**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**Form 10-K**

**(MarkOne)**

**x**                                 ANNUAL REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

**For the fiscal year ended September 30, 2006**

**OR**

**o**                                   TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**For the transition period from                   to                   **

**Commission file number: 333-133278**

**KIMBALLHILL, INC.**

(Exactname of Registrant as specified in its charter)

| **Illinois**                                                        |   | **36-2177380**      |
|---------------------------------------------------------------------|--------|---------------------|
| (State or other jurisdiction                                        |   | (I.R.S. Employer    |
| of incorporation or organization)                                   |   | Identification No.) |
| **5999 New Wilke Road,  Suite 504  Rolling Meadows, Illinois** |   | **60008**           |
| (Address of principal executive offices)                            |   | (Zip code)          |

 

**(847) 364-7300**

(Registrant’stelephone number, including area code)

Securitiesregistered pursuant to Section 12(b) of the Act: 

| Title of each class | ** ** | **Name of each exchange on which registered** |
|---------------------|------------|-----------------------------------------------|
| **None**            | ** ** | **None**                                      |

 

Securitiesregistered pursuant to Section 12(g) of the Act: **None**

Indicate by check markwhether the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act.o  Yes   x  No

Indicate by check markwhether the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act.x  Yes   o  No

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.x  Yes   o  No

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein and will not be contained, to the best of the registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to thisForm 10-K.x  Yes   o  No

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

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

 

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

As of March 31, 2006,the last business day of the registrant’s most recently completed second fiscalquarter, there was no established public trading market for the registrant’sequity securities.

As of December 15,2006, there were 4,544,861 shares of common stock outstanding.

**DOCUMENTS INCORPORATED BYREFERENCE: NONE**

 

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**KIMBALL HILL, INC.AND SUBSIDIARIES**

**FORM 10-K**

**TABLEOF CONTENTS**
|            | ** ** | ** **                                                                                                          | ** ** | **PAGE** |
|------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|----------|
|       |       | PART I.                                                                                                        |       |     |
| ITEM 1.    |       | BUSINESS                                                                                                            |       | 3        |
| ITEM 1A.   |       | RISK FACTORS                                                                                                        |       | 12       |
| ITEM 1B.   |       | UNRESOLVED  STAFF COMMENTS                                                                                          |       | 19       |
| ITEM 2.    |       | PROPERTIES                                                                                                          |       | 19       |
| ITEM 3.    |       | LEGAL  PROCEEDINGS                                                                                                  |       | 19       |
| ITEM 4.    |       | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                |       | 19       |
|       |       | PART II.                                                                                                       |       |     |
| ITEM 5.    |       | MARKET  FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER  PURCHASES OF EQUITY SECURITIES |       | 20       |
| ITEM 6.    |       | SELECTED  FINANCIAL DATA                                                                                            |       | 21       |
| ITEM 7.    |       | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                         |       | 23       |
| ITEM 7A.   |       | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                           |       | 43       |
| ITEM 8.    |       | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                                        |       | 44       |
| ITEM 9.    |       | CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                               |       | 75       |
| ITEM 9A.   |       | CONTROLS  AND PROCEDURES                                                                                            |       | 75       |
| ITEM 9B.   |       | OTHER  INFORMATION                                                                                                  |       | 75       |
|       |       | PART III.                                                                                                      |       |     |
| ITEM 10.   |       | DIRECTORS,  EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                                             |       | 76       |
| ITEM 11.   |       | EXECUTIVE  COMPENSATION                                                                                             |       | 80       |
| ITEM 12.   |       | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS                    |       | 83       |
| ITEM 13.   |       | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                                      |       | 84       |
| ITEM 14.   |       | PRINCIPAL  ACCOUNTING FEES AND SERVICES                                                                             |       | 86       |
|       |       | PART IV.                                                                                                       |       |     |
| ITEM 15.   |       | EXHIBITS  AND FINANCIAL STATEMENT SCHEDULES                                                                         |       | 87       |
| SIGNATURES |       | 94                                                                                                                  |

 

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Certain statements included in thisAnnual Report on Form 10-K contain “forward-looking statements”within the meaning of the Private Securities Litigation Reform Act of 1995.These forward-looking statements represent our current expectations orforecasts of future events, and no assurance can be given that the resultsdescribed in this report will be achieved. You can identify theseforward-looking statements by the fact that they do not relate strictly tohistoric or current facts. They use words such as “anticipate”, “believe”, “estimate”,“expect”, “forecast”, “goal”, “intend”, “objective”, “plan”, “projection”, “seek”,“strategy”, or other words and terms of similar meaning. Any or all of theforward-looking statements included in this report and in any other of ourreports or public statements may not approximate actual experience, and theexpectations derived from them may not be realized, due to known or unknownrisks and uncertainties. Many factors could cause our actual activities orresults to differ materially from the activities and results anticipated inforward-looking statements. These factors include those described in Item 1, “Business”,Item 1A, “Risk Factors” and Item 7, “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” included in this Form 10-K. Youshould understand that it is not possible to predict or identify all suchfactors. Consequently, you should not consider any such list to be a completeset of all potential risks or uncertainties. We do not undertake any obligationor duty to update forward-looking statements.

**PART I**

**Item 1.**                        Business

**Our company**

We are one of the largestprivately-owned homebuilders and one of the 30 largest homebuilders in theUnited States, as measured by home deliveries and revenues. We design, buildand market single-family detached, single-family attached and multi-familyhomes. Since we were founded in 1969, we have delivered over 44,000 homes to abroad range of customers, including first-time buyers and first- andsecond-time move-up buyers. Throughout this period, we have grown our businessorganically and operate within 17 markets, including Chicago, Dallas, Ft.Worth, Houston, Las Vegas, Sacramento and Tampa, in five regions: Florida, theMidwest, Nevada, the Pacific Coast and Texas. Markets in which we operaterepresent five of the top ten and 11 of the top 30 residential housing marketsin the United States based upon 2005 single-family housing new constructionpermits as measured by the United States Census Bureau.

**Our history**

We were founded in 1969 by David K. Hill in RollingMeadows, Illinois, where we remain headquartered. David Hill’s father, D.Kimball Hill, started building homes in 1939 and grew the business in the post-World War II era to help his fellow veterans find the affordable, qualityhousing they needed. His vision is largely responsible for building the city ofRolling Meadows. David Hill began building Kimball Hill Homes upon the samesolid foundation of value and caring that his father utilized. David Hillremains our Chairman and Chief Executive Officer and, together with members ofhis immediate family, beneficially owns approximately 69% of our common stock.Kimball Hill, Inc. was incorporated in Illinois in 1950.

Until 1989, ouroperations were focused exclusively within the Chicago market. Since then, wehave organically expanded our operations into additional markets within theMidwest as well as markets in four other regions: Florida, Nevada, the PacificCoast and Texas. We established operations in Houston, TX in 1989, followed by:

·       Portland,OR, Sacramento, CA, Stockton, CA and Vancouver, WA in 1995;

·       Austin,TX, Cleveland, OH and Las Vegas, NV in 1996;

·       Dallas,TX, Ft. Myers, FL, Ft. Worth, TX, Naples, FL, Sarasota, FL and Tampa, FL in1997;

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·       Milwaukee,WI in 2000; and

·       SanAntonio, TX in 2003.

In March 2006, we decided toexit the Cleveland market based on our perception regarding local marketconditions currently and in the foreseeable future. We have been winding downoperations with the objective of completing all construction and salesactivities during our second fiscal quarter of 2007.

Our geographicdiversification has been gradual and exclusively from de novo start-ups. Thisexpansion has resulted in increases in our total homebuilding revenues andhomes delivered from $199.8 million and 1,386 units, respectively, in fiscal1996 to $1,163.8 million and 4,079 units, respectively, in fiscal 2006. Inaddition, as we have expanded our operations geographically, we havestrengthened both the quality and depth of our management team.

**Financialinformation about segments**

We aggregate our homebuilding operations into fivereportable homebuilding segments and our mortgage banking operations into one reportablesegment. Our homebuilding segments are engaged in the acquisition anddevelopment of land, and construction and sale of residential homes. Ourmortgage banking segment originates mortgages, which are sold to third parties.

The five reportable homebuilding segments includeoperations in the following geographical regions:

Florida

Midwest: Illinois, Ohio and Wisconsin

Nevada

Pacific Coast: California, Oregon and Washington

Texas

Financial information regarding our homebuilding andmortgage banking segments is included in note 14 to our consolidated financialstatements, included herein.

**Our businessstrategy**

*Wecontinue to find the long-term fundamentals and growth opportunities within thedomestic homebuilding industry attractive. We have well-establishedhomebuilding operations in many of the most active housing markets in theUnited States. We believe the long-term demographic trends of the markets inwhich we compete are favorable and will help drive and support our long-termgrowth. We believe that our variety of products, broad customer base andgeographic diversity will reduce the impact of cyclical downturns and providefor long-term growth potential. We believe the experience and depth of our seniormanagement team enables us to quickly evaluate and capitalize on marketopportunities and to adjust to changing national, regional and local businessconditions.*

*Over the past year, market conditions for new home salesbecame considerably more difficult than had been experienced over the pastdecade. Both the breadth and pace of market deterioration have been greaterthan anticipated, given the relatively strong broader economic backdrop. Giventhese significant market changes and uncertainty about the timing and pace ofany recovery, we have adopted a strategy to manage our business through thecurrent market downturn. Our strategy focuses on balance sheet management, andincludes:*

*·**      **using free cash flow to reduce our debt and interestcosts, and to maximize our liquidity;*

*·**      **tailoring our product offerings and option packagesto address affordability constraints;*

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*·**      **increasing efforts to pre-sell homes beforeconstruction begins;*

*·**      **renegotiating with vendors and subcontractors tomanage our construction costs;*

*·**      **sizing our operating structure to match ourperception regarding market conditions currently and into the foreseeablefuture;*

*·**      **tightening land acquisition criteria and working withland sellers to renegotiate land purchase and option contracts to extendpurchase dates and reduce purchase prices; and*

*·**      **potentially selling lots to generatecash and reduce our overall land holdings.*

**Our markets andproducts**

We compete in the approximately $380 billion domesticmarket for new homes. The new home industry is cyclical and has experiencedconsiderable deterioration after several years of significant growth in termsof unit sales, housing permits and average base sales price. We believe therecent deterioration is the result of home affordability constraints, increasedcompetition from both new homes and the resale of existing homes and decreasingconsumer sentiment as prospective home buyers are concerned about future pricereductions. Over the long-term, we believe our markets will benefit fromcontinued population growth, household formation, population shifts, lowmortgage rates coupled with tax incentives for homeowners and a relativelystable economy.

Our management teamevaluates a number of factors when we determine which markets to enter,including supply/demand characteristics, raw land availability, population andjob growth, area employers, competition, climate, customer profile, legalenvironment, housing starts and regional raw material costs. Once in a market,our management team periodically evaluates local market conditions using thesesame factors to determine whether to modify our strategy within such market orto exit the market altogether.

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Elevenof the metropolitan areas in which we compete (consisting of 12 of our markets)are among the 30 most active homebuilding markets in the United States (as wellas five of the top ten), as measured by the number of building permits issuedfor single-family houses.

| ** **                         | ** ** | **2005 top metropolitan areas  by single-family permits**(1) | ** ** |
|------------------------------------|------------|---------------------------------------------------------------------------------------|------------|
| 1. Atlanta                         |       |                                                                                  | 61,600     |   |
| 2. Phoenix                         |       |                                                                                  | 60,900     |   |
| **3.  Houston**                    | ** ** | ** **                                                                            | **51,200** |   |
| 4. Riverside/San  Bernardino       |       |                                                                                  | 45,500     |   |
| **5.  Chicago**                    | ** ** | ** **                                                                            | **37,500** |   |
| **6.  Dallas**                     | ** ** | ** **                                                                            | **31,700** |   |
| **7. Las  Vegas**                  | ** ** | ** **                                                                            | **30,500** |   |
| **8.  Tampa/St. Petersburg**       | ** ** | ** **                                                                            | **27,600** |   |
| 9. Orlando                         |       |                                                                                  | 26,800     |   |
| 10. Washington DC                  |       |                                                                                  | 25,900     |   |
| 11. Miami/Fort  Lauderdale         |       |                                                                                  | 22,200     |   |
| **12. Ft.  Myers/Cape Coral**      | ** ** | ** **                                                                            | **22,200** |   |
| 13. New York                       |       |                                                                                  | 21,400     |   |
| 14. Charlotte                      |       |                                                                                  | 19,200     |   |
| 15. Jacksonville                   |       |                                                                                  | 18,600     |   |
| 16. Seattle                        |       |                                                                                  | 18,300     |   |
| **17. Ft.  Worth/Arlington**       | ** ** | ** **                                                                            | **17,800** |   |
| 18. Denver                         |       |                                                                                  | 17,800     |   |
| **19.  Austin/Round Rock**         | ** ** | ** **                                                                            | **17,300** |   |
| 20.  Minneapolis/St. Paul          |       |                                                                                  | 17,100     |   |
| 21. Los  Angeles/Long Beach        |       |                                                                                  | 16,600     |   |
| **22.  Sacramento**                | ** ** | ** **                                                                            | **16,400** |   |
| 23. Philadelphia                   |       |                                                                                  | 15,000     |   |
| **24. San  Antonio**               | ** ** | ** **                                                                            | **14,700** |   |
| 25. Nashville                      |       |                                                                                  | 14,100     |   |
| 26. Raleigh                        |       |                                                                                  | 14,000     |   |
| 27. Detroit                        |       |                                                                                  | 13,600     |   |
| 28. St. Louis                      |       |                                                                                  | 13,400     |   |
| **29.  Portland/Vancouver****(2)** | ** ** | ** **                                                                            | **12,800** |   |
| 30. Indianapolis                   |       |                                                                                  | 12,500     |   |

 

*Source: UnitedStates Census Bureau*

(1)     Ourmarkets are included in bold.

(2)     Weconsider this metropolitan area to be two separate markets.

The strong local market knowledge of our localmanagers allows us to tailor our homes to the demands of each market in whichwe operate. This enables us to target customers through a wide array of homeproducts such as single-family attached, single-family detached and multi-familyhomes with mixed price points depending on customer desires and local marketconditions. During fiscal 2006, the average sales price of homes delivered was$277,100. Base sales prices for actively selling projects in fiscal 2006 rangedfrom $100,000 to $870,000.

While offering a wide variety of products, we havefocused on, and will continue to focus on, our historical customer base, whichincludes first-time buyers, and first- and second-time move up buyers. We alsowill continue to adjust our offering mix to include markets outside of ourpresent markets but will do so only when the dynamics of a particular marketmeet our exacting specifications for new market entry.

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Since1989, we have expanded from Chicago to 16 additional markets across nine stateslocated in the following five geographic regions.

| **Florida** | ** ** | ** **       | ** ** | **Midwest** | ** ** | **Nevada**     | ** ** | **Pacific Coast** | ** ** | **Texas** | ** ** |
|-------------|------------|------------------|------------|-------------|------------|----------------|------------|------------------------|------------|-----------|------------|
| Ft. Myers   |       | Chicago, IL      |       | Las  Vegas  |       | Portland, OR   |       | Austin                 |       |
| Naples      |       | Cleveland, OH(a) |       |        |       | Sacramento, CA |       | Dallas                 |       |
| Sarasota    |       | Milwaukee, WI    |       |        |       | Stockton, CA   |       | Ft. Worth              |       |
| Tampa       |       |             |       |        |       | Vancouver, WA  |       | Houston                |       |
|        |       |             |       |        |       |           |       | San Antonio            |       |

 

(a)     In March 2006,we decided to exit the Cleveland market based on our perception regarding localmarket conditions currently and in the foreseeable future. We have been windingdown operations with the objective of completing all construction and salesactivities during our second fiscal quarter of 2007. We believe our exit fromthe Cleveland market will not have a material adverse impact on our futureoperating results.

The following tableincludes key metrics for our 17 markets within our five geographic regions:

| ** **                                            | ** ** | **Florida** | ** ** | **Midwest** | ** ** | **Nevada** | ** ** | **Pacific  Coast** | ** ** | **Texas**  | ** ** | **Total**  | ** ** | **United  States** | ** **    |
|-------------------------------------------------------|------------|-------------|------------|-------------|------------|------------|------------|--------------------|------------|------------|------------|------------|------------|--------------------|---------------|
| **Market information:**                               |       |        |       |        |       |       |       |               |       |       |       |       |       |               |          |
| Annual single-family  building permits:               |       |        |       |        |       |       |       |               |       |       |       |       |       |               |          |
| 2001                                                  |       | 33,300      |       | 41,300      |       | 21,900     |       | 29,400             |       | 87,000     |       | 212,900    |       | 1,235,600          |          |
| 2002                                                  |       | 35,800      |       | 43,500      |       | 22,100     |       | 33,700             |       | 94,500     |       | 229,600    |       | 1,332,600          |          |
| 2003                                                  |       | 41,100      |       | 46,300      |       | 27,400     |       | 35,700             |       | 106,300    |       | 256,800    |       | 1,460,900          |          |
| 2004                                                  |       | 53,200      |       | 46,400      |       | 31,700     |       | 36,000             |       | 120,200    |       | 287,500    |       | 1,613,400          |          |
| 2005                                                  |       | 65,300      |       | 46,700      |       | 30,500     |       | 34,900             |       | 132,700    |       | 310,100    |       | 1,682,000          |          |
| CAGR (2001-2005)                                      |       | 18.1        | %          | 3.2         | %          | 7.4        | %          | 4.0                | %          | 9.0        | %          | 8.7        | %          | 7.0                | %             |
| Population data:                                      |       |        |       |        |       |       |       |               |       |       |       |       |       |               |          |
| 2004 population                                       |       | 4,050,000   |       | 13,040,000  |       | 1,649,000  |       | 4,726,000          |       | 14,136,000 |       | 37,601,000 |       | 293,700,000        |          |
| 2005 population                                       |       | 4,173,000   |       | 13,082,000  |       | 1,711,000  |       | 4,802,000          |       | 14,442,000 |       | 38,210,000 |       | 296,400,000        |          |
| 2005 population growth rate                           |       | 3.0         | %          | 0.3         | %          | 3.8        | %          | 1.6                | %          | 2.2        | %          | 1.6        | %          | 0.9                | %             |
| **Kimball Hill information:**                         |       |        |       |        |       |       |       |               |       |       |       |       |       |               |          |
| 2006 sales of residential units and land         |       | $           | 112,348    |        | $          | 263,719    |       | $                  | 171,119    |       | $          | 289,913    |       | $                  | 323,581  |   | $ | 1,160,680 |   | — |   |
| % of Kimball Hill sales of residential units and land |       | 9.7         | %          | 22.7        | %          | 14.7       | %          | 25.0               | %          | 27.9       | %          | 100.0      | %          | —             |          |
| Backlog units at 9/30/06                              |       | 73          |       | 159         |       | 45         |       | 80                 |       | 401        |       | 758        |       | —             |          |
| % of Kimball Hill total backlog units            |       | 9.6         | %          | 21.0        | %          | 5.9        | %          | 10.6               | %          | 52.9       | %          | 100.0      | %          | —             |          |
| Average sales  price                                  |       | $           | 249,700    |        | $          | 361,600    |       | $                  | 393,400    |       | $          | 448,100    |       | $                  | 164,700  |   | $ | 277,100 |   | — |   |

 

*Source: United States CensusBureau*

**Land acquisitionand development**

As of September 30, 2006, we owned and controlled25,256 lots (15,596 of which we owned and 9,660 of which we controlled underoption agreements and purchase contracts). Given the recent marketdeterioration and uncertainty about the timing and pace of any recovery, wehave tightened our land acquisition criteria and are working with land sellersto renegotiate land purchase and option contracts to extend purchase dates andreduce purchase prices. To further match our land investment to the marketconditions currently and into the foreseeable future, we are consideringselling land to other homebuilders, land developers or investors.

We have established land departments in each of ourmarkets that identify, acquire and develop lot positions. Our approach tocontrolling and acquiring new land positions is a structured process initiatedby local land departments in conjunction with tiered corporate approval.

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We acquire landbased upon a variety of factors, including:

·       desirabilityof location, including proximity to local traffic corridors and amenities,access to quality schools and aesthetic appeal;

·       management’sjudgment as to the real estate market and economic trends, and our experiencein particular markets;

·       financialreview as to the feasibility of the proposed community, including projectedprofit margins and other financial measures;

·       suitabilityfor development generally within a four-year time period from the beginning ofthe development process to the delivery of the last home;

·       theability to secure governmental approvals and entitlements; and

·       theresults of legal and environmental due diligence.

We obtain control of land through a variety ofstructures, including option agreements and purchase contracts or jointventures. As of September 30, 2006, we had made $15.5 million in cashdeposits, excluding $1.1 million of cash deposits related to inventory notowned included in our consolidated balance sheet, and $1.4 million in letter ofcredit deposits on real estate under option agreements and purchase contracts.We controlled 9,660 lots through option agreements and purchase contracts as ofSeptember 30, 2006, which represents 38% of our land supply.

Generally, we secure undeveloped land with optionagreements and purchase contracts that allow us to defer the commitment topurchase until after all necessary zoning approvals and entitlements have beenobtained. The term “entitlements” refers to development agreements, tentativemaps or recorded plats, which in each case minimize the chance that we will beunable to obtain all required building permits during the development and constructionprocess. Although we purchase larger or smaller parcels in some of our marketswhen local conditions and opportunities dictate, we generally seek to developparcels with sizes sufficient to support a four year life cycle. Our largesthomebuilding project is in the Midwest region on which we are developing landand currently intend to construct and sell approximately 1,100 homes over thenext six years. We are further obligated to purchase additional land in thisproject, on which we intend to construct and sell an additional 1,500 homes, atvarious dates beginning in June 2009.

We conduct certain of our land development operations,including site planning and engineering as well as the construction of road,sewer, water, utilities, drainage, recreation facilities and other refinements,through subcontractors in each of our local markets. Our land developmentoperations also include the establishment of design and marketing concepts foreach project, including determining the range of sizes, styles and prices forthe homes. We also determine street layout, individual lot size and layout andoverall community design. The product line offered in each project depends uponmany factors, including the existing housing in the area, the needs of themarket and our lot costs.

Our principal focus is theconstruction and sale of single-family and for-sale multi-family residentialhousing. However, we sell residential lots or land to balance our overallinvestment in land or when we perceive an attractive market opportunity.Revenue from these sales was $30.5 million in fiscal 2006 and $33.4 million infiscal 2005.

**Constructionoperations**

We are the general contractor for our communities andtypically hire subcontractors on a community-by-community or reasonable geographic-proximitybasis to complete construction at a fixed price. Occasionally, we enter intolonger-term contracts with subcontractors and suppliers if we can obtain morefavorable terms. Our construction managers and field superintendents coordinateand supervise the 

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activities of subcontractors and suppliers, andsubject this work to quality and cost controls while monitoring compliance withzoning and building codes. At September 30, 2006, we employed 329construction and related customer service personnel.

We specify that quality, durable materials be used inthe construction of our homes and we do not maintain significant inventories ofconstruction materials, except for work-in-process materials for homes underconstruction. When possible, we negotiate price and volume discounts withmanufacturers and suppliers to take advantage of production volume. Agreementswith our vendors and subcontractors are generally entered into after acompetitive bidding process. In connection with this competitive biddingprocess, we obtain information from prospective subcontractors and vendors withrespect to their financial condition and overall abilities to perform. Pricesfor these goods and services may fluctuate due to various factors, includingsupply and demand shortages that may be beyond the control of our vendors. Webelieve that we have good relationships with our suppliers and subcontractors.

We generally build andsell homes in clusters or phases within our larger projects, which we believecreates efficiencies in land development and construction and improves customersatisfaction by reducing the number of vacant lots surrounding a completedhome. Construction schedules may vary depending on the availability of labor,materials and supplies, product type, location and weather. Our homes aregenerally designed to promote efficient use of space and materials and tominimize construction costs and time.

**Sales and marketing**

We use advertising and other promotional activities,our website at *www.kimballhillhomes.com*,magazine and newspaper advertisements, brochures, direct mailings and theplacement of strategically located signs in the immediate areas of ourdevelopments, to generate interest in new and existing communities.

We use furnished model homes to demonstrate theadvantages of our home designs and various features to prospective homebuyers.We generally contract with interior and landscape designers to create anattractive model home with many built-in options for each product line within aproject. We generally build between one and four model homes for each activelyselling community, depending upon the number of homes to be built and the rangeof products to be offered within the project. As of September 30, 2006, weowned 140 model homes.

Our homes generally aresold by full-time, commissioned employees who typically work from a salesoffice located in one of our model homes. At September 30, 2006, we had177 sales and marketing personnel. Our goal is to ensure that our sales forcehas extensive knowledge of our operating policies and housing products. Toachieve this goal, we train our sales associates and conduct periodic meetingsto update them on sales techniques, competitive products in the area, financingavailability, construction schedules, marketing and advertising plans and theavailable product lines, pricing, options and warranties offered. Our salesassociates are licensed real estate agents where required by law. In mostmarkets, independent brokers also sell our homes and are usually paid a salescommission based on the price of the home. Our sales professionals assist ourcustomers in selecting upgrades or in adding available customization featuresto their homes. Given the current market deterioration and competitiveconditions, we have increased our use of sales incentives to attract buyers.

**Customer relations, quality control and warrantyprograms**

Webelieve that positive customer relations and an adherence to stringent qualitycontrol standards are fundamental to our continued success. A Kimball Hillconstruction manager or project superintendent and a customer relationsrepresentative generally oversee compliance with quality control standards foreach community. Our quality control team performs the following tasks:

·       overseeshome construction;

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·       supervisessubcontractor and supplier performance;

·       reviewsthe progress of each home and conducts formal inspections as specific stages ofconstruction are completed; and

·       updatesbuyers regularly on the progress of their homes.

We believe wedifferentiate ourselves from many of our competitors by offering our customersa two-year limited warranty on workmanship and building materials and aten-year warranty with respect to structural defects. As subcontractors usuallyprovide an indemnity and a certificate of insurance before beginning work,claims relating to faulty workmanship and materials are generally theresponsibility of our subcontractors.

**Financial and title services**

We provide mortgagefinancing services to purchasers of our homes through our wholly-ownedsubsidiary, KH Financial, L.P. During fiscal 2006, we captured 60% of theavailable business from purchasers of our homes, originating $553 million ofmortgage loans. The mortgage loans originated by KH Financial, L.P. are sold tothird parties after origination.

We are party to a $100million flexible early purchase facility agreement which allows us to sellqualifying loans to the holder of the flexible early purchase facility aftersuch loans have been originated subject to our obligation to sell the loan toan investor in the secondary market. During the year ended September 30,2006, $457 million of mortgage loans were sold to the holder of the flexibleearly purchase facility. At September 30, 2006, the facility held $56.6million of loans sold by KH Financial, L.P. We are also party to a $5 millionwarehouse financing credit line for mortgages that do not qualify for saleunder our early purchase facility. At September 30, 2006, there were noborrowings outstanding under our warehouse financing credit line.

We also provide titleservices to our customers through joint ventures with unaffiliated thirdparties. These joint ventures provide title insurance policies and examinationand closing services to purchasers of our homes. We assume no underwriting riskassociated with the title policies.

**Employees**

At September 30,2006, we had approximately 926 full-time employees, including 284 in managementand administration, 177 in sales and marketing, 73 in mortgage banking, 63 inland acquisition and development and 329 in construction and customer serviceoperations. Our employees are not unionized, and we believe that we have goodemployee relationships.

**Competition**

The homebuilding industryis highly competitive and fragmented. We compete for sales of new homes in eachof our markets with national, regional and local homebuilders. We also facecompetition from existing home resales and, to a lesser extent, condominiumsand rental housing. Competition among both small and large residentialhomebuilders is based on a number of interrelated factors, including location,reputation, amenities, design, quality and price. Builders of new homes competenot only for homebuyers, but also for desirable properties, financing, rawmaterials and skilled subcontractors. The recent market deterioration hasincreased the competitive use of sales incentives to generate new home orders,thereby placing additional pressure on profitability.

**Seasonality**

Ourhomebuilding operating cycle generally reflects increased new order activity inour second and third fiscal quarters and increased deliveries in our third andfourth fiscal quarters. We believe that this 

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seasonalityreflects the tendency of homebuyers to shop for a new home in the spring withthe goal of closing in the fall, as well as the scheduling of paving andconstruction to accommodate seasonal weather conditions. We also experienceseasonality in our mortgage banking operations as loan originations correspondwith the closing of homes.

**Government regulation and environmental matters**

We acquire most of ourland after entitlements have been obtained, which provide for zoning andutility services to project sites and give us the right to obtain buildingpermits. Development may begin almost immediately on such entitled land uponcompliance with and receipt of specified permits, approvals and otherconditions, which generally are within our control. The time needed to obtainsuch approvals and permits affects the carrying costs of unimproved propertyacquired for development and construction. The continued effectiveness ofpermits already granted is subject to factors such as changes in governmentpolicies, rules and regulations and their interpretation and application.To date, the government approval processes discussed above have not had amaterial adverse effect on our development activities, although there is noassurance that these and other restrictions will not adversely affect futureoperations.

Local and stategovernments have broad discretion to impose development fees for projectswithin their jurisdictions. These fees are normally established when we receiverecorded maps and building permits. In addition, communities occasionallyimpose construction moratoriums. Because most of our land is entitled,construction moratoriums generally would affect us if they arose from health,safety or welfare issues, such as insufficient water, electric or sewage facilities.

We could become subject todelays or may be precluded entirely from developing communities due to buildingmoratoriums, “no growth” or “slow growth” initiatives or building permitallocation ordinances, which could be implemented in the future.

We are also subject to avariety of local, state, and federal statutes, ordinances, rules andregulations concerning the protection of health and the environment. In somemarkets, we are subject to environmentally sensitive land ordinances thatmandate open space areas with public elements in housing developments andprevent development on hillsides, wetlands and other protected areas. We mustalso comply with flood plain restrictions, desert wash area restrictions,native plant regulations, endangered species acts and view restrictions. Theseand similar laws may result in delays, cause substantial compliance and othercosts and prohibit or severely restrict development in certain environmentallysensitive regions or areas. To date, compliance with such ordinances has notmaterially affected our operations, although it may do so in the future.

We usually will conditionour obligation to acquire property on, among other things, an environmentalreview of the land. To date, we have not incurred any significant unanticipatedliabilities relating to the removal of toxic wastes or other environmentalmatters. However, there is no assurance that we will not incur materialliabilities in the future relating to toxic waste removal or otherenvironmental matters.

**Available information**

We file annual, quarterlyand current reports and other information with the Securities and ExchangeCommission (“SEC”). These filings are available to the public over the Internetat the SEC’s web site at http://www.sec.gov. You may also read and copy anydocument we file at the SEC’s public reference room located at 100 F Street,N.E., Room 1580, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330for further information on the public reference room.

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**Item1A.**                Risk Factors

Discussion of our businessand operations included in this Annual Report on Form 10-K should beread together with the risk factors set forth below. They describe variousrisks and uncertainties to which we are or may become subject. In addition tothe risks described below, there may be additional risks and uncertainties notcurrently known to us or that we currently deem to be immaterial that maybecome material risks. These risks and uncertainties, together with otherfactors described elsewhere in this report, have the potential to affect ourbusiness, financial condition, results of operations, cash flows, strategies orprospects in a material and adverse manner.

**High interest rates, changes in tax laws and inflationcan adversely affect demand for our homes.**

Increased interest rateswould make it more difficult for both our customers and potential buyers of ourcustomers’ existing homes to secure adequate mortgage financing. If mortgageinterest rates increase and the ability and willingness of prospective buyersto finance home purchases is adversely affected, our home sales revenues, grossmargins and cash flows may be adversely affected.

Changes in federal incometax laws may affect demand for home ownership. For example, various proposalshave been publicly discussed to limit an individual’s real estate tax andmortgage interest deductions and to tax an individual on gain from the sale ofa principal residence. Enactment of such proposals could have an adverse effecton home ownership and the homebuilding industry in general. No meaningfulprediction can be made as to whether any such proposals will be enacted and, ifenacted, the particular form such laws would take.

We, like otherhomebuilders, may be adversely affected during periods of high inflation due tohigher land, financing, labor and materials costs, which could cause ourfinancial results to decline.

**Ourindustry is vulnerable to changes in macroeconomic conditions in the marketsand regions in which weoperate.**

Historically, changes in demandbased on economic and market shifts and fluctuations in the availability andprice of land, labor and raw materials have created changes in the prices ofnew homes, sales volumes and margins. We conduct all of our business within 17markets across nine states located in five regions (Florida, the Midwest,Nevada, the Pacific Coast and Texas). From time to time, one or more of theseregions will account for a significant percentage of our gross homebuildingprofit, primarily due to shifting market conditions among all of our regions. Adownturn in one or more of these regions without corresponding growth in ourother regions, could result in an overall decline in profitability.Furthermore, because we conduct our operations in specific markets and stateswithin each of these regions, in the event of an economic downturn in one ormore of the markets or states within a particular region, our sales activity inthe entire region may be materially and adversely affected.

**Difficultyin obtaining sufficient capital and bonding could result in increased costs anddelays in completion ofprojects.**

The homebuilding industryis capital intensive and the acquisition and development of land requiressignificant up-front expenditures and bonding to ensure the completion of ourprojects. Our land acquisition, development and construction activities may beadversely affected if we are unable to finance our land purchases anddevelopment and construction activities at reasonable costs, or at all. Anydifficulty in obtaining sufficient capital and bonding for planned developmentexpenditures could result in lot shortages, project delays and cost increases,which could adversely affect our future operating results.

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**We face substantialinventory risk.**

The risks inherent in purchasing and developing landincrease as consumer demand for housing decreases. Thus, we may purchase anddevelop land on which we cannot profitably build and sell homes and we may notbe able to resell that land at prices sufficient to cover our costs. The marketvalue of land, building lots and housing inventories can fluctuatesignificantly as a result of changing market conditions and the measures weemploy to manage inventory risk may not be successful.

In addition, inventory carrying costs can besignificant and can result in losses in a poorly performing project or market.In the event of significant changes in economic or market conditions, we mayhave to sell homes at significantly lower margins or at a loss or recordimpairment charges. During fiscal 2006, we recorded impairment charges of $25.8million based on our intended use of particular assets at the time of ourreview. Changes in our intended use or a further deterioration in market conditionsbeyond our expectations could result in our recording material non-cashimpairment charges to our balance sheet in the future.

Our largest singlehomebuilding project is in the Midwest region, which has experienced a deteriorationin market conditions. The project consists of land we are developing and onwhich we currently intend to construct and sell approximately 1,100 homes overthe next 6 years. We are obligated to purchase additional land in this project,on which we intend to construct and sell an additional 1,500 homes, forapproximately $42 million at various dates beginning in June 2009. Thisproject’s total inventory balance was approximately $88 million atSeptember 30, 2006.

**We may not be ableto acquire desirable lots or land for residential buildout.**

Our future results dependupon our ability to acquire lots in premier locations for our communitydevelopment and homebuilding activities. We compete for desirable lots and landwith many other homebuilding companies, many of which have greater resourcesthan we do. Our financial condition and operating results will be adverselyaffected if desirable properties at reasonable prices are not available on anongoing basis. If we cannot procure desirable properties at reasonable prices,or at all, in any of our markets, we may be required to limit our developmentor homebuilding operations in those markets or instead purchase less desirableproperties, either of which would reduce our revenues without comparable costsavings.

**We may not be ableto compete effectively against homebuilders in our markets or with sales or rentals of existing homesin our markets.**

The homebuilding industryis highly competitive. We compete with large national homebuilding companiesand smaller local homebuilders for, among other things, lots in premierlocations, financing, raw materials, skilled labor and customers. Many of ourcompetitors have significantly greater financial, marketing, sales andmanufacturing resources than we do. The current homebuilding industryconsolidation trend may create larger and stronger competitors that may be ableto compete more effectively against us. In addition, there may be new entrantsin the markets in which we currently conduct business. Our potential customersmay also choose to purchase or rent existing homes, and as such we compete forsales with resales of existing homes and with available rental housing. Therecent market deterioration has increased the competitive use of salesincentives to generate new home orders, thereby placing additional pressure onprofitability. If we are unable to compete effectively with other homebuilders,or if our homes are perceived to be less attractive values than existing homesor rental properties, our operating results will be adversely impacted.

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**Adverse weatherconditions or natural disasters in the areas in which we operate could increaseour costs, reduce demandfor our homes and adversely affect our financial condition and operatingresults.**

Adverse weatherconditions, such as hurricanes, tornadoes, droughts, floods, wildfires,landslides, soil subsidence, earthquakes and other geologic events, coulddamage our projects, cause delays in completion of our projects or reduceconsumer demand for our projects. In addition to damaging our projectsdirectly, adverse weather conditions or natural disasters could damage roadsand highways providing access to those projects, or require us to temporarilyshut down our sales, marketing and building operations, thereby adverselyaffecting our ability to market homes in those areas and possibly increasingthe costs of completions. We may be unable to insure adequately against certainof these risks. A sizeable uninsured loss due to one or more of these eventscould adversely affect our business, financial condition and operating results.

**We depend on theavailability and quality of subcontractors and raw materials at reasonableprices.**

We rely heavily on the use of subcontractors in theconstruction of our homes. Since we generally do not enter into long-termcontractual commitments with our subcontractors, our ability to deliver homesin a timely and cost-effective manner depends upon the availability of skilled subcontractorsin our markets on an as-needed or project-by-project basis. Any materialincrease in the demand for subcontractors in any of our markets could result inconstruction delays or increased construction costs, resulting in reducedearnings. For example, the substantial repair and rebuilding activitiesundertaken in regions impacted by hurricanes could reduce the availability ofsubcontractors thereby increasing our operating costs and reducing margins.

In addition, while oursubcontractors are generally responsible for procuring necessary buildingmaterials, we have from time to time experienced, and may in the futureexperience, shortages in lumber and other materials. Any future reduction inavailability or increase in the cost of lumber or other raw materials couldresult in construction delays or cost increases, which could reduce ourrevenue, cash flows and earnings.

**Utility shortagesor price increases could have an adverse impact on our operations.**

We rely heavily on thecontinued availability of fuel, water, electricity and other utilities atreasonable prices for our operations. Some of our markets have recentlyexperienced shortages in water or electrical power, requiring us to delayconstruction projects and/or incur additional construction costs. In addition,we have incurred increased utility costs in many of our markets, includingsignificant additional costs due to recent increases in the cost of oil. We mayincur additional costs and may not be able to complete construction on a timelybasis if such utility rate increases continue, or if we experience additionalwater and/or power shortages. Furthermore, shortages of water or electricity,or utility rate increases, may adversely affect the regional economies in whichwe operate, which may reduce demand for our homes.

**If we are not ableto develop our communities successfully, our earnings will be diminished.**

Before a communitygenerates any revenues, time and material expenditures are required to acquireland, to obtain development approvals and to construct significant portions ofproject infrastructure, amenities, model homes and sales facilities. A declinein our ability to develop and market our communities successfully and togenerate positive cash flows from these operations in a timely manner wouldhave a material adverse effect on our operating results and ability to serviceour debt obligations and to meet our working capital requirements.

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**Wedepend upon the continued services of certain members of our senior managementteam and other keyemployees, without whom our business may be adversely affected.**

Our future successdepends, in part, on the efforts of our senior management team and other keyemployees. Our senior management team, led by David K. Hill, our Chairman andChief Executive Officer, has significant industry experience and would bedifficult to replace. Our senior management team and other key employeespossess sales, marketing, financial and administrative skills that are criticalto the operation of our business. If we lose or suffer an extended interruptionin the services of one or more members of our senior management team or otherkey employees, our financial condition and operating results may be adverselyaffected. Moreover, the market for qualified individuals is highly competitiveand we may not be able to attract and retain qualified personnel to replacemembers of our senior management team or other key employees should the needarise.

**Weface reduced coverages and increased costs of insurance.**

Insurance costs forhomebuilders have increased substantially in recent years due to a range offactors, including perceptions related to the risk of terrorist attacks, recentcorporate governance scandals, insurer insolvencies and recent increases inlosses due to hurricanes and other natural disasters. For these reasons, someinsurers have ceased to provide certain insurance products that werehistorically relied on by homebuilders and other industry participants.

In this difficultinsurance market, exposure to personal injury and property damage claims, aswell as to losses resulting from natural disasters, is at historically highlevels. For example, many lawsuits have recently been filed againsthomebuilders asserting claims for damage caused by the presence of mold inresidential dwellings, some resulting in substantial monetary judgments orsettlements. Our insurance may not cover all of the claims, including personalinjury claims, to which we may become subject, as coverage of such claims maynot be available on commercially reasonable terms, if at all. If we are unableto obtain adequate insurance coverage, substantial personal injury orconstruction defect claims could materially impact our earnings and cash flows.Continued increases in insurance costs, additional coverage restrictions orunavailability of certain insurance products in some of our regions (includingthe unavailability of or increased costs for flood or hurricane insurance), dueto these and other factors, including due to losses incurred in connection withthe hurricanes during the summer of 2005, will increase our operating costs andfurther increase our exposure to natural disasters and other causes ofcatastrophic loss, as well as personal injury and construction defect claims.

**Fluctuationsin real estate values may require us to adjust the book value of our realestate assets.**

The value of real estateis subject to significant fluctuations. Although we have generally developedparcels ranging from 100 to 300 lots, on a strategic basis we, from time totime, purchase larger parcels of land. In some cases, we acquire these parcelswith a joint venture partner, and in others we purchase them ourselves with theintent to develop lots for our homebuilding operations and for resale toothers. Since real estate values are subject to significant fluctuations, thedeterioration of economic conditions in our markets could require us to writedown the value of our owned real estate. During fiscal 2006, we recordedimpairment charges of $25.8 million based on our intended use of particularassets at the time of our review. Changes in our intended use or a further deteriorationin market conditions beyond our expectations could have a significant impact onthe carrying value of our assets and could lead to further impairment charges,which could have a material adverse effect on our financial condition andoperating results.

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**Poor relations with the residents of our communitiescould negatively impact sales, which could cause our revenues or resultsof operations to decline.**

Residents of communitieswe develop rely on us to resolve issues or disputes that may arise inconnection with the operation or development of their communities. Any effortsmade by us to resolve these issues or disputes could be deemed unsatisfactoryby the affected residents and any subsequent action by these residents couldnegatively impact sales, which would negatively impact our revenues and resultsof operations. In addition, we could be required to make material expendituresrelated to the settlement of such issues or disputes or to modify our communitydevelopment plans.

**We are subject topotential expenses related to construction defect, soil subsidence and home warranty claims thatcould adversely affect our financial performance.**

Construction defect andhome warranty claims are common in the homebuilding industry and can be costly.While we generally require our subcontractors and third party designprofessionals to indemnify us for liabilities arising from their work, theseindemnities may be insufficient to cover construction defects and warrantyclaims for which we may be held liable. While we establish reserves forwarranty claims, the reserves may from time to time be inadequate to cover ourwarranty costs. If conditions are such that the warranty reserves areinadequate, our earnings and cash flows may be materially reduced.

**Governmental lawsand regulations may increase our expenses, limit the number of homes that we can build or delay orprevent the completion of our projects.**

We are subject to numerouslocal, state, federal and other statutes, ordinances, rules andregulations concerning zoning, development, building design, construction andsimilar matters. Projects that are not entitled may be subjected to periodicdelays, changes in use, less intensive development or elimination ofdevelopment in certain specific areas due to government regulations. We mayalso be subject to periodic delays or may be precluded entirely from developingin certain communities due to building moratoriums or “slow-growth” or“no-growth” initiatives that could be implemented in our markets. Local andstate governments also have broad discretion regarding the imposition ofdevelopment fees for projects in their jurisdiction. Projects for which we havereceived land use and development entitlements or approvals may still require avariety of other governmental approvals and permits during the developmentprocess and can also be impacted adversely by unforeseen health, safety andwelfare issues, which can further increase our cost, delay these projects orprevent their development.

**Environmental lawsand regulations may increase development costs, delay completion of projects or prevent us from developingat all.**

We are subject to avariety of local, state, federal and other statutes, ordinances, rules andregulations concerning the environment. Environmental regulatory requirementscould result in delays, impose substantial compliance and other costs or severelyrestrict homebuilding activity. For example, we may be required to investigateand clean up hazardous or toxic substances or petroleum product releases onlots we either own or on which we built homes, and may be held liable forproperty damage and for investigation and clean up costs incurred by thirdparties in connection with contamination. In addition, the presence ofgovernment-protected wetlands, historical artifacts or endangered species couldprevent us from developing certain parcels of land at a reasonable cost, or atall.

**Regulationsapplicable to financial services companies may prevent us from conducting ourmortgage bankingbusiness as planned.**

Our mortgage bankingsubsidiary is subject to the rules and regulations of federal governmentaland quasi-governmental agencies such as HUD, FHA, VA, FNMA and FHLMC withrespect to originating, processing and selling mortgage loans. In addition,there are other federal and state statutes and 

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regulations affectingthese activities. Failure to comply with these regulations could negativelyimpact our financial performance.

**Our obligation torepurchase issued and outstanding shares could adversely affect our cash flows.**

We have contractualobligations to repurchase, upon termination of board membership or employmentby reason of specified circumstances (including retirement, death or permanentand total disability), shares of our common stock then owned by stock optionparticipants and recipients of deferred stock units (other than our Chairmanand Chief Executive Officer), including shares issuable pursuant to outstandingoptions or deferred stock units, at the fair market value of those shares atthe time the obligations to repurchase become due. As of September 30,2006, the aggregate repurchase obligation, net of proceeds to be received fromany stock option exercises, would have been approximately $43.3 million in theevent that all of these obligations were triggered.

**Geopolitical risksand market disruption could adversely affect our operating results and financial condition.**

Geopolitical events mayhave a substantial impact on the economy and the housing market. The terroristattacks on the World Trade Center and the Pentagon on September 11, 2001had an impact on our business and the occurrence of similar events in thefuture cannot be ruled out. The United States’ continuing involvement in Iraq,terrorism and related geopolitical risks have created many economic andpolitical uncertainties, some of which may have additional material adverseeffects on the United States economy, the housing market, our customers and, inturn, our results of operations and financial condition.

**Our substantiallevel of indebtedness could adversely affect our financial condition andprevent us fromfulfilling our debt obligations.**

Wehave substantial indebtedness. As of September 30, 2006, we had $500.2million of indebtedness. In addition, subject to restrictions in the indenturefor our senior subordinated notes, we may incur substantial additionalindebtedness. The high level of our indebtedness could have importantconsequences, including the following:

·  ourability to obtain additional financing for working capital, land acquisitioncosts, building costs, other capital expenditures or general corporate purposesmay be impaired;

·  we willneed to use a substantial portion of our cash flows from operations to payinterest and principal on our indebtedness, which will reduce the fundsavailable to us for other purposes;

·  we will have ahigher level of indebtedness than some of our competitors, which may put us ata competitive disadvantage and reduce our flexibility in planning for, orresponding to, changing conditions in our industry, including increasedcompetition; and

·  we will bemore vulnerable to economic downturns and adverse developments in our business.

We expect to obtain the money to payour expenses and to pay the principal and interest on our indebtedness fromcash flows from our operations. Our ability to meet our expenses thus dependson our future performance, which will be affected by financial, business,economic and other factors. We will not be able to control many of thesefactors, such as economic conditions in the markets where we operate andpressure from competitors. We cannot be certain that our cash flows will besufficient to allow us to pay principal and interest on our debt, support ouroperations and meet our other obligations. If we do not have enough money, wemay be required to refinance all or part of our existing debt, sell assets or borrowmore money. We cannot guarantee that we will be able to do so on termsacceptable to us, if at all. In addition, the terms of existing or future debtagreements, including our senior unsecured credit facility and the indenturefor our senior subordinated notes, may restrict us from pursuing any of thesealternatives.

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Inaddition, community development or improvement districts in which certain ofour communities are located may utilize bond financing programs to fundconstruction or acquisition of certain on-site and off-site infrastructureimprovements. The obligation to pay principal and interest on the bonds issuedby the districts is assigned to each parcel within the district. If the ownerof the parcel does not pay such obligation, a lien will be placed on theproperty to secure the unpaid obligation. The bonds, including interest andredemption premiums, if any, and the associated lien on the property aretypically payable, secured and satisfied by revenues, fees or assessments leviedon the property benefited.

**The indenture forour senior subordinated notes and other debt agreements impose significant operating and financialrestrictions, which may prevent us from capitalizing on business opportunitiesand taking certain corporate actions.**

Our seniorsubordinated notes impose significant operating and financial restrictions onus. These restrictions will limit our ability and that of our restrictedsubsidiaries among other things, to:

•     incur additionalindebtedness;

•     make certain distributions,investments and other restricted payments;

•     create certain liens;

•     enter into transactions withaffiliates;

•     limit the ability ofrestricted subsidiaries to make payments to us;

•     merge, consolidate or sellsubstantially all of our assets; and

•     sell assets.

In addition, our seniorunsecured credit facility contains many restrictive covenants similar to thecovenants of the indenture for our senior subordinated notes but the covenantsin this credit facility are generally more restrictive than those contained inthe indenture for our senior subordinated notes. Our existing, and any future,senior credit facilities will also require us to maintain specifiedconsolidated financial ratios and satisfy certain consolidated financial tests.Our ability to meet those financial ratios and financial tests may be affectedby events beyond our control, and we may not be able to continue to meet thosetests. If we fail to meet those tests or breach any of the covenants, thelenders under one or more of our senior credit facilities could declare allamounts outstanding thereunder, together with accrued interest, to beimmediately due and payable. Our assets may not be sufficient to repay in fullsuch indebtedness or any other indebtedness, including our senior subordinatednotes. In addition, any default under the senior subordinated notes indenture,one or more of our senior credit facilities or the instruments governing ourother indebtedness could constitute a cross-default under our other debtinstruments. Further, any subsequent senior credit facilities we enter into, aswell as any other agreements we may enter into in the future governing ourindebtedness, may impose additional restrictions on us, any of which mayadversely affect our ability to finance our future operations or capital needsor to pursue available business opportunities.

**We may considergrowth or expansion of our operations, which could have a material adverseeffect on our cash flowsor profitability.**

We may consideropportunities for growth, primarily within our existing markets, but also innew markets or product lines. Additional growth of our business, either throughincreased land purchases or the development of larger projects, may have amaterial adverse effect on our cash flows or profitability. Any expansion ofour business into new markets or product lines could divert the attention ofsenior management from our existing business, and could fail due to ourrelative lack of experience in those new markets or with those new products. Inaddition, while we do not currently intend to acquire any 

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homebuilding operationsfrom third parties, opportunities to do so may arise in the future and anyacquisition could be difficult to integrate with our operations, and couldrequire us to assume unanticipated liabilities or expenses.

**Our controllingstockholder may have interests that conflict with the interests of otherstakeholders.**

David K. Hill, ourChairman and Chief Executive Officer, together with members of Mr. Hill’simmediate family, beneficially owns approximately 69% of our common stock.Mr. Hill generally will have the ability to elect substantially all of themembers of our Board of Directors and will generally be able to select ourmanagement team, determine our corporate and management policies and makedecisions relating to fundamental corporate actions. The directors generally willhave the authority to make decisions affecting our capital structure, includingthe issuance of additional debt and declaration of dividends, and to authorizetransactions, such as joint ventures or acquisitions, subject to certainrestrictions as set forth in the indenture for our senior subordinated notesand in existing and future credit facilities. These decisions could enhanceMr. Hill’s equity investment while involving risks to the interests ofother stakeholders. In addition, Mr. Hill and various of his affiliates orimmediate family members have engaged, and will in the future continue toengage, in transactions with us as described in Item 13, “Certain Relationshipsand Related Transactions”.

**Item 1B.**   Unresolved Staff Comments

Not applicable.

**Item 2.**     Properties

As of September 30, 2006, we owned two officebuildings with approximately 111,000 square feet of space in Rolling Meadows,Illinois. One of the office buildings is currently used as our principalexecutive office for both our homebuilding and mortgage operations and theother building we intend to occupy in fiscal 2007 to use as our new principalexecutive office. Our local homebuilding operations and mortgage branchoperations generally lease office space for their day-to-day operations. Officeleases are generally for terms of three to five years and generally providerenewal options. We expect that in the normal course of business leases thatexpire will be renewed or replaced by other leases.

Because of the nature ofour homebuilding operations, significant amounts of property are held asinventory in the ordinary course of our homebuilding business. Such propertiesare not included in response to this Item.

**Item 3.**     Legal Proceedings

We are involved in variousroutine legal proceedings incidental to our business, some of which are coveredby insurance. With respect to the majority of pending litigation matters, ourultimate legal and financial responsibility, if any, cannot be estimated withcertainty and, in most cases, any potential losses related to these matters arenot considered probable. We accrue for legal expenses and settlement costswhere our ultimate exposure is considered probable and the potential loss canbe reasonably estimated. Most of these matters relate to construction defectand general customer claims. We believe that none of these matters will have amaterial adverse impact upon our consolidated financial condition, results ofoperations or cash flows.

**Item 4.        Submission of Matters to a Vote ofSecurity Holders**

Not applicable.

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**PART II**

**Item 5.     Marketfor Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of EquitySecurities**

**Market and other information**

We are a privately-owned company with no establishedpublic trading market for our common stock.

During fiscal 2006, wegranted stock options to purchase 12,000 shares of our common stock to a keyemployee under a new stock option plan. The option price equals the estimatedfair market value of our common stock on the date of grant. We received noproceeds from this grant. We granted the stock options in reliance on anexemption from registration under the Securities Act of 1933. No stock optionswere granted during fiscal 2005.

**Holders**

As of December 15,2006, there were 19 holders of our common stock. See Item 12, “SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters” for additional information about the ownership of our common stock.

**Dividends**

We arecurrently restricted in our ability to pay dividends under various covenants ofour debt agreements, including our senior unsecured credit facility and theindenture governing our senior subordinated notes. We have not in the last twofiscal years paid, and do not expect for the foreseeable future to pay,dividends on our common stock. Instead, we anticipate that all of our earningsin the foreseeable future will be used in the operation and expansion of ourbusiness. Any future determination to pay dividends will depend upon, amongother factors, our results of operations, financial condition, capitalrequirements, any contractual restrictions and any other considerations ourboard of directors deems relevant.

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**Item 6.        Selected Financial Data**

Setforth below is selected consolidated financial data for each of the past fivefiscal years. Theselected financial data should be read in conjunction with Item 7, “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andItem 8, “Financial Statements and Supplementary Data” included elsewhere inthis report.

| ** **                                                       | ** ** | **Fiscal year ended September 30,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(Dollars in thousands)**                             | ** ** | **2006**                                                | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Statement of operations data:**                                | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total  homebuilding revenues                                     |       | $                                                       | 1,163,844  |   | $ | 1,146,641 |   | $ | 920,055 |   | $ | 785,693 |   | $ | 689,336 |   |
| Cost of sales of  residential units and land                     |       | 973,203                                                 |       | 862,646 |   | 729,497 |   | 632,719 |   | 571,518 |   |
| Gross  homebuilding profit                                       |       | 190,641                                                 |       | 283,995 |   | 190,558 |   | 152,974 |   | 117,818 |   |
| Homebuilding  operating expenses                                 |       | 130,879                                                 |       | 145,320 |   | 105,039 |   | 92,484 |   | 74,858 |   |
| Equity in income  of unconsolidated  entities                    |       | 2,215                                                   |       | 3,282 |   | 833 |   | 618 |   | 1,123 |   |
| Minority  interests in net earnings of consolidated partnerships |       | (290                                                    | )          | (6,152 | ) | (4,232 | ) | (4,122 | ) | (4,453 | ) |
| Homebuilding  earnings before income  taxes                      |       | 61,687                                                  |       | 135,805 |   | 82,120 |   | 56,986 |   | 39,630 |   |
| Mortgage banking  earnings before income taxes                   |       | 3,633                                                   |       | 1,718 |   | 864 |   | 3,216 |   | 1,425 |   |
| Earnings before  income taxes                                    |       | 65,320                                                  |       | 137,523 |   | 82,984 |   | 60,202 |   | 41,055 |   |
| Provision for  income taxes                                      |       | 23,516                                                  |       | 50,689 |   | 27,365 |   | 22,563 |   | 16,035 |   |
| Net earnings                                                     |       | $                                                       | 41,804     |   | $ | 86,834 |   | $ | 55,619 |   | $ | 37,639 |   | $ | 25,020 |   |
| **Balance  sheet data (at end of period):**                      |       |                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash  equivalents                                       |       | $                                                       | 18,665     |   | $ | 21,460 |   | $ | 7,656 |   | $ | 25,597 |   | $ | 10,884 |   |
| Inventory                                                        |       | 899,297                                                 |       | 808,778 |   | 697,978 |   | 521,070 |   | 473,415 |   |
| Total assets                                                     |       | 1,091,577                                               |       | 970,495 |   | 762,975 |   | 654,235 |   | 533,285 |   |
| Total debt                                                       |       | 500,208                                                 |       | 473,411 |   | 431,121 |   | 435,239 |   | 337,581 |   |
| Total redeemable  equity                                         |       | 26,334                                                  |       | 33,763 |   | 10,681 |   | 5,174 |   | 343 |   |
| Total  shareholders’ equity                                 |       | 367,118                                                 |       | 250,809 |   | 171,228 |   | 120,330 |   | 89,295 |   |
| **Other  financial data:**                                       | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest incurred(1)                                             |       | $                                                       | 52,239     |   | $ | 38,255 |   | $ | 30,641 |   | $ | 29,964 |   | $ | 24,546 |   |
| Depreciation and  amortization                                   |       | 843                                                     |       | 880 |   | 966 |   | 929 |   | 812 |   |
| EBITDA(2)                                                        |       | 99,069                                                  |       | 166,133 |   | 119,957 |   | 88,963 |   | 61,697 |   |
| Gross  homebuilding profit margin(3)                             |       | 16.4                                                    | %          | 24.8 | % | 20.7 | % | 19.5 | % | 17.1 | % |
| Ratio of earnings  to fixed charges(4)                           |       | 1.83                                                    | x          | 4.37 | x | 3.92 | x | 3.02 | x | 2.62 | x |
| **Other data:**                                                  | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net new home  orders (units)(5)                                  |       | 3,367                                                   |       | 3,703 |   | 3,716 |   | 3,301 |   | 3,206 |   |
| Homes delivered  (units)                                         |       | 4,079                                                   |       | 3,881 |   | 3,616 |   | 3,294 |   | 3,059 |   |
| Average sales  price of homes delivered                          |       | $                                                       | 277        |   | $ | 286 |   | $ | 249 |   | $ | 233 |   | $ | 221 |   |
| Backlog at end of  period (units)(6)                             |       | 758                                                     |       | 1,470 |   | 1,648 |   | 1,548 |   | 1,541 |   |
| Backlog at end of period  (contract  value)(6)                   |       | $                                                       | 210,554    |   | $ | 423,506 |   | $ | 469,277 |   | $ | 380,788 |   | $ | 363,903 |   |

(1)     Interestincurred is the amount of interest paid and the net amount accrued (whetherexpensed or capitalized), and the amortization of debt issuance costs.

(2)     “EBITDA” represents net earnings before interestexpense, depreciation and amortization and provision for income taxes. EBITDAis included in this report because we use it to assess our operationalperformance. We believe it is useful to securities analysts, investors andother interested parties in the evaluation of companies like ours becauseinterest, taxes, depreciation and amortization can vary 

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significantlybetween companies due in part to differences in structure, accounting policies,tax strategies, levels of indebtedness and interest rates. EBITDA is not ameasure of our liquidity or financial performance in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”) andshould not be considered as an alternative to our net earnings or any otherperformance measure derived in accordance with GAAP, or as an alternative tocash flows from operating activities. EBITDA has limitations as an analyticaltool, and you should not consider it in isolation, or as a substitute for an analysisof our results as reported under GAAP. Some limitations are:

·   EBITDA does not reflect our cash expenditures, futurerequirements for capital expenditures or contractual commitments;

·   EBITDA does not reflect changes in, or cashrequirements for, our working capital needs;

·   EBITDA does not reflect the significant interestexpense, or the cash requirements necessary to service interest or principalpayments on our indebtedness;

·   EBITDA does not reflect the significant income tax expenseor cash requirements for federal and state income tax obligations;

·   although depreciation and amortization are non-cashcharges, the assets being depreciated and amortized will often have to bereplaced in the future, and EBITDA does not reflect any cash requirements forsuch replacements; and

·   other companies in our industry may calculate EBITDAdifferently than we do, limiting its usefulness as a comparative measure.

Because of these limitations, EBITDA should not beconsidered as a measure of discretionary cash available to us to invest in thegrowth of our business or to service our indebtedness. We compensate for theselimitations by relying primarily on our GAAP results and using EBITDA onlysupplementally. See the consolidated statements of operations and cash flowspresented in our consolidated financial statements included elsewhere in thisreport. The following is a reconciliation of EBITDA to net earnings, the mostdirectly comparable GAAP measure:

| ** **                                       | ** ** | **Fiscal year ended September 30,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(Dollars in thousands)**             | ** ** | **2006**                                                | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net earnings                                     |       | $                                                       | 41,804     |   | $ | 86,834 |   | $ | 55,619 |   | $ | 37,639 |   | $ | 25,020 |   |
| Provision for  income taxes                      |       | 23,516                                                  |       | 50,689 |   | 27,365 |   | 22,563 |   | 16,035 |   |
| Interest expense  in cost of sales               |       | 32,899                                                  |       | 27,696 |   | 35,382 |   | 26,883 |   | 19,584 |   |
| Interest expense  in mortgage banking operations |       | 7                                                       |       | 34 |   | 625 |   | 949 |   | 246 |   |
| Depreciation and  amortization                   |       | 843                                                     |       | 880 |   | 966 |   | 929 |   | 812 |   |
| EBITDA                                           |       | $                                                       | 99,069     |   | $ | 166,133 |   | $ | 119,957 |   | $ | 88,963 |   | $ | 61,697 |   |

(3)     Representsgross homebuilding profit divided by total homebuilding revenues.

(4)     Earningshave been calculated as (a) earnings before income taxes before adjustmentfor minority interests in consolidated subsidiaries or income or loss fromequity investees, plus (b) fixed charges, plus (c) capitalizedinterest included in cost of sales, plus (d) distributed income of equityinvestees,minus (e) interestcapitalized. Fixed charges are comprised of (a) interest incurred, bothexpensed and capitalized, (b) amortized premiums, discounts andcapitalized expenses related to indebtedness, and (c) the portion ofrental expense which is deemed to be representative of an interest factor.

(5)     Net newhome orders represents the number of new sales contracts executed withcustomers, net of sales contract cancellations.

(6)     Backlog represents homes under sales contracts but notyet delivered at the end of the period. The contract value of backlog at theend of fiscal years 2004 and 2003 includes an estimate, derived from ouraccounting records, of the contract value for subsequent contract cancellationsand amendments.

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

**Overview**

We areone of the largest privately-owned homebuilders and one of the 30 largesthomebuilders in the United States, as measured by home deliveries and revenues.We design, build and market single-family detached, single-family attached andmulti-family homes. Since we were founded in 1969, we have delivered over44,000 homes to a broad range of customers, including first-time buyers andfirst- and second-time move-up buyers. Throughout this period, we have grownour business organically and now operate within 17 markets across nine stateslocated in the following five geographic regions:

| **Florida** | ** ** | ** **        | ** ** | **Midwest** | ** ** | **Nevada**      | ** ** | **Pacific Coast** | ** ** | **Texas** | ** ** |
|-------------|------------|-------------------|------------|-------------|------------|-----------------|------------|------------------------|------------|-----------|------------|
| Ft. Myers   |       | Chicago,  IL      |       | Las  Vegas  |       | Portland,  OR   |       | Austin                 |       |
| Naples      |       | Cleveland,  OH(a) |       |        |       | Sacramento,  CA |       | Dallas                 |       |
| Sarasota    |       | Milwaukee,  WI    |       |        |       | Stockton,  CA   |       | Ft.  Worth             |       |
| Tampa       |       |              |       |        |       | Vancouver,  WA  |       | Houston                |       |
|        |       |              |       |        |       |            |       | San Antonio            |       |

(a)     In March 2006,we decided to exit the Cleveland market based on our perception regarding localmarket conditions currently and in the foreseeable future. We have been windingdown operations with the objective of completing all construction and salesactivities during our second fiscal quarter of 2007. We believe our exit fromthe Cleveland market will not have a material adverse impact on our futureoperating results.

Our revenues are primarilygenerated from designing, building, marketing and delivering for sale single-familydetached, single-family attached and multi-family homes. We also sell land andlots to third parties as a means of managing inventory and obtaining thedesired asset mix for our homebuilding operations. We also conduct mortgageorigination and title services for the benefit of our homebuilding operations,although revenues generated by these ancillary services have historicallycomprised less than 1% of our total consolidated revenues, and are not expectedto be significant in the future.

**Recent trends**

*Duringfiscal year 2006, market conditions for new home sales have become considerablymore difficult than has been experienced over the past decade. Both the breadthand pace of market deterioration has been greater than anticipated, given therelatively strong broader economic backdrop. This deterioration has beenamplified in the coastal markets and Las Vegas, as these markets had previouslyexperienced significant gains in both the volume of home deliveries and inprice appreciation. Many view the current homebuilding environment as a returnto a more normalized homebuilding marketplace, which may continue to showerosion of home sales and profitability. Currently we do not see conditions inthe housing market improving significantly in the near term.*

*The following describe some of the factors present in themarketplace during our fourth fiscal quarter of 2006:*

*·**      **increasing supply of resale homes and new homesavailable for purchase;*

*·**      **decreasing customer traffic and declining buyersentiment;*

*·**      **increasing cancellation rates resulting in lower netsales;*

*·**      **increasing frequency and level of customer incentivepackages;*

*·**      **increasing use and compensation of real estatebrokers; and*

*·**      **increasing abandonment of earnest money related toland option agreements and purchase contracts.*

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*Giventhese significant market changes and uncertainty about the timing and pace ofrecovery, we have adopted a strategy to manage our business through thiscurrent downturn. Our strategy focuses on balance sheet management, andincludes:*

*·**      **using free cash flow to reduce our debt and interestcosts, and to maximize our liquidity;*

*·**      **tailoring our product offerings and option packagesto address affordability constraints;*

*·**      **increasing efforts to pre-sell homes beforeconstruction begins;*

*·**      **renegotiating with vendors and subcontractors tomanage our construction costs;*

*·**      **sizing our operating structure to match ourperception regarding market conditions currently and into the foreseeablefuture;*

*·**      **tightening land acquisition criteria and working withland sellers to renegotiate land purchase and option contracts to extendpurchase dates and reduce purchase prices; and*

*·**      **potentially selling lots to generate cash and reduceour overall land holdings.*

We believe that ouroperating history and geographic diversification will continue to benefit us asthe homebuilding industry transitions through a changing environment.

**Recent events**

In December 2005, we issued$203 million aggregate principal amount of senior subordinated notes due December 2012in a private placement pursuant to Rule 144A promulgated under theSecurities Act of 1933. The senior subordinated notes were sold at 98.796% ofpar and accrue interest at a coupon rate of 10.5% per annum. In May 2006,we completed an offer to exchange all of the senior subordinated notes issuedin December 2005 for an issue of notes registered with the SEC with termssubstantially identical to the notes issued in the private placement.

In December 2005, we entered into a new seniorunsecured credit facility to finance our business operations. Proceeds of thenew credit facility were used to retire our existing senior secured revolvingcredit facilities and substantially all of our other senior secured creditfacilities. The credit facility has a maximum availability of $500 million,subject to a borrowing base as well as sublimits of $100 million for theissuance of letters of credit and $10 million for swing line loans. We have theright, without the consent of our lenders (other than those participating inthe increase), to increase the commitment by an amount of up to $200 million,provided that no such increase shall cause the senior unsecured credit facilityto exceed $700 million.

Given the current market conditions and thedeterioration of profitability, we believed that maintaining our original debtcovenants would become difficult. Therefore, on December 15, 2006, we paidfees of $0.9 million to amend our $500 million senior unsecured revolvingcredit facility. Many of our debt covenants were modified under the amendment,including the most restrictive covenant requiring us to maintain an interestcoverage ratio of no less than 2.25x, which was modified to require an interestcoverage ratio of no less than 1.75x through December 31, 2006, decreasingto 1.5x through March 31, 2007, decreasing to 1.4x through June 30,2007, decreasing to 1.35x through September 30, 2007, increasing to 1.5xthrough December 31, 2007, increasing to 1.75x through March 31, 2008and then increasing to 2.25x through the remaining term of the facility.

In March 2006, we decided toexit the Cleveland market. Our decision to exit the Cleveland market reflectsour perception regarding local market conditions currently and in theforeseeable future. We have been winding down operations with the objective ofcompleting all construction and sales activities during our second fiscalquarter of 2007. We believe our exit from the Cleveland market will not have amaterial adverse impact on our future operating results.

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In September 2006, wesold 952,380 shares of common stock to Equity Investments III, LLC for anaggregate purchase price of $110 million. Approximately $74 million of thenet proceeds from the sale of the shares were used to reduce our outstandingindebtedness and the remainder of the proceeds were used to repurchase sharesof common stock from certain current and former directors and officers.

**Results ofoperations and other data**

Thefollowing table presents selected statement of operations and other data forthe 2006, 2005 and 2004 fiscal years:

| ** **                                                       | ** ** | **Fiscal** | ** ** | ** **               | ** ** | **Fiscal** | ** ** | ** **               | ** ** | **2006   ** | **Fiscal** | ** ** | ** **               | ** ** | **2005  ** |
|------------------------------------------------------------------|------------|------------|------------|--------------------------|------------|------------|------------|--------------------------|------------|----------------------------|------------|------------|--------------------------|------------|----------------------|
| ** **                                                       | ** ** | **Year**   | ** ** | ** **               | ** ** | **Year**   | ** ** | ** **               | ** ** | **vs.   **  | **Year**   | ** ** | ** **               | ** ** | **vs.  **  |
| **(Dollars in thousands)**                             | ** ** | **2006**   | ** ** | **% of total** | ** ** | **2005**   | ** ** | **% of total** | ** ** | **2005   ** | **2004**   | ** ** | **% of total** | ** ** | **2004  ** |
| **Statement of operations data:**                                | ** ** | ** ** | ** ** |                     | ** ** | ** ** |       | ** **               | ** ** |                       | ** ** | ** ** |                     | ** ** | ** **           | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |
| Total homebuilding revenues                                      |       | $          | 1,163,844  |                     |       | 100.0      | %          |                     | $          | 1,146,641                  |       |       | 100.0                    | %          |                 | 1.5 | % | $ | 920,0555 |   |   | 100.0 | % |   | 24.6 | % |
| Cost of sales of residential units and land                      |       | 973,203    |       |                     | 83.6       | %          |       | 862,646                  |       |                       | 75.2       | %          |                     | 12.8       | %                    | 729,497 |   |   | 79.3 | % |   | 18.3 | % |
| Gross homebuilding profit                                        |       | 190,641    |       |                     | 16.4       | %          |       | 283,995                  |       |                       | 24.8       | %          |                     | (32.9      | )%                   | 190,558 |   |   | 20.7 | % |   | 49.0 | % |
| Homebuilding operating expenses                                  |       | 130,879    |       |                     | 11.2       | %          |       | 145,320                  |       |                       | 12.7       | %          |                     | (9.9       | )%                   | 105,039 |   |   | 11.4 | % |   | 38.3 | % |
| Equity in income of unconsolidated entities                      |       | 2,215      |       |                     | 0.2        | %          |       | 3,282                    |       |                       | 0.3        | %          |                     | (32.5      | )%                   | 833 |   |   | 0.1 | % |   | 294.0 | % |
| Minority interests in net earnings of consolidated  partnerships |       | (290       | )          |                     | (0.0       | )%         |       | (6,152                   | )          |                       | (0.5       | )%         |                     | (95.3      | )%                   | (4,232 | ) |   | (0.5 | )% |   | 45.4 | % |
| Homebuilding earnings before income taxes                        |       | 61,687     |       |                     | 5.3        | %          |       | 135,805                  |       |                       | 11.8       | %          |                     | (54.6      | )%                   | 82,120 |   |   | 8.9 | % |   | 65.4 | % |
| Mortgage banking earnings before income taxes               |       | 3,633      |       |                     | 0.3        | %          |       | 1,718                    |       |                       | 0.1        | %          |                     | 111.5      | %                    | 864 |   |   | 0.1 | % |   | 98.8 | % |
| Earnings before income taxes                                     |       | 65,320     |       |                     | 5.6        | %          |       | 137,523                  |       |                       | 12.0       | %          |                     | (52.5      | )%                   | 82,984 |   |   | 9.0 | % |   | 65.7 | % |
| Provision for income taxes                                       |       | 23,516     |       |                     | 2.0        | %          |       | 50,689                   |       |                       | 4.4        | %          |                     | (53.6      | )%                   | 27,365 |   |   | 3.0 | % |   | 85.2 | % |
| Net earnings                                                     |       | $          | 41,804     |                     |       | 3.6        | %          |                     | $          | 86,834                     |       |       | 7.6                      | %          |                 | (51.9 | )% | $ | 55,619 |   |   | 6.0 | % |   | 56.1 | % |
| **Other  data:**                                                 | ** ** | ** ** | ** ** |                     | ** ** | ** ** |       | ** **               | ** ** |                       | ** ** | ** ** |                     | ** ** | ** **           | ** ** | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |
| Net new home orders (units)(1)                                   |       | 3,367      |       |                     |       |       |       | 3,703                    |       |                       |       |       |                     | (9.1       | )%                   | 3,716 |   |   |   |   |   | (0.3 | )% |
| Homes delivered (units)                                          |       | 4,079      |       |                     |       |       |       | 3,881                    |       |                       |       |       |                     | 5.1        | %                    | 3,616 |   |   |   |   |   | 7.3 | % |
| Average sales price of homes delivered                           |       | $          | 277        |                     |       |       |       |                     | $          | 286                        |       |       |                     |       |                 | (3.1 | )% | $ | 249 |   |   |   |   |   | 14.9 | % |
| Backlog at end of period (units)(2)                              |       | 758        |       |                     |       |       |       | 1,470                    |       |                       |       |       |                     | (48.4      | )%                   | 1,648 |   |   |   |   |   | (10.8 | )% |
| Backlog at end of  period (contract value)(2)               |       | $          | 210,554    |                     |       |       |       |                     | $          | 423,506                    |       |       |                     |       |                 | (50.3 | )% | $ | 469,2777 |   |   |   |   |   | (9.8 | )% |
|                                                                  |            |            |            |                          |            |            |            |                          |            |                            |            |            |                          |            |                      |  |  |  |  |  |  |  |  |  |  |  |  |

(1)             Net new home orders represents the number of new salescontracts executed with customers, net of sales contract cancellations.

(2)             Backlog represents homes under salescontracts but not yet delivered at the end of the period. The contract value ofbacklog at the end of fiscal year 2004 includes an estimate, derived from our accountingrecords, of the contract value for subsequent contract cancellations andamendments.

***Year ended September 30, 2006compared to year ended September 30, 2005***

***Homebuilding revenues.******  ***Homebuilding revenues increased 1.5% to $1,163.8 million in fiscal 2006from $1,146.6 million in fiscal 2005. The increase was primarily due to a 5.1%increase in the number of homes delivered, which was offset partially by a 3.1%decrease in the average sales price of homes delivered primarily due to a shiftof deliveries to our Texas region. New home deliveries increased to 4,079 infiscal 2006 from 3,881 homes in fiscal 2005. The average sales price of homesdelivered decreased to $277 thousand in fiscal 2006 from $286 thousand isfiscal 2005. Land sales in fiscal 2006 were $30.5 million as compared to $33.4million in fiscal 2005.

***Home sales andbacklog.******  ***Net new home orders decreased 9.1% to 3,367 in fiscal2006 from 3,703 in fiscal 2005. Declining buyer sentiment combined with anincreased supply of resale homes and new homes available for purchase haveplaced increasing pressure on sales in many of the regions in which we operate.This changing marketplace has resulted in the increased utilization andmagnitude of sales incentives to remain competitive within the homebuildingindustry.

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At September 30, 2006, thecontract value of our backlog was $210.6 million, as compared to $423.5 millionat September 30, 2005. The average sales price per home in backlog of $278,000at September 30, 2006 was down $10,000, or 3.6%, over the average salesprice per home in backlog of $288,000 at September 30, 2005.

***Gross homebuildingprofit margin.******  ***Gross homebuilding profit margin decreased to 16.4%for fiscal 2006, compared to 24.8% for fiscal 2005. During fiscal 2006, therewas a significant shift from regions that historically had higher than averagegross profit margins to regions with lower than average gross profit margins.Additionally, included in our fiscal 2006 gross profit are inventory valuationcharges of $25.8 million related to our decision to exit the Cleveland marketand our expectations regarding the recoverability of certain assets from activeresidential construction projects and $8.3 million of costs related to theabandonment of projects and write-off of deposits on cancelled land optioncontracts. The remaining gross profit decrease reflects margin pressures acrossall of our regions, except for Texas.

***Homebuilding operatingexpenses.******  ***Homebuilding operating expenses, whichconsist of all homebuilding expenses other than cost of sales, decreased 9.9%to $130.9 million in fiscal 2006 from $145.3 million in fiscal 2005. Incentivecompensation expense decreased $11 million in fiscal 2006 due to lower overallcorporate earnings in fiscal 2006 as compared with fiscal 2005. Commissionspaid to outside real estate brokers increased by $8.6 million in fiscal 2006,as we increased our utilization of their services to sell our homes.Additionally, during fiscal 2005, we recorded $15.9 million of compensationexpense related to certain stock options granted that were considered to bevariable awards. We have since amended our equity-based compensation agreementsto amend the terms that resulted in variable accounting treatment. Homebuildingoperating expenses were 11.2% and 12.7% of homebuilding revenue in fiscal 2006and fiscal 2005, respectively.

***Net mortgageoperations.******  ***Mortgage banking earnings before taxes increased to$3.6 million in fiscal 2006, compared to $1.7 million in fiscal 2005. Theincrease in fiscal 2006 earnings was primarily due to a higher capture rate, areduction in operating costs and an increase in the average mortgage loan size.

***Income taxes.******  ***We recorded income tax expense of $23.5 million and $50.7 million in fiscal2006 and fiscal 2005, respectively, and our consolidated effective tax rateswere 36.0% and 36.9%, respectively, for the same periods.

***Net earnings.******  ***As a result of the above factors, our net earnings decreased 51.9% to $41.8million in fiscal 2006 from $86.8 million in fiscal 2005.

***Year ended September 30, 2005compared to year ended September 30, 2004***

***Homebuilding revenues.******  ***Homebuilding revenues increased 24.6% to $1,146.6million in fiscal 2005 from $920.1 million in fiscal 2004. The increasewas primarily due to a 14.9% increase in the average sales price of homesdelivered and a 7.3% increase in the number of homes delivered. New home deliveriesincreased to 3,881 in fiscal 2005 from 3,616 homes in fiscal 2004. The averagesales price of homes delivered increased to $286 thousand in fiscal 2005 from$249 thousand is fiscal 2004. Land sales in fiscal 2005 were $33.4 million ascompared to $14.6 million in fiscal 2004.

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***Home sales andbacklog.******  ***Net new home orders in fiscal 2005 remainedrelatively constant at 3,703 as compared to 3,716 in fiscal 2004. Our number ofnet new home orders per open selling location increased in fiscal 2005 ascompared to fiscal 2004, although our number of open selling locationsdecreased due to delays resulting from inclement weather and municipalapproval.

At September 30, 2005, thecontract value of our backlog was $423.5 million, as compared to $469.3 millionat September 30, 2004. The average sales price per home in backlog of $288,000at September 30, 2005 was up $3,000, or 1.1%, over the average sales priceper home in backlog of $285,000 at September 30, 2004. The reduction inbacklog units and the approximately flat average sales price reflect the delayin the opening of certain locations and our decision to reduce pre-sell effortsin certain markets so as to ensure more predictable delivery timelines, profitmargins and higher customer satisfaction levels.

***Gross homebuildingprofit margin.******  ***Gross homebuilding profit margin increased to 24.8%for fiscal 2005, compared to 20.7% for fiscal 2004, primarily due to increasedrevenues in the Nevada and Pacific Coast regions, where margins are highrelative to other regions, as well as our ability to raise prices in mostregions. During fiscal 2005, the Nevada and Pacific Coast regions contributed44% of the total homebuilding revenues and 67% of the total homebuilding grossprofit. During fiscal 2004, these two regions contributed 36% of the total homebuildingrevenues and 53% of the total homebuilding gross profit.

***Homebuildingoperating expenses.******  ***Homebuildingoperating expenses, which consist of all homebuilding expenses other than costof sales, increased 38.3% to $145.3 million in fiscal 2005 from $105.0 millionin fiscal 2004. During fiscal 2005, we recorded $15.9 million ofcompensation expense related to certain stock options granted that wereconsidered to be variable awards. We have since amended our equity-basedcompensation agreements to amend the terms that resulted in variable accountingtreatment. Excluding the compensation expense related to the variable awards,our homebuilding operating expenses grew proportionately with our growth intotal homebuilding revenues. Homebuilding operating expenses were 12.7% and11.4% of homebuilding revenue in fiscal 2005 and fiscal 2004,respectively.

***Net mortgageoperations.******  ***Mortgage banking earnings before taxes increased to$1.7 million in fiscal 2005, compared to $0.9 million in fiscal 2004. Theincrease in fiscal 2005 earnings was primarily due to an increase in mortgagevolume.

***Income taxes.******  ***We recorded income tax expense of $50.7 million and$27.4 million in fiscal 2005 and fiscal 2004, respectively, and ourconsolidated effective tax rates were 36.9% and 33.0%, respectively, for thesame periods. The effective tax rate for fiscal 2004 includes an adjustment toreduce prior state income tax estimates for periods in which the mix ofour earnings shifted from higher to lower tax rate jurisdictions.

***Net earnings.******  ***As a result of the above factors, our net earningsincreased 56.1% to $86.8 million in fiscal 2005 from $55.6 million in fiscal2004.

**Segment analysis**

We aggregate our homebuildingoperating segments into five reportable segments and our mortgage banking operationsinto one reportable segment. We historically aggregated our homebuildingoperating segments into one reportable segment and accordingly have revisedthat historical presentation for all periods to conform to the current yearpresentation of five reportable homebuilding segments. Our homebuilding segments are engaged in the acquisition and development ofland, and construction and sale of residential homes. Our mortgage bankingsegment originates mortgages, which are sold to third parties.

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The five reportable homebuildingsegments include operations in the following geographic regions:

Florida

Midwest: Illinois, Ohio and Wisconsin

Nevada

Pacific Coast: California, Oregon and Washington

Texas

Thefollowing table presents financial and operational information related to ourhomebuilding operations:

| **Year Ended September 30,  (Dollars in thousands)** | ** ** | ** ** | ** ** | **Average  sales price of  homes  delivered** | ** ** | **Homes  delivered** | ** ** | **Net new  home  orders**(1) | ** ** | **Backlog  (units) at  year end**(2) | ** ** | **Backlog  (contract  value) at  year end**(2) | ** ** |
|-------------------------------------------------------------------------------|------------|------------|------------|---------------------------------------------------------|------------|----------------------|------------|-----------------------------------|------------|------------------------------------------------|------------|----------------------------------------------------------|------------|
| **2006**                                                                      |       |       |       |                                                    |       |                 |       |                              |       |                                           |       |                                                     |       |   |   |
| Florida                                                                       |       |       | $          | 250                                                     |       |                 | 450        |                              |       | 259                                            |       |                                                     | 73         |   | $ | 24,000 |   |
| Midwest                                                                       |       |       | 362        |                                                    |       | 698                  |       |                              | 602        |                                           |       | 159                                                      |       | 57,000 |   |
| Nevada                                                                        |       |       | 393        |                                                    |       | 435                  |       |                              | 368        |                                           |       | 45                                                       |       | 17,318 |   |
| Pacific Coast                                                                 |       |       | 448        |                                                    |       | 647                  |       |                              | 443        |                                           |       | 80                                                       |       | 35,953 |   |
| Texas                                                                         |       |       | 165        |                                                    |       | 1,849                |       |                              | 1,695      |                                           |       | 401                                                      |       | 76,283 |   |
| Total                                                                         |       |       | $          | 277                                                     |       |                 | 4,079      |                              |       | 3,367                                          |       |                                                     | 758        |   | $ | 210,554 |   |
| **2005**                                                                      |       |       |       |                                                    |       |                 |       |                              |       |                                           |       |                                                     |       |   |   |
| Florida                                                                       |       |       | $          | 237                                                     |       |                 | 493        |                              |       | 337                                            |       |                                                     | 264        |   | $ | 60,990 |   |
| Midwest                                                                       |       |       | 378        |                                                    |       | 730                  |       |                              | 599        |                                           |       | 255                                                      |       | 95,366 |   |
| Nevada                                                                        |       |       | 353        |                                                    |       | 445                  |       |                              | 353        |                                           |       | 112                                                      |       | 45,272 |   |
| Pacific Coast                                                                 |       |       | 401        |                                                    |       | 814                  |       |                              | 866        |                                           |       | 284                                                      |       | 132,644 |   |
| Texas                                                                         |       |       | 167        |                                                    |       | 1,399                |       |                              | 1,548      |                                           |       | 555                                                      |       | 89,234 |   |
| Total                                                                         |       |       | $          | 286                                                     |       |                 | 3,881      |                              |       | 3,703                                          |       |                                                     | 1,470      |   | $ | 423,506 |   |
| **2004**                                                                      |       |       |       |                                                    |       |                 |       |                              |       |                                           |       |                                                     |       |   |   |
| Florida                                                                       |       |       | $          | 228                                                     |       |                 | 424        |                              |       | 548                                            |       |                                                     | 420        |   | $ | 98,145 |   |
| Midwest                                                                       |       |       | 362        |                                                    |       | 608                  |       |                              | 762        |                                           |       | 386                                                      |       | 138,701 |   |
| Nevada                                                                        |       |       | 274        |                                                    |       | 410                  |       |                              | 359        |                                           |       | 204                                                      |       | 67,911 |   |
| Pacific Coast                                                                 |       |       | 331        |                                                    |       | 654                  |       |                              | 745        |                                           |       | 232                                                      |       | 94,097 |   |
| Texas                                                                         |       |       | 168        |                                                    |       | 1,520                |       |                              | 1,302      |                                           |       | 406                                                      |       | 70,423 |   |
| Total                                                                         |       |       | $          | 249                                                     |       |                 | 3,616      |                              |       | 3,716                                          |       |                                                     | 1,648      |   | $ | 469,277 |   |

(1)     Net newhome orders represent the number of new sales contracts executed withcustomers, net of sales contract cancellations.

(2)     Backlogrepresents homes under sales contracts but not yet delivered at the end of theperiod. The contract value of backlog at the end of fiscal year 2004 includesan estimate, derived from our accounting records, of the contract value forsubsequent contract cancellations and amendments.

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The following table presents financial information based onour internal measurement system, which is not in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”). Ourinternal measurement system is intended to establish accountabilities tocontinually improve business focus, motivate behavior and drive performance.

| ** **                           | ** ** | **For the year ended September 30:** | ** ** | **As of September 30:**                  | ** ** |
|--------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **Revenues**                                                  | ** ** | ** Earnings before  income taxes ** | ** ** | **Assets** | ** ** |
| **2006**                             |       |                                                          |       |                                                    |       |   |   |   |   |   |   |
| Florida                              |       | $                                                             | 112,470    |                                                    |       | $ | 7,502 |   |   |   | $     91,226 |   |
| Midwest                              |       | 263,506                                                       |       |                                                    | (13,870    | ) |   |   | 267,519 |   |
| Nevada                               |       | 171,455                                                       |       |                                                    | 42,143     |   |   |   | 224,331 |   |
| Pacific Coast                        |       | 290,406                                                       |       |                                                    | 68,620     |   |   |   | 181,289 |   |
| Texas                                |       | 323,887                                                       |       |                                                    | 15,066     |   |   |   | 197,604 |   |
| Mortgage banking                     |       | 8,222                                                         |       |                                                    | 3,633      |   |   |   | 10,859 |   |
| Segment subtotal                     |       | 1,169,946                                                     |       |                                                    | 123,094    |   |   |   | 972,828 |   |
| Corporate and  unallocated           |       | 2,120                                                         |       |                                                    | (29,780    | ) |   |   | 118,749 |   |
|                                 |       | 1,172,066                                                     |       |                                                    | 93,314     |   |   |   | 1,091,577 |   |
| Homebuilding interest  expense(1)    |       |                                                          |       |                                                    | (32,899    | ) |   |   |   |   |
| GAAP adjustment(2)                   |       |                                                          |       |                                                    | 4,905      |   |   |   |   |   |
| Consolidated total                   |       | $                                                             | 1,172,066  |                                                    |       | $ | 65,320 |   |   |   | $1,091,577 |   |
| **2005**                             |       |                                                          |       |                                                    |       |   |   |   |   |   |
| Florida                              |       | $                                                             | 116,951    |                                                    |       | $ | 15,168 |   |   |   | $     77,432 |   |
| Midwest                              |       | 280,859                                                       |       |                                                    | 25,035     |   |   |   | 237,467 |   |
| Nevada                               |       | 176,803                                                       |       |                                                    | 67,543     |   |   |   | 196,815 |   |
| Pacific Coast                        |       | 326,482                                                       |       |                                                    | 110,103    |   |   |   | 184,617 |   |
| Texas                                |       | 243,843                                                       |       |                                                    | 5,572      |   |   |   | 173,620 |   |
| Mortgage banking                     |       | 6,557                                                         |       |                                                    | 1,718      |   |   |   | 8,388 |   |
| Segment subtotal                     |       | 1,151,495                                                     |       |                                                    | 225,139    |   |   |   | 878,339 |   |
| Corporate and  unallocated           |       | 1,703                                                         |       |                                                    | (39,233    | ) |   |   | 92,156 |   |
|                                 |       | 1,153,198                                                     |       |                                                    | 185,906    |   |   |   | 970,495 |   |
| Homebuilding interest  expense(1)    |       |                                                          |       |                                                    | (27,696    | ) |   |   |   |   |
| GAAP adjustment(2)                   |       |                                                          |       |                                                    | (20,687    | ) |   |   |   |   |
| Consolidated total                   |       | $                                                             | 1,153,198  |                                                    |       | $ | 137,523 |   |   |   | $   970,495 |   |
| **2004**                             |       |                                                          |       |                                                    |       |   |   |   |   |   |
| Florida                              |       | $                                                             | 96,824     |                                                    |       | $ | 9,862 |   |   |   |   |   |
| Midwest                              |       | 220,711                                                       |       |                                                    | 19,231     |   |   |   |   |   |
| Nevada                               |       | 116,115                                                       |       |                                                    | 30,682     |   |   |   |   |   |
| Pacific Coast                        |       | 222,752                                                       |       |                                                    | 60,640     |   |   |   |   |   |
| Texas                                |       | 269,721                                                       |       |                                                    | 17,309     |   |   |   |   |   |
| Mortgage banking                     |       | 5,992                                                         |       |                                                    | 864        |   |   |   |   |   |
| Segment subtotal                     |       | 932,115                                                       |       |                                                    | 138,588    |   |   |   |   |   |
| Corporate and  unallocated           |       | 1,648                                                         |       |                                                    | (22,788    | ) |   |   |   |   |
|                                 |       | 933,763                                                       |       |                                                    | 115,800    |   |   |   |   |   |
| Homebuilding interest  expense(1)    |       |                                                          |       |                                                    | (35,382    | ) |   |   |   |   |
| GAAP adjustment(2)                   |       | (7,716                                                        | )          |                                                    | 2,566      |   |   |   |   |   |
| Consolidated total                   |       | $                                                             | 926,047    |                                                    |       | $ | 82,984 |   |   |   |   |   |
|                                      |            |                                                               |            |                                                         |            |  |  |  |  |  |  |  |  |

(1)     Forinternal measurement purposes, we measure our homebuilding operating resultsexclusive of any interest expense or other financing costs.

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(2)     The GAAP adjustment to revenue relates to certainprojects managed, but not owned or consolidated by us. For internal measurementpurposes, the projects were included, as if owned by us, in our operatingsegment reports. The GAAP adjustments to earnings before income taxes relateto: (a) timing differences of certain capitalizable indirect constructioncosts that are expensed as incurred in our internal measurement system, and (b) minorityinterest expense which is not included in our internal measurement system. Inaddition, the fiscal 2005 GAAP adjustment to earnings before income taxesincludes compensation expense, which was not included in our internalmeasurement system, of $15.9 million related to stock options that were deemedto be variable awards.

***Year ended September 30, 2006compared to year ended September 30, 2005***

***Florida.******  ***Homebuilding revenues decreased in fiscal 2006,compared to fiscal 2005, primarily due to an 8.7% decrease in the number ofhomes delivered, offset partially by a $13 thousand increase in the averagesales price of homes delivered. Homebuilding gross profit margins were 15.5% infiscal 2006, compared to 20.3% in fiscal 2005. Fiscal 2006 gross profit wasnegatively impacted by $0.4 million of inventory valuation charges and $4.5million of costs related to the abandonment of projects and write-off of depositson cancelled land option contracts.

***Midwest.******  ***Homebuilding revenues decreased in fiscal 2006,compared to fiscal 2005, primarily due to a 4.4% decrease in the number ofhomes delivered and a $16 thousand decrease in the average sales price of homesdelivered. This decrease in revenue was offset partially by a $6.6 millionincrease in land sales primarily related to exiting the Cleveland market.Homebuilding gross profit margins were 1.0% in fiscal 2006, compared to 13.8%in fiscal 2005. Fiscal 2006 gross profit was negatively impacted by $18.7 millionof inventory valuation charges and $2.4 million of costs related to theabandonment of projects and write-off of deposits on cancelled land optioncontracts.

***Nevada.******  ***Homebuilding revenues decreased in fiscal 2006,compared to fiscal 2005, primarily due to a $19 million decrease in land salesrevenue, which was offset significantly by a $40 thousand increase in theaverage sales price of homes delivered. Homebuilding gross profit margins were30.2% in fiscal 2006, compared to 40.4% in fiscal 2005.

***Pacific Coast.******  ***Homebuilding revenues decreased in fiscal 2006,compared to fiscal 2005, primarily due to a 20.5% decrease in the number ofhomes delivered, offset partially by a $47 thousand increase in the averagesales price of homes delivered. Homebuilding gross profit margins were 27.3% infiscal 2006, compared to 36.9% in fiscal 2005. Fiscal 2006 gross profit wasnegatively impacted by $3.1 million of inventory valuation charges and $1.2million of costs related to the abandonment of projects and write-off ofdeposits on cancelled land option contracts.

***Texas.******  ***Homebuilding revenues increased in fiscal 2006,compared to fiscal 2005, primarily due to a 32.2% increase in the number ofhomes delivered. Revenues from land sales increased by $9.5 million and theaverage sales price of homes delivered decreased by $2 thousand. Homebuildinggross profit margins were 12.2% in fiscal 2006, compared to 12.0% in fiscal2005. Fiscal 2006 gross profit was negatively impacted by $3.6 million ofinventory valuation charges and $0.2 million of costs related to theabandonment of projects and write-off of deposits on cancelled land optioncontracts.

***Mortgage banking.  ***Mortgage banking earnings before taxes increased to$3.6 million in fiscal 2006, compared to $1.7 million in fiscal 2006. Theincrease in fiscal 2006 earnings was primarily due to a higher capture rate, areduction in operating costs and an increase in the average mortgage loan size.

***Corporate and unallocated.******  ***Corporate and unallocated costs totaled $29.8 millionfor fiscal 2006 and $39.2 million for fiscal 2005. The reduction in corporateand unallocated costs is primarily related to a decrease in incentivecompensation due to lower overall corporate earnings. Corporate and unallocatedcosts as a percentage of total consolidated revenues were 2.5% for fiscal 2006and 3.4% for fiscal 2005.

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***Year ended September 30, 2005compared to year ended September 30, 2004***

***Florida.******  ***Homebuilding revenues increased in fiscal 2005, compared to fiscal 2004,primarily due to a 16.3% increase in the number of homes delivered and a $9thousand increase in the average sales price of homes delivered. Homebuildinggross profit margins were 20.3% in fiscal 2005, compared to 18.5% in fiscal2004.

***Midwest.******  ***Homebuilding revenues increased in fiscal 2005, compared to fiscal 2004,primarily due to a 20.1% increase in the number of homes delivered and a $16thousand increase in the average sales price of homes delivered. Homebuildinggross profit margins were 13.8% in fiscal 2005, compared to 14.0% in fiscal2004.

***Nevada.******  ***Homebuilding revenues increased in fiscal 2005, compared to fiscal 2004,primarily due to an 8.5% increase in the number of homes delivered and a $79thousand increase in the average sales price of homes delivered. Homebuildinggross profit margins were 40.4% in fiscal 2005, compared to 30.8% in fiscal2004.

***Pacific Coast.******  ***Homebuilding revenues increased in fiscal 2005, compared to fiscal 2004,primarily due to a 24.5% increase in the number of homes delivered and a $70thousand increase in the average sales price of homes delivered. Homebuildinggross profit margins were 36.9% in fiscal 2005, compared to 30.0% in fiscal2004.

***Texas.******  ***Homebuilding revenues decreased in fiscal 2005, compared to fiscal 2004,primarily due to a 7.9% decrease in the number of homes delivered. Homebuildinggross profit margins were 12.0% in fiscal 2005 compared to 15.2% in fiscal2004.

***Mortgage banking.  ***Mortgage banking earnings before taxes increased to$1.7 million in fiscal 2005, compared to $0.9 million in fiscal 2004. Theincrease in fiscal 2005 earnings was primarily due to an increase in mortgagevolume.

***Corporate and unallocated.******  ***Corporate and unallocated costs totaled $39.2 million for fiscal 2005 and$22.8 million for fiscal 2004. The increase in corporate and unallocated costsis primarily related to an increase in incentive compensation due to higheroverall corporate earnings and overall staffing levels. Corporate andunallocated costs as a percentage of total consolidated revenues were 3.4% forfiscal 2005 and 2.5% for fiscal 2004.

**Liquidityand capital resources**

Ourprincipal uses of cash are land purchases, lot development and homeconstruction. As a result, our financing needs depend principally on salesvolume, land acquisition and inventory balances. We fund our operations withcash flows from operating activities, borrowings under a senior unsecuredcredit facility, other bank debt and minority interests in consolidatedpartnerships. We do not hold cash for investment purposes and we manage ourcash and debt positions to minimize financing costs.

***Operating cash flows activities***

Cash used in operatingactivities totaled $70.2 million during fiscal 2006, compared to $9.5 millionprovided by operating activities during fiscal 2005. The decrease in operatingcash flows is primarily due to reduced profitability from our homebuildingoperations during fiscal 2006 while maintaining a significant continuedinvestment in inventory. The net investment in inventory is related to landpurchases, lot development and home construction.

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***Investing cash flows activities***

Cash used in investingactivities totaled $16.3 million during fiscal 2006, compared to $25.2 millionduring fiscal 2005. The decrease in cash used in investing activities wasprimarily due to a reduction in the cash contributed and advanced tounconsolidated entities, partially offset by the purchase of a building to beused as our future principal executive office.

***Financing cash flows activities***

Cash provided by financing activities totaled $83.7million during fiscal 2006, compared to $29.6 million during fiscal 2005.Net borrowings of $26.8 million were primarily used to increase our investmentin inventory. Net proceeds from the sale of common stock totaled $114.8million, including the sale of 952,380 shares of common stock to an investorfor an aggregate purchase price of $110 million. The net proceeds from the saleof the investor shares were used to reduce our outstanding indebtedness, and torepurchase shares of common stock from certain current and former directors andofficers. During fiscal 2006, we repurchased 423,986 shares of common stock for$48.8 million.

In December 2005, we issued$203 million aggregate principal amount of senior subordinated notes due December 2012in a private placement pursuant to Rule 144A promulgated under theSecurities Act of 1933. The senior subordinated notes were sold at 98.796% ofpar and accrue interest at a coupon rate of 10.5% per annum. Interest is paidsemi-annually in June and December. The net proceeds were used to repayamounts outstanding under working capital loans and certain senior securedrevolving credit facilities. We may redeem the notes, in whole or part, at anytime on or after December 15, 2009, at a redemption price equal to 100% ofthe principal amount, plus a 5.25% premium declining ratably to par on December 15,2011, plus accrued and unpaid interest. In addition, at any time prior to December 15,2008, we may redeem up to 35% of the aggregate principal amount of the noteswith the proceeds of qualified equity offerings at a redemption price equal to110.5% of the principal amount, plus accrued and unpaid interest. The notes areunsecured senior subordinated obligations and subordinated in right of paymentto all of our existing and future senior debt, including borrowings under oursenior unsecured credit facility. All of our wholly owned subsidiaries, otherthan our mortgage subsidiary, have fully and unconditionally guaranteed thenotes on a joint and several, unsecured senior subordinated, basis. Theguarantees are general unsecured obligations of the guarantors and will besubordinated in right of payment to all existing and future senior debt of theguarantors, which includes their guarantees of our senior unsecured creditfacility. The indenture governing the senior subordinated notes contains anumber of significant covenants that restricts our ability and that of ourrestricted subsidiaries to, among other things: incur additional indebtedness,make certain distributions, investments and other restricted payments, createcertain liens, enter into transactions with affiliates, and merge, consolidateor sell substantially all of our assets. As of September 30, 2006, we wererestricted from incurring additional indebtedness, except under certain limitedcircumstances.

In May 2006, we completed an offer to exchangeall of the senior subordinated notes issued in December 2005 for an issueof notes registered with the SEC with terms substantially identical to thenotes issued in the private placement.

In December 2005, we entered into a new seniorunsecured credit facility to finance our business operations. Proceeds of thenew credit facility were used to retire our existing senior secured revolvingcredit facilities and substantially all of our other senior secured creditfacilities. The credit facility has a maximum availability of $500 million,subject to a borrowing base as well as sublimits of $100 million for theissuance of letters of credit and $10 million for swing line loans. We have theright, without the consent of our lenders (other than those participating inthe increase), to increase the commitment by an amount of up to $200 million,provided that no such increase shall cause the senior unsecured credit facilityto exceed $700 million. The applicable borrowing base will be determinedregularly throughout the life of the 

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facility. The composition of the borrowing base willbe limited to parameters set forth in the credit facility agreement and certaintypes of real estate (such as unimproved entitled land and lots underdevelopment) will be removed from the borrowing base if held beyond specifiedmaturity dates. Borrowings under the credit facility will generally bearinterest based on an applicable margin plus LIBOR or an alternate base rate.The applicable margin for interest ranges from 1.5% to 2.25%, depending uponour senior leverage ratio, which is defined as the ratio of total liabilitiesto consolidated net worth. Fees for letters of credit are based on LIBOR plus amargin of 1.5%. An unused commitment fee equal to 0.2% to 0.3% per year accrueson the undrawn portion of the facility and is payable quarterly in arrears. Asof September 30, 2006, we had $245 million of borrowings under the creditfacility at an effective interest rate of 7.34% and, after giving effect to theborrowing base limitation, had additional availability of approximately $254million. Our obligations under the senior unsecured credit facility areguaranteed by all of our wholly-owned subsidiaries, other than ourmortgage subsidiary, and are subject to a number of customary financial andoperating covenants, including covenants requiring us to: maintain a minimumtangible net worth of at least $225 million plus 50% of positive net income asearned subsequent to September 30, 2005; maintain a ratio of totalliabilities to adjusted tangible net worth not to exceed 2.50x; maintain aratio of total debt to adjusted tangible net worth not in excess of 2.0x(decreasing to 1.75x as of March 31, 2007); maintain an interest coverageratio of no less than 2.25x; and limit the number of speculative housing unitsowned by us, excluding foundations, as of the end of any fiscal quarter to amaximum of 30% of our housing unit closings during the previous 12-monthperiod; and limit the number of speculative housing units in any buildingregion, excluding foundations, as of the end of any fiscal quarter to a maximumof 35% of our housing unit closings in such region during the previous 12-monthperiod. In addition to these covenants, the credit facility includesrestrictions upon debt and investments which permit: subordinated debt up to$300 million; other unsecured debt up to $25 million; secured debt up to 25% oftangible net worth; guarantees of minority-owned joint venture debt up to 35%of adjusted tangible net worth; and investments in minority-owned jointventures up to 30% of tangible net worth. For purposes of these tests (whichwere amended as described below), adjusted tangible net worth is benefited byadjustments of 50% of our outstanding senior subordinated debt (up to a maximum$100 million adjustment) and 100% of minority interests in consolidatedentities (up to a maximum $50 million adjustment). As of and during the yearended September 30, 2006, we were in compliance with the covenants of thisfacility.

Given the current market conditions and thedeterioration of profitability, we believed that maintaining our original debtcovenants would become difficult. Therefore, on December 15, 2006, we paidfees of $0.9 million to amend certain covenants in our $500 million seniorunsecured revolving credit facility. The covenants as amended, require us to:maintain a minimum tangible net worth of at least $300 million plus 50% ofpositive net income earned subsequent to September 30, 2006; maintain aratio of total liabilities to adjusted tangible net worth not to exceed 2.0x(decreasing to 1.75x as of June 30, 2007 and increasing to 2.5x as of December 31,2008); maintain a ratio of total debt to adjusted tangible net worth not toexceed 1.5x; maintain a ratio of total land (including undeveloped land, landunder development and finished lots on which home construction has yet tobegin) to adjusted tangible net worth not to exceed 1.5x; and maintain aninterest coverage ratio of no less than 1.75x through December 31, 2006(decreasing to 1.5x through March 31, 2007, decreasing to 1.4x through June 30,2007, decreasing to 1.35x through September 30, 2007, increasing to 1.5xthrough December 31, 2007, increasing to 1.75x through March 31, 2008and then increasing to 2.25x through the remaining term of the facility).

On November 22, 2006, we entered into a two yearinterest rate cap agreement to protect $100 million of our borrowings fromsharp increases in the prevailing short-term interest rates. Under the terms ofthe agreement, the LIBOR rate is capped at 5.5% per annum.

We are party to two senior secured project-specificacquisition, development and construction loans. These loans bear interest at afloating rate ranging from the prime rate to the prime rate plus 1% withmaturities 

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generally tied to the sale of the underlyinginventory. As of September 30, 2006, we had $45.7 million outstandingrelated to these project-specific acquisition, development and constructionloans.

Prior to the issuance of our senior subordinated notesand the closing of our unsecured credit facility, our borrowing facilitiesconsisted primarily of four revolving credit facilities that provided formaximum borrowings of $824 million. The senior secured revolving creditfacilities bore interest at variable interest rates, ranging from LIBOR plus2.0% to prime plus 0.9%. Pursuant to one of the senior secured revolving creditfacilities, we borrowed $25 million and $20 million under two working capitalloan agreements with fixed interest rates of 13.75% and 12.5%, respectively. Inaddition to the senior secured revolving credit facilities and working capitalloans, we were party to several senior secured project-specific acquisition,development and construction loans that bore interest at a floating rateranging from the prime rate to the prime rate plus 1%.

We have a first mortgage note for an office complex inRolling Meadows, Illinois. The mortgage note is secured by the office complexand bears interest at 4.81%. We make monthly principal and interest payments of$25,488 with the balance due October 2007. As of September 30, 2006,we had $4.0 million outstanding on the mortgage note.

We have a term loan of $4.8 million for an officebuilding in Rolling Meadows, Illinois. The term loan is secured by the officebuilding and bears interest equal to the prime rate. We make monthly interestpayments with the principal balance due March 2009. As of September 30,2006, we had $4.8 million outstanding on the term loan.

We are party to several unsecured loan agreements thatfund our operations on an ongoing basis. In addition, KH Financial, L.P., ourwholly owned mortgage subsidiary, is party to a $5 million warehouse lineof credit, used to fund its mortgage origination operations. This facilitybears interest at a floating rate equal to LIBOR plus 2.25%, and as of September 30,2006 there were no amounts outstanding under the warehouse facility.

We are also party to a $100 million flexibleearly purchase facility agreement which allows us to sell qualifying mortgageloans to the holder of the flexible early purchase facility after such loanshave been originated subject to our obligation to sell the loan to an investorin the secondary market. At September 30, 2006, the facility held$56.6 million of loans sold by KH Financial, L.P.

We believe that our cash,other liquid assets and operating cash flow, together with available borrowingsand potential access to credit and capital markets, will be sufficient to meetour operating expenses and capital expenditures and service our debtrequirements over the next twelve months. However, our ongoing ability to meetour substantial debt service and other obligations, including compliance withfinancial covenants in our senior unsecured credit facility and seniorsubordinated notes, will be dependent upon our future performance which will besubject to business, financial and other factors. We will not be able tocontrol many of these factors, such as economic conditions in the markets wherewe operate and pressure from competitors. We cannot be certain that our cashflow will be sufficient to allow us to pay principal and interest on our debt,including our senior unsecured credit facility and senior subordinated notes,support our operations and meet our other obligations. If we do not have enoughmoney, we may be required to refinance all or part of our existing debt, sellassets or borrow more money. We cannot guarantee that we will be able to do soon terms acceptable to us, if at all. In addition, the terms of existing orfuture debt agreements, including our senior unsecured credit facility and theindenture for our senior subordinated notes, may restrict us from pursuing anyof these alternatives.

**Contractualobligations**

Our primary contractual cash obligations for ouroperations are payments under our debt agreements and purchase obligations withspecific performance requirements under land option agreements and purchase 

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contracts. These land option agreements and purchasecontracts may require us to purchase land contingent upon us and the sellermeeting certain obligations. We expect to fund our contractual obligations inthe ordinary course of business through our operating cash flows and our creditfacilities.

The following summarizes our aggregate contractualcommitments at September 30, 2006:

| ** **                           | ** ** | ** ** | ** ** | ** **                      | ** ** | ** **         | ** ** | **Payments due by period** | ** ** |
|--------------------------------------|------------|------------|------------|---------------------------------|------------|--------------------|------------|-------------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **Total**  | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years**                        | ** ** | **More than**

**5 years** | ** ** |
| Notes payable(1)                     |       | $          | 696,467    |                            |       | $                  | 52,290     |                                      |       | $ | 125,480 |   | $291,599 |   | $ | 227,098 |   |
| Operating leases                     |       | 10,700     |       |                            | 2,266      |               |       | 4,827                                     |       | 2,750 |   | 857 |   |
| Purchase  obligations(2)             |       | 46,652     |       |                            | 4,797      |               |       | 41,855                                    |       |   |   |   |   |
| Total                                |       | $          | 753,819    |                            |       | $                  | 59,353     |                                      |       | $172,162 |   | $ | 294,349 |   | $ | 227,955 |   |
|                                 |       |       |       |                            |       |               |       |                                      |       |   |   |   |   |
|                                      |            |            |            |                                 |            |                    |            |                                           |            |  |  |  |  |  |  |  |  |  |

(1)     Includesour senior subordinated notes, senior unsecured credit facility, otherhomebuilding debt, mortgage loans relating to our mortgage banking operations,and related interest payments for the life of the debt. Interest on variablerate obligations is based on rates effective as of September 30, 2006.

(2)     Representsobligations under land option agreements and purchase contracts with specificperformance provisions, net of cash deposits.

Under the terms of our amended stock plans, we may berequired to purchase shares of our common stock at fair market value, includingshares issuable under outstanding options or deferred stock units, from ourdirectors and certain of our executive officers and other key employees, in theevent of termination of board membership or employment, as applicable, byreason of specified circumstances, including death, disability, termination,retirement or resignation. As of September 30, 2006, the aggregate repurchaseobligation, net of proceeds to be received from any stock option exercises,would have been approximately $43.3 million in the event that all of theseobligations were triggered.

We arecontingently liable to banks and financial institutions for approximately $54million for outstanding letters of credit and performance bonds securingperformance of certain contractual obligations and land purchase contracts.Approximately $2.3 million of the outstanding letters of credit have beenissued by a wholly owned subsidiary. At September 30, 2006, we hadcommitted to fund $19.8 million in mortgage loans to homebuyers atagreed-upon rates. We have entered into best-efforts and mandatory salecommitments to sell these mortgages to third parties.

**Landand lot position and homes in inventory**

At September 30, 2006, we owned and controlled 25,256lots, approximately 38% of which were pursuant to option agreements andpurchase contracts. The following is a summary of our land/lot position as ofSeptember 30, 2006:

| ** **                                                         | ** ** | **Number of lots** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------|------------|
| Finished lots  owned                                               |       |                         | 4,421      |   |
| Lots under  development owned                                      |       |                         | 11,175     |   |
| Total lots owned                                                   |       |                         | 15,596     |   |
| Lots controlled  under option agreements and purchase contracts(1) |       |                         | 9,660      |   |
| Total land/lots  controlled                                        |       |                         | 25,256     |   |
|                                                               |       |                         |       |   |

(1)     Includes 1,893 lotsrelated to inventory not owned which was consolidated under the accountingguidance of FIN 46R and 1,777 lots that we expect to purchase fromunconsolidated entities in which we have an investment as an equity member.

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**Off-balancesheet arrangements**

Our primary use ofoff-balance sheet arrangements is to secure desirable lots on which to buildhomes in a manner that we believe reduces the overall risk to us. Ouroff-balance sheet arrangements relating to our homebuilding operations includeland option agreements and purchase contracts and joint ventures.

***Land option agreements and purchase contracts***

In theordinary course of business, we enter into option agreements and purchasecontracts to secure land for the construction of homes. These agreementsgenerally require us to pay a deposit to the seller as consideration for theright to acquire land during a specified period, usually at predeterminedprices. Some of these option agreements and purchase contracts contain specificperformance clauses, which require us to purchase the land upon satisfaction ofcertain requirements. Otherwise, our liabilities under option agreements andpurchase contracts are generally limited to forfeiture of the nonrefundabledeposits, letters of credit and other nonrefundable amounts incurred. Below isa summary of the aggregate exercise price of all option agreements and purchasecontracts as of September 30, 2006:
| (Dollars in thousands)                                               | ** ** | **Aggregate exercise  price of land  options**(1)                                 | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|
| Land option  agreements and purchase contracts with specific performance       |       | $               4,797 |       |
| Land option  agreements and purchase contracts without specific performance(2) |       | 380,072                                                                                          |       |
| Total land option  agreements and purchase contracts                           |       | $          384,869                             |       |
|                                                                           |       |                                                                                             |       |

(1)              Excludes $48 million related toinventory not owned included on our consolidated balance sheet, of which $42million contains specific performance obligations.

(2)              Includes $165million related to purchases from joint ventures in which we have an investmentbalance of approximately $34 million as of September 30, 2006. Theseinvestments are recorded in investments in and advances to unconsolidatedentities on our consolidated balance sheets.

Giventhe recent market deterioration and uncertainty about the timing and pace ofany recovery, we have tightened our land acquisition criteria and are workingwith land sellers to renegotiate land purchase and option contracts to extendpurchase dates and reduce purchase prices. If we are unable to obtain satisfactoryterms, we will not exercise our land option agreements and will abandon ourearnest money if contractually obligated to do so. During fiscal 2006, we wrote-off$8.3 million of costs related to the abandonment of land option contracts. Weexpect to exercise all of our land option agreements and purchase contractswith specific performance obligations.

***Investments in and advances tounconsolidated entities***

Investments in and advances tounconsolidated entities represent our ownership interests in entities accountedfor under the equity method when we have a significant influence over theentity but hold less than a controlling interest in the entity or we are notthe primary beneficiary in a variable interest entity as defined by theFinancial Accounting Standards Board (“FASB”) Revised Interpretation No. 46(“FIN 46R”). See notes 1 and 4 to our consolidated financial statements. Ourpartners generally are unaffiliated homebuilders, land sellers or other realestate entities.

In the ordinary course of business, we periodicallyenter into arrangements with land developers or other homebuilders to acquireland and develop lots. These arrangements include the creation of jointventures, in which our current interests range from 6% to 49%. We account forour interest in these joint ventures under the equity method, and ourconsolidated balance sheets include investments in and advances to jointventures totaling $48.2 million and $37.0 million at September 30, 2006and 2005, respectively. These joint ventures typically obtain securedacquisition, development and construction financing. At September 30, 2006and 2005, our unconsolidated joint ventures had outstanding third partyborrowings of $865 million 

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and $803 million, respectively. From time to time wehave issued repayment guarantees and/or loan-to-value maintenance guarantees inrespect of this indebtedness. These guarantees require us to repay debt of thejoint venture in the event of a payment default or in the event that the debtof the joint venture exceeds the value of the property securing the debt. At September 30,2006 and 2005, we had guarantees of $74.3 million and $67.6 million,respectively, related to the outstanding indebtedness of these joint ventures.

The following is a summary of oursignificant investments as of September 30, 2006:

We have invested in two joint ventures to acquire anddevelop land in Nevada. We have a 6.29% and 9.59% ownership interest,respectively, in these two ventures. As ofSeptember 30, 2006 and 2005, we had investments in the two joint venturestotaling $34.5 million and $29.6 million, respectively. At September 30,2006, these joint ventures had third party debt of $471 million and $386million, respectively, of which each joint venture member has guaranteed itspro rata share. These payment guarantees are only triggered in the event ofbankruptcy of each joint venture. We expect to purchase land from theseventures in the future.

In December 2002, we enteredinto a joint venture, in which we have a 23.75% interest, to develop propertyand construct single-family residences in Chicago, Illinois. At September 30,2006 and 2005, we had investments in and advances to the joint venture totaling$4.9 million and $4.0 million, respectively. We have provided a financialand performance guaranty in connection with the venture’s $20 millionconstruction financing for a single phase of the project. In addition, we haveprovided a guarantee on a $9 million tax increment financing bond for thisproject. As of September 30, 2006, $3.4 million of funds have been drawnon the construction financing facility and $4.3 million was drawn on the taxincrement financing bond. We are not obligated to loan additional fundsto the venture.

In May 2004, we entered into a joint venture, inwhich we have a 35% interest, to developproperty in Detroit, Michigan. At September 30, 2006 and 2005, we hadinvestments in and advances to the joint venture totaling $1.8 million and $1.3million, respectively. We are not obligated to loan additional funds to theventure.

In August 2004, we entered into a joint venture,in which we have a 33.3% interest, to develop property and constructsingle-family residences in Chicago, Illinois. At September 30, 2006 and2005, we had investments in and advances to the joint venture totaling $3.1million and $1.5 million,respectively. We have provided a financial and performance guaranty inconnection with certain of the venture’s indebtedness totaling $90.8 million,with our maximum financial guaranty limited to $10 million in the aggregate. AtSeptember 30, 2006, there were no borrowings outstanding under thesecredit facilities. We have also provided aguarantee in connection with a $9.8 million capital contribution to be made byan unrelated joint venture member, whereby we would make the contribution ifthe unrelated joint venture member does not. We are not obligated toloan additional funds to the venture.

In October 2005, we entered into a joint venture,in which we have a 49% interest, to develop property and constructsingle-family residences in Chicago, Illinois. At September 30, 2006, wehad investments in and advances to the joint venture totaling $0.4 million. Weare not obligated to loan additional funds to the venture.

In January 2006, we entered into a joint venture,in which we have a 35% interest, to develop a high-rise mixed-use towerin San Jose, California. At September 30, 2006, we had investments in thejoint venture of $2.5 million and have committed to investing an additional $0.4million in the venture.

In June 2006, weentered into a joint venture, in which we have a 33% interest, to developproperty and construct single-family residences in Detroit, Michigan. At September 30,2006, we had investments in and advances to the joint venture totaling $0.8million. We are not obligated to loan additional funds to the venture.

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**Seasonalityand variability in quarterly results**

Ourhomebuilding operating cycle generally reflects increased new order activity inour second and third fiscal quarters and increased deliveries in our third andfourth fiscal quarters. We believe that this seasonality reflects the tendencyof homebuyers to shop for a new home in the spring with the goal of closing inthe fall, as well as the scheduling of paving and construction to accommodateseasonal weather conditions. We also experience seasonality in our mortgagebanking operations as loan originations correspond with the closing of homes.

**Backlog**

Our sales contractsrequire cash deposits in line with respective market practices and may besubject to certain contingencies such as the buyer’s ability to qualify forfinancing. Homes covered by such sales contracts but not yet delivered areconsidered “backlog.” We do not recognize revenue upon the sale of a home untilit is delivered to the homebuyer and other criteria for sale and profitrecognition are met. We sometimes build homes before obtaining a salescontract, however, these homes are excluded from backlog until a sales contractis signed. At September 30, 2006 and 2005, we had 285 units and 122 units,respectively, of completed homes in inventory without sales contracts whichrepresented 20% and 7%, respectively, of our total completed home inventory.Our cancellation rates for the fiscal years ended September 30, 2006 and2005 were 32% and 24%, respectively. The increases in completed homes ininventory and cancellation rates are due to a general deterioration of thehomebuilding and residential housing markets.

**Interestrates and inflation**

Our business is significantlyaffected by the level of interest rates. Higher interest rates may decreasedemand for our homes by making it more difficult for homebuyers to qualify formortgages or to obtain mortgages at interest rates that are acceptable to them.Higher interest rates would also increase our borrowing costs because a portionof our bank loans fluctuate with LIBOR and prime lending rates.

We maybe adversely affected during periods of high inflation because of higher land,financing, labor and material costs. We attempt to pass to our customers anyincreases in our costs through increased sales prices, although this isbecoming increasingly difficult given the recent deterioration in thehomebuilding market. To date, inflation has not had a material adverse effecton our results of operations. However, there is no assurance that inflationwill not have a material adverse impact on our future results of operations.

**Critical accountingestimates and policies**

The discussion and analysis of ourfinancial condition and results of operations is based upon our consolidatedfinancial statements which have been prepared in accordance with GAAP. Thepreparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses, and related disclosure of contingent assets and liabilities. Weevaluate our estimates on an on-going basis. We base our estimates onhistorical experience and on various other assumptions that we believe arereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions.

Managementbelieves that the following critical accounting policies affect its moresignificant judgments and estimates used in preparation of its consolidatedfinancial statements:

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***Revenue recognition***

*Homebuilding.**  *Revenue from home and land sales is recorded whentitle is conveyed to the home or land buyer, adequate cash payment has beenreceived and there is no continued involvement.

*Mortgage banking.**  *We recognize the majority of the revenues associatedwith our mortgage operations when the mortgage loans and related servicingrights are sold to third-party investors. Origination fees, net of directorigination costs, are deferred and recognized as revenues, along with theassociated gains and losses on the sales of the loans and related servicingrights, when the loans are sold. We sell all mortgage loans and relatedservicing rights to third-party investors.

***Homebuilding inventory and cost ofsales***

We state inventories at accumulatedcosts unless the inventory within a community is determined to be impaired, inwhich case the impaired inventory is written down to fair market value. Inaddition to the costs of direct land acquisition, land development and homeconstruction, inventory costs include interest, real estate taxes and fieldconstruction and supervision salaries and related overhead expenses.

We use the specific identificationmethod for the purpose of accumulating home construction costs. Cost of salesfor homes delivered includes the specific construction costs of each home andall applicable land acquisition, land development and related costs, bothincurred and estimated to be incurred, based upon the total number of homesexpected to be delivered in each project. Construction cost of the homeincludes amounts paid through the closing date of the home, plus an accrual forcosts incurred but not yet paid, based on an analysis of budgeted constructioncost. This accrual is reviewed for accuracy based on actual payments made afterclosing compared to the amount accrued, and adjustments are made if needed. Anysignificant changes to the estimated total development costs subsequent to theinitial home deliveries in a project are generally allocated on a pro-ratabasis to the total homes in the project. The change in estimate allocated tohomes previously delivered is charged to cost of sales during the period inwhich the estimate is changed.

***In accordance with Statement of Financial AccountingStandards No. 144,******Accountingfor the Impairment or Disposal of Long-Lived Assets******(“SFAS 144”), we***assess housing projects and land held for development and sale forrecoverability whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be recoverable. Recoverability of assets ismeasured by comparing the carrying amount of an asset to future undiscountednet cash flows expected to be generated by the asset based on our intentions atthe time of the review. If these assets are considered to be impaired, theimpairment to be recognized is measured by the amount by which the carryingamount of the assets exceeds the fair value of the assets. For purposes ofthese impairment calculations, we determine the fair value of each assetdetermined to be impaired either by using internal project modeling software todetermine the present value of the estimated future cash flows on acommunity-by-community basis using discount rates which are commensurate withthe risk of the community or by comparing to recent comparable land sales whenthe land appeared to have a better use other than for homebuilding.

The largest homebuilding project reviewed is in theMidwest region where we are developing land and currently intend to constructand sell approximately 1,100 homes over the next 6 years. In addition, we areobligated to purchase additional land in this project, on which we intend toconstruct and sell an additional 1,500 homes, for approximately $42 million atvarious dates beginning in June 2009. Due to the project’s overall size,timeline and complexity and our limited experience to date, our estimates offuture recoverability are sensitive to management’s judgments and expectationsof future market conditions. The project’s total inventory balance wasapproximately $88 million at September 30, 2006.

These evaluations forimpairment are significantly impacted by estimates of revenues, costs andexpenses and other factors. We continue to monitor the homebuilding climate ineach of our markets and could 

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change our intentionsabout whether to continue homebuilding activities related to any assets in thefuture. Changes in our intentions or our expectations of market performancecould have a material impact on the carrying value of our assets as certain ofthe assets determined to be recoverable on an undiscounted cash flow basis mayhave carrying values greater than fair value.

***Variable interest entities***

In December 2003, the FASBissued FIN 46R, *Consolidation of Variable Interest Entities*.**Under FIN 46R, a variable interest entity (“VIE”) iscreated when (i) the equity investment at risk is not sufficient to permitthe entity to finance its activities without additional subordinated financialsupport from other parties or (ii) equity holders either (a) lack adirect or indirect ability to make decisions about the entity, (b) are notobligated to absorb expected losses of the entity or (c) do not have theright to receive expected residual returns of the entity, if they occur. FIN 46R requires the primary beneficiary of a VIE toconsolidate that entity. The primary beneficiary of a VIE is the party thatabsorbs a majority of the VIE’s expected losses, receives a majority of theentity’s expected residual returns or both, as a result of ownership,contractual interests or other financial interests in the entity. Expectedlosses are the expected negative variability in the fair value of an entity’snet assets exclusive of its variable interests, and expected residual returnsare the expected positive variability in the fair value of an entity’s netassets, exclusive of its variable interests.

Forward contracts, such as the purchaseagreements we use to acquire land and finished lot inventory, are deemed to be “variableinterests” under FIN 46R. Therefore, the seller entities with which we enterinto purchase agreements are examined under FIN 46R for possible consolidationby us, including the joint venture entities or structures utilized by us on alimited basis. We have developed a methodology to determine whether we are theprimary beneficiary. The methodology used to evaluate our primary beneficiarystatus requires substantial management judgment and estimates. These judgmentsand estimates involve assigning probabilities to various estimated cash flowpossibilities relative to the seller entity’s expected profits and losses andthe cash flows associated with changes in the fair value of the net assetswithin the entity. Because we do not have any contractual or ownershipinterests in the seller entities with which we contract to buy land or finishedlots (other than the limited use of the joint venture entities or structures),we do not have the ability to compel these seller entities to provide financialor other data to assist us in the performance of our primary beneficiaryevaluation. In many instances, these entities provide little, if any, financialinformation to us. This lack of direct information from the seller entities mayresult in our evaluation being conducted solely based on the aforementionedmanagement judgments and estimates. Although we believe that our accountingpolicy is designed to properly assess our primary beneficiary status relativeto our involvement with these seller entities from which we acquire land andfinished lots, changes to the probabilities and the cash flow possibilitiesused in our evaluation could produce widely different conclusions regarding ourstatus or non-status as a seller entity’s primary beneficiary, possiblyresulting in additional, or fewer, seller entities being consolidated on ourfinancial statements.

We have applied,as required, FIN 46R to all variable interests and have determined that many ofour options on land represent a variable interest in VIEs. We have determinedwe are the primary beneficiary of certain of these option contracts andalthough we do not have legal title to the optioned land, under FIN 46R,we are required to consolidate the land under the option at initial fair value.

***Investments in and advances tounconsolidated entities***

Investmentsin and advances to unconsolidated entities represent our ownership interest inentities that are accounted for under the equity method when we have asignificant influence over the entity but hold less than a controlling interestor are not the primary beneficiary as defined by FIN 46R. Our partners in theseentities generally are unrelated homebuilders, land sellers or other realestate entities. We record our investments in these entities in ourconsolidated balance sheets as investments in and advances to 

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unconsolidatedentities and our share of the entities’ earnings or losses in our consolidatedstatements of operations as equity in income of unconsolidated entities. We donot recognize earnings from home sites we purchase from joint ventures, butinstead reduce our cost basis in these home sites by our share of the earningson the home sites. Advances to these entities are included in the investmentbalance.

***Warranty costs***

Warrantyand product liability accruals are established to provide for estimated futureexpenses as a result of construction and product defects and product recallsincidental to our business. Liability estimates are determined based onmanagement’s judgment, considering such factors as historical experience, thelikely current cost of corrective action, manufacturers’ and subcontractors’participation in sharing the cost of corrective action, consultations withthird party experts such as engineers, and discussions with our general counseland other outside counsel retained to handle specific product liability cases.Although we consider the warranty and product liability accrual to be adequate,there can be no assurance that this accrual will prove to be adequate over timeto cover losses due to increased costs for material and labor, the inability orrefusal of manufacturers or subcontractors to financially participate incorrective action, unanticipated adverse legal settlements or otherunanticipated changes to the assumptions used to estimate the warranty andproduct liability accrual.

***Litigation reserves***

We havebeen named as defendants in various cases arising in the normal course ofbusiness. We accrue for these costs when the loss is both probable and can bereasonably estimated. We have accrued for costs to be incurred with respect tothese cases based upon information provided by our legal counsel.

***Insurance claims costs***

We have,and require the majority of our subcontractors to have, general liability andworkers’ compensation insurance. These insurance policies protect us against aportion of our risk of loss from claims, subject to certain self-insuredretentions, deductibles and other coverage limits. We reserve for costs tocover our self-insured and deductible amounts under those policies and for anyestimated costs of claims and lawsuits in excess of our coverage limits or notcovered by our policies, based on an analysis of our historical claims, whichincludes an estimate of construction defect claims incurred but not yetreported. Projection of losses related to these liabilities is subject to ahigh degree of variability due to uncertainties such as trends in constructiondefect claims relative to our markets and the types of products we build, claimsettlement patterns, insurance industry practices and legal interpretations,among others. Because of the judgment required in determining these estimatedreserve amounts, actual future costs could differ from our currently estimatedamounts.

***Valuation of deferred tax assets***

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

Webelieve that the accounting estimate for the valuation of deferred tax assetsis a critical accounting estimate because judgment is required in assessing thelikely future tax consequences of events that have been recognized in ourfinancial statements or income tax returns. We base our estimate of deferredtax 

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assetsand liabilities on current tax laws and rates and, in certain cases, businessplans and other expectations about future outcomes. Changes in existing taxlaws or rates could affect actual tax results and future business results mayaffect the amount of deferred tax liabilities or the valuation of deferred taxassets over time. Our accounting for deferred tax consequences represents ourbest estimate of future events. Although it is possible there will be changesthat are not anticipated in our current estimates, we believe it is unlikelysuch changes would have a material period-to-period impact on our financialposition or results of operations.

***Stock-based compensation***

Weoccasionally issue options to purchase our common stock to our employees anddirectors. All of these stock options have an exercise price equal to the fairmarket value of the underlying common shares on the date of grant and eithervest immediately or vest in equal installments over four years from theanniversary of the grant date. We have estimated the fair market value of theunderlying common shares on the date of grant by reference to recent stocktransactions or recent valuations by independent specialists. We account forstock options under the provisions of Accounting Principles Board(APB) Opinion No. 25, *Accounting for StockIssued to Employees*. SFAS No. 123, *Accountingfor Stock-Based Compensation* (“SFAS No. 123”), andSFAS No. 148, *Accounting for Stock-BasedCompensation—Transition and Disclosure, an amendment of FASB Statement No. 123*(“SFAS No. 148”), require us to disclose the effects on net incomehad we recorded compensation expense in accordance with SFAS No. 123.

**Recent AccountingPronouncements**

In December 2004, the FASB issued Statement ofFinancial Accounting Standards No. 123 (revised 2004), *Share-Based Payment*, (“SFAS 123R”). SFAS 123R is a revisionof SFAS 123 and supersedes APB No. 25. SFAS 123R requires that thecost resulting from all share-based payment transactions be recognized in thefinancial statements and establishes fair value as the measurement objective inaccounting for share-based payment arrangements. SFAS 123R applies to allawards granted, modified, repurchased or cancelled after the effective date.Since we previously used the minimum value method under SFAS 123, we willcontinue to account for any portion of awards outstanding at the date ofinitial application using the accounting principles originally applied to thoseawards. SFAS 123R becomes effective for us on October 1, 2006 and is notexpected to have a material impact on our results of operations or financialposition.

In May 2005, the FASB issued SFAS No. 154, *Accounting Changes and Error Corrections—a replacement for APB Opinion No. 20and FASB Statement No. 3* (“SFAS 154”). SFAS 154 requires priorperiod financial statements to be restated for changes in accountingprinciples. SFAS 154 also redefines restatement as the revision of previouslyissued financial statements to reflect the correction of an error. SFAS 154 iseffective for accounting changes and corrections of errors made in fiscal yearsbeginning after December 15, 2005. SFAS 154 becomes effective for us on October 1,2006 and is not expected to have a material impact on our consolidatedfinancial statements.

In June 2005, the Emerging Issues Task Force (“EITF”)released Issue No. 04-5, *Determining Whether aGeneral Partner, or the General Partners as a Group, Controls a LimitedPartnership or Similar Entity When the Limited Partners Have Certain Rights*(“EITF 04-5”). EITF 04-5 creates a framework for evaluating whethera general partner or a group of general partners controls a limited partnershipand therefore should consolidate the partnership. EITF 04-5 states thatthe presumption of general partner control would be overcome only when thelimited partners have certain specific rights as outlined in EITF 04-5.EITF 04-5 is effective immediately for all newly formed limitedpartnerships and for existing limited partnership agreements that are modified.For general partners in all other limited partnerships, EITF 04-5 iseffective no later than the beginning of the first reporting period in fiscalyears beginning after December 15, 2005. EITF 04-5 becomes effectivefor us on October 1, 2006 and is not expected to have a material impact onour results of operations or financial position.

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In July 2006, the FASB issued FASB InterpretationNo. 48, *Accounting for Uncertainty in Income Taxes*(“FIN48”), which prescribes a recognition threshold and measurement process forrecording in the financial statements uncertain tax positions taken or expectedto be taken in a tax return. Additionally, FIN 48 provides guidance on thederecognition, classification, accounting in interim periods and disclosurerequirements for uncertain tax positions. The accounting provisions of FIN 48will be effective for us beginning October 1, 2007. We are in the processof determining the effect, if any, the adoption of FIN 48 will have on ourfinancial statements.

In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements*(“SFAS 157”),which defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles and expands disclosure about fair valuemeasurements. SFAS 157 is effective for financial statements issued for fiscalyears beginning after November 15, 2007, and interim periods within thosefiscal years. We are in the process of determining the effect, if any, theadoption of SFAS 157 will have on our financial statements.

In September 2006,the SEC issued Staff Accounting Bulletin No. 108, *Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements*(“SAB 108”), which provides guidanceas to how the effects on prior year uncorrected misstatements should beconsidered when quantifying misstatements in the current financial statements.SAB 108 was issued in order to eliminate the diversity of practice surroundinghow public companies quantify financial statement misstatements. SAB 108 willrequire us to quantify misstatements using both a balance sheet and incomestatement approach, with adjustment required if either method results in amaterial error. SAB 108 is effective for financial statements issued for fiscalyears beginning after November 15, 2006. We are in the process ofdetermining the effect, if any, the adoption of SAB 108 will have on ourfinancial statements.

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

We are exposed to a number of market risks in theordinary course of business. Our primary market risk exposure for financialinstruments relates to fluctuations in interest rates. We do not believe ourexposure in this area is material to cash flows or earnings. As of September 30,2006, we had a total of $290.6 million of floating rate debt outstanding,including our senior unsecured credit facility and other facilities. Borrowingsunder these facilities generally bear interest based on applicable margins plusLIBOR or an alternate base rate. Holding our variable rate debt balancesconstant as of September 30, 2006, each one percentage point increase ininterest rates would result in an increase in interest incurred for the nextfiscal year of approximately $2.9 million. A one percentage point increase ininterest rates on our average variable rate debt outstanding during fiscal 2006would have resulted in an increase in interest incurred of approximately $4.1million.

From time to time, we enter into interest rate swap orinterest rate cap agreements to manage interest costs and hedge against risksassociated with fluctuating interest rates with respect to our floating ratedebt. We do not enter into or hold derivatives for trading or speculativepurposes. As of September 30, 2006, we were not a party to any derivativetransactions. Subsequent to September 30, 2006, we entered into a two yearinterest rate cap agreement with a third-party to protect $100 million of ouroutstanding borrowings from sharp increases in the prevailing short-terminterest rates.

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**Item 8.**                        FinancialStatements and Supplementary Data

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Shareholders ofKimball Hill, Inc.Rolling Meadows, Illinois

We have audited the accompanying consolidated balancesheets of Kimball Hill, Inc. and subsidiaries (the “Company”) as of September 30,2006 and 2005, and the related consolidated statements of operations,shareholders’ equity, and cash flows for each of the three years in the periodended September 30, 2006. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged toperform, an audit of its internal control over financial reporting. Our auditsincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion*.*An audit alsoincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, as well as evaluating theoverall financial statement presentation. We believe that our audits provide areasonable basis for our opinion.

In our opinion, such consolidated financial statementspresent fairly, in all material respects, the financial position of the Companyas of September 30, 2006 and 2005, and the results of its operations andits cash flows for each of the three years in the period ended September 30,2006, in conformity with accounting principles generally accepted in the UnitedStates of America.

Asdiscussed in Note 14 to the financial statements, the Company revised itssegments for financial reporting purposes.
| /s/ DELOITTE & TOUCHE  LLP |   |
|--------------------------------|--------|
| Chicago, Illinois              |
| December 20, 2006         |

 

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**KimballHill, Inc. and Subsidiaries**

**ConsolidatedBalance Sheets**

| **As of September 30, 2006 and 2005 (in thousands, except shares)**                       | ** ** | ** ** | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| **Assets**                                                                                                                                  | ** ** | ** ** |       |     |       |
| HOMEBUILDING:                                                                                                                               |       |       |       |     |       |
| Cash and cash  equivalents                                                                                                                  |       | $          | 16,042     |     | $          | 16,763   |       |
| Receivables                                                                                                                                 |       | 35,323     |       | 22,879   |       |
| Inventory                                                                                                                                   |       | 899,297    |       | 808,778  |       |
| Inventory not owned                                                                                                                         |       | 37,821     |       | 46,721   |       |
| Deferred expenses and  other assets                                                                                                         |       | 19,229     |       | 11,207   |       |
| Investments in and  advances to unconsolidated entities                                                                                     |       | 48,238     |       | 37,033   |       |
| Deferred income taxes                                                                                                                       |       | 14,133     |       | 13,541   |       |
| Property and equipment,  net of accumulated depreciation                                                                                    |       | 10,635     |       | 5,185    |       |
|                                                                                                                                        |       | 1,080,718  |       | 962,107  |       |
| MORTGAGE BANKING:                                                                                                                           |       |       |       |     |       |
| Cash and cash  equivalents                                                                                                                  |       | 2,623      |       | 4,697    |       |
| Trade accounts  receivable                                                                                                                  |       | 2,319      |       | 1,586    |       |
| Mortgage loans held for  sale                                                                                                               |       | 5,663      |       | 1,785    |       |
| Property and equipment,  net of accumulated depreciation                                                                                    |       | 254        |       | 320      |       |
|                                                                                                                                        |       | 10,859     |       | 8,388    |       |
| TOTAL ASSETS                                                                                                                                |       | $          | 1,091,577  |     | $          | 970,495  |       |
| **Liabilities and equity**                                                                                                                  |       |       |       |     |       |
| HOMEBUILDING:                                                                                                                               |       |       |       |     |       |
| Accounts payable and  accrued expenses                                                                                                      |       | $          | 106,779    |     | $          | 94,370   |       |
| Deposits on sales of  residential units                                                                                                     |       | 6,333      |       | 14,008   |       |
| Liabilities related to  inventory not owned                                                                                                 |       | 5,015      |       | 10,402   |       |
| Income taxes payable                                                                                                                        |       | 3,702      |       | 15,368   |       |
| Notes payable                                                                                                                               |       | 500,208    |       | 473,225  |       |
|                                                                                                                                        |       | 622,037    |       | 607,373  |       |
| MORTGAGE BANKING:                                                                                                                           |       |       |       |     |       |
| Accounts payable and  accrued expenses                                                                                                      |       | 927        |       | 914      |       |
| Other liabilities                                                                                                                           |       | 196        |       | 234      |       |
| Notes payable for  mortgage loans                                                                                                           |       |       |       | 186      |       |
|                                                                                                                                        |       | 1,123      |       | 1,334    |       |
| Total liabilities                                                                                                                           |       | 623,160    |       | 608,707  |       |
| MINORITY INTEREST IN  CONSOLIDATED PARTNERSHIPS                                                                                             |       | 43,244     |       | 45,495   |       |
| MINORITY INTEREST IN  INVENTORY NOT OWNED                                                                                                   |       | 31,721     |       | 31,721   |       |
| REDEEMABLE EQUITY:                                                                                                                          |       |       |       |     |       |
| Redeemable common stock,  no par value; shares outstanding: 228,002 and 298,000 at September 30,  2006 and 2005                        |       | 26,334     |       | 33,763   |       |
| SHAREHOLDERS’ EQUITY:                                                                                                                  |       |       |       |     |       |
| Common stock, no par  value; 10,000,000 shares authorized; shares outstanding: 4,316,878 and  3,578,486 at September 30, 2006 and 2005 |       | 111,305    |       | 20,216   |       |
| Retained earnings                                                                                                                           |       | 255,813    |       | 230,593  |       |
| Total shareholders’  equity                                                                                                            |       | 367,118    |       | 250,809  |       |
| TOTAL LIABILITIES AND EQUITY                                                                                                                |       | $          | 1,091,577  |     | $          | 970,495  |       |
|                                                                                                                                        |       |       |       |     |       |

 

*See notes to consolidated financial statements.*

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**KimballHill, Inc. and SubsidiariesConsolidated Statements of Operations**

| For the years ended September 30, 2006, 2005 and 2004 (in thousands) | ** ** | **2006**  | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| HOMEBUILDING:                                                                                                               |       |      |       |      |       |      |       |
| Revenues:                                                                                                                   |       |      |       |      |       |      |       |
| Sales of residential units  and land                                                                                        |       | $         | 1,160,680  |      | $          | 1,143,671 |       | $ | 915,327 |   |
| Rental and other income                                                                                                     |       | 3,164     |       | 2,970     |       | 4,728     |       |
| Total homebuilding revenues                                                                                                 |       | 1,163,844 |       | 1,146,641 |       | 920,055   |       |
| Expenses:                                                                                                                   |       |      |       |      |       |      |       |
| Cost of sales of residential  units and land                                                                                |       | 973,203   |       | 862,646   |       | 729,497   |       |
| General and administrative                                                                                                  |       | 70,007    |       | 94,013    |       | 58,103    |       |
| Sales and marketing                                                                                                         |       | 60,121    |       | 50,551    |       | 46,064    |       |
| Depreciation                                                                                                                |       | 751       |       | 756       |       | 872       |       |
| Total homebuilding expenses                                                                                                 |       | 1,104,082 |       | 1,007,966 |       | 834,536   |       |
| Equity in income of unconsolidated joint ventures                                                                           |       | 2,215     |       | 3,282     |       | 833       |       |
| Minority interests in net  earnings of consolidated partnerships                                                            |       | (290      | )          | (6,152    | )          | (4,232    | )          |
| Homebuilding earnings before income taxes                                                                                   |       | 61,687    |       | 135,805   |       | 82,120    |       |
| MORTGAGE BANKING:                                                                                                           |       |      |       |      |       |      |       |
| Revenues:                                                                                                                   |       |      |       |      |       |      |       |
| Gain on sales of mortgage  loans                                                                                            |       | 8,188     |       | 6,496     |       | 4,946     |       |
| Interest income                                                                                                             |       | 34        |       | 61        |       | 1,046     |       |
| Total mortgage banking  revenues                                                                                            |       | 8,222     |       | 6,557     |       | 5,992     |       |
| Expenses:                                                                                                                   |       |      |       |      |       |      |       |
| General and administrative                                                                                                  |       | 4,490     |       | 4,681     |       | 4,409     |       |
| Interest expense                                                                                                            |       | 7         |       | 34        |       | 625       |       |
| Depreciation                                                                                                                |       | 92        |       | 124       |       | 94        |       |
| Total mortgage banking expenses                                                                                             |       | 4,589     |       | 4,839     |       | 5,128     |       |
| Mortgage banking earnings  before income taxes                                                                              |       | 3,633     |       | 1,718     |       | 864       |       |
| EARNINGS BEFORE  INCOME TAXES                                                                                               |       | 65,320    |       | 137,523   |       | 82,984    |       |
| PROVISION FOR INCOME TAXES                                                                                                  |       | 23,516    |       | 50,689    |       | 27,365    |       |
| NET EARNINGS                                                                                                                |       | $         | 41,804     |      | $          | 86,834    |       | $ | 55,619 |   |
|                                                                                                                        |       |      |       |      |       |      |       |

 

*See notes to consolidated financial statements.*

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**Kimball Hill, Inc. and SubsidiariesConsolidated Statements of Shareholders’ Equity**

| **For the years ended**                         | ** ** | ** **            | ** ** | ** **      | ** ** | ** **           | ** **                                                                            | ** **             | ** ** | **Total**  | ** ** |
|----------------------------------------------------------------|------------|-----------------------|------------|-----------------|------------|----------------------|---------------------------------------------------------------------------------------|------------------------|------------|------------|------------|
| **September 30, 2006, 2005 and 2004** | ** ** | **Common stock** | ** ** | **Unallocated** | ** ** | **Retained**         | ** **                                                                            | **shareholders’** | ** ** |
| **(in thousands, except shares)**               | ** ** | **Shares**            | ** ** | **Amount**      | ** ** | **ESOP shares** | ** **                                                                            | **earnings**           | ** ** | **equity** | ** ** |
| BALANCE—October 1,  2003                             |       | 3,472,467             |       | $               | 2,573      |                 | $     (1,667                                                 | )                      | $          | 119,424    |       | $   120,330 |   |
| Net earnings                                                   |       |                  |       |            |       |                 |                                                                                  | 55,619                 |       | 55,619     |       |
| Allocated ESOP shares                                          |       |                  |       |            |       | 971                  |                                                                                  |                   |       | 971        |       |
| Net change in redeemable common stock                          |       | (52,000               | )          | (332            | )          |                 |                                                                                  | (5,175                 | )          | (5,507     | )          |
| Issuance of common stock                                       |       | 29,903                |       | 285             |       |                 |                                                                                  |                   |       | 285        |       |
| Repurchases of common stock                                    |       | (11,001               | )          | (470            | )          |                 |                                                                                  |                   |       | (470       | )          |
| BALANCE—September 30,  2004                          |       | 3,439,369             |       | 2,056           |       | (696                 | )                                                                                     | 169,868                |       | 171,228    |       |
| Net earnings                                                   |       |                  |       |            |       |                 |                                                                                  | 86,834                 |       | 86,834     |       |
| Distributions (net of tax of $3,160)                           |       |                  |       |            |       |                 |                                                                                  | (5,266                 | )          | (5,266     | )          |
| Allocated ESOP shares                                          |       |                  |       |            |       | 696                  |                                                                                  |                   |       | 696        |       |
| Net change in redeemable common stock                          |       | (148,000              | )          | (2,239          | )          |                 |                                                                                  | (20,843                | )          | (23,082    | )          |
| Issuance of common stock                                       |       | 312,000               |       | 4,129           |       |                 |                                                                                  |                   |       | 4,129      |       |
| Tax benefit of stock options                                   |       |                  |       | 1,440           |       |                 |                                                                                  |                   |       | 1,440      |       |
| Equity-based compensation                                      |       |                  |       | 16,687          |       |                 |                                                                                  |                   |       | 16,687     |       |
| Repurchases of common stock                                    |       | (24,883               | )          | (1,857          | )          |                 |                                                                                  |                   |       | (1,857     | )          |
| BALANCE—September 30,  2005                          |       | 3,578,486             |       | 20,216          |       | —               |                                                                                  | 230,593                |       | 250,809    |       |
| Net earnings                                                   |       |                  |       |            |       |                 |                                                                                  | 41,804                 |       | 41,804     |       |
| Net change in redeemable common stock                          |       | (188,013              | )          | (5,659          | )          |                 |                                                                                  | (16,584                | )          | (22,243    | )          |
| Issuance of common stock (net of issuance costs  of $150) |       | 1,092,380             |       | 114,825         |       |                 |                                                                                  |                   |       | 114,825    |       |
| Tax benefit of stock options                                   |       |                  |       | 249             |       |                 |                                                                                  |                   |       | 249        |       |
| Equity-based compensation                                      |       |                  |       | 821             |       |                 |                                                                                  |                   |       | 821        |       |
| Repurchases of common stock                                    |       | (165,975              | )          | (19,147         | )          |                 |                                                                                  |                   |       | (19,147    | )          |
| BALANCE—September 30,  2006                          |       | 4,316,878             |       | $               | 111,305    |                 | $             — |                   | $          | 255,813    |       | $   367,118 |   |

 

|  |   |   |   |   |   |   |   |   |   |   |   |
|--|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|

 

 

*See notes to consolidated financial statements.*

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**Kimball Hill, Inc. and SubsidiariesConsolidated Statements of Cash Flows**

| **For the years  ended September 30, 2006, 2005 and 2004 (in thousands)**                                                                                 | ** ** | ** ** | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|----------|------------|
| **Cash flows from operating  activities:**                                                                                                                |       |       |       |       |       |       |       |
| Net earnings                                                                                                                                              |       | $          | 41,804     |       | $          | 86,834     |       | $        | 55,619     |   |
| Adjustments  to reconcile net earnings to cash flows from operating activities:                                                                           |       |       |       |       |       |       |       |
| Depreciation                                                                                                                                              |       | 843        |       | 880        |       | 966        |       |
| Inventory valuation adjustments                                                                                                                           |       | 25,780     |       |       |       |       |       |
| Write-off of land option costs                                                                                                                            |       | 8,308      |       |       |       |       |       |
| Amortization of deferred expenses                                                                                                                         |       | 5,321      |       | 6,461      |       | 5,017      |       |
| Equity-based compensation                                                                                                                                 |       | 821        |       | 16,687     |       |       |       |
| ESOP compensation expense                                                                                                                                 |       |       |       | 696        |       | 971        |       |
| Distributions of income from investments in  unconsolidated entities                                                                                      |       | 1,322      |       | 3,204      |       | 826        |       |
| Net earnings from investments in unconsolidated  entities                                                                                                 |       | (2,215     | )          | (3,282     | )          | (833       | )          |
| Minority interest in consolidated earnings                                                                                                                |       | 290        |       | 6,152      |       | 4,232      |       |
| Deferred income taxes                                                                                                                                     |       | (592       | )          | (6,373     | )          | (2,744     | )          |
| Changes  in operating assets and liabilities:                                                                                                             |       |       |       |       |       |       |       |
| Receivables                                                                                                                                               |       | (13,177    | )          | (2,468     | )          | 2,968      |       |
| Mortgage loans held for sale                                                                                                                              |       | (3,878     | )          | 2,970      |       | 64,400     |       |
| Inventory                                                                                                                                                 |       | (120,130   | )          | (115,398   | )          | (176,908   | )          |
| Deferred expenses and other assets                                                                                                                        |       | (7,945     | )          | (9,190     | )          | (6,428     | )          |
| Accounts payable and accrued expenses                                                                                                                     |       | 12,422     |       | 24,177     |       | 18,208     |       |
| Deposits and other liabilities                                                                                                                            |       | (7,713     | )          | (5,402     | )          | 10,600     |       |
| Income taxes payable                                                                                                                                      |       | (11,417    | )          | 3,506      |       | 2,208      |       |
| Net cash (used in) provided by operating activities                                                                                                       |       | (70,156    | )          | 9,454      |       | (20,898    | )          |
| **Cash  flows from investing activities:**                                                                                                                |       |       |       |       |       |       |       |
| Purchases of property and equipment                                                                                                                       |       | (7,236     | )          | (555       | )          | (660       | )          |
| Disposals of property and equipment                                                                                                                       |       | 1,009      |       |       |       |       |       |
| Distributions of contributed capital from investments  in unconsolidated entities                                                                         |       | 748        |       | 824        |       |       |       |
| Contributions and advances to investments in  unconsolidated entities                                                                                     |       | (10,824    | )          | (25,506    | )          | (12,021    | )          |
| Net cash used in investing activities                                                                                                                     |       | (16,303    | )          | (25,237    | )          | (12,681    | )          |
| **Cash  flows from financing activities:**                                                                                                                |       |       |       |       |       |       |       |
| Proceeds from issuance of notes and mortgage loans  payable                                                                                               |       | 1,218,599  |       | 1,056,071  |       | 1,416,163  |       |
| Repayments of notes and mortgage loans payable                                                                                                            |       | (1,191,802 | )          | (1,013,781 | )          | (1,420,281 | )          |
| Debt issuance costs                                                                                                                                       |       | (6,598     | )          |       |       |       |       |
| Net proceeds from issuance of common stock                                                                                                                |       | 114,825    |       | 4,129      |       | 285        |       |
| Repurchases of common stock                                                                                                                               |       | (48,819    | )          | (1,857     | )          | (470       | )          |
| Distributions                                                                                                                                             |       |       |       | (8,426     | )          |       |       |
| Contributions from minority interests                                                                                                                     |       |       |       | 36,000     |       | 47,400     |       |
| Distributions to minority interests                                                                                                                       |       | (2,541     | )          | (42,549    | )          | (27,459    | )          |
| Net cash provided by financing activities                                                                                                                 |       | 83,664     |       | 29,587     |       | 15,638     |       |
| **Net (decrease) increase in cash and cash  equivalents**                                                                                                 |       | (2,795     | )          | 13,804     |       | (17,941    | )          |
| Cash and cash equivalents—Beginning of year                                                                                                          |       | 21,460     |       | 7,656      |       | 25,597     |       |
| Cash and cash equivalents—End of year                                                                                                                |       | $          | 18,665     |       | $          | 21,460     |       | $        | 7,656      |   |
| **Reconciliation  to cash and cash equivalents reported on the consolidated balance sheets:**                                                             |       |       |       |       |       |       |       |
| Homebuilding                                                                                                                                              |       | $          | 16,042     |       | $          | 16,763     |       |     |       |
| Mortgage banking                                                                                                                                          |       | 2,623      |       | 4,697      |       |       |       |
| Total                                                                                                                                                     |       | $          | 18,665     |       | $          | 21,460     |       |     |       |
| **Supplemental disclosure of cash  flow information:**                                                                                                    |       |       |       |       |       |       |       |
| Cash paid for interest                                                                                                                                    |       | $          | 44,336     |       | $          | 38,275     |       | $        | 31,101     |   |
| Cash paid for income taxes                                                                                                                                |       | $          | 35,525     |       | $          | 53,557     |       | $        | 27,901     |   |
| **Supplemental disclosure of  noncash investing and financing activities:**                                                                               |       |       |       |       |       |       |       |
| Inventory not owned includes $5,015 and $10,402 of  liabilities related to inventory not owned for the years ended  September 30, 2006 and 2005 |       |       |       |       |       |       |       |

 

|  |   |   |   |   |   |   |   |
|--|--------|--------|--------|--------|--------|--------|--------|

 

*See notes to consolidated financial statements.*

48

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**Kimball Hill, Inc.and SubsidiariesNotes to Consolidated Financial Statements**

**1.**                 Summaryof Significant Accounting Policies

Kimball Hill, Inc. and its subsidiaries(the “Company”) are actively involved in residential construction. TheCompany builds homes which include a wide range of single-family detached andmultifamily products. The Company also owns a mortgage banking operation,KH Financial, L.P, which originates mortgages with an emphasis onfacilitating the financing of residential loans secured by homes sold andconstructed by the Company. All mortgages are sold to third parties. TheCompany has ownership interests in ventures which provide title agencyservices. The Company has residential development activities in the followingstates: California, Florida, Illinois, Nevada, Ohio, Oregon, Texas, Washingtonand Wisconsin.

***Management’s Use ofEstimates—******The***preparationof financial statements in conformity with accounting principles generallyaccepted in the United States of America (“GAAP”) requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities, disclosure of contingent assets and liabilities, and reportedamounts of revenues and expenses during the reporting period. Actual resultscould differ from those estimates.

***Principles ofConsolidation—******The***accompanying consolidated financial statements include the accounts ofKimball Hill, Inc. and all of its wholly-owned, majority-owned andcontrolled subsidiaries, as well as certain variable interest entitiesfrom which the Company is purchasing land or lots under option agreementsand purchase contracts. All significant intercompany balances and transactionshave been eliminated.

***Cash and CashEquivalents—******The*** Companyconsiders investments in money market and bank certificates purchased with amaturity of three months or less to be cash equivalents.

***Mortgage Loans Heldfor Sale—******Mortgage***loans held for sale consist of loans originated by the Company and intended forsale in the secondary market. In the aggregate, such loans are carried at thelower of cost or market. The Company sells all originated loans to thirdparties.

***Inventory—***TheCompany records inventory at accumulated costsunless the inventory within a community is determined to be impaired, in whichcase the impaired inventory is written down to fair market value. Inaddition to the costs of direct land acquisition, land development and homeconstruction, inventory costs include interest, real estate taxes and fieldconstruction and supervision salaries and related overhead expenses. TheCompany uses the specific identification method for the purpose of accumulatinghome construction costs.

***Deferred Expenses—******Deferred***expenses include certain costs incurred which are expected to benefit futureperiods and are recognized as a component of sales and marketing or general andadministrative expenses as units of a project are delivered. Deferred expensesalso include debt issuance costs which are amortized over the lives of therespective debt obligations as a component of interest expense.

***Investments In andAdvances to Unconsolidated Entities—******Investments***in and advances to unconsolidated entities represent the Company’s ownershipinterest in unconsolidated entities and are accounted for under the equitymethod when the Company has a significant influence over the entity but holdsless than a controlling interest or is not the primary beneficiary in avariable interest entity as defined by the Financial Accounting Standards Board(“FASB”) Revised Interpretation, *Consolidation of VariableInterest Entities* (“FIN 46R”).

49

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***Property andEquipment—******Depreciation***is computed principally by the straight-line method over the followingestimated useful lives:

| Land improvements          |   | 40 years                |   |
|----------------------------|--------|-------------------------|--------|
| Buildings                  |   | 40 years                |   |
| Buildings—residential |   | 30 years                |   |
| Tenant  improvements       |   | Terms of related leases |   |
| Other                      |   | 3 to 10 years           |   |
|                       |   |                    |   |

 

The cost and accumulated depreciation relating toassets retired or otherwise disposed of are eliminated from the respectiveaccounts at the time of disposition. The resultant gain or loss is includedin operations.

***Impairment ofLong-Lived Assets—******In accordance with Statement ofFinancial Accounting Standards No. 144,******Accountingfor the Impairment or Disposal of Long-Lived Assets******(“SFAS 144”), the***Company assesses housing projects, land held for development and sale, andproperty and equipment for recoverability whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable. Recoverability of assets is measured by comparing the carryingamount of an asset to future undiscounted net cash flows expected to begenerated by the asset. These evaluations for impairment are significantlyimpacted by estimates of revenues, costs and expenses and other factors. Ifthese assets are considered to be impaired, the impairment to be recognized ismeasured by the amount by which the carrying amount of the assets exceeds thefair value of the assets.

Due to the current change in market conditions, thenational homebuilding climate and the Company’s expectations regarding therecoverability of certain assets, the Company reviewed all of its inventory forimpairment and recorded an inventory impairment charge of $25.8 millionduring the year ended September 30, 2006. This charge is included in costof sales in the accompanying consolidated statements of operations. Whenreviewing for impairment, the Company evaluated the future undiscounted netcash flows expected to be generated by each asset based upon the Company’sintentions at the time of the review to continue with planned homebuildingactivities related to each asset. The impairment charge recorded consisted of$17.9 million of inventory write-downs in markets with active residentialconstruction projects and $7.9 million of inventory write-downs related to theCompany’s decision to exit the Cleveland market. For purposes of theseimpairment calculations, the Company determined the fair value of each assetdetermined to be impaired either by using internal project modeling software todetermine the present value of the estimated future cash flows on a community-by-communitybasis using discount rates which are commensurate with the risk of the communityor by comparing to recent comparable land sales when the land appeared to havea better use other than for homebuilding. The Company did not record anyinventory impairment charges during the years ended September 30, 2005 or2004.

The largest homebuilding project reviewed is in theMidwest region where the Company is developing land and currently intends toconstruct and sell approximately 1,100 homes over the next 6 years. Inaddition, the Company is obligated to purchase additional land in this project,on which it intends to construct and sell an additional 1,500 homes, forapproximately $42 million at various dates beginning in June 2009. Due tothe project’s overall size, timeline and complexity and the Company’s limitedexperience to date, its estimates of future recoverability are sensitive tomanagement’s judgments and expectations of future market conditions. Theproject’s total inventory balance was approximately $88 million at September 30,2006.

These evaluations for impairment are significantlyimpacted by estimates of revenues, costs and expenses and other factors. TheCompany will continue to monitor the homebuilding climate in each of itsmarkets and could change its intentions about whether to continue homebuildingactivities related to any assets in the future. Changes in the Company’sintentions or its expectations of market performance could have a 

50

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material impact on the carrying value of its assets ascertain of the assets determined to be recoverable on an undiscounted cash flowbasis may have carrying values greater than fair value.

***Profit Recognition—******Income*** fromthe sale of residential units or land parcels is recognized when title isconveyed to the home or land buyer, adequate cash payment has been received andthere is no continuing involvement by the Company. Land and land developmentcosts (including estimated costs to complete) are allocated to units and toland sold based on relative sales values. Payments received from customers priorto closing are recorded as deposits.

Gain on sales of mortgage loans, in the mortgagebanking segment, is recognized as the difference between the sales price andthe adjusted book value of the loans at the time of sale. The adjusted bookvalue of the loans includes the original principal amount plus various basisadjustments related primarily to the deferrals of fees and points received andcertain direct loan origination costs.

The Company entered into a flexible early purchasefacility agreement in February 2004 which provided for a maximum facilitylimit of $75 million, then was subsequently amended in August 2004 toprovide for a maximum facility limit of $150 million and was recently amendedin March 2006 to provide for a maximum facility limit of $100 million. Theterms of the purchase facility agreement allow the Company to sell qualifyingloans to the holder of the flexible early purchase facility after such loanshave been originated subject to the Company’s obligation to sell the loan to aninvestor in the secondary market. During the year ended September 30,2006, approximately $457 million of mortgage loans were sold to the holder ofthe flexible early purchase facility. At September 30, 2006, the facilityheld $56.6 million of loans sold by the Company.

***Income Taxes—******Deferred*** taxliabilities and assets are determined based upon the temporary differencebetween the financial reporting carrying values and income tax bases of assetsand liabilities, and are measured using enacted tax rates in effect for theyear in which the differences are expected to reverse. The most significant ofthese differences arise from the computation of depreciation, inventoryvaluation adjustments, timing of settlement of certain insurance, legal, andwarranty reserves, and the tax basis step-up of related party partnershipinterest purchases (see note 11).

***Warranty Costs—******Warranty***reserves for homes are established in an amount estimated based on historicalresults to be adequate to cover expected warranty-related costs for materialsand outside labor to be incurred during the warranty period.

***Guarantees—******The Company conducts a portion ofits land acquisition, development and other activities through itsnon-controlling participation in joint ventures. For certain of the jointventures, the Company provides guarantees considered normal in the industry towhich it may be obligated to indemnify the other party with respect to certainmatters (see note 4). The Company records the fair value of guarantees providedto non-consolidated joint ventures as an investment in the joint venture with acorresponding liability if the Company has determined the fair value to be morethan insignificant. To date, the Company has not incurred any significant costsas a result of such indemnification agreements. As of September 30, 2006,the fair value of these guarantees are insignificant to the consolidatedfinancial statements.***

***Self-Insurance—******Certain***insurable risks such as general liability and medical are self-insured by theCompany up to certain limits. Undiscounted accruals for claims under theCompany’s self-insurance program are based on claims filed and estimates forclaims incurred but not reported.

***Stock Plans—******In***accordance with the provisions of Statement of Financial Accounting Standards No. 123,*Accounting for Stock-Based Compensation*(“SFAS 123”), the Company has elected to apply the accounting prescribedby Accounting Principles Board Opinion No. 25 and related Interpretations(“APB 25”) in accounting for its stock plans.

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The Company has recognized employee compensation costfor certain of its stock options granted that were considered to be variableawards (see note 9). If the Company had elected to recognize compensation costbased on the fair value of the options granted at the grant date as prescribedby SFAS 123, earnings before income taxes would have been reduced byapproximately $0.1 million for the year ended September 30, 2006,increased by approximately $15.9 million for the year ended September 30,2005 and reduced by approximately $0.6 million for the year ended September 30,2004.

During fiscal 2005, the Company granted 37,500deferred stock units, representing a right to receive 37,500 shares of theCompany’s common stock at a future date. Under the terms of the agreement, one-thirdof the deferred stock units fully vest on each of October 1, 2005, 2006and 2007, respectively, with the shares being issued on the earlier of: a) thefifth anniversary of the date of grant, b) the executive’s separation ofservice, c) the executive’s death or disability, or d) a change in control.Each year, the Company recognizes compensation cost, for the relative serviceperiod covered, equal to the market value of the underlying common shares ofthe Company on the date of grant. During both fiscal 2006 and 2005,compensation cost of $0.8 million related to deferred stock units is includedin the Company’s consolidated statement of operations.

***Fair Value ofFinancial Instruments—***Statement of FinancialAccounting Standards No. 107, *Disclosures about FairValue of Financial Instruments*, requires companies to disclose theestimated fair value of their financial instruments, both assets andliabilities. The fair value of financial instruments is determined by referenceto various market data and other valuation techniques as appropriate. TheCompany’s financial instruments consist of cash equivalents, receivables,customer deposits, accounts payable and accrued expenses, mortgage loans heldfor sale, notes payable for mortgage loans, its senior unsecured creditfacility, other senior secured credit facilities and its senior subordinatednotes payable. The fair value of the senior subordinated notes payable isestimated based on the quoted market prices for the same or similar issues oron the current rates offered to the Company for debt of the same maturities.The fair value of the senior subordinated notes payable is estimated at $182.7million as of September 30, 2006. The carrying values of all otherfinancial instruments approximate fair values because of the short maturity ofthose instruments and the terms available to the Company for similar types ofinstruments.

***DerivativeFinancial Instruments—***The Company’s riskmanagement objective for its mortgage loans held for sale is to protect earningsfrom an unexpected charge due to a decline in value. The Company’s strategy isto engage in a risk management program involving the use of best-efforts andmandatory sales commitments to hedge 100% of its loans held for sale. Thederivatives are carried at fair value with the changes in fair value recordedto current earnings.

***Recent AccountingPronouncements***—In December 2004, the FASB issuedStatement of Financial Accounting Standards No. 123 (revised 2004), *Share-Based Payment,* (“SFAS 123R”). SFAS 123R is a revisionof SFAS 123 and supersedes APB No. 25. SFAS 123R requires that the costresulting from all share-based payment transactions be recognized in thefinancial statements and establishes fair value as the measurement objective inaccounting for share-based payment arrangements. SFAS 123R applies to allawards granted, modified, repurchased or cancelled after the effective date.Since the Company previously used the minimum value method under SFAS 123, theCompany will continue to account for any portion of awards outstanding at thedate of initial application using the accounting principles originally appliedto those awards. SFAS 123R becomes effective for the Company on October 1,2006 and is not expected to have a material impact on the Company’s results ofoperations or financial position.

In May 2005, the FASB issued SFAS No. 154, *Accounting Changes and Error Corrections—a replacement for APB Opinion No. 20and FASB Statement No. 3* (“SFAS 154”). SFAS 154 requires priorperiod financial statements to be restated for changes in accountingprinciples. SFAS 154 also redefines restatement as the revision of previouslyissued financial statements to reflect the correction of an error. SFAS 154 iseffective for accounting changes and corrections of errors made in fiscal yearsbeginning after December 15, 2005. 

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SFAS 154 becomes effective for the Company on October 1,2006 and is not expected to have a material impact on its consolidatedfinancial statements.

In June 2005, the Emerging Issues Task Force (“EITF”)released Issue No. 04-5, *Determining Whether aGeneral Partner, or the General Partners as a Group, Controls a LimitedPartnership or Similar Entity When the Limited Partners Have Certain Rights*(“EITF 04-5”). EITF 04-5 creates a framework for evaluating whethera general partner or a group of general partners controls a limited partnershipand therefore should consolidate the partnership. EITF 04-5 states thatthe presumption of general partner control would be overcome only when thelimited partners have certain specific rights as outlined in EITF 04-5.EITF 04-5 is effective immediately for all newly formed limitedpartnerships and for existing limited partnership agreements that are modified.For general partners in all other limited partnerships, EITF 04-5 iseffective no later than the beginning of the first reporting period in fiscalyears beginning after December 15, 2005. EITF 04-5 becomes effectivefor the Company on October 1, 2006 and is not expected to have a materialimpact on the Company’s results of operations or financial position.

In July 2006, the FASB issued FASB InterpretationNo. 48, *Accounting for Uncertainty in Income Taxes*(“FIN48”), which prescribes a recognition threshold and measurement process forrecording in the financial statements uncertain tax positions taken or expectedto be taken in a tax return. Additionally, FIN 48 provides guidance on thederecognition, classification, accounting in interim periods and disclosurerequirements for uncertain tax positions. The accounting provisions of FIN 48will be effective for the Company beginning October 1, 2007. The Companyis in the process of determining the effect, if any, the adoption of FIN 48will have on its financial statements.

In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements*(“SFAS 157”),which defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles and expands disclosure about fairvalue measurements. SFAS 157 is effective for financial statements issued forfiscal years beginning after November 15, 2007, and interim periods withinthose fiscal years. The Company is in the process of determining the effect, ifany, the adoption of SFAS 157 will have on its financial statements.

In September 2006,the SEC issued Staff Accounting Bulletin No. 108, *Consideringthe Effects of Prior Year Misstatements when Quantifying Misstatements inCurrent Year Financial Statements*(“SAB 108”), which providesguidance as to how the effects on prior year uncorrected misstatements shouldbe considered when quantifying misstatements in the current financialstatements. SAB 108 was issued in order to eliminate the diversity of practicesurrounding how public companies quantify financial statement misstatements.SAB 108 will require the Company to quantify misstatements using both a balancesheet and income statement approach, with adjustment required if either methodresults in a material error. SAB 108 is effective for financial statementsissued for fiscal years beginning after November 15, 2006. The Company isin the process of determining the effect, if any, the adoption of SAB 108 willhave on its financial statements.

**2.**                 Inventory

Inventoryconsists of the following at September 30, 2006 and 2005:

| **(in thousands)**                                | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------------|------------|----------|------------|----------|------------|
| Residential  lots—developed and under development |       | $        | 581,701    |     | $          | 541,169 |   |
| Finished homes  and construction in progress           |       | 262,392  |       | 248,878  |       |
| Deposits on land  purchases                            |       | 15,499   |       | 15,612   |       |
| Land held for  future development or sale              |       | 39,705   |       | 3,119    |       |
| Total                                                  |       | $        | 899,297    |     | $          | 808,778 |   |
|                                                   |       |     |       |     |       |

 

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The Company capitalizes interest during development andconstruction. Capitalized interest is charged to cost of sales as residentialunits are closed. Interest costs for the years ended September 30, 2006,2005 and 2004 are as follows:

| **(in thousands)**                      | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Capitalized  interest—beginning of year |       | $        | 40,076     |     | $          | 29,551   | ** ** | $ | 34,917 |   |
| Interest incurred                            |       | 52,232   |       | 38,221   | ** ** | 30,016   |       |
| Interest included  in cost of sales          |       | (32,899  | )          | (27,696  | )          | (35,382  | )          |
| Capitalized interest—end  of year       |       | $        | 59,409     |     | $          | 40,076   | ** ** | $ | 29,551 |   |
|                                         |       |     |       |     | ** ** |     |       |

 

**3*.****                *Inventory NotOwned

In December 2003, the FASB issued FIN 46R, *Consolidation of Variable Interest Entities.*Under FIN 46R,a variable interest entity (“VIE”) is created when (i) the equityinvestment at risk is not sufficient to permit the entity to finance itsactivities without additional subordinated financial support from other partiesor (ii) equity holders either (a) lack a direct or indirect abilityto make decisions about the entity, (b) are not obligated to absorbexpected losses of the entity or (c) do not have the right to receiveexpected residual returns of the entity, if they occur. FIN 46R requires theconsolidation of VIEs in which an enterprise absorbs a majority of the entity’sexpected losses, receives a majority of the entity’s expected residual returns,or both, as a result of ownership, contractual or other financial interests inthe entity.

The Company has applied, as required, FIN 46R to allvariable interests and has determined that many of its options on landrepresent a variable interest in VIEs. The Company has determined it is theprimary beneficiary of certain of these option contracts and although theCompany does not have legal title to the optioned land, under FIN 46R, it isrequired that the Company consolidate the land under the option at initial fairvalue.

At September 30, 2006and 2005, the Company has consolidated optioned land with an initial fair valueof approximately $37.8 million and $46.7 million for which it paid cash optiondeposits of $1.1 million and $4.6 million, respectively. The Company estimatedthe initial fair value of the consolidated optioned land based upon the Company’soption contract price. In many cases, the Company was unable to obtain therelevant financial information from the selling entities, therefore, theCompany has used the information available to make an assumption as to whetherthe selling entity has additional assets or has debt obligations outstanding. Thedifference between the fair value of the land under contract and the Company’snon-refundable deposit is recorded in liabilities related to inventory notowned unless it is determined by the Company that the selling entity does notcarry debt in which case the difference is recorded as minority interest ininventory not owned.

**4.**                 InvestmentsIn and Advances to Unconsolidated Entities

Investments in and advances to unconsolidated entitiesrepresent the Company’s ownership interest in entities accounted for under theequity method when it has a significant influence over the entity but holdsless than a controlling interest in the entity or it is not the primary beneficiaryin a VIE as defined by FIN 46R. The Company’s partners generally areunrelated homebuilders, land sellers or other real estate entities. Thefollowing is a summary of the Company’s significant investments as of September 30,2006 and 2005:

The Company has invested in two joint ventures toacquire and develop land in Nevada. The Company has a 6.29% and 9.59% ownershipinterest, respectively, in these two ventures. As of September 30, 2006 and 2005, the Company had investmentsin the two joint ventures totaling $34.5 million and $29.6 million,respectively. At September 30, 2006, these joint ventures had third partydebt of $471 million and $386 million, respectively, of which each jointventure member has guaranteed its pro rata share. These payment 

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guarantees are only triggered in the event ofbankruptcy of each joint venture. The Company expects to purchase land fromthese ventures in the future.

The Company has a 45% ownership interest in a jointventure to acquire and develop land in California. As of September 30, 2006, the venture had sold all of its land andrepaid all borrowings under the loan facility. As of September 30,2005, the Company had an investment of $0.5 million in the venture. As of September 30,2005, the venture had borrowings of approximately $12 million outstanding ofwhich the Company had guaranteedits pro-rata share.

In December 2002, the Companyentered into a joint venture, in which it has a 23.75% interest, to developproperty and construct single-family residences in Chicago, Illinois. At September 30,2006 and 2005, the Company had investments in and advances to the joint venturetotaling $4.9 million and $4.0 million, respectively. The Company hasprovided a financial and performance guaranty in connection with the venture’s$20 million construction financing for a single phase of the project. Inaddition, the Company has provided a guarantee on a $9 million tax incrementfinancing bond for this project. As of September 30, 2006, $3.4 million offunds have been drawn on the construction financing facility and $4.3 millionwas drawn on the tax increment financing bond. The Company is notobligated to loan additional funds to the venture.

In May 2004, the Company entered into a jointventure, in which it has a 35% interest, to develop property in Detroit, Michigan. At September 30, 2006and 2005, the Company had investments in and advances to the joint venturetotaling $1.8 million and $1.3 million, respectively. The Company is notobligated to loan additional funds to the venture.

In August 2004, the Company entered into a jointventure, in which it has a 33.3% interest, to develop property and constructsingle-family residences in Chicago, Illinois. At September 30, 2006 and2005, the Company had investments in and advances to the joint venture totaling$3.1 million and $1.5 million,respectively. The Company has provided a financial and performance guaranty inconnection with certain of the venture’s indebtedness totaling $90.8 million,with the Company’s maximum financial guaranty limited to $10 million in theaggregate. At September 30, 2006, there were no borrowings outstandingunder these credit facilities. The Company hasalso provided a guarantee in connection with a $9.8 million capitalcontribution to be made by an unrelated joint venture member, whereby theCompany would make the contribution if the unrelated joint venture member doesnot. The Company is not obligated to loan additional funds to theventure.

In October 2005, the Company entered into a jointventure, in which it has a 49% interest, to develop property and constructsingle-family residences in Chicago, Illinois. At September 30, 2006, theCompany had investments in and advances to the joint venture totaling $0.4million. The Company is not obligated to loan additional funds to the venture.

In January 2006, the Company entered into a jointventure, in which it has a 35% interest, to develop a high-rise mixed-use towerin San Jose, California. At September 30, 2006, the Company hadinvestments in the joint venture of $2.5 million and the Company has committedto investing an additional $0.4 million in the venture.

In June 2006, theCompany entered into a joint venture, in which it has a 33% interest, todevelop property and construct single-family residences in Detroit, Michigan.At September 30, 2006, the Company had investments in and advances to thejoint venture totaling $0.8 million. The Company is not obligated to loanadditional funds to the venture.

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**5.**                 Leases

TheCompany leases certain property from others under non-cancelable leases. Officeleases are generally for terms of three to five years and generally providerenewal options. The Company expects that in the normal course of business,leases that expire will be renewed or replaced by other leases. The futureminimum lease payments required under operatingleases are as follows:

| **Year ending September 30 (in thousands):** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------|------------|------------|------------|
| 2007                                                                  |       | $          | 2,266      |   |
| 2008                                                                  |       | 2,514      |       |
| 2009                                                                  |       | 2,313      |       |
| 2010                                                                  |       | 1,979      |       |
| 2011                                                                  |       | 771        |       |
| After 2011                                                            |       | 857        |       |
| Total                                                                 |       | $          | 10,700     |   |

 

|  |   |   |   |
|--|--------|--------|--------|

 

**6.**                 Propertyand Equipment

The following is a summary of property and equipment as of September 30,2006 and 2005:

| **(in  thousands)**                 | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|
| Homebuilding:                       |       |     |       |     |       |
| Operating  properties:              |       |     |       |     |       |
| Land and land improvements          |       | $        | 2,592      |     | $          | 1,649 |   |
| Buildings                           |       | 9,373    |       | 5,761    |       |
| Building and tenant improvements    |       | 2,256    |       | 1,552    |       |
| Total operating properties          |       | 14,221   |       | 8,962    |       |
| Other:                              |       |     |       |     |       |
| Office equipment                    |       | 7,103    |       | 6,822    |       |
| Vehicles and construction equipment |       | 131      |       | 131      |       |
| Total other                         |       | 7,234    |       | 6,953    |       |
|                                |       | 21,455   |       | 15,915   |       |
| Accumulated depreciation            |       | (10,820  | )          | (10,730  | )          |
| Total homebuilding                  |       | $        | 10,635     |     | $          | 5,185 |   |
| Mortgage banking:                   |       |     |       |     |       |
| Leasehold improvements              |       | $        | 79         |     | $          | 79 |   |
| Office equipment                    |       | 588      |       | 562      |       |
|                                |       | 667      |       | 641      |       |
| Accumulated depreciation            |       | (413     | )          | (321     | )          |
| Total mortgage  banking             |       | $        | 254        |     | $          | 320 |   |

 

|  |   |   |   |   |   |
|--|--------|--------|--------|--------|--------|

 

Operating propertiesconsist of two office developments with approximately 111,000 square feetof leasable area. The properties are pledged as collateral for certain mortgageloans (see note 7).

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**7.**                 Financing

***Homebuilding***

TheCompany’s notes payable consist of the following as of September 30, 2006and 2005:

| **(in thousands)**                                  | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|
| Senior  subordinated notes (net of unamortized discount) |       | $        | 200,750    |     |       |   |
| Senior unsecured  credit facility                        |       | 244,947  |       |     |       |
| Other senior  secured credit facilities                  |       | 54,511   |       | $        | 115,178    |   |
| Other senior debt                                        |       |     |       | 6,921    |       |
| Senior secured  revolving credit facilities              |       |     |       | 306,126  |       |
| Working capital  loans                                   |       |     |       | 45,000   |       |
| Total                                                    |       | $        | 500,208    |     | $          | 473,225 |   |

 

|  |   |   |   |   |   |
|--|--------|--------|--------|--------|--------|

                                                

In December 2005,the Company issued $203 million aggregate principal amount of seniorsubordinated notes due December 2012 in a private placement pursuant to Rule 144Apromulgated under the Securities Act of 1933. The senior subordinated noteswere sold at 98.796% of par and accrue interest at a coupon rate of 10.5% perannum. Interest is paid semi-annually in June and December. The netproceeds were used to repay amounts outstanding under working capital loans andcertain senior secured revolving credit facilities. The Company may redeem thenotes, in whole or part, at any time on or after December 15, 2009, at aredemption price equal to 100% of the principal amount, plus a 5.25% premium decliningratably to par on December 15, 2011, plus accrued and unpaid interest. Inaddition, at any time prior to December 15, 2008, the Company may redeemup to 35% of the aggregate principal amount of the notes with the proceeds ofqualified equity offerings at a redemption price equal to 110.5% of theprincipal amount, plus accrued and unpaid interest. The notes are unsecuredsenior subordinated obligations and subordinated in right of payment to all ofthe Company’s existing and future senior debt, including borrowings under theCompany’s senior unsecured credit facility. All of the Company’s wholly ownedsubsidiaries, other than the Company’s mortgage subsidiary, have fully andunconditionally guaranteed the notes on a joint and several, unsecured seniorsubordinated, basis. The guarantees are general unsecured obligations of theguarantors and will be subordinated in right of payment to all existing andfuture senior debt of the guarantors, which includes their guarantees of theCompany’s senior unsecured credit facility. The indenture governing the seniorsubordinated notes contains a number of significant covenants that couldrestrict the Company’s ability and that of its restricted subsidiaries to,among other things: incur additional indebtedness, make certain distributions,investments and other restricted payments, create certain liens, enter intotransactions with affiliates, and merge, consolidate or sell substantially allof the Company’s assets. As of September 30, 2006, the Company wasrestricted from incurring additional indebtedness, except under certain limitedcircumstances.

In May 2006, theCompany completed an offer to exchange all of the senior subordinated notesissued in December 2005 for an issue of notes registered with the SEC withterms substantially identical to the notes issued in the private placement.

In December 2005, theCompany entered into a new senior unsecured credit facility to finance itsbusiness operations. Proceeds of the new credit facility were used to retireits existing senior secured revolving credit facilities and substantially allof its other senior secured credit facilities. The credit facility has amaximum availability of $500 million, subject to a borrowing base as well assublimits of $100 million for the issuance of letters of credit and $10 millionfor swing line loans. The Company has the right, without the consent of itslenders (other than those participating in the increase), to increase thecommitment by an amount of up to $200 million, provided that no such increaseshall cause the senior unsecured credit facility to exceed $700 million. Theapplicable borrowing base will be determined regularly throughout the life ofthe facility. The composition of the borrowing base will be limited toparameters set forth in the 

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credit facility agreementand certain types of real estate (such as unimproved entitled land and lotsunder development) will be removed from the borrowing base if held beyondspecified maturity dates. Borrowings under the credit facility will generallybear interest based on an applicable margin plus LIBOR or an alternate baserate. The applicable margin for interest ranges from 1.5% to 2.25%, dependingupon the Company’s senior leverage ratio, which is defined as the ratio oftotal liabilities to consolidated net worth. Fees for letters of credit arebased on LIBOR plus a margin of 1.5%. An unused commitment fee equal to 0.2% to0.3% per year accrues on the undrawn portion of the facility and is payablequarterly in arrears. As of September 30, 2006, the Company had $245million of borrowings under the credit facility at an effective interest rateof 7.34% and, after giving effect to the borrowing base limitation, hadadditional availability of approximately $254 million. The Company’s obligationsunder the senior unsecured credit facility are guaranteed by all of itswholly-owned subsidiaries, other than the Company’s mortgage subsidiary, andare subject to a number of customary financial and operating covenants,including covenants requiring the Company to: maintain a minimum tangible networth of at least $225 million plus 50% of positive net income as earnedsubsequent to September 30, 2005; maintain a ratio of total liabilities toadjusted tangible net worth not to exceed 2.50x; maintain a ratio of total debtto adjusted tangible net worth not in excess of 2.0x (decreasing to 1.75x as ofMarch 31, 2007); maintain an interest coverage ratio of no less than2.25x; and limit the number of speculative housing units owned by the Company,excluding foundations, as of the end of any fiscal quarter to a maximum of 30%of the Company’s housing unit closings during the previous 12-monthperiod; and limit the number of speculative housing units in any buildingregion, excluding foundations, as of the end of any fiscal quarter to a maximumof 35% of the Company’s housing unit closings in such region during theprevious 12-month period. In addition to these covenants, the creditfacility includes restrictions upon debt and investments which permit: subordinateddebt up to $300 million; other unsecured debt up to $25 million; secured debtup to 25% of tangible net worth; guarantees of minority-owned joint venturedebt up to 35% of adjusted tangible net worth; and investments inminority-owned joint ventures up to 30% of tangible net worth. For purposes ofthese tests, adjusted tangible net worth is benefited by adjustments of 50% ofthe Company’s outstanding senior subordinated debt (up to a maximum $100million adjustment) and 100% of minority interests in consolidated entities (upto a maximum $50 million adjustment). As of and during the year ended September 30,2006, the Company was in compliance with the covenants of this facility. Thisfacility has been amended subsequent to September 30, 2006 (see note 16).

The Company is party totwo senior secured project-specific acquisition, development and constructionloans. These loans bear interest at a floating rate ranging from the prime rateto the prime rate plus 1% with maturities generally tied to the sale of theunderlying inventory. As of September 30, 2006, the Company had $45.7million outstanding related to these project-specific acquisition, developmentand construction loans.

The Company has a firstmortgage note for an office complex in Rolling Meadows, Illinois. The mortgagenote is secured by the office complex and bears interest at 4.81%. The Companymakes monthly principal and interest payments of $25,488 with the balance due October 2007.As of September 30, 2006, the Company had $4.0 million outstanding on themortgage note.

The Company has a termloan of $4.8 million for an office building in Rolling Meadows, Illinois. Theterm loan is secured by the office building and bears interest equal to theprime rate. The Company makes monthly interest payments with the principalbalance due March 2009. As of September 30, 2006, the Company had$4.8 million outstanding on the term loan.

Prior to the issuance of the senior subordinated notes and the closing of the Company’s unsecuredcredit facility, the Company’s borrowing facilities consisted primarily of fourrevolving credit facilities that provided for maximum borrowings of $824million. The senior secured revolving credit facilities bore interest atvariable interest rates, ranging from LIBOR plus 2.0% to prime plus 0.9%.Pursuant to one of the senior secured revolving credit facilities, the Companyborrowed $25 million and $20 million under two 

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working capital loan agreements with fixed interestrates of 13.75% and 12.5%, respectively. In addition to the senior securedrevolving credit facilities and working capital loans, the Company was party toseveral senior secured project-specific acquisition, development andconstruction loans that bore interest at a floating rate ranging from the primerate to the prime rate plus 1%.

Theaggregate principal payments due on the notes payable are as follows:

| **Year ending September 30 (in thousands):** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------|------------|------------|------------|
| 2007                                                                  |       | $          | 9,942      |   |
| 2008                                                                  |       | 39,769     |       |
| 2009                                                                  |       | 4,800      |       |
| 2010                                                                  |       | 244,947    |       |
| 2011                                                                  |       | —     |       |
| After 2011                                                            |       | 200,750    |       |
| Total                                                                 |       | $          | 500,208    |   |

 

|  |   |   |   |
|--|--------|--------|--------|

 

***Mortgage Banking***

Notespayable for mortgage loans represent borrowings from a third partyfinancial institution under a revolving credit agreement which was entered intoin January 2001, and provided for maximum borrowings of $75 million. TheCompany amended the credit agreement in August 2004 to provide for maximumborrowings of $10 million and extended the termination date to March 2006with a third amendment in March 2005. The Company again amended the creditagreement in March 2006 to provide for maximum borrowings of $5 millionand extended the termination date to March 2007, at which time the Companyexpects to enter into a new agreement. Borrowings under the credit agreementare secured by the underlying mortgage loans. Interest accrues at LIBOR plus2.25% (8.08% at September 30, 2006). The terms of the credit agreementcontain restrictive covenants which require KH Financial, L.P., among otherthings, to maintain a minimum net worth amount, to maintain certain financialratios and limit distributions. At September 30, 2006 and 2005, there was$0 and approximately $0.2 million outstanding on notes payable for mortgageloans. As of and during the year ended September 30, 2006, the Company wasin compliance with the covenants of this credit agreement.

**8.**                  RedeemableCommon Stock

Under the terms of theCompany’s amended stock option plans (see note 9), the Company has contractualobligations to purchase shares of its outstanding common stock from itsdirectors and certain of its executive officers and other key employees in theevent of termination of board membership or employment, as applicable, byreason of specified circumstances, including death, disability, termination,retirement or resignation. The terms of the original stock option agreementsrequired the repurchase obligation at an amount other than fair market value.Subsequent to September 30, 2005, the Company amended the stock optionagreements so that the repurchase obligation is at fair market value.

At the time outstandingshares qualify for this redemption right, the redemption amount is transferredfrom shareholders’ equity to redeemable common stock. Subsequent changes to theredemption amount are transferred from shareholders’ equity to redeemablecommon stock in the case of an increasing redemption amount, or, fromredeemable common stock to shareholders’ equity in the case of a decreasingredemption amount. During fiscal 2006, 61,000 shares that were not redeemableas of September 30, 2005 became redeemable, 140,000 new shares thatqualified for this redemption right were issued upon the exercise of stockoptions, and 12,987 shares were sold by shareholders who qualified for thisredemption right to shareholders who did not qualify for this redemption right.During fiscal 2006, 258,011 redeemable shares were repurchased by the Company.

Certain outstandingoptions would qualify for this redemption right after exercise of the options.

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**9.**                 Stock Plans

Executives and other keyemployees have been granted options to purchase common shares of the Company.In each case, the option price equals the estimated fair market value of thecommon shares on the day of the grant. The options’ terms range from three toeight years and vesting terms from immediately upon grant to vesting in equalannual installments over four years.

The various stock optionagreements issued under the Company’s stock option plans, prior to September 30,2005, included a feature that required the Company to repurchase outstandingshares, issued under the agreements, at an amount other than fair market value,upon termination of board membership or employment by reason of specifiedcircumstances. As those specified circumstances were within the control ofcertain of the option holders as of September 30, 2005, the Companyrecorded compensation expense of $15.9 million, and a related tax benefit of$4.1 million during fiscal 2005, to record those equity based awards at theirother than fair market value repurchase price as of that date. Subsequent to September 30,2005, the Company amended its stock option agreements to provide that anyrepurchases of shares under the agreements be of shares owned for longer thansix months at fair market value.

The fair value of eachstock option granted is estimated on the date of grant using a Black-Scholesoption-pricing model with the following weighted average assumptions usedfor grants in 2006 and 2004: risk-free interest rate of 5.00% and 2.83%,respectively, expected lives of 3 years to 7 years and no dividend yield. Therewere no stock options granted in 2005. A summary of shares is as follows:

| ** **                                  | ** ** | **2006**   | ** ** | ** **   | **2005**   | ** ** | **2004**   | ** ** |
|---------------------------------------------|------------|------------|------------|--------------|------------|------------|------------|------------|
| ** **                                  | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                  | ** ** | ** ** | ** ** | **average**  | ** ** | ** ** | ** ** | ** ** | **average** | ** ** | ** ** | ** ** | **average** | ** ** |
| ** **                                  | ** ** | ** ** | ** ** | **exercise** | ** ** | ** ** | ** ** | ** ** | **exercise** | ** ** | ** ** | ** ** | **exercise** | ** ** |
| ** **                                  | ** ** | **Shares** | ** ** | **price**    | ** ** | ** ** | **Shares** | ** ** | **price** | ** ** | **Shares** | ** ** | **price** | ** ** |
| Options  outstanding—beginning of year |       | 214,000    |       | $            | 32.08      |       |       | 529,000    |   |   | $ | 20.98 |   |   | 486,000 |   |   | $ | 13.06 |   |   |
| Granted                                     |       | 12,000     |       | 115.50       |       |       |       |       |   |   |   |   | 135,000 |   |   | 41.80 |   |   |
| Forfeited                                   |       | (10,000    | )          | 23.40        |       |       |       |       |   |   |   |   | (62,097 | ) |   | 9.70 |   |   |
| Exercised                                   |       | (140,000   | )          | 35.54        |       |       | (315,000   | )          |   | 13.45 |   |   | (29,903 | ) |   | 9.51 |   |   |
| Options  outstanding—end of year       |       | 76,000     |       | $            | 40.02      |       |       | 214,000    |   |   | $ | 32.08 |   |   | 529,000 |   |   | $ | 20.98 |   |   |
| Options exercisable—end  of year       |       | 64,000     |       |         |       |       | 214,000    |       |   |   |   |   | 529,000 |   |   |   |   |   |

 

 

|  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|--|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|

 

The weighted average fairvalue of the stock options granted in 2006 and 2004 calculated using a Black-Scholesoption-pricing model is $30.36 and $4.14 per share, respectively.

Additionalinformation for stock options outstanding at September 30, 2006 is asfollows:

| ** **        | ** ** | ** **      | ** ** | **Weighted**              | ** ** | ** ** | ** **      | ** ** | ** **   | ** ** |
|-------------------|------------|-----------------|------------|---------------------------|------------|------------|-----------------|------------|--------------|------------|
| ** **        | ** ** | ** **      | ** ** | **average**               | ** ** | ** ** | ** **      | ** ** | **Weighted** | ** ** |
| **Range of** | ** ** | ** **      | ** ** | **remaining**             | ** ** | ** ** | ** **      | ** ** | **average**  | ** ** |
| **exercise**      | ** ** | **Outstanding** | ** ** | **contractual life** | ** ** | ** ** | **Exercisable** | ** ** | **exercise** | ** ** |
| **prices**        | ** ** | **options**     | ** ** | **(in years)**       | ** ** | ** ** | **options**     | ** ** | **price**    | ** ** |
| $ 7.75       |       | 15,000          |       | 0.25                      |       |       | 15,000          |       | $            | 7.75       |   |
| $ 10.00      |       | 16,000          |       | 1.14                      |       |       | 16,000          |       | $            | 10.00      |   |
| $ 41.80      |       | 33,000          |       | 1.25                      |       |       | 33,000          |       | $            | 41.80      |   |
| $115.50           |       | 12,000          |       | 9.56                      |       |       | —          |       | $            | 115.50     |   |
|              |       | 76,000          |       |                      |       |       | 64,000          |       |         |       |

 

|  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|--|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|

 

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**10.**          EmployeeStock Ownership Plan

The Company initiated anEmployee Stock Ownership Plan (“ESOP”) in December 2000 as part of itsbenefit plan package covering substantially all employees, provided they havemet certain eligibility requirements as defined in the plan document. The ESOPis designed to provide employees with ownership of the Company’s stock.

In December 2000, theESOP borrowed $4 million from a third party and used the proceeds topurchase 234,467 shares of the Company’s common stock (6.7% of the outstandingcommon stock of the Company at that date). The ESOP notes were guaranteed bythe Company with a four-year maturity and a variable interest rate at prime.The notes were repaid in full in December 2004.

The number of shares allocatedto participants was based on the quarterly payments of principal and interestdue on the ESOP notes. During the years ended September 30, 2005 and 2004,shares valued at approximately $0.7 million and $1.0 million, respectively,were allocated to participants and were included in the consolidated statementsof operations as compensation cost. All shares were allocated to participantsas of September 30, 2005, therefore, there were no shares allocated toparticipants during fiscal 2006.

During fiscal 2006, theCompany purchased, directly from former employees, 20,785 shares that werepreviously allocated under the ESOP. During fiscal 2005 and 2004, the Companypurchased, directly from former employees, 25,580 and 6,001 shares,respectively, that were previously allocated under the ESOP. As of September 30,2006, all shares under the ESOP were allocated to participants.

**11.**          IncomeTaxes

Theprovision for income taxes for the years ended September 30, 2006, 2005and 2004 consists of the following:

| **(in thousands)**     | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current tax  expense:       |       |     |       |     |       |     |       |
| Federal                     |       | $        | 21,924     |     | $          | 52,383   |       | $ | 27,900 |   |
| State                       |       | 2,184    |       | 4,679    |       | 2,209    |       |
| Total current tax  expense  |       | 24,108   |       | 57,062   |       | 30,109   |       |
| Deferred tax benefit        |       |     |       |     |       |     |       |
| Federal                     |       | (538     | )          | (5,852   | )          | (2,549   | )          |
| State                       |       | (54      | )          | (521     | )          | (195     | )          |
| Total deferred  tax benefit |       | (592     | )          | (6,373   | )          | (2,744   | )          |
| Total                       |       | $        | 23,516     |     | $          | 50,689   |       | $ | 27,365 |   |

 

|  |   |   |   |   |   |   |   |
|--|--------|--------|--------|--------|--------|--------|--------|

 

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Deferredincome taxes reflect the net tax effects of temporary differences between thecarrying amounts of the assets and liabilities for financial reporting purposesand for income tax purposes. The tax effects of significant temporarydifferences that give rise to the net deferred tax asset as of September 30,2006 and 2005 are as follows:

| **(in  thousands)**                                     | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax assets:                                    |       |     |       |     |       |
| Warranty, general  liability and litigation reserves    |       | $        | 4,763      |     | $          | 4,920 |   |
| Inventory valuation  adjustments                        |       | 7,387    |       |     |       |
| Tax basis step-up on  purchase of partnership interests |       | 1,591    |       | 3,160    |       |
| Deferred and equity  based compensation                 |       | 1,100    |       | 6,031    |       |
| Other                                                   |       | 23       |       |     |       |
| Total deferred tax  assets                              |       | 14,864   |       | 14,111   |       |
| Deferred tax  liabilities:                              |       |     |       |     |       |
| Depreciation                                            |       | 731      |       | 570      |       |
| Total deferred tax  liabilities                         |       | 731      |       | 570      |       |
| Net deferred tax asset                                  |       | $        | 14,133     |     | $          | 13,541 |   |

 

|  |   |   |   |   |   |
|--|--------|--------|--------|--------|--------|

 

Thefollowing table reconciles the federal statutory income tax rate to theeffective income tax rate for the years ended September 30, 2006, 2005 and2004:

| ** **                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Income taxes at federal  statutory rate |       | 35.0     | %          | 35.0     | %          | 35.0     | %          |
| State income taxes, net  of federal tax |       | 2.1      |       | 2.0      |       | 1.6      |       |
| Pemanent differences                    |       | (1.5     | )          | (0.4     | )          | 0.2      |       |
| Other                                   |       | 0.4      |       | 0.3      |       | (3.8     | )          |
| Effective rate                          |       | 36.0     | %          | 36.9     | %          | 33.0     | %          |

 

|  |   |   |   |   |   |   |   |
|--|--------|--------|--------|--------|--------|--------|--------|

 

**12.**          Related-PartyTransactions

On September 12,2006, the Company entered into a Subscription Agreement and Investor RightsAgreement with Equity Investments III, LLC (“EI”). Pursuant to the SubscriptionAgreement, the Company sold 952,380 shares of its common stock to EI for anaggregate purchase price of $110 million, effectively making EI a relatedparty.

In addition to thetransaction described above, the following is a summary of the transactionsbetween the Company and EI or its affiliates since October 1, 2005:

*Notes Payable.**  *The Company was a party to several credit facilitiesand loans with an affiliate of EI, which were used to fund acquisition,development or construction projects. All amounts outstanding under thesefacilities and loans were repaid on December 19, 2005 with proceeds fromthe issuance of $203 million of senior subordinated bonds and a new $500million unsecured revolving credit facility. From October 1, 2005 until December 19,2005, the Company paid approximately $3.0 million to the affiliate of EI, whichrepresented interest and fees payable under these facilities and loans.

*Limited PartnershipInvestment.**  *Anaffiliate of EI is currently a limited partner in three consolidatedpartnerships formed by the Company to engage in certain residential developmentand construction projects. The affiliate of EI has provided a total of $35million in equity capital in exchange for ownership interests in the respectivepartnerships. As of September 30, 2006, EI or an affiliate had a totalcapital balance of approximately $35 million in those consolidated partnershipswhich is reflected as minority interest in the Company’s consolidated balancesheets as of September 30, 2006.

During fiscal 2006, theCompany repurchased 403,201 shares from certain current and former directorsand officers for $46.4 million.

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TheCompany has also entered into various transactions with other related entities(those owned wholly or partially by the controlling shareholder). Thesetransactions during the years ended September 30, 2005 and 2004 aresummarized below:

| **(in thousands)**                                                                                                                             | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Purchase of lots from  related entities                                                                                                             |       |     |       | $        | 16,780     |   |
| Purchase of membership  interest in, and receivables from, an unconsolidated joint venture                                                     |       |     |       | $        | 3,296      |   |
| Purchase of the general  partnership interest in a land development partnership                                                                     |       |     |       | $        | 4,299      |   |
| Fees paid by related  entities to the Company for management of non-consolidated housing projects; fees  are based on a percentage of revenues |       | $        | 108        |     | $          | 1,254 |   |
| Amounts due from related entities and the controlling  shareholder                                                                                  |       |     |       | $        | 3,104      |   |
|                                                                                                                                                |       |     |       |     |       |
|                                                                                                                                                     |            |          |            |          |            |  |  |

 

 

There were no homebuilding transactions with relatedentities (those owned wholly or partially by the controlling shareholder)during the year ended September 30, 2006.

Anentity controlled by the controlling shareholder of the Company has enteredinto several limited partnerships with the Company. A summary of the activityincluded in the Company’s financial statements is as follows:

| **(in thousands)**                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Beginning balance of  related party included in minority interest |       | $        | 36,446     |     | $          | 21,350 |   |
| Contributions from  related party                                 |       |     |       | 38,400   |       |
| Distributions to related  party                                   |       | (42,399  | )          | (27,516  | )          |
| Minority interest in net  earnings                                |       | 5,953    |       | 4,212    |       |
| Ending balance of related party included in minority  interest    |       | $        | —     |     | $          | 36,446 |   |
|                                                              |       |     |       |     |       |

 

 

During fiscal 2005, the Company purchased the relatedentity’s interests in these partnerships at a price of $27.3 million, which wasapproximately $8.4 million over the reported minority interest financialstatement basis. The transaction was treated as an exchange of assets betweenentities under common control, and the amount of purchase price over thefinancial statement basis was treated as a distribution to the controllingshareholder of the Company. For income tax purposes, the distribution was treatedas a step-up in basis in inventory owned and represents a deferred tax asset ofapproximately $1.6 million and $3.2 million to the Company as of September 30,2006 and 2005, respectively.

As of September 30, 2005, the Company had paidcumulative premiums totaling $3.8 million relating to life insurance policiesfor the controlling shareholder. The cumulative premiums paid were recorded,with the Company’s cash surrender value on policies where the Company is thebeneficiary, in deferred expenses and other assets on the consolidated balancesheets. In response to the uncertainty created by Section 402 of theSarbanes-Oxley Act of 2002, on April 11, 2006, the controlling shareholderpaid the Company approximately $4.2 million for all premiums advanced by theCompany under these policies and suspended making any further payments onbehalf of the controlling shareholder.

During fiscal 2004, theCompany’s controlling shareholder purchased lots from the Company at theCompany’s cost basis of $0.4 million.

**13.**          Commitmentsand Contingencies

In the normal course ofbusiness, the Company acquires rights under option agreements to purchase landfor future development and/or developed lots. The agreements generally arecontingent upon municipality approvals. As of September 30, 2006, theCompany has rights, under such agreements, to purchase approximately 9,700lots, within 50 separate developments, with an aggregate contract price of

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approximately$433 million. Approximately 1,700 of those lots contain specificperformance requirements, with an aggregate purchase price of approximately $47million, of which the Company is obligated to pay approximately $5 millionwithin the next twelve months and the remaining $42 million at various datesbeginning in June 2009. Approximately 1,800 of the lots, with an aggregatepurchase price of approximately $165 million, are to be purchased from jointventures in which the Company has an investment balance of approximately $34million as of September 30, 2006. This investment is recorded ininvestments in and advances to unconsolidated entities on the consolidatedbalance sheets.

At September 30,2006, excluding inventory not owned (see note 3), the Company was contingentlyliable to banks and financial institutions for approximately $54 millionfor outstanding letters of credit and performance bonds securing performance ofcertain contractual obligations and land option contracts.

Under the terms of theCompany’s amended stock plans (see notes 1 and 9), the Company has contractualobligations to purchase shares of its common stock, including shares issuableunder outstanding options, from its directors and certain of its executiveofficers and other key employees in the event of termination of board membershipor employment, as applicable, by reason of specified circumstances, includingdeath, disability, termination, retirement or resignation. As of September 30,2006, the aggregate repurchase obligation, net of proceeds to be received fromany stock option exercises, would have been approximately $43.3 million in theevent that all of these obligations were triggered.

The Company is involved inlitigation incidental to its business, the disposition of which should not havea material effect on the Company’s financial position or results of operations.

TheCompany provides product warranties to its customers covering workmanship,materials and certain mechanical systems for two years, and structural systemsfor ten years. The Company estimates and records warranty liabilities based onhistorical experience and known risks at the time a home closes, and in thecase of unexpected claims, upon identification and quantification of theobligations. The Company’s warranty accrual is included in accounts payable andaccrued expenses in its consolidated balance sheets. Changes in the Company’swarranty liability for the fiscal years ended September 30, 2006, 2005 and2004 are as follows:

| **(in thousands)**            | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Balance at  beginning of year      |       | $        | 5,844      |     | $          | 3,324    |       | $ | 3,448 |   |
| Warranties issued                  |       | 5,419    |       | 6,204    |       | 3,608    |       |
| Settlements and  other adjustments |       | (5,465   | )          | (3,684   | )          | (3,732   | )          |
| Balance at end of year             |       | $        | 5,798      |     | $          | 5,844    |       | $ | 3,324 |   |

 

|  |   |   |   |   |   |   |   |
|--|--------|--------|--------|--------|--------|--------|--------|

 

At September 30,2006, the Company was committed to fund approximately $19.8 million in mortgageloans to homebuyers at agreed-upon rates. The Company has entered into best-effortsand mandatory sale commitments to sell these mortgages to third parties.

**14.**          SegmentInformation and Concentrations

In accordance with Statement of Financial AccountingStandards No. 131, *Disclosures about Segmentsof an Enterprise and Related Information* (“SFAS 131”)*,*the Company has identified five reportable homebuildingsegments, conducting business in 9 states, and one mortgage banking reportablesegment. The Company historically aggregated its homebuilding operatingsegments into one reportable segment and accordingly has revised thathistorical presentation for all periods to conform to the current yearpresentation of five reportable homebuilding segments. The Company’shomebuilding segments are engaged in the acquisition and development of land,and construction and sale of residential homes. The Company’s mortgage bankingsegment originates mortgages, which are sold to third parties.

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The Company’s chief decision maker, its chiefexecutive officer, routinely reviews information on the Company’s operatingsegments. Management evaluates a segment’s performance based upon a number offactors including segment earnings before income taxes.

The Company’s corporate departments provide certainservices that are advantageous to perform in a centralized manner, givencertain cost efficiencies or required technical expertise. The Company’scorporate functions include: financial analysis, human resources, informationtechnology, legal, planning, risk management, sales training, strategicmarketing and treasury. Only corporate costs that are deemed to directlybenefit certain operating segments are allocated to those operating segments.

Operations within the Company’s reportablehomebuilding segments have been determined to have similar economiccharacteristics, including: similar historical and expected future operatingperformance, employment trends, land availability, acquisition and developmentconstraints, municipality behavior and meet the other aggregation criteria inSFAS 131. The reportable homebuilding segments include operations in thefollowing geographical regions:

Florida

Midwest: Illinois, Ohio andWisconsin

Nevada

Pacific Coast: California,Oregon and Washington

Texas

The Company’s internal measurement system hasestablished accountabilities to continually improve business focus and increaseits ability to react quickly to changes in particular markets as well aschanges to the overall homebuilding business cycle. This measurement system,which is not based on GAAP, is intended to motivate behavior of employees anddrive performance. The sales and cost information used for internal purposesvaries from the Company’s consolidated, externally reported informationresulting in reconciling items.

Thefollowing tables illustrate the revenue, earnings before income taxes andassets of the Company’s reportable segments. Included are reconciliations tothe amounts reported in the Company’s consolidated financial statements.

| ** **                            | ** ** | **For the fiscal years ended September 30:** | ** ** |
|---------------------------------------|------------|----------------------------------------------------------------------------|------------|
| **Revenues (in thousands)** | ** ** | **2006**                                                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Florida                               |       | $                                                                          | 112,470    |   | $ | 116,951 |   | $ | 96,824 |   |
| Midwest                               |       | 263,506                                                                    |       | 280,859 |   | 220,711 |   |
| Nevada                                |       | 171,455                                                                    |       | 176,803 |   | 116,115 |   |
| Pacific Coast                         |       | 290,406                                                                    |       | 326,482 |   | 222,752 |   |
| Texas                                 |       | 323,887                                                                    |       | 243,843 |   | 269,721 |   |
| Mortgage banking                      |       | 8,222                                                                      |       | 6,557 |   | 5,992 |   |
| Segment revenue  subtotal             |       | 1,169,946                                                                  |       | 1,151,495 |   | 932,115 |   |
| Corporate and  unallocated(a)         |       | 2,120                                                                      |       | 1,703 |   | 1,648 |   |
|                                  |       | 1,172,066                                                                  |       | 1,153,198 |   | 933,763 |   |
| GAAP adjustment(b)                    |       |                                                                       |       |   |   | (7,716 | ) |
| Consolidated total  revenues          |       | $                                                                          | 1,172,066  |   | $ | 1,153,198 |   | $ | 926,047 |   |
|                                  |       |                                                                       |       |   |   |   |   |

 

(a)     Corporate andunallocated includes land sales where the asset was held in the Company’scorporate department rather than one of the Company’s operating segments.Rental and other income are also included within corporate and unallocatedrevenues.

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(b)     GAAP adjustment relates to certain projects managed,but not owned or consolidated by the Company. For internal measurement purposesthe projects were included, as if owned by the Company, in its operatingsegment reports.

|                                                                          | ** ** | **For the fiscal years ended September 30:** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| **Earnings Before Income Taxes (in thousands)** | ** ** | **2006**                                                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| Florida                                                                  |       | $                                                                          | 7,502      |   | $ | 15,168 | ** ** | $ | 9,862 | ** ** |
| Midwest                                                                  |       | (13,870                                                                    | )          | 25,035 | ** ** | 19,231 | ** ** |
| Nevada                                                                   |       | 42,143                                                                     |       | 67,543 | ** ** | 30,682 | ** ** |
| Pacific Coast                                                            |       | 68,620                                                                     |       | 110,103 | ** ** | 60,640 | ** ** |
| Texas                                                                    |       | 15,066                                                                     |       | 5,572 | ** ** | 17,309 | ** ** |
| Mortgage banking                                                         |       | 3,633                                                                      |       | 1,718 | ** ** | 864 | ** ** |
| Segment earnings before  income taxes subtotal                           |       | 123,094                                                                    |       | 225,139 | ** ** | 138,588 | ** ** |
| Corporate and  unallocated                                               |       | (29,780                                                                    | )          | (39,233 | ) | (22,788 | ) |
|                                                                          |       | 93,314                                                                     |       | 185,906 | ** ** | 115,800 | ** ** |
| Homebuilding interest  expense                                           |       | (32,899                                                                    | )          | (27,696 | ) | (35,382 | ) |
| GAAP adjustment(c)                                                       |       | 4,905                                                                      |       | (20,687 | ) | 2,566 | ** ** |
| Consolidated earnings  before income taxes                               |       | $                                                                          | 65,320     |   | $ | 137,523 | ** ** | $ | 82,984 | ** ** |
|                                                                     |       |                                                                       |       |   | ** ** |   | ** ** |

 

(c)     Included in the fiscal2005 GAAP adjustment is compensation expense of $15.9 million related to stockoptions that were deemed to be variable awards. This expense was not includedwithin the Company’s internal measurement system. Also included in the GAAPadjustment for all fiscal years presented is (a) a timing difference for certain capitalizable indirectconstruction costs that are expensed as incurred in the Company’s internalmeasurement system and (b) minorityinterest expense which is not included in the Company’s internal measurementsystem.

| ** **                          | ** ** | **As of September 30:** | ** ** |
|-------------------------------------|------------|----------------------------------------|------------|
| **Assets (in thousands)** | ** ** | **2006**                               | ** ** | **2005** | ** ** |
| Florida                             |       | $                                      | 91,226     |   | $ | 77,432 |   |
| Midwest                             |       | 267,519                                |       | 237,467 |   |
| Nevada                              |       | 224,331                                |       | 196,815 |   |
| Pacific Coast                       |       | 181,289                                |       | 184,617 |   |
| Texas                               |       | 197,604                                |       | 173,620 |   |
| Mortgage banking                    |       | 10,859                                 |       | 8,388 |   |
| Segment assets subtotal             |       | 972,828                                |       | 878,339 |   |
| Corporate and  unallocated          |       | 118,749                                |       | 92,156 |   |
| Consolidated assets                 |       | $                                      | 1,091,577  |   | $ | 970,495 |   |
|                                |       |                                   |       |   |   |

 

 

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**15.**   SummarizedFinancial Information

TheCompany’s senior subordinated notes and senior unsecured credit facility arefully and unconditionally guaranteed, on a joint and several basis, by all ofthe Company’s wholly owned subsidiaries (“Guarantor Subsidiaries”), other thanthe Company’s mortgage subsidiary. The Company’s mortgage subsidiary andmajority owned and controlled subsidiaries are non-guarantors (“Non-GuarantorSubsidiaries”) of the senior subordinated notes and the senior unsecured creditfacility. In lieu of providing separate audited financial statements for theGuarantor Subsidiaries, consolidated condensed financial statements arepresented below. Separate financial statements and other disclosures concerningthe Guarantor Subsidiaries are not presented because management has determinedthat they are not material to investors.

| **As of September 30, 2006  (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                            |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| HOMEBUILDING:                                                         |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                            |       | $          | 1,518      |                        |       | $                               | 14,511     |             |       |             | $          | 13 |   |   |   | $ | — |   |   |   | $ | 16,042 |   |   |
| Receivables                                                           |       |       |       |                        | 32,834     |                            |       |             | 2,489      |             |       |   |   |   |   |   | 35,323 |   |   |
| Inventory                                                             |       |       |       |                        | 720,984    |                            |       |             | 178,313    |             |       |   |   |   |   |   | 899,297 |   |   |
| Inventory not owned                                                   |       |       |       |                        | 37,821     |                            |       |             |       |             |       |   |   |   |   |   | 37,821 |   |   |
| Deferred expenses and  other assets                                   |       | 9,103      |       |                        | 9,938      |                            |       |             | 188        |             |       |   |   |   |   |   | 19,229 |   |   |
| Investments in and  advances to unconsolidated entities               |       |       |       |                        | 48,238     |                            |       |             |       |             |       |   |   |   |   |   | 48,238 |   |   |
| Deferred income taxes                                                 |       | 14,133     |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   | 14,133 |   |   |
| Property and equipment,  net of accumulated depreciation              |       | 8,291      |       |                        | 2,344      |                            |       |             |       |             |       |   |   |   |   |   | 10,635 |   |   |
| Investments in  subsidiaries                                          |       | 309,830    |       |                        | 19,523     |                            |       |             |       |             |       |   | (329,353 | ) |   |   |   |   |   |
|                                                                  |       | 342,875    |       |                        | 886,193    |                            |       |             | 181,003    |             |       |   | (329,353 | ) |   |   | 1,080,718 |   |   |
| MORTGAGE BANKING                                                      |       |       |       |                        |       |                            |       |             | 10,859     |             |       |   |   |   |   |   | 10,859 |   |   |
| TOTAL ASSETS                                                          |       | $          | 342,875    |                        |       | $                               | 886,193    |             |       |             | $          | 191,862 |   |   |   | $ | (329,353 | ) |   |   | $ | 1,091,577 |   |   |
| **Liabilities and equity**                                            |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| HOMEBUILDING:                                                         |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Accounts payable and accrued expenses                                 |       | $          | 228        |                        |       | $                               | 105,809    |             |       |             | $          | 742 |   |   |   | $ | — |   |   |   | $ | 106,779 |   |   |
| Deposits on sales of  residential units                               |       |       |       |                        | 6,246      |                            |       |             | 87         |             |       |   |   |   |   |   | 6,333 |   |   |
| Liabilities related to  inventory not owned                           |       |       |       |                        | 5,015      |                            |       |             |       |             |       |   |   |   |   |   | 5,015 |   |   |
| Income taxes payable                                                  |       | 3,702      |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   | 3,702 |   |   |
| Notes payable                                                         |       | 454,665    |       |                        | 9,801      |                            |       |             | 35,742     |             |       |   |   |   |   |   | 500,208 |   |   |
| Intercompany                                                          |       | (509,172   | )          |                        | 423,848    |                            |       |             | 85,324     |             |       |   |   |   |   |   |   |   |   |
|                                                                  |       | (50,577    | )          |                        | 550,719    |                            |       |             | 121,895    |             |       |   |   |   |   |   | 622,037 |   |   |
| MORTGAGE BANKING                                                      |       |       |       |                        |       |                            |       |             | 1,123      |             |       |   |   |   |   |   | 1,123 |   |   |
| Total liabilities                                                     |       | (50,577    | )          |                        | 550,719    |                            |       |             | 123,018    |             |       |   |   |   |   |   | 623,160 |   |   |
| MINORITY INTEREST IN CONSOLIDATED  PARTNERSHIPS                       |       |       |       |                        |       |                            |       |             | 43,827     |             |       |   | (583 | ) |   |   | 43,244 |   |   |
| MINORITY INTEREST IN INVENTORY  NOT OWNED                             |       |       |       |                        | 31,721     |                            |       |             |       |             |       |   |   |   |   |   | 31,721 |   |   |
| REDEEMABLE EQUITY                                                     |       | 26,334     |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   | 26,334 |   |   |
| SHAREHOLDERS’ EQUITY                                             |       | 367,118    |       |                        | 303,753    |                            |       |             | 25,017     |             |       |   | (328,770 | ) |   |   | 367,118 |   |   |
| TOTAL LIABILITIES AND EQUITY                                          |       | $          | 342,875    |                        |       | $                               | 886,193    |             |       |             | $          | 191,862 |   |   |   | $ | (329,353 | ) |   |   | $ | 1,091,577 |   |   |

 

|  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|--|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|

 

67

----

 

| **As of September 30, 2005  (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                            | ** ** | ** ** | ** ** |                        | ** ** | ** **                      |       |             | ** ** | ** **       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| HOMEBUILDING:                                                         |       |       |       |                        |       |                            |       |             |       | ** **       |       |   |   |   |   |   |   | ** ** |   |
| Cash and cash equivalents                                             |       | $          | 6,875      |                        |       | $                               | 9,786      |             |       |             | $          | 102 | ** ** |   |   | $ | — |   |   |   | $ | 16,763 | ** ** |   |
| Receivables                                                           |       |       |       |                        | 22,849     |                            |       |             | 30         | ** **       |       |   |   |   |   |   | 22,879 | ** ** |   |
| Inventory                                                             |       |       |       |                        | 670,170    |                            |       |             | 138,608    | ** **       |       |   |   |   |   |   | 808,778 | ** ** |   |
| Inventory not owned                                                   |       |       |       |                        | 46,721     |                            |       |             |       | ** **       |       |   |   |   |   |   | 46,721 | ** ** |   |
| Deferred expenses and other assets                                    |       | 6,364      |       |                        | 4,671      |                            |       |             | 172        | ** **       |       |   |   |   |   |   | 11,207 | ** ** |   |
| Investments in and advances to unconsolidated  entities               |       |       |       |                        | 37,033     |                            |       |             |       | ** **       |       |   |   |   |   |   | 37,033 | ** ** |   |
| Deferred income taxes                                                 |       | 13,541     |       |                        |       |                            |       |             |       | ** **       |       |   |   |   |   |   | 13,541 | ** ** |   |
| Property and equipment, net of accumulated  depreciation              |       | 2,593      |       |                        | 1,734      |                            |       |             | 858        | ** **       |       |   |   |   |   |   | 5,185 | ** ** |   |
| Investments in subsidiaries                                           |       | 269,215    |       |                        | 9,522      |                            |       |             |       | ** **       |       |   | (278,737 | ) |   |   |   | ** ** |   |
|                                                                  |       | 298,588    |       |                        | 802,486    |                            |       |             | 139,770    | ** **       |       |   | (278,737 | ) |   |   | 962,107 | ** ** |   |
| MORTGAGE BANKING                                                      |       |       |       |                        |       |                            |       |             | 8,388      | ** **       |       |   |   |   |   |   | 8,388 | ** ** |   |
| TOTAL ASSETS                                                          |       | $          | 298,588    |                        |       | $                               | 802,486    |             |       |             | $          | 148,158 | ** ** |   |   | $ | (278,737 | ) |   |   | $ | 970,495 | ** ** |   |
| **Liabilities and equity**                                            | ** ** | ** ** | ** ** |                        | ** ** | ** **                      |       |             | ** ** | ** **       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| HOMEBUILDING:                                                         |       |       |       |                        |       |                            |       |             |       | ** **       |       |   |   |   |   |   |   | ** ** |   |
| Accounts payable and accrued expenses                                 |       | $          | 33         |                        |       | $                               | 93,547     |             |       |             | $          | 790 | ** ** |   |   | $ | — |   |   |   | $ | 94,370 | ** ** |   |
| Deposits on sales of residential units                                |       |       |       |                        | 13,830     |                            |       |             | 178        | ** **       |       |   |   |   |   |   | 14,008 | ** ** |   |
| Liabilities related to inventory not  owned                           |       |       |       |                        | 10,402     |                            |       |             |       | ** **       |       |   |   |   |   |   | 10,402 | ** ** |   |
| Income taxes payable                                                  |       | 15,368     |       |                        |       |                            |       |             |       | ** **       |       |   |   |   |   |   | 15,368 | ** ** |   |
| Notes payable                                                         |       | 4,126      |       |                        | 397,038    |                            |       |             | 72,061     | ** **       |       |   |   |   |   |   | 473,225 | ** ** |   |
| Intercompany                                                          |       | (5,511     | )          |                        | (9,071     | )                               |       |             | 14,582     | ** **       |       |   |   |   |   |   |   | ** ** |   |
|                                                                  |       | 14,016     |       |                        | 505,746    |                            |       |             | 87,611     | ** **       |       |   |   |   |   |   | 607,373 | ** ** |   |
| MORTGAGE BANKING                                                      |       |       |       |                        |       |                            |       |             | 1,334      | ** **       |       |   |   |   |   |   | 1,334 | ** ** |   |
| Total liabilities                                                     |       | 14,016     |       |                        | 505,746    |                            |       |             | 88,945     | ** **       |       |   |   |   |   |   | 608,707 | ** ** |   |
| MINORITY INTEREST  IN CONSOLIDATED PARTNERSHIPS                       |       |       |       |                        | 446        |                            |       |             | 45,049     | ** **       |       |   |   |   |   |   | 45,495 | ** ** |   |
| MINORITY INTEREST  IN INVENTORY NOT OWNED                             |       |       |       |                        | 31,721     |                            |       |             |       | ** **       |       |   |   |   |   |   | 31,721 | ** ** |   |
| REDEEMABLE EQUITY                                                     |       | 33,763     |       |                        |       |                            |       |             |       | ** **       |       |   |   |   |   |   | 33,763 | ** ** |   |
| SHAREHOLDERS’  EQUITY                                            |       | 250,809    |       |                        | 264,573    |                            |       |             | 14,164     | ** **       |       |   | (278,737 | ) |   |   | 250,809 | ** ** |   |
| TOTAL LIABILITIES AND EQUITY                                          |       | $          | 298,588    |                        |       | $                               | 802,486    |             |       |             | $          | 148,158 | ** ** |   |   | $ | (278,737 | ) |   |   | $ | 970,495 | ** ** |   |

 

|  |   |   |   |   |   |   |   |   |   | ** ** |   |   |   |   |   |   |   | ** ** |   |
|--|--------|--------|--------|--------|--------|--------|--------|--------|--------|------------|--------|--------|--------|--------|--------|--------|--------|------------|--------|

 

68

----

| **For the year ended  September 30, 2006 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| HOMEBUILDING:                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |
| Revenues:                                                                               |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |
| Sales of residential units and land                                                     |       | $          | —     |                        | $          | 1,141,282                       |       |             | $          | 30,961           |       |   |   | $ | (11,563 | ) |   |   | $ | 1,160,680 |   |   |
| Rental and other income                                                                 |       | 477        |       | 1,820                       |       |                            | 867        |             |       |             |       |   |   |   | 3,164 |   |   |
| Total homebuilding revenues                                                             |       | 477        |       | 1,143,102                   |       |                            | 31,828     |             |       |             | (11,563    | ) |   |   | 1,163,844 |   |   |
| Expenses:                                                                               |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |
| Cost of sales of residential units and land                                             |       |       |       | 956,240                     |       |                            | 27,749     |             |       |             | (10,786    | ) |   |   | 973,203 |   |   |
| General and administrative                                                              |       | 24,495     |       | 45,434                      |       |                            | 78         |             |       |             |       |   |   |   | 70,007 |   |   |
| Sales and marketing                                                                     |       |       |       | 58,968                      |       |                            | 1,153      |             |       |             |       |   |   |   | 60,121 |   |   |
| Depreciation                                                                            |       | 185        |       | 566                         |       |                            |       |             |       |             |       |   |   |   | 751 |   |   |
| Total homebuilding expenses                                                             |       | 24,680     |       | 1,061,208                   |       |                            | 28,980     |             |       |             | (10,786    | ) |   |   | 1,104,082 |   |   |
| Intercompany charge                                                                     |       | 24,203     |       | (24,203                     | )          |                            |       |             |       |             |       |   |   |   |   |   |   |
| Equity in income of unconsolidated joint ventures                                  |       |       |       | 2,215                       |       |                            |       |             |       |             |       |   |   |   | 2,215 |   |   |
| Minority interests in net losses (earnings) of  consolidated partnerships          |       |       |       | 590                         |       |                            | (1,463     | )                |       |             | 583        |   |   |   | (290 | ) |   |
| Homebuilding earnings before income taxes                                               |       | —     |       | 60,496                      |       |                            | 1,385      |             |       |             | (194       | ) |   |   | 61,687 |   |   |
| MORTGAGE BANKING:                                                                       |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |
| Revenues:                                                                               |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |
| Gain on sales of mortgage loans                                                         |       |       |       |                        |       |                            | 8,188      |             |       |             |       |   |   |   | 8,188 |   |   |
| Interest income                                                                         |       |       |       |                        |       |                            | 34         |             |       |             |       |   |   |   | 34 |   |   |
| Total mortgage banking revenues                                                         |       |       |       |                        |       |                            | 8,222      |             |       |             |       |   |   |   | 8,222 |   |   |
| Expenses:                                                                               |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |
| General and administrative                                                              |       |       |       |                        |       |                            | 4,490      |             |       |             |       |   |   |   | 4,490 |   |   |
| Interest expense                                                                        |       |       |       |                        |       |                            | 7          |             |       |             |       |   |   |   | 7 |   |   |
| Depreciation                                                                            |       |       |       |                        |       |                            | 92         |             |       |             |       |   |   |   | 92 |   |   |
| Total mortgage banking expenses                                                         |       |       |       |                        |       |                            | 4,589      |             |       |             |       |   |   |   | 4,589 |   |   |
| Mortgage banking earnings before income taxes                                           |       |       |       |                        |       |                            | 3,633      |             |       |             |       |   |   |   | 3,633 |   |   |
| EQUITY IN INCOME  OF CONSOLIDATED SUBSIDIARIES                                          |       | 65,320     |       | 722                         |       |                            |       |             |       |             | (66,042    | ) |   |   |   |   |   |
| EARNINGS BEFORE  INCOME  TAXES                                                          |       | 65,320     |       | 61,218                      |       |                            | 5,018      |             |       |             | (66,236    | ) |   |   | 65,320 |   |   |
| PROVISION FOR  INCOME TAXES                                                             |       | 23,516     |       | 22,038                      |       |                            | 1,806      |             |       |             | (23,844    | ) |   |   | 23,516 |   |   |
| NET EARNINGS                                                                            |       | $          | 41,804     |                        | $          | 39,180                          |       |             | $          | 3,212            |       |   |   | $ | (42,392 | ) |   |   | $ | 41,804 |   |   |

 

|  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|--|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|

 

69

----

 

| **For the year ended  September 30, 2005 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| HOMEBUILDING:                                                                                |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |
| Revenues:                                                                                    |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |
| Sales of residential units and land                                                          |       | $          | —     |                        | $          | 1,127,655                       |       |             | $          | 16,016           |       |   | $ | — |   |   | $ | 1,143,671 |   |   |
| Rental and other income                                                                      |       | 246        |       | 2,376                       |       |                            | 348        |             |       |             |       |   | 2,970 |   |   |
| Total homebuilding revenues                                                                  |       | 246        |       | 1,130,031                   |       |                            | 16,364     |             |       |             |       |   | 1,146,641 |   |   |
| Expenses:                                                                                    |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |
| Cost of sales of residential units and land                                             |       |       |       | 850,199                     |       |                            | 12,447     |             |       |             |       |   | 862,646 |   |   |
| General and administrative                                                                   |       | 26,981     |       | 66,738                      |       |                            | 294        |             |       |             |       |   | 94,013 |   |   |
| Sales and marketing                                                                          |       |       |       | 49,816                      |       |                            | 735        |             |       |             |       |   | 50,551 |   |   |
| Depreciation                                                                                 |       | 105        |       | 617                         |       |                            | 34         |             |       |             |       |   | 756 |   |   |
| Total homebuilding expenses                                                                  |       | 27,086     |       | 967,370                     |       |                            | 13,510     |             |       |             |       |   | 1,007,966 |   |   |
| Intercompany charge                                                                          |       | 26,840     |       | (26,840                     | )          |                            |       |             |       |             |       |   |   |   |   |
| Equity in income of unconsolidated joint ventures                                            |       |       |       | 3,282                       |       |                            |       |             |       |             |       |   | 3,282 |   |   |
| Minority interests in net earnings of consolidated  partnerships                             |       |       |       | (5,953                      | )          |                            | (199       | )                |       |             |       |   | (6,152 | ) |   |
| Homebuilding earnings before income taxes                                                    |       | —     |       | 133,150                     |       |                            | 2,655      |             |       |             |       |   | 135,805 |   |   |
| MORTGAGE BANKING:                                                                            |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |
| Revenues:                                                                                    |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |
| Gain on sales of mortgage loans                                                              |       |       |       |                        |       |                            | 6,496      |             |       |             |       |   | 6,496 |   |   |
| Interest income                                                                              |       |       |       |                        |       |                            | 61         |             |       |             |       |   | 61 |   |   |
| Total mortgage banking revenues                                                              |       |       |       |                        |       |                            | 6,557      |             |       |             |       |   | 6,557 |   |   |
| Expenses:                                                                                    |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |
| General and administrative                                                                   |       |       |       |                        |       |                            | 4,681      |             |       |             |       |   | 4,681 |   |   |
| Interest expense                                                                             |       |       |       |                        |       |                            | 34         |             |       |             |       |   | 34 |   |   |
| Depreciation                                                                                 |       |       |       |                        |       |                            | 124        |             |       |             |       |   | 124 |   |   |
| Total mortgage banking expenses                                                              |       |       |       |                        |       |                            | 4,839      |             |       |             |       |   | 4,839 |   |   |
| Mortgage banking earnings before income taxes                                           |       |       |       |                        |       |                            | 1,718      |             |       |             |       |   | 1,718 |   |   |
| EQUITY IN INCOME  OF CONSOLIDATED SUBSIDIARIES                                               |       | 137,523    |       | 2,655                       |       |                            |       |             |       | (140,178         | )          |   |   |   |   |
| EARNINGS BEFORE  INCOME TAXES                                                                |       | 137,523    |       | 135,805                     |       |                            | 4,373      |             |       | (140,178         | )          |   | 137,523 |   |   |
| PROVISION FOR  INCOME TAXES                                                                  |       | 50,689     |       | 50,112                      |       |                            | 1,614      |             |       | (51,726          | )          |   | 50,689 |   |   |
| NET EARNINGS                                                                                 |       | $          | 86,834     |                        | $          | 85,693                          |       |             | $          | 2,759            |       |   | $ | (88,452 | ) |   | $ | 86,834 |   |   |

\

|  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|--|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|

 

70

----

 

| **For the year ended  September 30, 2004 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| HOMEBUILDING:                                                                           |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Revenues:                                                                               |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Sales of residential units and land                                                     |       | $          | —     |                        |       | $                               | 915,327    |             |       |             | $          | — |   |   |   | $ | — |   |   |   | $ | 915,327 |   |   |
| Rental and other income                                                                 |       | 211        |       |                        | 4,223      |                            |       |             | 294        |             |       |   |   |   |   |   | 4,728 |   |   |
| Total homebuilding revenues                                                             |       | 211        |       |                        | 919,550    |                            |       |             | 294        |             |       |   |   |   |   |   | 920,055 |   |   |
| Expenses:                                                                               |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Cost of sales of residential units and land                                             |       |       |       |                        | 729,332    |                            |       |             | 165        |             |       |   |   |   |   |   | 729,497 |   |   |
| General and administrative                                                              |       | 21,788     |       |                        | 36,082     |                            |       |             | 233        |             |       |   |   |   |   |   | 58,103 |   |   |
| Sales and marketing                                                                     |       |       |       |                        | 45,847     |                            |       |             | 217        |             |       |   |   |   |   |   | 46,064 |   |   |
| Depreciation                                                                            |       | 97         |       |                        | 742        |                            |       |             | 33         |             |       |   |   |   |   |   | 872 |   |   |
| Total homebuilding expenses                                                             |       | 21,885     |       |                        | 812,003    |                            |       |             | 648        |             |       |   |   |   |   |   | 834,536 |   |   |
| Intercompany charge                                                                     |       | 21,674     |       |                        | (21,674    | )                               |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Equity in income of unconsolidated joint ventures                                  |       |       |       |                        | 833        |                            |       |             |       |             |       |   |   |   |   |   | 833 |   |   |
| Minority interests in net earnings of consolidated  partnerships                        |       |       |       |                        | (4,232     | )                               |       |             |       |             |       |   |   |   |   |   | (4,232 | ) |   |
| Homebuilding earnings before income taxes                                               |       | —     |       |                        | 82,474     |                            |       |             | (354       | )                |       |   |   |   |   |   | 82,120 |   |   |
| MORTGAGE BANKING:                                                                       |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Revenues:                                                                               |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Gain on sales of mortgage loans                                                         |       |       |       |                        |       |                            |       |             | 4,946      |             |       |   |   |   |   |   | 4,946 |   |   |
| Interest income                                                                         |       |       |       |                        |       |                            |       |             | 1,046      |             |       |   |   |   |   |   | 1,046 |   |   |
| Total mortgage banking revenues                                                         |       |       |       |                        |       |                            |       |             | 5,992      |             |       |   |   |   |   |   | 5,992 |   |   |
| Expenses:                                                                               |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| General and administrative                                                              |       |       |       |                        |       |                            |       |             | 4,409      |             |       |   |   |   |   |   | 4,409 |   |   |
| Interest expense                                                                        |       |       |       |                        |       |                            |       |             | 625        |             |       |   |   |   |   |   | 625 |   |   |
| Depreciation                                                                            |       |       |       |                        |       |                            |       |             | 94         |             |       |   |   |   |   |   | 94 |   |   |
| Total mortgage banking expenses                                                         |       |       |       |                        |       |                            |       |             | 5,128      |             |       |   |   |   |   |   | 5,128 |   |   |
| Mortgage banking earnings before income taxes                                           |       |       |       |                        |       |                            |       |             | 864        |             |       |   |   |   |   |   | 864 |   |   |
| EQUITY IN INCOME  OF CONSOLIDATED SUBSIDIARIES                                          |       | 82,984     |       |                        | (378       | )                               |       |             |       |             |       |   | (82,606 | ) |   |   |   |   |   |
| EARNINGS BEFORE  INCOME TAXES                                                           |       | 82,984     |       |                        | 82,096     |                            |       |             | 510        |             |       |   | (82,606 | ) |   |   | 82,984 |   |   |
| PROVISION FOR  INCOME TAXES                                                             |       | 27,365     |       |                        | 27,092     |                            |       |             | 168        |             |       |   | (27,260 | ) |   |   | 27,365 |   |   |
| NET EARNINGS                                                                            |       | $          | 55,619     |                        |       | $                               | 55,004     |             |       |             | $          | 342 |   |   |   | $ | (55,346 | ) |   |   | $ | 55,619 |   |   |

 

|  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|--|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|

 

 

71

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| **For the year ended  September 30, 2006 (in thousands)**       | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Cash flows from operating  activities:**                                                    |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Net earnings                                                                                  |       | $          | 41,804     |                        |       | $                               | 39,180     |             |       |             | $          | 3,212 |   |   |   | $ | (42,392 | ) |   |   | $ | 41,804 |   |   |
| Adjustments to reconcile net earnings to cash flows  from operating activities                |       | (47,564    | )          |                        | (59,949    | )                               |       |             | (45,401    | )                |       |   | 40,954 |   |   |   | (111,960 | ) |   |
| Net cash used in operating activities                                                         |       | (5,760     | )          |                        | (20,769    | )                               |       |             | (42,189    | )                |       |   | (1,438 | ) |   |   | (70,156 | ) |   |
| **Cash  flows from investing activities:**                                                    |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Purchases of property and equipment                                                           |       | (5,883     | )          |                        | (1,328     | )                               |       |             | (25        | )                |       |   |   |   |   |   | (7,236 | ) |   |
| Disposals of property and equipment                                                           |       |       |       |                        | 151        |                            |       |             | 858        |             |       |   |   |   |   |   | 1,009 |   |   |
| Distributions of contributed capital from investments  in unconsolidated entities             |       |       |       |                        | 748        |                            |       |             |       |             |       |   |   |   |   |   | 748 |   |   |
| Contributions to investments in unconsolidated  entities                                      |       |       |       |                        | (10,824    | )                               |       |             |       |             |       |   |   |   |   |   | (10,824 | ) |   |
| Contributions to investments in subsidiaries                                                  |       |       |       |                        | (9,079     | )                               |       |             |       |             |       |   | 9,079 |   |   |   |   |   |   |
| Net cash (used in) provided by investing activities                                           |       | (5,883     | )          |                        | (20,332    | )                               |       |             | 833        |             |       |   | 9,079 |   |   |   | (16,303 | ) |   |
| **Cash  flows from financing activities:**                                                    |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Proceeds from issuance of notes and mortgage loans  payable                                   |       | 868,922    |       |                        | 323,189    |                            |       |             | 26,488     |             |       |   |   |   |   |   | 1,218,599 |   |   |
| Repayments of notes and mortgage loans  payable                                               |       | (418,383   | )          |                        | (710,426   | )                               |       |             | (62,993    | )                |       |   |   |   |   |   | (1,191,802 | ) |   |
| Debt issuance costs                                                                           |       | (6,598     | )          |                        |       |                            |       |             |       |             |       |   |   |   |   |   | (6,598 | ) |   |
| Net proceeds from issuance of common stock                                                    |       | 114,825    |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   | 114,825   |   |   |
| Repurchases of common stock                                                                   |       | (48,819    | )          |                        |       |                            |       |             |       |             |       |   |   |   |   |   | (48,819 | ) |   |
| Distributions to minority interests                                                           |       |       |       |                        | 144        |                            |       |             | (2,685     | )                |       |   |   |   |   |   | (2,541 | ) |   |
| Contributions from parent and guarantors                                                      |       |       |       |                        |       |                            |       |             | 9,079      |             |       |   | (9,079 | ) |   |   |   |   |   |
| Distributions to parent and guarantors                                                        |       |       |       |                        |       |                            |       |             | (1,438     | )                |       |   | 1,438 |   |   |   |   |   |   |
| Intercompany                                                                                  |       | (503,661   | )          |                        | 432,919    |                            |       |             | 70,742     |             |       |   |   |   |   |   |   |   |   |
| Net cash provided by financing activities                                                     |       | 6,286      |       |                        | 45,826     |                            |       |             | 39,193     |             |       |   | (7,641 | ) |   |   | 83,664 |   |   |
| **Net (decrease) increase in cash and cash  equivalents**                                     |       | (5,357     | )          |                        | 4,725      |                            |       |             | (2,163     | )                |       |   | — |   |   |   | (2,795 | ) |   |
| Cash and cash equivalents—  Beginning of year                                            |       | 6,875      |       |                        | 9,786      |                            |       |             | 4,799      |             |       |   |   |   |   |   | 21,460 |   |   |
| Cash and cash equivalents—  End of year                                                  |       | $     | 1,518      |                        |       | $                          | 14,511     |             |       |             | $     | 2,636 |   |   |   | $  | — |   |   |   | $  | 18,665 |   |   |
| **Reconciliation to cash and cash equivalents  reported on the consolidated balance sheets:** |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Homebuilding                                                                                  |       | $          | 1,518      |                        |       | $                               | 14,511     |             |       |             | $          | 13 |   |   |   |   |   |   |   | $ | 16,042 |   |   |
| Mortgage banking                                                                              |       |       |       |                        |       |                            |       |             | 2,623      |             |       |   |   |   |   |   | 2,623 |   |   |
| Total                                                                                         |       | $          | 1,518      |                        |       | $                               | 14,511     |             |       |             | $          | 2,636 |   |   |   |   |   |                 |   | $ | 18,665 |   |   |
|                                                                                          |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |

 

72

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| **For the year ended  September 30, 2005 (in thousands)**       | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Cash flows from operating  activities:**                                                    | ** ** | ** ** | ** ** |                        | ** ** | ** **                      |       |             | ** ** | ** **       |       |   | ** ** | ** ** |   | ** ** | ** ** |
| Net earnings                                                                                  |       | $          | 86,834     |                        |       | $                               | 85,693     |             |       |             | $          | 2,759 |   |   |   | $ | (88,452 | ) |   | $ | 86,834 |   |
| Adjustments to reconcile net earnings to cash flows  from operating activities                |       | (73,722    | )          |                        | (46,000    | )                               |       |             | (45,685    | )                |       |   | 88,027 |   |   | (77,380 | ) |
| Net cash provided by (used in) operating activities                                      |       | 13,112     |       |                        | 39,693     |                            |       |             | (42,926    | )                |       |   | (425 | ) |   | 9,454 |   |
| **Cash  flows from investing activities:**                                                    | ** ** | ** ** | ** ** |                        | ** ** | ** **                      |       |             | ** ** | ** **       |       |   | ** ** | ** ** |   | ** ** | ** ** |
| Purchases of property and equipment                                                           |       |       |       |                        | (452       | )                               |       |             | (103       | )                |       |   |   |   |   | (555 | ) |
| Distributions of contributed capital from investments  in unconsolidated entities             |       |       |       |                        | 824        |                            |       |             |       |             |       |   |   |   |   | 824 |   |
| Contributions to investments in unconsolidated  entities                                      |       |       |       |                        | (25,506    | )                               |       |             |       |             |       |   |   |   |   | (25,506 | ) |
| Contributions to investments in subsidiaries                                             |       |       |       |                        | (8,004     | )                               |       |             |       |             |       |   | 8,004 |   |   |   |   |
| Net cash used in investing activities                                                         |       |       |       |                        | (33,138    | )                               |       |             | (103       | )                |       |   | 8,004 |   |   | (25,237 | ) |
| **Cash  flows from financing activities:**                                                    | ** ** | ** ** | ** ** |                        | ** ** | ** **                      |       |             | ** ** | ** **       |       |   | ** ** | ** ** |   | ** ** | ** ** |
| Proceeds from issuance of notes and mortgage loans  payable                              |       |       |       |                        | 982,575    |                            |       |             | 73,496     |             |       |   |   |   |   | 1,056,071 |   |
| Repayments of notes and mortgage loans payable                                                |       | (111       | )          |                        | (966,626   | )                               |       |             | (47,044    | )                |       |   |   |   |   | (1,013,781 | ) |
| Net proceeds from issuance of  common stock                                                   |       | 4,129      |       |                        |       |                            |       |             |       |             |       |   |   |   |   | 4,129 |   |
| Repurchases of common stock                                                                   |       | (1,857     | )          |                        |       |                            |       |             |       |             |       |   |   |   |   | (1,857 | ) |
| Distributions                                                                                 |       | (8,426     | )          |                        |       |                            |       |             |       |             |       |   |   |   |   | (8,426 | ) |
| Contributions from minority interests                                                         |       |       |       |                        |       |                            |       |             | 36,000     |             |       |   |   |   |   | 36,000 |   |
| Distributions to minority interests                                                           |       |       |       |                        | (42,399    | )                               |       |             | (150       | )                |       |   |   |   |   | (42,549 | ) |
| Contributions from parent and guarantors                                                      |       |       |       |                        |       |                            |       |             | 8,004      |             |       |   | (8,004 | ) |   |   |   |
| Distributions to parent and guarantors                                                        |       |       |       |                        |       |                            |       |             | (425       | )                |       |   | 425 |   |   |   |   |
| Intercompany                                                                                  |       | (3,199     | )          |                        | 26,852     |                            |       |             | (23,653    | )                |       |   |   |   |   |   |   |
| Net cash (used in) provided by financing activities                                      |       | (9,464     | )          |                        | 402        |                            |       |             | 46,228     |             |       |   | (7,579 | ) |   | 29,587 |   |
| **Net increase in cash and cash equivalents**                                                 |       | 3,648      |       |                        | 6,957      |                            |       |             | 3,199      |             |       |   | — |   |   | 13,804 |   |
| Cash and cash equivalents—  Beginning of year                                       |       | 3,227      |       |                        | 2,829      |                            |       |             | 1,600      |             |       |   |   |   |   | 7,656 |   |
| Cash and cash equivalents—  End of year                                                  |       | $     | 6,875      |                        |       | $                          | 9,786      |             |       |             | $     | 4,799 |   |   |   | $  | — |   |   | $  | 21,460 |   |
| **Reconciliation to cash and cash equivalents  reported on the consolidated balance sheets:** | ** ** | ** ** | ** ** |                        | ** ** | ** **                      |       |             | ** ** | ** **       |       |   | ** ** | ** ** |   | ** ** | ** ** |
| Homebuilding                                                                                  |       | $          | 6,875      |                        |       | $                               | 9,786      |             |       |             | $          | 102 |   |   |   |   |   |   | $ | 16,763 |   |
| Mortgage banking                                                                              |       |       |       |                        |       |                            |       |             | 4,697      |             |       |   |   |   |   | 4,697 |   |
| Total                                                                                         |       | $          | 6,875      |                        |       | $                               | 9,786      |             |       |             | $          | 4,799 |   |   |   |   |   |   | $ | 21,460 |   |
|                                                                                          |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |

 

73

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| **For the year ended  September 30, 2004 (in thousands)** | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Cash flows from operating activities:**                                               |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |
| Net earnings                                                                            |       | $          | 55,619     |                        |       | $                               | 55,004     |             |       |             | $          | 342 |   |   |   | $ | (55,346 | ) |   |   | $ | 55,619 |   |   |
| Adjustments to reconcile net earnings to net cash flows from  operating activities |       | (55,426    | )          |                        | (63,203    | )                               |       |             | (13,234    | )                |       |   | 55,346 |   |   |   | (76,517 | ) |   |
| Net cash provided by (used in) operating  activities                                    |       | 193        |       |                        | (8,199     | )                               |       |             | (12,892    | )                |       |   |   |   |   |   | (20,898 | ) |   |
| **Cash  flows from investing activities:**                                              | ** ** | ** ** | ** ** |                        | ** ** | ** **                      |       |             | ** ** | ** **       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Purchases of property and equipment                                                     |       |       |       |                        | (465       | )                               |       |             | (195       | )                |       |   |   |   |   |   | (660 | ) |   |
| Contributions to investments in unconsolidated  entities                                |       |       |       |                        | (12,021    | )                               |       |             |       |             |       |   |   |   |   |   | (12,021 | ) |   |
| Contributions to investments in subsidiaries                                            |       |       |       |                        | (100       | )                               |       |             |       |             |       |   | 100 |   |   |   |   |   |   |
| Net cash used in investing activities                                                   |       |       |       |                        | (12,586    | )                               |       |             | (195       | )                |       |   | 100 |   |   |   | (12,681 | ) |   |
| **Cash  flows from financing activities:**                                              | ** ** | ** ** | ** ** |                        | ** ** | ** **                      |       |             | ** ** | ** **       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Proceeds from issuance of notes and mortgage loans  payable                             |       |       |       |                        | 1,164,228  |                            |       |             | 251,935    |             |       |   |   |   |   |   | 1,416,163 |   |   |
| Repayments of notes and mortgage loans  payable                                         |       | (80        | )          |                        | (1,148,060 | )                               |       |             | (272,141   | )                |       |   |   |   |   |   | (1,420,281 | ) |   |
| Net proceeds from issuance of common stock                                              |       | 285        |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   | 285 |   |   |
| Repurchases of common stock                                                             |       | (470       | )          |                        |       |                            |       |             |       |             |       |   |   |   |   |   | (470 | ) |   |
| Contributions from minority interests                                                   |       |       |       |                        | 38,400     |                            |       |             | 9,000      |             |       |   |   |   |   |   | 47,400 |   |   |
| Distributions to minority interests                                                     |       |       |       |                        | (27,459    | )                               |       |             |       |             |       |   |   |   |   |   | (27,459 | ) |   |
| Contributions from parent and guarantors                                                |       |       |       |                        |       |                            |       |             | 100        |             |       |   | (100 | ) |   |   |   |   |   |
| Intercompany                                                                            |       | (7,023     | )          |                        | (17,086    | )                               |       |             | 24,109     |             |       |   |   |   |   |   |   |   |   |
| Net cash (used in) provided by financing activities                                     |       | (7,288     | )          |                        | 10,023     |                            |       |             | 13,003     |             |       |   | (100 | ) |   |   | 15,638 |   |   |
| **Net decrease in cash and cash equivalents**                                           |       | (7,095     | )          |                        | (10,762    | )                               |       |             | (84        | )                |       |   | — |   |   |   | (17,941 | ) |   |
| Cash and cash equivalents—  Beginning of year                                      |       | 10,322     |       |                        | 13,591     |                            |       |             | 1,684      |             |       |   |   |   |   |   | 25,597 |   |   |
| Cash and cash  equivalents—  End of year                                           |       | $     | 3,227      |                        |       | $                          | 2,829      |             |       |             | $     | 1,600 |   |   |   | $  | — |   |   |   | $  | 7,656 |   |   |
|                                                                                    |       |       |       |                        |       |                            |       |             |       |             |       |   |   |   |   |   |   |   |   |

 

**16.**          SubsequentEvents

On November 22, 2006, the Company entered into atwo year interest rate cap agreement to protect $100 million of our borrowingsfrom sharp increases in the prevailing short-term interest rates. Under theterms of the agreement, the LIBOR rate is capped at 5.5% per annum.

Given the current marketconditions and the deterioration of profitability, the Company believed thatmaintaining its original debt covenants would become difficult. Therefore, onDecember 15, 2006, the Company paid fees of $0.9 million to amend certaincovenants in its $500 million senior unsecured revolving credit facility. Thecovenants as amended, require the Company to: maintain a minimum tangible networth of at least $300 million plus 50% of positive net income earnedsubsequent to September 30, 2006; maintain a ratio of total liabilities toadjusted tangible net worth not to exceed 2.0x (decreasing to 1.75x as ofJune 30, 2007 and increasing to 2.5x as of December 31, 2008);maintain a ratio of total debt to adjusted tangible net worth not to exceed1.5x; maintain a ratio of total land (including undeveloped land, land underdevelopment and finished lots on which home construction has yet to begin) toadjusted tangible net worth not to exceed 1.5x; and maintain an interestcoverage ratio of no less than 1.75x through December 31, 2006 (decreasingto 1.5x through March 31, 2007, decreasing to 1.4x through June 30,2007, decreasing to 1.35x through September 30, 2007, increasing to 1.5xthrough December 31, 2007, increasing to 1.75x through March 31, 2008and then increasing to 2.25x through the remaining term of the facility). Forpurposes of these tests, adjusted tangible net worth is benefited byadjustments of 50% of the Company’s outstanding senior subordinated debt (up toa maximum $100 million adjustment) and 100% of minority interests in consolidatedentities (up to a maximum $50 million adjustment).

74

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**17.**          SummarizedConsolidated Quarterly Financial Data (Unaudited)

| Three months ended (in thousands) | ** ** | **Dec. 31** | ** ** | **March 31** | ** ** | **June 30** | ** ** | **Sept. 30** | ** ** |
|-------------------------------------------------------|------------|------------------|------------|-------------------|------------|------------------|------------|-------------------|------------|
| Fiscal 2006:                                          |       |             |       |              |       |             |       |              |       |
| Total revenues                                        |       | $                | 223,920    |              | $          | 233,439          |       | $                 | 312,852    |   | $ | 401,855 |   |
| Gross homebuilding profit                             |       | 55,247           |       | 49,634            |       | 52,913           |       | 32,847            |       |
| Net earnings                                          |       | 15,547           |       | 10,998            |       | 11,965           |       | 3,294             |       |
| Fiscal 2005:                                          |       |             |       |              |       |             |       |              |       |
| Total revenues                                        |       | $                | 190,805    |              | $          | 215,936          |       | $                 | 298,407    |   | $ | 448,050 |   |
| Gross homebuilding profit                             |       | 40,113           |       | 50,683            |       | 77,649           |       | 115,550           |       |
| Net earnings                                          |       | 8,259            |       | 12,339            |       | 25,183           |       | 41,053            |       |
|                                                  |       |             |       |              |       |             |       |              |       |

 

**Item 9.**                        Changesin and Disagreements With Accountants on Accounting and Financial Disclosure

None.

**Item9A.**                Controls and Procedures

***Disclosure controlsand procedures.*********Wemaintain disclosure controls and procedures (as defined in Rule 13a-15(e) ofthe Securities Exchange Act of 1934, as amended (the “Act”)) that are designedto provide reasonable assurance that information required to be disclosed byus, including our consolidated entities, in the reports that we file or submitunder the Act, is recorded, processed, summarized and reported, within the timeperiods specified in the SEC’s rules and forms and that such informationis accumulated and communicated to management, including the Chairman and ChiefExecutive Officer (the “Principal Executive Officer”) and Chief FinancialOfficer (the “Principal Financial Officer”), as appropriate, to allow timelydecisions regarding required disclosure. Prior to the filing of this report, wecompleted an evaluation under the supervision and with the participation ofsenior management, including our Principal Executive Officer and our PrincipalFinancial Officer, of the effectiveness of the design and operation of ourdisclosure controls and procedures as of September 30, 2006. Based on thisevaluation, our Principal Executive Officer and our Principal Financial Officerconcluded that our disclosure controls and procedures were effective at thereasonable assurance level as of September 30, 2006.

***Changes in internal control over financial reporting.*****There were no changes in our internal control overfinancial reporting that occurred during the fourth fiscal quarter of 2006 thathave materially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

**Item9B.**               Other Information

None.

75

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**PART III**

**Item 10.**                 Directors,Executive Officers and Corporate Governance

Thenames, ages and positions of our directors and executive officers as of September 30,2006 are set forth below:

| **Name**            | ** ** | ** ** | ** ** | **Age**                                                            | ** ** | **Position** |
|---------------------|------------|------------|------------|--------------------------------------------------------------------|------------|--------------|
| David K. Hill       |       | 65         |       | Chairman, Chief  Executive Officer and Director                    |
| C. Kenneth Love(1)  |       | 53         |       | Vice Chairman, President  and Director                             |
| Isaac Heimbinder(1) |       | 63         |       | Vice Chairman, President  and Chief Operating Officer and Director |
| Hal H. Barber       |       | 63         |       | Senior Vice President,  Finance                                    |
| Brian A. Loftus     |       | 64         |       | Senior Vice President,  General Counsel and Secretary              |
| Eugene K. Rowehl    |       | 46         |       | Senior Vice President  and Chief Financial Officer                 |
| Robert J. Ryan(2)   |       | 53         |       | Senior Vice President,  People                                     |
| William E. Long     |       | 65         |       | President and Chief  Executive Officer, KH Financial, L.P.         |
| Bradley R. Grining  |       | 32         |       | Vice President and  Controller                                     |
| Edward J. Madell    |       | 41         |       | Vice President and  Treasurer                                      |
| Larry H. Dale       |       | 60         |       | Director                                                           |
| Kent W. Colton      |       | 62         |       | Director                                                           |
| Roy Humphreys       |       | 65         |       | Director                                                           |
| Bruce I. McPhee     |       | 62         |       | Director                                                           |
| Gregory B. Schultz  |       | 55         |       | Director                                                           |

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(1)              Mr. Heimbinder retired as President and ChiefOperating Officer of Kimball Hill, Inc. effective October 1, 2006,and his executive management responsibilities were reassigned to David K. Hill,Chairman, Chief Executive Officer and Director, and C. Kenneth Love, ViceChairman, President and Director. Mr. Love was elected President on October 1,2006. Effective October 23, 2006, Mr. Heimbinder resigned asnon-executive Vice Chairman and a member of the Board of Directors.

(2)              On October 23, 2006, Robert J. Ryan joined us asour Senior Vice President, People.

***David K. Hill,***Chairman, Chief Executive Officer and Director, founded us in 1969 and has overthirty years of experience in the home building industry. In 2001, Mr. Hillwas inducted into the National Association of Home Builders (“NAHB”) Hall ofFame. Mr. Hill has served as president of the Home Builders Association ofGreater Chicago, a two-term chair of the NAHB Standing Committee on MortgageFinance, a member of the NAHB Executive Committee, an officer of the HomeBuilding Mortgage Access Corporation, vice chairman of the AFL-CIO HousingInvestment Trust, a board member of the Federal Home Loan Bank of Chicago andpresident of the National Center for Housing Policy. Mr. Hill is an honorsgraduate of Princeton University and Northwestern University Law School.

***C. Kenneth Love,***Vice Chairman, President and Director, joined us on June 1, 2005. Beforejoining us, Mr. Love was employed by Deloitte & Touche LLP from1976-2005 and had significant responsibilities in client service and firmmanagement roles, including service as a Senior Partner. He served as ManagingPartner of the Midwest Assurance and Enterprise Risk Services (AERS) practiceand was a member of the national AERS Management Committee. Mr. Love alsoserved as the Lead Client Service Partner for a number of Deloitte’smanufacturing clients in the firm’s Global Strategic Client Services program. Mr. Lovegraduated with honors from the University of Texas at Austin with post graduateeducation at Columbia University and IMD International in Switzerland. Mr. Lovewas elected President on October 1, 2006.

***Isaac Heimbinder,***Vice Chairman, President and Chief Operating Officer and Director, joined us asVice Chairman in 2001 and was elected President and Chief Operating Officer in2002. Builder magazine named Mr. Heimbinder as one of the 100 mostinfluential people in the housing industry in the 20th century. Previously, Mr. Heimbinderserved for 14 years as president of US Home Corporation and served 

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as chairman and CEO of Homewrite, a web-based home managementsystem for builders, real estate professionals and other companies marketing tohomeowners. Mr. Heimbinder is a graduate of New York University Law Schooland American University. Effective October 1, 2006, Mr. Heimbinderretired as President and Chief Operating Officer. Effective October 23,2006, Mr. Heimbinder resigned as non-executive Vice Chairman and a memberof the Board of Directors.

***Hal H. Barber,***Senior Vice President, Finance, joined us in 1983 as a Director and VicePresident of Finance and Administration. He became a Senior Vice President in2003. Mr. Barber has held key positions with major corporations in theinsurance industry, including as a member of the long-range planning task forcefor Kemper Insurance. Mr. Barber attended the University of Denver.

***Brian A. Loftus,*****Senior Vice President, General Counseland Secretary, joined us as Senior Vice President and General Counsel in 2001,after having served as a director since 1996. Previously, Mr. Loftus was asenior partner at Winston & Strawn, where he served for 24 years, andserved as Vice President and General Counsel of UOP LLC and UNO-VEN Company. Amember of the Association of Corporate Counsel, he served as a director andpresident of the Chicago chapter. Mr. Loftus is an honors graduate ofPrinceton University and New York University School of Law.

***Eugene K. Rowehl,*****Senior Vice President and Chief FinancialOfficer, has been with us since 1990. Mr. Rowehl served as Controller from1990-1995, and was appointed Chief Financial Officer in 1995. Previously,Mr. Rowehl served as corporate controller for a large national homebuilderand was employed by an accounting firm specializing in service to nationalhomebuilders. Mr. Rowehl earned a Bachelor of Business Administration fromSam Houston State University.

***Robert J. Ryan,*****Senior Vice President, People, joined uson October 23, 2006. Mr. Ryan has over 25 years of experience withboth private and public corporations in the manufacturing industry. He beganhis career in production management and moved into human resources in 1998 atProcter & Gamble. Subsequently, he held senior human resourcepositions at Griffith Laboratories and Bombardier Recreation Products. Mr. Ryanholds a bachelor’s degree in mechanical engineering from Carleton University inOttawa, Canada.

***William E. Long,*****President and Chief Executive Officer ofKH Financial, L.P., our mortgage banking subsidiary, has over 30 years ofexperience in the mortgage industry and was the president of a major nationalmortgage bank for 19 years prior to joining us in 2000. Mr. Long serves onthe Mortgage Bankers Association of America’s board of governors and haschaired the organization’s GNMA Liaison, Capital Markets and Membershipcommittees. Mr. Long has also served on task forces and advisory boardsfor federal and state housing finance agencies, as well as the private mortgageinsurance industry. Mr. Long graduated from the University of Notre Dameand holds an MBA from the University of Chicago.

***Bradley R. Grining,***Vice President and Controller, joined us in 2002. Previously, Mr. Griningwas employed by Deloitte & Touche LLP from 1997-2002 and mostrecently served as a manager in their Mergers and Acquisitions group. Mr. Griningearned a Bachelor of Business Administration from Saint Louis University.

***Edward J. Madell,*****VicePresident and Treasurer, joined us in 2004. Prior to joining us, Mr. Madellwas a Vice President in the Commercial Real Estate Market- Special Industriesdivision of Harris Trust & Savings Bank from 2000-2004. He wasresponsible for syndicating over $1 billion in homebuilding credit facilities. Mr. Madellholds a master’s degree from DePaul University.

***Larry H. Dale,*********Director, was elected to the board in 1996. Mr. Dale was employedby GMACCH Capital Corp., a subsidiary of GMAC, from 1997 to 2006 where heserved as Executive Vice President. In March 2006, GMACCH Capital Corp. wassold and became CapMark Finance. Mr. Dale continued his employment through July2006 at which point he retired from the firm. Beginning in July 2006, Mr. Dalewas retained by CapMark Finance as an independent contractor and continues inthat capacity today. 

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Mr. Dale is alsoChairman of the Board of the National Equity Fund and a director of the LocalInitiatives Support Corporation, Community Preservation and DevelopmentCorporation, and Mercy Housing, Inc. Formerly a Deputy Assistant Secretary forthe Housing/FHA Commissioner, Mr. Dale also spent 10 years as Senior VicePresident of Fannie Mae. Mr. Dale is a graduate of Cornell University andholds a master’s degree from Syracuse University.

***Kent W. Colton,*****Director, was elected to the board in1999. Mr. Colton served for 15 years as the Executive Vice President andChief Executive Officer of the NAHB, and is a member of the NAHB Hall of Fame.Previously, Mr. Colton was the Executive Vice President of Policy,Planning and Economic Research at Freddie Mac and staff director for thePresident’s Commission on Housing. Currently, Mr. Colton is a seniorscholar at Harvard University’s Joint Center for Housing Studies and Presidentof K. Colton LLC. Mr. Colton currently serves on the Board of Directors ofApple REIT Seven, Inc. and Apple Hospitality Five, Inc. Mr. Colton is agraduate of Utah State University and holds a Masters of Public Administrationfrom Syracuse University and a Ph.D. in urban studies and planning from theMassachusetts Institute of Technology.

***Roy Humphreys,*****Director, was elected to the board in2003. Mr. Humphreys was President of Shea Homes from 1980 until hisretirement in 2002. Mr. Humphreys has been named Builder of the Year by *California Builder* magazine and wasinducted into the California Building Industry Foundation’s Hall of Fame. AGeorgia Tech University graduate, Humphreys received an MBA from the WhartonSchool at the University of Pennsylvania.

***Bruce I. McPhee,*****Director, has been a director since 1990and was a Vice Chairman of Kimball Hill, Inc. from 1993 until 2006. Beforejoining us, Mr. McPhee was the President and Chief Executive Officer ofBank One Chicago. Mr. McPhee has 28 years of banking industry experienceand has served on several corporate boards. He holds a bachelor’s degree fromDrake University and an MBA from Loyola University.

***Gregory B. Schultz,*****Director, was elected to the board in2006. Mr. Schultz is Senior Managing Director and President of theBusiness Capital Group of GMAC Residential Funding Corporation, where he hasbeen employed since 1986. Previously, Mr. Schultz was co-founder and ChiefFinancial Officer of Miller Securities, Inc. Mr. Schultz was adirector of John Laing Homes from 2001 through May, 2006. Mr. Schultz is agraduate of Valparaiso University and is a certified public accountant.

**Regional presidents**

***Thomas W. Jacobs,***40, Pacific Coast Regional President, began his career with us in 1991 andserved as a Division President prior to becoming Regional President in 2003. Hehas experienced all facets of the residential construction business. Mr. Jacobsreceived his degree in construction engineering from Texas Tech University.

***Michael T.Richardson,*** 54, Texas Regional President, hasdirected our Texas operations since 2004. Mr. Richardson brings over 30years of homebuilding experience to the company. Mr. Richardson is agraduate of Angelo State University with a degree in mathematics.

***R. Lee Venable,***52, Nevada Regional President, joined us in 1995 as a division manager in LasVegas after a 19-year career with a national homebuilder. He becameNevada Regional President in 2003. Mr. Venable received his Bachelors ofBusiness Administration degree from Southwest Texas State University.

***Francine Miller,***51, Florida Regional President, joined us in 2005 to manage our Floridahomebuilding business. Prior to joining us, Ms. Miller had more than 25years of homebuilding experience with US Home Corporation, principally in theTampa Bay area. She attended Loyola University in Los Angeles, California.

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***Jack Wexelberg,*** 56,Midwest Regional President, joined us in 1997 as an area manager in the Chicagoand Milwaukee homebuilding markets. He has served as both Area President andDivision President in our Chicago homebuilding market prior to becomingRegional President in 2006. He has more than 28 years of homebuildingexperience in multiple regions of the United States. Mr. Wexelberg is agraduate of Elmhurst College with a Bachelor of Science degree in business.

**Board committees**

***Executive committee***

Our board of directors hasestablished an executive committee, on which Messrs. Hill, Love and McPheecurrently serve. The executive committee has the power and authority totransact all business for us and on our behalf when the full board of directorsis not in session.

***Audit committee***

Our board of directors hasestablished an audit committee, on which Messrs. McPhee, Colton, Dale andHumphreys currently serve. The audit committee recommends our independentauditors, evaluates the effectiveness of our accounting practices, our internalcontrols, and our disclosures and reporting, reviews our periodic financialreports, and reviews and recommends approval of the annual audit report. Wehave determined that Mr. Dale is an “audit committee financial expert,” asdefined under SEC regulations, but we have not determined at this time whetherMr. Dale is independent.

***Compensation committee***

Our board of directors hasestablished a compensation committee, on which Messrs. Humphreys, Schultz,Love and Colton currently serve. The compensation committee recommends ourgeneral compensation policies and reviews the administration of ourcompensation policies, including salaries, bonuses, stock options, directorfees and our employee stock ownership program.

***Community services committee***

Our board of directors hasestablished a community services committee, on which Messrs. Dale, Colton,Hill, and Love currently serve. The community services committee reviews ourcommunity contributions policies and procedures and provides guidance and inputregarding our community contributions program.

***Nominating committee***

Our board of directors hasestablished a nominating committee, on which Messrs. Hill, McPhee, Daleand Schultz currently serve. The nominating committee reviews the performanceof our current board members and provides guidance and input regarding theappointment of new board members.

**Code of Ethics**

In addition to a written code of ethics applicable toall employees, officers and directors of Kimball Hill, Inc., we have alsoadopted a supplemental code of ethics applicable to our principal executiveofficer, principal financial officer, principal accounting officer (controller)and other senior financial officers. You may request a free copy of our code ofethics by writing to us at: Kimball Hill, Inc., 5999 New Wilke Road, Suite 504,Rolling Meadows, IL 60008, Attention: Edward J. Madell, or by telephoning us at(847) 364-7300.

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**Item 11.**                 ExecutiveCompensation

The following tablesummarizes compensation earned during fiscal 2006 and 2005 by our chiefexecutive officer and our other four most highly compensated executive officersduring fiscal 2006:

|                                                | ** ** | ** ** | ** ** | **Annual compensation** | ** ** | **Long-term  compensation** | ** ** | ** **      | ** ** |
|------------------------------------------------|------------|------------|------------|------------------------------|------------|-----------------------------|------------|-----------------|------------|
| ** **                                     | ** ** | ** ** | ** ** | ** **                   | ** ** | ** **                  | ** ** | **No. of** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | ** ** | ** ** | ** **                   | ** ** | ** **                  | ** ** | **Other**       | ** ** | **Restricted** | ** ** | **securities** | ** ** | **All other** | ** ** |
| ** **                                     | ** ** | ** ** | ** ** | ** **                   | ** ** | ** **                  | ** ** | **annual**      | ** ** | **stock unit** | ** ** | **underlying** | ** ** | **compensation** | ** ** |
| **Name and principal position** | ** ** | ** ** | ** ** | **Year**                     | ** ** | **Salary**                  | ** ** | **Bonus**       | ** ** | **compensation** | ** ** | **award(s)** | ** ** | **options** | ** ** | **(1)(2)** | ** ** |
| David K. Hill,                                 |       |       |       |                         |       |                        |       |            |       |   |   |   |   |   |   |   |   |   |   |   |
| Chairman, Chief Executive                      |       | 2006       |       | $                            | 1,500,000  |                        | $          | —          |       |   | — |   |   | $ | — |   |   | — |   |   |   | $175,076 |   |
| Officer and Director                           |       | 2005       |       | 1,200,000                    |       | 4,300,000                   |       |            | —     |   |   | — |   |   | — |   |   |   | 213,365 |   |
| Isaac Heimbinder,                              |       |       |       |                         |       |                        |       |            |       |   |   |   |   |   |   |   |   |   |   |   |
| Vice Chairman, President,                      |       | 2006       |       | 1,300,000                    |       | 1,959,600                   |       |            | —     |   |   | — |   |   | — |   |   |   | 4,620 |   |
| Chief Operating Officer                        |       | 2005       |       | 1,200,000                    |       | 4,300,000                   |       |            | —     |   |   | — |   |   | — |   |   |   | 4,900 |   |
| and Director                                   |       |       |       |                         |       |                        |       |            |       |   |   |   |   |   |   |   |   |   |   |   |
| C. Kenneth Love,                               |       |       |       |                         |       |                        |       |            |       |   |   |   |   |   |   |   |   |   |   |   |
| Vice Chairman, President                       |       | 2006       |       | 700,000                      |       | 840,000                     |       |            | —     |   |   | — |   |   | — |   |   |   | 4,620 |   |
| and Director(3)                                |       | 2005       |       | 219,167                      |       | 310,000                     |       |            | —     |   |   | 2,463,750 |   |   | 37,500 |   |   |   | — |   |
| William E. Long,                               |       |       |       |                         |       |                        |       |            |       |   |   |   |   |   |   |   |   |   |   |   |
| President and Chief                            |       | 2006       |       | 430,000                      |       | 365,000                     |       |            | —     |   |   | — |   |   | — |   |   |   | 4,620 |   |
| Executive Officer, KH                          |       | 2005       |       | 414,423                      |       | 300,000                     |       |            | —     |   |   | — |   |   | — |   |   |   | 4,900 |   |
| Financial, L.P.                                |       |       |       |                         |       |                        |       |            |       |   |   |   |   |   |   |   |   |   |   |   |
| Eugene K. Rowehl,                              |       |       |       |                         |       |                        |       |            |       |   |   |   |   |   |   |   |   |   |   |   |
| Senior Vice President and                      |       | 2006       |       | 550,000                      |       | —                      |       |            | —     |   |   | — |   |   | — |   |   |   | 4,620 |   |
| Chief Financial Officer                        |       | 2005       |       | 500,000                      |       | 800,000                     |       |            | —     |   |   | — |   |   | — |   |   |   | 4,900 |   |
|                                           |       |       |       |                         |       |                        |       |            |       |   |   |   |   |   |   |   |   |   |   |   |
|                                                |            |            |            |                              |            |                             |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

(1)     Does not include allocations under our Employee StockOwnership Plan (“ESOP”) for shares allocated on December 31, 2005 or 2004.At December 31, 2006, each of Messrs. Hill, Heimbinder, Love, Longand Rowehl will be eligible for an additional allocation of shares under theESOP. These benefits are available to all full-time employees that meet thecustomary eligibility criteria.

(2)     The amounts shown represent matching contributions thatwe made for each executive officer under our 401(k) Plan and, in the caseof Mr. Hill, also include $170,456 and $208,465 for fiscal 2006 and 2005,respectively, representing the interest portion on an interest free loanassociated with split-dollar life insurance policy premiums we paid on behalfof Mr. Hill. All premiums advanced by us under these policies were repaidby Mr. Hill on April 11, 2006 (which was prior to our initial filingwith the SEC). For more information on this and other related partytransactions, see Item 13, “Certain Relationships and Related Transactions”.

(3)     Mr. Lovebegan his employment with us on June 1, 2005. As part of Mr. Love’semployment agreement, we granted 37,500 deferred stock units, representing aright to receive 37,500 shares of the Company’s common stock at a future date.Under the terms of the agreement, one-third of the deferred stock units fullyvest on each of October 1, 2005, 2006 and 2007, respectively, with theshares being issued on the earlier of: (a) the fifth anniversary of thedate of grant, (b) the executive’s separation of service, (c) theexecutive’s death or disability, or (d) a change in control. The deferredstock units were valued at the fair market value of our underlying common stockon the date of grant.

**Option grants infiscal year 2006**

We did not grant any stockoptions to named executive officers during fiscal year 2006.

**Aggregate option exercises in fiscal year 2006 andfiscal year-end option values**

The following table provides information on theexercise of options to purchase our common stock in fiscal 2006 by the namedexecutive officers and the value of unexercised in-the-money options as of September 30,2006.

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| ** **       | ** ** | ** ** | ** ** | ** **           | ** ** | **Number of securities  underlying unexercised  options at end of fiscal year** | ** ** | **Value of unexercised  in-the-money options  at fiscal year end** | ** ** |
|------------------|------------|------------|------------|----------------------|------------|-------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|
| ** **       | ** ** | ** ** | ** ** | **Shares  acquired** | ** ** | **Value**                                                                                                               | ** ** | ** **                                                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Name**         | ** ** | ** ** | ** ** | **on exercise** | ** ** | **realized**                                                                                                            | ** ** | **Exercisable**                                                                                  | ** ** | **Unexercisable** | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| David K. Hill    |       |       | —     |                 |       | $                                                                                                                       | —     |                                                                                             |       | — |   |   |   | — |   |   | $ | — |   |   | $ | — |   |   |
| Isaac Heimbinder |       |       | 100,000    |                 |       | 7,370,000                                                                                                               |       |                                                                                             | —     |   |   |   | — |   |   | — |   |   | — |   |   |
| C. Kenneth Love  |       |       | —     |                 |       | —                                                                                                                  |       |                                                                                             | —     |   |   |   | — |   |   | — |   |   | — |   |   |
| William E. Long  |       |       | 7,000      |                 |       | 390,900                                                                                                                 |       |                                                                                             | 18,000     |   |   |   | — |   |   | 1,326,600 |   |   | — |   |   |
| Eugene K. Rowehl |       |       | —     |                 |       | —                                                                                                                  |       |                                                                                             | —     |   |   |   | — |   |   | — |   |   | — |   |   |
|             |       |       |       |                 |       |                                                                                                                    |       |                                                                                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                  |            |            |            |                      |            |                                                                                                                         |            |                                                                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Employmentagreement**

On March 3, 2005, weentered into an employment agreement with C. Kenneth Love pursuant to which hecurrently serves as Vice Chairman and a Director. The agreement states that, onor before October 1, 2008, Mr. Love will either be elected ChiefExecutive Officer or receive a commitment from us to be so elected no laterthan October 1, 2009. Although not expressly stated in the agreement, theelection of Mr. Love as Chief Executive Officer would require the approvalof our Board of Directors at the time of such election. The initial term of theagreement is from June 1, 2005 until June 1, 2010, and the employmentagreement will renew automatically for one year terms unless terminated byeither party upon 90 days notice. The employment agreement provides for aminimum base salary of $700,000 effective October 1, 2005, an annual bonusranging from 120-160% of base salary based on achievement of performancegoals (subject, except for fiscal 2006, to the achievement of minimum targetperformance goals), and equity compensation consisting of 37,500 deferred stockunits which are scheduled to fully vest by October 1, 2007. If Mr. Love’semployment is terminated by us without cause or by Mr. Love for goodreason****(which includes, among other things, not being elected as Chief ExecutiveOfficer in accordance with the terms of the agreement), he is entitledto receive: (a) a payment equal to his base salary earned but unpaidthrough the date of termination, a prorated portion of his target bonus and anyincentive bonus amount earned but not yet paid, (b) a lump sum paymentequal to the product of (x) his then current annual base salary plus atarget bonus in an amount equal to 120% of such salary and (y) a specifiedmultiplier factor that depends on the circumstances of employment termination, (c) vestingof any outstanding unvested equity-based awards, (d) continued coverageunder all health and other employee benefit plans for a number of years equalto the multiplier factor and (e) if applicable, specified excise and othertax reimbursement payments. If Mr. Love’s employment is terminated by uswithout cause prior to June 1, 2010, the multiplier factor is two (threeif the termination occurs in anticipation of or within one year following achange of control) plus the number of years between the full initial five yearterm of the agreement and the actual termination date. If Mr. Love’s employmentis terminated by us without cause on or after June 1, 2010 or at any timeby Mr. Love for good reason, the multiplier factor is two (three if thetermination occurs in anticipation of or within one year following a change ofcontrol). The employment agreement also contains transfer restrictions on Mr. Love’sequity, equity put and call rights upon employment termination and equityregistration rights, as well as non-competition and non-solicitation provisionsthat continue for a period of two years after his employment with us has beenterminated.

**Stock option plans**

We have granted options topurchase our common stock to certain of our executives, other key employees anddirectors. The exercise price for each option granted is the estimated fairmarket value of the common stock into which the option is exercisable, measuredas of the date of the grant. The terms of the stock options range from three toten years with vesting terms from immediately upon grant to vesting in equal annualinstallments over four years. As of September 30, 2006, an aggregate of76,000 shares of our common stock, representing approximately 2% of our issuedand outstanding shares on a fully-diluted basis, were subject to unexpiredoptions.

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***Incentive stock option plan***

We adopted the Kimball Hill Homes Incentive StockOption Plan on October 28, 1995. The plan, as amended, provides for thegrant to certain of our executive and other key employees of options topurchase shares of our common stock. A committee designated by our board ofdirectors administers the Incentive Stock Option Plan. The committee has broadpowers under the plan, including exclusive authority (except as otherwiseprovides in the plan) to determine who will receive awards and the type, sizeand terms of awards to be granted. Options awarded under the Incentive StockOption Plan are exercisable into shares of our common stock. The original planprovided for the grant of options to purchase up to 65,000 shares of our commonstock, and subsequent amendments have provided for the issuance of options topurchase an additional 1,004,000 shares of common stock. The original plan andeach amendment thereto specifically allocated all of the shares to individualexecutives and other key employees such that an amendment would be required togrant additional options.

All shares issued to participants in the IncentiveStock Option Plan upon exercise of a stock option issued pursuant to that planare subject to certain transfer restrictions contained in the relevant stockoption agreement, including a right of first refusal by us. Furthermore, in theevent that any participant ceases to be employed by us or our subsidiaries, wemay have the right to, or we may in certain cases be required to, repurchaseall shares owned by that participant. Any share repurchases are at fair marketvalue and are only of shares held by the shareholder for greater than sixmonths.

If we undergo a reorganization, recapitalization,stock dividend or stock split or other changes in shares of our common stock,the committee may make adjustments to the Incentive Stock Option Plan andoutstanding options in order to prevent dilution of or enlargement of rightsunder outstanding options. In the event of a sale of our company, the optionsawarded under the plan become immediately exercisable unless provision is madein writing in connection with such transaction for the continuance of the plan.

No new options will begranted under this plan as it expired on October 31, 2005.

***Nonstatutory stock option plan***

We adopted the KimballHill Homes Nonstatutory Stock Option Plan on December 31, 1997. The planallows us to grant stock options to those of our directors who are notemployees and therefore are not eligible to receive stock options under ourIncentive Stock Option Plan and certain other employees who have not beendesignated under the Incentive Stock Option Plan. The original plan providedfor the grant of options to purchase up to 15,000 shares of our common stock,and subsequent amendments have provided for the issuance of options to purchasean additional 93,000 shares of common stock. The terms of the stock optionsgranted under the plan are substantially similar to those granted under ourIncentive Stock Option Plan.

**Board of directors’compensation**

**Directorswho are our employees receive no additional compensation for their services asdirectors. Directors who are not our employees receive annual compensation of$30,000 each (paid quarterly) plus $7,500 for each board meeting attended andare reimbursed for reasonable travel expenses related to meeting attendance.Directors are also eligible to receive stock options at the discretion of ourChairman and Chief Executive Officer. No stock options were granted todirectors in fiscal 2006.**

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

**Principalshareholders**

The following tablesets forth information with respect to the beneficial ownership of our commonstock as of September 30, 2006 by:

·       eachperson who is known by us to beneficially own more than 5% of our outstandingshares of common stock;

·       eachexecutive officer named in the Summary Compensation Table;

·       eachmember of our board of directors; and

·       alldirectors and executive officers as a group.

To ourknowledge, each of the holders of common stock listed below has sole voting andinvestment power as to the shares of common stock owned, unless otherwisenoted.

| **Name of beneficial owner**                   | ** ** | ** ** | ** ** | **Number of  shares of  common  stock**(1) | ** ** | **Number of  shares  under  exercisable  options**(2) | ** ** | **Total  shares  beneficially  owned** | ** ** | **Percentage  of total  common  stock** | ** ** |
|---------------------------------------------------------------|------------|------------|------------|------------------------------------------------------|------------|------------------------------------------------------------|------------|----------------------------------------|------------|----------------------------------------------|------------|
| David K. Hill**(3)**                                          |       | 3,126,576  |       |                                                 | —     |                                                       |       | 3,126,576                              |       |                                         | 68.8       | % |   |
| Equity Investments III,  LLC**(4)**                           |       | 952,380    |       |                                                 | —     |                                                       |       | 952,380                                |       |                                         | 21.0       |   |   |
| Isaac Heimbinder**(5)**                                       |       | 78,285     |       |                                                 | —     |                                                       |       | 78,285                                 |       |                                         | 1.7        |   |   |
| C. Kenneth Love**(6)**                                        |       | 25,000     |       |                                                 | —     |                                                       |       | 25,000                                 |       |                                         | *          |   |   |
| William E. Long                                               |       | 16,326     |       |                                                 | 18,000     |                                                       |       | 34,326                                 |       |                                         | *          |   |   |
| Eugene K. Rowehl                                              |       | 56,546     |       |                                                 | —     |                                                       |       | 56,546                                 |       |                                         | 1.2        |   |   |
| Larry H. Dale                                                 |       | 13,000     |       |                                                 | 10,000     |                                                       |       | 23,000                                 |       |                                         | *          |   |   |
| Kent W. Colton                                                |       | 4,000      |       |                                                 | 5,000      |                                                       |       | 9,000                                  |       |                                         | *          |   |   |
| Roy Humphreys                                                 |       | 8,000      |       |                                                 | —     |                                                       |       | 8,000                                  |       |                                         | *          |   |   |
| Bruce I. McPhee**(7)**                                        |       | 14,192     |       |                                                 | 15,000     |                                                       |       | 29,192                                 |       |                                         | *          |   |   |
| Gregory B. Schultz(4)                                         |       | —     |       |                                                 | —     |                                                       |       | —                                 |       |                                         | *          |   |   |
| All directors and executive  officers as a group (14 persons) |       | 3,442,906  |       |                                                 | 49,000     |                                                       |       | 3,491,906                              |       |                                         | 76.0       |   |   |
|                                                          |       |       |       |                                                 |       |                                                       |       |                                   |       |                                         |       |   |   |

 

*       Less than one percent

(1)     Includes shares allocated to individuals through theEmployee Stock Ownership Plan as follows: David K. Hill, 1,876 shares; IsaacHeimbinder, 987 shares; William E. Long, 1,342 shares; Eugene K. Rowehl,1,546 shares; Bruce I. McPhee, 1,472 shares; and all directors and executiveofficers as a group 10,204 shares.

(2)     Includes shares subject to options that are exercisableon September 30, 2006 and options which become exercisable within 60 daysthereafter.

(3)     Includes 2,818,655 shares held in the name of David K.Hill as trustee of the David K. Hill Trust dated March 4, 2004, 246,836shares held in the name of Diane G. Hill as trustee of the Diane G. Hill Trustdated March 4, 2004, 29,605 shares held by Diane G. Hill as the trustee ofthe David K. Hill III irrevocable insurance trust, and 29,604 shares held inthe name of David K. Hill III.

(4)     Equity Investments III, LLC (“EI”) is therecord holder of these shares. The shares held by EI may be deemed to bebeneficially owned by Residential Funding Company, LLC (“RFC”), the sole memberof EI. We have been informed by RFC that RFC disclaims any beneficial ownershipof any shares directly held by EI. Mr. Schultz is Senior Managing Director andPresident of the Business Capital Group of RFC and disclaims beneficialownership of any shares directly held by EI. Mr. Schultz ws appointed to ourBoard of Directors pursuant to EI’s contractual right as described furtherunder Item 13, “Certain Relationships and Related Transactions.”

(5)     Shares are held in the name of Isaac Heimbinder andSheila Heimbinder.

(6)     Represents shares underlying deferred stock units thatvested on October 1, 2005 and 2006. None of the shares have been issued.

(7)     Includes8,000 shares held in the name of Bruce I. McPhee and 4,720 shares held in thename of Bruce McPhee and Jennifer Miller.

**Securities authorized for issuance under equitycompensation plans**

We occasionally issue options to purchase our commonstock to our employees and directors as discussed in Item 11, “Executive Compensation”, included elsewherein this report. All of these options have an exercise price equal to thefair market value of the underlying common shares on the date of grant andeither vested immediately or vest in equal annual installments over four yearsfrom the anniversary of the 

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grant date. The following table provides furtherinformation regarding securities authorized for issuance under our equitycompensation plans as of September 30, 2006. See Item 11, “ExecutiveCompensation—Stock Option Plans” for a description of our equity compensationplans. 

| ** **                                                 | ** ** | ** **                                                                                                   | ** ** | **(a)**                                                                     | ** ** | **(b)**                                                                                                                                                                                                              | ** ** | **(c)** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------|------------|
| **Plan category**                                     | ** ** | **Number of shares to  be issued upon  exercise of  outstanding options** | ** ** | **Weighted-average  exercise price of  outstanding options** | ** ** | **Number of securities remaining  available for future issuance  under equity compensation plans  (excluding securities reflected in  column (a))** | ** ** |
| Equity  compensation plans approved by stockholders   |       | —                                                                                                       |       | —                                                                      |       | —                                                                                                                                                                                                               |       |
| Equity  compensation plans not approved by stockholders(1) |       | 76,000                                                                                                       |       | $40.02                                                                      |       | —                                                                                                                                                                                                               |       |
| Total                                                      |       | 76,000                                                                                                       |       | $40.02                                                                      |       | —                                                                                                                                                                                                               |       |
|                                                       |       |                                                                                                         |       |                                                                        |       |                                                                                                                                                                                                                 |       |    |       |   |   |   |   |
|                                                            |            |                                                                                                              |            |                                                                             |            |                                                                                                                                                                                                                      |            |         |            |  |  |  |  |  |  |

(1)     Includes options granted to a key employee under a newstock option plan to purchase 12,000 shares of our common stock. The optionprice equals the estimated fair market value of the common stock on the day ofthe grant. The options expire on the tenth anniversary of the grant date andvest in equal installments on the first, second, third and fourth anniversaryof the grant date. The plan specifically allocated all of the shares to anindividual key employee such that an amendment would be required to grantadditional options under the plan.

**Item 13.**                 CertainRelationships and Related Transactions

**Relationships withDavid K. Hill and his family and affiliated entities**

David K. Hill, our Chairman, ChiefExecutive Officer and Director, together with members of Mr. Hill’simmediate family, beneficially owns approximately 69% of our common stock.

As of September 30, 2005, we had paid cumulativepremiums totaling $3.8 million relating to life insurance policies for Mr. Hill.In response to the uncertainty created by Section 402 of theSarbanes-Oxley Act of 2002, on April 11, 2006 (which was prior to ourinitial filing with the SEC), Mr. Hill paid us approximately $4.2 millionfor all premiums advanced by us under these policies and we suspended makingany further payments on behalf of Mr. Hill.

We have entered into arrangementswith Property Specialists, Inc. (“PSI”), a property management companyowned by Mr. Hill’s brother. During fiscal 2006, we paid management feesof $47,000 to PSI in exchange for property management services relating to ourprincipal executive office and certain of our rental properties. PSI alsoserves as manager for many of the homeowner associations we have establishedfor residential communities we have developed in Illinois. We typicallycontribute to the operating expenses of these homeowner associations during thedevelopment period. During fiscal year 2006, PSI received $102,000 in fees fromthe homeowner associations. We also make available office space at ourcorporate headquarters in Rolling Meadows, Illinois to PSI in connection withthese arrangements. During fiscal 2006, PSI paid us $123,000 in rent.

Duringfiscal year 2006 we employed Mr. Hill’s wife and son. During fiscal years2006, Mr. Hill’s wife received a salary of $60,000 and Mr. Hill’s sonreceived a salary of $22,500, in each case, plus employee benefits generallyavailable to all Kimball Hill employees. Mr. Hill’s son ceased employmentwith us in February 2006.

**Certain otherrelationships and related party transactions**

On September 12, 2006, we entered into aSubscription Agreement and Investor Rights Agreement with Equity InvestmentsIII, LLC (“EI”). Pursuant to the Subscription Agreement, we sold 952,380 sharesof its common stock to EI for an aggregate purchase price of $110 million.Approximately $74 million of the net proceeds from the sale of the shareswere used to reduce our outstanding indebtedness and the remainder 

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of the proceeds were usedto repurchase shares of common stock from certain current and former directorsand officers.

The Investor RightsAgreement provides for, among other things:

·  the rightof EI to designate one member of our Board of Directors;

·  the rightof EI to approve certain corporate actions, such as certain indebtedness, liensor guarantees of more than $100 million;

·  certainpre-emptive rights to enable EI to maintain a 20% ownership interest;

·  the rightof EI to receive certain financial reports and information from us;

·  “tag along”rights and “drag along” obligations of EI in the event of certain sales of ourcommon stock by David K. Hill or members of his immediate family;

·  a right offirst refusal in our favor if EI wishes to sell its shares to a third partyprior to December 31, 2009; and

·  if we consummatean initial public offering, demand registration rights and piggy-backregistration rights of EI on secondary offerings.

Certain of the rights provided to EI under theInvestor Rights Agreement expire upon the consummation of an initial publicoffering.

In addition to the transaction described above, thefollowing is a summary of the transactions between us and EI or its affiliatessince October 1, 2005:

*NotesPayable.**  *We werea party to several credit facilities and loans with an affiliate of EI, whichwere used to fund acquisition, development or construction projects. Allamounts outstanding under these facilities and loans were repaid on December 19,2005 with proceeds from the issuance of $203 million of senior subordinatedbonds and a new $500 million unsecured revolving credit facility. From October 1,2005 until December 19, 2005, we paid approximately $3.0 million to theaffiliate of EI, which represented interest and fees payable under thesefacilities and loans.

*LimitedPartnership Investment.**  *Anaffiliate of EI is currently a limited partner in three consolidatedpartnerships formed by us to engage in certain residential development andconstruction projects. The affiliate of EI has provided a total of $35 millionin equity capital in exchange for ownership interests in the respectivepartnerships. As of September 30, 2006, EI or an affiliate had a totalcapital balance of approximately $35 million in those consolidated partnershipswhich is reflected as minority interest in our consolidated balance sheets asof September 30, 2006.

Gregory B. Schultz, one of our directors, is SeniorManaging Director and President of the Business Capital Group of GMACResidential Funding Corporation, which is the sole member of EI. Mr. Schultzdoes have a direct relationship with EI and is involved with and doesparticipate in aspects of the relationship between EI and us. Mr. Schultzwas appointed to our Board of Directors pursuant to EI’s right under theInvestor Rights Agreement.

Larry H. Dale, one of ourdirectors, was Executive Vice President of GMACCH Capital Corp., which was anaffiliate of EI prior to EI’s investment in Kimball Hill. Mr. Dale hasnever been involved with and has never participated in any aspect of therelationship between EI or its affiliates and us.

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Duringfiscal 2006, we repurchased common shares from certain current and formerdirectors and officers as follows:

| **Name**                  | ** ** | **Position**                                                           | ** ** | **Number of   common  shares**(1) | ** ** | **Repurchase  price** | ** ** |
|---------------------------|------------|------------------------------------------------------------------------|------------|---------------------------------------------|------------|-----------------------|------------|
| David K. Hill             |       | Chairman, Chief  Executive Officer and Director                        |       | 46,190                                      |       | $                     | 5,334,945  |   |
| Isaac Heimbinder(2)       |       | Vice Chairman, President  and Chief Operating Officer and Director     |       | 62,702                                      |       | 7,242,081             |       |
| Hal H. Barber             |       | Senior Vice President,  Finance                                        |       | 62,000                                      |       | 7,161,000             |       |
| Brian A. Loftus           |       | Senior Vice President,  General Counsel and Secretary                  |       | 10,000                                      |       | 1,155,000             |       |
| Eugene K. Rowehl          |       | Senior Vice President  and Chief Financial Officer                     |       | 22,000                                      |       | 2,541,000             |       |
| William E. Long           |       | President and Chief  Financial Officer,  KH Financial, L.P.  |       | 12,016                                      |       | 1,323,457             |       |
| Kirk T. Breitenwischer(3) |       | Senior Vice President  and National Land  President                    |       | 77,000                                      |       | 8,893,500             |       |
| Larry H. Dale             |       | Director                                                               |       | 5,000                                       |       | 577,500               |       |
| Kent W. Colton            |       | Director                                                               |       | 2,000                                       |       | 231,000               |       |
| Roy Humphreys             |       | Director                                                               |       | 2,000                                       |       | 231,000               |       |
| Bruce I. McPhee           |       | Director                                                               |       | 31,293                                      |       | 3,549,950             |       |
| John P. Toren(4)          |       | Director                                                               |       | 28,000                                      |       | 3,234,000             |       |
|                      |       |                                                                   |       |                                        |       |                  |       |
|                           |            |                                                                        |            |                                             |            |                       |            |  |

(1)     Includes common share repurchases directlyby us, repurchases deemed to occur upon the exercise of stock options andrepurchases of common shares deemed to occur upon the withholding of a portionof the common shares issued, granted or awarded to certain current and formerdirectors and officers in respect of the payment of taxes payable by suchdirector or officer upon such issuance, grant or award.

(2)     Mr. Heimbinder retired as President andChief Operating Officer of Kimball Hill, Inc. effective October 1, 2006. Mr.Heimbinder resigned as non-executive Vice Chairman and a member of the Board ofDirectors effective October 23, 2006.

(3)     Mr. Breitenwischer resigned as Senior VicePresident and National Land President effective April 30, 2006.

(4)     Mr. Torenretired as Director effective April 30, 2006

**Item 14.**                 PrincipalAccounting Fees and Services

For the fiscal years ended September 30, 2006 and2005, professional services were performed by Deloitte & Touche LLP (“D&T”).

Fees paid to D&T during the fiscal years ended September 30,2006 and 2005 were composed of the following:

***Audit Fees—***Theaggregate fees paid during fiscal 2006 and 2005 for the audits of our annualfinancial statements, for reviews of our quarterly financial statements and forassurance and related services in connection with our senior subordinated debtoffering and subsequent registration statement with the SEC were $531,235 and$270,000, respectively.

***Audit-Related Fees—***Theaggregate fees billed for the audit of our mortgage banking company for thefiscal years ended September 30, 2006 and 2005 were $63,000 and $60,000,respectively.

***Tax Fees—***Theaggregate fees billed for tax services for the fiscal years ended September 30,2006 and 2005 were $121,818 and $38,350, respectively. These fees relate toprofessional services performed by D&T with respect to tax compliance, taxadvice and tax planning.

***All Other Fees—***Theaggregate fees billed for all other fees was $1,500 for an online subscriptionto D&T’s internal accounting literature database for each of the fiscalyears ending September 30, 2006 and 2005.

The audit committee annually approves each year’sengagement for audit services in advance. The audit committee has also establishedcomplementary procedures to require pre-approval of all permitted non-auditservices provided by our independent auditors.

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**PART IV**

**Item15.**                 Exhibits andFinancial Statement Schedules

(a)           1.   *Financial Statements*

Theconsolidated financial statements required to be filed in the Annual Report onForm 10-K are in Part II, Item 8.

2.   *Financial StatementSchedules*

Nonerequired.

3.   *Exhibits*

The following list ofexhibits includes both exhibits submitted with this Form 10-K asfiled with the Commission and those incorporated by reference to other filings:

**EXHIBITINDEX**

| EXHIBIT NO. | ** ** | **DESCRIPTION**                                                                        |
|-------------|------------|----------------------------------------------------------------------------------------|
| 3.1         |       | Articles  of Incorporation of Kimball Hill, Inc.(1)                                    |
| 3.2         |       | By-Laws of Kimball Hill, Inc.(1)                                                       |
| 3.3         |       | Articles of Organization of 18th and Peoria, LLC.(1)                              |
| 3.4 (a)     |       | Operating Agreement of 18th and Peoria, LLC.(1)                                   |
| 3.4 (b)     |       | First Amendment to Operating Agreement of 18th and Peoria, LLC.                   |
| 3.5         |       | Certificate of Limited Partnership of Astor Place  Limited Partnership.(1)             |
| 3.6(a)      |       | Limited Partnership Agreement of Astor Place Limited  Partnership.(1)                  |
| 3.6(b)      |       | Fourth Amendment to Limited Partnership Agreement of  Astor Place Limited Partnership. |
| 3.7         |       | Certificate of Limited Partnership of Bolingbrook  Limited Partnership.(1)             |
| 3.8(a)      |       | Limited Partnership Agreement of Bolingbrook Limited  Partnership.(1)                  |
| 3.8(b)      |       | Fourth Amendment to Limited Partnership Agreement of  Bolingbrook Limited Partnership. |
| 3.9         |       | Certificate of Limited Partnership of Bridle Ridge  Limited Partnership.(1)            |
| 3.10(a)     |       | Limited Partnership Agreement of Bridle Ridge  Limited Partnership.(1)                 |
| 3.10(b)     |       | Third Amendment to Limited Partnership Agreement of  Bridle Ridge Limited Partnership. |
| 3.11        |       | Articles of Organization of Cactus Hills, LLC.(1)                                      |
| 3.12(a)     |       | Operating Agreement of Cactus Hills, LLC.(1)                                           |
| 3.12(b)     |       | First Amendment to Operating Agreement of Cactus  Hills, LLC.                          |
| 3.13        |       | Articles of Incorporation of East Lake Park, Inc.(1)                                   |
| 3.14        |       | By-laws of East Lake Park, Inc.(1)                                                     |
| 3.15        |       | Certificate of Limited Partnership of Edgewater  Limited Partnership.(1)               |
| 3.16(a)     |       | Limited Partnership Agreement of Edgewater Limited  Partnership.(1)                    |
| 3.16(b)     |       | Second Amendment to Limited Partnership Agreement of  Edgewater Limited Partnership.   |
| 3.17        |       | Certificate of Limited Partnership of Gables at  Hiddenbrook Limited Partnership.(1)   |
| 3.18(a)     |       | Limited Partnership Agreement of Gables at  Hiddenbrook Limited Partnership.(1)        |

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| 3.18(b) |   | Second Amendment to Limited Partnership Agreement of  Gables at Hiddenbrook Limited Partnership.           |
|---------|--------|------------------------------------------------------------------------------------------------------------|
| 3.19    |   | Certificate of Limited Partnership of Huntington  Chase Limited Partnership.(1)                            |
| 3.20(a) |   | Limited Partnership Agreement of Huntington Chase  Limited Partnership.(1)                                 |
| 3.20(b) |   | Third Amendment to Limited Partnership Agreement of  Huntington Chase Limited Partnership.                 |
| 3.21    |   | Certificate of Limited Partnership of Indian Trails  Limited Partnership.(1)                               |
| 3.22(a) |   | Limited Partnership Agreement of Limited Partnership  of Indian Trails Limited Partnership.(1)             |
| 3.22(b) |   | Limited Partnership Agreement of Limited Partnership  of Indian Trails Limited Partnership.                |
| 3.23    |   | Articles of Incorporation of KH Financial Holding  Company.(1)                                             |
| 3.24    |   | By-laws of KH Financial Holding Company.(1)                                                                |
| 3.25    |   | Articles of Organization of KH Ingham Park South,  LLC.(1)                                                 |
| 3.26    |   | Operating Agreement of KH Ingham Park South, LLC.(1)                                                       |
| 3.27    |   | Articles of Organization of KH SRAV II, LLC.(1)                                                            |
| 3.28    |   | Operating Agreement of KH SRAV II, LLC.(1)                                                                 |
| 3.29    |   | Certificate of Limited Partnership of KHH Texas  Trading Company L.P.(1)                                   |
| 3.30    |   | Amended and Restated  Limited Partnership Agreement of KHH Texas Trading Company L.P.                      |
| 3.31    |   | Certificate of Limited Partnership of Kimball Cove  Limited Partnership.(1)                                |
| 3.32(a) |   | Limited Partnership Agreement of Kimball Cove  Limited Partnership.(1)                                     |
| 3.32(b) |   | Third Amendment to Limited Partnership Agreement of  Kimball Cove Limited Partnership.                     |
| 3.33    |   | Articles of Organization of Kimball Hill Bellevue  Ranch, LLC.(1)                                          |
| 3.34    |   | Limited Liability Company Operating Agreement of  Kimball Hill Bellevue Ranch, LLC.(1)                     |
| 3.35    |   | Certificate of Limited Partnership of Kimball Hill  Calusa Palms Limited Partnership.(1)                   |
| 3.36(a) |   | Limited Partnership Agreement of Kimball Hill Calusa  Palms Limited Partnership.(1)                        |
| 3.36(b) |   | Second Amendment to Limited Partnership Agreement of  Kimball Hill Calusa Palms Limited Partnership.       |
| 3.37    |   | Certificate of Limited Partnership of Kimball Hill  Centennial Heights Limited Partnership.(1)             |
| 3.38(a) |   | Limited Partnership Agreement of Kimball Hill  Centennial Heights Limited Partnership.(1)                  |
| 3.38(b) |   | Second Amendment to Limited Partnership Agreement of  Kimball Hill Centennial Heights Limited Partnership. |
| 3.39    |   | Certificate of Limited Partnership of Kimball Hill  Chadwick Farms Limited Partnership.(1)                 |
| 3.40(a) |   | Limited Partnership Agreement of Kimball Hill  Chadwick Farms Limited Partnership.(1)                      |
| 3.40(b) |   | Second Amendment to Limited Partnership Agreement of  Kimball Hill Chadwick Farms Limited Partnership.     |

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| 3.41    |   | Articles of Organization of Kimball Hill Far East  Detroit, LLC.(1)                                      |
|---------|--------|----------------------------------------------------------------------------------------------------------|
| 3.42(a) |   | Operating Agreement of Kimball Hill Far East  Detroit, LLC.(1)                                           |
| 3.42(b) |   | First Amendment to Operating Agreement of Kimball  Hill Far East Detroit, LLC.                           |
| 3.43    |   | Certificate of Limited Partnership of Kimball Hill  Heathers/Caparola Limited Partnership.(1)            |
| 3.44(a) |   | Limited Partnership Agreement of Kimball Hill  Heathers/Caparola Limited Partnership.(1)                 |
| 3.44(b) |   | Third Amendment to Limited Partnership Agreement of  Kimball Hill Heathers/Caparola Limited Partnership. |
| 3.45    |   | Certificate of Limited Partnership of Kimball Hill  Homes Austin, L.P.(1)                                |
| 3.46    |   | Amended and Restated Limited Partnership Agreement  of Kimball Hill Homes Austin, L.P.                   |
| 3.47    |   | Articles of Incorporation of Kimball Hill Homes  California, Inc.(1)                                     |
| 3.48    |   | By-laws of Kimball Hill Homes California, Inc.(1)                                                        |
| 3.49    |   | Certificate of Limited Partnership of Kimball Hill  Homes Dallas, L.P.(1)                                |
| 3.50    |   | Amended and Restated Limited Partnership Agreement  of Kimball Hill Homes Dallas, L.P.                   |
| 3.51    |   | Articles of Incorporation of Kimball Hill Homes  Florida, Inc.(1)                                        |
| 3.52    |   | By-laws of Kimball Hill Homes Florida, Inc.(1)                                                           |
| 3.53    |   | Certificate of Limited Partnership of Kimball Hill  Homes Houston, L.P.(1)                               |
| 3.54    |   | Amended and Restated Limited Partnership Agreement  of Kimball Hill Homes Houston, L.P.                  |
| 3.55    |   | Articles of Organization of Kimball Hill Homes  Illinois, LLC.(1)                                        |
| 3.56    |   | Operating Agreement of Kimball Hill Homes Illinois,  LLC.(1)                                             |
| 3.57    |   | Articles of Incorporation of Kimball Hill Homes  Nevada, Inc.(1)                                         |
| 3.58    |   | By-laws of Kimball Hill Homes Nevada, Inc.(1)                                                            |
| 3.59    |   | Articles of Incorporation of Kimball Hill Homes  Ohio, Inc.(1)                                           |
| 3.60    |   | By-laws of Kimball Hill Homes Ohio, Inc.(1)                                                              |
| 3.61    |   | Articles of Incorporation of Kimball Hill Homes  Oregon, Inc.(1)                                         |
| 3.62    |   | By-laws of Kimball Hill Homes Oregon, Inc.(1)                                                            |
| 3.63    |   | Articles of Incorporation of Kimball Hill Homes  Realty Florida, Inc.(1)                                 |
| 3.64    |   | By-laws of Kimball Hill Homes Realty Florida, Inc.(1)                                                    |
| 3.65    |   | Certificate of Limited  Partnership of Kimball Hill Homes San Antonio, L.P.(1)                           |
| 3.66    |   | Amended and Restated Limited Partnership Agreement  of Kimball Hill Homes San Antonio, L.P.              |
| 3.67    |   | Articles of Incorporation of Kimball Hill Homes  Texas, Inc.(1)                                          |
| 3.68    |   | By-laws of Kimball Hill Homes Texas, Inc.(1)                                                             |
| 3.69    |   | Articles of Incorporation of Kimball Hill Homes  Washington, Inc.(1)                                     |
| 3.70    |   | By-laws of Kimball Hill Homes Washington, Inc.(1)                                                        |
| 3.71    |   | Articles of Incorporation of Kimball Hill Homes  Wisconsin, Inc.(1)                                      |

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| 3.72    |   | By-laws of Kimball Hill Homes Wisconsin, Inc.(1)                                                         |
|---------|--------|----------------------------------------------------------------------------------------------------------|
| 3.73    |   | Certificate of Limited Partnership of Kimball Hill  Marbella Estates Limited Partnership.(1)             |
| 3.74(a) |   | Limited Partnership Agreement of Kimball Hill  Marbella Estates Limited Partnership.(1)                  |
| 3.74(b) |   | Second Amendment to Limited Partnership Agreement of  Kimball Hill Marbella Estates Limited Partnership. |
| 3.75    |   | Articles of Organization of Kimball Hill  Reflections, LLC.(1)                                           |
| 3.76    |   | Limited Liability Company Operating Agreement of  Kimball Hill Reflections, LLC.(1)                      |
| 3.77    |   | Articles of Organization of Kimball Hill Sheldon Lakes,  LLC.(1)                                         |
| 3.78    |   | Operating Agreement of Kimball Hill Sheldon Lakes,  LLC.(1)                                              |
| 3.79    |   | Articles of Incorporation of Kimball Hill Stateway,  Inc.(1)                                             |
| 3.80    |   | By-laws of Kimball Hill Stateway, Inc.(1)                                                                |
| 3.81    |   | Articles of Organization of Kimball Hill Suburban  Centers, L.L.C.(1)                                    |
| 3.82(a) |   | Operating Agreement of Kimball Hill Suburban  Centers, L.L.C.(1)                                         |
| 3.82(b) |   | First Amendment to Operating Agreement of Kimball  Hill Suburban Centers, L.L.C.                         |
| 3.83    |   | Articles of Organization of Kimball Hill Texas  Investment Company, LLC.(1)                              |
| 3.84(a) |   | Operating Agreement of  Kimball Hill Texas Investment Company, LLC.(1)                                   |
| 3.84(b) |   | First Amendment to Operating Agreement of Kimball  Hill Texas Investment Company, LLC.                   |
| 3.85    |   | Articles of Organization of Kimball Hill TX  Properties, LLC.(1)                                         |
| 3.86    |   | Limited Liability Operating Agreement of Kimball  Hill TX Properties, LLC.(1)                            |
| 3.87    |   | Articles of Organization of Kimball Hill Urban  Centers Chicago One, L.L.C.(1)                           |
| 3.88(a) |   | Operating Agreement of Kimball Hill Urban Centers  Chicago One, L.L.C.(1)                                |
| 3.88(b) |   | First Amendment to Operating Agreement of Kimball  Hill Urban Centers Chicago One, L.L.C.                |
| 3.89    |   | Articles of Organization of Kimball Hill Urban  Centers Chicago Two, L.L.C.(1)                           |
| 3.90(a) |   | Operating Agreement of Kimball Hill Urban Centers  Chicago Two, L.L.C.(1)                                |
| 3.90(b) |   | First Amendment to Operating Agreement of Kimball  Hill Urban Centers Chicago Two, L.L.C.                |
| 3.91    |   | Articles of Organization of Kimball Hill Urban  Centers, L.L.C.(1)                                       |
| 3.92(a) |   | Operating Agreement of Kimball Hill Urban Centers,  L.L.C.(1)                                            |
| 3.92(b) |   | First Amendment to Operating Agreement of Kimball  Hill Urban Centers, L.L.C.                            |
| 3.93    |   | Articles of Organization of Kimball Hill Villages,  LLC.(1)                                              |
| 3.94    |   | Limited Liability Company Operating Agreement of  Kimball Hill Villages, LLC.(1)                         |
| 3.95    |   | Certificate of Limited Partnership of Kimball  Mountain First Limited Partnership.(1)                    |
| 3.96(a) |   | Limited Partnership Agreement of Kimball Mountain  First Limited Partnership.(1)                         |
| 3.96(b) |   | Third Amendment to Limited Partnership Agreement of  Kimball Mountain First Limited Partnership.         |
| 3.97    |   | Certificate of Limited Partnership of Kimball West  Frisco Limited Partnership.(1)                       |
| 3.98(a) |   | Limited Partnership Agreement of Kimball West Frisco  Limited Partnership.(1)                            |

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| 3.98(b)  |   | Third Amendment Limited Partnership Agreement of  Kimball West Frisco Limited Partnership.    |
|----------|--------|-----------------------------------------------------------------------------------------------|
| 3.99     |   | Certificate of Limited Partnership of Legend Lakes  Limited Partnership.(1)                   |
| 3.100(a) |   | Limited Partnership Agreement of Legend Lakes  Limited Partnership.(1)                        |
| 3.100(b) |   | Fifth Amendment to Limited Partnership Agreement of  Legend Lakes Limited Partnership.        |
| 3.101    |   | Certificate of Incorporation of National Credit and  Guaranty Corporation.(1)                 |
| 3.102    |   | By-laws of National Credit and Guaranty Corporation.(1)                                       |
| 3.103    |   | Articles of Organization of Park Shore, L.L.C.(1)                                             |
| 3.104(a) |   | Operating Agreement of Park Shore, L.L.C.(1)                                                  |
| 3.104(b) |   | First Amendment to Operating Agreement of Park  Shore, L.L.C.                                 |
| 3.105    |   | Certificate of Limited Partnership of Parkview  Limited Partnership.(1)                       |
| 3.106(a) |   | Limited Partnership Agreement of Parkview Limited  Partnership.(1)                            |
| 3.106(b) |   | Third Amendment to Limited Partnership Agreement of  Parkview Limited Partnership.            |
| 3.107    |   | Certificate of Limited Partnership of River Oaks  Homes, L.L.P.(1)                            |
| 3.108    |   | Limited Partnership Agreement of River Oaks Homes,  L.L.P.(1)                                 |
| 3.109    |   | Certificate of Limited Partnership of River Oaks  Realty, L.P.(1)                             |
| 3.110(a) |   | Limited Partnership Agreement of River Oaks Realty,  L.P.(1)                                  |
| 3.110(b) |   | Third Amendment to Limited Partnership Agreement of  River Oaks Realty, L.P.                  |
| 3.111    |   | Certificate of Limited Partnership of River Pointe  Limited Partnership.(1)                   |
| 3.112(a) |   | Limited Partnership Agreement of River Pointe  Limited Partnership.(1)                        |
| 3.112(b) |   | Third Amendment to Limited Partnership Agreement of  River Pointe Limited Partnership.        |
| 3.113    |   | Certificate of Limited Partnership of Sonata at  Morada Limited Partnership.(1)               |
| 3.114(a) |   | Limited Partnership Agreement of Sonata at Morada  Limited Partnership.(1)                    |
| 3.114(b) |   | Second Amendment to Limited Partnership Agreement of  Sonata at Morada Limited Partnership.   |
| 3.115    |   | Certificate of Limited Partnership of The Glen  Townhomes Limited Partnership.(1)             |
| 3.116(a) |   | Limited Partnership Agreement of The Glen Townhomes  Limited Partnership.(1)                  |
| 3.116(b) |   | Fourth Amendment to Limited Partnership Agreement of  The Glen Townhomes Limited Partnership. |
| 3.117    |   | Articles of Organization of The Glens at Westlake,  L.L.C.(1)                                 |
| 3.118    |   | Operating Agreement of The Glens at Westlake, L.L.C.(1)                                       |
| 3.119    |   | Certificate of Limited Partnership of The Hamilton  Place Limited Partnership.(1)             |
| 3.120    |   | Limited Partnership Agreement of The Hamilton Place  Limited Partnership.(1)                  |
| 3.121    |   | Certificate of Limited Partnership of Waterford  Limited Partnership.(1)                      |
| 3.122(a) |   | Limited Partnership Agreement of Waterford Limited  Partnership.(1)                           |
| 3.122(b) |   | Second Amendment to Limited Partnership Agreement of  Waterford Limited Partnership.          |
| 3.123    |   | Certificate of Limited Partnership of Whispering  Meadow Limited Partnership.(1)              |

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| 3.124(a) |   | Limited Partnership Agreement of Whispering Meadow  Limited Partnership.(1)                                                                                                                                              |
|----------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.124(b) |   | Second Amendment to Limited Partnership Agreement of  Whispering Meadow Limited Partnership.                                                                                                                             |
| 3.125    |   | Certificate of Limited Partnership of White Oak  Limited Partnership.(1)                                                                                                                                                 |
| 3.126(a) |   | Limited Partnership Agreement of White Oak Limited  Partnership.(1)                                                                                                                                                      |
| 3.126(b) |   | Fifth Amendment to Limited Partnership Agreement of  White Oak Limited Partnership.                                                                                                                                      |
| 3.127    |   | Certificate of Limited Partnership of Windmill Park  Limited Partnership.(1)                                                                                                                                             |
| 3.128(a) |   | Limited Partnership Agreement of Windmill Park  Limited Partnership.(1)                                                                                                                                                  |
| 3.128(b) |   | Third Amendment to Limited Partnership Agreement of  Windmill Park Limited Partnership.                                                                                                                                  |
| 3.129    |   | Articles of Organization of Kimball Hill Homes  Austin Investments, L.L.C.(1)                                                                                                                                            |
| 3.130(a) |   | Operating Agreement of Kimball Hill Homes Austin  Investments, L.L.C.(1)                                                                                                                                                 |
| 3.130(b) |   | First Amendment to Operating Agreement of Kimball  Hill Homes Austin Investments, L.L.C.                                                                                                                                 |
| 3.131    |   | Articles of Organization of Kimball Hill Homes  Austin Operations, L.L.C.(1)                                                                                                                                             |
| 3.132(a) |   | Operating Agreement of Kimball Hill Homes Austin  Operations, L.L.C.(1)                                                                                                                                                  |
| 3.132(b) |   | First Amendment to Operating Agreement of Kimball  Hill Homes Austin Operations, L.L.C.                                                                                                                                  |
| 3.133    |   | Articles of Organization of Kimball Hill Homes  Dallas Investments, L.L.C.(1)                                                                                                                                            |
| 3.134(a) |   | Operating Agreement of Kimball Hill Homes Dallas  Investments, L.L.C.(1)                                                                                                                                                 |
| 3.134(b) |   | First Amendment to Operating Agreement of Kimball  Hill Homes Dallas Investments, L.L.C.                                                                                                                                 |
| 3.135    |   | Articles of Organization of Kimball Hill Homes  Dallas Operations, L.L.C.(1)                                                                                                                                             |
| 3.136(a) |   | Operating Agreement of Kimball Hill Homes Dallas  Operations, L.L.C.(1)                                                                                                                                                  |
| 3.136(b) |   | First Amendment to Operating Agreement of Kimball  Hill Homes Dallas Operations, L.L.C.                                                                                                                                  |
| 3.137    |   | Articles of Organization of Kimball Hill Homes  Houston Investments, L.L.C.(1)                                                                                                                                           |
| 3.138(a) |   | Operating Agreement of Kimball Hill Homes Houston  Investments, L.L.C.(1)                                                                                                                                                |
| 3.138(b) |   | First Amendment to Operating Agreement of Kimball  Hill Homes Houston Investments, L.L.C.                                                                                                                                |
| 3.139    |   | Articles of Organization of Kimball Hill Homes  Houston Operations, L.L.C.(1)                                                                                                                                            |
| 3.140(a) |   | Operating Agreement of Kimball Hill Homes Houston  Operations, L.L.C.(1)                                                                                                                                                 |
| 3.140(b) |   | First Amendment to Operating Agreement of Kimball  Hill Homes Houston Operations, L.L.C.                                                                                                                                 |
| 4.1(a)   |   | Indenture, dated December 19, 2005, by and among  Kimball Hill, Inc., the guarantors named therein, and U.S. Bank National  Association, with respect to 101¤2% Senior Subordinated Notes  due 2012.(1)             |
| 4.1(b)   |   | First Supplemental Indenture, dated June 15, 2006,  by and among Kimball Hill, Inc., the guarantors named therein, and U.S. Bank  National Association, with respect to 101¤2%  Senior Subordinated Notes due 2012. |
| 4.2      |   | Form of Senior Subordinated Note (attached as  exhibit to Exhibit 4.1(a)).                                                                                                                                               |

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| 10.1(a) |   | Credit Agreement, dated December 21, 2005, by and  among Kimball Hill, Inc., the guarantors named therein, the lenders from time  to time party thereto, Harris, N.A., Bank of America, N.A., KeyBank National  Association, Wachovia Bank, National Association, Harris Nesbitt and Banc of  America Securities, LLC.(1) |
|---------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1(b) |   | First Modification of Credit Agreement, dated  December 15, 2006, by and among Kimball Hill, Inc., the guarantors named  therein, the several financial institutions signatory thereto that are party to  the Credit Agreement and Harris N.A., as administrative agent.                                        |
| 10.2    |   | Employment Agreement, dated March 3, 2005, by and  between Kimball Hill, Inc. and C. Kenneth Love.(1)†                                                                                                                                                                                                          |
| 10.3    |   | Kimball Hill Homes Incentive Stock Option Plan,  dated October 28, 1995.(1)†                                                                                                                                                                                                                                         |
| 10.4    |   | Kimball Hill Homes Nonstatutory Stock Option Plan,  dated December 31, 1997.(1)†                                                                                                                                                                                                                                     |
| 10.5    |   | Form of Incentive Stock Option Agreement.(1)†                                                                                                                                                                                                                                                                        |
| 10.6    |   | Form of Nonstatutory Stock Option Agreement.(1)†                                                                                                                                                                                                                                                                     |
| 10.7    |   | Flexible Early Purchase Facility, dated as of  October 14, 2004, by and between Washington Mutual Bank, FA and KH Financial,  L.P.(1)                                                                                                                                                                                     |
| 10.8    |   | Confidential Separation Agreement, dated as of May  2, 2006, by and between Kimball Hill, Inc. and Kirk T. Breitenwischer.(1)†                                                                                                                                                                                       |
| 10.9    |   | Subscription Agreement, dated September 12, 2006, by  and among Kimball Hill, Inc. and Equity Investment III, LLC.(2)                                                                                                                                                                                                     |
| 10.10   |   | Investor Rights Agreement, dated September 12, 2006,  by and among Kimball Hill, Inc. and Equity Investments III, LLC.(2)                                                                                                                                                                                                 |
| 12.1    |   | Statement re computation of ratio of earnings to  fixed charges.                                                                                                                                                                                                                                                          |
| 21.1    |   | Subsidiaries of Kimball Hill, Inc.                                                                                                                                                                                                                                                                                        |
| 31.1    |   | Rule 13a-14(a)/15d-14(a) Certification of David K.  Hill, Chairman, Chief Executive Officer and Director.                                                                                                                                                                                                                 |
| 31.2    |   | Rule 13a-14(a)/15d-14(a) Certification of Eugene K.  Rowehl, Senior Vice President and Chief Financial Officer.                                                                                                                                                                                                           |
| 32.1    |   | Section 1350 Certification of David K. Hill,  Chairman, Chief Executive Officer and Director.                                                                                                                                                                                                                             |
| 32.2    |   | Section  1350 Certification of Eugene K. Rowehl, Senior Vice President and Chief  Financial Officer.                                                                                                                                                                                                                      |

†       Managementor compensatory plan or agreement

(1)     Incorporatedby reference to the Registration Statement on Form S-4, as amended, filed byKimball Hill, Inc. (Registration No. 333-133278).

(2)     Incorporatedby reference to the Current Report on Form 8-K filed by Kimball Hill, Inc. onSeptember 13, 2006.

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**SIGNATURES**

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

|                                | KIMBALL HILL, INC.                                  |
|--------------------------------|-----------------------------------------------------|
|                           | *Registrant*                                        |
| Dated: December 21,  2006 | /s/ DAVID K. HILL                                   |
|                           | David K. Hill                                       |
|                           | *Chairman, Chief Executive Officer and Director*    |
|                           | *(Principal Executive Officer)*                     |
| Dated: December 21,  2006 | /s/ EUGENE K. ROWEHL                                |
|                           | Eugene K. Rowehl                                    |
|                           | *Senior Vice President and Chief Financial Officer* |
|                           | *(Principal Financial Officer)*                     |
| Dated: December 21,  2006 | /s/ BRADLEY R. GRINING                              |
|                           | Bradley R. Grining                                  |
|                           | *Vice President and Controller*                     |
|                           | *(Principal Accounting Officer)*                    |
| Dated: December 21,  2006 | /s/ C. KENNETH LOVE                                 |
|                           | C. Kenneth Love                                     |
|                           | *Vice Chairman, President and Director*             |
| Dated: December 21,  2006 | /s/ KENT W. COLTON                                  |
|                           | Kent W. Colton                                      |
|                           | *Director*                                          |
| Dated: December 21,  2006 | /s/ LARRY H. DALE                                   |
|                           | Larry H. Dale                                       |
|                           | *Director*                                          |
| Dated: December 21,  2006 | /s/ ROY HUMPHREYS                                   |
|                           | Roy Humphreys                                       |
|                           | *Director*                                          |
| Dated: December 21,  2006 | /s/ BRUCE I. MCPHEE                                 |
|                           | Bruce I. McPhee                                     |
|                           | *Director*                                          |

 

SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTSFILED PURSUANT TO SECTION 15(d) OF THE SECURITIES EXCHANGE ACT OF1934 BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12OF THE ACT.

The Registrant did not provide any annual report orproxy material to its security holders for the past fiscal year.

94

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