<PAGE>   1
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549

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                                  FORM 10-K
               ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                     THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2000     Commission file number 0-28024

                           THE FORTRESS GROUP, INC.
            (Exact name of registrant as specified in its charter)

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                      Delaware                                  54-1774997
          (State or other jurisdiction of                    (I.R.S. Employer
           incorporation or organization)                  Identification No.)

 1650 Tysons Boulevard, Suite 600, McLean, Virginia               22102
      (Address of principal executive offices)                  (Zip Code)

      Registrant's telephone number, including area code: (703) 442-4545

         Securities registered pursuant to Section 12(b) of the Act:

                                     NONE

         Securities registered pursuant to Section 12(g) of the Act:

                         Common Stock, par value $.01

         Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days: YES X No

         Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statement incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. /X/

         Aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 28, 2001 was $3,643,100.

         As of March 28, 2001, 3,099,754 shares of the Registrant's Common
Stock, $.01 par value per share, were outstanding.

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                     Documents Incorporated By Reference

         Certain information required by Items 10, 11, 12 and 13 of Form 10-K
is incorporated by reference into Part III hereof, from the registrant's proxy
statement, which will be filed with the Securities and Exchange Commission
within 120 days after the close of the fiscal year covered by this Form 10-K,
and certain documents are incorporated by reference into Part IV hereof.

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PART I

ITEM 1.  BUSINESS

INTRODUCTION

The Fortress Group, Inc. (the "Company" or "Fortress") is a national
homebuilding company engaged in designing, building and selling single family
homes in the metropolitan areas surrounding a diversified group of cities in
the United States. The Company offers high-quality, innovative homes,
targeting a diverse range of market segments including the first-time,
entry-level buyer, move-up buyer and luxury homebuyer. The Company markets a
wide range of single family detached and attached homes ranging in size from
1,000 to 6,000 square feet at prices ranging generally from $90,000 to
$700,000.

The Company was formed in June 1995 to create a national homebuilding company
through the simultaneous acquisition of four homebuilding companies and an
initial public offering of the Company's equity and debt securities.
Subsequent to the initial acquisitions the Company acquired nine additional
homebuilding companies from 1996 to 1998. In March of 1999, the Company sold
the assets of one subsidiary, consolidated the operations of two subsidiaries
that were operating in the same market areas, and closed down the operations
of a third subsidiary. As of February 28, 2001, the Company sold Brookstone
Homes (see Acquisitions and Dispositions - page 9).

As of December 31, 2000 The Company conducted homebuilding operations in the
following markets:

<TABLE>
<CAPTION>
STATES                  MARKET AREAS                    YEAR ENTERED      MARKETING NAME
------                  ------------                    ------------      --------------
<S>                     <C>                             <C>               <C>
Arizona                 Tucson                              1996          The Genesee Company

Colorado                Denver, Fort Collins                1996          The Genesee Company

Florida                 Jacksonville                        1997          Fortress Homes and Communities
                                                                          of Florida

Missouri                St. Louis                           1998          Whittaker Homes

Nevada                  Las Vegas                           1996          Christopher Homes

New Jersey              Atlantic City                       1999          Iacobucci Homes

North Carolina          Raleigh-Durham                      1996          Sunstar Homes

North Carolina          Charlotte                           1997          Don Galloway Homes

Oregon / Washington     Portland MSA                        1998          Quail Homes

Pennsylvania            Philadelphia                        1997          Iacobucci Homes

South Carolina          Charleston                          1997          Don Galloway Homes

Texas                   Austin and San Antonio              1996          Wilshire Homes

Wisconsin               Janesville-Madison-Milwaukee        1996          Brookstone Homes
                                                                          (Sold February 2001)
</TABLE>

During 2000, management decided to reposition and reorganize the Company from a
divisional structure to a regional one, focusing operations on three
primary regional business units in its strongest markets that show the
greatest potential for growth. These regions will be organized along
geographic lines and will be characterized as the Western, Central, and
Eastern region.



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In January 1997, Fortress formed Fortress Mortgage, Inc. ("Fortress
Mortgage"), a wholly-owned subsidiary, to provide mortgage financing to the
Company's customers. Fortress Mortgage is licensed as a mortgage banker in
Alaska, Arizona, California, Colorado, Florida, Illinois, Missouri, New
Jersey, North Carolina, Oregon, Pennsylvania, South Carolina, Texas, Virginia,
Washington and Wisconsin.

MARKETS AND PRODUCTS

OVERVIEW

The Company's operations serve the metropolitan areas noted above. The Company
maintains the flexibility to tailor its product mix within a given market
depending upon market conditions including demographic trends, demand for a
particular type of product, margins, timing and the economic strength of the
market. Depending on the local market and our strategy to serve that market we
develop and build housing that addresses first-time homebuyers, first-time and
second-time move up homebuyers, retirees, empty nesters, and semi-custom
buyers.

The table below details our diversified product offerings and the number of
lots controlled by the Company in each of its operating subsidiaries at
December 31, 2000.

<TABLE>
<CAPTION>
  OPERATING DIVISION                AVERAGE SELLING PRICE        PRODUCT RANGE (SQ. FT)      TOTAL LOTS UNDER CONTROL
  ------------------                ---------------------        ----------------------      ------------------------
<S>                                 <C>                          <C>                         <C>
  Brookstone Homes                        $150,800                     1,040-2,400                     850
  (sold February 2001)

  Christopher Homes                       $521,000                     3,100-6,000                     128

  Don Galloway Homes                      $151,500                     1,000-3,100                    2,581

  Fortress Homes and                      $139,300                     1,200-4,000                    2,166
  Communities of Florida

  The Genesee Company                     $275,100                     1,100-3,700                    3,018

  Iacobucci Homes                         $214,900                     1,650-3,200                    1,109

  Quail Homes                             $191,000                     1,000-4,100                     178

  Sunstar Homes                           $223,400                     1,150-4,100                    1,089

  Whittaker Homes                         $173,300                     1,100-3,600                    2,751

  Wilshire Homes                          $184,200                     1,300-4,400                    2,412
</TABLE>

LAND ACQUISITION AND DEVELOPMENT

The Company's policies and strategies regarding land acquisition and
development vary and are dictated by the specific market conditions where the
Company conducts its operations. Overall, the Company's land acquisition and
development practices include (i) acquiring and exercising options to purchase
finished lots; (ii) purchasing finished lots; (iii) controlling (by option or
conditional purchase contract) fully entitled land; (iv) securing options to
purchase land, which options are subject to the seller obtaining required
entitlements; and (v) in some instances, controlling or purchasing raw land
and assuming the cost of obtaining the necessary entitlements. Generally, the
Company seeks to minimize its

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overall land costs and the risks associated with developing unentitled land
by, whenever possible, using options and other purchase arrangements that
allow the Company to control land through the entitlement process but defer
the acquisition of such land until the entitlement process has been completed
and the Company is prepared to commence construction. The Company has also
entered into contracts where it acts as a general contractor providing
construction and marketing services but avoiding land development risk, as
well as joint ventures with other builders and developers to allow the Company
to participate in larger parcels of land without assuming responsibility for
the entire parcel.

The Company selects land for development based upon a variety of factors,
including (i) internal and external demographic and marketing studies; (ii)
financial review as to the feasibility of the proposed project, including
total investment risk, projected profit margins and return on capital
employed; (iii) competition for the proposed project; (iv) the ability to
secure governmental approvals and entitlements; (v) results of environmental
and legal due diligence; (vi) proximity to concentrated job markets, quality
school districts and local traffic corridors; (vii) infrastructure
requirements for grading, drainage, utilities and streets; and (viii)
management's judgment as to the real estate market, economic trends and the
Company's experience in a particular market. The Company does not acquire land
without the approval of its Land Acquisition Committee, a group composed of
senior management and members of the Company's board of directors.

The Company strives to develop a design and marketing concept for each of its
communities based on the specific geographic and target market, which includes
determination of size, style, price range of homes, layout of streets, size
and layout of individual lots and overall community design. The development
and construction of each project are managed by the Company's local
operations.

At December 31, 2000, the Company had homes under construction on 1,516 lots
and owned 2,330 finished lots and 2,729 lots held for or under development. As
of December 31, 2000, the Company also had under contract or option, subject
to the satisfaction of the Company's purchase contingencies, 9,707 finished,
undeveloped or partially developed lots.

CONSTRUCTION

The Company's subsidiaries act as the general contractor for the construction
of its homes and development of finished lots. The Company's project
development operations are also controlled by its local operations, whose
employees oversee the construction of each community, including coordinating
activities of subcontractors and suppliers and insuring that all work is
subject to quality and cost controls and complies with zoning and building
codes. Subcontractors typically are retained on a subdivision-by-subdivision
basis to complete construction at a fixed price. Agreements with the Company's
subcontractors and materials suppliers are generally entered into after
competitive bidding on an individual basis.

Fortress management specifies that quality, durable materials be used in
constructing the Company's homes. The Company does not maintain a significant
inventory of construction materials. Each of the Company's local operations
maintains close contact with its respective subcontractors and suppliers, and
the Company believes that its relationship with its suppliers and
subcontractors is good. When possible, the Company negotiates price and volume
discounts with manufacturers and suppliers on behalf of subcontractors to take
advantage of its volume of production. Although the Company generally has made
no long-term purchase commitments to materials suppliers in the past and
although certain key materials and supplies are, and will continue to be,
purchased at local/regional levels, the Company negotiates contractual terms
with certain of its vendors to provide additional cost savings on a national
basis. Generally, access to the Company's principal subcontracting trades,
materials and supplies continues to

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be readily available in each of its markets; however, prices for these goods
and services may fluctuate due to various factors, including supply and demand
shortages which may be beyond the control of the Company or its vendors.

The Company generally provides a one-year limited warranty of workmanship and
materials with each of its homes although warranty policies may differ within
each local operation and by project. The Company's subcontractors generally
provide the Company with an indemnity and a certificate of insurance prior to
receiving payments for their work; therefore, claims relating to workmanship
and materials are primarily the responsibility of the Company's
subcontractors. In many cases we supplement our one year limited warranty with
a ten year limited warranty on structural items, through policies purchased
from third parties. Historically, the Company's divisions have not incurred
material costs relating to warranty claims or defects in construction.

SALES AND MARKETING

Each of the Company's subsidiaries is responsible for the sales and marketing
activities relating to its communities. The Company makes extensive use of
advertising and other promotional activities, including newspaper
advertisements, brochures, direct mail and signage in the immediate areas of
its developments. In addition the Company utilizes extensive market research
developed internally and provided by third parties. A national sales and
marketing council promotes the sharing of best practices across the
organization, as well as the exchange of product designs and cost saving
programs. The Company believes that each of its local operations has an
established reputation for developing high quality homes in the markets it
serves, which generates additional interest in the Company's new projects.

The effective use of model homes plays an integral part in demonstrating the
competitive advantages of our home designs and features to prospective
homebuyers. The Company generally builds between one and five model homes for
each active community, depending upon the number of homes to be built within
each community and the products to be offered. Each local operation is
responsible for creating an attractive model home presentation designed to
appeal to the preferences of potential homebuyers.

The Company's objective is to enter into sales contracts for its homes in
advance of construction, thereby reducing the risk of unsold inventory.
Depending on market conditions and the specific project, the Company may also
build speculative homes. Speculative homes are homes that are under
construction or completed but for which the Company does not yet have sales
contracts. These homes are often sold while under construction or soon after
completion. The Company reviews local market factors, such as new employment
opportunities, significant job relocations and growing housing demand, in
determining an appropriate level of speculative home inventory. The
construction of such homes is often necessary to supply homes to individuals
who are relocating who have immediate housing needs. The Company's sales
contracts for its homes generally provide for mortgage approval within a
specified period. The Company attempts to minimize cancellations by requiring
a nonrefundable cash deposit of on average 5% to 10% of the purchase price for
buyers using conventional financing and by training its sales force to assess
the qualification of potential homebuyers.

BACKLOG

The Company's homes are generally offered for sale in advance of their
construction. The majority of the Company's homes sold in 2000 were sold
pursuant to standard sales contracts entered into prior to commencement of
construction. Such sales contracts are usually subject to certain
contingencies such as the buyer's ability to qualify for financing. Homes
covered by such sales contracts but not yet delivered


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are considered the Company's "backlog." As of December 31, 2000, the Company
had backlog of $261.4 million (1,115 homes). The Company generally does not
recognize revenue on homes covered by such contracts until the sales are
closed and the risk of ownership has been legally transferred to the buyer.

CUSTOMER FINANCING

In January 1997, the Company created Fortress Mortgage for the purpose of
providing mortgage origination and centralized underwriting to the buyers of
homes sold by the Company's subsidiaries. Fortress Mortgage is approved by the
Federal Housing Administration (FHA) and Veterans Administration (VA) as a
qualified mortgage lender and is licensed as a mortgage banker in Alaska,
Arizona, California, Colorado, Florida, Illinois, Missouri, New Jersey, North
Carolina, Oregon, Pennsylvania, South Carolina, Texas, Virginia, Washington
and Wisconsin. The mortgage company facilitates the sale of the Company's
homes through the origination of first mortgage loans utilizing programs
established by FHA, VA, Government National Mortgage Association (GNMA),
Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage
Corporation (FHLMC). As a mortgage banker, Fortress Mortgage completes the
processing of loan applications, performs credit checks, processes
applications to underwrite loans and originates and subsequently sells the
mortgage loans.

CORPORATE OPERATIONS

The Company's corporate personnel oversee all of the Company's local
operations. Senior managers of the Company have extensive homebuilding
experience. This senior management group is primarily responsible for
formulating and implementing the Company's policies and procedures to promote
the cohesiveness and direction of its local operations.

Specifically, the Company's senior management (i) reviews and approves
subsidiary capital requirements and requests, short and long range plans,
project acquisition activity, and monitors all operational and financial
performance as it relates to established objectives; (ii) evaluates and
selects geographic markets; (iii) maintains relationships with various
institutional lenders; (iv) develops operational improvement initiatives and
oversees the integration and sharing of "best practices" between homebuilding
subsidiaries; (v) provides accounting services, establishes financial policies
and performs financial analyses for the operations; (vi) provides for human
resource development; and (vii) secures and obtains capital resources.

The Company allocates the necessary capital resources for new communities
consistent with its overall strategy and utilizes anticipated return on
capital as the primary criterion for allocating capital. In addition to
establishing certain pre-determined targets, the Company establishes its
capital allocation policies based on the existing market, results of
operations and other factors. Capital commitments are determined by the
Project and Feasibility Review Committee of the Board of Directors.

Structurally, the Company operates through separate subsidiaries, which are
located within the areas in which they operate. Each subsidiary is managed by
executives with substantial experience in the subsidiary's markets. Although
formal approval of new communities is determined by a committee of the Board,
each subsidiary is fully equipped with the skills and resources to oversee all
local operations including land acquisition, land development, construction,
marketing, sales and product service.

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CUSTOMER RELATIONS AND QUALITY CONTROL

Strong customer relations and an adherence to tough quality control standards
are fundamental to the Company's continued success. The Company believes that
its commitment to customer relations and quality control has significantly
contributed to its reputation as a quality builder in each of its local
markets. The Company contracts with a third party to perform standardized
customer satisfaction surveys. These surveys allow the Company to benchmark
its performance against its own subsidiaries and against national averages,
and they allow the Company to measure the effect of its initiatives on
customer satisfaction.

Generally, for each development, Company representatives oversee compliance
with the Company's quality control standards. These representatives allocate
responsibility for (i) overseeing the entire project from land development
through construction; (ii) overseeing performance by the Company's
subcontractors and suppliers; (iii) reviewing the progress of each home and
conducting formal inspections as specific stages of construction are
completed; and (iv) updating each buyer on the progress of its home.

ACQUISITIONS AND DISPOSITIONS

The Company did not acquire or dispose of any companies during 2000. Full year
comparisons between 1999 and 1998 are affected by the acquisition, effective
March 1, 1998, of Whittaker Homes, the acquisition, effective April 1, 1998, of
Quail Homes, and the dispositions noted below.

During 1999 the Company discontinued or disposed of three operating divisions.
Effective March 31, 1999 the company (i) sold the assets of its Landmark Homes
division and exited the Wilmington, North Carolina and Myrtle Beach, South
Carolina markets, (ii) sold excess land inventory of its Buffington Homes
Division and combined the remaining operations of Buffington into its Wilshire
Homes subsidiary and (iii) began the phase out of its Westbrook Homes
operation and exited the Virginia market.

In the fourth quarter of 2000 the Company made a decision to sell Brookstone
Homes. After an open auction process, the Company sold, on February 28, 2001,
the subsidiary to a company owned by the Company's former Chief Operating
Officer. The sales price was $4.2 million before closing costs. The operating
revenues and income before impairment charges for Brookstone Homes during the
years ended December 31, 2000 and 1999 were $28.1 million and $1.1 million and
$31.8 million and $2.3 million, respectively.

EXECUTIVE OFFICERS OF THE COMPANY

As of December 31, 2000, The Executive Officers of the Company were as
follows:

<TABLE>
<CAPTION>
               Name                       Age                  Position
               ----                       ---                  --------
<S>                                      <C>        <C>
         George C. Yeonas                 46         Chief Executive Officer and Director
         Paul A. Giusti                   43         Chief Operating Officer
         Jeffrey W. Shirley               42         Chief Financial Officer
</TABLE>

George C. Yeonas joined the Company as Chief Operating Officer and Director in
August of 1997 and in March of 1999 was appointed Chief Executive Officer. He
has over 20 years of experience in the homebuilding industry. Prior to joining
Fortress, Mr. Yeonas served for seven years as Vice President and General
Manager of the Arvida Company's South Florida division. His responsibilities
there included the

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management of the city of Weston, Florida's number one selling community.
Prior to joining Arvida Mr. Yeonas served as Vice President of Development for
NVR in Washington, DC, and as a Divisional Partner for Trammell Crow in Tampa,
Florida.

Paul A. Giusti joined the Company as Chief Executive Officer of Brookstone,
which was acquired by the Company in December of 1996. He retained that
position, in addition to being appointed a regional vice president of the
Company in June of 1997. In March 1999 he was named Chief Operating Officer of
the Company.  Mr. Giusti co-founded a Chicago area developer, Golden
Development, Inc. in 1989, which subsequently merged with Brookstone. From
1985 to 1989, Mr. Giusti held several management positions with General
Electric, Inc., including those of Manager, International Sales Support and
Manager, International Trade Development.  Mr. Giusti's tenure as Chief
Operating Officer of the Company terminated as of January 1, 2001.

Jeffrey W. Shirley joined the Company as Vice President of Finance in November
of 1996. He was named Chief Financial Officer in November of 1999. Mr. Shirley
has over 15 years of experience in the homebuilding industry. From 1984 to
1995, Mr. Shirley was with Kenneth Leventhal & Company providing audit and
consulting expertise to both local and regional homebuilders, developers and
syndicators of real estate operating properties. Mr. Shirley was a leader in
developing a homebuilding practice for the Chicago office of Kenneth Leventhal
& Company. From June of 1995 to November of 1996, Mr. Shirley was a director
of real estate services for the Chicago office of Price Waterhouse LLP
focusing on transactional services for a variety of real estate clients.

EMPLOYEES AND SUBCONTRACTORS

As of December 31, 2000, the Company employed 1,077 persons, including
corporate staff and other personnel involved in sales, construction
management, customer service and 234 employees who are tradesman in our
Whittaker subsidiary. Although most of the Company's employees are not covered
by collective bargaining agreements, many of the subcontractors and suppliers,
which the Company engages in various markets are represented by labor unions
or are subject to collective bargaining agreements. The Company believes that
its relations with its employees, subcontractors and suppliers are good.

RISK FACTORS

SUPPLEMENTAL WARRANTS; POTENTIAL CHANGE IN CONTROL. In connection with the
issuance of the Company's Class AAA preferred stock to Prometheus Homebuilders
LLC ("Prometheus"), the Company also issued to Prometheus Supplemental Warrants
to purchase common stock at an exercise price of $0.01 per share. The
Supplemental Warrants expire on March 31, 2004. The number of shares of common
stock issuable upon exercise of the Supplemental Warrants is subject to
adjustment depending upon the 60 day average closing price of the common stock
between the period from September 30, 2001 and September 30, 2003. If during
such period the closing price is less than $8.00 per share, the Supplemental
Warrants would be exercisable for 5,937,500 shares. The Supplemental Warrants
were initially scheduled to become exercisable on September 30, 2001. However,
they were amended in March 2001 to limit the number of Supplemental Warrants
which may be exercised prior to the "Extended Exercise Date" to a number equal
to the number of shares of common stock of the Company which would not cause
such Warrant Holder or any "group" of which the Warrant Holder is a member to
be deemed to beneficially own 50% or more of the aggregate voting power of the
common equity of the Company. The Extended Exercise Date is the first to occur
of (a) January 2, 2002, (b) the day proceeding the day on which any "Event of
Default" under the Indenture governing the Company's outstanding Senior Note
occurs, (c) the day on which such Indenture ceases to require the Company to
make a "Change of Control Offer" upon the occurrence of a "Change of Control",
or (d) the tenth day prior to the record date for taking certain actions by
stockholders of the Company; provided that in no event shall the Extended
Exercise Date be earlier than September 30, 2001.




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Prometheus' exercise of the Supplemental Warrants could (depending on the number
of Supplemental Warrants exercised) result in its owning a majority of the
outstanding common stock and would enable Prometheus to control all matters
submitted to a vote of the Company's stockholders, including the election of
directors, the amendment of the Company's certificate of incorporation and the
approval of extraordinary transactions, including a merger or a sale of assets.
See "Prometheus Voting Rights." In addition, the exercise of the Supplemental
Warrants could (depending on the number of Supplemental Warrants exercised)
materially dilute the economic interest of the Company's existing stockholders.
See "Dilution of Earnings Per Share." Further, if the obligation under the
Senior Note Indenture to make a Change of Control Offer following a Change of
Control is not removed (whether by amendment, waiver, payment of the Senior
Notes or otherwise) or the Supplemental Warrants are not further amended, the
Company would be required to commence to make a Change of Control Offer by no
later than December 3, 2001. See "Potential Obligation to Make Change in Control
Offer."

DILUTION OF EARNINGS PER SHARE. Following exchange of the Class AA preferred
stock for Class AAA preferred stock in 1999 (See Note 9 - Shareholders Equity in
the Company's consolidated financial statements, included in Item 8 of this
report), the Supplemental Warrants did not have the right to convert to common
stock unless and until the Company achieved a cumulative revenue threshold. The
exercisability of the Supplemental Warrants was subject to a revenue test, which
provided that the Supplemental Warrants could not be exercised unless the
Company's consolidated revenues for the most recent 16 full fiscal quarters
exceeds $2,397,225,750 (as adjusted for the sale of any Company subsidiary).
During the third quarter of 2000, this revenue threshold was exceeded and
consequently the Supplemental Warrants have vested and first become exercisable
in part beginning September 30, 2001. For purposes of illustration of the impact
on earnings per share, assuming (i) the Supplemental Warrants had been vested
for the entire year of 2000 and 1999, (ii) the current balance of 28,500 shares
of Class AAA preferred stock was outstanding for both entire years and, (iii) a
current market value of the Company's stock of less than $8.00 per share, then
an additional 5,937,500 shares of common stock would have been included in the
calculation of diluted earnings per share for 2000 and 1999. Diluted net
income/(loss) per share for 2000 and 1999, on a pro forma unaudited basis, would
have been $0.87 and $1.13 before the asset impairment charges, restructuring
charge and loss on the sale of Landmark and would have been $(0.15) and $0.79
using net income, as reported. Further the exercise of the Supplemental Warrants
could (depending on the number of Supplemental Warrants exercised) materially
dilute the economic interest of the Company's existing stockholders.

PROMETHEUS VOTING RIGHTS. Pursuant to the terms of the Class AAA preferred
stock, Prometheus has the right to elect three Preferred Stock directors of
the current eight-member board of directors. A proportionate number of the
Preferred Stock directors also are entitled to serve on each committee of the
board of directors. Upon the occurrence of certain events under the Class AAA
preferred stock (which principally consists of non-payment of dividends or
other obligations), Prometheus is entitled to elect additional Preferred Stock
directors sufficient to constitute a majority of the board of directors and
all committees of the board of directors. On September 30, 2000 (and certain
dates thereafter), the Company failed to pay a required dividend to Prometheus
under the terms of the Class AAA preferred stock. As of the date hereof,
Prometheus has not exercised its right to elect additional directors but has
reserved its right to make such an election.

Prometheus, as the holder of Class AAA preferred stock, is entitled to vote on
all matters voted on by holders of common stock, voting together with the
common stock as a single class at all meetings of the stockholders. Each share
of Class AAA preferred stock entitles its holder to cast the number of votes
equal to the number of shares of common stock into which such share of Class
AAA preferred stock is

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convertible, based on the $24.00 per share conversion price. Based upon its
ownership of $28,500,000 initial liquidation value (28,500 shares) of Class
AAA preferred stock and 224,711 shares of common stock, Prometheus currently
holds approximately 33% of the total voting power of the Company's stock. As
described above, upon the exercise of the Supplemental Warrants, Prometheus
could acquire up to 5,937,500 additional shares of common stock, resulting in
Prometheus holding up to 72% of the total voting power of the Company's stock.

Prometheus, as the holder of the Class AAA preferred stock also has certain
consent rights, which require the approval of the holders of at least 66 2/3%
of the Class AAA preferred stock to effect certain significant corporate
actions or transactions, including a merger or sale of substantial assets.
Further, under the Company's amended bylaws, and the amended bylaws of the
Company's subsidiaries, the Company may not, and may not permit any of its
subsidiaries to, engage in or agree to engage in a number of significant
actions or transactions, including adopting an annual operating budget, taking
actions materially inconsistent with the budget, incurring new debt and
issuing securities, without the affirmative vote of over 81% of the board of
directors. Therefore, the Company needs the approval of at least two of the
three Preferred Stock directors (together with 5 non-Preferred Stock
directors) to engage in significant actions or transactions. As a result of
the foregoing, Prometheus has substantial influence over, and could under
certain circumstances obtain control of, the direction and management of the
Company and the conduct of its business.

POTENTIAL OBLIGATION TO MAKE CHANGE OF CONTROL OFFER. Under the Senior Note
Indenture, the Company would be obligated to offer to redeem all of the Senior
Notes at 101% of their aggregate principal amount plus any accrued and unpaid
interest following a Change of Control of the Company, as defined in the
Indenture. This definition includes any transaction that results in any person
acquiring "beneficial ownership" (as defined in Securities Exchange Act Rule
13d-3) of 50% or more of the total voting power of the Company's common equity.
Consequently, a Change of Control will be deemed to take place at any time
(among others) that Prometheus has the right, within 60 days of such time, to
exercise such number of Supplemental Warrants that, following such exercise,
by reason of its ownership of the shares of common stock issuable upon such
exercise and all other shares of common stock beneficially owned by Prometheus
and any group of which it is a member, it would beneficially own 50% or more of
the total voting power of the Company's common equity. See "Supplemental
Warrants; Potential Change in Control" above.  The Company currently does not
have the requisite liquidity from internal sources to fund a Change of Control
redemption of all or a substantial portion of the Senior Notes. Any failure by
the Company to make and consummate a required change of control offer could
result in an event of default under the Indenture that would materially and
adversely affect the Company.

ANTI-TAKEOVER EFFECTS. Prometheus's representation on the board of directors
and the executive committee, its voting rights, its consent rights and the
requirements of Supermajority Director Approval and Supermajority Executive
Committee Approval for certain significant actions and transactions could have
anti-takeover effects. Also, provisions of Delaware law and of the Company's
Amended and Restated Certificate of Incorporation could have the effect of
making it more difficult for a third party to acquire, or of discouraging a
third party from attempting to acquire, control of the Company. These
provisions could deter, delay or prevent tender offers or other takeover
proposals or attempts that might result in benefits to stockholders, including
the payment to stockholders of a premium over the market price of the common
stock.

COMPETITION AND MARKET FACTORS. The development and sale of residential
property is highly competitive and fragmented. The Company competes for
residential sales with national, regional and local developers and
homebuilders, resales of existing homes and, to a lesser extent, condominiums
and

                                      11

<PAGE>   12

available rental housing. The Company's competitors include a number of large
national and regional homebuilding companies and small local homebuilding
companies, some of which may have greater financial resources, easier access
to capital markets and/or lower costs than the Company. Competition among both
small and large residential homebuilders is based on a number of interrelated
factors, including location, reputation, amenities, design, quality and price.

The homebuilding industry is cyclical and affected by consumer confidence
levels, prevailing economic conditions in general and job availability and
interest rate levels in particular. A variety of other factors affects the
homebuilding industry and demand for new homes, including changes in costs
associated with home ownership such as increases in property taxes and energy
costs, changes in consumer preferences, demographic trends and the availability
of and changes in mortgage financing programs. In addition, homebuilders are
subject to various risks often outside of their control, including weather
conditions and natural disasters, construction delays, cost overruns, changes in
governmental regulations, counterparty non-performance risk associated with
performance bonds, availability and price fluctuations of land, labor and raw
materials, and availability and cost of working capital financing.

The homebuilding industry is also subject to the potential for significant
variability and fluctuations in real estate values. Although the Company
believes the real estate assets currently reflected on the Company balance
sheet are reasonable in amount given the size of the Company's business and
are reflected at or below their fair value, no assurances can be given that
write-downs to the fair market value of some or all of the Company's assets
will not occur if market conditions deteriorate, or that such write-downs,
should they occur, will not be material in amount.

GOVERNMENT REGULATIONS AND ENVIRONMENTAL CONTROLS. The Company is subject to a
variety of Federal, state and local statutes, ordinances, rules and
regulations concerning protection of health and the environment. These laws
may result in delays, cause the Company to incur substantial compliance costs
and prohibit or severely restrict development in certain environmentally
sensitive regions or areas. Prior to purchasing a parcel of land, the
Company's local management evaluates such land for the presence of hazardous
or toxic materials, wastes or substances. The Company frequently engages
independent environmental engineers to complete such an evaluation. The
Company has not been materially adversely affected to date by the presence or
potential presence of such materials. However, no assurance can be given that
such a material adverse affect will not occur in the future.

Whether Fortress controls entitled or unentitled land, certain building and
other permits, as well as approvals, are required to complete all residential
developments. The ability of the Company to obtain necessary approvals and
permits for its planned communities is often beyond the Company's control and
could restrict or prevent the development of otherwise desirable property. The
length of time necessary to obtain permits and approvals increases the
carrying costs of unimproved land acquired for the purpose of development and
construction. In addition, the continued effectiveness of permits already
granted is subject to factors such as changes in policies, rules and
regulations and their interpretation and application.

Our mortgage activities also need to comply with various federal and state
laws, consumer credit rules and regulations and other requirements unique to
mortgage activities. Additionally mortgage loans originated under various
national mortgage programs such as FHA, VA, or FNMA are subject to regulations
imposed by the respective agency.

INTEREST RATES; MORTGAGE FINANCING. Virtually all purchasers of the Company's
homes finance their acquisitions through third-party lenders providing
mortgage financing. In general, housing demand is


                                      12

<PAGE>   13

adversely affected by increases in interest rates, unavailability of mortgage
financing, increasing housing costs and unemployment levels. If mortgage
interest rates increase and the ability of prospective buyers to finance home
purchases is adversely affected, the Company's sales, gross margins and net
income and the market price of the common stock may be adversely impacted. The
Company's homebuilding activities are also dependent upon the availability and
cost of mortgage financing for buyers of homes owned by potential customers so
those customers ("move-up buyers") can sell their homes and purchase a home
from the Company. In addition, the Company believes that the availability of
FHA and VA mortgage financing is an important factor in marketing a number of
its homes. Any limitation or restriction on the availability of such financing
could adversely affect the Company's sales. Furthermore, changes in Federal
income tax laws pertaining to the deductibility of mortgage interest could
affect demand for new homes.

SHARES ELIGIBLE FOR FUTURE SALE. The Company has outstanding approximately
3,100,000 shares of common stock, of which approximately 2,040,000 shares are
freely tradable without restriction and approximately 1,060,000 shares are
saleable subject to certain volume and other restrictions of Rule 144 under
the Securities Act. In addition, at least 1,218,000 shares are issuable upon
the conversion of the Company's outstanding classes of preferred stock and
69,290 shares are issuable upon exercise of currently exercisable options.
Additional shares would be issuable upon the conversion of the Class AAA
preferred stock and the adjustment and exercise of the Supplemental Warrants.
Sale of substantial amounts of such shares in the public market or the
prospect of such sales could materially adversely affect the market price of
the common stock.

DEPENDENCE ON MANAGEMENT. The Company's operations are dependent on the
continued efforts of its executive officers and on senior management of the
Company. In addition, the operations of each subsidiary are dependent upon the
senior management of that subsidiary. If any of these people become unable to
continue in their present roles, or if the Company is unable to attract and
retain other skilled employees, the Company's business could be adversely
affected.

                                      13


<PAGE>   14


ITEM 2.  PROPERTIES

The Company's principal executive offices are located at 1650 Tysons
Boulevard, Suite 600, McLean, Virginia 22102. The Company occupies
approximately 4,800 square feet of leased office space for its corporate
office in Virginia and leases an aggregate of approximately 123,000 square
feet of office space in 21 locations for its homebuilding and mortgage
subsidiaries.


ITEM 3.  LEGAL PROCEEDINGS

The Company is, from time to time, a party to litigation arising in the normal
course of its business. Management believes that none of the actions to which
it is a party will have a material adverse effect on the financial condition,
results of operations or cash flows of the Company.


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

No matters were submitted to the Company's stockholders for consideration
during the quarter ended December 31, 2000.

                                      14

<PAGE>   15


PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

(a)    Price Range of Common Stock. The Company's common stock has traded on
       the Nasdaq National Market since May 16, 1996. On March 28, 2001, the
       closing price of the common stock was $1.61 per share. The following
       table sets forth the range of high and low sale prices for the common
       stock, as reported on the Nasdaq National Market, for the periods
       indicated, as adjusted for the one-for-four reverse stock split
       implemented July 10, 2000:

<TABLE>
<CAPTION>
                                                     High               Low
<S>                                                <C>                <C>
            Fiscal year 1999
                First fiscal quarter                $11.00             $6.50
                Second fiscal quarter                $9.75             $4.50
                Third fiscal quarter                 $7.75             $4.50
                Fourth fiscal quarter                $6.63             $2.00
            Fiscal year 2000
                First fiscal quarter                 $6.38             $2.50
                Second fiscal quarter                $4.25             $2.00
                Third fiscal quarter                 $4.13             $1.50
                Fourth fiscal quarter                $3.47             $1.38
</TABLE>

(b)    Approximate Number of Equity Security Holders. The number of record
       holders of the Company's common stock as of March 28, 2001 was 66,
       which does not include beneficial owners who hold the Company's stock
       in street name.

(c)    Dividends. No dividends were declared or paid on the Company's common
       stock during 2000 or 1999. Pursuant to the terms of the Class AAA
       preferred stock the Company may not pay dividends on its common stock
       so long as any dividends on the Class AAA preferred stock remain
       accrued and unpaid (see Prometheus Voting Rights - page 10).

                                      15
<PAGE>   16


ITEM 6.  SELECTED FINANCIAL DATA

The selected financial data provided should be read in conjunction with the
Combined Predecessor Companies Financial Statements and the individual
Founding Builders Financial Statements (which are not included in this
report), The Fortress Group, Inc. Consolidated Financial Statements, the
related notes thereto and "Management's Discussion and Analysis of Financial
Condition and Results of Operations."

       The Fortress Group, Inc. and Combined Predecessor Companies (1)
     (dollars in thousands, except per share amounts and operating data)

<TABLE>
<CAPTION>
                                              COMBINES
                                              --------
                                            PREDECESSOR
                                            -----------
                                             COMPANIES     THE FORTRESS            THE FORTRESS GROUP, INC. YEAR ENDED DECEMBER 31
                                             ---------     ------------            -----------------------------------------------
                                            JANUARY 1 -    GROUP, INC.
                                            -----------    -----------
                                              MAY 20,     MAY 21 - DEC.    1996        1997        1998        1999         2000
                                              ------      -------------    ----        ----        ----        ----         ----
                                                1996           1996       TOTAL
                                                ----           ----       -----
<S>                                         <C>           <C>            <C>       <C>         <C>         <C>          <C>
Statement of Operations Data:
Revenues                                       $66,119     $  210,354    $276,473  $  447,374  $  692,645  $  740,785   $  688,457
Gross Profit                                     9,694         32,967      42,661      67,704     104,629     108,015      100,620
Operating income                                 1,113         12,787      13,900      16,236      24,099      19,187        3,317
Income before provision for
income taxes                                     1,274         13,221      14,495      13,923      21,628      14,746        3,940
Net income(2)                                  $ 1,274     $    8,208    $  9,482  $    8,460  $   12,834  $    8,277   $    2,214
                                               =======     ==========    ========  ==========  ==========  ==========   ==========

Basic Earnings/(loss) per share(3)                         $     2.76              $     2.72  $     1.84  $     1.70   $     (.15)
Diluted Earnings/(loss) per share(3)                       $     2.76              $     2.52  $     1.66  $     1.50   $     (.15)
                                                           ==========              ==========  ==========  ==========   ==========

Cash dividends per common share                            $      .00              $     .003  $     .001  $      .00   $      .00


Weighted average shares outstanding, basic                  2,925,397               2,939,928   2,954,722   3,029,917    3,076,354
Weighted average shares outstanding, diluted                2,979,986               3,215,543   3,285,059   3,656,374    3,076,354
</TABLE>

<TABLE>
<CAPTION>
                                                                                 THE FORTRESS GROUP, INC.
                                                                                 ------------------------
                                                                   1996       1997       1998       1999       2000
                                                                   ----       ----       ----       ----       ----
<S>                                                             <C>          <C>        <C>       <C>         <C>
Balance Sheet Data: (as of December 31)
Cash                                                              $16,212    $12,406    $23,102    $17,526    $ 7,412
Inventory                                                         144,106    217,342    310,706    328,513    308,187
Total Assets                                                      193,733    331,327    449,903    451,181    421,567
13.75% Senior Notes due 2003                                      100,000    100,000    100,000    100,000    100,000
Notes and mortgages payable                                        40,136    122,443    192,769    201,658    185,641
Minority interests                                                    274        268         67         79          0
Stockholders equity                                                31,986     62,897     91,193     79,673     77,346

<CAPTION>

                                                                COMBINED (1)        THE FORTRESS GROUP, INC.
                                                                ------------        ------------------------
                                                                   1996       1997       1998       1999       2000
                                                                   ----       ----       ----       ----       ----
<S>                                                             <C>          <C>        <C>       <C>         <C>
Operating Data: (for the years ended December 31)
Units
  New contracts, net of cancellations                               1,410      2,706      4,366      3,729      3,247
  Closings                                                          1,402      2,762      4,016      4,034      3,385
  Backlog(4)                                                          512      1,056      1,606      1,253      1,115
Aggregate sales value of backlog (in thousands)(4)                $95,992   $198,247   $308,832   $268,299   $261,361
Average sales price per home closed                              $189,500   $159,300   $168,600   $178,500   $195,600
</TABLE>


(1)  As a result of the substantial continuing interests in the Company of the
     former stockholders of the Founding Builders and Fortress (the Combined
     Predecessor Companies), the historical financial and operational
     information of the Combined Predecessor Companies has been combined on a
     historical cost basis for the period presented prior to the Acquisitions
     as if these companies had always been members of the same operating
     group. However, during the period presented prior to the Acquisitions,
     the Founding Builders were not under common control or management.

(2)  All of the Founding Builders were S corporations prior to May 20, 1996.
     As S corporations, the Founding Builders were not subject to Federal
     income tax. Accordingly, the data presented should not be viewed as
     comparable to the post-combination results of the Company. Subsequent to
     the Acquisitions, the information presented is on a consolidated basis of
     The Fortress Group, Inc.

(3)  See calculation in Note 10- Earnings Per Share in the Company's
     consolidated financial statements included in Item 8 hereof, which has
     been restated to take into account the effects of the one-for-four
     reverse stock split implemented July 10, 2000.

(4)  At end of period and represents homes sold but not closed.

                                      16

<PAGE>   17


ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS

         The following table sets forth for the periods indicated certain
items of the Company's consolidated results of operations and those results as
a percentage of the Company's total revenues and, its segment revenues:

<TABLE>
<CAPTION>
(dollars expressed in millions)
                                      For the Year                  For the Year                  For the Year
                                  Ended Dec. 31, 2000           Ended Dec. 31, 1999           Ended Dec. 31, 1998
                                  -------------------           -------------------           -------------------
                                             % of      % of                % of      % of                % of      % of
                                            Total   Segment               Total   Segment               Total   Segment
                                            -----   -------               -----   -------               -----   -------
<S>                            <C>        <C>       <C>       <C>        <C>     <C>        <C>       <C>        <C>
Total revenues                  $688.5     100.0%              $740.8    100.0%              $692.6    100.0%
Homebuilding revenues            682.7      99.2%    100.0%     734.6     99.2%    100.0%     687.9     99.3%    100.0%
Gross profit                     100.6      14.6%     14.7%     108.0     14.6%     14.7%     104.6     15.1%     15.2%
Operating expenses (incl.
amortization & restructuring)     97.3      14.1%     14.3%      88.8     12.0%     12.1%      80.5     11.6%     11.7%
Homebuilding pre-tax income        3.5       0.5%      0.5%      17.6      2.4%      2.4%      21.5      3.1%      3.1%
Mortgage revenues                  5.7       0.8%    100.0%       6.2      0.8%    100.0%       4.7      0.7%    100.0%
Mortgage expenses                  5.3       0.8%     93.0%       6.2      0.8%    100.0%       4.5      0.7%     95.7%

Mortgage pre-tax income            0.4       0.1%      7.0%         -        -         -        0.2        -       4.3%
Pre-tax income                     3.9       0.6%                14.7      2.0%                21.6      3.1%
</TABLE>


ACQUISITIONS, DISPOSITIONS, AND CLOSURES

The Company did not acquire or dispose of any companies during 2000. Full year
comparisons between 1999 and 1998 are affected by the acquisition, effective
March 1, 1998, of Whittaker Homes, the acquisition, effective April 1, 1998,
of Quail Homes, and the dispositions noted below.

During 1999 the Company discontinued or disposed of three operating divisions.
Effective March 31, 1999 the Company (i) sold the assets of its Landmark Homes
division and exited the Wilmington, North Carolina and Myrtle Beach, South
Carolina markets, (ii) sold excess land inventory of its Buffington Homes
Division and combined the remaining operations of Buffington into its Wilshire
Homes subsidiary and (iii) began the phase out of its Westbrook Homes
operation and exited the Virginia market.

In the fourth quarter of 2000 the Company made a decision to sell Brookstone
Homes. After an open auction process, the Company sold, on February 28, 2001,
the subsidiary to a company owned by the Company's former Chief Operating
Officer. The sale price was $4.2 million before closing costs. The operating
revenues and income before impairment charges for Brookstone Homes during the
years ended December 31, 2000 and 1999 were $28.1 million and $1.1 million and
$31.8 million and $2.3 million, respectively.

During the fourth quarter of 2000, the Company established a committee to
explore methods to maximize value for its stockholders, see "Planning
Committee". As a result of the Planning Committee's analysis


                                      17

<PAGE>   18

and recommendation, the Company may decide in 2001 to divest certain assets or
divisions either through liquidation or sale.

PLANNING COMMITTEE

In November 2000, the Board of Directors of the Company created a planning
committee (the "Planning Committee") for the purpose of maximizing the value and
future prospects of the Company. The members of the Planning Committee are Mr.
Andrew Zobler, Mr. George Yeonas, and Mr. Robert Short. The Planning Committee
was charged with identifying the core and non-core businesses and divisions of
the Company and its operating profile and performance targets. The Planning
Committee will also assess and recommend to the Board of Directors any changes
to the Company's operations to best support the Company's core business and to
best implement its business plan. These may include setting forth an action plan
for (i) exiting underperforming or overleveraged businesses and (ii)
rationalizing or refinancing the Company's capital structure. The Company
expects that, in 2001, the Planning Committee will continue to meet and make
recommendations to the Board of Directors. The work of the Planning Committee
may result in various actions to be implemented by the Company including without
limitation asset sales or other extraordinary transactions.

HOME SALES ACTIVITY

The following table sets forth information relating to new orders, home
closings, and sales backlog by state for the years ended December 31, 2000,
1999, and 1998:

<TABLE>
<CAPTION>
                                NEW ORDERS (NET)                      CLOSINGS                  BACKLOG AT DECEMBER 31,
                                ----------------                      --------                  -----------------------
                           2000       1999       1998       2000        1999       1998       2000       1999       1998
<S>                       <C>        <C>        <C>        <C>         <C>        <C>        <C>        <C>        <C>
State
-----
Arizona                     122         46         92        115          75         66         12          5         34
Colorado                    414        350        360        348         329        361        270        204        183
Florida                     611        773        850        711         775        702        197        297        299
Missouri                    406        458        462        425         550        438         77         96        188
Nevada                       86        118        153        126         123        130         41         81         86
New Jersey                   61         23        N/A         45          13        N/A         26         10        N/A
North Carolina              536        676        726        524         764        692        167        155        285
Oregon/Washington            79        128        120         75         127        131         18         14         13
Pennsylvania                158        145        220        149         159        216         48         39         53
South Carolina               85        140        189        131         146        181         29         75         87
Texas                       515        642        904        549         707        853        201        235        300
Virginia                      1         18         53          2          34         48          0          1         17
Wisconsin                   173        212        237        185         232        198         29         41         61
                            ---        ---        ---        ---         ---        ---         --         --         --

         Total            3,247      3,729      4,366      3,385       4,034      4,016      1,115      1,253      1,606
</TABLE>


                                      18

<PAGE>   19


CONSOLIDATED RESULTS OF OPERATIONS

RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2000 COMPARED TO THE
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1999

HOMEBUILDING OPERATIONS

General

As indicated in the chart above, net new orders for the Company totaled 3,247
homes and 3,729 homes in the years ended December 31, 2000 and 1999, a 12.9%
decrease. While several of the Company's markets, Denver and Tucson in
particular, experienced strong increases from 1999 to 2000, most of our other
markets showed declines. The softening of these markets was due in part, we
believe, to rising interest rates in the early portion of 2000, as well as
delays in opening of new and replacement communities in several locations. This
decrease is also attributable in part to the Company's dispositions and closures
(See Note 11- Sale of Assets and Special Charges in the Company's consolidated
financial statements included in Item 8 hereof). Approximately 16.4% (79 out of
482) of the decline in new orders from 1999 to 2000 is attributable to the
dispositions and closures. The balance of the decline is due in part to a
reduction in the number of communities in Texas, which the Company operated
during all of 2000, and to a reduction in sales pace in several markets,
primarily Florida and North Carolina.

At December 31, 2000, the Company had a combined backlog of 1,115 homes with a
value of $261.4 million as compared to 1,253 homes with a value of $268.3
million as of December 31, 1999, representing a 11.0% decline in backlog homes
and a 2.6% decline in backlog value. Over the same period the average value of a
home in backlog has increased 9.5% to $234,400 from $214,200. Furthermore, the
decline in volume in a number of markets was offset by the mix of backlog
between divisions. In Colorado where our average sales price is the second
highest in the Company we experienced a year over year increase in backlog of 66
units (32%) along with a 9.9% increase in average revenue per unit.

Revenue

Homebuilding revenues for the Company totaled $682.7 million for the year
ended December 31, 2000 as compared to $734.6 million for the year ended
December 31, 1999, a decrease of 7.1%. Approximately $21.8 million (42%) of
this decrease is attributable to the dispositions noted above. The number of
homes closed decreased to 3,385 in 2000 from 4,034 in 1999 (approximately
16.1%). The decline in revenue was offset by an increase of 9.6% in the
average home closing value to $195,600 in 2000 from $178,500 in the prior
year. While the majority of the Company's markets experienced increases in
average prices, the Denver division contributed most significantly, due to
increases in the average price of its already higher-priced homes, as well as
a very large increase in the volume of homes closed.


Revenue from lot sales increased to $20.7 million in 2000 from $14.6 million
in 1999. Lot sales revenue represented 3.0% of revenue in 2000 compared to
2.0% of revenue in 1999. The increase in this area resulted primarily from the
increases in lot sales in both our Jacksonville and St. Louis operations.
Although the Company purchases land and engages in land development activities
primarily to support

                                      19

<PAGE>   20

its own homebuilding activities, lots and land are occasionally sold to other
developers and homebuilders.

Gross Profit

The Company's homebuilding gross profit decreased to $100.6 million in 2000
from $108.0 million in 1999, a 6.9% decline. Homebuilding gross profit margin
remained consistent at 14.7% for both periods. As disclosed in previous
filings, profit margins in the Company's Las Vegas subsidiary declined as
compared to prior years. This decline had a significant effect on the
Company's consolidated gross profit. Excluding the results of the Las Vegas
subsidiary, the Company's consolidated gross margin would have risen to 15.9%
from 15.3% in 1999. We expect the Las Vegas operations to continue to depress
the Company's gross profit in the coming year.

Operating Expenses

Operating expenses (including selling, general and administrative, asset
impairment charges, restructuring charges and goodwill amortization) for the
years ending December 31, 2000 and 1999 were $97.3 million (14.3% of
homebuilding revenue) and $88.8 million (12.1% of homebuilding revenue),
respectively. The Company recognized $14.8 million and $2.0 million in asset
impairment charges during 2000 and 1999, respectively pertaining to the write
down of land and work-in-process inventory (See Note 12 -Asset Impairment
Charge). The Company also recognized $1.3 million in special charges during
1999 pertaining to restructuring costs associated with several of its
subsidiaries (See Note 11 - Sale of Assets and Special Charges in the
Company's consolidated financial statements included in Item 8 hereof.)
Excluding the impact of these charges, total operating expenses for 2000 and
1999 would have been $82.5 million (12.1% of homebuilding revenue) and $85.6
million (11.6% of homebuilding revenue) respectively.

Selling expenses decreased to $44.9 million (6.6% of revenue) for the year
ending December 31, 2000 as compared to $46.5 million (6.3% of revenue) for the
same period of 1999. The majority of this percentage increase is due to sales
and marketing initiatives implemented in order to offset declining sales. The
decrease in absolute dollar amounts is due to lower variable expenses related to
decreased closings for the 2000 period, which was in part due to previously
discussed dispositions. Commission costs for the year ended December 31, 2000,
declined $1.8 million and other selling and marketing costs increased by
approximately $200,000.

General and administrative expenses were $35.0 million in 2000, an increase, as
a percent of revenues, from $36.4 million in 1999. Although there is a decrease
in absolute dollar amounts year-over-year, the dollar amount as a percentage of
homebuilding revenue essentially remained unchanged at 5.0%

Financial Services Operations

Fortress Mortgage's closing volume, number of mortgages originated, and
capture rates for 2000 all increased compared with 1999. Mortgages originated
increased 7.8% to 1,677 from 1,555 in 1999. Capture rates increased 40.2% to
55.8% from 39.8% in 1999. Total revenues for the year decreased 8.1% to $5.7
million from $6.2 million in 1999. This was caused by increased competitive
pressure and reduced revenues per loan originated.

Financial services pretax income generated by Fortress Mortgage was $440,000
for 2000 compared with $4,000 for 1999. This increase was affected by a
reduction in the expenses net of interest income to $5.3 million from $6.2
million in 1999.

                                      20

<PAGE>   21


Asset Impairment Charge

 The Company determined that an adjustment to current carrying value was
appropriate for several communities in 1999 and 2000 in accordance with
Statement of Financial Accounting Standard No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
The fair value of the communities was determined using a discounted cash flow
projection of future revenues and current and projected costs. The assets
involved include developed lots, homes under construction, and completed
homes. Based on the analysis of fair value the Company recognized asset
impairment charges (See Note 12 - Asset Impairment Charge), which have been
included in the Company's determination of Net Operating Income.

During the third quarter of 1999, the Company evaluated the carrying value of
two communities in its Las Vegas market. The Company recognized during the
third quarter an asset impairment charge of approximately $2.0 million.

During the fourth quarter of 2000, the Company evaluated the carrying value of
two additional communities in its Las Vegas market. The Company recognized
during the fourth quarter an asset impairment charge of approximately $7.0
million.

During the fourth quarter of 2000, the Company evaluated the carrying value of
seven communities in its Portland MSA market. The Company recognized during
the fourth quarter an asset impairment charge of approximately $5.2 million
($1.8 million of goodwill).

During the fourth quarter of 2000, the Company determined to sell the
Brookstone subsidiary. Based on the sales price the Company recognized an
impairment charge of $2.6 million. Included in this charge is $2.2 million of
goodwill. The subsidiary was sold February 28, 2001 (See Note 21 - Subsequent
Events).

A significant portion of the 2000 impairment charges relating to Portland and
Brookstone was the result of management's decision to reposition and reorganize
the Company from a divisional structure to a regional one.

Loss on Sale of Landmark Homes

The Company sold the assets of Landmark Homes in March 1999 as part of its
strategy to redeploy capital invested in under-performing assets. Concurrent
with the sale of these assets the Company exited the Wilmington, North
Carolina and Myrtle Beach, South Carolina markets. The Company recognized a
pretax loss of $2.9 million on this disposition, due primarily to unrecovered
goodwill of approximately $3.0 million. (See Note 11 - Sale of Assets and
Special Charges in the Company's consolidated financial statements included in
Item 8 hereof).

Net Income and Net Income Per Share

Due to the previously described factors, primarily the asset impairment
charge, the restructuring charges, and the income tax effect thereof, net
income for 2000 was $2.2 million, a 73.5% decrease from the $8.3 million
achieved in 1999.

Net income/(loss) per share, on a diluted basis, was $(0.15) for 2000 compared
with $1.50 for 1999, a 110.0% decline. Diluted net income per share was
affected by the decline in net income noted above and by the changes in
preferred dividends and the number of convertible preferred shares included in
the calculation of net income per share noted below. (See Note 9 -
Shareholders' Equity in the Company's consolidated financial statements
included in Item 8 hereof). Excluding the effect of the asset impairment
charges in 2000 and 1999, the restructuring charge and the sale of Landmark in
1999, the Company's net income per share on a diluted basis would have been
$1.29 for 2000 compared with $2.40 for 1999, a 46.3% decline.

                                      21

<PAGE>   22

Following exchange of the Class AA stock to Class AAA stock in 1999 (See Note
9- Shareholders Equity in the Company's consolidated financial statements
included in Item 8 hereof) the warrants related to the AAA stock did not have
the right to convert to common stock unless and until the Company achieved a
cumulative revenue threshold. The exercisability of the Supplemental Warrants
was subject to a revenue test, which provided that the Supplemental Warrants
may not be exercised unless the Company's consolidated revenues for the most
recent 16 full fiscal quarters exceeds $2,397,225,750 (as adjusted for the
sale of any Company subsidiary). During the third quarter of 2000 this revenue
threshold was exceeded and consequently the Supplemental Warrants have vested
and may become exercisable as early as September 30, 2001. For sake of
illustration of the impact on net income per share, if one assumes, (i) these
supplemental warrants had been vested the entire year of 2000 and 1999, (ii)
the current balance of 28,500 shares of preferred stock was outstanding for
both entire years and, (iii) a current market value of the Company's stock of
less than $8.00 per share, then an additional 5,937,500 shares of common stock
would have been included in the calculation of diluted earnings per share for
2000 and 1999. Diluted net income/(loss) per share for 2000 and 1999, on a pro
forma unaudited basis, would have been $0.87 and $1.13 before the asset
impairment charges, restructuring charge and loss on the sale of Landmark and
would have been $(0.15) and $0.79 using net income, as reported.

Earnings Before Interest, Taxes, Depreciation and Amortization

Earnings before interest, taxes, depreciation and amortization (EBITDA)
decreased 5.8% to $58.6 million in 2000 compared to $62.2 million in 1999.
EBITDA as a percentage of gross revenues increased to 8.5% from 8.4% in 1999.
EBITDA is provided as a supplemental measurement of the Company's operating
performance. EBITDA does not represent cash flows from operations as defined
by generally accepted accounting principles and should not be considered as an
alternative to net income as an indicator of the Company's operating
performance or to cash flows as a measure of liquidity. In addition, EBITDA
measures presented by the Company may not be comparable to other similarly
titled measures of other companies.

Earnings before interest, taxes, depreciation and amortization (EBITDA)
increased 4.3% to $62.2 million in 1999 compared to $59.6 million in 1998.
EBITDA is provided as a supplemental measurement of the Company's operating
performance.


<TABLE>
<CAPTION>
  ------------------------------------------------------- -------------------- -------------------- ------------------
  OPERATING DIVISION                                             2000                 1999                1998
  ------------------                                             ----                 ----                ----
  <S>                                                     <C>                  <C>                  <C>
  Cash provided by/(used in) operating activities               $15,854             $(4,210)             $11,498
  ------------------------------------------------------- -------------------- -------------------- ------------------
  Cash (used in)/provided by investing activities              $(5,908)              $4,717             $(38,906)
  ------------------------------------------------------- -------------------- -------------------- ------------------
  Cash (used in)/provided by financing activities              $(20,060)            $(6,083)             $38,104
  ------------------------------------------------------- -------------------- -------------------- ------------------
</TABLE>

                                      22

<PAGE>   23


RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1999 COMPARED TO THE
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998

HOMEBUILDING OPERATIONS
General

As indicated in the chart above, net new orders for the Company totaled 3,729
homes and 4,366 homes in the years ended December 31, 1999 and 1998, a 14.6%
decrease. This decrease is attributable in part to the Company's dispositions
and closures (See Note 11- Sale of Assets and Special Charges in the Company's
consolidated financial statements included in Item 8 hereof) as well as new
order declines in a number of the Company's operations. Of this decrease in
sales, 6.9% is attributable to the dispositions and closures. The balance of
the decline is due in part to a reduction in the number of communities in
which the Company operated during a portion of 1999, and to a reduction in
sales pace in several markets, primarily Pennsylvania, Florida and Missouri,
during the last six months of 1999. During the year, the Company experienced
delays in the acquisition, permitting and/or completion of lots affecting the
continuity and growth in the number of communities from which to sell homes.
The Company moved to improve the processes, systems and reporting of supply
management indicators to mitigate this situation in the future.

At December 31, 1999, the Company had a combined backlog of 1,253 homes with a
value of $268.3 million as compared to 1,606 homes with a value of $308.8
million as of December 31, 1998, representing a 22.0% decline in backlog homes
and a 13.1% decline in backlog value. Of the backlog decrease, 9.0% of the
decline in homes and 7.4% on the decline in value is attributable to the
closure of subsidiaries and dispositions of communities. Over the same period
the average value of a home in backlog increased 11.4% to $214,200 from
$192,300.

Revenue

Homebuilding revenues for the Company totaled $734.6 million for the year
ended December 31, 1999 as compared to $687.9 million for the year ended
December 31, 1998, an increase of 6.8%. Although the number of homes closed
and the corresponding revenues were negatively affected by the dispositions
noted above, the year over year comparisons were favorably impacted by the
acquisitions, during 1998 of Whittaker and Quail. The number of homes closed
increased to 4,034 in 1999 from 4,016 in 1998 (approximately 0.4%). The
improvement in revenue was also driven by an increase of 5.9% in the average
home closing value to $178,500 in 1999 from $168,600 in the prior year.

Revenue from lot sales increased to $14.6 million in 1999 from $10.6 million
in 1998. Lot sales revenue represented 2.0% of revenue in 1999 compared to
1.5% of revenue in 1998. The increase in this area resulted primarily from the
increases in lot sales in both our Genesee and Wilshire Homes operations.
Although the Company purchases land and engages in land development activities
primarily to support its own homebuilding activities, lots and land are
occasionally sold to other developers and homebuilders.

Gross Profit

The Company's homebuilding gross profit increased to $108.0 million in 1999
from $104.6 million in 1998, a 3.3% improvement. Homebuilding gross profit
margin decreased to 14.7% from 15.2% over the same period. As disclosed in
previous filings, profit margins in the Company's Las Vegas subsidiary
declined as compared to prior years. This decline had a significant impact on
the Company's

                                      23

<PAGE>   24


consolidated gross profit. Excluding the results of the Las Vegas subsidiary,
the Company's consolidated gross margin would have risen slightly to 15.3%
from 15.2% in 1998.

Operating Expenses

Operating expenses (including selling, general and administrative, asset
impairment charges, and goodwill amortization) for the years ending December
31, 1999 and 1998 were $88.8 million (12.1% of homebuilding revenue) and $80.5
million (11.7% of homebuilding revenue), respectively. The Company recognized
$2.0 million in asset impairment charges during 1999 pertaining to the write
down of land and work-in-process inventory in two communities nearing
close-out in our Las Vegas market (See Note 12 -Asset Impairment Charge). The
Company also recognized $1.3 million in special charges pertaining to
restructuring costs associated with several of its subsidiaries (See Note 11 -
Sale of Assets and Special Charges in the Company's consolidated financial
statements included in Item 8 hereof.) Excluding the impact of these charges,
total operating expenses for 1999 and 1998 would have been $85.6 million
(11.6% of homebuilding revenue) and $80.5 million (11.7% of homebuilding
revenue) respectively.

Selling expenses increased to $46.5 million for the year ending December 31,
1999 as compared to $43.6 million for the same period of 1998. However,
selling expense, as a percentage of homebuilding revenue remained unchanged at
6.3% for both years.

General and administrative expenses were $36.4 million (5.0% of homebuilding
revenue) in 1999, consistent, as a percent of revenues, with $34.5 million
(5.0% of homebuilding revenue) in 1998. The increase in absolute dollars
includes increases arising from the implementation of Statement of Position
98-1 (SOP 98-1) Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use, which requires certain costs, which under previous
pronouncements would have been capitalized, to be expensed as incurred. The
amortization and depreciation of previously capitalized information and
technology costs, is also a factor contributing to this increase.

Financial Services Operations

Fortress Mortgage's closing volume, number of mortgages originated, and
capture rates for 1999 all increased compared with 1998. These increases
resulted from additional volume generated at Fortress Mortgage branches that
were open for the full year of 1999 but were only open for a portion of 1998.
The increase in revenue is also due to a significant increase in the overall
percentage of Fortress customers served by Fortress Mortgage (capture rate).
Total revenues for the year increased 31.9% to $6.2 million from $4.7 million
in 1998.

Financial services pretax income generated by Fortress Mortgage was $4,000 for
1999 compared with $168,000 for 1998. Market conditions during the third and
fourth quarters of 1999 led to increased competitive pressure and reduced
margins on loans originated. The expenses net of interest income increased to
$6.0 million from $4.6 million 1998. These increases resulted from increases
in some loan related expenses as well increases due to the expansion into new
markets during late 1998.

For the year ended December 31, 1999, Fortress Mortgage provided mortgages to
39.8% of the Company's closings in those markets which it serves, as compared
to 25.7% for the year ended December 31,1998.

                                      24

<PAGE>   25


Asset Impairment Charge

 The Company determined that an adjustment to current carrying value was
appropriate for several communities in 1999 and 2000 in accordance with
Statement of Financial Accounting Standard No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
The fair value of the communities was determined using a discounted cash flow
projection of future revenues and current and projected costs. The assets
involved include developed lots, homes under construction, and completed
homes. Based on the analysis of fair value the Company recognized asset
impairment charges (See Note 12 - Asset Impairment Charge), which have been
included in the Company's determination of Net Operating Income.

During the third quarter of 1999, the Company evaluated the carrying value of
two communities in its Las Vegas market. The Company recognized during the
third quarter an asset impairment charge of approximately $2.0 million.

Loss on Sale of Landmark Homes

The Company sold the assets of Landmark Homes in March 1999 as part of its
strategy to redeploy capital invested in under-performing assets. Concurrent
with the sale of these assets the Company exited the Wilmington, North
Carolina and Myrtle Beach, South Carolina markets. The Company recognized a
pretax loss of $2.9 million on this disposition, due primarily to unrecovered
goodwill of approximately $3.0 million. (See Note 11 - Sale of Assets and
Special Charges in the Company's consolidated financial statements included in
Item 8 hereof).

Net Income and Net Income Per Share

Due to the previously described factors, including the asset impairment
charge, the restructuring charge and the loss on the sale of Landmark, and the
income tax effect thereof, net income for 1999 was $8.3 million, a 35.2%
decrease from the $12.8 million achieved in 1998.

Net income per share, on a diluted basis, was $1.50 for 1999 compared with
$1.66 for 1998, a 9.6% decline. Diluted net income per share was affected by
the decline in net income detailed above and by the changes in preferred
dividends and the number of convertible preferred shares included in the
calculation of net income per share noted below. (See Note 9 - Shareholders'
Equity in the Company's consolidated financial statements included in Item 8
hereof).

Excluding the effect of the asset impairment charge, the restructuring charge
and the sale of Landmark, the Company's net income per share on a diluted
basis would have been $2.40 for 1999 compared with $1.68 for 1998.

The restructuring of the Prometheus agreement (effective February 4, 1999)
resulted in an increase in the preferred dividend rate related to that class
of stock from 6% to 9% annually, resulting in increased dilution of net income
per share. Redemption of approximately 28.8% ($11.5 million) of the
outstanding AAA preferred stock, in the second quarter of 1999 (See Note 9 -
Shareholders' Equity in the Company's consolidated financial statements
included in Item 8 hereof) partially offset this increased dilution.

During 1998, the Class AA Preferred Stock was convertible at $24.00 per share.
However, Class AA preferred stock and the related warrants included future
reset tables that provided that between

                                      25

<PAGE>   26

September 30, 2001 and September 30, 2003, the conversion rate changed based
on the then current market price of the Common Stock (See Note 9 -
Shareholders' Equity in the Company's consolidated financial statements
included in Item 8 hereof.) The dilution of earnings per share was
significantly increased during 1998 due to the lower average stock value
during the quarters ended September 30, 1998 and December 31, 1998. In
accordance with generally accepted accounting principles, the Company was
required to report currently the potential future conversion based on the
contractual reset tables and the current market price even though the holder
of the Class AA preferred stock and warrants could not effect a conversion
under these reset tables until September 30, 2001.

Following exchange of the Class AA stock for Class AAA stock in 1999 (See Note
9- Shareholders Equity in the Company's consolidated financial statements
included in Item 8 hereof) the warrants related to the AAA stock did not have
the right to convert to common stock unless and until the Company achieved a
cumulative revenue threshold, or failed to achieve a minimum quarterly or
annual revenue amount. For the sake of illustration of the impact on net
income per share, if one assumes (i) these supplemental warrants had vested
during the entire year of 1999, (ii) the current balance of 28,500 shares of
preferred stock was outstanding for the entire year and, (iii) a current
market value of the Company's stock of less than $8.00 per share, then an
additional 5,937,500 shares of common stock would have been included in the
calculation of diluted net income per share for 1999.

LIQUIDITY AND CAPITAL RESOURCES

The Company's operating activities involve several components, principally
home construction, land development and mortgage loan origination for home
purchasers. During 2000, the Company's operating activities, taken in the
aggregate, provided approximately $15.9 million of cash. This cash flow
provided in operating activities included $6.6 million returned from real
estate inventories and an $8.1 million decrease in mortgage loans held for
sale.

The $5.9 million of cash utilized by the Company's investing activities include
$4.4 million in new equipment investments and $3.5 million in payments related
to contingent consideration on previous acquisitions. These cash flows were
offset by $3.6 million in proceeds from land held for resale activities.

The Company's financing activities utilized $20.1 million of cash flow, $17.1
million of net repayments under notes and mortgages payable in addition to
$2.6 million in preferred stock dividends and purchase of treasury stock. The
net repayments were used to fund the decrease of inventory and mortgage loans
held for sale discussed above as part of cash flow from operations.

The Company regularly refinances existing loan agreements, executes new loan
agreements and, in the case of acquisitions, assumes loans related to the
assets being acquired. Approximately $487.4 million of secured financing
commitments were in place at the subsidiary level at year-end. Under these
credit facilities, the Company has borrowed $183.0 million at December 31,
2000. The total amount available under these commitments varies based on
individual loan covenants and inventory levels.

As of December 31, 2000 the Company had cash and cash equivalents on hand of
$7.4 million. The Company believes that funds available through the existing
credit facilities coupled with the cash on hand and cash generated through
operations should be adequate for the anticipated cash needs for the
foreseeable future. However, there can be no assurances that any current

                                      26

<PAGE>   27


working capital lender will agree to renew or extend its existing facility
or, if renewed, that such renewal or extension would be on similar or more
advantageous terms. No assurances can be given that, in the event any current
working capital lender declines to renew its facility, the Company would be
able to replace such facility on similar or more advantageous terms.

As of December 31, 2000, one of the Company's subsidiaries, Christopher Homes
LLC, was not in compliance with its minimum tangible net worth covenant of $15
million, contained in its credit agreement with the lender. Currently, the
lender has not declared a default as a result of this technical non-compliance
with the net worth covenant. The principal reason for Christopher Homes'
continued non-compliance with this covenant is the Company's inability to invest
the required amount in Christopher Homes as a result of the potentially
applicable restrictions on certain investments that are contained in the Senior
Note Indenture. Christopher Homes is not in default of any of its payment
obligations to the lender. The current principal amount outstanding to the
lender is approximately $24.6 million. This amount is secured by a lien on the
assets of Christopher Homes. The loan is not cross-collateralized with any of
the Company's other operating subsidiaries and no default in respect of the loan
would, by reason of the default alone, cause a default in respect of any other
loans to the Company or any of its subsidiaries. The Company is working with the
lender to secure continued financing from the lender for Christopher Homes. No
assurances can be given that the lender will agree to waive the effects of this
non-compliance or that the lender will agree to continue to finance for
Christopher Homes.

At December 31, 2000, the Company had 5,460 lots in inventory, in excess of
backlog, which represents a 21-month supply of land based on sales absorption
rates during 2000. It is one of the Company's operating strategies to keep a
relatively low supply of finished lots and lots under development in order to
manage and minimize risk associated with land ownership. The Company utilizes
land options and investments in partnerships as methods of controlling and
subsequently acquiring land. The Company plans to continue these practices and
expects to exercise, subject to market conditions, substantially all of its
option contracts. At December 31, 2000, the Company had 9,707 lots under
option representing a 32-month supply of land based on the same absorption
rates as above.

By letter dated February 12, 2001, Prometheus delivered a notice of election
under section 2.6 of the Restructuring Agreement purporting to confirm that it
had elected to exercise its rights under section 2.6 of the Restructuring
Agreement. By letter dated February 15, 2001, the Company advised Prometheus
that it disagreed that a timely election had been made. Each party has
reserved its rights with respect to this matter. Depending on the outcome of
this dispute, the Company may be obligated to make the payments required under
2.6 of the Restructuring Agreement, which amount to approximately $1.4
million, and which would be accounted for as an equity transaction.

It is possible that the Company may experience a change of control (as defined
in the Senior Note Indenture) in 2001 as a result of the Supplemental Warrants
becoming exercisable. See "Risk Factors - Potential Obligation to Make Change
in Control Offer." The Company's liquidity position could be materially and
adversely impacted if it becomes obligated to make a change in control offer
to redeem the Senior Notes. The Company's ability to satisfy its obligations
in such circumstances will depend upon its ability to raise capital or sell
assets in a timely and sufficient manner.

SEASONALITY AND VARIABILITY OF RESULTS

The Company, and the homebuilding industry in general, experience significant
seasonality and quarterly variability in homebuilding activity levels. The
annual operating cycle generally reflects greater new home orders in the
spring and autumn months and slower new orders in the winter and summer
months. Closings are slowest during the first quarter and increase throughout
the remainder of the year. The Company believes that this seasonality is a
reflection of the impact of winter weather on construction activity and the
preference of homebuyers to close on their new home either prior to the start
of a new school year in the fall or prior to the holiday season.

                                      27

<PAGE>   28

OUTLOOK

The Company experienced a decline in new order activity during 2000 compared to
1999. As noted above a portion of this decline is attributable to the exiting of
several markets, as well as some delays in opening new communities, and to some
extent increases in interest rates in early 2000. While the direct impact of
increases in interest rates is difficult to measure, the Company believes that
it has had an impact, particularly in its first-time buyer product offerings
during 2000. The Company has seen a strong increase in its Denver market new
order activity, but has seen a softening in the early part of the year in
several other markets including Philadelphia, Jacksonville and St. Louis.
Overall the Company expects new orders in 2001 to slightly exceed 2000 levels.

The Company believes the successful implementation of its key strategies should
benefit future operating results in the long run. The Company has addressed and
continues to address key business strategies through (i) the continued focus of
operational and financial management groups on the Company-wide program to
reduce direct construction costs, identification and implementation of processes
to improve return on assets at the subsidiary level, the sharing of "best
practices" and the implementation of an integrated computer information system,
and (ii) ongoing evaluations of certain under performing assets and alternative
strategies to improve performance or redeploy funds which might be recovered
from the sale of assets assets (see "Planning Committee").

Please refer to Business- Risk Factors and the Statement on Forward-Looking
Information.

INFLATION

The Company's business performance and the homebuilding industry in general
can be negatively affected by the impact of inflation and the adverse effect
inflation has on interest rates and the overall economic climate both
nationally and in the Company's markets.

Inflation affects the Company in a number of ways including increasing the
Company's cost of construction. Costs including land acquisition and
development, materials and subcontractor labor, overhead and interest rates on
floating rate credit facilities can all be adversely affected by inflation. In
addition, inflation may reduce consumers' ability to purchase a new home,
thereby adversely affecting the Company's new order flow. During 2000 and
1999, inflation has not significantly affected the performance of the Company.

While inflation has not been a significant factor in 2000 or 1999, rising
inflation in the future would likely have an adverse long-term impact on the
Company's business performance.

ADOPTION OF NEW ACCOUNTING STANDARDS

In 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, as amended by SFAS 138, "Accounting
for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and
hedging activities. The Company intends to adopt SFAS 133 in the first quarter
of fiscal 2001. The adoption of SFAS 133 will not have a material effect on
the financial position or results of operations of the Company. The Company's
only derivative is in the form of mandatory forward looking commitments on
loan sales.

                                      28

<PAGE>   29

Recognition of gains and losses is based on SFAS No. 125, Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,
which was effective for transfers and servicing of financial assets and
extinguishment of liabilities occurring after December 31, 1996. SFAS No. 125
is based upon consistent application of a financial components approach that
focuses on control. Under that approach, after a transfer of financial assets,
an entity recognizes the financial and servicing assets it controls and the
liabilities it has incurred, reverses financial assets when control has been
surrendered, and reverses liabilities when extinguished. The Company will
adopt SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets
and Extinguishment of Liabilities, in 2001, which will not have a material
effect on the financial position or results of operations of the Company.

In 1999, the Securities and Exchange Commission ("SEC") staff issued Staff
Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements." SAB 101 explains how generally accepted accounting principles
should be applied in the recognition of revenue in financial statements. The
Company implemented SAB 101 in the fourth quarter of 2000. The adoption of SAB
101 did not have a material effect on the financial position or results of
operations of the Company.

STATEMENT ON FORWARD-LOOKING INFORMATION

Certain information included in this report is "forward-looking" within the
meaning of the Private Securities Litigation Reform Act of 1995. You can
identify this information by use of words like "may," "will," "expect,"
"anticipate," "estimate," or "continue" or similar expressions. Such statements
represent the Company's judgment and involve known and unknown risks,
uncertainties and other factors that may cause actual results to differ
materially from those expressed or implied in the forward-looking statements.
Such risks, uncertainties and other factors include, but are not limited to,
fluctuations in interest rates, availability of land, raw materials, and labor
costs, levels of competition, housing demand in our markets, the effect of
government regulation, the availability of working capital, the price of the
Company's common stock, weather conditions, changes in general economic
conditions and other factors which may adversely affect The Fortress Group's
operating results including net income and/or net income per share and other
matters addressed in Business- Risk Factors.



                                      29

<PAGE>   30
ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

         The Company is exposed to market risks related to fluctuations in
interest rates on its debt and on its mortgage loans held for sale. The
Company utilizes forward sale (best efforts and mandatory) commitments to
mitigate the risk associated with the mortgage loan portfolio. Other than the
commitments noted above, the Company does not utilize interest rate swaps,
forward option contracts on foreign currencies or commodities, or other types
of derivative financial instruments.

         Fortress Mortgage provides mortgage loans, which are generally sold
upon closing and subsequently delivered to a third-party purchaser within
approximately 30 days. Due to the frequency of these loan sales, the market
risk associated with these mortgage loans is minimal.

         The Company utilizes both short-term and long-term debt in its
financing strategy. For fixed rate debt, changes in interest rates generally
affect the fair value of the debt instrument, but not the Company's earnings
or cash flows. Conversely, for variable rate debt, changes in interest rates
generally do not impact the fair value of the debt instrument, but may affect
the Company's future earnings and cash flows. The Company does not have an
obligation to prepay fixed rate debt prior to maturity and, as a result,
interest rate risk and changes in fair value should not have a significant
impact on the fixed rate debt until the Company would be required to refinance
such debt.

         As of December 31, 2000, short-term debt was $151.9 million, which
consisted primarily of loans secured by real estate inventories. Also included
in that amount is a mortgage warehouse line that is collateralized by
residential mortgage loans. The Company borrows on a short-term basis from
banks under committed lines of credit, which bear interest at the prevailing
market rates.

         Long-term debt obligations outstanding and their maturities at
December 31, 2000 are as follows (in thousands). The estimated fair value at
December 31, 2000 for all debt indicated is the face value, except for the
$100.0 million of Senior Notes due in 2003, which, based on available market
information, had an estimated fair market value of $40.0 million at December 31,
2000. This estimated fair market value is extremely difficult to determine
based on the thinly traded market for the Senior Notes.

<TABLE>
<CAPTION>
                                                             Maturities through December 31,
                                        ---------------------------------------------------------------------------
                                                2001           2002           2003            2004           2005
                                                ----           ----           ----            ----           ----
<S>                                     <C>            <C>             <C>            <C>            <C>
Fixed Rate Debt.................        $       3,055  $        1,669  $     101,106  $           5  $         5
     Average Interest Rate......                 8.3%            8.8%          13.7%           8.0%         8.0%

Variable Rate Debt.............         $     148,825  $       32,921  $         661  $           0  $         0
     Average Interest Rate......                 9.4%            9.3%           9.5%            N/A          N/A
</TABLE>

         The Company believes that its overall balance sheet structure has
repricing and cash flow characteristics that mitigate the impact of interest
rate movements.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The financial statements are listed under Item 14(a)(1) and filed as part of
this report on the pages indicated and are incorporated herein by reference.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

         None.

                                      30


<PAGE>   31



PART III

         The information required by Part III is omitted from this Annual
Report on Form 10-K and is incorporated by reference from the definitive proxy
statement with respect to the 2001 Annual Meeting of Stockholders (the Proxy
Statement) which the Company will file with the Securities and Exchange
Commission (the Commission) not later than 120 days after the end of the
fiscal year covered by this Report.


Item 10.  Directors and Executive Officers of the Registrant

     (a)  Identification of Directors. Information required by this Item will
          be set forth under the caption "Proposal 1, Election of Directors -
          Nominees for Election at this Annual Meeting" in the Proxy
          Statement, which information is incorporated herein by reference.

     (b)  Identification of Executive Officers. Information required by this
          Item is set forth under the caption "Executive Officers of the
          Company" under Part I, Item 1 of this Report, which information is
          incorporated herein by reference.

Item 11.  Executive Compensation

         Information required by this Item will be set forth under the
captions "Executive Compensation" and "Proposal 1, Election of Directors -
Directors' Remuneration" in the Proxy Statement, which information is
incorporated herein by reference.


Item 12.  Security Ownership of Certain Beneficial Owners and Management

         Information required by this Item will be set forth under the caption
"Stock Ownership" in the Proxy Statement, which information is incorporated
herein by reference.


Item 13.  Certain Relationships and Related Transactions

         Information required by this Item will be set forth under the caption
"Certain Transactions" in the Proxy Statement, which information is
incorporated herein by reference.


                                      31

<PAGE>   32

PART IV


ITEM 14.  EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K.


(a)  Financial Statements, Schedules and Exhibits.

     1.  Financial Statements

THE FORTRESS GROUP, INC.

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                          Page
<S>                                                                      <C>
THE FORTRESS GROUP, INC.
     Report of Ernst & Young LLP, Independent Accountants                  F-1
     Report of PricewaterhouseCoopers LLP, Independent Accountants         F-2
     Consolidated Balance Sheets as of December 31, 2000 and 1999          F-3
     Consolidated Statement of Operations for the years ended
     December 31, 2000, 1999, and 1998                                     F-4
     Consolidated Statement of Shareholders' Equity for the years
     ended December 31, 2000, 1999, and 1998                               F-5
     Consolidated Statement of Cash Flows for the years ended
     December 31, 2000, 1999, and 1998                                     F-6
     Notes to Consolidated Financial Statements                            F-7
</TABLE>


                                      32


<PAGE>   33



2.       Financial Statement Schedules
              None.

3.       Exhibits

Number    Description

2.1      Agreement and Plan of Reorganization dated as of March 11, 1996 by
         and among the Company, Buffington Acquisition, Inc., Buffington
         Holdings, Inc. and the Stockholders named therein ("Buffington Merger
         Agreement"). (Exhibit 2.1 of the Registration Statement on Form S-1
         (File No. 333-2332) effective May 16, 1996, is hereby incorporated by
         reference.)

2.1(a)   First Amended to Buffington Merger Agreement, dated May 15, 1996.
         (Exhibit 2.1(a) of the Registration Statement on Form S-1 (File No.
         333-2332) is hereby incorporated by reference.)

2.2      Amended and Restated Agreement and Plan of Reorganization dated as of
         March 11, 1996 by and among the Company, Christopher Acquisition,
         Inc., Christopher Homes, Custom Homes Division, Inc. and the
         Stockholders named therein ("Christopher Merger Agreement"). (Exhibit
         2.2 of the Registration Statement on Form S-1 (File No. 333-2332) is
         hereby incorporated by reference.)

2.2(a)   First Amendment to Christopher Merger Agreement, dated May 15, 1996.
         (Exhibit 2.2(a) of the Registration Statement on Form S-1 (File No.
         333-2332) is hereby incorporated by reference.)

2.3      Amended and Restated Agreement and Plan of Reorganization dated as of
         March 11, 1996 by and among the Company, Genesee Acquisition, Inc.,
         The Genesee Company, The Genesee Company/Castle Pines, Ltd., The
         Genesee Company of Michigan, Ltd., Genesee Development Company and
         the Stockholders named therein ("Genesee Merger Agreement"). (Exhibit
         2.3 of the Registration Statement on Form S-1 (File No. 333-2332) is
         hereby incorporated by reference.)

2.3(a)   First Amendment to Genesee Merger Agreement, dated May 15, 1996.
         (Exhibit 2.3(a) of the Registration Statement on Form S-1 (File No.
         333-2332) is hereby incorporated by reference.)

2.4      Amended and Restated Agreement and Plan of Reorganization dated as of
         March 11, 1996 by and among the Company, Sunstar Acquisition, Inc.,
         Solaris Development Corporation and the Stockholders named therein
         ("Sunstar Merger Agreement"). (Exhibit 2.4 of the Registration
         Statement on Form S-1 (File No. 333-2332) is hereby incorporated by
         reference.)

2.4(a)   First Amendment to Sunstar Merger Agreement, dated May 15, 1996.
         (Exhibit 2.4(a) of the Registration Statement on Form S-1 (File No.
         333-2332) is hereby incorporated by reference.)


                                      33

<PAGE>   34

2.5      Asset Purchase Agreement, dated August 31, 1996 by and among The
         Fortress Group, Inc., Fortress Acquisition, Inc., Landmark Homes,
         Inc., B. Rex Stephens, and Bobby W. Harrelson. (Exhibit 2.1 of the
         Current Report on Form 8-K dated September 16, 1996 is hereby
         incorporated by reference.)

2.6      Asset Purchase Agreement, dated February 28, 1997 by and among The
         Fortress Group, Inc., Fortress-Florida, Inc., DW Hutson Construction,
         Inc., and David Hutson. (Exhibit 10.1 of the Current Report on Form
         8-K dated March 17, 1997 is hereby incorporated by reference.)

2.7      Purchase Agreement dated August 18, 1997 among The Fortress Group,
         Inc.; Fortress Galloway, Inc.; Don Galloway Homes, Inc.; Don Galloway
         Land, LLC; Galloway Limited Partnership; Thornblade, LLC, and the
         Persons named herein. (Exhibit 1 of the Current Report on Form 8-K
         dated August 27, 1997 is hereby incorporated by reference.)

2.8      Amended and Restated Purchase Agreement among the Company; Whittaker
         Construction, Incorporated; RRKTG Lumber, Inc.; Lewis and Clark Title
         Company and person named therein (Exhibit 2.1 of the Current Report
         on Form 8-K dated March 16, 1998 is hereby incorporated by
         reference.)

3.1      Amended and Restated Certificate of Incorporation of the Registrant.
         (Exhibit 3.1 of the Registration Statement on Form S-1  (File No.
         333-2332) is hereby incorporated by reference.)

3.2      Certificate of Amendment of Certificate of Incorporation of the
         Company (Exhibit 3.1(a) of Amendment No. 3 to the Registration
         Statement on Form S-1 (File No. 333-2332) is hereby incorporated by
         reference.)

3.3      Certificate of Amendment of Certificate of Incorporation of the
         Company, effective March 6, 1998 (Exhibit 3.1 of the Form 8-K dated
         March 16, 1998 is hereby incorporated by reference.)

3.4      Notice of Election to Terminate Charter Provisions (Exhibit 3.3(a) of
         the Company's 1998 Annual Report on Form 10-K dated March 30, 1999 is
         hereby incorporated by reference)

3.5      Certificate of Amendment of the Certificate of Incorporation of the
         Company, effective July 10,2000 (Exhibit 3.5 of the Form 10-Q dated
         August 14, 2000 is hereby incorporated by reference.)

3.6      Amended and Restated Bylaws of the Registrant. (Exhibit 3.2 of the
         Registration Statement on Form S-1 (File No. 333-2332) effective May
         16, 1996, is hereby incorporated by reference.)

3.7      Amendments to the Company's By-laws, effective March 6, 1998 (Exhibit
         3.2 of the Form 8-K dated March 16, 1998 is hereby incorporated by
         reference.)

3.8      Amendment to the Company's By-laws adopted February 4, 1999 (Exhibit
         2 of the Form 8-K dated March 5, 1999 is hereby incorporated by
         reference.)

                                      34

<PAGE>   35

4.2      Form of Indenture for Senior Notes. (Exhibit 4.2 of the Registration
         Statement on Form S-1 (File No. 333-2332) is hereby incorporated by
         reference.)

4.3      Form of Certificate for Senior Notes. (Exhibit 4.3 of the
         Registration Statement on Form S-1 (File No. 333-2332) is hereby
         incorporated by reference.)

         The Company is a party to a number of other instruments defining the
         rights of holders of long-term debt. No such instrument authorizes an
         amount of securities in excess of 10% of the total assets of the
         Company and its subsidiaries on a consolidated basis.  On request,
         the Company agrees to furnish a copy of each such instrument to the
         Commission.

4.3(a)   Second Supplemental Indenture dated May 27, 1997 (Exhibit 4 of the
         Company's Quarterly Report on Form 10Q/A Amendment No. 1 for the
         quarter ended June 30, 1997 is hereby incorporated by reference.)

4.5      Amended and Restated Warrant Agreement dated as of March 6, 1998 by
         and between the Company and Prometheus Homebuilders LLC (Exhibit 4.6
         of the Company's Current Report on Form 8-K dated March 16, 1998 is
         hereby incorporated by reference.)

4.5(a)   Supplemental Warrant Agreement dated as of February 4, 1999 by and
         between the Company and Prometheus Homebuilders LLC (Exhibit D of
         Exhibit 1 of the Schedule 13D, Amendment No. 4 filed by Prometheus
         Homebuilders LLC on January 12, 1999 is hereby incorporated by
         reference.)

4.6      Amended and Restated Stockholders Agreement, dated as of March 6,
         1998, by and among the Company and the Stockholders named therein
         (Exhibit 4.7 of the Current Report on Form 8-K dated March 16, 1998
         is hereby incorporated by reference.)

4.6(a)   Second Amended and Restated Stockholders Agreement dated as of
         February 4, 1999 by and between the Company and Prometheus
         Homebuilders LLC (Exhibit C of Exhibit 1 of the Schedule 13D,
         Amendment No. 4 filed by Prometheus Homebuilders LLC on January 12,
         1999 is hereby incorporated by reference.)

4.7      Amended and Restated Registration Rights Agreement dated as of March
         6, 1998 by and between the Company and Prometheus Homebuilders LLC
         (Exhibit 4.8 of the Current Report on Form 8-K dated March 16, 1998
         is hereby incorporated by reference.)

4.7(a)   Second Amended and Restated Registration Rights Agreement dated as of
         February 4, 1999 by and between the Company and Prometheus
         Homebuilders LLC (Exhibit B of Exhibit 1 of the Schedule 13D,
         Amendment No. 4 filed by Prometheus Homebuilders LLC on January 12,
         1999 is hereby incorporated by reference.)

4.8(a)   Amended Certificate of Designations, Preferences and Rights of Series
         C Convertible Preferred Stock of The Fortress Group Inc. (Exhibit
         4.8(a) of the Company's 1998 Annual Report on Form 10-K dated March
         30, 1999 is hereby incorporated by reference)

4.8(b)   Certificate of Designations, Preferences and Rights of Series D
         Convertible Preferred Stock of The Fortress Group Inc. (Exhibit 2 of
         the Current Report on Form 8-K dated August 27, 1997 is hereby
         incorporated by reference.)


                                      35

<PAGE>   36


4.8(c)   Amended Certificate of Designations, Preferences and Rights of Series
         E 6% Convertible Preferred Stock of The Fortress Group, Inc. (Exhibit
         4.1 of the Quarterly Report on Form 10-Q for the Quarter ended March
         31, 1997 is hereby incorporated by reference.)

4.8(e)   Certificate of Designations, Preferences and Relative, Participating,
         Optional and Other Special Rights of Preferred Stock and
         Qualifications, Limitations and Restrictions thereof of Class AAA
         Convertible Redeemable Preferred Stock (Exhibit A of Exhibit 1 of the
         Schedule 13D, Amendment No. 4 filed by Prometheus Homebuilders LLC on
         January 12, 1999 is hereby incorporated by reference.)

10.1     Stock Incentive Plan. (Exhibit 10.1 of the Registration Statement on
         Form S-1 (File No. 333-2332) is hereby incorporated by reference.)

10.2     Stock Purchase Agreement dated as of August 14, 1997 by and between
         the Company and Prometheus Homebuilders LLC (Exhibit 1 of the
         Schedule 13D filed by Prometheus Homebuilders LLC on August 25, 1997
         is hereby incorporated by reference.)

10.2(a)  Amended and Restated Stock Purchase Agreement dated as of September
         30, 1997 by and between the Company and Prometheus Homebuilders LLC
         (Exhibit 1 of the Schedule 13D, Amendment No. 1 filed by Prometheus
         Homebuilders LLC on October 15, 1997 is hereby incorporated by
         reference.)

10.2(b)  Second Amended and Restated Stock Purchase Agreement dated as of
         February 19, 1998 by and between the Company and Prometheus
         Homebuilders LLC (Exhibit 10 of the Current Report on Form 8-K dated
         March 16, 1998 is hereby incorporated by reference.)

10.2(c)  Restructuring Agreement by and among The Fortress Group, Inc.,
         Prometheus Homebuilders LLC and the Homebuilder Stockholders listed
         therein dated as of December 31, 1998 (Exhibit 1 of the Schedule 13D,
         Amendment No. 4 filed by Prometheus Homebuilders LLC on January 12,
         1999 is hereby incorporated by reference.)

10.3     Incentive Compensation Plan. (Exhibit 10.3 of the Registration
         Statement on Form S-1 (File No. 333-2332) is hereby incorporated by
         reference.)

10.4 (k) Employment agreement between The Fortress Group, Inc. and George C.
         Yeonas (Exhibit 10.14 of the Company's 1997 Annual Report on Form 10K
         is hereby incorporated by reference.)

10.5     Directors Indemnification Agreement between The Fortress Group, Inc.
         and Thomas B. Buffington, J. Marshall Coleman, Charles F. Smith, Mark
         L. Fine, Steve D. Rivers, James F. McEneaney, James J. Martell, Jr.,
         J. Christopher Stuhmer, Lawrence J. Witek and Robert Short. (Exhibit
         10.5 of the Registration Statement on Form S-1  (File No. 333-2332)
         is hereby incorporated by reference.)

10.7     Stockholders' Agreement between Charles F. Smith, Jr., James J.
         Martell, Jr., Patricia Donnelly, Michael P. Kahn and Pepi A. Kahn,
         Co-Trustees of Kahn Grantor Trust of 1993, James F. McEneaney, Jr.,
         James M. Pirrello, Brian McGregor, Brian Buchanan, Thomas B.
         Buffington, Edward A. Kirkpartrick, James M. Giddens, J. Christopher
         Stuhmer, Robert Short, Lanold W. Caldwell, and Lawrence J. Witek.
         (Exhibit 10.7 of the Registration


                                      36

<PAGE>   37
         Statement on Form S-1  (File No. 333-2332) is hereby incorporated by
         reference.)

10.10    Lease Agreement between Christopher Homes Custom Home Division, Inc.,
         and Towne Center Limited Partnership  (Exhibit 10.10 of the Company's
         1996 Annual Report on Form 10-K dated March 31, 1997 is hereby
         incorporated by reference.)

10.11    Lease Agreement between The Genesee Company and Genesee Holdings
         Corporation (Exhibit 10.11 of the Company's 1996 Annual Report on
         Form 10-K dated March 31, 1997 is hereby incorporated by reference.)

10.12    Asset Purchase Agreement, dated July 1, 1996 by and among The Genesee
         Company and Genesee Custom Homes, Inc. (Exhibit 2.1 of the Quarterly
         Report on Form 10-Q for the quarter ended June 30, 1996 is hereby
         incorporated by reference.)

10.13    Purchase and Sale Agreement between The Genesee Company and RS
         Investments/Stonebridge LLC, dated December 1, 1999 (Exhibit 10.13 of
         the Company's 1999 Annual Report on Form 10-K dated March 24, 2000 is
         hereby incorporated by reference).

10.14    Amendment to Purchase and Sale Agreement between The Genesee Company
         and RS Investments/Stonebridge LLC, dated December 1, 1999 (Exhibit
         10.14 of the Company's 1999 Annual Report on Form 10-K dated March
         24, 2000 is hereby incorporated by reference).

10.15    Option Agreement between RS Investments/Stonebridge, LLC, and The
         Genesee Company, dated December 1, 1999 (Exhibit 10.15 of the
         Company's 1999 Annual Report on Form 10-K dated March 24, 2000 is
         hereby incorporated by reference).

10.16    Amendment to Option Agreement between RS Investments/Stonebridge,
         LLC, and The Genesee Company, dated December 1, 1999 (Exhibit 10.16
         of the Company's 1999 Annual Report on Form 10-K dated March 24, 2000
         is hereby incorporated by reference).

10.17    Amendment to Option Agreement between RS Investments/Stonebridge,
         LLC, and The Genesee Company, dated December 10, 1999 (Exhibit 10.17
         of the Company's 1999 Annual Report on Form 10-K dated March 24, 2000
         is hereby incorporated by reference).


21.1     List of Subsidiaries (included herein.)

23.1     Consent of Accountants (included herein.)

23.2     Consent of Accountants (included herein.)

                                      37

<PAGE>   38


(b)  Reports on Form 8-K.

         None



                                      38

<PAGE>   39



                  SIGNATURES

     Pursuant to the requirements Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized March 30, 2001.

                            THE FORTRESS GROUP, INC.

                            By:        /s/ George C. Yeonas
                                  ----------------------------
                            Name:  George C. Yeonas
                            Title:   Chief Executive Officer and Director

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant
and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
     Signature                          Capacity In Which Signed                     Date
<S>                                 <C>                                        <C>
/s/ George C. Yeonas                Chief Executive Officer and Director              3/29/01
---------------------------                                                    --------------
George C. Yeonas

/s/ Jeffrey W. Shirley              Chief Financial Officer,                          3/29/01
---------------------------         and Principal Accounting Officer           --------------
Jeffrey W. Shirley

/s/ Mark L. Fine                    Director                                          3/29/01
---------------------------                                                    --------------
Mark L. Fine


/s/ Richard I. Gilchrist            Director                                          3/29/01
---------------------------                                                    --------------
Richard I. Gilchrist


/s/ Sandra A. Lamb                  Director                                          3/29/01
---------------------------                                                    --------------
Sandra A. Lamb

                                    Director
---------------------------                                                    --------------
Robert Short


                                    Director
---------------------------                                                    --------------
William A. Shutzer

/s/ J. Christopher Stuhmer          Director                                          3/29/01
--------------------------                                                     --------------
J. Christopher Stuhmer


                                    Director
---------------------------                                                    --------------
Andrew E. Zobler
</TABLE>

                                      39
<PAGE>   40
                        Report of Independent Auditors

Board of Directors
The Fortress Group, Inc.

We have audited the accompanying consolidated balance sheet of The Fortress
Group, Inc. as of December 31, 2000, and the related consolidated statements
of operations, shareholders' equity and cash flows for the year then ended.
These financial statements are the responsibility of the management of The
Fortress Group, Inc. Our responsibility is to express an opinion on these
financial statements based on our audit.

We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of The Fortress
Group, Inc. as of December 31, 2000, and the consolidated results of its
operations and its cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States.


                                                          /s/ ERNST & YOUNG LLP


February 28, 2001, except for the third paragraph of Note 21,
         as to which the date is March 29, 2001

                                     F-1

<PAGE>   41

                      Report of Independent Accountants

To the Board of Directors and
Shareholders of The Fortress Group, Inc.

In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of shareholders' equity and of cash
flows present fairly, in all material respects, the financial position of The
Fortress Group, Inc. (the "Company") at December 31, 1999, and the results of
its operations and its cash flows for each of the two years in the period
ended December 31, 1999 in conformity with accounting principles generally
accepted in the United States of America. These financial statements are the
responsibility of the Company's management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for the
opinion expressed above. We have not audited the financial statements of The
Fortress Group, Inc. for any period subsequent to December 31, 1999.



PRICEWATERHOUSECOOPERS LLP


Washington, DC
February 21, 2000, except for the fourth paragraph of Note 2, as to which the
date is July 10, 2000.

                                     F-2


<PAGE>   42





                           THE FORTRESS GROUP, INC.
                         CONSOLIDATED BALANCE SHEETS
                          December 31, 2000 and 1999
               (Dollars in thousands, except per share amounts)

<TABLE>
<CAPTION>
                                                                                  2000            1999
                                                                                  ----            ----
<S>                                                                             <C>             <C>

                                    ASSETS

Cash and cash equivalents                                                        $  7,412        $ 17,526
Accounts and notes receivable                                                      11,400          12,748
Real estate inventories                                                           308,187         328,513
Land held for resale                                                                  825               0
Mortgage loans                                                                     12,153          20,229
Investments in land partnerships                                                    3,099           1,518
Property and equipment, net                                                        11,032          12,392
Prepaid expenses and other assets                                                  38,444          22,803
Goodwill, net                                                                      29,015          35,452
                                                                                 --------        --------
Total assets                                                                     $421,567        $451,181
                                                                                 ========        ========


                     LIABILITIES AND SHAREHOLDERS' EQUITY

Accounts payable and accrued construction liabilities                            $ 31,056        $ 38,915
Notes and mortgages payable                                                       285,641         301,658
Accrued expenses                                                                   18,526          18,905
Customer deposits                                                                   8,998          10,530
                                                                                 --------        --------
       Total liabilities                                                          344,221         370,008
                                                                                 --------        --------

Commitments and Contingencies (see Note 20)

Minority interest                                                                       0              79
Obligation under preferred stock redemption agreement (see Note 9)                      0           1,421
Shareholders' equity
     Preferred stock, all classes and series, $.01 par value, 1 million
       authorized (see Note 9)                                                          1               1
     Common stock, $.01 par value, 99 million authorized,
       3,094,754 and 12,496,260 (pre-split) (see Note 2)
       issued, respectively                                                            31             125
     Additional paid-in capital                                                    52,559          54,308
     Retained earnings                                                             26,005          26,460
     Treasury stock, at cost, 0 and 265,100 common shares
       and 30,000 and 0 preferred shares, respectively                             (1,250)         (1,221)
                                                                                 --------        --------

       Total shareholders' equity                                                  77,346          79,673
                                                                                 --------        --------

       Total liabilities and shareholders' equity                                $421,567        $451,181
                                                                                 ========        ========
</TABLE>

  The accompanying notes are an integral part of these financial statements.



                                     F-3

<PAGE>   43



                           THE FORTRESS GROUP, INC.
                    CONSOLIDATED STATEMENTS OF OPERATIONS
               (Dollars in thousands, except per share amounts)


<TABLE>
<CAPTION>
                                                          For the Year         For the Year         For the Year
                                                             Ended                Ended                 Ended
                                                       December 31, 2000    December 31, 1999     December 31, 1998
                                                       -----------------    -----------------     -----------------
<S>                                                    <C>                  <C>                   <C>
TOTAL REVENUES                                            $  688,457            $  740,785             $  692,645
                                                          ----------            ----------             ----------

HOMEBUILDING:
  Residential Sales                                       $  662,022            $  719,970             $  677,271
  Lot sales and other                                         20,711                14,647                 10,636
                                                          ----------            ----------             ----------
  Homebuilding revenues                                      682,733               734,617                687,907
  Cost of sales                                              582,113               626,602                583,278
                                                          ----------            ----------             ----------
       Gross profit                                          100,620               108,015                104,629
   Selling                                                    44,945                46,514                 43,601
   General and administrative                                 34,975                36,436                 34,534
   Asset impairment charge                                    14,849                 1,990                      0
   Special charges                                                 0                 1,270                      0
   Goodwill amortization                                       2,534                 2,618                  2,395
                                                          ----------            ----------             ----------
       Net operating income                                    3,317                19,187                 24,099
                                                          ----------            ----------             ----------
     Other expense (income):
       Interest expense                                        3,369                 4,592                  5,547
       Interest income                                          (680)                 (608)                  (916)
       Minority interest                                           0                     0                    (35)

       Other, net                                             (2,872)               (2,439)                (1,957)
                                                          ----------            ----------             ----------

    Homebuilding income before taxes                           3,500                17,642                 21,460

FINANCIAL SERVICES:
    Operating revenues                                         5,724                 6,168                  4,738
    General, administrative and other expenses                 5,020                 5,987                  4,592
    Interest expense                                           1,429                 1,210                    755
    Interest income                                           (1,165)               (1,033)                  (777)
                                                          ----------            ----------             ----------

    Financial Services income before taxes                       440                     4                    168

Loss on sale of Landmark Homes                                     0                 2,900                      0

Income before taxes                                            3,940                14,746                 21,628

Provision for income taxes                                     1,726                 6,469                  8,794
                                                          ----------            ----------             ----------

Net income                                                $    2,214            $    8,277             $   12,834
                                                          ==========            ==========             ==========

Income/(loss) available to common shareholders,
basic                                                     $     (455)           $    5,149             $    5,436
                                                          ==========            ==========             ==========

Income/(loss) available to common shareholders,
diluted                                                   $     (455)           $    5,484             $    5,464
                                                          ==========            ==========             ==========

NET INCOME/(LOSS) PER SHARE DATA (See Note 10):

     Basic net income/(loss) per share                    $     (.15)           $     1.70             $     1.84
                                                          ==========            ==========             ==========
     Diluted net income/(loss) per share                        (.15)                 1.50             $     1.66
                                                          ==========            ==========             ==========

     Basic weighted average shares outstanding             3,076,354             3,029,917              2,954,722
                                                          ==========            ==========             ==========
     Diluted weighted average shares outstanding           3,076,354             3,656,374              3,285,059
                                                          ==========            ==========             ==========
</TABLE>

  The accompanying notes are an integral part of these financial statements.

                                     F-4

<PAGE>   44
                           THE FORTRESS GROUP, INC.
               CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
                                (In thousands)
<TABLE>
<CAPTION>
                                        ------Shares--------


                                        Preferred    Common
                                        ---------    ------
<S>                                     <C>         <C>
Balance at December 31, 1997                  151    11,629
                                              ===    ======

Issuance of preferred stock                    53
Cancellation of preferred stock                (1)

Redemption of preferred stock                 (35)
Conversion of preferred stock                 (19)      339
Preferred stock dividend

Imputed preferred stock dividend
Issuance of common stock                                 85
Common stock dividends declared
Vesting of non-qualified options
Purchase of treasury stock                             (145)
Subscription receivable relief
Net income
                                              ---    ------

Balance at December 31, 1998                  149    11,908
                                              ===    ======

Issuance of preferred stock
Redemption of preferred stock                 (33)
Conversion of preferred stock                 (21)      212
Preferred stock dividend
Issuance of common stock                                111
Preferred Stock Redemption Obligation
Net income
                                              ---    ------

Balance at December 31, 1999                   95    12,231
                                              ===    ======

  Redemption of preferred stock               (22)
  Preferred stock dividends
  Issuance of common stock                               94
  Retirement of treasury stock
  Reverse stock split                                (9,230)
  Preferred Stock Redemption Obligation
    (see Note 9)
Purchase of treasury stock (see Note 9)       (30)
  Net income
                                              ---    ------

Balance at December 31, 2000                   43     3,095
                                               ==    ======
</TABLE>

<TABLE>
<CAPTION>
                                        ------------------------------------Amount-------------------------------------------
                                                             Additional                                             Total
                                                              Paid-In     Subscription  Retained   Treasury    Shareholders'
                                       Preferred    Common    Capital     Receivables   Earnings     Stock         Equity
                                       ---------    ------    -------     -----------   --------     -----         ------
<S>                                   <C>          <C>       <C>          <C>           <C>        <C>         <C>
Balance at December 31, 1997                  $1     $117    $ 47,371                   $15,936     $  (528)      $ 62,897
                                              ==     ====    ========                   =======     =======       ========

Issuance of preferred stock                                    27,301         $(500)                                26,801
Cancellation of preferred stock                                   (50)                                                 (50)

Redemption of preferred stock                                  (3,534)                                              (3,534)
Conversion of preferred stock                           4        (327)                                                (323)
Preferred stock dividend                                                                 (7,330)                    (7,330)

Imputed preferred stock dividend                                   68                       (68)
Issuance of common stock                                1         459                                                  460
Common stock dividends declared                                                             (61)                       (61)
Vesting of non-qualified options                                   25                                                   25
Purchase of treasury stock                                                                             (693)          (693)
Subscription receivable relief                                                  167                                    167
Net income                                                                               12,834                     12,834
                                              --     ----    --------         -----     -------     -------       --------

Balance at December 31, 1998                   1      122      71,313          (333)     21,311      (1,221)        91,193
                                              ==     ====    ========         =====     =======     =======       ========

Issuance of preferred stock                                      (342)                                                (342)
Redemption of preferred stock                                 (13,693)          333                                (13,360)
Conversion of preferred stock                           2      (1,695)                                              (1,693)
Preferred stock dividend                                                                 (3,128)                    (3,128)
Issuance of common stock                                1         146                                                  147
Preferred Stock Redemption Obligation                          (1,421)                                              (1,421)
Net income                                                                                8,277                      8,277
                                              --     ----    --------         -----     -------     -------       --------

Balance at December 31, 1999                   1      125      54,308             0      26,460      (1,221)        79,673
                                              ==     ====    ========         =====     =======     =======       ========

  Redemption of preferred stock                                (2,127)                                              (2,127)
  Preferred stock dividends                                                              (2,669)                    (2,669)
  Issuance of common stock                              1          83                                                   84
  Retirement of treasury stock                         (3)     (1,218)                                1,221
  Reverse stock split                                 (92)         92
  Preferred Stock Redemption Obligation
    (see Note 9)                                                1,421                                                1,421
Purchase of treasury stock (see Note                                                                 (1,250)        (1,250)
  Net income                                                                              2,214                      2,214
                                              --     ----    --------         -----     -------     -------       --------

Balance at December 31, 2000                  $1     $ 31    $ 52,559                   $26,005     $(1,250)      $ 77,346
                                              ==     ====    ========                   =======     =======       ========
</TABLE>

  The accompanying notes are an integral part of these financial statements.

                                     F-5

<PAGE>   45


                            THE FORTRESS GROUP, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                        For the Year          For the Year       For the Year
                                                                           Ended                 Ended              Ended
                                                                     December 31, 2000     December 31, 1999  December 31, 1998
                                                                     -----------------     -----------------  -----------------
<S>                                                                  <C>                   <C>                <C>
Cash flows from operating activities
   Net income                                                            $   2,214             $   8,277           $  12,834
   Adjustments to reconcile net income to net cash provided by/
   used in operating activities:
    Depreciation and amortization                                            8,634                 9,640               9,170
    Deferred tax provision                                                  (7,270)                 (654)               (421)
    Minority interest                                                            0                     0                 (35)
    Special charges                                                              0                 1,270                   0
    Asset impairment charge                                                 14,849                 1,990                   0
    (Gain) on sale of investment in land partnerships                            0                  (291)                  0
    Loss on sale of Landmark Homes                                               0                 2,900                   0
    (Gain) loss on sale of property and equipment                                7                   168                 (96)
    Changes in operating assets and liabilities
    Accounts receivable                                                      1,348                 1,113              11,289
    Real estate inventories                                                  6,596               (28,440)            (28,487)
    Land held for resale                                                      (825)                7,954              (1,020)
    Mortgage loans                                                           8,076                (4,832)             (4,269)
    Prepaid expenses and other assets                                      (15,641)               (7,413)              1,370
    Accounts payable and accrued construction liabilities                     (589)                4,201               7,355
    Accrued expenses                                                           (13)                   (2)              1,816
    Customer deposits                                                       (1,532)                  (91)              1,992
                                                                         ---------             ---------           ---------
       Net cash provided by/(used in) operating activities                  15,854                (4,210)             11,498
                                                                         ---------             ---------           ---------

Cash flows from investing activities
    Acquisition of homebuilders, net of acquired cash                            0                     0             (27,616)
    Proceeds from sale of Landmark Homes net of cash sold                        0                 3,078                   0
    Proceeds from sale of land partnership interests                             0                 5,351                   0
    Payment of contingent consideration                                     (3,504)               (2,372)             (2,034)
    Minority interest - change in investment                                   (79)                    0                   0
    Proceeds from land held for resale                                       3,584                     0                   0
    Purchase of property and equipment                                      (4,431)               (4,981)             (6,841)
    Proceeds from sale of property and equipment                               102                   263                 438
    Change in investment in limited partnerships                            (1,580)                3,378              (2,853)
                                                                         ---------             ---------           ---------
       Net cash (used in)/ provided by investing activities                 (5,908)                4,717             (38,906)
                                                                         ---------             ---------           ---------

Cash flows from financing activities
    Borrowings under notes and mortgages payable                           754,253               744,313             685,844
    Repayment of notes and mortgages payable                              (771,389)             (731,153)           (662,651)
    Related party borrowings                                                   285                   109                 118
    Repayment of related party borrowings                                     (145)                 (381)               (483)
    Proceeds from issuance of common stock, net                                 84                   148                  86
    Proceeds from issuance of Class AA Preferred Stock, net                      0                  (342)             24,813
    Conversion of preferred stock                                                0                (1,693)               (324)
    Preferred stock redemption                                                (521)              (13,360)             (1,500)
    Preferred dividends paid                                                (1,377)               (3,724)             (7,017)
    Common dividends paid                                                        0                     0                 (89)
    Purchase of treasury stock (see Note 9)                                 (1,250)                    0                (693)
                                                                         ---------             ---------           ---------
       Net cash (used in)/provided by financing activities                 (20,060)               (6,083)             38,104
                                                                         ---------             ---------           ---------

Net (decrease) increase in cash and cash equivalents                       (10,114)               (5,576)             10,696
Cash and cash equivalents, beginning of period                              17,526                23,102              12,406
                                                                         ---------             ---------           ---------
Cash and cash equivalents, end of period                                 $   7,412             $  17,526           $  23,102
                                                                         =========             =========           =========
</TABLE>

  The accompanying notes are an integral part of these financial statements.

                                     F-6



<PAGE>   46
                           THE FORTRESS GROUP, INC.
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1 - BUSINESS AND ORGANIZATION

The Fortress Group, Inc. ("Fortress" or the "Company") was formed in June 1995
to create a national homebuilding company for the acquisition and development
of land or improved lots and the construction of residential for-sale housing.

Fortress began operations simultaneous with the closing of its initial public
offering on May 21, 1996 (the "Offering"), and the acquisition of four
homebuilding companies (the "Predecessor Companies"):

<TABLE>
<CAPTION>
    Homebuilder                                Market(s)
    -----------                                ---------
<S>                                            <C>
    The Genesee Company ("Genesee")            Denver and Fort Collins, Colorado
                                               and Tucson, Arizona
    Buffington Homes, Inc.  ("Buffington")     Austin and San Antonio, Texas
                                               (Buffington merged with Wilshire
                                               (see below); as of 1999,
                                               operations exclusively marketed
                                               under Wilshire name)
    Christopher Homes ("Christopher")          Las Vegas, Nevada
    Solaris Development Corp. ("Sunstar")      Raleigh-Durham, North Carolina
</TABLE>

Subsequent to the Offering, Fortress acquired the following homebuilding
companies:

<TABLE>
<CAPTION>
    Homebuilder                               Date Acquired            Market(s)
    -----------                               -------------            ---------
<S>                                           <C>                      <C>
    Landmark Homes, Inc. ("Landmark")         August 31, 1996          Wilmington North Carolina, Myrtle
                                              (sold March 1999)        Beach, South Carolina
    Brookstone Homes, Inc. ("Brookstone")     December 31, 1996        Janesville, Madison, and Milwaukee
                                              (sold February 2001)     Wisconsin
                                              (see Note 21)
    D.W. Hutson Construction Company, now     February 28, 1997        Jacksonville, Florida
    known as Fortress Homes and Communities
    of Florida ("Fortress Florida")
    Wilshire Homes, Ltd. ("Wilshire")         April 1, 1997            Austin and San Antonio, Texas

    Don Galloway Homes, Inc. ("Galloway")     August 1, 1997           Charlotte, North Carolina and
                                                                       Charleston, South Carolina
    Iacobucci Homes ("Iacobucci")             October 1, 1997          Philadelphia, Pennsylvania
    WestBrook Homes ("WestBrook")             January 1, 1998          Loudoun County, Virginia
                                              (phased out during
                                              1999)
    Whittaker Construction ("Whittaker")      March 1, 1998            St. Louis, Missouri
    Quail Construction ("Quail")              April 1, 1998            Portland, Oregon
</TABLE>

In January 1997, Fortress formed Fortress Mortgage, Inc. ("Fortress
Mortgage"), a wholly-owned subsidiary, to provide mortgage lending services to
the customers of the Company's builder subsidiaries. Fortress Mortgage is
licensed as a mortgage banker in Alaska, Arizona, California, Colorado,
Florida, Illinois, Missouri, New Jersey, North Carolina, Oregon, Pennsylvania,
South Carolina, Texas, Virginia, Washington and Wisconsin.

The Company's reportable segments are homebuilding and financial services. The
Company's various homebuilding subsidiaries comprise the homebuilding segment.
These subsidiaries engage in acquiring or developing land primarily on which
to build residential for-sale housing. Fortress Mortgage is the financial
services segment. Its function is to originate mortgage loans primarily to the
buyers of homes constructed by the homebuilding segment of the Company.

                                     F-7

<PAGE>   47


NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The accompanying consolidated financial statements include the accounts of
Fortress, a Delaware corporation, and its majority-owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated in
consolidation.

Each acquisition subsequent to the Offering has been accounted for under the
purchase method of accounting. The purchase price of each of the acquired
companies was allocated first to record the assets and liabilities acquired at
estimated fair value on the acquisition date with any remaining balances
recorded as goodwill.

The consolidated statements of operations, shareholders' equity and cash flows
include the results of Fortress, inclusive of the Predecessor Companies and
all of the companies acquired since their respective dates of acquisition.

Certain prior period amounts have been reclassified to conform to the current
year presentation. All periods presented have been restated except for, the
consolidated balance sheet as of December 31, 1999 and the consolidated
statement of shareholders' equity which, have not been restated to take into
account the effects of a one-for-four reverse stock split implemented July 10,
2000.

GENERAL POLICIES

Cash and cash equivalents

For purposes of reporting cash flows, the Company considers all highly liquid
investments with an original maturity of three months or less to be cash
equivalents.

Property and equipment

Property and equipment are carried at cost less accumulated depreciation and
are depreciated using the straight-line method over the estimated useful lives
of the assets, which range from two to ten years. Significant additions and
improvements are capitalized while expenditures for repairs and maintenance
are charged to operations as incurred. Costs incurred for common area model
improvements and certain furnishings are amortized on a per unit basis as home
sales in the related development are closed.

Deferred financing costs

Costs associated with the issuance of the 13.75% Senior Notes (see Note 8 -
Notes and Mortgages Payable) have been capitalized and are being amortized
using the straight-line method over the seven-year term of the related notes.

Beneficial conversion feature

In accordance with Emerging Issues Task Force Topic D-60, Accounting for the
Issuance of Convertible Preferred Stock and Debt Securities with a
Non-detachable Conversion Feature, the Company recorded a $274,000 "discount"
for the 11,700 shares of Class AA convertible preferred stock issued during
1997. (See description of preferred stock in Note 9 - Shareholders' Equity.)
As required by Topic D-60, the Company amortized this discount using the
effective interest method from the date of issuance, September 30, 1997,
through the date at which the Class AA was exchanged for Class AAA preferred
stock. This amortization was recognized as an additional return to the
preferred shareholders (see Note 10 - Earnings per Share) and is included in
the Statement of Shareholders' Equity for the year ended December 31, 1998 as
an "imputed preferred stock dividend."

Use of estimates

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

                                     F-8

<PAGE>   48


Homebuilding Segment Policies

Revenue recognition

Residential homes and lot sales are recognized when all conditions precedent
to closing have been fulfilled and title has passed to the buyer. The
Company's homes are generally sold in advance of their construction. The
Company's standard sales contract generally requires the customer to make an
earnest money deposit, which is recognized as a liability until the unit
closes.

Real estate inventories and cost of sales

Real estate inventories are carried at the lower of cost or fair market value
as measured in accordance with Statement of Financial Accounting Standards
("SFAS") SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of. Costs incurred which are included in
inventory consist of land, land development, direct and certain indirect
construction costs, capitalized interest during the period of development
through the completion of construction, real estate taxes, direct model
construction costs, and related improvements.

At the time of revenue recognition, cost of sales is charged with the actual
construction costs incurred and an estimate of cost to complete, plus an
allocation of the total estimated cost of land and land development, interest,
real estate taxes and any other capitalizable common costs based on the
relative sales value method of accounting.

Certain components of cost of sales, particularly those pertaining to land
development, are based on management estimates of the total expected costs of
an ongoing project. These estimates are subject to change.

Warranty Costs

The Company generally provides a one-year limited warranty of workmanship and
materials with each of its homes. Accordingly, a warranty reserve, based on
the Company's historical experience, is provided as residential sales are
closed. Warranty reserves are included in "accrued expenses" and amounted to
approximately $3.7 million and $3.0 million as of December 31, 2000 and 1999,
respectively.

Investments in land partnerships

The Company records its investments in land partnerships in which it holds
less than a majority interest under the equity method of accounting.

Option deposits

The Company enters into option agreements that allow the takedown of land
under the specified terms. When a deposit is required, the Company records the
deposit amount in "other assets." When the land is taken down, the deposit
becomes part of the cost basis of the land and is reclassified as land
inventory. If the decision is made not to take down the land, the deposit is
expensed. Option deposits totaling approximately $17.3 million and $10.0
million are included in "other assets" at December 31, 2000 and 1999,
respectively.

Goodwill

Goodwill represents the excess of the purchase price over the fair value of
assets acquired and is being amortized over periods ranging from five to
twenty years. Accumulated amortization at December 31, 2000 and amortization
expense for the year then ended were $8.6 million and $2.5 million,
respectively. Accumulated amortization at December 31, 1999 and amortization
expense for the year then ended were $6.0 million and $2.6 million,
respectively. Accumulated amortization at December 31, 1998 and amortization
expense for the year then ended were $3.4 million and $2.4 million,
respectively. If facts and circumstances dictate, the Company evaluates the
recoverability of goodwill based on the estimated future undiscounted cash
flows associated with the assets. In the event that the analysis indicates
that the carrying value of goodwill is impaired, it would be written down to
its estimated fair value. During the first quarter of 1999, the Company sold
the assets of Landmark and wrote off unrecovered goodwill of $3.0 million.
During the second quarter of 1999, the Company wrote off $0.3 million in
remaining goodwill of WestBrook as part of its decision to wind down the
operations of that subsidiary. Also

                                     F-9

<PAGE>   49

during the fourth quarter of 2000, the Company wrote off $1.8 million and $2.2
million in remaining goodwill of Quail and Brookstone respectively, included
with an asset impairment charge with respect to each of these companies. (See
Note 12 - Asset Impairment Charge and Note 14 - Related Party Transactions)

Minority interest

Certain of the Company's subsidiaries are participants in real estate joint
ventures in which parties unrelated to the Company own a minority interest.
Joint venture profits are allocated to the Company and the other partners
according to their respective ownership.

New accounting pronouncements

In 1999, the Securities and Exchange Commission ("SEC") staff issued Staff
Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements." SAB 101 explains how generally accepted accounting principles
should be applied in the recognition of revenue in financial statements. The
Company implemented SAB 101 in the fourth quarter of 2000. The adoption of SAB
101 did not have a material effect on the financial position or results of
operations of the Company.

FINANCIAL SERVICES SEGMENT POLICIES

Mortgage income

SFAS No. 91, Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases, requires
the deferral of loan origination income and direct loan origination costs over
the estimated life of the loans. The Company defers the loan fees and costs
and recognizes them at the time of sale of the loans. A total of $10,671 and
$64,984 was recorded as part of the loans held for sale balance for
unamortized loan origination fees and costs recognized under SFAS No.91 as of
December 31, 2000 and 1999, respectively.

Gains and losses from sales of mortgage loans are recognized at the time of
sale and are determined by the difference between net sale proceeds and the
carrying value of the mortgage loans sold.

Recognition of gains and losses is based on SFAS No. 125, Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,
which was effective for transfers and servicing of financial assets and
extinguishment of liabilities occurring after December 31, 1996. SFAS No. 125
is based upon consistent application of a financial components approach that
focuses on control. Under that approach, after a transfer of financial assets,
an entity recognizes the financial and servicing assets it controls and the
liabilities it has incurred, reverses financial assets when control has been
surrendered, and reverses liabilities when extinguished. The Company will
adopt SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets
and Extinguishment of Liabilities, in 2001, which will not have a material
effect on the financial position or results of operations of the Company.

The Company does not retain servicing on loans sold.

Mortgage loans

Mortgage loans held for sale to nonaffiliated investors are recorded in the
aggregate at the lower of cost or market. Fair value is based upon
contractually established prices at which mortgage loans will be sold or, if
loans are not committed for sale, at current market prices. Mortgage loans
associated with construction loans consist of draws that have been funded
under a specific program developed for borrowers buying upper-end homes in
Nevada. No valuation allowance was required at December 31, 2000 or 1999.

New accounting pronouncements

In 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, as amended by SFAS 138, "Accounting
for Derivative Instruments and Hedging Activities" ("SFAS 133"). These
standards established accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts and hedging activities. The Company intends to adopt SFAS 133 in the
first quarter of fiscal 2001. The adoption of SFAS 133 will not have a
material effect on the financial position or

                                     F-10

<PAGE>   50

results of operations of the Company. The Company's only derivative is in the
form of mandatory forward looking commitments on loan sales.

NOTE 3 - ACQUISITIONS

The Company made no acquisitions during 2000 and 1999.

Effective January 1, 1998, the Company acquired certain assets and assumed
certain related indebtedness of WestBrook. Additionally, the Company acquired
the stock of Whittaker and Quail effective March 1, 1998 and April 1, 1998,
respectively. The initial purchase price for these acquisition totaled $86.7
million consisting of cash of $30.0 million, short-term notes of $0.5 million,
preferred stock with a liquidation value of $2.0 million, and assumption of
liabilities totaling $54.2 million.

Several of the Company's acquisition agreements include earnout provisions, by
which the seller(s) may receive future consideration based upon the
operational results of the purchased business. These provisions generally
extend two to four years past the purchase date and are calculated as a set
percentage of operational results in excess of operational goal "hurdles." In
each of the acquisitions that include earnout provisions, the earnout
consideration is accounted for as additional purchase price and, accordingly,
increases the goodwill related to the acquisitions and is amortized over the
corresponding remaining goodwill amortization periods. Pursuant to these
agreements, the Company has recorded additional purchase price for earnouts in
the amount of approximately $0.1 million, $2.0 million and $3.8 million for
the years ended December 31, 2000, 1999 and 1998, respectively.

NOTE 4 - SUPPLEMENTAL CASH FLOW INFORMATION

Supplemental disclosures of cash flow information are as follows (in
thousands):

<TABLE>
<CAPTION>
                                                                           For the Year
                                                                        Ended December 31,
                                                                   2000           1999      1998
                                                                   ----           ----      ----
<S>                                                             <C>            <C>         <C>
     Cash paid for the following:
      Interest                                                   $37,316        $34,849    $32,415
      Income taxes                                               $10,254        $ 6,065    $10,838
</TABLE>

Significant non-cash transactions

     In connection with acquisitions, the Company paid the following in the form
     of the Company's common and preferred stock during 2000, 1999 and 1998:
         (Dollars in thousands)

<TABLE>
<CAPTION>
                                                                   2000           1999      1998
                                                                   ----           ----      ----
<S>                                                             <C>            <C>         <C>
         Preferred Shares                                            0              0      19,881
         Common Shares                                               0              0           0
         Amount                                                      0              0      $1,988
</TABLE>

     Also in connection with acquisitions, the following contingent
     consideration amounts ("earnouts") were recorded as non-cash transactions.

<TABLE>
<CAPTION>
                                                                   2000            1999     1998
                                                                   ----            ----     ----
<S>                                                             <C>            <C>         <C>
         Applied against amounts advanced
          to sellers at acquisition                              $    0         $    57    $1,393

         Recorded as due to related parties at year end          $    99        $ 1,927    $2,372
</TABLE>

     In accordance with a Restructuring Agreement dated December 31, 1998
     between the Company and Prometheus Homebuilders LLC (Prometheus), the
     Company issued 40,000 shares of Class AAA Redeemable Convertible
     Preferred Stock in exchange for 40,000 shares of Class AA Convertible
     Preferred Stock, effective February 4, 1999 (see Note 9- Shareholders'
     Equity).

     As part of the Restructuring Agreement referenced above, and in
     conjunction with the partial redemption of the Company's Class AAA
     preferred stock, which occurred during 1999, the Company incurred a
     potential

                                     F-11

<PAGE>   51

     obligation to arrange for the sale of a portion of the Class AAA holder's
     common stock holdings and to guarantee the net proceeds received from
     that sale. The Company believes that this obligation has expired (see
     Note 21 - Subsequent Events) and, as such, the Company has reclassified
     as shareholders' equity the portion of shareholders' equity that was
     reserved for this obligation and that had previously been excluded from
     total shareholders' equity. (see Note 9 - Shareholders' Equity).

     The Company is amortizing debt issuance costs associated with its 13.75%
     Senior Notes (see Note 8 - Notes and Mortgages Payable) over the
     remaining term of those notes. The Company amortized approximately $1.1
     million in such fees in each of the years ended 2000, 1999 and 1998.
     These financing costs were capitalized into inventory along with other
     interest and financing costs incurred in accordance with SFAS No. 34,
     Capitalization of Interest Cost.


NOTE 5 - REAL ESTATE INVENTORIES

Real estate inventories are summarized as follows (in thousands):

<TABLE>
<CAPTION>
                                                          December 31,
                                                     2000              1999
                                                     ----              ----
<S>                                                <C>             <C>
   Work-in-progress
     Sold homes                                    $ 99,580         $100,759
     Speculative                                     47,135           70,228
                                                    -------         --------
      Total work-in-progress                        146,715          170,987

   Land
     Finished lots                                   99,593          105,432
     Land under development                          38,035           22,420
     Unimproved land held for development            12,753           13,924
                                                   --------         --------
      Total land                                    150,381          141,776

   Lumber yard inventory                              2,651            2,404
   Model homes                                        8,440           13,346
                                                    -------         --------
                                                   $308,187         $328,513
                                                    =======         ========
</TABLE>

Model homes are constructed to assist in the marketing effort of a
development. Speculative homes, included above in work-in-progress, represent
both completed and under-construction, non-model homes, which are not subject
to a sales contract. Both work-in-progress and model homes include the
allocation of land, land development, and other allocable costs.


NOTE 6 - INTEREST

Information regarding interest is as follows (in thousands):

<TABLE>
<CAPTION>
                                                                     2000        1999         1998
                                                                     ----        ----         ----
<S>                                                               <C>          <C>         <C>
     Interest incurred                                            $ 36,891     $ 34,315    $ 32,444
     Interest capitalized                                          (32,093)     (28,514)    (26,142)
     Relief of previously capitalized interest                      32,015       28,543      24,271
                                                                   -------      -------      ------
       Total interest expensed in statement of operations         $ 36,813     $ 34,344    $ 30,573
                                                                   =======      =======      ======

     Capitalized interest in ending inventory                     $ 23,159     $ 23,081    $ 23,426
                                                                   =======      =======      ======
</TABLE>


                                     F-12

<PAGE>   52



NOTE 7 - PROPERTY AND EQUIPMENT

Property and equipment is summarized as follows (in thousands):

<TABLE>
<CAPTION>
                                                                        December 31,
                                                                    2000            1999
                                                                  --------        --------
<S>                                                               <C>              <C>
     Buildings                                                    $    434        $    410
     Model home upgrades and furnishings                            12,155          10,749
     Equipment and furniture                                        10,955          10,053
     Vehicles                                                        1,717           1,361
     Plans                                                           2,614           1,767
     Leasehold improvements                                          1,950           1,625
                                                                  --------        --------
                                                                    29,825          25,965
     Less:  Accumulated depreciation and amortization              (18,793)        (13,573)
                                                                  --------        --------
                                                                  $ 11,032        $ 12,392
                                                                  ========        ========
</TABLE>

NOTE 8 - NOTES AND MORTGAGES PAYABLE

Notes and mortgages payable consist of the following (in thousands):

<TABLE>
<CAPTION>
                                                                        December 31,
                                                                    2000            1999
                                                                  --------        --------
<S>                                                               <C>              <C>
    13.75% Senior Notes due 2003                                  $100,000        $100,000
    Project specific land, land development and
        construction loans                                         172,483         183,298
    Mortgage warehouse lines of credit                              11,422          19,242
    Other loans                                                      4,349           2,850
                                                                  --------        --------
                                                                   288,254         305,390
    Less:  Unamortized debt issuance costs                          (2,613)         (3,732)
                                                                  --------        --------
                                                                  $285,641        $301,658
                                                                  ========        ========
</TABLE>

The Company pays interest on the Senior Notes in arrears on May 15 and
November 15 of each year at the rate of 13.75% per annum. The Senior Notes may
not be redeemed at any time prior to maturity. The Senior Notes are unsecured
and rank pari passu with, or senior in right of payment to, all other existing
and future unsecured indebtedness of the Company. The Senior Notes, however,
are effectively subordinated to secured debt of the Company to the extent of
any collateral, as well as to the Company's subsidiaries indebtedness. The
Company is required to maintain a consolidated tangible net worth of at least
$15.0 million and other financial covenants, as defined, in the Senior Note
Indenture. The Company was in compliance with these financial covenants at
December 31, 2000 and 1999.

In addition to financial covenants, the Senior Note Indenture imposes certain
operating restrictions on the Company, based on its performance. These
provisions place certain restrictions on the Company's ability to incur new
debt above levels previously outstanding if the Company's Consolidated Fixed
Charge Coverage Ratio, (basically EBITDA to interest incurred for the
Company's Restricted Subsidiaries) is below a ratio of two to one. The Senior
Note Indenture also restricts, and under certain conditions prevents, certain
payments including the payment of dividends and the repurchase or redemption
of the Company's stock. As of December 31, 2000 and 1999, the Company had in
excess of $12.2 million and $9.0 million, respectively, available for such
payments, subject to the potential limitations discussed in this paragraph.
Since June 30, 2000, the Company's Consolidated Fixed Charge Coverage Ratio
has been below a ratio of two to one, thereby potentially limiting the
Company's ability to make any such restricted payments (See Note 9 -
Shareholders' Equity).

The loan agreements for project specific land, land development and
construction loans are secured by a lien on the applicable residential
development project or a specific unit under construction. Repayment of the
loans are generally due upon sale of the collateral property. The loans bear
interest at annual variable rates ranging from 200 basis points over the LIBOR
rate to 1.5% over Prime rate and fixed rates ranging from zero interest to
9.8%. Certain of the subsidiary credit facilities contain covenants that limit
the subsidiary's overall ratio of debt to tangible

                                     F-13

<PAGE>   53

net worth, and other covenants including minimum tangible net worth, current
ratio and interest coverage. In addition, a few of the credit facilities
include similar covenants at the Company level.

As of December 31, 2000, one of the Company's subsidiaries, Christopher Homes
LLC, was not in compliance with its minimum tangible net worth covenant of $15
million, contained in its credit agreement with the lender. Currently, the
lender has not declared a default as a result of this technical non-compliance
with the net worth covenant. The principal reason for Christopher Homes'
continued non-compliance with this covenant is the Company's inability to invest
the required amount in Christopher Homes as a result of the potentially
applicable restrictions on certain investments that are contained in the Senior
Note Indenture. Christopher Homes is not in default of any of its payment
obligations to the lender. The current principal amount outstanding to the
lender is approximately $24.6 million. This amount is secured by a lien on the
assets of Christopher Homes. The loan is not cross-collateralized with any of
the Company's other operating subsidiaries and no default in respect of the loan
would, by reason of the default alone, cause a default in respect of any other
loans to the Company or any of its subsidiaries. The Company is working with the
lender to secure continued financing from the lender for Christopher Homes. No
assurances can be given that the lender will agree to waive the effects of this
non-compliance or that the lender will agree to continue to finance Christopher
Homes.

The Company's mortgage subsidiary has two lines of credit outstanding for the
purpose of originating loans. The lines of credit are secured by the mortgage
loans held for sale and are repaid upon sale of the mortgage loans. These
lines bear interest at variable rates ranging from 1.5% over the LIBOR rate to
1.5% over the Fed Funds rate based on the type of loan and lending
requirements. The aggregate commitment available under these lines was $40.0
million with $11.4 million outstanding at December 31, 2000.

One of the Company's subsidiaries has a line of credit for the purpose of
purchasing lumber yard inventory. The line of credit matures October 1, 2001
and bears interest at Prime minus 0.5%. At December 31, 2000, the total
commitment available is $2.0 million with $1.8 million outstanding. This
outstanding portion is included in "other loans" above. The remainder of other
loans consists primarily of debt financed corporate insurance policies which
bear interest at varying rates between 7.3% and 8.9%.

Principal maturities of the above indebtedness at December 31, 2000 are as
follows (in thousands):

<TABLE>
<CAPTION>
         Year Ended December 31,
         ----------------------
<S>                                     <C>
                2001                         $151,880
                2002                           34,590
                2003                          101,767
                2004                                5
                2005                                5
                Thereafter                          7
                                         ------------
                                             $288,254
                                         ============
</TABLE>

Under the Senior Note Indenture, the Company would be obligated to offer to
redeem all of the Senior Notes at 101% of their aggregate principal amount plus
any accrued and unpaid interest following a "change of control" of the Company,
as defined in the Indenture. This definition includes any transaction that
results in any person acquiring "beneficial ownership" (as defined in Securities
Exchange Act Rule 13d-3) of 50% or more of the total voting power of the
Company's stock. Unless the obligation under the Senior Note Indenture to make a
change in control offer following a change in control is removed (whether by
amendment, waiver, payment of the Senior Notes or otherwise) or the Supplemental
Warrants are further amended, the Company would be required to commence to make
a "change in control offer" by no later than 30 days prior to September 30, 2001
(See Note 21 - Subsequent Events).

NOTE 9 - SHAREHOLDERS' EQUITY

Preferred stock

The Company has authorized 1 million shares of $.01 par value preferred stock.
The following are the Company's classes and series of preferred stock, amounts
designated, and amounts outstanding at December 31, 2000 and December 31,
1999:


                                     F-14

<PAGE>   54
      Class AAA cumulative convertible (rate of 9% per annum), 40,000
               designated, 28,500 issued and outstanding ($28.5 million
               aggregate liquidation  preference)
      Series C convertible, 70,000 designated, 2,433 and 18,493, respectively,
               issuable (See below)
      Series D convertible, 67,500 designated, 0 and 30,000, respectively,
               issued and outstanding ($0 aggregate liquidation preference)
      Series E convertible, 50,000 designated, 12,229 and 17,443, respectively,
               issued and outstanding ($1,222,900 aggregate liquidation
               preference)

In May 2000 the Company eliminated the following classes/series of preferred
stock, which were authorized but none of which were outstanding as of December
31, 1999:
         Class AA cumulative convertible
         Series A 11% cumulative convertible
         Series B convertible
         Series F convertible

Class AA

Effective September 30, 1997, the Company completed a first closing related to
its agreement with Prometheus Homebuilders LLC (Prometheus). In connection
with this agreement to sell Prometheus $75.0 million in preferred stock ($40.0
million in Class AA and $35.0 million in Class AB), the Company issued 53,333
shares of Class AA Convertible Preferred Stock. The Company, through its
Restructuring Agreement (see below) extinguished its obligation to sell the
Class AB stock. The Class AA preferred shares carried a cumulative 12% return
per annum, until the second closing at which time the rate was reduced to 6%
per annum, calculated on the liquidation value of $1,000 per share.

Under a Restructuring Agreement dated December 31, 1998 between the Company
and Prometheus, the Company agreed to issue to Prometheus, 40,000 shares of
Class AAA Redeemable Convertible Preferred Stock having an initial liquidation
value of $40.0 million in exchange for the outstanding 40,000 shares of Class
AA Convertible Preferred Stock having a liquidation value of $40.0 million
held by Prometheus. This exchange was effective February 4, 1999. In
connection with the restructuring agreement, the Company paid $5.0 million as
a non-recurring dividend on December 31, 1998.

Class AAA

The Class AAA preferred stock ranks senior to the Company's common stock as to
the payment of dividends and distributions upon the dissolution, liquidation
or winding up of the Company. Dividends are payable in cash at the annual rate
of 9% cumulative and compounded quarterly, on the liquidation value of $1,000
per share. The Company is required to declare and pay such dividends to the
extent that funds are legally available for the payment of dividends. The
Class AAA preferred stock is convertible, in whole or in part, at the option
of the holder, into the Company's common stock, at any time after issuance, at
an initial conversion price of $24.00 per share, subject to certain customary
anti-dilution adjustments. In conjunction with the issuance of the Class AAA
preferred stock, the Company also issued Supplemental Warrants. These
supplemental warrants include "reset" provisions substantially the same as
those previously included in the Class AA preferred stock. See the description
of the Supplemental Warrants, below.

The Company had the right to redeem the Class AAA Preferred Stock at any time
until December 31, 2000 for its liquidation value plus dividends that, when
combined with dividends previously paid on the Class AA preferred stock and
subsequent dividend payments on the Class AAA Preferred Stock, would have
provided a 20% annual return from the inception of Prometheus' investment in
the Company. The Company did not redeem any Class AAA Preferred Stock during
the year ended December 31, 2000. As of December 31, 2000, the Company has
redeemed $11.5 million in Class AAA Preferred Stock.

The Class AAA preferred stock includes provisions that would entitle
Prometheus to elect a majority of the Board following certain adverse events,
including any failure to pay the required dividends on the Class AAA preferred
stock or the amounts required to be paid in connection with the redemption of
the Class AAA preferred stock. Although the Company did not make dividends
payments for the 3rd or 4th quarters of 2000, Prometheus has not exercised its
rights to elect a majority of the board of directors but has reserved its right
to make such election. Dividends payable totaled $1.3 million and are included
in accrued expenses at December 31, 2000.

Under the terms of the Class AAA Preferred Stock, the Company is obligated to
pay, on a quarterly basis, a 9% annual dividend. Due to the potential
applicability of certain restrictions in the Senior Note Indenture, the amount
of

                                     F-15

<PAGE>   55

dividend due for the quarter ended September 30, 2000 and December 31, 2000
was not paid and is included in accrued expenses. (See Note 8 - Notes and
Mortgages Payable)

In conjunction with the issuance of the Class AAA Preferred Stock, the Company
also issued Supplemental Warrants. Subject to the stock price and revenue tests
described below, the Supplemental Warrants become exercisable at an exercise
price of $0.01 per share of common stock and expire on March 31, 2004. The
number of shares of common stock subject to the Supplemental Warrants is
subject to adjustment depending upon the 60 day average closing price of the
common stock between the period from September 30, 2001 and September 30, 2003.
If during such period the closing price remains greater than $48.00 per share,
no shares would be issuable pursuant to the Supplemental Warrants. If during
such period the closing price is $48.00 per share or less, the number of shares
of common stock issuable upon the exercise of the Supplemental Warrants could
be adjusted, up to five times per year, in accordance with the following table:

<TABLE>
<CAPTION>
           Issue Price ($)          Warrants
        ------------------      ------------
<S>                             <C>
        $48.01 or greater                  0
           40.01 -  48.00            107,955
           32.01 -  40.00            237,500
           24.01 -  32.00            593,750
           16.01 -  24.00          1,187,500
            8.01 -  16.00          2,375,000
            0.00 -   8.00          5,937,500
</TABLE>

The number of shares into which each Supplemental Warrant may be exercisable
will also be subject to certain customary anti-dilution adjustments. The
exercisability of the Supplemental Warrants was subject to a revenue test,
which provided that the Supplemental Warrants may not be exercised unless the
Company's consolidated revenues for the most recent 16 full fiscal quarters
exceeded $2,397,225,750 (as adjusted for the sale of any Company subsidiary).
During the third quarter of 2000 the revenue threshold was achieved and
consequently the Supplemental Warrants have vested and become exercisable on
September 30, 2001 (See Note 21 - Subsequent Events).

In connection with the issuance of the Class AAA preferred stock and the
issuance of the Supplemental Warrants, Prometheus surrendered for cancellation
outstanding warrants to purchase 93,750 shares of the Company's common stock,
and the parties terminated the Company's obligation to issue, and Prometheus'
obligation to purchase, $35.0 million liquidation value of Class AB preferred
stock and warrants to purchase an additional 156,250 shares of common stock,
which would have been issued in connection with the issuance of the Class AB
preferred stock.

Series A

As part of the acquisition of the Predecessors Companies, 20,000 shares were
issued in 1996 as Series A 11% cumulative convertible non-voting preferred
stock. The 10,000 shares outstanding at December 31, 1997 were converted
during the second quarter of 1998.

Series B

In connection with the Hutson acquisition, Fortress issued 12,000 shares net
of Series B convertible preferred stock with a liquidation value of $100 per
share. During 1998, these preferred shares were converted into common stock
and cash with a total value of $100 per share.

Series C

In connection with the Hutson acquisition, Fortress agreed to issue 60,000
shares (70,000 authorized) of Series C convertible preferred stock on an
annual basis over a period not to exceed six years ($6 million liquidation
preference). The acquisition agreement (as amended) allows the Company to pay
the earnout in cash or Series C preferred stock. The stock has been treated as
outstanding for the purpose of calculating earnings per share; however, it
will only be legally outstanding upon issuance. The Series C preferred stock
is convertible into common stock based on $100 liquidation value per Series C
share, payable in common stock, cash, or a combination of both, at the option
of Fortress. The 1997 earnout was paid in cash during 1998. The 1998 earnout
was paid in 1999 by issuing 21,163 shares of Series C stock, which were
immediately converted into 52,908 shares of common stock.


                                     F-16

<PAGE>   56


During the first quarter of 2000, the earnout for 1999 was paid in cash. At
December 31, 2000, 2,433 shares remain issuable.

Series D

In connection with the Galloway acquisition, Fortress issued 60,000 shares of
Series D convertible preferred stock with a liquidation value of $100 per
share ($6 million aggregate liquidation preference). Each Series D share is
convertible into 2.5 shares of common stock. Series D shares are redeemable at
the option of the holder up to 25% each year, cumulative, over a four-year
period. The shares can be redeemed in cash, common stock or a combination of
both equal to the $100 per share liquidation value. The allocation between
common stock and cash is at the sole option of Fortress. During each of 1998
and 1999, 15,000 shares were redeemed resulting in 30,000 shares outstanding
at December 31, 1999. During the fourth quarter of 2000 Fortress Mortgage
purchased the remaining 30,000 shares for $1,250,000, which are reflected as
treasury shares. All claims held by, and obligations to the former holder of
the Series D shares have been released and waived as of December 31, 2000.

Series E

The Company has designated 50,000 shares as Series E 6% convertible preferred
stock ("Series E"), with a liquidation value of $100 per share. In connection
with the WestBrook and Quail acquisitions, the Company issued 19,881 shares of
Series E. The purchase price was subsequently adjusted and 500 Series E shares
were returned to the Company. Each Series E share is convertible into 2.5
shares of common stock at any time at the option of the holder. After the
common stock has traded for $40.00 per share or more for ten consecutive
business days, the Company may require the conversion of the Series E at the
same 2.5-for-1 conversion rate. At the option of the holder, the Company may
be required to redeem up to 20% of the total number of shares initially issued
each year beginning with the first anniversary of the date of issuance in cash.
The holder's redemption right is cumulative. During 2000, the Company redeemed
5,214 shares, resulting in 12,229 shares outstanding at December 31, 2000. Due
in part to the potential limitations on the Company's ability to redeem
preferred stock, the Company did not redeem any Series E shares subsequent to
June 30, 2000. A holder of 1,000 Series E shares has filed an arbitration action
against the Company for wrongful failure to redeem 400 shares of stock, which
had allegedly become redeemable. The Company is strenuously defending against
this action and does not expect a material negative outcome.

Series F

In connection with the Whittaker acquisition, the Company loaned $500,000 and
then sold 5,000 shares of Series F 6% Cumulative Convertible Preferred Stock
("Series F") with a liquidation value of $100 per share to a key member of
management at Whittaker. The loan bore interest at 6%, which was offset by the
6% dividend rate on the Series F. The Series F was to be convertible, based on
the future earnings of the acquired business, for a period of 60 days
commencing on February 15, 1999, 2000, and 2001 at the closing price of the
Common Stock on the Closing Date and the first and second anniversaries of the
Closing Date, respectively. The loan was accounted for as a subscription
receivable in the equity section of the Company's balance sheet and was to be
reduced based on the future earnings of the acquired business. In the fourth
quarter of 1999, the Company redeemed the entire 5,000 shares, offsetting the
outstanding subscription receivable against the proceeds.

Common stock

In November 1996, the Company's Board of Directors approved a stock repurchase
plan authorizing the purchase of up to 87,500 shares of the Company's
currently outstanding common stock. Such repurchases were effected at various
prices from time to time in the open market. During the year ended December
31, 1998, the Company repurchased 36,250 shares. These shares and certain
others previously acquired were subsequently canceled with the total of 66,275
shares being cancelled in June of 2000.

Warrants

Under the agreement with Prometheus, the Company issued warrants to purchase a
minimum of 93,750 shares of common stock to Prometheus. The warrants were
exercisable between September 30, 1999 and September 30, 2004, at an exercise
price of $28.00 per share of common stock, subject to adjustment between
September 30, 2001 and September 30, 2003.

                                     F-17

<PAGE>   57

In connection with the issuance of the Class AAA preferred stock and the
related issuance of the Supplemental Warrants in the first quarter of 1999,
Prometheus surrendered for cancellation the outstanding warrants to purchase
93,750 shares of the Company's common stock. See the section describing the
Class AAA preferred stock for further discussion on the Supplemental Warrants.

NOTE 10 - EARNINGS PER SHARE

The following table reconciles the numerators (income) and the denominators
(shares) used to calculate the basic and diluted earnings per-share (in
thousands):

<TABLE>
<CAPTION>
                                                          FOR THE YEAR ENDED DECEMBER 31,
                                                      2000             1999              1998
                                                      ----             ----              ----
<S>                                               <C>              <C>              <C>
Net income                                         $    2,214       $    8,277       $   12,834

Less: Preferred stock dividends                        (2,669)          (3,128)          (7,330)
Less: Imputed preferred stock dividend                      0                0              (68)
                                                   ----------       ----------       ----------

Income/(loss) available to common shareholders     $     (455)      $    5,149       $    5,436
                                                   ==========       ==========       ==========
BASIC EPS
Income/(loss) available to common
     Shareholders                                  $     (455)      $    5,149       $    5,436
Weighted average number of
     common shares outstanding                      3,076,354        3,029,917        2,954,722
                                                   ----------       ----------       ----------

Basic earnings/(loss) per share                    $     (.15)      $     1.70       $     1.84
                                                   ==========       ==========       ==========
DILUTED EPS
Income/(loss) available to common
     shareholders, basic                           $     (455)      $    5,149       $    5,436
Plus preferred stock dividends                              0              335               28
                                                   ----------       ----------       ----------
Income/(loss) available to common
     shareholders, diluted                         $     (455)      $    5,484       $    5,464
                                                   ==========       ==========       ==========

Weighted average number of
     common shares outstanding                      3,076,354        3,029,917        2,954,722
Effect of dilutive securities:
     Preferred stock                                        0          626,457          280,001
     Options                                                0                0            1,046
     Warrants                                               0                0           49,290
                                                   ----------       ----------       ----------
Weighted average number of
     common shares outstanding, diluted             3,076,354        3,656,374        3,285,059
                                                   ==========       ==========       ==========

Diluted earnings/(loss) per share                  $     (.15)      $     1.50       $     1.66
                                                   ==========       ==========       ==========
</TABLE>

The Company's intention upon conversion or redemption (as the case may be and
if and when such conversion or redemption occurs) of Series C and E Preferred
Stock is to issue Common Stock on the basis of the 2.5-for-1 conversion ratio
contemplated in the respective agreements and to pay cash for the difference
between the $100 liquidation value per share and the market value of the
Common Stock converted at 2.5-for-1. Accordingly, the Company would normally
include in its calculation of earnings per share additional shares of common
stock to be issued under the "if converted" method at the 2.5-for-1 conversion
ratio.


                                     F-18

<PAGE>   58



The following common stock equivalents of the Company's various classes of
preferred stock were not included in the computation of diluted earnings per
share because the effect of adding back the related dividends and weighted
average common shares would be antidilutive:

<TABLE>
<CAPTION>
               Outstanding at December     Convertible into Common Shares   Potential Common Stock outstanding,
               31,                         as of  December 31,              twelve months ended December 31,

               2000       1999     1998    2000       1999       1998       2000       1999         1998
               ----       ----     ----    ----       ----       ----       ----       ----         ----
<S>            <C>        <C>      <C>     <C>        <C>        <C>        <C>        <C>          <C>
Class/
Series
Class AA       0          0        40,000  0          0          1,666,667  0          Dilutive     2,796,138
Class AAA      28,500     28,500   0       1,187,500  1,187,500  0          1,187,500  1,195,875    N/A
Series A       0          0        0       0          0          0          0          0            Dilutive
Series B       0          0        0       0          0          0          0          0            Dilutive
Series C       2,433      18,493   39,656  6,083      46,233     99,140     14,878     Dilutive     Dilutive
Series D       0          30,000   45,000  0          75,000     112,500    59,733     Dilutive     Dilutive
Series E       12,229     17,443   19,381  30,573     43,608     48,453     35,808     45,703       38,423
Series F       0          0        5,000   0          0          12,500     N/A        Dilutive     Dilutive
Common
Stock
Warrants       5,937,500  0        0       5,937,500  0          0          2,984,973  N/A          N/A
</TABLE>


SFAS No.128 requires that options are included in the earnings per share
calculation on a quarterly basis only when the average market price of the
common stock during that period exceeds the exercise price of the options. The
options included in the annual computation of earnings per share is based on
the average of the four quarters. Certain options were not included in the
computations of diluted EPS at certain quarter-ends because the options'
exercise price was greater than the average market price of the common shares.
Note 16 - Employee Benefit and Incentive Plans contains more detailed
disclosure regarding the Company's outstanding options.

NOTE 11 - SALE OF ASSETS AND SPECIAL CHARGES

On March 26, 1999, the Company sold the assets of Landmark and realized a loss
of $2.9 million. As of the disposition date, Landmark had total assets of
approximately $11.3 million, which included unrecovered goodwill of
approximately $3.0 million. The total selling price was approximately $8.3
million.

On March 31, 1999 the Company, as part of a restructuring of its Texas
operations, sold its interest in several land partnerships in its Austin and
San Antonio markets. The total proceeds to the Company from this sale were
approximately $5.4 million and were received in April 1999. The gain on the
sale of these partnership interests of approximately $291,000 is included in
other income in the accompanying Consolidated Statement of Operations.

Concurrent with the decision to sell its interest in several land partnerships
in Texas, the Company decided to exit certain communities. Restructuring costs
totaling $480,000 related to employee severance, carrying costs for model
homes, and the write off of other product-line related assets that were
determined to provide no future benefit under the restructured Wilshire
operation. As of December 31, 1999, substantially all of the estimated
restructuring costs had been paid and charged against the liability.

In addition, during the second quarter of 1999 the Company decided to wind
down the operations of its WestBrook Homes subsidiary. Charges taken during
the first quarter of 1999 totaled $790,000 and included the write off of land
purchase deposits, previously capitalized architectural costs, other land
development costs and $294,000 in remaining goodwill. As of December 31, 1999,
all of these costs had been incurred and charged against the liability. Two
homes remained in WestBrook's inventory as of December 31, 1999, both of which
closed during the first quarter of 2000.

During 1999 the Company sold a 960-acre parcel of land located in Raleigh,
North Carolina. The land had been carried on the Company's books as land held
for resale. The $8.2 million sales price for the property resulted in a gain
of approximately $108,000. The gain on the sale of this property is reflected
in the income statement as other income.

                                     F-19

<PAGE>   59

NOTE 12 - ASSET IMPAIRMENT CHARGE

The Company determined that an adjustment to current carrying value was
appropriate for several communities in 1999 and 2000 in accordance with
Statement of Financial Accounting Standard No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
The fair value of the communities was determined using a discounted cash flow
projection of future revenues and current and projected costs. The assets
involved include developed lots, homes under construction, and completed
homes.

During the third quarter of 1999, the Company evaluated the carrying value of
two communities in its Las Vegas market. These two communities closed out
during the year 2000. Based on the analysis of fair value, referenced above,
the Company recognized during the third quarter an asset impairment charge of
approximately $2.0 million. This charge has been included in the Company's
determination of Net Operating Income.

During the fourth quarter of 2000, the Company evaluated the carrying value of
two additional communities in its Las Vegas market. These two communities will
potentially be closed out or at a minimum sold out during the year 2001 with a
total of 52 homes remaining to close. Based on the analysis of fair value,
referenced above, the Company recognized during the fourth quarter an asset
impairment charge of approximately $7.0 million. This charge has been included
in the Company's determination of Net Operating Income.

During the fourth quarter of 2000, the Company evaluated the carrying value of
seven communities in its Portland MSA market. These seven communities are
scheduled to be closed out during the year 2001 with a total of 93 homes
remaining to close. Based on the analysis of fair value, referenced above, the
Company recognized during the fourth quarter an asset impairment charge of
approximately $5.2 million ($1.8 million of goodwill). This charge has been
included in the Company's determination of Net Operating Income.

During the fourth quarter of 2000, the Company determined to sell the
Brookstone subsidiary. Based on the sales price the Company recognized an
impairment charge of $2.6 million. Included in this charge is $2.2 million of
goodwill. The subsidiary was sold February 28, 2001 (See Note 21 - Subsequent
Events).


NOTE 13 - OTHER INCOME & EXPENSES

The Company's St. Louis operation owns and maintains a lumberyard that
provides lumber and millwork to the homebuilder. Intercompany sales are
eliminated in consolidation and profits deferred until the homes close.
Beginning in 1999, the lumberyard began to sell products to outside customers.
Revenues and costs associated with these outside sales are netted in other
income. For the year ended 2000 and 1999, the lumberyard generated outside
revenue of approximately $3.0 and $2.4 million respectively, and profit of
$153,000 and $102,000 respectively.

This subsidiary also owns a title company that was formed to capture profits
from title insurance issued on the sale of its' homes. Revenue and costs
associated with the title insurance operation are included in other income.
For the year ended December 31, 2000 and 1999, the title company generated
revenue of $338,000 and $454,000 respectively, and profit of $115,000 and
$171,000 respectively. For the period from the date of acquisition through
December 31, 1998, the title company generated revenue of $329,000 and profits
of $80,000.

NOTE 14 - RELATED PARTY TRANSACTIONS

Due to related parties

Due to related parties, which are included in accrued expenses at December 31,
2000 totals $1.7 million. The balance is made up of approximately $99,000
representing accrued but not paid earnouts due to the former owners of certain
acquisitions, $1.4 million representing accrued dividends payable and the
balance representing individually immaterial amounts due to various related
parties.

Other transactions

During 1998 the Company sold and leased back 2 model homes to related parties.
Total revenue recognized in connection with these sales was approximately
$406,500; and the total gross profit recognized on these sales was $19,000.
(See Note 15 - Leases.)

                                     F-20

<PAGE>   60

During 2000, 1999, and 1998, Fortress Florida purchased a majority of its
finished lots under written agreements with an entity whose principal is a
significant holder of the Company's Series B and C preferred stock. In 2000,
1999, and 1998, Fortress Florida purchased approximately $13.9 million, $16.1
million and $18.0 million, respectively, of such lots. Fortress Florida had
deposits of approximately $0.5 million at December 31, 2000 with this related
party for future acquisitions of finished lots with an aggregate purchase
price of approximately $2.1 million. Fortress Florida intends to fulfill its
obligation under this agreement by acquiring these remaining lots. (See Note
20 - Commitments and Contingencies.)

Fortress Florida contracted cabinetry, interior finish services and other
items from an affiliated party amounting to approximately $5.9 million, $5.0
million and $4.8 million for the years ended December 31, 2000, 1999 and 1998,
respectively.

Pursuant to an option agreement executed simultaneously with the acquisition
of Iacobucci, the Company has an option to acquire land from certain parties
related to Iacobucci's vice presidents over a period of five years. In 2000,
1999, and 1998, the Company acquired 88, 117 and 169 of these lots,
respectively, at a total cost of approximately $1.3 million, $2.0 million and
$5.8 million, respectively. The total purchase price of the remaining optioned
lots will be approximately $5.4 million. (See Note 21 - Commitments and
Contingencies.)

Pursuant to an agreement executed simultaneously with the acquisition of
Brookstone, the Company purchases finished lots from an entity owned by a
former officer of the Company. During the years ended December 31, 2000, 1999,
and 1998, the Company purchased 15, 39 and 66 lots for an aggregate purchase
price of $0.5 million, $1.1 million and $1.5 million, respectively.

A significant shareholder and director of the Company is a member of certain
limited liability companies ("LLCs") established for the purpose of
constructing and selling real estate. Christopher has been engaged as the
manager for the projects, offering sales and marketing and construction
expertise in exchange for fees amounting to $2.5 million in 2000. In addition,
Christopher has entered into an agreement with the shareholder and director
requiring him to share the profits from three of these LLCs' with the Company.

Another significant shareholder and director of the Company is a member of
several LLC's which are engaged in developing lots. Genesee has placed
deposits of $0.9 million with these LLC's, in exchange for an option agreement
to purchase lots from it. During the calendar year 2000 the Company purchased
71 lots totaling $4.8 million.


NOTE 15 - LEASES

The Company is obligated under various noncancelable operating leases for
office facilities, model homes and equipment expiring at various times through
2006. Rental expense under these agreements amounted to approximately $5.0
million, $5.6 million and $5.1 million for the years ended December 31, 2000,
1999 and 1998, respectively. Included in this amount is rent paid to
affiliated companies, under office, model home, and warehouse leases, totaling
$0.7 million, $0.9 million and $1.1 million for the respective periods.

Future minimum lease payments under noncancelable operating lease agreements
are as follows (in thousands):

<TABLE>
<CAPTION>
       Year Ended
      December 31,
      ------------
<S>                                       <C>
      2001                                  $ 4,106
      2002                                    2,389
      2003                                    1,453
      2004                                    1,028
      2005                                      836
      Thereafter                              1,745
                                           --------
                                            $11,557
</TABLE>

                                     F-21

<PAGE>   61

NOTE 16 - EMPLOYEE BENEFIT AND INCENTIVE PLANS

Bonus award plan

The Company has a bonus award plan under which directors, officers, employees
and key consultants of the Company may be awarded cash or common stock based
upon the satisfaction of specific performance criteria. The plan provides for
the grant of up to 143,750 shares of common stock. No awards have been made
under the plan as of December 31, 2000.

Profit sharing plan

The Company's profit sharing plan is a defined contribution plan qualified
under the Internal Revenue Code. All employees who have completed one-half
year of service with the Company may participate in the plan on the first day
of the month after becoming eligible. A participant's interest in Company
contributions are 100% vested after six years of credited service.
Contributions to the plan are entirely within the discretion of the Company's
Board of Directors and are determined annually. Company contributions to the
plan were approximately $629,000, $518,000 and $123,000 for 2000, 1999 and
1998, respectively.

Stock purchase plan

The Board of Directors of the Company has approved a stock purchase plan under
which 125,000 shares of the Company's common stock are reserved for issuance
and sale to substantially all of the employees of the Company at 85% of market
price of the stock on specified offering dates. The number of shares issued
and the average price per share under this plan during the years ended
December 31, 2000, 1999, and 1998 were 36,935 and $2.28, 27,856 and $5.32, and
5,809 and $14.88, respectively. At December 31, 2000, a total of 53,546 shares
were available for issuance.

Stock incentive plan

The Company has a stock incentive plan under which non-employee directors,
officers, key employees and consultants of the Company may be granted options
to purchase up to 387,500 shares of the Company's common stock. The stock
incentive plan also allows for the award of stock appreciation rights,
restricted stock and deferred stock. As of December 31, 2000, no stock
appreciation rights, restricted stock or deferred stock had been granted under
this plan.

The stock options granted may be either nonqualified or incentive stock
options although only employees of the Company may be granted incentive stock
options. The option price shall not be less than the fair market value of the
common stock on the date of grant; the option period shall not exceed ten
years from the grant date. Options granted as of December 31, 2000 vest over
various periods from immediately to over three years.

The Company accounts for its stock option plans under Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly,
as the option price equals the market price at the date of issuance, no
compensation expense is recognized for options issued to employees. The
Company provides disclosure in accordance with SFAS No. 123, Accounting for
Stock-Based Compensation.

The fair value of each stock option grant is estimated on the date of the
grant using the Black-Scholes option-pricing model, using the following
weighted average assumptions:

<TABLE>
<CAPTION>
                                                             Year Ended December 31,
                                                             -----------------------
                                                       2000           1999          1998
                                                       ----           ----          ----
<S>                                                    <C>         <C>           <C>
    Expected volatility                                 N/A           60%            50%
    Risk-free interest rate                             N/A           5.7%          5.0%
    Expected life                                       N/A        5.84 years    5.82 years

    Number of stock options granted                      0           45,250         6,875
    Weighted-average fair value of options granted      N/A          $3.86         $11.44
    Total value of stock options granted                N/A         $175,000        $79,000
</TABLE>

                                     F-22

<PAGE>   62

<TABLE>
<CAPTION>
    Had the Company determined the compensation cost of these
    options in accordance with SFAS No. 123, the following
    unaudited proforma results would have been reported:
<S>                                                     <C>              <C>           <C>
    Net Income                                            $2,075,000      $8,124,000    $12,610,000
    Earnings per share, basic                                $(0.19)        $1.65          $1.76
    Earnings per share, diluted                              $(0.19)        $1.46          $1.60
</TABLE>


Option activity is summarized as follows:

<TABLE>
<CAPTION>
                                                         Shares                       Weighted
                                                        available      Number          average
                                                       for options    of shares     option price
                                                       -----------    ---------     ------------
<S>                                                   <C>            <C>           <C>
As of December 31, 1997                                   143,732       137,518         $23.00
     Increase in shares available under the plan          106,250
     Grants                                                (6,875)        6,875          21.48
     Cancellations                                         20,993       (20,993)         23.48
                                                       ----------      --------          -----
As of December 31, 1998                                   264,100       123,400          23.08
     Grants                                               (45,250)       45,250           6.35
     Cancellations                                         62,339       (62,339)         22.85
                                                          -------       -------         ------
As of December 31, 1999                                   281,189       106,311          16.09
     Grants                                                     0             0
     Cancellations                                          5,771        (5,771)         22.98
                                                       ----------      ---------        ------
As of December 31, 2000                                   286,960       100,540         $15.69
</TABLE>

The following table summarizes information about options outstanding at
December 31, 2000:

<TABLE>
<CAPTION>
                                 Outstanding Options                 Exercisable Options
                                 -------------------                 -------------------
                                                 Remaining                         Weighted
   Range of Exercise     Number Outstanding     Contractual                        Average
         Prices         at December 31, 2000  Life (in years)   Exercisable     Exercise Price
<S>                     <C>                   <C>               <C>             <C>
     $5.50 - $6.50               45,250             8.6             23,375          $ 6.32
    $20.25 - $22.00              16,065             3.0             16,065          $21.52
    $23.75 - $24.00              30,750             5.6             30,750          $23.90
    $24.50 - $25.00               8,475             6.2              8,475          $24.79
                                -------             ---             ------          ------
                                100,540             6.6             78,665          $18.29
                                =======             ===             ======          ======
</TABLE>

                                     F-23


<PAGE>   63



NOTE 17 - INCOME TAXES

The provision for income taxes consists of the following (in thousands):

<TABLE>
<CAPTION>
                                   Year ended December 31,
                                2000        1999         1998
                                ----        ----         ----
<S>                          <C>          <C>          <C>
       Current:
          Federal             $ 7,559      $5,350       $7,638
          State                 1,437       1,773        1,577
                              -------      ------       ------
                                8,996       7,123        9,215
       Deferred:
          Federal              (5,996)       (579)        (379)
          State                (1,274)        (75)         (42)
                              -------      ------       ------
                               (7,270)       (654)        (421)

       Total                  $ 1,726      $6,469       $8,794
                              =======      ======       ======
</TABLE>

The provision for income taxes differs from the amount computed by applying
the Federal income tax statutory rate of 35% for the years ended December 31,
2000, 1999 and 1998, respectively, as follows (in thousands):

<TABLE>
<CAPTION>
                                                      2000      1999      1998
                                                      ----      ----      ----
<S>                                                <C>        <C>       <C>
    Income tax computed at statutory rate           $1,379     $5,161    $7,570
    State income taxes, net of Federal benefit         225      1,097       997
    Other, net                                         122        211       227
                                                    ------     ------    ------

    Total                                           $1,726     $6,469    $8,794
                                                    ======     ======    ======

    Effective Rate                                   43.8%      43.9%     40.7%
                                                    ======     ======    ======
</TABLE>

Deferred tax assets (liabilities) arise due to the recognition of income and
expense items for tax purposes in periods which differ from those used for
financial statement purposes. At December 31, 2000 and 1999, the net deferred
tax asset was comprised of the following (in thousands):


<TABLE>
<CAPTION>
                                                       2000         1999
                                                       ----         ----
<S>                                                  <C>        <C>
     Deferred Tax Assets:
     Warranty and other reserves                     $ 7,971       $1,743
     Depreciation                                      1,276            0
     Capitalized inventory                               348          365
     Payroll accruals                                    170          119
     Workers compensation accruals                       309          272
     Deferred profit                                     388          245
     Other                                                29           30
                                                     -------       ------
               Total gross deferred tax assets        10,491        2,774

      Deferred Tax Liabilities:
      Depreciation                                         0          (31)
      Prepaid expenses                                  (261)        (331)
      Amortization                                      (471)        (248)
      Rebates                                              0          (40)
                                                     -------       ------
               Total gross deferred tax liabilities     (732)        (650)

      Net deferred tax asset                         $ 9,759       $2,124
                                                     =======       ======
</TABLE>

Deferred tax assets are included with Prepaid expenses and other assets on the
balance sheet. Deferred tax liabilities are included with Accrued expenses on
the balance sheet.

                                     F-24

<PAGE>   64

Fortress and its wholly owned subsidiaries file a consolidated federal income
tax return. The consolidated tax return of Fortress has not been selected for
audit by the Internal Revenue Service since the Company's inception.

NOTE 18 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

Quarterly financial information for the years ended December 31, 2000 and 1999
is presented below. The sum of the individual quarterly data may not equal the
annual data due to rounding and fluctuations in weighted average shares
outstanding on a quarter-to-quarter basis.

<TABLE>
<CAPTION>
                                                            In Thousands Except Per Share Data
                                                                    Three Months Ended
----------------------------------------------------------------------------------------------------------------
                                       December 31, 1999(a)  September 30, 1999   June 30, 1999    March 31, 1999
                                       --------------------  ------------------   -------------    --------------
<S>                                      <C>                <C>                  <C>              <C>
  Revenues                                    $199,289           $174,913          $171,108          $143,147
  Net income/(loss)                             (3,911)             3,346             2,146               633
  Net income/(loss) per share, basic             (1.48)              0.87              0.48              0.00
  Net income/(loss) per share, diluted           (1.48)              0.29              0.47              0.00
</TABLE>

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------
                                         December 31, 1999  September 30, 1999   June 30, 1999    March 31, 1999
                                         -----------------  ------------------   -------------    --------------
<S>                                      <C>                <C>                  <C>              <C>
Revenues                                      $225,974           $182,076          $182,011          $150,724
Net income/(loss)                                4,514              2,278             3,429            (1,944)
Net income/(loss) per share, basic                1.26               0.53              0.88             (1.00)
Net income/(loss) per share, diluted              1.02               0.50              0.74             (1.00)
</TABLE>

         (a)  includes $14.8 million of impairment charges

NOTE 19 - FAIR VALUE OF FINANCIAL INSTRUMENTS

The financial instruments of the Company consist of accounts receivable, loans
held for sale, due to and from related parties, accounts payable and
construction liabilities and notes and mortgages payable. Mortgage loans held
for sale to nonaffiliated investors of $12.2 million and $20.2 million at
December 31, 2000 and 1999 are recorded in the aggregate at the lower of cost
or market. The estimated fair value of $12.3 million and $20.7 million at
December 31, 2000 and 1999 is based upon contractually established prices at
which mortgage loans will be sold or, if loans are not committed for sale, at
current market prices. The fair value of the Company's Senior Notes at December
31, 2000 and 1999, which are recorded at their carrying value of $100 million
is extremely difficult to determine based on the thinly traded market for the
Senior Notes. Based on available market information, the Company estimates the
value was approximately $40 million as of December 31, 2000, and $55 million
as of December 31, 1999, based on quoted market prices. The fair value of the
remainder of the financial instruments is equal to the recorded amounts due to
the short-term nature of the instruments.


NOTE 20 - COMMITMENTS AND CONTINGENCIES

The Company believes that the homebuilding industry is subject to risks and
uncertainties including 1) cyclical markets sensitive to changes in general
and local economic conditions; 2) volatility of interest rates, which may
affect homebuilding demand and credit availability; 3) seasonal and
weather-related factors; 4) significant fluctuations on building material
prices, finished lots and subcontracted labor; 5) counterparty non-performance
risk associated with performance bonds; and 6) environmental regulations.

In the ordinary course of business, the Company enters into option agreements
to purchase land. As of December 31, 2000, the Company had approximately $17.3
million in deposits outstanding to acquire land with an aggregate purchase
price of approximately $308.7 million.

The Company is involved in various routine legal proceedings incidental to the
conduct of its normal business operations. The Company's management believes
that none of these legal proceedings will have a material adverse impact on
the financial condition or results of operations of the Company.

                                     F-25

<PAGE>   65

Loan Commitments

Commitments to originate loans have an off-balance sheet market risk to the
extent that the Company does not have matching commitments to sell loans
originated under such commitments. Commitments to sell loans have off-balance
sheet market risk to the extent the Company does not have the available loans
to fill those commitments, which would require the Company to purchase the
loans in the open market.

At December 31, 2000 and 1999, the Company had mandatory or best efforts
delivery commitments to cover all of the Company's loans held for sale. As of
December 31, 2000 and 1999, the Company had commitments to originate loans
(pipeline) in the amount of $98.8 million and $107.5 million; which will sell
at the prevailing market rates at the time of closing.

NOTE 21 - SUBSEQUENT EVENTS

Sale of Brookstone Homes

In the fourth quarter of 2000 the Company made a decision to sell Brookstone
Homes. After an open auction process, the Company sold, on February 28, 2001,
the subsidiary to a company owned by the Company's former Chief Operating
Officer. The purchase price was $4.2 million before closing costs. The
operating revenues and income before impairment charges for Brookstone Homes
during the years ended December 31, 2000 and 1999 were $28.1 million and $1.1
million and $31.8 million and $2.3 million, respectively.

Prometheus Make-Whole Election Notice

By letter dated February 12, 2001, Prometheus delivered to the Company a
notice of election under section 2.6 of the Restructuring Agreement purporting
to confirm that it had elected to exercise its rights under section 2.6 of the
Restructuring Agreement. By letter dated February 15, 2001, the Company
advised Prometheus that it disagreed that a timely election had been made.
Each party has reserved its rights with respect to this matter. Depending on
the outcome of this dispute, the Company may be obligated to make the payments
required under 2.6 of the Restructuring Agreement, which amount to
approximately $1.4 million, and which would be accounted for as an equity
transaction.

Modification of Supplemental Warrant Exercise Date

By a letter of agreement dated March 29, 2001, Prometheus amended the
Supplemental Warrants to limit the number of Supplemental Warrants which may be
excused prior to the "Extended Exercise Date" to a number equal to the number of
shares of common stock of the Company which would not cause such Warrant Holder
or any "group" of which the Warrant Holder is a member to be deemed beneficially
own 50% or more of the aggregate voting power of the common equity of the
Company. The Extended Exercise Date is the first to occur of (a) January 2,
2002, (b) the day preceding the day on which any "Event of Default" under the
Indenture governing the Company's outstanding Senior Notes occurs, (c) the day
on which such Indenture ceases to require the Company to make a "Change of
Control Offer" upon the occurrence of a "Change of Control", or (d) the tenth
day prior to the record date for taking certain actions by stockholders of the
Company; provided that in no event shall the Extended Exercise Date be earlier
than September 30, 2001. Based upon the amendment to the Supplemental Warrants,
unless the obligation under the Senior Note Indenture to make a "Change of
Control Offer" following a change of control is removed (whether by amendment,
waiver, payment of the Senior Notes, or otherwise) or the Supplemental Warrants
are further amended, the Company would be required to commence to make a "Change
of Control Offer" by no later than 30 days prior to January 2, 2002.



                                     F-26