Data**

**QUARTERLY FINANCIAL DATA**

 
| (in thousands, except per share  data) unaudited | ** ** | ** **       | ** **    | ** **        | ** **  | ** **             | ** ** | **2006**               | ** **    | ** **             | ** **  | ** **              | ** ** | ** **             | ** ** | **2005**         | ** ** |
|---------------------------------------------------------------------------|------------|------------------|---------------|-------------------|-------------|------------------------|------------|------------------------|---------------|------------------------|-------------|-------------------------|------------|------------------------|------------|------------------|------------|
|                                                                           | ** ** | **DEC. 31** | ** **    | **SEPT. 30** | ** **  | **JUN. 30 ** | ** ** | **MAR. 31 ** | ** **    | **DEC. 31 ** | ** **  | **SEPT. 30 ** | ** ** | **JUN. 30 ** | ** ** | **MAR. 31** | ** ** |
| CONSOLIDATED RESULTS                                                      |       |             |          |              |        |                   |       |                   |          |                   |        |                    |       |                   |       |             |       |
| Revenues                                                                  |       | **$ **      | **1,354,544** | ** **        | **$ ** | **1,130,942**          | ** ** | **$ **            | **1,196,892** | ** **             | **$ ** | **1,074,838**           |       | $                      | 1,529,567  |             | $          | 1,254,313 |   | $ | 1,159,712 |   | $ | 873,974 |   |
| Earnings before taxes                                                     |       | **139,448**      | ** **    | **131,907**       | ** **  | **151,706**            | ** ** | **144,047**            |          | 261,280                |        | 190,313                 |       | 168,290                |       | 101,168          |       |
| Tax expense                                                               |       | **52,293**       | ** **    | **43,966**        | ** **  | **56,889**             | ** ** | **54,018**             |          | 99,288                 |        | 72,319                  |       | 63,950                 |       | 38,442           |       |
| Net earnings                                                              |       | **$**            | **87,155**    | ** **        | **$**       | **87,941**             | ** ** | **$**                  | **94,817**    | ** **             | **$**       | **90,029**              |       | $                      | 161,992    |             | $          | 117,994 |   | $ | 104,340 |   | $ | 62,726 |   |
| Net earnings per   common share:                                          |       | ** **       | ** **    | ** **        | ** **  | ** **             | ** ** | ** **             |          |                   |        |                    |       |                   |       |             |       |
| Basic                                                                     |       | **$**            | **2.05**      | ** **        | **$**       | **2.04**               | ** ** | **$**                  | **2.11**      | ** **             | **$**       | **1.95**                |       | $                      | 3.48       |             | $          | 2.52 |   | $ | 2.22 |   | $ | 1.32 |   |
| Diluted                                                                   |       | **1.98**         | ** **    | **1.97**          | ** **  | **2.03**               | ** ** | **1.86**               |          | 3.32                   |        | 2.39                    |       | 2.10                   |       | 1.25             |       |
| Weighted-average common   shares outstanding:                             |       | ** **       | ** **    | ** **        | ** **  | ** **             | ** ** | ** **             |          |                   |        |                    |       |                   |       |             |       |
| Basic                                                                     |       | **42,594**       | ** **    | **43,159**        | ** **  | **45,026**             | ** ** | **46,134**             |          | 46,540                 |        | 46,779                  |       | 47,057                 |       | 47,489           |       |
| Diluted                                                                   |       | **44,123**       | ** **    | **44,542**        | ** **  | **46,763**             | ** ** | **48,339**             |          | 48,860                 |        | 49,365                  |       | 49,625                 |       | 50,083           |       |

 

62

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**Report of Management**

Management of the Companyis responsible for the integrity and accuracy of the financial statements andall other annual report information. The financial statements are prepared inconformity with generally accepted accounting principles and include amountsbased on management’s judgments and estimates.

The accounting systems,which record, summarize and report financial information, are supported byinternal control systems designed to provide reasonable assurance, at anappropriate cost, that the assets are safeguarded and that transactions arerecorded in accordance with Company policies and procedures. Developing andmaintaining these systems are the responsibility of management. Properselection, training and development of personnel also contribute to theeffectiveness of the internal control systems. For the purpose of evaluatingand documenting its systems of internal control, management elected to use theintegrated framework promulgated by the Committee of Sponsoring Organizationsof the Treadway Commission (“COSO”). The Company’s systems, evaluation and testresults were documented. The Company’s internal auditors regularly test thesesystems. Based on its evaluation, management believes that its systems ofinternal control over financial reporting were effective and is not aware ofany material weaknesses.

The Company’s independentregistered public accounting firm also reviewed and tested the effectiveness ofthese systems to the extent it deemed necessary to express an opinion on theconsolidated financial statements and systems of internal control; anattestation report on management’s assessment of the Company’s internal controlover financial reporting was then issued.

The Audit Committee ofthe Board of Directors periodically meets with management, the internalauditors and the independent registered public accounting firm to reviewaccounting, auditing and financial matters. Both internal auditors and theindependent registered public accounting firm have unrestricted access to theAudit Committee.

***/s/ Gordon A. Milne***

Gordon A. Milne

*Executive Vice President and*

*Chief Financial Officer*

***/s/ David L. Fristoe***

David L. Fristoe

*Senior Vice President, Controller and*

*Chief Accounting Officer*

63

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**Report of Independent RegisteredPublic Accounting Firm**

**Board of Directors and Stockholders**

**The Ryland Group, Inc.**

We have audited theaccompanying consolidated balance sheets of The Ryland Group, Inc. andsubsidiaries as of December 31, 2006 and 2005, and the related consolidatedstatements of earnings, stockholders’ equity and cash flows for each of thethree years in the period ended December 31, 2006. Our audits also included thefinancial statement schedule listed in the Index at Item 15(a). These financialstatements and schedule are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements andschedule based on our audits.

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

In our opinion, the financialstatements referred to above present fairly, in all material respects, theconsolidated financial position of The Ryland Group, Inc. and subsidiaries atDecember 31, 2006 and 2005, and the consolidated results of their operationsand their cash flows for each of the three years in the period ended December31, 2006, in conformity with U.S. generally accepted accounting principles.Also, in our opinion, the related financial statement schedule, when consideredin relation to the basic financial statements taken as a whole, presents fairlyin all material respects the information set forth therein.

As discussed in Note A tothe financial statements, in 2006 the Company changed its method of accountingfor share-based payments.

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of The Ryland Group, Inc.’s internal controlover financial reporting as of December 31, 2006, based on criteria establishedin Internal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated February 21, 2007expressed an unqualified opinion thereon.

*** /s/ Ernst & Young LLP***

Ernst & Young LLP

Los Angeles, California

February 21, 2007

64

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**Report of Independent RegisteredPublic Accounting Firm**

**Board of Directors and Stockholders**

**The Ryland Group, Inc.**

We have auditedmanagement’s assessment, included in the accompanying Report of Management,that The Ryland Group, Inc. maintained effective internal control over financial reporting as of December 31,2006, based on criteria established in Internal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission(the COSO criteria). The Ryland Group, Inc.’s management is responsible formaintaining effective internal control over financial reporting and for its assessment of the effectivenessof internal control over financialreporting. Our responsibility is to express an opinion on management’s assessmentand an opinion on the effectiveness of the company’s internal control over financial reporting based on ouraudit.

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control over financial reporting was maintained inall material respects. Our audit included obtaining an understanding ofinternal control over financialreporting, evaluating management’s assessment, testing and evaluating thedesign and operating effectiveness of internal control, and performing suchother procedures as we considered necessary in the circumstances. We believethat our audit provides a reasonable basis for our opinion.

A company’s internalcontrol over financialreporting is a process designed to provide reasonable assurance regarding thereliability of financialreporting and the preparation of financialstatements for external purposes in accordance with generally acceptedaccounting principles. A company’s internal control over financial reporting includes thosepolicies and procedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonable assurancethat transactions are recorded as necessary to permit preparation of financial statements in accordancewith generally accepted accounting principles, and that receipts andexpenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financialstatements.

Because of its inherentlimitations, internal control over financial reporting may not prevent or detect misstatements.Also, projections of any evaluation of effectiveness to future periods aresubject to the risk that controls may become inadequate because of changes inconditions, or that the degree of compliance with the policies or proceduresmay deteriorate.

In our opinion,management’s assessment that The Ryland Group, Inc. maintained effectiveinternal control over financialreporting as of December 31, 2006 is fairly stated, in all material respects,based on the COSO criteria. Also, in our opinion, The Ryland Group, Inc.maintained, in all material respects, effective internal control over financial reporting as of December 31,2006, based on the COSO criteria.

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated balance sheets of The Ryland Group, Inc. andsubsidiaries as of December 31, 2006 and 2005, and the related consolidatedstatements of earnings, stockholders’ equity, and cash flows for each of thethree years in the period ended December 31, 2006, and our report datedFebruary 21, 2007 expressed an unqualified opinion thereon.

*** /s/ Ernst& Young LLP***

Ernst & YoungLLP

Los Angeles,California

February 21, 2007

 

65

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**Item 9. Changes in and Disagreements With Accountantson Accounting and Financial Disclosure**

None.

**Item 9A. Controls and Procedures**

The Company hasprocedures in place for accumulating and evaluating information that enable it toprepare and filereports with the SEC. At the end of the period covered by the report on Form 10-K,an evaluation was performed by the Company’s management, including the CEO andCFO, of the effectiveness of the Company’s disclosure controls and proceduresas defined in Rule 13a-15(e) promulgatedunder the Exchange Act. Based on that evaluation, the Company’s management, includingthe CEO and CFO, concluded that the Company’s disclosure controls andprocedures were effective as of December 31, 2006.

The Company has acommittee consisting of key officers, including the chief accounting officer and general counsel, to ensure that all informationrequired to be disclosed in the Company’s reports is accumulated andcommunicated to those individuals responsible for the preparation of thereports, as well as to all principal executive and financial officers,in a manner that will allow timely decisions regarding required disclosures.

The Company’s management,including the CEO and CFO, has evaluated any changes in the Company’s internalcontrol over financialreporting that occurred during the quarterly period ended December 31, 2006,and has concluded that there was no change during this period that hasmaterially affected, or is reasonably likely to materially affect, the Company’sinternal control over financialreporting.

At December 31, 2006, theCompany completed a detailed evaluation of its internal control over financial reporting, including theassessment, documentation and testing of its controls as required by theSarbanes-Oxley Act of 2002. No material weaknesses were identified. The Company’s managementsummarized its assessment process and documented its conclusions in the Reportof Management, which appears in Part II, Item 8., “Financial Statements andSupplementary Data.” The Company’s independent registered public accounting firm summarized its review ofmanagement’s assessment of internal control over financial reporting in an attestation report which also appearsin Part II, Item 8., “Financial Statements and Supplementary Data.”

**NYSE Certi****fication**

The NYSE requires thatthe chief executive officersof its listed companies certify annually to the NYSE that they are not aware ofviolations by their companies of NYSE corporate governance listing standards.The Company submitted a non-qualifiedcertification by its ChiefExecutive Officer to the NYSE in2006 in accordance with the NYSE’s rules. Further, the Company filed certifications by its Chief Executive Officer and Chief Financial Officer with the SEC in accordance with the Sarbanes-Oxley Act of2002. These certifications were filed as exhibits to this AnnualReport on Form 10-K.

**Item 9B. Other Information**

None.

66

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**Part III****                         Item10.****                                    Directors,Executive Officers and Corporate Governance**

Information as to theCompany’s directors, executive officers and corporate governance is incorporated by referencefrom the Company’s *2007 Proxy Statement*,including the determination by the Board of Directors, with respect to the “AuditCommittee’s financial expert,”and the identity of each member of the Audit Committee of the Board ofDirectors. Additional information as to the Company’s executive officers is shown under Part I as aseparate item.

The Company has adopted acode of ethics that is applicable to its senior officers, directors and employees. Toretrieve the Company’s code of ethics, visit *www.ryland.com*,select “Investors” and scroll down the page to “Code of Ethics.”

**Item 11.****                    ExecutiveCompensation**

The information requiredby this item is incorporated by reference from the *2007 ProxyStatement*. The Compensation Committee Report to be included in the *2007 Proxy Statement* shall be deemed furnished in thisAnnual Report on Form 10-K and shall not be incorporated by reference into any filing under the Securities Act or theExchange Act as a result of such furnishing in this Item 11.

**Item 12.****                    SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters**

The information requiredby this item is incorporated by reference from the *2007 ProxyStatement.*

**Item 13.       CertainRelationships and Related Transactions, and Director Independence**

The information requiredby this item is incorporated by reference from the *2007 ProxyStatement.*

**Item 14.****                    PrincipalAccountant Fees and Services**

The information requiredby this item is incorporated by reference from the *2007 ProxyStatement.*

67

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**Part IV****                        Item15.****                                    Exhibitsand Financial Statement Schedules**
|          | ** ** | ** **                                                                                                                                                                                | ** **                                                                                                                                                                             | **Page  No**. |
|----------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------|
| (a)      | 1.         | Financial Statements                                                                                                                                                                      |                                                                                                                                                                                   |          |
|     |       |                                                                                                                                                                                      |                                                                                                                                                                                   |          |
|     |       | Consolidated Statements of Earnings—years ended  December 31, 2006, 2005 and 2004                                                                                               |                                                                                                                                                                                   | 35            |
|     |       |                                                                                                                                                                                      |                                                                                                                                                                                   |          |
|     |       | Consolidated Balance Sheets—December 31, 2006 and  2005                                                                                                                              |                                                                                                                                                                                   | 36            |
|     |       |                                                                                                                                                                                      |                                                                                                                                                                                   |          |
|     |       | Consolidated Statements of Stockholders’  Equity—years ended   December 31, 2006, 2005 and 2004                                                                                 |                                                                                                                                                                                   | 37            |
|     |       |                                                                                                                                                                                      |                                                                                                                                                                                   |          |
|     |       | Consolidated Statements of Cash Flows—years ended  December 31, 2006, 2005 and 2004                                                                                                  |                                                                                                                                                                                   | 38            |
|     |       |                                                                                                                                                                                      |                                                                                                                                                                                   |          |
|     |       | Notes to Consolidated Financial Statements                                                                                                                                                |                                                                                                                                                                                   | 39            |
|     |       |                                                                                                                                                                                      |                                                                                                                                                                                   |          |
|     | 2.         | Financial Statement Schedule   Schedule II—Valuation and Qualifying Accounts                                                                                                         |                                                                                                                                                                                   | 71            |
|     |       |                                                                                                                                                                                      |                                                                                                                                                                                   |          |
| * * | * *   | *Schedules not listed above have been omitted  either because they are inapplicable or because the required information has  been provided in the financial statements or notes thereto.* | * *                                                                                                                                                                               | * *      |
| * * | * *   | * *                                                                                                                                                                                  | * *                                                                                                                                                                               | * *      |
|     | 3.         | Exhibits                                                                                                                                                                                  |                                                                                                                                                                                   |          |
|     |       |                                                                                                                                                                                      |                                                                                                                                                                                   |          |
|     |       | The following exhibits are included with this report  or incorporated herein by reference as indicated below:                                                                             |                                                                                                                                                                                   |          |
|     |       |                                                                                                                                                                                      |                                                                                                                                                                                   |          |
|     |       | 3.1                                                                                                                                                                                  | Articles of Restatement of The Ryland Group, Inc.,  as amended  (Incorporated by reference from Form 10-Q for the quarter ended March 31,  2005)                                       |          |   |
|     |       |                                                                                                                                                                                      |                                                                                                                                                                                   |          |   |
|     |       | 3.2                                                                                                                                                                                       | Bylaws of The Ryland Group, Inc., as amended  (Incorporated by reference from Form 10-K for the year ended December 31,  1996)                                                         |          |   |
|     |       |                                                                                                                                                                                      |                                                                                                                                                                                   |          |   |
|     |       | 4.1                                                                                                                                                                                       |  Senior Notes,  dated as of August 16, 2001  (Incorporated by reference from Registration Statement on Form S-3,  Registration No. 333-58208)                                     |          |   |
|     |       |                                                                                                                                                                                      |                                                                                                                                                                                   |          |   |
|     |       | 4.2                                                                                                                                                                                       | Senior Notes, dated as of June 5, 2003  (Incorporated by reference from Registration Statement on Form S-3,  Registration No. 333-100167)                                              |          |   |
|     |       |                                                                                                                                                                                      |                                                                                                                                                                                   |          |   |
|     |       | 4.3                                                                                                                                                                                       | Senior Notes, dated as of January 11, 2005  (Incorporated by reference from Registration Statement on Form S-3,  Registration No. 333-121469)                                          |          |   |
|     |       |                                                                                                                                                                                      |                                                                                                                                                                                   |          |   |
|     |       | 4.4                                                                                                                                                                                  | Senior Notes, dated as of May 9, 2005  (Incorporated by reference from Registration Statement on Form S-3,  Registration No. 333-124000)                                               |          |   |
|     |       |                                                                                                                                                                                      |                                                                                                                                                                                   |          |   |
|     |       | 4.5                                                                                                                                                                                  | Senior Notes, dated as of May 30, 2006  (Incorporated by reference from Registration Statement on Form S-3,  Registration No. 333-124000)                                              |          |   |
|     |       |                                                                                                                                                                                      |                                                                                                                                                                                   |          |   |
|     |       | 10.1                                                                                                                                                                                      | Credit Agreement, dated as of January 12, 2006,  between  The Ryland Group, Inc. and certain financial institutions  (Incorporated by reference from Form 8-K, filed January 13, 2006) |          |   |

 

68

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|        | 3.     | Exhibits, *continued* |                                                                                                                                                                                                                    |   |
|--------|--------|-----------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   |   |                  |                                                                                                                                                                                                                    |   |
|   |   | 10.2             | 1992 Equity Incentive Plan of The Ryland Group, Inc.  (Incorporated by reference from Form 10-Q for the quarter ended  June 30, 1992)                                                                                   |   |   |
|   |   |                  |                                                                                                                                                                                                                    |   |   |
|   |   | 10.3             | 2002 Equity Incentive Plan of The Ryland Group, Inc.    (Incorporated by reference from Form 10-Q for the quarter ended  June 30, 2002)                                                                                 |   |   |
|   |   |                  |                                                                                                                                                                                                                    |   |   |
|   |   | 10.4                  | 2005 Equity Incentive Plan of The Ryland Group, Inc.  (Incorporated by reference from Form 10-Q for the quarter ended March 31,  2005)                                                                                  |   |   |
|   |   |                  |                                                                                                                                                                                                                    |   |   |
|   |   | 10.5                  | Form of Non-Qualified Stock Option Agreement for The  Ryland Group, Inc. 2005 Equity Incentive Plan  (Incorporated by reference from Form 8-K, filed April 29, 2005)                                                    |   |   |
|   |   |                  |                                                                                                                                                                                                                    |   |   |
|   |   | 10.6                  | Form of Stock Unit Agreement for The Ryland Group,  Inc. 2005 Equity Incentive Plan  (Incorporated by reference from Form 8-K, filed April 29, 2005)                                                                    |   |   |
|   |   |                  |                                                                                                                                                                                                                    |   |   |
|   |   | 10.7             | 2004 Non-Employee Director Equity Plan of The Ryland  Group, Inc.  (Incorporated by reference from Form 10-Q for the quarter ended March 31,  2004)                                                                     |   |   |
|   |   |                  |                                                                                                                                                                                                                    |   |   |
|   |   | 10.8                  | Amended and Restated Employment Agreement, dated as  of April 20, 2005, between The Ryland Group, Inc. and R. Chad Dreier  (Incorporated by reference from Form 8-K/A, filed May 4, 2005)                               |   |   |
|   |   |                  |                                                                                                                                                                                                                    |   |   |
|   |   | 10.9                  | The Ryland Group, Inc. Dreier Supplemental Executive  Retirement Plan   (Incorporated by reference from Form 10-Q for the quarter ended September 30,  2003)                                                            |   |   |
|   |   |                  |                                                                                                                                                                                                                    |   |   |
|   |   | 10.10                 | The Ryland Group, Inc. Dreier Supplemental Executive  Retirement Plan II   (Incorporated by reference from Form 8-K/A, filed May 4, 2005)                                                                               |   |   |
|   |   |                  |                                                                                                                                                                                                                    |   |   |
|   |   | 10.11                 | Form of 2003 and 2004 Senior Executive Severance  Agreement between The Ryland Group, Inc. and executive officers of the Company   (Incorporated by reference from Form 10-Q for the quarter ended September 30,  2000) |   |   |
|   |   |                  |                                                                                                                                                                                                                    |   |   |
|   |   | 10.12                 | Form of 2007 Senior Executive Severance Agreement  between The Ryland Group, Inc. and executive officers of the Company   (Filed herewith)                                                                              |   |   |
|   |   |                  |                                                                                                                                                                                                                    |   |   |
|   |   | 10.13                 | Amendment and Restatement of the Executive and  Director Deferred Compensation Plan, effective March 1, 1998  (Incorporated by reference from Form 10-K for the year ended  December 31, 1999)                     |   |   |
|   |   |                  |                                                                                                                                                                                                                    |   |   |
|   |   | 10.14                 | The Ryland Group, Inc. Executive and Director  Deferred Compensation Plan II, effective January 1, 2005   (Filed herewith)                                                                                              |   |   |
|   |   |                  |                                                                                                                                                                                                                    |   |   |
|   |   | 10.15                 | Non-Employee Director Stock Unit Plan, effective  January 1, 1998, between The Ryland Group, Inc. and the Board of Directors  (Incorporated by reference from Form 10-K for the year ended December 31,  1997)          |   |   |
|   |   |                  |                                                                                                                                                                                                                    |   |   |
|   |   | 10.16                 | 2000 Non-Employee Director Equity Plan of The Ryland  Group, Inc., as amended  (Incorporated by reference from Form 10-K for the year ended December 31,  2000)                                                         |   |   |

 

69

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|        | 3.     | Exhibits, *continued* |                                                                                                                                                                                                              |   |
|--------|--------|-----------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   |   |                  |                                                                                                                                                                                                              |   |
|   |   | 10.17                 | Non-Employee Director Stock Plan, effective April  26, 2006  (Incorporated by reference from Form 8-K, filed April 27, 2006)                                                                                      |   |   |
|   |   |                  |                                                                                                                                                                                                              |   |   |
|   |   | 10.18                 | TRG Incentive Plan, as amended and restated,  effective  January 1, 2003  (Incorporated by reference from Form 10-Q for the quarter ended March 31,  2003)                                                        |   |   |
|   |   |                  |                                                                                                                                                                                                              |   |   |
|   |   | 10.19                 | The Ryland Group, Inc. Performance Award Program,  effective  July 1, 2002  (Incorporated by reference from Form 10-Q for the quarter ended March 31, 2003)                                                       |   |   |
|   |   |                  |                                                                                                                                                                                                              |   |   |
|   |   | 10.20                 | The Ryland Group, Inc. Senior Executive Performance  Plan  (Incorporated by reference from Form 10-Q for the quarter ended March 31,  2003)                                                                       |   |   |
|   |   |                  |                                                                                                                                                                                                              |   |   |
|   |   | 10.21                 | The Ryland Group, Inc. Senior Executive Supplemental  Retirement Plan  (Incorporated by reference from Form 10-Q for the quarter ended September 30,  2003)                                                       |   |   |
|   |   |                  |                                                                                                                                                                                                              |   |   |
|   |   | 10.22                 | Lease Agreement, dated as of December 29, 1999, by  and between The Ryland Group, Inc. and Kilroy Realty Group  (Incorporated by reference from Form 10-K for the year ended December 31,  1999)                  |   |   |
|   |   |                  |                                                                                                                                                                                                              |   |   |
|   |   | 10.23                 | First Amendment to Office Building Lease, dated August  26, 2005,  by and between The Ryland Group, Inc. and Kilroy Realty, L.P.  (Incorporated by reference from Form 10-K for the year ended December 31, 2005) |   |   |
|   |   |                  |                                                                                                                                                                                                              |   |   |
|   |   | 10.24                 | Lease Agreement, dated February 28, 2006, by and  between The Ryland Group, Inc. and PCCP HC Kierland, LLC  (Incorporated by reference from Form 8-K, filed March 6, 2006)                                        |   |   |
|   |   |                  |                                                                                                                                                                                                              |   |   |
|   |   | 12.1                  | Computation of Ratio of Earnings to Fixed Charges  (Filed herewith)                                                                                                                                               |   |   |
|   |   |                  |                                                                                                                                                                                                              |   |   |
|   |   | 21                    | Subsidiaries of the Registrant  (Filed herewith)                                                                                                                                                                  |   |   |
|   |   |                  |                                                                                                                                                                                                              |   |   |
|   |   | 23                    | Consent of Independent Registered Public Accounting  Firm  (Filed herewith)                                                                                                                                       |   |   |
|   |   |                  |                                                                                                                                                                                                              |   |   |
|   |   | 24                    | Power of Attorney  (Filed herewith)                                                                                                                                                                               |   |   |
|   |   |                  |                                                                                                                                                                                                              |   |   |
|   |   | 31.1                  | Certification of Principal Executive Officer Pursuant to Section 302  of the Sarbanes-Oxley Act of 2002  (Filed herewith)                                                                                         |   |   |
|   |   |                  |                                                                                                                                                                                                              |   |   |
|   |   | 31.2                  | Certification of Principal Financial Officer Pursuant to Section 302  of the Sarbanes-Oxley Act of 2002  (Filed herewith)                                                                                         |   |   |
|   |   |                  |                                                                                                                                                                                                              |   |   |
|   |   | 32.1                  | Certification of Principal Executive Officer Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002  (Furnished herewith)                                                                                     |   |   |
|   |   |                  |                                                                                                                                                                                                              |   |   |
|   |   | 32.2                  | Certification of Principal Financial Officer Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002  (Furnished herewith)                                                                                     |   |   |

 

70

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**The Ryland Group, Inc. and Subsidiaries**

**Schedule II—Valuation andQualifying Accounts**
|                          |   | BALANCE AT |       | CHARGED TO |       | DEDUCTIONS |       | BALANCE AT |       |
|--------------------------|--------|------------|------------|------------|------------|------------|------------|------------|------------|
|                     |   | BEGINNING  |       | COSTS AND  |       | AND        |       | END OF     |       |
| *(in  thousands)*        |   | OF PERIOD  |       | EXPENSES   |       | TRANSFERS  |       | PERIOD     |       |
| Valuation  allowance:    |   |       |       |       |       |       |       |       |       |
| Homebuilding inventories |   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |       |
| **2006**                 |   | **$**      | **486**    | ** ** | **$**      | **62,910** | ** ** | **$**      | **(3,661** | **)** | **$** | **59,735** |   |
| 2005                     |   | 1,405      |       | 804        |       | (1,723     | )          | 486        |       |
| 2004                     |   | 1,526      |       | 33         |       | (154       | )          | 1,405      |       |
|                          |        |            |            |            |            |            |            |            |            |  |  |  |  |

 

71

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**Signatures**

Pursuant to therequirements of Section 13 or 15(d) of the Exchange Act, the Company has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
| **The Ryland Group, Inc.**       | * *             |
|----------------------------------|----------------------|
|                             | * *             |
| By:                              | * *             |
| ***/s/  R. Chad Dreier***        | *February  28, 2007* |
| R. Chad Dreier                   |                 |
| *Chairman,  President and*       |                 |
| *Chief  Executive Officer*       |                 |
| *(Principal  Executive Officer)* |                 |

 

Pursuant to therequirements of the Exchange Act, this report has been signed below by thefollowing persons on behalf of the Registrant and in the capacities and on thedates indicated.
| **Principal Executive Of****ficer:** | * *             |
|--------------------------------------|----------------------|
| ***/s/  R. Chad Dreier***            | *February  28, 2007* |
| R. Chad Dreier                       |                 |
| *Chairman,  President and*           |                 |
| *Chief  Executive Officer*           |                 |

 
| **Principal Financial Of****ficer:** | * *             |
|--------------------------------------|----------------------|
| ***/s/  Gordon A. Milne***           | *February  28, 2007* |
| Gordon A. Milne                      |                 |
| *Executive  Vice President and*      |                 |
| *Chief  Financial Officer*           |                 |

 
| **Principal Accounting Of****ficer:** | * *             |
|---------------------------------------|----------------------|
| ***/s/  David L. Fristoe***           | *February  28, 2007* |
| David L. Fristoe                      |                 |
| *Senior  Vice President and*          |                 |
| *Chief  Accounting Officer*           |                 |

 

 

Members of the Board of Directors: Daniel T. Bane, Leslie M. Frécon,Roland A. Hernandez, William L. Jews, Ned Mansour,

Robert E. Mellor, NormanJ. Metcalfe, Charlotte St. Martin, Paul J. Varello and John O. Wilson
| By:                          | * *             |
|------------------------------|----------------------|
| ***/s/  Timothy J. Geckle*** | *February  28, 2007* |
| Timothy J.  Geckle           |                 |
| *As  Attorney-in-Fact*       |                 |

 

72

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**Index ofExhibits**
| 10.12  |   | Form of 2007 Senior Executive Severance Agreement  between The Ryland Group, Inc. and executive officers of the Company |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                    |
| 10.14  |   | The Ryland Group, Inc. Executive and Director  Deferred Compensation Plan II, effective January 1, 2005                 |
|   |   |                                                                                                                    |
| 12.1   |   | Computation of Ratio of Earnings to Fixed Charges                                                                       |
|   |   |                                                                                                                    |
| 21     |   | Subsidiaries of the Registrant                                                                                          |
|   |   |                                                                                                                    |
| 23     |   | Consent of Independent Registered Public Accounting  Firm                                                               |
|   |   |                                                                                                                    |
| 24     |   | Power of Attorney                                                                                                       |
|   |   |                                                                                                                    |
| 31.1   |   | Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                 |
|   |   |                                                                                                                    |
| 31.2   |   | Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                 |
|   |   |                                                                                                                    |
| 32.1   |   | Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002                 |
|   |   |                                                                                                                    |
| 32.2   |   | Certification of Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002                 |
|   |   |                                                                                                                    |

 

73

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