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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

Form 10-K

|(Mark One)                                   |  |                                                                                         
|-------------------------------------------- |  | ----------------------------------------------------------------------------------------
|ý                                            |  | ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|For the fiscal year ended September 30, 2007
|OR                                          
|o                                            |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from        to

Commission file number: 333-133278

KIMBALL HILL, INC.(Exact name of Registrant as specified in its charter)

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

(847) 364-7300(Registrant's telephone number, including area code)

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

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

Securities registered pursuant to Section 12(g) of the Act:None

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

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ý Yes    o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer
and large accelerated filer" in Rule 12b-2 of the Exchange Act.

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

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

As of March 31, 2007, the last business day of the registrant's most recently completed second fiscal quarter, there was no established public trading market for the
registrant's equity securities.

As
of November 30, 2007, there were 4,385,898 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE: NONE

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KIMBALL HILL, INC. AND SUBSIDIARIES

FORM 10-K

TABLE OF CONTENTS



|           |  |                                                                                                              |  | PAGE
|---------- |  | ------------------------------------------------------------------------------------------------------------ |  | ----
|           |  | PART I.                                                                                                      |  |     
|ITEM 1.    |  | BUSINESS                                                                                                     |  | 3   
|ITEM 1A.   |  | RISK FACTORS                                                                                                 |  | 10  
|ITEM 1B.   |  | UNRESOLVED STAFF COMMENTS                                                                                    |  | 20  
|ITEM 2.    |  | PROPERTIES                                                                                                   |  | 20  
|ITEM 3.    |  | LEGAL PROCEEDINGS                                                                                            |  | 20  
|ITEM 4.    |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                          |  | 20  
|           |  | PART II.                                                                                                     |  |     
|ITEM 5.    |  | MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |  | 21  
|ITEM 6.    |  | SELECTED FINANCIAL DATA                                                                                      |  | 22  
|ITEM 7.    |  | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                        |  | 24  
|ITEM 7A.   |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                   |  | 45  
|ITEM 8.    |  | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                  |  | 46  
|ITEM 9.    |  | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                         |  | 81  
|ITEM 9A.   |  | CONTROLS AND PROCEDURES                                                                                      |  | 81  
|ITEM 9B.   |  | OTHER INFORMATION                                                                                            |  | 81  
|           |  | PART III.                                                                                                    |  |     
|ITEM 10.   |  | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                                       |  | 82  
|ITEM 11.   |  | EXECUTIVE COMPENSATION                                                                                       |  | 85  
|ITEM 12.   |  | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS               |  | 96  
|ITEM 13.   |  | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, DIRECTOR INDEPENDENCE                                        |  | 98  
|ITEM 14.   |  | PRINCIPAL ACCOUNTING FEES AND SERVICES                                                                       |  | 101 
|           |  | PART IV.                                                                                                     |  |     
|ITEM 15.   |  | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES                                                                   |  | 102 
|SIGNATURES |  | 110                                                                                                         

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Certain statements included in this Annual 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 or forecasts of future events, and no assurance can be given that the results described in this report will be achieved. You can identify
these forward-looking statements by the fact that they do not relate strictly to historic 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 the forward-looking statements included in this report and in any other of
our reports or public statements may not approximate actual experience, and the expectations derived from them may not be realized, due to known or unknown risks and uncertainties. Many factors could
cause our actual activities or results to differ materially from the activities and results anticipated in forward-looking statements. These factors include those described in Item 1, "Business", Item
1A, "Risk Factors" and Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in this Form 10-K. You should understand that it is
not possible to predict or identify all such factors. Consequently, you should not consider any such list to be a complete set of all potential risks or uncertainties. We do not undertake any
obligation or duty to update forward-looking statements.

PART I

Item 1.    Business

Our company

We are one of the largest privately-owned homebuilders and one of the 30 largest homebuilders in the United States, as measured by home deliveries and revenues. We design,
build and market single-family detached, single-family attached and multi-family homes. Since we were founded in 1969, we have delivered over 48,000 homes to a broad range of customers, including
first-time buyers
and first-and second-time move-up buyers. Throughout this period, we have grown our business organically and we currently operate within 12 markets, including, among others,
Chicago, Dallas, Ft. Worth, Houston, Las Vegas, Sacramento and Tampa, in five regions: Florida, the Midwest, Nevada, the Pacific Coast and Texas. We operate in four of the top ten and ten of
the top 30 residential housing markets in the United States based upon 2006 single-family housing new construction permits as measured by the United States Census Bureau.

Market
conditions for new home sales have deteriorated significantly throughout our fiscal year as inventory levels of both new and existing homes have continued to climb and price competition placed
pressure on already strained profit margins. During the year ended September 30, 2007, we recognized a net loss of $220.5 million and incurred negative cash flows from operations of
$17.1 million. Included within our net loss are inventory impairment charges of $240.0 million which have significantly impacted the reported values of our inventory and shareholders'
equity.

As
of September 30, 2007, we were not in compliance with certain of the amended covenants of our senior credit facility, including the covenant requiring us to maintain a minimum tangible net
worth (as defined in the senior credit facility). Our failure to meet these covenants allows the lenders under our senior credit facility to declare all amounts outstanding thereunder, together with
accrued interest, to be immediately due and payable. An acceleration under our senior credit facility would also trigger a cross-default under the indenture governing our senior subordinated notes,
thereby allowing our bondholders to accelerate the repayment of all amounts outstanding on the senior subordinated notes. In addition, certain other credit facilities within our joint ventures to
which we have provided guarantees include provisions for acceleration or events of default in the event of a default under our senior credit facility.

We
have begun discussions with our bank group to seek a temporary waiver of the breached covenants and to amend our senior credit facility. The bank group has not provided formal assurance that we
will

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be
able to amend our senior credit facility upon reasonable terms, or at all. Nonetheless, there has been no indication that it intends to accelerate amounts due under the facility, and discussions
with our lenders regarding an amendment are active and ongoing. Our ability to continue as a going concern is dependent upon our ability to return to profitable operations in the future and to retain
the necessary financing to meet our obligations and pay our liabilities when they come due.

Due
to the uncertainties mentioned above, there are substantial doubts about whether we will be able to continue as a going concern, and therefore, we may be unable to realize our assets and discharge
our liabilities in the normal course of business. See notes 1 and 7 to our consolidated financial statements.

Our history

We were founded in 1969 by David K. Hill in Rolling Meadows, 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, quality housing they needed. His vision is largely responsible for building the city of
Rolling Meadows. David Hill began building Kimball Hill Homes upon the same solid foundation of value and caring that his father utilized. David Hill, our Executive Chairman, together with members of
his immediate family, beneficially owns approximately 71% of our common stock. Kimball Hill, Inc. was incorporated in Illinois in 1950.

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



Since
March 2006, we have exited the following markets:



Financial information about segments

Financial information regarding our homebuilding and mortgage banking segments is included in note 14 to our consolidated financial statements included elsewhere herein.

Our business strategy

In the long-term, we continue to find the fundamentals and growth opportunities within the domestic homebuilding industry attractive. We have established
homebuilding operations in many of the most active housing markets in the United States. We believe the long-term demographic trends of the markets in which we compete are favorable and
when combined with our variety of products, broad customer base and geographic diversity will reduce the impact of cyclical downturns and provide for long-term growth potential. We believe
the experience and depth of our senior management team enables us to evaluate and capitalize on market opportunities and to adjust to changing national, regional and local business conditions.

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Over
the past year, market conditions for new home sales have become considerably more difficult than had been experienced over the past decade. Both the breadth and pace of market deterioration have
been greater than anticipated, given the relatively strong broader economic backdrop. Given the significant market deterioration and uncertainty about the timing and pace of any recovery, we have
adopted a strategy to manage our business through this current downturn. Our strategy focuses on:



Our markets and products

We compete in the approximately $320 billion domestic market for new homes. The new home industry is cyclical and has experienced considerable deterioration over the
past two years in terms of unit sales,
housing permits and average base sales price after several years of significant growth. We believe this deterioration is the result of home affordability constraints, increased competition from both
new homes and the resale of existing homes and decreasing consumer sentiment as prospective home buyers are concerned about future price reductions. Further, we believe the turmoil in the mortgage
market has negatively impacted the availability of mortgage financing for potential home buyers. Over the long-term, however, we believe our markets will benefit from continued population
growth, household formation, population shifts, low mortgage rates coupled with tax incentives for homeowners and a relatively stable economy.

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

We
target customers through a wide array of home products such as single-family attached, single-family detached and multi-family homes with mixed price points depending on customer desires and local
market conditions. While offering a wide variety of products, we have focused on, and will continue to focus on, our historical customer base, which includes first-time buyers, and first-
and second-time move up buyers. During fiscal 2007, the average sales price of homes delivered was $257,000, which represents a 7.2% decrease from fiscal 2006. Base sales prices for
actively selling projects in fiscal 2007 ranged from $100,000 to $700,000.

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The
following table includes key metrics for our 12 active markets within our five geographic regions:

|                                          |                                                      
|----------------------------------------- | -----------------------------------------------------
|
|                                          |                                                      
|Market information:                       |                                                      
|Annual single-family building permits:    |                                                      
|                                          | 2002                                                 
|                                          | 2003                                                 
|                                          | 2004                                                 
|                                          | 2005                                                 
|                                          | 2006                                                 
|                                          | CAGR (2002-2006)                                     
|Population data:                          |                                                      
|                                          | 2005 population                                      
|                                          | 2006 population                                      
|                                          | 2006 population growth rate                          
|Kimball Hill information:($ in thousands) |                                                      
|                                          | 2007 sales of residential units and land             
|                                          | % of Kimball Hill sales of residential units and land
|                                          | Backlog units at 9/30/07                             
|                                          | % of Kimball Hill total backlog units                
|                                          | Average sales price of homes delivered               
|                                          |                                                      

Source for market information: United States Census Bureau

Land management

As of September 30, 2007, we owned and controlled 18,815 lots (12,654 of which we owned and 6,161 of which we controlled under option agreements and purchase contracts).
Given the recent market deterioration and uncertainty about the timing and pace of any recovery, we have tightened our land acquisition criteria and are working with land sellers to renegotiate land
purchase and option contracts to extend purchase dates and reduce purchase prices. While our principal focus is the construction and sale of single-family and for-sale multi-family
residential housing, we sell residential lots or land to balance our overall investment in land or when we perceive an attractive market opportunity. Revenue from these land sales was
$58.9 million in fiscal 2007 and $30.5 million in fiscal 2006. We expect revenue from the sale of residential lots and land to increase in fiscal 2008 as we continue to seek to match our
land investment to current and foreseeable market conditions by selling certain land inventory that is not critical to our homebuilding operations over the next 24 months.

We
have established land departments in each of our markets that identify, acquire and develop lot positions. Our approach to controlling and acquiring new land positions is a structured process
initiated by local land departments in conjunction with tiered corporate approval.

We
acquire land based upon a variety of factors, including:



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We
obtain control of land through a variety of structures, including option agreements and purchase contracts or joint ventures. As of September 30, 2007, we had $3.2 million in cash
deposits, excluding $0.7 million of cash deposits related to inventory not owned included in our consolidated balance sheet, and $1.4 million in letter of credit deposits on real estate
under option agreements and purchase contracts. We controlled 6,161 lots through option agreements and purchase contracts as of September 30, 2007, which represents 33% of our land supply.

Generally,
we secure undeveloped land with option agreements and purchase contracts that allow us to defer the commitment to purchase until after all necessary zoning approvals and entitlements have
been obtained. The term "entitlements" refers to development agreements, tentative maps or recorded plats, which in each case minimize the chance that we will be unable to obtain all required building
permits during the development and construction process. Although we purchase larger or smaller parcels in some of our markets when local conditions and opportunities dictate, we generally seek to
develop parcels with sizes sufficient to support a four-year life cycle. Our largest homebuilding project is in the Midwest region on which we are developing land and currently intend to construct and
sell approximately 1,200 homes over the next six years. We are further obligated to purchase additional land, which is approved for an additional 1,500 homes, at various dates beginning in
March 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 independent contractors in each of our local markets. Our land development operations also include the establishment of design and marketing concepts for each project, including
determining the range of sizes, styles and prices for the homes. We also determine street layout, individual lot size and layout and overall community design. The product line offered in each project
depends upon many factors, including the existing housing in the area, the needs of the market and our lot costs.

Construction operations

We typically hire independent contractors on a community-by-community or reasonable geographic-proximity basis to complete construction at a fixed
price. Occasionally, we enter into longer-term contracts with independent contractors and suppliers if we can obtain more favorable terms. Our construction managers and field
superintendents coordinate and supervise the activities of independent contractors and suppliers, and subject this work to quality and cost controls while monitoring compliance with zoning and
building codes. We specify that quality, durable materials be used in the construction of our homes and we do not maintain significant inventories of construction materials, except for
work-in-process materials for homes under construction. When possible, we negotiate price and volume discounts with manufacturers and suppliers to take advantage of production
volume. Agreements with our vendors and independent contractors are generally entered into after a competitive bidding process. In connection with this competitive bidding process, we obtain
information from prospective independent contractors and vendors with respect to their financial condition and overall abilities to perform. Prices for these goods and services may fluctuate due to
various factors, including supply and demand shortages that may be beyond the control of our vendors. We believe that we have good relationships with our suppliers and independent contractors.

We
generally build and sell homes in clusters or phases within our larger projects, which we believe creates efficiencies in land development and construction and improves customer satisfaction by
reducing the number of vacant lots surrounding a completed home. Construction schedules may vary depending on the availability of labor, materials and supplies, product type, location and weather. Our
homes are generally designed to promote efficient use of space and materials and to minimize construction costs and time.

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Sales and marketing

We use advertising and other promotional programs, our website atwww.kimballhillhomes.com, magazine and newspaper
advertisements, brochures, direct mailings and the placement of strategically located signs in the immediate areas of our developments, to generate interest in new and existing communities.

We
use furnished model homes to demonstrate the advantages of our home designs and various features to prospective homebuyers. We generally contract with interior and landscape designers to create an
attractive model home with many built-in options for each product line within a project. We generally build between one and four model homes for each actively selling community,
depending upon the number of homes to be built and the range of products to be offered within the project. As of September 30, 2007, we owned 128 model homes and leased 39 model homes under
sales-leaseback agreements.

Our
homes generally are sold by full-time, commissioned employees who typically work from a sales office located in one of our model homes. Our goal is to ensure that our sales force has
extensive knowledge of our operating policies and housing products. To achieve this goal, we train our sales associates and conduct periodic meetings to update them on sales techniques, competitive
products in the area, financing availability, construction schedules, marketing and advertising plans and the available product lines, pricing, options and warranties offered. Our sales associates are
licensed real estate agents where required by law. In most markets, independent brokers also sell our homes and are usually paid a sales commission based on the price of the home. Our sales
professionals assist our customers in selecting upgrades or in adding available customization features to their homes.

Customer relations, quality control and warranty programs

We believe that positive customer relations and an adherence to stringent quality control standards are fundamental to our continued success. A Kimball Hill construction
manager or project superintendent and a customer relations representative generally oversee compliance with quality control standards for each community. Our quality control team performs the
following tasks:



We
believe we differentiate ourselves from many of our competitors by offering our customers a two-year limited warranty on workmanship and building materials and a
ten-year warranty with respect to structural defects. As independent contractors usually provide an indemnity and a certificate of insurance before beginning work, claims relating to
faulty workmanship and materials are generally the responsibility of our independent contractors.

Financial and title services

During fiscal 2007, we provided mortgage financing services to purchasers of our homes through our wholly-owned subsidiary, KH Financial, L.P. We captured 54% of the available
business from purchasers of our homes, originating $385 million of mortgage loans. The mortgage loans originated by KH Financial, L.P. were sold to third parties after origination.

Due
to the recent turmoil in the mortgage industry, credit standards have tightened and the availability of mortgage financing for our customers has been reduced. Our wholly-owned mortgage subsidiary
has

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found
it increasingly difficult to provide our home buyers with the competitive mortgage products needed to finance the purchase of their new home. Therefore, in October 2007, we entered into a
definitive agreement with Wells Fargo Ventures, LLC, a wholly-owned subsidiary of Wells Fargo Bank, N.A., to form a joint venture that will operate as a full-service mortgage bank
to our homebuilding customers. We have a 49.9% interest in the new venture and believe the new venture will provide competitive mortgage products to our customers and that the joint venture's cost
structure will provide us with profit opportunities as the homebuilding market continues to work through this down cycle. We will assume no underwriting risk in this new venture. Our wholly-owned
mortgage subsidiary will cease operations during the second fiscal quarter of 2008.

We
also provide title services to our customers through joint ventures with unaffiliated third parties. These joint ventures provide title insurance policies and examination and closing services to
purchasers of our homes. We assume no underwriting risk associated with the title policies.

Employees

At September 30, 2007, we had 748 full-time employees, including 249 in management and administration, 157 in sales and marketing, 63 in mortgage banking, 38
in land acquisition and development and 241 in construction and customer service operations. Our employees are not unionized, and we believe that we have good employee relationships.

Competition

The homebuilding industry is highly competitive and fragmented. We compete with large national homebuilding companies and smaller regional and local homebuilders. We also face
competition from existing home resales (including the growing number of foreclosed homes offered at substantially reduced prices) and, to a lesser extent, condominiums and rental housing. Competition
among both small and large residential homebuilders is based on a number of interrelated factors, including location, reputation, amenities, design, quality and price. Builders of new homes compete
not only for homebuyers, but also for desirable properties, financing, raw materials and skilled independent contractors. The continued market deterioration has increased the competitive use of sales
price reductions to generate new home orders, thereby placing additional pressure on sales volume and gross profit.

Seasonality

Our homebuilding operating cycle typically reflects increased new order activity in our second and third fiscal quarters and increased deliveries in our third and fourth fiscal
quarters. We believe that this seasonality reflects the tendency of homebuyers to shop for a new home in the spring with the goal of closing in the fall, as well as the scheduling of paving and
construction to accommodate seasonal weather conditions. However, the historical norms have been disrupted in recent years as a result of the continued deterioration in market conditions.

Government regulation and environmental matters

We acquire most of our land after entitlements have been obtained, which provide for zoning and utility services to project sites and give us the right to obtain building
permits. Development may begin almost immediately on such entitled land upon compliance with and receipt of specified permits, approvals and other conditions, which generally are within our control.
The time needed to obtain such approvals and permits affects the carrying costs of unimproved property acquired for development and construction. The continued effectiveness of permits already granted
is subject to factors such as changes in government policies, rules and regulations and their interpretation and application. To date, the government approval processes discussed above have not had a
material adverse effect on our

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development
activities, although there is no assurance that these and other restrictions will not adversely affect future operations.

Local
and state governments have broad discretion to impose development fees for projects within their jurisdictions. These fees are normally established when we receive recorded maps and building
permits. In addition, communities occasionally impose 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 to delays or may be precluded entirely from developing communities due to building moratoriums, "no growth" or "slow growth" initiatives or building permit allocation
ordinances, which could be implemented in the future.

We
are also subject to a variety of local, state, and federal statutes, ordinances, rules and regulations concerning the protection of health and the environment. In some markets, we are subject to
environmentally sensitive land ordinances that mandate open space areas with public elements in housing developments and prevent development on hillsides, wetlands and other protected areas. We must
also comply with flood plain restrictions, desert wash area restrictions, native plant regulations, endangered species acts and view restrictions. These and similar laws may result in delays, cause
substantial compliance and other costs and prohibit or severely restrict development in certain environmentally sensitive regions or areas. To date, compliance with such ordinances has not materially
affected our operations, although it may do so in the future.

We
usually will condition our obligation to acquire property on, among other things, an environmental review of the land. To date, we have not incurred any significant unanticipated liabilities
relating to the removal of toxic wastes or other environmental matters. However, there is no assurance that we will not incur material liabilities in the future relating to toxic waste removal or
other environmental matters.

Available information

We file annual, quarterly and current reports and other information with the Securities and Exchange Commission ("SEC"). These filings are available to the public over the
Internet at the SEC's web site at http://www.sec.gov. You may also read and copy any document 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-0330 for further information on the public reference room.

Item 1A.    Risk Factors

Discussion of our business and operations included in this report on Form 10-K should be read together with the risk factors set forth below. They describe
various risks and uncertainties to which we are or may become subject. In addition to the risks described below, there may be additional risks and uncertainties not currently known to us or that we
currently deem to be immaterial that may become material risks. These risks and uncertainties, together with other factors described elsewhere in this report, have the potential to affect our
business, financial condition, results of operations, cash flows, strategies or prospects in a material and adverse manner.

The homebuilding industry continues to experience deteriorating conditions that may continue for an indefinite period and may further adversely affect our business and results
of operations compared to prior periods.

The U.S. homebuilding industry as a whole continues to experience a significant and sustained decrease in demand for new homes and an oversupply of new and existing homes
available for sale (including as a result of the growing number of foreclosures). The rapid increase in new and existing home prices in

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our
markets over the past several years reduced housing affordability and tempered buyer demand. In particular, investors and speculators reduced their purchasing activity and instead stepped up their
efforts to sell the residential property they had earlier acquired. These trends resulted in overall fewer new home sales, greater cancellations of home purchase agreements by buyers and higher
inventories of unsold homes. Reflecting these demand and supply trends, we, like many other homebuilders, experienced, and continue to experience: a large drop in net new sales orders; a reduction in
our margins as a result of the increased use of price discounts and other sales incentives, marketing and advertising programs, and third party real estate brokers; slower price appreciation for new
homes sold and in many cases price declines. The homebuilding market may not improve in the near future, and it may weaken further, all of which could negatively impact our margins. Continued weakness
in the homebuilding market has had and will continue to have a material adverse effect on our business and our results of operations.

Our financial statements have been prepared assuming that we will continue as a going concern. However, if we do not return to profitable operations in the future and retain
the necessary financing to meet our obligations and pay our liabilities when they come due, we may have to liquidate assets or curtail our operations.

The factors described in this Annual Report on Form 10-K, including in the footnotes to our consolidated financial statements, raise substantial doubt about
our ability to continue as a going concern. Our financial statements do not include any adjustments that might result from this uncertainty. In addition, our independent registered public accounting
firm has included an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern in their audit report for the fiscal year ended September 30, 2007. We
also cannot assure you that we will be able to return to profitable operations in the future and retain the necessary financing to meet our obligations and pay our liabilities when they come due. If
we cannot return to profitable operations and/or retain the necessary financing on acceptable terms, we will need to liquidate assets or substantially curtail our operations and an investor could
suffer the loss of a significant portion or all of its investment in Kimball Hill.

Our substantial level of indebtedness could adversely affect our financial condition and prevent us from fulfilling our debt obligations.

We have substantial indebtedness. As of September 30, 2007, we had $563.7 million of indebtedness. In addition, subject to restrictions in our senior credit
facility and the indenture for our senior subordinated notes, we may incur substantial additional indebtedness. The high level of our indebtedness could have important consequences, including the
following:



We
expect to obtain the money to pay our expenses and to pay the principal and interest on our indebtedness from cash flow from our operations, as supplemented by additional borrowing under our senior
credit facility as necessary and available. Our ability to meet our expenses thus depends on our future performance and continued funding availability under our senior credit facility, which will be

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affected
by financial, business, economic and other factors. We will not be able to control many of these factors, such as economic conditions in the markets where we operate and pressure from
competitors. We cannot be certain that our cash flow will be sufficient to allow us to pay principal and interest on our debt, support our operations and meet our other obligations. If we do not have
enough money, we may be required to refinance all or part of our existing debt, sell assets or borrow more money. We cannot guarantee that we will be able to do any of these on terms acceptable to us,
if at all. The terms of existing or future debt agreements, including our senior credit facility and the indenture for our senior subordinated notes, may restrict us from pursuing certain
alternatives. In addition, increased debt levels, decreased earnings and/or continuing deterioration in the U.S. homebuilding market could result in further downgrades in our credit ratings, which, in
turn, could impede access to additional borrowings and/or raise our debt borrowing costs.

Community
development or improvement districts in which certain of our communities are located may utilize bond financing programs to fund construction or acquisition of certain on-site
and off-site infrastructure improvements. The obligation to pay principal and interest on the bonds issued by the districts is assigned to each parcel within the district. If the owner of
the parcel does not pay such obligation, a lien will be placed on the property to secure the unpaid obligation. The bonds, including interest and redemption premiums, if any, and the associated lien
on the property are typically payable, secured and satisfied by revenues, fees or assessments levied on the property benefited.

We are not in compliance with the financial covenants contained in our senior credit facility. If we are unable to enter into an amendment or waiver of such financial
covenants, we will be unable to borrow additional amounts and may be forced to declare bankruptcy.

Our existing, and any future, senior credit facilities require us to maintain specified consolidated financial ratios and satisfy certain consolidated financial tests. Our
ability to meet those financial ratios and financial tests may be affected by events beyond our control, including the continued deterioration in market conditions. At September 30, 2007, we
were not in compliance with certain of the covenants, limitations and restrictions under our existing senior credit facility, including the covenant requiring us to maintain a minimum tangible net
worth (as defined in our senior credit facility). As a result of this non-compliance or upon our failure to comply with any of the covenants in the future, we are currently unable to
borrow additional amounts under our senior credit facility, and the lenders under our senior credit facility could declare all amounts outstanding thereunder, together with accrued interest, to be
immediately due and payable. An acceleration under our senior credit facility would also trigger a cross-default under the indenture governing our senior subordinated notes, thereby allowing our
bondholders to accelerate the repayment of all amounts outstanding on the senior subordinated notes, subject to certain payment blockage periods. Our assets may not be sufficient to repay in full such
indebtedness or any other indebtedness. In addition, any default under the senior subordinated notes, our senior credit facility or the instruments governing our other indebtedness (including certain
guaranteed indebtedness) would or could constitute a cross-default under one or more of our senior subordinated notes, our senior credit facility and other debt instruments. If an event of default
under one or more debt instruments was to occur, and we are unable to find alternative financing or obtain a waiver, we may not have sufficient assets to repay the outstanding debt that is
accelerated. Further, any subsequent senior credit facilities we enter into, as well as any other agreements we may enter into in the future governing our indebtedness, may impose additional
restrictions on us, any of which may adversely affect our ability to finance our future operations or capital needs or to pursue available business opportunities. We have begun discussions with our
bank group regarding amending our senior credit facility. The bank group has not provided formal assurance that we will be able to obtain a waiver or amend our senior credit facility upon reasonable
terms, or at all.

12

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We face substantial inventory risk.

The risks inherent in purchasing and developing land increase as consumer demand for housing decreases. Thus, we may purchase and develop land on which we cannot profitably
build and sell homes and we may not be able to resell that land at prices sufficient to cover our costs. The market value of land, building lots and housing inventories has, and is expected to
continue to, fluctuate significantly as a result of deteriorating market conditions in the United States homebuilding market and the measures we employ to manage inventory risk may not be successful.
Further, the volume of land inventory currently being sold by us and other homebuilders is substantial and may have an adverse effect on our ability to sell such land at favorable prices, or at all.
In addition, inventory carrying costs can be significant and can result in losses in a poorly performing project or market. As a
result of continuing changes in economic or market conditions, we may have to continue to sell homes at significantly lower margins or at a loss.

Fluctuations in real estate values may require us to adjust the book value of our real estate assets and may limit our access to borrowings under our senior credit facility.

The value of real estate is subject to significant fluctuations. Although we have generally developed parcels ranging from 100 to 300 lots, on a strategic basis we, from time
to time, purchase larger parcels of land. In some cases, we acquire these parcels with a joint venture partner, and in others we purchase them ourselves with the intent to develop lots for our
homebuilding operations and for resale to others. Since real estate values are subject to significant fluctuations, the deterioration of economic conditions in our markets could require us to further
write down the value of our owned real estate. During fiscal 2007 and 2006, we recorded impairment charges of $240.0 million and $25.8 million based on our intended use of particular
assets at the time of our review. Changes in our intended use or further deterioration in market conditions could have a significant impact on the carrying value of our assets, and could lead to
further impairment charges and limit our access to new borrowings and trigger repayment requirements for existing borrowings under our senior credit facility, each of which could have a material
adverse effect on our financial condition and operating results and our ability to maintain compliance with the financial covenants in and other requirements of our senior credit facility.

Borrowing limits under our senior credit facility are subject to redetermination.

Our senior credit facility has a maximum availability of $500 million, subject to a borrowing base. The borrowing base is redetermined monthly and is based on the lesser
of book value and appraised value of our inventory, which generally consists of land holdings, home sale contracts and finished and unfinished homes. As of September 30, 2007, we had
$323 million of outstanding borrowings under our senior credit facility and, after calculating the borrowing base limitation, had additional availability of approximately $82 million. We
are currently undergoing an appraisal process with respect to a substantial portion of our land-based inventory. In the event our then-redetermined borrowing base is reduced,
our availability will also be reduced. In addition, if our then-redetermined borrowing base is less than our outstanding borrowings under the facility, we are required to immediately repay the
deficit. Our operations are funded, in part, from borrowings under our senior credit facility. If we are unable to continue borrowing under our senior credit facility and if we cannot obtain alternate
borrowing sources at commercially reasonable rates, or if we are required to repay debt under our senior credit facility as a result of a downward borrowing base redetermination, we may not be able to
continue our operations without substantial disruptions, or at all.

13

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The indenture for our senior subordinated notes and other debt agreements impose significant operating and financial restrictions, which may prevent us from capitalizing on
business opportunities and taking certain corporate actions.

Our senior subordinated notes impose significant operating and financial restrictions on us. These restrictions limit our ability and that of our restricted subsidiaries among
other things, to:



In
addition, our senior credit facility contains many restrictive covenants similar to the covenants of the indenture for our senior subordinated notes but the covenants in the senior credit facility
are generally more restrictive than those contained in the indenture for our senior subordinated notes.

The availability and affordability of residential mortgage financing could adversely affect our business, revenues and profitability.

The majority of our customers finance their purchases through mortgage financing obtained from us or other sources. Increases in interest rates or decreases in the availability
of mortgage funds could cause a decline in the market for new homes as potential homebuyers may not be able to obtain affordable financing. In particular, because the availability of mortgage
financing is an important factor in marketing many of our homes, any limitations or restrictions on the availability of financing could reduce our home sales and the lending volume related to our
mortgage operations. Increased interest rates can also limit our ability to realize our backlog because our sales contracts typically provide our customers with a financing contingency. Financing
contingencies allow customers to cancel their home purchase contracts in the event they cannot arrange for financing. Even if our potential customers do not need financing, changes in interest rates
and mortgage availability could make it harder for them to sell their existing homes to potential buyers who need financing.

During
2007, the mortgage market received negative attention, resulting in tighter lending standards throughout the mortgage industry. As a result, the mortgage markets experienced significant
disruption and, in particular, the market for "sub-prime" loans virtually disappeared when significant default rates on those loans became known to investors. This volatility in the
mortgage market led to reduced investor demand for mortgage loans and mortgage-backed securities and to tightened credit requirements, which in turn made it more difficult for certain of our
homebuyers to obtain financing. Some of our homebuyers experienced difficulty in obtaining mortgage loans or faced increased expense (in the form of higher interest rates and/or larger down payment
requirements), which further reduced the demand for mortgage loans and, consequently, for new homes.

Our financial statements, which describe uncertainties related to our ability to continue as a going concern and include an audit report from our independent registered public
accounting firm that refers to that uncertainty, reductions in our credit ratings and difficulty in obtaining sufficient capital and bonding could limit our ability to raise additional capital and
result in delays in the completion of projects.

The homebuilding industry is capital intensive and the acquisition and development of land requires significant up-front expenditures and bonding to ensure the
completion of our projects. Although our

14

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financials
that refer to uncertainties related to our ability to continue as a going concern or reductions in our credit ratings may not have an immediate impact on the cost of debt or our liquidity,
they may impact the cost of debt and liquidity over the near to medium term. If we continue to have financial statements that refer to uncertainties related to our ability to continue as a going
concern or our credit ratings are not increased or if they are further reduced, our access to capital may be limited, which would have a material and adverse impact to our future access to capital.
Our land acquisition, development and construction activities may be adversely affected if we are unable to finance our land purchases and development and construction activities at reasonable costs,
or at all. Any difficulty in obtaining sufficient capital and bonding for planned development expenditures could result in lot shortages, project delays and cost increases, which could adversely
affect our future operating results. If the market remains weak or deteriorates further, there can be no assurance that we will be able to maintain adequate bonding. In addition, our decreased
earnings and the continuing deterioration in the homebuilding market could result in further downgrades in our credit ratings, which, in turn, could cause our bonding companies to (1) file
financing statements to secure our assets or (2) require us to post collateral in order to obtain adequate bonding. Such actions by our bonding companies may further reduce our borrowing
capacity under our senior credit facility or cause us not to be in compliance with the permitted lien covenant under our senior credit facility, all of which would or could have a material adverse
impact on our liquidity.

If we are not able to develop our communities successfully, our results of operations will be adversely affected.

Before a community generates any revenues, time and material expenditures are required to acquire land, to obtain development approvals and to construct significant portions of
project infrastructure, amenities, model homes and sales facilities. A decline in our ability to develop and market our communities successfully and to generate positive cash flows from these
operations in a timely manner would have a material adverse effect on our operating results and ability to service our debt obligations and to meet our working capital requirements.

We may not be able to compete effectively against homebuilders in our markets or with sales or rentals of existing homes in our markets.

The homebuilding industry is highly competitive. We compete with large national homebuilding companies and smaller local homebuilders for, among other things, lots in premier
locations, financing, raw materials, skilled independent contractors and customers. Many of our competitors have significantly greater financial, marketing, sales and manufacturing resources than we
do. Industry consolidation may create larger and stronger competitors that may be able to compete more effectively against us. In addition, there may be new entrants in the markets in which we
currently conduct business. Our potential customers may also choose to purchase or rent existing homes (including the growing number of foreclosed homes offered at substantially reduced prices), and
as such we compete for sales with resales of existing homes and with available rental housing. The recent market deterioration has increased price competition to generate new home orders and increased
the supply of new and existing homes that our potential customers may chose from, in each case placing additional pressure on profitability and our financial condition. If we are unable to compete
effectively with other homebuilders, or if our homes are perceived to be less attractive values than existing homes or rental properties (including the growing number of foreclosed homes offered at
substantially reduced prices), our operating results will be adversely impacted.

15

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We depend on the availability and quality of independent contractors and raw materials at reasonable prices.

We
rely heavily on the use of independent contractors in the construction of our homes. Since we generally do not enter into long-term contractual commitments with our contractors, our
ability to deliver homes in a timely and cost-effective manner depends upon the availability of skilled contractors in our markets on an as-needed or
project-by-project basis. Any material increase in the demand for contractors in any of our markets could result in construction delays or increased construction costs,
resulting in reduced earnings. Further, the ongoing deterioration in the housing market may negatively impact our contractors, or other contractors in the homebuilding market. If a material amount of
these contractors are forced to go out of business or change their cost structure, we would experience construction delays or increased construction costs, resulting in reduced revenue, cash flows and
earnings.

In
addition, while our contractors are generally responsible for procuring necessary building materials, we have from time to time experienced, and may in the future experience, shortages in lumber
and other materials. Any future reduction in availability or increase in the cost of lumber or other raw materials could result in construction delays or cost increases, which could reduce our
revenue, cash flows and earnings.

We depend upon the continued services of certain members of our senior management team and other key employees, without whom our business may be adversely affected.

Our future success depends, in part, on the efforts of our senior management team and other key employees. Our senior management team, led by David K. Hill, our Executive
Chairman, and C. Kenneth Love, our President and Chief Executive Officer, has significant industry and general business experience, which may be difficult to replace. Our senior management
team, regional presidents and other key employees possess operational, financial, sales, marketing and administrative skills that are critical to the operation of our business. If we lose or suffer an
extended interruption in the services of one or more members of our senior management team or other key employees, our financial condition and operating results may be adversely affected. Moreover,
the market for qualified individuals is highly competitive and we may not be able to attract and retain qualified personnel to replace members of our senior management team or other key employees
should the need arise.

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

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

Changes
in federal income tax laws may affect demand for home ownership. For example, various proposals have been publicly discussed to limit an individual's real estate tax and mortgage interest
deductions and to tax an individual on gain from the sale of a principal residence. Enactment of such proposals could have an adverse effect on home ownership and the homebuilding industry in general.
No meaningful prediction can be made as to whether any such proposals will be enacted and, if enacted, the particular form such laws would take.

We,
like other homebuilders, may be adversely affected during periods of high inflation due to higher land, financing, labor and materials costs, which could cause our financial results to decline.

16

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Our industry is vulnerable to changes in macroeconomic conditions in the markets and regions in which we operate.

Historically, changes in demand based on economic and market shifts and fluctuations in the availability and price of land, labor and raw materials have created changes in the
prices of new homes, sales volumes and margins. We currently conduct all of our business within 12 markets in five regions (Florida, the Midwest, Nevada, the Pacific Coast and Texas). From time to
time, one or more of these regions will account for a significant percentage of our gross homebuilding profit, primarily due to shifting market conditions among all of our regions. A downturn in one
or more of these regions without corresponding growth in our other regions, could result in an overall decline in profitability. Furthermore, because we conduct our operations in specific markets and
states within each of these regions, in the event of an economic downturn in one or more of the markets or states within a particular region, our sales activity in the entire region may be materially
and adversely affected.

We are subject to potential expenses related to construction defect and home warranty claims that could adversely affect our financial performance.

Construction defect and home warranty claims are common in the homebuilding industry and can be costly. While we generally require our independent contractors and third party
design professionals to indemnify us for liabilities arising from their work, these indemnities may be insufficient to cover construction defects and warranty claims for which we may be held liable.
While we establish reserves for warranty claims, the reserves may from time to time be inadequate to cover our warranty costs. If conditions are such that the warranty reserves are inadequate, our
earnings and cash flows may be materially reduced.

We face reduced coverages and increased costs of insurance.

Insurance costs for homebuilders have increased substantially in recent years due to a range of factors, including perceptions related to the risk of terrorist attacks, recent
corporate governance scandals, insurer insolvencies and recent increases in losses due to hurricanes and other natural disasters. For
these reasons, some insurers have ceased to provide certain insurance products that were historically relied on by homebuilders and other industry participants.

In
this difficult insurance market, exposure to personal injury and property damage claims, as well as to losses resulting from natural disasters, is at historically high levels. For example, many
lawsuits have been filed against homebuilders asserting claims for damage caused by the presence of mold in residential dwellings, some resulting in substantial monetary judgments or settlements. Our
insurance may not cover all of the claims, including personal injury claims, to which we may become subject, as coverage of such claims may not be available on commercially reasonable terms, if at
all. If we are unable to obtain adequate insurance coverage, substantial personal injury or other claims could materially impact our earnings and cash flows. Continued increases in insurance costs,
additional coverage restrictions or unavailability of certain insurance products in some of our regions (including the unavailability of or increased costs for flood or hurricane insurance), due to
these and other factors will increase our operating costs and further increase our exposure to natural disasters and other causes of catastrophic loss, as well as personal injury and other claims.

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

Residents of communities we develop rely on us to resolve issues or disputes that may arise in connection with the operation or development of their communities. Any efforts
made by us to resolve these issues or disputes could be deemed unsatisfactory by the affected residents and any subsequent action by these residents could negatively impact sales, which would
negatively impact our revenues and

17

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results
of operations. In addition, we could be required to make material expenditures related to the settlement of such issues or disputes or to modify our community development plans.

Our obligation to repurchase issued and outstanding shares could adversely affect our cash flows.

We have contractual obligations to repurchase, upon termination of board membership or employment by reason of specified circumstances (including retirement, death or permanent
and total disability), shares of our common stock then owned by stock option participants and recipients of deferred stock units (other than our Executive Chairman), including shares issuable pursuant
to outstanding options or deferred stock units, at the fair market value of those shares at the time the obligations to repurchase become due. As of September 30, 2007, the aggregate repurchase
obligation, net of proceeds to be received from any stock option exercises, would have been approximately $13.3 million in the event that all of these obligations were triggered. Our ability to
satisfy our repurchase obligations is subject to
certain limitations set forth in the indenture governing the senior subordinated notes. In addition, if Mr. Hill's employment is terminated by reason of his death or permanent disability, his
family trust may request us to purchase up to 500,000 shares of our common stock, and upon receipt of such request we will reasonably determine in our sole discretion how many shares to purchase in
light of our financial condition and prospects and the limitations, restrictions and constraints in our loan and financing arrangements at the time. The purchase price payable by us will be the fair
market value at that time.

Utility shortages or price increases could have an adverse impact on our operations.

We rely heavily on the continued availability of fuel, water, electricity and other utilities at reasonable prices for our operations. Our markets have in the past experienced
shortages in water or electrical power, requiring us to delay construction projects and/or incur additional construction costs. In addition, we have incurred increased utility costs in many of our
markets, including significant additional costs due to recent increases in the cost of oil. We may incur additional costs and may not be able to complete construction on a timely basis if such utility
rate increases continue, or if we experience additional water and/or power shortages. Furthermore, shortages of water or electricity, or utility rate increases, may adversely affect the regional
economies in which we operate, which may reduce demand for our homes.

Adverse weather conditions or natural disasters in the areas in which we operate could increase our costs, reduce demand for our homes and adversely affect our financial
condition and operating results.

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

We may not be able to acquire desirable lots or land for residential buildout.

Our future results depend upon our ability to acquire lots in premier locations for our community development and homebuilding activities. We compete for desirable lots and
land with many other homebuilding companies, many of which have greater resources than we do. Our financial condition and operating results will be adversely affected if desirable properties at
reasonable prices are not available on an ongoing basis. If we cannot procure desirable properties at reasonable prices, or at all

18

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(especially
in light of our liquidity issues), in any of our markets, we may be required to limit our development or homebuilding operations in those markets or instead purchase less desirable
properties, either of which would reduce our revenues and future results.

Governmental laws and regulations may increase our expenses, limit the number of homes that we can build or delay or prevent the completion of our projects.

We are subject to numerous local, state, federal and other statutes, ordinances, rules and regulations concerning zoning, development, building design, construction and similar
matters. Projects that are not entitled may be subjected to periodic delays, changes in use, less intensive development or elimination of development in certain specific areas due to government
regulations. We may also be subject to periodic delays or may be precluded entirely from developing in certain communities due to building moratoriums or "slow-growth" or
"no-growth" initiatives that could be implemented in our markets. Local and state governments also have broad discretion regarding the imposition of development fees for projects in their
jurisdiction. Projects for which we have received land use and development entitlements or approvals may still require a variety of other governmental approvals and permits during the development
process and can also be impacted adversely by unforeseen health, safety and welfare issues, which can further increase our cost, delay these projects or prevent their development.

Environmental laws and regulations may increase development costs, delay completion of projects or prevent us from developing at all.

We are subject to a variety of local, state, federal and other statutes, ordinances, rules and regulations concerning the environment. Environmental regulatory requirements
could result in delays, impose substantial compliance and other costs or severely restrict homebuilding activity. For example, we may be required to investigate and clean up hazardous or toxic
substances or petroleum product releases on lots we either own or on which we built homes, and may be held liable for property damage and for
investigation and clean up costs incurred by third parties in connection with contamination. In addition, the presence of government-protected wetlands, historical artifacts or endangered species
could prevent us from developing certain parcels of land at a reasonable cost, or at all.

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

Geopolitical events may have a substantial impact on the economy and the housing market. The terrorist attacks on the World Trade Center and the Pentagon on
September 11, 2001 had an impact on our business and the occurrence of similar events in the future cannot be ruled out. The United States' continuing involvement in Iraq, terrorism and related
geopolitical risks have created many economic and political uncertainties, some of which may have additional material adverse effects on the United States economy, the housing market, our customers
and, in turn, our results of operations and financial condition.

We may consider growth or expansion of our operations, which could have a material adverse effect on our cash flows or profitability.

We may consider opportunities for growth, primarily within our existing markets, but also in new markets or product lines. Additional growth of our business, either through
increased land purchases or the development of larger projects, may have a material adverse effect on our cash flows or profitability. Any expansion of our business into new markets or product lines
could divert the attention of senior management from our existing business, and could fail due to our relative lack of experience in those new markets or with those new products. In addition, while we
do not currently intend to acquire any homebuilding operations from third parties, opportunities to do so may arise in the future

19

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and
any acquisition could be difficult to integrate with our operations, and could require us to assume unanticipated liabilities or expenses.

Our controlling stockholder may have interests that conflict with the interests of other stakeholders.

David K. Hill, our Executive Chairman, together with members of Mr. Hill's immediate family, beneficially owns approximately 71% of our common stock. Mr. Hill
generally will have the ability to elect substantially all of the members of our Board of Directors and will generally be able to select our
management team, determine our corporate and management policies and make decisions relating to fundamental corporate actions. The directors generally will have the authority to make decisions
affecting our capital structure, including the issuance of additional debt and declaration of dividends, and to authorize transactions, such as joint ventures or acquisitions, subject to certain
restrictions as set forth in the indenture for our senior subordinated notes and in existing and future credit facilities. These decisions could enhance Mr. Hill's equity investment while
involving risks to the interests of other stakeholders. In addition, Mr. Hill and various of his affiliates or immediate family members have engaged, and will in the future continue to engage,
in transactions with us as described in Item 13, "Certain Relationships and Related Transactions, Director Independence".

Item 1B.    Unresolved Staff Comments

Not applicable.

Item 2.    Properties

As of September 30, 2007, we owned two office buildings with approximately 111,000 square feet of space in Rolling Meadows, Illinois. One of the office buildings is
currently used as our principal executive office for both our homebuilding and mortgage operations and the other building we intend to occupy in fiscal 2008 to use as our new principal executive
office. Our local homebuilding operations and mortgage branch operations generally lease office space for their day-to-day operations. Office leases are generally for terms of
three to five years and generally provide renewal options. We expect that in the normal course of business leases that expire will be renewed or replaced by other leases.

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

Item 3.    Legal Proceedings

We are involved in various routine legal proceedings incidental to our business, some of which are covered by insurance. With respect to the majority of pending litigation
matters, our ultimate legal and financial responsibility, if any, cannot be estimated with certainty and, in most cases, any potential
losses related to these matters are not considered probable. We accrue for legal expenses and settlement costs where our ultimate exposure is considered probable and the potential loss can be
reasonably estimated. Most of these matters relate to construction defect and general customer claims. We believe that none of these matters will have a material adverse impact upon our consolidated
financial condition, results of operations or cash flows.

Item 4.    Submission of Matters to a Vote of Security Holders

Not applicable.

20

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PART II

Item 5.    Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market and other information

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

No
stock options were granted during fiscal 2007. During fiscal 2006, we granted stock options to purchase 12,000 shares of our common stock to a key employee under our stock option plan. The option
price equals the estimated fair market value of our common stock on the date of grant. We received no proceeds from this grant. We granted the stock options in reliance on an exemption from
registration under the Securities Act of 1933.

Holders

As of November 30, 2007, there were 18 holders of our common stock. See Item 12, "Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters" for additional information about the ownership of our common stock.

Dividends

We are currently restricted in our ability to pay dividends under various covenants of our debt agreements, including our senior credit facility and the indenture governing our
senior subordinated notes. We have not in the last two fiscal years paid, and do not expect for the foreseeable future to pay, dividends on our common stock. Any future determination to pay dividends
will depend upon, among other factors, our results of operations, financial condition, capital requirements, any contractual restrictions and any other considerations our Board of Directors deems
relevant.

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Item 6.    Selected Financial Data

Set forth below is selected consolidated financial data for each of the past five fiscal years. The selected financial data should be read in conjunction with Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of Operations" and Item 8, "Financial Statements and Supplementary Data" included elsewhere in this report.

|                                                                         | 
|------------------------------------------------------------------------ | 
|
|
|                                                                         | 
|Statement of operations data:                                            | 
|Total homebuilding revenues                                              | 
|Cost of sales of residential units and land                              | 
|                                                                         | 
|Gross homebuilding (loss) profit                                         | 
|Homebuilding operating expenses                                          | 
|Equity in (losses) income of unconsolidated entities                     | 
|Minority interests in net losses (earnings) of consolidated partnerships | 
|                                                                         | 
|Homebuilding (loss) earnings before income taxes                         | 
|Mortgage banking earnings before income taxes                            | 
|                                                                         | 
|(Loss) earnings before income taxes                                      | 
|(Benefit) provision for income taxes                                     | 
|                                                                         | 
|Net (loss) earnings                                                      | 
|                                                                         | 
|Balance sheet data (at end of period):                                   | 
|Cash and cash equivalents                                                | 
|Inventory                                                                | 
|Total assets                                                             | 
|Total debt                                                               | 
|Total redeemable equity                                                  | 
|Total shareholders' equity                                               | 
|Other financial data:                                                    | 
|Interest incurred(1)                                                     | 
|Depreciation and amortization                                            | 
|EBITDA(2)(3)                                                             | 
|Gross homebuilding (loss) profit margin(4)                               | 
|Ratio of earnings to fixed charges(5)                                    | 
|Coverage deficiency(5)                                                   | 
|Other data:                                                              | 
|Net new home orders (units)(6)                                           | 
|Homes delivered (units)                                                  | 
|Average sales price of homes delivered                                   | 
|Backlog at end of period (units)(7)                                      | 
|Backlog at end of period (contract value)(7)                             | 
|                                                                         | 



22

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Fiscal year ended September 30,(Dollars in thousands)

2007

2006

2005

2004

2003Net (loss) earnings

$
(220,536
)
$
41,804

$
86,834

$
55,619

$
37,639(Benefit) provision for income taxes


(46,467
)

23,516


50,689


27,365


22,563Interest expense in cost of sales


38,079


32,899


27,696


35,382


26,883Interest expense in mortgage banking operations





7


34


625


949Depreciation and amortization


916


843


880


966


929EBITDA

$
(228,008
)
$
99,069

$
166,133

$
119,957

$
88,963


23

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Item 7.    Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

We are one of the largest privately-owned homebuilders and one of the 30 largest homebuilders in the United States, as measured by home deliveries and revenues. We design,
build and market single-family detached, single-family attached and multi-family homes. Since we were founded in 1969, we have delivered over 48,000 homes to a broad range of customers, including
first-time buyers and first-and second-time move-up buyers. Throughout this period, we have grown our business organically and our fiscal 2007 results reflect
operations within 17 markets, including, among others, Chicago, Dallas, Ft. Worth, Houston, Las Vegas, Sacramento and Tampa located in five regions: Florida, the Midwest, Nevada, the Pacific Coast and
Texas. As described in Item 1, "BusinessOur history" we have exited certain markets and we presently operate in 12 markets located in five regions.

Our
revenues are primarily generated from designing, building, marketing and delivering for sale single-family detached, single-family attached and multi-family homes. We also sell land and lots to
third parties as a means of managing inventory and obtaining the desired asset mix for our near-term homebuilding operations.

As
part of our current operating strategy, we are selling certain land inventory to: manage our debt, adjust the balance of our land holdings by region and reduce our overall investment in land.
During the year ended September 30, 2007, we sold $58.9 million of land inventory. As of September 30, 2007, we have identified $49.2 million of land inventory that we
intend to sell and are actively marketing the properties for delivery within the next 12 months. In addition to the land identified for sale, we intend to further match our investment in land
to current and foreseeable market conditions by continually evaluating and selling land that is not critical to our homebuilding operations over the next 24 months.

Due
to the continued deterioration in market conditions and the overall national homebuilding climate, we reviewed our inventory for impairment and recorded inventory impairment charges of
$240.0 million
during the year ended September 30, 2007. Additionally, during the year ended September 30, 2007, we recorded a $21.5 million charge to write-off our investment in one of our
joint ventures and wrote-off $15.8 million of costs related to the abandonment of land option contracts.

We
also conduct mortgage origination and title services for the benefit of our homebuilding operations, although revenues generated by these ancillary services have historically comprised less than 1%
of our total consolidated revenues, and are not expected to be significant in the future.

Recent trends

Market conditions for new home sales have continued to deteriorate significantly throughout our fiscal year. Inventory levels of both new and existing homes have continued to
climb and aggressive price competition has continued to put pressure on already strained profit margins. Significant home price appreciation combined with fluctuating interest rates and tightening
credit standards in the mortgage industry have negatively affected affordability and consumer sentiment for housing. We do not see conditions in the homebuilding market improving significantly in the
near term, which will continue to negatively impact both our revenues and earnings.

The
following describe certain negative market trends, the pace of which accelerated during the course of fiscal 2007:



24

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Given
the significant market deterioration and uncertainty about the timing and pace of any recovery, we have adopted a strategy to manage our business through this current downturn. Our strategy
focuses on:



Financing Overview

In August 2007, we amended and restated our existing senior credit facility to further amend certain covenants, require that the senior credit facility be secured by all
properties to be included in the borrowing base for the senior credit facility and related assets and prohibit the incurrence of any additional secured debt. The August 2007 amendments:
(1) permit us to ignore, for purposes of financial covenant calculations (but not for interest margin calculations), up to $40 million of tangible net worth reductions due to impairment
and abandonment charges; (2) suspend the interest coverage ratio covenant until March 31, 2009 and add a minimum $25 million trailing four-quarter adjusted EBITDA
requirement (as defined in our senior credit facility) and a minimum $50 million liquidity requirement (defined as unrestricted cash, available borrowings under the senior credit facility and
other available lines of credit and receivables from home closings); (3) require us to test liquidity monthly; and (4) reduce permitted unsecured debt from $25 million to
$15 million and permitted joint venture investments from 30% of tangible net worth to 25% of tangible net worth.

As
of September 30, 2007, we were not in compliance with certain of the covenants in our senior credit facility, including the covenant requiring us to maintain a minimum tangible net worth (as
defined in our senior credit facility). Our failure to meet these covenants allows the lenders under our senior credit facility to declare all amounts outstanding thereunder, together with accrued
interest, to be immediately due and payable. An acceleration under our senior credit facility would also trigger a cross-default under the indenture governing our senior subordinated notes, thereby
allowing our bondholders to accelerate the repayment of all amounts outstanding on the senior subordinated notes. In addition, certain other credit facilities within our joint ventures to which we
have provided guarantees include provisions for acceleration or events of default in the event of a default under our senior credit facility.

25

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We
have begun discussions with our bank group regarding amending our senior credit facility. The bank group has not provided formal assurance that we will be able to amend our senior credit facility
upon reasonable terms, or at all. Nonetheless, there has been no indication that it intends to accelerate amounts due under our facility, and discussions with our lenders regarding an amendment are
active and ongoing.

Results of operations and other data

Our ability to continue as a going concern is dependent upon our ability to return to profitable operations in the future and to retain the necessary financing to meet our
obligations and pay our liabilities when they come due. Due to these uncertainties, there are substantial doubts about whether we will be able to continue as a going concern, and therefore, we may be
unable to realize our assets and discharge our liabilities in the normal course of business. Our consolidated financial statements have been prepared on a going concern basis, which contemplates the
realization of assets and the settlement of liabilities and commitments in the normal course of business. The accompanying financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or to the amounts and classification of liabilities that may be necessary if we are unable to continue as a going concern. See note 1
to our consolidated financial statements for further information.

The
following table presents selected statement of operations and other data for the 2007, 2006 and 2005 fiscal years:

|                                                                         | 
|------------------------------------------------------------------------ | 
|
|                                                                         | 
|Statement of operations data:                                            | 
|Total homebuilding revenues                                              | 
|Cost of sales of residential units and land                              | 
|                                                                         | 
|Gross homebuilding (loss) profit                                         | 
|Homebuilding operating expenses                                          | 
|Equity in (losses) income of unconsolidated entities                     | 
|Minority interests in net losses (earnings) of consolidated partnerships | 
|                                                                         | 
|Homebuilding (loss) earnings before income taxes                         | 
|Mortgage banking earnings before income taxes                            | 
|                                                                         | 
|(Loss) earnings before income taxes                                      | 
|(Benefit) provision for income taxes                                     | 
|                                                                         | 
|Net (loss) earnings                                                      | 
|                                                                         | 
|Other data:                                                              | 
|Net new home orders (units)(1)                                           | 
|Homes delivered (units)                                                  | 
|Average sales price of homes delivered                                   | 
|Backlog at end of period (units)(2)                                      | 
|Backlog at end of period (contract value)(2)                             | 
|                                                                         | 

Year ended September 30, 2007 compared to year ended September 30, 2006

Homebuilding revenues.Our homebuilding revenues consist primarily of revenue from new homes delivered and land
sales. Homebuilding revenues decreased 23.1% to $894.7 million in fiscal 2007 from $1,163.8 million in fiscal 2006. The decrease was primarily due to a 20.4% decrease in the number of

26

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homes
delivered as the new home market continued to retract and a 7.2% decrease in the average sales price of homes delivered due to increased price competition in all of our markets and a shift of
deliveries to our Texas region. New home deliveries decreased to 3,246 in fiscal 2007 from 4,079 homes in fiscal 2006. The average sales price of homes delivered decreased to $257 thousand in
fiscal 2007 from $277 thousand is fiscal 2006. Revenue from land sales in fiscal 2007 was $58.9 million as compared to $30.5 million in fiscal 2006.

Home sales and backlog.Net new home orders decreased 8.5% to 3,081 in fiscal 2007 from 3,367 in fiscal 2006.
Declining buyer sentiment combined with an increased supply of resale homes and new homes available for purchase have placed increasing pressure on sales volume. This changing marketplace has also
resulted in the increased utilization and magnitude of sales price reductions to remain competitive within the homebuilding industry.

At
September 30, 2007, the contract value of our backlog was $148.7 million, as compared to $210.6 million at September 30, 2006. The average sales price per home in
backlog of $251 thousand at September 30, 2007 was down $27 thousand, or 9.7%, over the average sales price per home in backlog of $278 thousand at September 30,
2006.

Gross homebuilding profit margin.Gross homebuilding profit margin decreased to (16.2)% for fiscal 2007, compared
to 16.4% for fiscal 2006. During fiscal 2007, we experienced margin pressures as price competition increased. Gross profit also was negatively affected by inventory valuation charges of
$240.0 million and $15.8 million of costs related to the abandonment of projects and write-off of deposits on cancelled land option contracts. Included in our fiscal 2006
gross profit are inventory valuation charges of $25.8 million and $8.3 million of costs related to the abandonment of projects and write-off of deposits on cancelled land
option contracts. Included within our 2007 and 2006 gross profit is $18.2 million and $2.5 million, respectively, of gross profit from the sale of land.

Homebuilding operating expenses.Homebuilding operating expenses, which consist of all homebuilding expenses other
than cost of sales, decreased 10.1% to $117.6 million in fiscal 2007 from $130.9 million in fiscal 2006. We reduced our overall work force by 30%, from 1,076 employees at
August 1, 2006 to 748 employees at September 30, 2007, which reduced our compensation and related expenses by $10.3 million in fiscal 2007 as compared with fiscal 2006. We also
reduced charitable contributions by $2.3 million and travel related expenditures by $1.6 million, however, these cost savings were partially offset by a $2.4 million increase in
amortization expense of model homes. Homebuilding operating expenses were 13.1% and 11.2% of homebuilding revenue in fiscal 2007 and fiscal 2006, respectively.

(Losses) income of unconsolidated joint ventures.(Losses) income of unconsolidated joint ventures, which consist
of our share of unconsolidated entities' earnings or losses, decreased from earnings of $2.2 million during fiscal 2006 to losses of $20.4 million during fiscal 2007. During fiscal 2007,
we determined that our investment in one of our ventures was more than temporarily impaired and recorded a $21.5 million charge to write-off the investment balance and to accrue
anticipated additional committed capital contributions.

Income taxes.We recorded an income tax benefit of $46.5 million in fiscal 2007, compared to an income tax
expense of $23.5 million in fiscal 2006. Our consolidated effective tax rates were 17.4% and 36.0%, respectively, for the same periods. During fiscal 2007 we recorded a valuation allowance of
$52.7 million against certain of our deferred tax assets, which impacted our effective tax rate by 19.7%.

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

Homebuilding revenues.Homebuilding revenues increased 1.5% to $1,163.8 million in fiscal 2006 from
$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 shift of deliveries to our Texas region. New home deliveries increased to

27

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4,079
in fiscal 2006 from 3,881 homes in fiscal 2005. The average sales price of homes delivered decreased to $277 thousand in fiscal 2006 from $286 thousand is fiscal 2005. Land sales
in fiscal 2006 were $30.5 million as compared to $33.4 million in fiscal 2005.

Home sales and backlog.Net new home orders decreased 9.1% to 3,367 in fiscal 2006 from 3,703 in fiscal 2005.
Declining buyer sentiment combined with an increased supply of resale homes and new homes available for purchase have placed increasing pressure on sales in many of the regions in which we operate.
This changing marketplace has resulted in the increased utilization and magnitude of sales price reductions to remain competitive within the homebuilding industry.

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

Gross homebuilding profit margin.Gross homebuilding profit margin decreased to 16.4% for fiscal 2006, compared to
24.8% for fiscal 2005. During fiscal 2006, there was a significant shift from regions that historically had higher than average gross profit margins to regions with lower than average gross profit
margins. Additionally, included in our fiscal 2006 gross profit are inventory valuation charges of $25.8 million related to our decision to exit the Cleveland market and our expectations
regarding the recoverability of certain assets from active residential construction projects and $8.3 million of costs related to the abandonment of projects and write-off of
deposits on cancelled land option contracts. The remaining gross profit decrease reflects margin pressures across all of our regions, except for Texas.

Homebuilding operating expenses.Homebuilding operating expenses, which consist 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. Incentive compensation expense decreased $11 million in fiscal 2006 due to
lower overall corporate earnings in fiscal 2006 as compared with fiscal 2005. Commissions paid 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 compensation expense related to certain stock options granted that were
considered to be variable awards. We have since amended our equity-based compensation agreements to amend the terms that resulted in variable accounting treatment. Homebuilding operating expenses were
11.2% and 12.7% of homebuilding revenue in fiscal 2006 and fiscal 2005, respectively.

Income taxes.We recorded income tax expense of $23.5 million and $50.7 million in fiscal 2006 and
fiscal 2005, respectively, and our consolidated effective tax rates were 36.0% and 36.9%, respectively, for the same periods.

Segment analysis

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

The
five reportable homebuilding segments include operating results from the following geographic regions:



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In
March 2006, we decided to exit the Cleveland market based on our perception regarding local market conditions. We completed all construction and sales activities during our second fiscal
quarter of 2007.

In
May 2007, we decided to exit the Milwaukee, Wisconsin market. Our decision to exit the Milwaukee market reflects our perception regarding local market conditions currently and in the
foreseeable future. As of September 30, 2007, we have completed homebuilding operations in this market and we are actively marketing our remaining $4.8 million of land for sale.

In
May 2007, we decided to exit the Portland, Oregon and Vancouver, Washington markets. A decision to continue in these markets would have required near term investments to provide lots for the
future to sustain our operations. We decided to redeploy our capital and narrow our management focus to our other existing markets. As of September 30, 2007, we have completed homebuilding
operations in these markets and we are actively marketing our remaining $2.5 million of land for sale.

The
following table presents financial and operational information related to our homebuilding operations:

|    
|----
|
|    
|2007
|    
|    
|    
|    
|    
|    
|    
|2006
|    
|    
|    
|    
|    
|    
|    
|2005
|    
|    
|    
|    
|    
|    
|    
|    

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The following table presents financial information based on our internal measurement system, which is not intended to conform with accounting principles generally accepted in the United States of
America ("GAAP"). Our internal measurement system is intended to establish accountabilities to continually improve business focus, motivate behavior and drive performance.

|    
|----
|
|
|    
|2007
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    
|2006
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    
|2005
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    
|    

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Year ended September 30, 2007 compared to year ended September 30, 2006

Florida.Homebuilding revenues decreased in fiscal 2007, compared to fiscal 2006, primarily due to a 19.8% decrease
in the number of homes delivered, offset partially by a $6 thousand increase in the average sales price of homes delivered. Homebuilding gross profit margins were (28.6)% in fiscal 2007,
compared to 15.5% in fiscal 2006. Fiscal 2007 gross profit was negatively impacted by $33.0 million of inventory valuation charges and $1.3 million of costs related to the abandonment of
projects and write-off of deposits on cancelled land option contracts. Fiscal 2006 gross profit was negatively impacted by $0.4 million of inventory valuation charges and
$4.5 million of costs related to the abandonment of projects and write-off of deposits on cancelled land option contracts.

Midwest.Homebuilding revenues decreased in fiscal 2007, compared to fiscal 2006, primarily due to a 31.2% decrease
in the number of homes delivered and a $27 thousand decrease in the average sales price of homes delivered. Homebuilding gross profit margins were (46.6)% in fiscal 2007, compared to 1.0% in
fiscal 2006. Fiscal 2007 gross profit was negatively impacted by $82.5 million of inventory valuation charges and $3.1 million of costs related to the abandonment of projects and
write-off of deposits on cancelled land option contracts. Fiscal 2006 gross profit was negatively impacted by $18.7 million of inventory valuation charges and $2.4 million of
costs related to the abandonment of projects and write-off of deposits on cancelled land option contracts.

Nevada.Homebuilding revenues remained flat in fiscal 2007, compared to fiscal 2006, primarily due to a
$30.6 million increase in land sales revenue, offset by a $23 thousand decrease in the average sales price of homes delivered and an 8.0% decrease in the number of homes delivered.
Homebuilding gross profit margins were 9.7% in fiscal 2007, compared to 30.2% in fiscal 2006. Fiscal 2007 gross profit was positively impacted by $15.9 million of profit generated by the sale
of land and negatively impacted by $22.5 million of inventory valuation charges. During fiscal 2007, we determined that our investment in one of our joint ventures was more than temporarily
impaired and recorded a $21.5 million charge to write-off the investment balance and accrue anticipated additional commited capital contributions.

Pacific Coast.Homebuilding revenues decreased in fiscal 2007, compared to fiscal 2006, primarily due to a 40.3%
decrease in the number of homes delivered and a $62 thousand decrease in the average sales price of homes delivered. Homebuilding gross profit margins were (45.8)% in fiscal 2007, compared to
27.3% in fiscal 2006. Fiscal 2007 gross profit was negatively impacted by $76.9 million of inventory valuation charges and $10.8 million of costs related to the abandonment of projects
and write-off of deposits on cancelled land option contracts. Fiscal 2006 gross profit was negatively impacted by $3.1 million of inventory valuation charges and $1.2 million
of costs related to the abandonment of projects and write-off of deposits on cancelled land option contracts.

Texas.Homebuilding revenues decreased in fiscal 2007, compared to fiscal 2006, primarily due to a 12.4% decrease
in the number of homes delivered, offset partially by an $11 thousand increase in the average sales price of homes delivered. Homebuilding gross profit margins were 8.3% in fiscal 2007,
compared to 12.2% in fiscal 2006. Fiscal 2007 gross profit was negatively impacted by $14.6 million of inventory valuation charges and $0.6 million of costs related to the abandonment of
projects and write-off of deposits on cancelled land option contracts. Fiscal 2006 gross profit was negatively impacted by $3.6 million of inventory valuation charges and
$0.2 million of costs related to the abandonment of projects and write-off of deposits on cancelled land option contracts.

Mortgage banking.Mortgage banking earnings before income taxes decreased to $0.6 million in fiscal 2007,
compared to $3.6 million in fiscal 2006. The decrease in fiscal 2007 earnings was primarily due to

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a
decrease in home closings, a decrease in the average mortgage loan size and a reduced mortgage capture rate.

Corporate and unallocated.Corporate and unallocated costs totaled $36.7 million for fiscal 2007 and
$29.8 million for fiscal 2006. Included within fiscal 2007 corporate and unallocated costs is $10.5 million of inventory valuation charges related to a land purchase obligation with
specific performance requirements, which is included in inventory not owned on our accompanying balance sheets. Partially offsetting this charge was a decrease in compensation and related expenses as
we have reduced our workforce to match our view of the marketplace currently and into the foreseeable future. Corporate and unallocated costs as a percentage of total revenues were 4.1% for fiscal
2007 and 2.5% for fiscal 2006.

Year ended September 30, 2006 compared 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 of homes delivered, offset partially by a $13 thousand increase in the average sales price of homes delivered. Homebuilding gross profit margins were 15.5% in fiscal 2006,
compared to 20.3% in fiscal 2005. Fiscal 2006 gross profit was negatively impacted by $0.4 million of inventory valuation charges and $4.5 million of costs related to the abandonment of
projects and write-off of deposits on 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 of homes delivered and a $16 thousand decrease in the average sales price of homes delivered. This decrease in revenue was offset partially by a $6.6 million increase 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 million of inventory valuation charges and $2.4 million of costs related to the abandonment of projects and write-off of deposits on cancelled land option
contracts.

Nevada.Homebuilding revenues decreased in fiscal 2006, compared to fiscal 2005, primarily due to a
$19 million decrease in land sales revenue, which was offset significantly by a $40 thousand increase in the average sales price of homes delivered. Homebuilding gross profit margins
were 30.2% 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 of homes delivered, offset partially by a $47 thousand increase in the average sales price of homes delivered. Homebuilding gross profit margins were 27.3% in fiscal
2006, compared to 36.9% in fiscal 2005. Fiscal 2006 gross profit was negatively impacted by $3.1 million of inventory valuation charges and $1.2 million of costs related to the
abandonment of projects and write-off of deposits 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 of homes delivered. Revenues from land sales increased by $9.5 million and the average sales price of homes delivered decreased by $2 thousand. Homebuilding gross profit
margins were 12.2% in fiscal 2006, compared to 12.0% in fiscal 2005. Fiscal 2006 gross profit was negatively impacted by $3.6 million of inventory valuation charges and $0.2 million of
costs related to the abandonment of projects and write-off of deposits on cancelled land option contracts.

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

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

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Liquidity and capital resources

Our principal uses of cash are land purchases, lot development, home construction and the funding of debt service. As a result, our financing needs depend principally on sales
volume, land acquisition and inventory balances. We fund our operations with available cash flows from operating activities, borrowings under our senior credit facility, other bank debt and minority
interests in consolidated partnerships. We do not hold cash for investment purposes and we generally manage our cash and debt positions to minimize financing costs.

Operating cash flows activities

Cash used in operating activities totaled $17.1 million during fiscal 2007, compared to $70.2 million during fiscal 2006. Lower sales volume and margins during
fiscal 2007 reduced the amount of cash generated by home deliveries. However, significantly less cash was used in fiscal 2007 when compared to fiscal 2006 to fund land purchases, lot development and
home construction.

Investing cash flows activities

Cash used in investing activities totaled $5.5 million during fiscal 2007, compared to $16.3 million during fiscal 2006. The decrease in cash used in investing
activities was primarily due to a decrease in fixed asset purchases and a decrease in the net contributions to investments in unconsolidated entities during fiscal 2007.

Financing cash flows activities

Cash provided by financing activities totaled $35.0 million during fiscal 2007, compared to $83.7 million during fiscal 2006. During fiscal 2007, we increased our
outstanding borrowings by $63.2 million. These additional borrowings primarily were used to fund operating activities, to make distributions to minority interests, to repurchase company stock
and to make incremental investments in unconsolidated entities.

In
December 2005, we entered into a new senior credit facility to finance our business operations. Proceeds of the new senior credit facility were used to retire our existing senior secured
revolving credit facilities and substantially all of our other senior secured credit facilities. The senior credit facility has a maximum availability of $500 million, subject to a borrowing
base as well as sublimits of $100 million for the issuance of letters of credit and $10 million for swing line loans. We have the right, without the consent of our lenders (other than
those participating in the increase), to increase the commitment by an amount of up to $200 million, provided that no such increase shall cause the senior credit facility to exceed
$700 million. We amended the senior credit facility in December 2006 to amend certain covenants and we amended and restated the senior credit facility in August 2007 to further
amend certain covenants, require that the senior credit facility be secured by all properties to be included in the borrowing base for the senior credit facility and related assets and prohibit the
incurrence of any additional secured debt.

The
applicable borrowing base is determined regularly throughout the life of the senior credit facility. The composition of the borrowing base is limited to parameters set forth in the senior credit
facility and certain types of real estate (such as unimproved entitled land and lots under development) are removed from the borrowing base if held beyond specified maturity dates. As a result of the
August 2007 amendments to the senior credit facility, the property of certain non-wholly owned subsidiaries cannot be included in the borrowing base calculation unless and until
such subsidiaries are able to guarantee the senior credit facility (on a secured basis), which will be subject to the consent of minority interest holders and there is no assurance that we would be
able to obtain such consent. New properties that are proposed to be included as borrowing base property would also be mortgaged and pledged to secure the senior credit facility and also would need to
satisfy specified parameters or otherwise be approved by the majority lenders.

33

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Borrowings
under the senior credit facility generally bear interest 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 upon our senior leverage ratio, which is defined as the ratio of total liabilities to consolidated net worth. Fees for letters of credit are based on LIBOR plus a margin of 1.5%. An unused
commitment fee equal to 0.2% to 0.3% per year accrues on the undrawn portion of the senior credit facility and is payable quarterly in arrears. The August 2007 amendments provide that the
applicable interest margins are subject to increase by 0.375% to 0.875% in the event that liquidity (as defined below) is more than $50 million but less than or equal to $100 million.

The
covenants under the senior credit facility, as amended, require us to: maintain a minimum tangible net worth of at least $300 million plus 50% of positive net income earned subsequent to
September 30, 2006; maintain a ratio 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 to exceed 1.5x; maintain a ratio of total land (including undeveloped land, land under development and
finished lots on which home construction has yet to begin) to adjusted tangible net worth not to exceed 1.5x; and maintain an interest 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 1.5x through
December 31, 2007, increasing to 1.75x through March 31, 2008 and then increasing to 2.25x through the remaining term of the senior credit facility). For purposes of these tests,
adjusted tangible net worth is benefited by adjustments of 50% of our outstanding senior subordinated debt (up to a maximum $100 million adjustment) and 100% of minority interests in
consolidated entities (up to a maximum $50 million adjustment). The August 2007 amendments: (1) permit us to ignore, for purposes of financial covenant calculations (but not for
interest margin calculations), up to $40 million of tangible net worth reductions due to impairment and abandonment charges; (2) suspend the interest coverage ratio covenant until
March 31, 2009 and add a minimum $25 million trailing four-quarter adjusted EBITDA requirement (as defined in our senior credit facility) and a minimum $50 million
liquidity requirement (defined as unrestricted cash, available borrowings under the senior credit facility and other available lines of credit and receivables from home closings); (3) require
us to test liquidity monthly; and (4) reduce permitted unsecured debt from $25 million to $15 million and permitted joint venture investments from 30% of tangible net worth to 25%
of tangible net worth.

As
of September 30, 2007, we had $323 million of borrowings under the senior credit facility at an effective interest rate of 7.04% and, after calculating the borrowing base limitation
based on removal of the property of such non-wholly owned subsidiaries, had additional availability of approximately $82 million. As of September 30, 2007, we were not in
compliance with certain of the covenants in our senior credit facility, including the covenant requiring us to maintain a minimum tangible net worth (as defined in our senior credit facility). Our
failure to meet these covenants allows the lenders under our senior credit facility to declare all amounts outstanding thereunder, together with accrued interest, to be immediately due and payable. An
acceleration under our senior credit facility would also trigger a cross-default under the indenture governing our senior subordinated notes, thereby allowing our bondholders to accelerate the
repayment of all amounts outstanding on the senior subordinated notes, subject to certain payment blockage periods. In addition, certain other credit facilities within our joint ventures to which we
have provided guarantees include provisions for acceleration or events of default in the event of a default under our senior credit facility.

We
have begun discussions with our bank group regarding amending our senior credit facility. The bank group has not provided formal assurance that we will be able to amend our senior credit facility
upon reasonable terms, or at all. Nonetheless, there has been no indication that it intends to accelerate amounts due under our facility, and discussions with our lenders regarding an amendment are
active and ongoing.

In
December 2005, we issued $203 million aggregate principal amount of senior subordinated notes due December 2012 in a private placement pursuant to Rule 144A promulgated
under the Securities Act of 1933. In May 2006, we exchanged all of the senior subordinated notes issued in December 2005 for an

34

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issue
of notes registered with the SEC with terms substantially identical to the notes issued in the private placement. The senior subordinated notes were sold at 98.796% of par and accrue interest at
a coupon rate of 10.5% per annum. Interest is paid semi-annually in June and December. The net proceeds were used to repay amounts outstanding under working capital loans and certain
senior secured revolving credit facilities. We may redeem the notes, in whole or part, at any time on or after December 15, 2009, at a redemption price equal to 100% of the principal amount,
plus a 5.25% premium declining ratably to par on December 15, 2011, plus accrued and unpaid interest. At any time prior to December 15, 2008, we may redeem up to 35% of the aggregate
principal amount of the notes with the proceeds of qualified equity offerings at a redemption price equal to 110.5% of the principal amount, plus accrued and unpaid interest. In addition, if we
experience specific kinds of changes of control, we are required to make an offer to purchase all of the notes at a purchase price of 101% of the principal amount thereof, plus accrued and unpaid
interest. The notes are unsecured senior subordinated obligations and subordinated in right of payment to all of our existing and future senior debt, including borrowings under our senior credit
facility. All of our wholly owned subsidiaries, other than our mortgage subsidiary, have fully and unconditionally guaranteed the notes on a joint and several, unsecured senior subordinated, basis.
The guarantees are general unsecured obligations of the guarantors and will be subordinated in right of payment to all existing and future senior debt of the guarantors, which includes their
guarantees of our senior credit facility described above. The indenture governing the senior subordinated notes contains a number of significant covenants that restricts our ability and that of our
restricted subsidiaries to, among other things: incur additional indebtedness, make certain distributions, investments and other restricted payments, create certain liens, enter into transactions with
affiliates, and merge, consolidate or sell substantially all of our assets. As of September 30, 2007, we were restricted from incurring additional indebtedness (excluding available borrowings
under the senior credit facility), except under certain limited circumstances.

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

We
are party to a senior secured project-specific acquisition and development loan. This loan bears interest at LIBOR plus 2.25% with maturity tied to the sale of the underlying inventory. As of
September 30, 2007, we had $31.6 million outstanding related to this project-specific acquisition and development loan.

We
are party to several unsecured loan agreements that fund our operations on an ongoing basis. In addition, KH Financial, L.P., our wholly owned mortgage subsidiary, is party to a $5 million
warehouse line of credit, used to fund its mortgage origination operations. This facility bears interest at a floating rate equal to LIBOR plus 2.25%, and as of September 30, 2007 there were no
amounts outstanding under the warehouse facility.

We
are also party to a $100 million flexible early purchase facility agreement which allows us to sell qualifying mortgage loans to the holder of the flexible early purchase facility after such
loans have been originated subject to our obligation to sell the loan to an investor in the secondary market. At September 30, 2007, the facility held $31.6 million of loans sold by KH
Financial, L.P.

Our
current levels of cash flow have not been sufficient to allow us to pay principal and interest on our debt, including our senior credit facility and senior subordinated notes, support our
operations and meet our other obligations without continued reliance upon additional borrowings under our senior credit facility. Our ongoing ability to meet our substantial debt service and other
obligations, including compliance with financial covenants in our senior credit facility and senior subordinated notes, will be dependent upon our future performance which will be subject to business,
financial and other factors. We will not be able to control many of these factors, such as the continued deterioration in the homebuilding industry, economic conditions in the markets where we operate
and pressure from competitors. If we do not have enough money, or access to additional borrowings, or are unable to maintain compliance with financial and other covenants in our senior credit facility
and senior

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subordinated
notes, we may be required to seek to refinance all or part of our existing debt, sell assets or borrow more money.

As
of September 30, 2007, we were not in compliance with certain of the covenants in our senior credit facility, including the covenant requiring us to maintain a minimum tangible net worth (as
defined in our senior credit facility). Our failure to meet these covenants allows the lenders under our senior credit facility to declare all amounts outstanding thereunder, together with accrued
interest, to be immediately due and payable. We have begun discussions with our bank group regarding amending our senior credit facility. The bank group has not provided formal assurance that we will
be able to amend our senior credit facility upon reasonable terms, or at all. Nonetheless, there has been no indication that it intends to accelerate amounts due under our facility, and discussions
with our lenders regarding an amendment are active and ongoing.

Contractual obligations

Our primary contractual cash obligations for our operations are payments under our debt agreements and purchase obligations with specific performance requirements under land
option agreements and purchase contracts. These land option agreements and purchase contracts may require us to purchase land contingent upon us and the seller meeting certain obligations.

The
following summarizes our aggregate contractual commitments at September 30, 2007:

|                       
|-----------------------
|
|
|                       
|Notes payable(1)       
|Operating leases       
|Purchase obligations(2)
|                       
|Total                  
|                       
|                       

Under the terms of our stock option plans, we may be required to purchase shares of our common stock at fair market value, including shares issuable under
outstanding options or deferred stock units, from certain of our directors, executive officers and other key employees, in the event of termination of board membership or employment, as applicable, by
reason of specified circumstances, including death, disability, involuntary termination or retirement. As of September 30, 2007, the aggregate repurchase obligation, net of proceeds to be
received from any stock option exercises, would have been $13.3 million in the event that all of these obligations were triggered. Our ability to satisfy our repurchase obligations is subject
to certain limitations set forth in the indenture governing our senior subordinated notes. In addition, if Mr. Hill's employment is terminated by reason of his death or permanent disability,
his family trust may request us to purchase up to 500,000 shares of our common stock, and upon receipt of such request we will reasonably determine in our sole discretion how many shares to purchase
in light of our financial condition and prospects and the limitations, restrictions and constraints in our loan and financing arrangements at the time. The purchase price payable by us will be the
fair market value at that time.

We
are contingently liable to banks and financial institutions for approximately $102 million for outstanding letters of credit and performance bonds securing performance of certain contractual
obligations and land purchase contracts. Approximately $1.4 million of the outstanding letters of credit have been issued by a wholly owned subsidiary. At September 30, 2007, we had
committed to fund approximately $5.1 million in mortgage loans to homebuyers at agreed-upon rates. We have entered into best-efforts and mandatory sale commitments to
sell these mortgages to third parties.

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Land and lot position and homes in inventory

At September 30, 2007, we owned and controlled 18,815 lots, approximately 33% of which were pursuant to option agreements and purchase contracts. The following is a
summary of our land/lot position as of September 30, 2007:

|                                                                 
|-----------------------------------------------------------------
|
|                                                                 
|Finished lots owned                                              
|Lots under development owned                                     
|Lots held for sale                                               
|
|Total lots owned                                                 
|Lots controlled under option agreements and purchase contracts(1)
|
|Total land/lots controlled                                       
|
|                                                                 

Off-balance sheet arrangements

Our primary use of off-balance sheet arrangements is to secure desirable lots on which to build homes in a manner that we believe reduces the overall risk to us.
Our off-balance sheet arrangements relating to our homebuilding operations include land option agreements and purchase contracts and joint ventures.

Land option agreements and purchase contracts

In the ordinary course of business, we enter into option agreements and purchase contracts to secure land for the construction of homes. These agreements generally require us
to pay a deposit to the seller as consideration for the right to acquire land during a specified period, usually at predetermined prices. Some of these option agreements and purchase contracts contain
specific performance clauses, which require us to purchase the land upon satisfaction of certain requirements. Otherwise, our exposure under option agreements and purchase contracts are generally
limited to forfeiture of the nonrefundable deposits, letters of credit and other nonrefundable amounts incurred. Below is a summary of the aggregate exercise price of all option agreements and
purchase contracts as of September 30, 2007:

|                                                                             
|-----------------------------------------------------------------------------
|
|                                                                             
|Land option agreements and purchase contracts with specific performance      
|Land option agreements and purchase contracts without specific performance(2)
|                                                                             
|Total land option agreements and purchase contracts                          
|                                                                             
|                                                                             

Given the continued deterioration in market conditions and uncertainty about the timing and pace of any recovery, we have tightened our land acquisition
criteria and are working with land sellers to renegotiate land purchase and option contracts to extend purchase dates and reduce purchase prices. If we are unable to obtain satisfactory terms, we will
not exercise our land option agreements and will

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abandon
our earnest money if contractually obligated to do so. During fiscal 2007, we wrote-off $15.8 million of costs related to the abandonment of land option contracts.

Investments in and advances to unconsolidated entities

Investments in and advances to unconsolidated entities represent our ownership interests in entities accounted for under the equity method when we have a significant influence
over the entity but hold less than a controlling interest in the entity or we are not the primary beneficiary in a variable interest entity as defined by FIN 46R. See notes 1 and 4 to our consolidated
financial statements. Our partners generally are unaffiliated homebuilders, land sellers or other real estate entities.

In
the ordinary course of business, we periodically enter into arrangements with land developers or other homebuilders to acquire land and develop lots. These arrangements include the creation of
joint ventures, in which our current interests range from 6% to 49%. We account for our interest in these joint ventures under the equity method, and our consolidated balance sheets include
investments in and advances to joint ventures totaling $24.9 million and $48.2 million at September 30, 2007 and 2006, respectively. These joint ventures typically obtain secured
acquisition, development and construction financing. At September 30, 2007 and 2006, our unconsolidated joint ventures had outstanding third party borrowings of $940 million and
$865 million, respectively. From time to time we have issued completion guarantees, repayment guarantees and/or loan-to-value maintenance guarantees in respect of this
indebtedness. These guarantees require us to repay debt of the joint venture in the event of a payment default or in the event that the debt of the joint venture exceeds the value of the property
securing the debt.

The
following is a summary of our significant investments as of September 30, 2007 and 2006:

In
January 2005, we entered into a joint venture, in which we have a 9.59% interest, to acquire and develop land in Nevada. As of September 30, 2007, we determined that our investment in
the venture was more than temporarily impaired and we recorded a $21.5 million charge to write-down the investment balance and to accrue anticipated additional capital
contributions. At September 30, 2006, we had investments in the joint venture totaling $18.3 million. At September 30, 2007, this joint venture had third party debt of
$433 million under a secured credit facility, of which each joint venture member has guaranteed payment of its pro rata share in the event of specified bankruptcy events or in the event
of certain improper or fraudulent actions involving the related joint venture. Our pro rata portion of the debt is $41.5 million at September 30, 2007. We have also provided
pro rata completion guarantees for this joint venture. Recently, this joint venture received notice from the administrative agent under its secured credit facility that it was not in compliance
with certain covenants thereunder, including a performance covenant requiring that the joint venture make a specified amount of progress with respect to the projects contemplated under the secured
credit facility. Breach of such covenant constitutes an event of default under its secured credit facility. If such default remains uncured, the lenders under this facility may terminate commitments
under the facility and may accelerate the joint venture's repayment obligations. Further, our repayment guarantee requires that we be in compliance with the financial covenants contained in our senior
credit facility, which, as of September 30, 2007, we are not in compliance with. In addition, our current default under our senior credit facility constitutes an event of default under this
joint venture's secured credit facility. Failure to cure such defaults could result in the acceleration of the joint venture's repayment obligations under the facility. To our knowledge, the lenders
under this facility have not indicated they will accelerate amounts due under the facility as a result of these defaults, however, there can be no assurance that they will not.

In
May 2004, we entered into a joint venture, in which we have a 6.29% interest, to acquire and develop land in Nevada. At September 30, 2007 and 2006, we had investments in the joint
venture totaling $11.7 million and $16.1 million, respectively. At September 30, 2007, this joint venture had third party debt of $458 million under a secured credit
facility, of which each joint venture member has

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guaranteed
payment of its pro rata share in the event of specified bankruptcy events or in the event of certain improper or fraudulent actions involving the related joint venture. Our pro rata
portion of the debt is $28.8 million at September 30, 2007. We have also provided pro rata completion guarantees for this joint venture. Further, our repayment guarantee requires
that we be in compliance with the financial covenants contained in our senior credit facility, which, as of September 30, 2007, we are not in compliance with. In addition, our current default
under our senior credit facility constitutes an event of default under this joint venture's secured credit facility. Failure to cure such defaults could result in the acceleration of the joint
venture's repayment obligations under the facility. To our knowledge, the lenders under this facility have not indicated they will accelerate amounts due under the facility as a result of these
defaults, however, there can be no assurance that they will not.

In
December 2002, we entered into a joint venture, in which we have a 23.75% interest, to develop property and construct single-family and multi-family residences in Chicago, Illinois. At
September 30, 2007 and 2006, we had investments in and advances to the joint venture totaling $4.3 million and $4.9 million, respectively. We have provided completion, financial
and performance guarantees in
connection with the venture's $20 million construction financing for a single phase of the project. In addition, we have provided a guarantee on a $9 million tax increment financing bond
for this project. As of September 30, 2007, $12.5 million of funds have been drawn on the construction financing facility and $5.4 million was drawn on the tax increment financing
bond. We are not obligated to loan additional funds to the venture.

In
May 2004, we entered into a joint venture, in which we have a 35% interest, to develop property in Detroit, Michigan. At September 30, 2007 and 2006, we had investments in and
advances to the joint venture totaling $2.8 million and $1.8 million, respectively. We are not obligated to loan additional funds to the venture.

In
August 2004, we entered into a joint venture, in which we have a 33.3% interest, to develop property and construct single-family and multi-family residences in Chicago, Illinois. At
September 30, 2007 and 2006, we had investments in and advances to the joint venture totaling $2.4 million and $3.1 million, respectively. We have provided completion, financial
and performance guarantees in connection with certain of the venture's indebtedness totaling $125.1 million, with our maximum financial guarantees limited to $15.5 million in the
aggregate. At September 30, 2007, there was $27.7 million outstanding under these credit facilities. We have also provided guarantees in connection with $9.8 million and
$14.5 million of capital contributions to be made by an unrelated joint venture member, whereby we would make the contributions if the unrelated joint venture member does not. We are not
obligated to loan additional funds to the venture.

In
January 2006, we entered into a joint venture, in which we had a 35% interest, to develop a high-rise mixed use tower in San Jose, California. At September 30, 2006, we
had investments in the joint venture of $2.5 million. In January 2007, we sold our ownership interest in the joint venture to an entity controlled by our Executive Chairman for
$2.9 million, which was equal to our total financial investment in the project. This transaction was approved by our Board of Directors.

In
October 2006, we entered into a joint venture, in which we have a 45% interest, to develop property and construct single-family residences in Houston, Texas. At September 30, 2007, we
had investments in and advances to the joint venture totaling $3.2 million. We are not obligated to loan additional funds to the venture.

Seasonality and variability in quarterly results

Our homebuilding operating cycle typically reflects increased new order activity in our second and third fiscal quarters and increased deliveries in our third and fourth fiscal
quarters. We believe that this seasonality reflects the tendency of homebuyers to shop for a new home in the spring with the goal of closing in the fall, as well as the scheduling of paving and
construction to accommodate seasonal

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weather
conditions. However, the historical norms have been disrupted in recent years as a result of the continued deterioration in market conditions.

Backlog

Our sales contracts require cash deposits in line with respective market practices and may be subject to certain contingencies such as the buyer's ability to qualify for
financing. Homes covered by such sales contracts but not yet delivered are considered "backlog." We do not recognize revenue upon the sale of a home until it is delivered to the homebuyer and other
criteria for sale and profit recognition are met. We sometimes build homes before obtaining a sales contract, however, these homes are excluded from backlog until a sales contract is signed. At
September 30, 2007 and 2006, we had 327 units and 285 units, respectively, of completed homes in inventory without sales contracts which represented 32% and 20%, respectively, of our total home
inventory (in units). The increase in completed homes in inventory is attributed to a general deterioration of the homebuilding and residential housing markets. Our cancellation rates for the fiscal
years ended September 30, 2007 and 2006 were 28% and 32%, respectively.

Interest rates and inflation

Our business is significantly affected by the level of interest rates. Higher interest rates may decrease demand for our homes by making it more difficult for homebuyers to
qualify for mortgages or to obtain mortgages at interest rates that are acceptable to them. Higher interest rates would also increase our borrowing costs because a portion of our bank loans fluctuate
with LIBOR and prime lending rates. In November 2006, we entered into a two year interest rate cap agreement to protect $100 million of our borrowings from sharp increases in the LIBOR
lending rate.

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

Critical accounting estimates and policies

The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements which have been prepared in accordance with
GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure
of contingent assets and liabilities. We evaluate our estimates on an on-going basis. We base our estimates on historical experience and on various other assumptions that we believe are
reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or conditions.

Management
believes that the following critical accounting policies affect its more significant judgments and estimates used in preparation of its consolidated financial statements:

Revenue recognition

Homebuilding.Revenue from home and land sales is recorded when title is conveyed to the home or land buyer, adequate cash payment has been
received and there is no continued involvement. We occasionally sell homes with the express purpose of leasing the homes back to use as our model home and sales office for a specified period of time.
We record the sale of the home at the time of the home

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closing
and if the leaseback is more than minor, the profit on the sale is deferred and recognized over the lease term, as a reduction to rent expense, in accordance with the provisions of Statement
of Financial Accounting Standards No. 98,Accounting for Leases.

Mortgage banking.We recognize the majority of the revenues associated with our mortgage operations when the mortgage loans and related
servicing rights are sold to third party investors. Origination fees, net of direct origination costs, are deferred and recognized as revenues, along with the associated gains and losses on the sales
of the loans and related servicing rights, when the loans are sold. We sell all mortgage loans and related servicing rights to third party investors.

Homebuilding inventory and cost of sales

We state inventories at accumulated costs unless the inventory within a community is determined to be impaired, in which case the impaired inventory is written down to fair
market value. In addition to the costs of direct land acquisition, land development and home construction, inventory costs include interest, real estate taxes and field construction and supervision
salaries and related overhead expenses.

We
use the specific identification method for the purpose of accumulating home construction costs. Cost of sales for homes delivered includes the specific construction costs of each home and all
applicable land acquisition, land development and related costs, both incurred and estimated to be incurred, based upon the total number of homes expected to be delivered in each project. Construction
cost of the home includes amounts paid through the closing date of the home, plus an accrual for costs incurred but not yet paid, based on an analysis of budgeted construction cost. This accrual is
reviewed for accuracy based on actual payments made after closing compared to the amount accrued, and adjustments are made if needed. Any significant changes to the estimated total development costs
subsequent to the initial home deliveries in a project are generally allocated on a pro-rata basis to the total homes in the project. The change in estimate allocated to homes previously
delivered is charged to cost of sales during the period in which the estimate is changed.

In
accordance with Statement of Financial Accounting Standards No. 144,Accounting for the Impairment or Disposal of Long-Lived
Assets("SFAS 144"), we assess housing projects and land held for development and sale for recoverability whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets is measured by comparing the carrying amount of an asset to future undiscounted net cash flows expected to be generated by
the asset. If these assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. For
purposes of these impairment calculations, we determine the fair value of each asset determined to be impaired either by using internal project modeling software to determine the present value of the
estimated future cash flows on a community-by-community basis using discount rates which are commensurate with the risk of the community or by referring to independent
project-specific appraisals or by comparing to recent comparable land sales when the land appeared to have a better use other than for homebuilding.

These
evaluations for impairment are significantly impacted by estimates of revenues, costs and expenses and other factors. We continue to monitor the homebuilding climate in each of our markets and
could change our intentions about whether to continue homebuilding activities related to any assets
in the future. Changes in our intentions or our expectations of market performance could have a material impact on the carrying value of our assets as certain of the assets determined to be
recoverable on an undiscounted cash flow basis may have carrying values greater than fair value.

Variable interest entities

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 equity investment at risk is not

41

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sufficient
to permit the entity to finance its activities without additional subordinated financial support from other parties or (ii) equity holders either (a) lack a direct or indirect
ability to make decisions about the entity, (b) are not obligated to absorb expected losses of the entity or (c) do not have the right to receive expected residual returns of the entity,
if they occur. FIN 46R requires the primary beneficiary of a VIE to consolidate that entity. The primary beneficiary of a VIE is the party that absorbs a majority of the VIE's expected losses,
receives a majority of the entity's expected residual returns or both, as a result of ownership, contractual interests or other financial interests in the entity.

Forward
contracts, such as the purchase agreements we use to acquire land and finished lot inventory, are deemed to be "variable interests" under FIN 46R. Therefore, the seller entities with which we
enter into purchase agreements are examined under FIN 46R for possible consolidation by us, including the joint venture entities or structures utilized by us. We have developed a methodology to
determine whether or not we are the primary beneficiary at the time we enter into land option agreements and purchase contracts or joint ventures or at the time when those agreements change. The
methodology used to evaluate our primary beneficiary status requires substantial management judgment and estimates. These judgments and estimates involve assigning probabilities to various estimated
cash flow possibilities relative to the seller entity's expected profits and losses and the cash flows associated with the entity. Because we do not have any contractual or ownership interests in the
seller entities with which we contract to buy land or finished lots (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 financial or other data to assist us in the performance of our primary beneficiary evaluation. In many instances, these entities provide little, if any, financial information to us. This
lack of direct information from the seller entities may result in our evaluation being conducted solely based on the aforementioned management judgments and estimates. Although we believe that our
accounting policy is designed to properly assess our primary beneficiary status relative to our involvement with these seller entities from which we acquire land and finished lots, changes to the
probabilities and the cash flow possibilities used in our evaluation could produce widely different conclusions regarding our status or non-status as a seller entity's primary beneficiary,
possibly resulting in additional, or fewer, seller entities being consolidated on our financial statements.

We
have applied, as required, FIN 46R to all variable interests and have determined that many of our options on land represent a variable interest in VIEs. We have determined we are the primary
beneficiary of certain of these option contracts and although 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 to unconsolidated entities

Investments in and advances to unconsolidated entities represent our ownership interest in entities that are accounted for under the equity method when we have a significant
influence over the entity but hold less than a controlling interest or are not the primary beneficiary in variable interest entities as defined by FIN 46R. Our partners in these entities generally are
unrelated homebuilders, land sellers or other real estate entities. We record our investments in these entities in our consolidated balance sheets as investments in and advances to unconsolidated
entities and our share of the entities' earnings or losses in our consolidated statements of operations as equity in income of unconsolidated entities. When indicators exist that our equity and cost
method investments are impaired, we consider whether that impairment is other than temporary. If the impairment is determined to be other than temporary, we record an impairment by the amount which
the carrying amount of the investment exceeds its fair value. We do not recognize earnings from home sites we purchase from joint ventures, but instead reduce our cost basis in these home sites by our
share of the earnings on the home sites. Advances to these entities are included in the investment balance.

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Warranty costs

Warranty and product liability accruals are established to provide for estimated future expenses as a result of construction and product defects and product recalls incidental
to our business. Liability estimates are determined based on management's judgment, considering such factors as historical experience, the likely current cost of corrective action, manufacturers' and
independent contractors' participation in sharing the cost of corrective action, consultations with third party experts such as engineers, and discussions with our general counsel and 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 time to cover losses due to increased costs for material and labor, the inability or refusal of manufacturers or independent contractors to financially participate in corrective
action, unanticipated adverse legal settlements or other unanticipated changes to the assumptions used to estimate the warranty and product liability accrual.

Litigation reserves

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

Insurance claims costs

We have, and require the majority of our independent contractors to have, general liability and workers' compensation insurance. These insurance policies protect us against a
portion of our risk of loss from claims, subject to certain self-insured retentions, deductibles and other coverage limits. We reserve for costs to cover our self-insured and
deductible amounts under those policies and for any estimated costs of claims and lawsuits in excess of our coverage limits or not covered by our policies, based on an analysis of our historical
claims, which includes an estimate of construction defect and other claims incurred but not yet reported. Projection of losses related to these liabilities is subject to a high degree of variability
due to uncertainties such as trends in construction defect claims relative to our markets and the types of products we build, claim settlement patterns, insurance industry practices and legal
interpretations, among others. Because of the judgment required in determining these estimated reserve amounts, actual future costs could differ from our currently estimated amounts.

Valuation of deferred tax assets

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

We
believe that the accounting estimate for the valuation of deferred tax assets is a critical accounting estimate because judgment is required in assessing the likely future tax consequences of
events that have been recognized in our financial statements or income tax returns. We base our estimate of deferred tax assets and liabilities on current tax laws and rates and, in certain cases,
business plans and other expectations about future outcomes. Changes in existing tax laws or rates could affect actual tax results and future business results may affect the amount of deferred tax
liabilities or the valuation of deferred tax assets over time. Our accounting for deferred tax consequences represents our best

43

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estimate
of future events. Differences between the anticipated and actual outcomes of these future tax consequences could have a material impact on our consolidated results of operations or financial
position.

Stock-based compensation

We occasionally issue options to purchase our common stock to our employees and directors. All of these stock options have an exercise price equal to the fair market value of
the underlying common shares on the date of grant and either vest immediately or vest in equal installments over four years from the anniversary of the grant date. We estimate the fair market value of
the underlying common shares on the date of grant by reference to recent stock transactions between willing parties or based upon recent valuations of our stock.

Effective
October 1, 2006, we adopted SFAS 123R,Share-Based Payment, which requires that the cost resulting from all share-based payment
transactions be recognized in the financial statements and establishes fair value as the measurement objective in accounting for share-based payment arrangements. SFAS 123R applies to all
awards granted, modified, repurchased or cancelled by us after the effective date of adoption. We have not granted, modified, repurchased or cancelled any awards since the effective date. Since we
previously used the minimum value method under SFAS 123,Accounting for Stock-Based Compensation, we will continue to account for any portion of
awards outstanding at October 1, 2006 using the accounting principles originally applied to those awards.

Redeemable common stock

Under the terms of our amended stock option plans, we have contractual obligations to purchase shares of our outstanding common stock at fair value from certain of our
directors, executive officers and other key employees in the event of termination of board membership or employment, as applicable, by reason of specified circumstances, including death, disability,
involuntary termination or retirement. Certain outstanding options would qualify for this redemption right after exercise of the options.

At
the time outstanding shares qualify for this redemption right, the redemption amount is transferred from shareholders' equity to redeemable common stock. Subsequent changes to the redemption amount
are transferred from shareholders' equity to redeemable common stock in the case of an increasing redemption amount, or, from redeemable common stock to shareholders' equity in the case of a
decreasing redemption amount.

We
establish the fair value of our stock on a quarterly basis. The evaluation of fair value is significantly impacted by the homebuilding industry climate and our relative performance. Considering the
continued deterioration in market conditions and the uncertainties about our ability to continue as a going concern (see note 1 to the consolidated financial statements), the estimated fair
value of the redeemable common stock includes significant subjective assumptions, but represents our best estimate as of the consolidated balance sheets dates.

Recent Accounting Pronouncements

In July 2006, the FASB issued FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes("FIN 48"),
which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Additionally, FIN 48
provides guidance on the derecognition, classification, accounting in interim periods and disclosure requirements for uncertain tax positions. FIN 48 became effective for us on October 1, 2007,
but is not expected to have a material impact on our results of operations or financial position.

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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 in generally accepted accounting principles and expands disclosure about fair value measurements. SFAS 157 is effective for financial statements issued for
fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. However, the FASB did provide a one year deferral for the implementation of SFAS 157 for
certain nonfinancial assets and liabilities. We are in the process of determining the effect, if any, the adoption of SFAS 157 will have on our financial statements.

In
September 2006, the SEC issued Staff Accounting Bulletin No. 108,Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current
Year Financial Statements("SAB 108"), which provides guidance as to how the effects on prior year uncorrected misstatements should be considered when quantifying misstatements
in the current financial statements. SAB 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. SAB 108 required us
to quantify misstatements using both a balance sheet
and income statement approach, with adjustment required if either method results in a material error. SAB 108 became effective for us on October 1, 2007, but is not expected to have a material
impact on our results of operations or financial position.

In
February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement
No. 115("SFAS 159"). SFAS 159 permits a company to measure certain financial instruments and other items at fair value. SFAS 159 is effective for
financial statements issued for fiscal years beginning after November 15, 2007, with early adoption permitted. We are in the process of determining the effect, if any, the adoption of
SFAS 159 will have on our financial statements.

In
December 2007, the FASB issued SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements("SFAS 160")an amendment of ARB No. 51. SFAS 160 establishes accounting and reporting standards for noncontrolling interests in consolidated financial
statements. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Early adoption is prohibited. We
are in the process of determining the effect, if any, the adoption of SFAS 160 will have on our financial statements.

Item 7A.    Quantitative and Qualitative Disclosures About Market Risk

We are exposed to a number of market risks in the ordinary course of business. Our primary market risk exposure for financial instruments relates to fluctuations in interest
rates. We do not believe our exposure in this area is material to cash flows or earnings. As of September 30, 2007, we had a total of $359.2 million of floating rate debt outstanding,
including our senior credit facility and other facilities. Borrowings under these facilities generally bear interest based on applicable margins plus LIBOR or an alternate base rate. Holding our
variable rate debt balances constant as of September 30, 2007, each one percentage point increase in interest rates would result in an increase in interest incurred for the next fiscal year of
approximately $3.6 million. A one percentage point increase in interest rates on our average variable rate debt outstanding during fiscal 2007 would have resulted in an increase in interest
incurred of approximately $3.3 million.

From
time to time, we enter into interest rate swap or interest rate cap agreements to manage interest costs and hedge against risks associated with fluctuating interest rates with respect to our
floating rate debt. Currently, we hedge exposure on $100 million of our variable rate debt from interest rate fluctuations through the use of an interest rate cap. Under the terms of the
agreement, the LIBOR rate is capped at 5.5% per annum. We do not enter into or hold derivatives for trading or speculative purposes.

45

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Item 8.    Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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

We
have audited the accompanying consolidated balance sheets of Kimball Hill, Inc. and subsidiaries (the "Company") as of September 30, 2007 and 2006, and the related consolidated
statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended September 30, 2007. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control
over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, such financial statements present fairly, in all material respects, the consolidated financial position of the Company as of September 30, 2007 and 2006 and the consolidated
results of its operations and its cash flows for each of the three years in the period ended September 30, 2007, in conformity with accounting principles generally accepted in the United States
of America.

The
accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company's losses
from operations and default under its senior credit facility raise substantial doubt about its ability to continue as a going concern. Management's plans concerning these matters are also discussed in
Note 1 to the financial statements. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/
DELOITTE & TOUCHE LLP

Chicago,
Illinois
January 11, 2008

46

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Kimball Hill, Inc. and Subsidiaries        Consolidated Balance Sheets

|                                              
|----------------------------------------------
|
|                                              
|Assets                                        
|HOMEBUILDING:                                 
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|MORTGAGE BANKING:                             
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|TOTAL ASSETS                                  
|                                              
|Liabilities and equity                        
|HOMEBUILDING:                                 
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|MORTGAGE BANKING:                             
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|MINORITY INTEREST IN CONSOLIDATED PARTNERSHIPS
|MINORITY INTEREST IN INVENTORY NOT OWNED      
|REDEEMABLE EQUITY:                            
|                                              
|SHAREHOLDERS' EQUITY:                         
|                                              
|                                              
|                                              
|                                              
|                                              
|TOTAL LIABILITIES AND EQUITY                  
|                                              
|                                              

See notes to consolidated financial statements.

47

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Kimball Hill, Inc. and Subsidiaries        Consolidated Statements of Operations

|                                     |                                                                         
|------------------------------------ | ------------------------------------------------------------------------
|
|                                     |                                                                         
|HOMEBUILDING:                        |                                                                         
|                                     | Revenues:                                                               
|                                     |                                                                         
|                                     |                                                                         
|                                     |                                                                         
|                                     |                                                                         
|                                     | Expenses:                                                               
|                                     |                                                                         
|                                     |                                                                         
|                                     |                                                                         
|                                     |                                                                         
|                                     |                                                                         
|                                     |                                                                         
|                                     | Equity in (losses) income of unconsolidated joint ventures              
|                                     | Minority interests in net losses (earnings) of consolidated partnerships
|                                     |                                                                         
|                                     |                                                                         
|                                     |                                                                         
|MORTGAGE BANKING:                    |                                                                         
|                                     | Revenues:                                                               
|                                     |                                                                         
|                                     |                                                                         
|                                     |                                                                         
|                                     |                                                                         
|                                     | Expenses:                                                               
|                                     |                                                                         
|                                     |                                                                         
|                                     |                                                                         
|                                     |                                                                         
|                                     |                                                                         
|                                     |                                                                         
|                                     |                                                                         
|                                     |                                                                         
|(LOSS) EARNINGS BEFORE INCOME TAXES  |                                                                         
|(BENEFIT) PROVISION FOR INCOME TAXES |                                                                         
|                                     |                                                                         
|NET (LOSS) EARNINGS                  |                                                                         
|                                     |                                                                         
|                                     |                                                                         

See notes to consolidated financial statements.

48

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Kimball Hill, Inc. and Subsidiaries        Consolidated Statements of Shareholders' Equity

|                           |                                                         
|-------------------------- | --------------------------------------------------------
|
|
|
|
|                           |                                                         
|BALANCEOctober 1, 2004    |                                                         
|                           | Net earnings                                            
|                           | Distributions (net of tax of $3,160)                    
|                           | Allocated ESOP shares                                   
|                           | Net change in redeemable common stock                   
|                           | Issuance of common stock                                
|                           | Tax benefit of stock options                            
|                           | Equity-based compensation                               
|                           | Repurchases of common stock                             
|                           |                                                         
|BALANCESeptember 30, 2005 |                                                         
|                           | Net earnings                                            
|                           | Net change in redeemable common stock                   
|                           | Issuance of common stock (net of issuance costs of $150)
|                           | Tax benefit of stock options                            
|                           | Equity-based compensation                               
|                           | Repurchases of common stock                             
|                           |                                                         
|BALANCESeptember 30, 2006 |                                                         
|                           | Net loss                                                
|                           | Net change in redeemable common stock                   
|                           | Issuance of common stock                                
|                           | Tax benefit of stock options                            
|                           | Equity-based compensation                               
|                           | Repurchases of common stock                             
|                           |                                                         
|BALANCESeptember 30, 2007 |                                                         
|                           |                                                         
|                           |                                                         

See notes to consolidated financial statements.

49

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Kimball Hill, Inc. and Subsidiaries        Consolidated Statements of Cash Flows

|                                                                                         |                                                                                      
|---------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------
|
|                                                                                         |                                                                                      
|Cash flows from operating activities:                                                    |                                                                                      
|                                                                                         | Net (loss) earnings                                                                  
|                                                                                         | Adjustments to reconcile net (loss) earnings to cash flows from operating activities:
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|Cash flows from investing activities:                                                    |                                                                                      
|                                                                                         | Purchases of property and equipment                                                  
|                                                                                         | Disposals of property and equipment                                                  
|                                                                                         | Distributions of contributed capital from investments in unconsolidated entities     
|                                                                                         | Contributions and advances to investments in unconsolidated entities                 
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|Cash flows from financing activities:                                                    |                                                                                      
|                                                                                         | Proceeds from issuance of notes and mortgage loans payable                           
|                                                                                         | Repayments of notes and mortgage loans payable                                       
|                                                                                         | Debt issuance costs                                                                  
|                                                                                         | Net proceeds from issuance of common stock                                           
|                                                                                         | Repurchases of common stock                                                          
|                                                                                         | Distributions                                                                        
|                                                                                         | Contributions from minority interests                                                
|                                                                                         | Distributions to minority interests                                                  
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|Net increase (decrease) in cash and cash equivalents                                     |                                                                                      
|                                                                                         | Cash and cash equivalentsBeginning of year                                          
|                                                                                         |                                                                                      
|                                                                                         | Cash and cash equivalentsEnd of year                                                
|                                                                                         |                                                                                      
|Reconciliation to cash and cash equivalents reported on the consolidated balance sheets: |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|Supplemental disclosure of cash flow information:                                        |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|Supplemental disclosure of noncash investing and financing activities:                   |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      
|                                                                                         |                                                                                      

See notes to consolidated financial statements.

50

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Kimball Hill, Inc. and Subsidiaries    Notes to Consolidated Financial Statements

1.     Basis of Presentation and Summary of Significant Accounting Policies

Kimball Hill, Inc. and its subsidiaries (the "Company") are actively involved in residential construction. The Company builds homes which include a wide range of
single-family detached and multi-family products. The Company has ownership interests in ventures which provide title agency services. The Company also owned a mortgage banking operation, KH
Financial, L.P, through its fiscal year ended September 2007, which originated mortgages with an emphasis on facilitating the financing of residential loans secured by homes sold and
constructed by the Company. All mortgages were sold to third parties. During fiscal 2007, the Company had residential development activities in the following states: California, Florida, Illinois,
Nevada, Ohio, Oregon, Texas, Washington and Wisconsin.

Going ConcernThe Company's ability to continue as a going concern is dependent upon its ability to return to
profitable operations in the future and to retain the necessary financing to meet its obligations and pay its liabilities when they come due.

Market
conditions for new home sales have deteriorated significantly throughout the Company's fiscal year as inventory levels of both new and existing homes have continued to climb and price
competition places pressure on already strained profit margins. During the year ended September 30, 2007, the Company recognized a net loss of $220.5 million and incurred negative cash
flows from operations of $17.1 million. Included within the Company's net loss are inventory impairment charges of $240.0 million which have significantly impacted the reported values of
the Company's inventory and shareholders' equity.

As
of September 30, 2007, the Company was not in compliance with certain of its amended covenants of its senior credit facility, including the covenant requiring the Company to maintain a
minimum tangible net worth (as defined in the senior credit facility). See note 7 for a description of the covenants in the Company's senior credit facility. The Company's failure to meet these
covenants is an event of default
that allows the lenders under the senior credit facility to declare all amounts outstanding thereunder, together with accrued interest, to be immediately due and payable. Acceleration under the senior
credit facility would also trigger a cross-default under the indenture governing the Company's senior subordinated notes, thereby allowing the Company's bondholders to accelerate the repayment of all
amounts outstanding on the senior subordinated notes, subject to certain payment blockage periods. In addition, certain other credit facilities within the Company's joint ventures to which the Company
has provided guarantees include provisions for acceleration or events of default in the event of a default under the Company's senior credit facility.

The
Company has begun discussions with its bank group regarding amending the senior credit facility. The bank group has not provided formal assurance that the Company will be able to amend its senior
credit facility upon reasonable terms, or at all. Nonetheless, there has been no indication that it intends to accelerate amounts due under the facility, and discussions with the Company's lenders
regarding an amendment are active and ongoing. The Company currently has no alternative financing in place and if it is unable to find alternative financing or obtain a waiver, the Company may not
have sufficient assets to repay the outstanding debt if accelerated.

In
an effort to manage through its current situation, the Company is selling certain land inventory. As of September 30, 2007, the Company has identified $49.2 million of land inventory
that it intends to sell and is actively marketing the properties for delivery within the next 12 months. In addition to the land identified for sale, the Company intends to further match its
investment in land to current and foreseeable market conditions by continually evaluating and selling land that is not critical to its homebuilding operations over the next 24 months. The
Company has also reduced headcount by 30%, from 1,076 employees at August 1, 2006 to 748 employees at September 30, 2007.

51

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Due
to the uncertainties mentioned above, there are doubts about whether the Company will be able to continue as a going concern, and therefore, the Company may be unable to realize its assets and
discharge its liabilities in the normal course of business. The Company's consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets
and the settlement of liabilities and commitments in the normal course of business. The accompanying financial statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts or to the amounts and classification of liabilities that may be necessary if the Company is unable to continue as a going concern.

Management's Use of EstimatesThe preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities, and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Principles of ConsolidationThe accompanying consolidated financial statements include the accounts of Kimball
Hill, Inc. and all of its wholly-owned, majority-owned and controlled subsidiaries, as well as certain variable interest entities from which the Company is purchasing land or lots under option
agreements and purchase contracts. All significant intercompany balances and transactions have been eliminated.

Cash and Cash EquivalentsThe Company considers investments in money market and bank certificates purchased with a
maturity of three months or less to be cash equivalents.

Mortgage Loans Held for SaleMortgage loans held for sale consist of loans originated by the Company and intended
for sale in the secondary market. In the aggregate, such loans are carried at the lower of cost or market. The Company sells all originated loans to third parties.

InventoryThe Company records inventory at accumulated costs unless the inventory within a community is determined
to be impaired, in which case the impaired inventory is written down to fair market value. In addition to the costs of direct land acquisition, land development and home construction, inventory costs
include interest, real estate taxes and field construction and supervision salaries and related overhead expenses. The Company uses the specific identification method for the purpose of accumulating
home construction costs.

Deferred ExpensesDeferred expenses include certain costs incurred which are expected to benefit future periods and
are recognized as a component of sales and marketing or general and administrative expenses as units of a project are delivered. Deferred expenses also include debt issuance costs which are amortized
over the lives of the respective debt obligations as a component of interest expense.

Investments In and Advances to Unconsolidated EntitiesInvestments in and advances to unconsolidated entities
represent the Company's ownership interest in unconsolidated entities and are accounted for under the equity method when the Company has a significant influence over the entity but holds less than a
controlling interest or is not the primary beneficiary in a variable interest entity as defined by the Financial Accounting Standards Board ("FASB") Revised Interpretation, Consolidation of Variable Interest
Entities("FIN 46R"). The Company uses the cost method for ventures over which it does not have a significant
influence. When indicators exist that the Company's equity and cost method investments are impaired, the Company considers whether that impairment is other than temporary. If the impairment is
determined to be other than temporary, the Company records an impairment by the amount which the carrying amount of the investment exceeds its fair value. During 2007, the Company recorded a
$21.5 million charge to write-down an investment balance and to accrue additional capital contributions. The Company did not write-down any investments in 2006 or 2005. These charges are

52

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included
in equity in (losses) income of unconsolidated joint ventures in the accompanying consolidated statements of operations.

Property and EquipmentDepreciation is computed principally by the straight-line method over the
following estimated useful lives:

|                                   
|-----------------------------------
|Land improvements                  
|Buildings and building improvements
|Tenant improvements                
|Other                              
|                                   

The cost and accumulated depreciation relating to assets retired or otherwise disposed of are eliminated from the respective accounts at the time of disposition. The resultant
gain or loss is included in operations.

Impairment of Long-Lived AssetsIn accordance with Statement of Financial Accounting Standards
No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets("SFAS 144"), the Company assesses housing projects,
land held for development and sale, and property and equipment for recoverability whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets is measured by comparing the carrying amount of an asset to future undiscounted net cash
flows expected to be generated by the asset. If these assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount exceeds the fair
value of the assets.

For
purposes of measuring impairment, SFAS 144 distinguishes between long-lived assets held for sale and long-lived assets to be held and used. Long-lived
assets held for sale should be reported at the lower of the carrying amount or fair value, less costs to sell the assets. Long-lived assets to be held and used with a carrying value that
will not be recoverable from future undiscounted cash flows should be reported at the lower of the carrying amount or fair value.

When
reviewing for impairment, the Company evaluated the future undiscounted net cash flows expected to be generated by each asset based upon the Company's intentions at the time of the review. For
purposes of these impairment calculations, the Company determined the fair value of each asset determined to be impaired either by using internal project modeling software to determine the present
value of the estimated future cash flows on a community-by-community basis using discount rates which are commensurate with the risk of the community or by referring to
independent project-specific appraisals or by comparing to recent comparable land sales and recent discussions with land brokers and potential buyers where the Company is actively marketing the land
for sale.

These
evaluations for impairment are significantly impacted by estimates of revenues, costs and expenses and other factors. Market conditions in the United States homebuilding market have continued to
weaken since the end of the Company's fiscal year end, and the Company has included these changes in market conditions in its set of assumptions used to estimate recoverability. The Company will
continue to monitor the homebuilding climate in each of its markets and could change its intentions about whether to continue homebuilding activities related to any assets in the future. Changes in
the Company's intentions or its expectations of market performance could have a material impact on the carrying value of its assets as certain of the assets determined to be recoverable on an
undiscounted cash flow basis may have carrying values greater than fair value.

Due
to the continued deterioration in market conditions and the overall national homebuilding climate, the Company reviewed all of its inventory for impairment and recorded inventory impairment
charges of $240.0 million and $25.8 million during the years ended September 30, 2007 and 2006, respectively. The Company did not record any inventory impairment charges during
the year ended September 30,

53

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2005.
These charges are included in cost of sales in the accompanying consolidated statements of operations.

The
Company's current operating strategy includes selling certain land inventory to: reduce debt, adjust the balance of its land holdings by region and reduce its overall investment in land. The
Company has identified certain land parcels it intends to sell and is actively marketing the properties for delivery within the next 12 months. As of September 30, 2007, the Company has
$49.2 million of land inventory that is held for sale on which the Company recorded an impairment charge of $52.1 million.

Given
the continued deterioration in market conditions and uncertainty about the timing and pace of any recovery, the Company has tightened its land acquisition criteria and is working with land
sellers to renegotiate land purchase and option contracts to extend purchase dates and reduce purchase prices. If the Company is unable to obtain satisfactory terms, the Company will not exercise its
land option agreements and will abandon its earnest money if contractually obligated to do so. During the years ended September 30, 2007 and 2006, the Company wrote-off
$15.8 million and $8.3 million of costs related to the abandonment of land option contracts.

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

The
Company occasionally sells homes with the express purpose of leasing the homes back to use as its model home and sales office for a specified period of time. The Company records the sale of the
home at the time of the home closing, and if the leaseback is more than minor the profit on the sale is deferred and recognized over the lease term, as a reduction to rent expense, in accordance with
the provisions of the Statement of Financial Accounting Standards No. 98,Accounting for Leases.

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

The
Company entered into a flexible early purchase facility agreement in February 2004, which as amended, provides for a maximum facility limit of $100 million. The terms of the purchase
facility agreement allow the Company to sell qualifying loans to the holder of the flexible early purchase facility after such loans have been originated subject to the Company's obligation to sell
the loan to an investor in the secondary market. During the year ended September 30, 2007, approximately $366 million of mortgage loans were sold to the holder of the flexible early
purchase facility. At September 30, 2007, the facility held $31.6 million of loans sold by the Company.

Income TaxesDeferred tax liabilities and assets are determined based upon the temporary difference between the
financial reporting carrying values and income tax bases of assets and liabilities, and are measured using enacted tax rates in effect for the year in which the differences are expected to reverse. In
assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. A portion of the
Company's deferred tax assets will be realized through a federal tax refund generated by carrying back tax losses against taxable income generated in prior tax years. The ultimate realization of the
Company's remaining deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. In determining the future
tax consequences of events that have been recognized in the Company's consolidated financial statements or tax returns, judgment is required. Differences between the anticipated and actual outcomes of
these

54

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future
tax consequences could have a material impact on the Company's consolidated results of operations or financial position.

Warranty CostsWarranty reserves for homes are established in an amount estimated based on historical results to be
adequate to cover expected warranty-related costs for materials and outside labor to be incurred during the warranty period.

GuaranteesThe Company conducts a portion of its land acquisition, development and other activities through its
non-controlling participation in joint ventures. For certain of the joint ventures, the Company provides guarantees considered normal in the industry to which it may be obligated to
indemnify the other party with respect to certain matters (see note 4). The Company records the fair value of guarantees provided to non-consolidated joint ventures as an investment
in the joint venture with a corresponding liability if the Company has determined the fair value to be more than insignificant at the inception of the guarantee. To date, the Company has not incurred
any significant costs as a result of such indemnification agreements.

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

Stock PlansEffective October 1, 2006, the Company adopted SFAS 123R, Share-Based Payment, which requires that the cost resulting from
all share-based payment transactions be recognized in the financial statements and
establishes fair value as the measurement objective in accounting for share-based payment arrangements. SFAS 123R applies to all awards granted, modified, repurchased or cancelled by the
Company after the effective date of adoption. The Company has not granted, modified, repurchased or cancelled any awards since the effective date. Since the Company previously used the minimum value
method under SFAS 123,Accounting for Stock-Based Compensation, the
Company will continue to account for any portion of awards outstanding at October 1, 2006 using the accounting principles originally applied to those awards.

The
Company has recognized employee compensation cost for certain of its stock options granted that were considered to be variable awards (see note 9). If the Company had elected to recognize
compensation cost based on the fair value of the options granted at the grant date as prescribed by SFAS 123, earnings before income taxes would have been reduced by approximately
$0.1 million for the years ended September 30, 2007 and 2006 and increased by approximately $15.9 million for the year ended September 30, 2005.

During
fiscal 2005, the Company granted 37,500 deferred stock units, representing a right 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 fully vest on each of October 1, 2005, 2006, and 2007, respectively, with the shares being issued on the earlier of: a) the fifth
anniversary of the date of grant, b) the executive's separation of service, c) the executive's death or disability, or d) a change in control. Each year, the Company recognizes
compensation cost, for the relative service period covered, equal to the market value of the underlying common shares of the Company on the date of grant. During each of fiscal 2007, 2006 and 2005,
compensation cost of $0.8 million related to deferred stock units is included in the Company's consolidated statement of operations.

Fair Value of Financial InstrumentsStatement of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments,
 requires companies to disclose the estimated fair value of their financial instruments, both
assets and liabilities. The fair value of financial instruments is determined by reference to various market data and other valuation techniques as appropriate. The Company's financial instruments
consist of cash equivalents, receivables, customer deposits, accounts payable and accrued expenses, mortgage loans held for sale, its senior credit facility, other senior secured credit facilities and
its senior subordinated notes payable. The fair value of the senior

55

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subordinated
notes payable is estimated based on the quoted market prices for the same or similar issues or on 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 $144.6 million as of September 30, 2007. The carrying values of all other financial instruments approximate fair values because
of the short maturity of those instruments and the terms available to the Company for similar types of instruments. The Company believes that the fair value of its senior credit facility approximates
its carrying value.

Derivative Financial InstrumentsThe Company uses best-efforts and mandatory sales commitments to hedge
100% of its mortgage loans held for sale from an unexpected charge due to a decline in value and uses interest rate cap agreements to protect a portion of its homebuilding borrowings from sharp
increases in short-term interest rates. The derivatives are carried at fair value with the changes in fair value recorded to current earnings.

In
November 2006, the Company entered into a two year interest rate cap agreement to protect $100 million of its borrowings. Under the terms of the agreement the LIBOR rate is capped at
5.5% per annum.

Recent Accounting PronouncementsIn July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes("FIN 48"), which prescribes a recognition threshold and measurement process for recording in the financial
statements uncertain tax positions taken or expected to be taken in a tax return. Additionally, FIN 48 provides guidance on the derecognition, classification, accounting in interim periods and
disclosure requirements for uncertain tax positions. FIN 48 became effective for the Company on October 1, 2007, but is not expected to have a material impact on the Company's results of
operations or financial position.

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 in generally accepted accounting principles and expands disclosure about fair value measurements. SFAS 157 is effective for financial statements issued for
fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. However, the FASB did provide a one year deferral for the implementation of SFAS 157 for
certain nonfinancial assets and liabilities. The Company is in the process of determining the effect, if any, the adoption of SFAS 157 will have on its financial statements.

In
September 2006, the SEC issued Staff Accounting Bulletin No. 108,Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current
Year Financial Statements("SAB 108"), which provides guidance as to how the effects on prior year uncorrected misstatements should be considered when quantifying misstatements
in the current financial statements. SAB 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. SAB 108 requires
the Company to quantify misstatements using both a balance sheet and income statement approach, with adjustment required if either method results in a material error. SAB 108 became effective for the
Company on October 1, 2007, but is not expected to have a material impact on the Company's results of operations or financial position.

In
February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement
No. 115("SFAS 159"). SFAS 159 permits a company to measure certain financial instruments and other items at fair value. SFAS 159 is effective for
financial statements issued for fiscal years beginning after November 15, 2007, with early adoption permitted. The Company is in the process of determining the effect, if any, the adoption of
SFAS 159 will have on its financial statements.

In
December 2007, the FASB issued SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements("SFAS 160")an amendment of ARB No. 51. SFAS 160 establishes accounting and reporting standards for noncontrolling interests in consolidated financial
statements. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after

56

---



December 15,
2008. Early adoption is prohibited. The Company is in the process of determining the effect, if any, the adoption of SFAS 160 will have on its financial statements.

2.     Inventory

Inventory consists of the following at September 30, 2007 and 2006:

|                                                
|------------------------------------------------
|
|                                                
|Residential lotsdeveloped and under development
|Finished homes and construction in progress     
|Deposits on land purchases                      
|Land held for future development or sale        
|                                                
|Total                                           
|                                                
|                                                

The Company capitalizes interest during development and construction. Capitalized interest is charged to cost of sales as residential units are closed. Interest
costs for the years ended September 30, 2007, 2006 and 2005 are as follows:

|                                       | 
|-------------------------------------- | 
|
|                                       | 
|Capitalized interestbeginning of year | 
|Interest incurred                      | 
|Interest included in cost of sales     | 
|                                       | 
|Capitalized interestend of year       | 
|                                       | 
|                                       | 

Inventory impairment charges are recognized against all inventory costs of a community, such as land, land improvements, cost of home construction and
capitalized interest. The amounts included in the above table reflect the gross amount of capitalized interest before allocation of any impairment charges recognized.

3.     Inventory Not Owned

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 equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial
support from other parties or (ii) equity holders either (a) lack a direct or indirect ability to make decisions about the entity, (b) are not obligated to absorb expected losses
of the entity or (c) do not have the right to receive expected residual returns of the entity, if they occur. FIN 46R requires the consolidation of VIEs in which an enterprise absorbs a
majority of the entity's expected losses, receives a majority of the entity's expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity.

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

At
September 30, 2007 and 2006, the Company has consolidated optioned land with a fair value of approximately $30.1 million and $37.8 million for which it paid cash option
deposits of $0.7 million and $1.1 million, respectively. The Company estimated the initial fair value of the consolidated optioned land based upon the Company's option contract price. In
many cases, the Company was unable to obtain the relevant financial information from the selling entities, therefore, the Company has used the information available to make an assumption as to whether
the selling entity has additional assets or has debt obligations outstanding. During fiscal 2007, the Company recorded $10.5 million of impairment charges to reduce the recorded value of
inventory not owned from its initial fair value to its estimated fair value as of September 30, 2007. The remaining difference between the fair value of the land under contract and the
Company's non-refundable deposit is recorded in liabilities related to inventory not owned unless it is determined by the Company that the selling entity does not carry debt in which case
the difference is recorded as minority interest in inventory not owned.

57

---



4.     Investments In and Advances to Unconsolidated Entities

Investments in and advances to unconsolidated entities represent the Company's ownership interest in entities accounted for under the equity method when it has a significant
influence over the entity but holds less than a controlling interest in the entity or it is not the primary beneficiary in a VIE as defined by FIN 46R. The Company's partners generally are unrelated
homebuilders, land sellers or other real estate entities. The following is a summary of the Company's significant investments as of September 30, 2007 and 2006:

In
January 2005, the Company entered into a joint venture, in which it has a 9.59% interest, to acquire and develop land in Nevada. As of September 30, 2007, the Company determined that its
investment in the venture was more than temporarily impaired and recorded a $21.5 million charge to write-down the investment balance and to accrue anticipated additional capital contributions. At
September 30, 2006, the Company had investments in the joint venture totaling $18.3 million. At September 30, 2007, this joint venture had third party debt of $433 million
under a secured credit facility, of which each joint venture member has guaranteed payment of its pro rata share in the event of specified bankruptcy events or in the event of certain improper
or fraudulent actions involving the related joint venture. The Company's pro rata portion of the debt is $41.5 million at September 30, 2007. The Company has also provided pro rata
completion guarantees for this joint venture. Recently, this joint venture received notice from the administrative agent under its secured credit facility that it was not in compliance with certain
covenants thereunder, including a performance covenant requiring that the joint venture make a specified amount of progress with respect to the projects contemplated under the secured credit facility.
Breach of such covenant constitutes an event of default under its secured credit facility. If such default remains uncured, the lenders under this facility may terminate commitments under the facility
and may accelerate the joint venture's repayment obligations. Further, the Company's repayment guarantee requires that the Company be in compliance with the financial covenants contained in the
Company's senior credit facility, which, as of September 30, 2007, the Company is not in compliance with. In addition, the Company's current default under its senior credit facility constitutes
an event of default under this joint venture's secured credit facility. Failure to cure such defaults could result in the acceleration of the joint venture's repayment obligations under the facility.
To the Company's knowledge, the lenders under this facility have not indicated they will accelerate amounts due under the facility as a result of these defaults, however, there can be no assurance
that they will not.

In
May 2004, the Company entered into a joint venture, in which it has a 6.29% interest, to acquire and develop land in Nevada. At September 30, 2007 and 2006, the Company had investments in
the joint venture totaling $11.7 million and $16.1 million, respectively. At September 30, 2007, this joint venture had third party debt of $458 million under a secured
credit facility, of which each joint venture member has guaranteed payment of its pro rata share in the event of specified bankruptcy events or in the event of certain improper or fraudulent
actions involving the related joint venture. The Company's
pro rata portion of the debt is $28.8 million at September 30, 2007. The Company has also provided pro rata completion guarantees for this joint venture. Further, the Company's repayment
guarantee requires that the Company be in compliance with the financial covenants contained in its senior credit facility, which, as of September 30, 2007, the Company is not in compliance
with. In addition, the Company's current default under its senior credit facility constitutes an event of default under this joint venture's secured credit facility. Failure to cure such defaults
could result in the acceleration of the joint venture's repayment obligations under the facility. To the Company's knowledge, the lenders under this facility have not indicated they will accelerate
amounts due under the facility as a result of these defaults, however, there can be no assurance that they will not.

In
December 2002, the Company entered into a joint venture, in which it has a 23.75% interest, to develop property and construct single-family and multi-family residences in Chicago, Illinois.
At September 30, 2007 and 2006, the Company had investments in and advances to the joint venture

58

---



totaling
$4.3 million and $4.9 million, respectively. The Company has provided completion, financial and performance guarantees in connection with the venture's $20 million
construction financing for a single phase of the project. In addition, the Company has provided a guarantee on a $9 million tax increment financing bond for this project. As of
September 30, 2007, $12.5 million of funds have been drawn on the construction financing facility and $5.4 million was drawn on the tax increment financing bond. The Company is
not obligated to loan additional funds to the venture.

In
May 2004, the Company entered into a joint venture, in which it has a 35% interest, to develop property in Detroit, Michigan. At September 30, 2007 and 2006, the Company had
investments in and advances to the joint venture totaling $2.8 million and $1.8 million, respectively. The Company is not obligated to loan additional funds to the venture.

In
August 2004, the Company entered into a joint venture, in which it has a 33.3% interest, to develop property and construct single-family and multi-family residences in Chicago, Illinois. At
September 30, 2007 and 2006, the Company had investments in and advances to the joint venture totaling $2.4 million and $3.1 million, respectively. The Company has provided
completion, financial and performance guarantees in connection with certain of the venture's indebtedness totaling $125.1 million, with the Company's maximum financial guarantees limited to
$15.5 million in the aggregate. At September 30, 2007, there was $27.7 million outstanding under these credit facilities. The Company has also provided guarantees in connection
with $9.8 million and $14.5 million of capital contributions to be made by an unrelated joint venture member, whereby the Company would make the contributions if the unrelated joint
venture member does not. The Company is not obligated to loan additional funds to the venture.

In
January 2006, the Company entered into a joint venture, in which it had a 35% interest, to develop a high-rise mixed use tower in San Jose, California. At September 30,
2006, the Company had investments in the joint venture of $2.5 million. In January 2007, the Company sold its ownership interest in the joint venture to an entity controlled by the
Executive Chairman for $2.9 million, which
was equal to the Company's total financial investment in the project. This transaction was approved by the Company's Board of Directors.

In
October 2006, the Company entered into a joint venture, in which it has a 45% interest, to develop property and construct single-family residences in Houston, Texas. At September 30,
2007, the Company had investments in and advances to the joint venture totaling $3.2 million. The Company is not obligated to loan additional funds to the venture.

5.     Leases

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

|          
|----------
|
|          
|2008      
|2009      
|2010      
|2011      
|2012      
|After 2012
|          
|          
|          
|          

59

---



6.     Property and Equipment

The following is a summary of property and equipment as of September 30, 2007 and 2006:

|                  |                         
|----------------- | ------------------------
|
|                  |                         
|Homebuilding:     |                         
|                  | Operating properties:   
|                  |                         
|                  |                         
|                  |                         
|                  |                         
|                  |                         
|                  | Other:                  
|                  |                         
|                  |                         
|                  |                         
|                  |                         
|                  |                         
|                  |                         
|                  | Accumulated depreciation
|                  |                         
|                  | Total homebuilding      
|                  |                         
|Mortgage banking: |                         
|                  |                         
|                  |                         
|                  |                         
|                  |                         
|                  | Accumulated depreciation
|                  |                         
|                  | Total mortgage banking  
|                  |                         
|                  |                         

Operating properties consist of two office developments with approximately 111,000 square feet of leasable area. The properties are pledged as collateral for certain term loans
(see note 7).

7.     Financing

Homebuilding

The Company's notes payable consist of the following as of September 30, 2007 and 2006:

|                                                       
|-------------------------------------------------------
|
|                                                       
|Senior credit facility                                 
|Senior subordinated notes (net of unamortized discount)
|Other senior secured credit facilities                 
|                                                       
|Total                                                  
|                                                       
|                                                       

In December 2005, the Company entered into a new senior credit facility to finance its business operations. Proceeds of the new senior credit facility were used to
retire its existing senior secured revolving credit facilities and substantially all of its other senior secured credit facilities. The senior credit facility has a maximum availability of
$500 million, subject to a borrowing base as well as sublimits of $100 million for the issuance of letters of credit and $10 million for swing line loans. The Company has the
right, without the consent of its lenders (other than those participating in the increase), to increase the commitment by an amount of up to $200 million, provided that no such

60

---



increase
shall cause the senior credit facility to exceed $700 million. The Company amended the senior credit facility in December 2006 to amend certain covenants and it amended and
restated the senior credit facility in August 2007 to further amend certain covenants, require that the senior credit facility be secured by all properties to be included in the borrowing base
for the senior credit facility and related assets and prohibit the incurrence of any additional secured debt.

The
applicable borrowing base is determined regularly throughout the life of the senior credit facility. The composition of the borrowing base is limited to parameters set forth in the senior credit
facility agreement and certain types of real estate (such as unimproved entitled land and lots under development) are removed from the borrowing base if held beyond specified maturity dates. As a
result
of the August 2007 amendments to the senior credit facility, the property of certain non-wholly owned subsidiaries cannot be included in the borrowing base calculation unless and
until such subsidiaries are able to guarantee the senior credit facility (on a secured basis), which will be subject to the consent of minority interest holders and there is no assurance that the
Company would be able to obtain such consent. New properties that are proposed to be included as borrowing base property would also be mortgaged and pledged to secure the senior credit facility and
also would need to satisfy specified parameters or otherwise be approved by the majority lenders.

Borrowings
under the senior credit facility generally bear interest 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 upon the Company's senior leverage ratio, which is defined as the ratio of total liabilities to consolidated net worth. Fees for letters of credit are based on LIBOR plus a margin of 1.5%.
An unused commitment fee equal to 0.2% to 0.3% per year accrues on the undrawn portion of the senior credit facility and is payable quarterly in arrears. The August 2007 amendments provide that
the applicable interest margins are subject to increase by 0.375% to 0.875% in the event that liquidity (as defined below) is more than $50 million but less than or equal to
$100 million.

The
covenants under the senior credit facility, as amended, require the Company to: maintain a minimum tangible net worth of at least $300 million plus 50% of positive net income earned
subsequent to September 30, 2006; maintain a ratio 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 to exceed 1.5x; maintain a ratio of total land (including undeveloped land, land under development
and finished lots on which home construction has yet to begin) to adjusted tangible net worth not to exceed 1.5x; and maintain an interest 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 1.5x
through December 31, 2007, increasing to 1.75x through March 31, 2008 and then increasing to 2.25x through the remaining term of the senior credit facility). For purposes of these tests,
adjusted tangible net worth is benefited by adjustments of 50% of the Company's outstanding senior subordinated debt (up to a maximum $100 million adjustment) and 100% of minority interests in
consolidated entities (up to a maximum $50 million adjustment). The August 2007 amendments: (1) permit the Company to ignore, for purposes of financial covenant calculations (but
not for interest margin calculations), up to $40 million of tangible net worth reductions due to impairment and abandonment charges; (2) suspend the interest coverage ratio covenant
until March 31, 2009 and add a minimum requirement of adjusted earnings before interest, taxes, depreciation and amortization (as defined in the senior credit facility) of $25 million on
a trailing four-quarter basis, and a minimum $50 million liquidity requirement (defined as unrestricted cash, available borrowings under the senior credit facility and other
available lines of credit and receivables from home closings); (3) require the Company to test liquidity monthly; and (4) reduce permitted unsecured debt from $25 million to
$15 million and permitted joint venture investments from 30% of tangible net worth to 25% of tangible net worth.

61

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As
of September 30, 2007, the Company had $323 million of borrowings under the senior credit facility at an effective interest rate of 7.04% and, after calculating the borrowing base
limitation based on removal of the property of such non-wholly owned subsidiaries, had additional availability of approximately $82 million. As of September 30, 2007, the
Company was not in compliance with certain of the covenants in the senior credit facility, including the covenant requiring the Company to maintain a minimum tangible net worth (as defined in the
senior credit facility). The Company's failure to meet these covenants allows the lenders under the senior credit facility to declare all amounts outstanding thereunder, together with accrued
interest, to be immediately due and payable. An acceleration under the senior credit facility would also trigger a cross-default under the indenture governing the senior subordinated notes, thereby
allowing the bondholders to accelerate the repayment of all amounts outstanding on the senior subordinated notes, subject to certain payment blockage periods. In addition, certain other credit
facilities within the Company's joint ventures to which the Company has provided guarantees include provisions for acceleration or events of default in the event of a default under the Company's
senior credit facility. The Company has begun discussions with its bank group regarding amending its senior credit facility. The bank group has not provided formal assurance that the Company will be
able to amend its senior credit facility upon reasonable terms, or at all. Nonetheless, there has been no indication that it intends to accelerate amounts due under the facility, and discussions with
the Company's lenders regarding an amendment are active and ongoing.

In
December 2005, the Company issued $203 million aggregate principal amount of senior subordinated notes due December 2012 in a private placement pursuant to Rule 144A
promulgated under the Securities Act of 1933. In May 2006, the Company exchanged all of the senior subordinated notes issued in the private placement for an issue of notes registered with the
SEC with terms substantially identical to the notes issued in the private placement. The senior subordinated notes were sold at 98.796% of par and accrue interest at a coupon rate of 10.5% per annum.
Interest is paid semi-annually in June and December. The net proceeds were used to repay amounts outstanding under working capital loans and certain senior secured revolving credit
facilities. The Company may redeem the notes, in whole or part, at any time on or after December 15, 2009, at a redemption price equal to 100% of the principal amount, plus a 5.25% premium
declining ratably to par on December 15, 2011, plus accrued and unpaid interest. At any time prior to December 15, 2008, the Company may also redeem up to 35% of the aggregate principal
amount of the notes with the proceeds of qualified equity offerings at a redemption price equal to 110.5% of the principal amount, plus accrued and unpaid interest. In addition, if the Company
experiences specific kinds of changes of control, the Company is required to make an offer to purchase all of the notes at a purchase price of 101% of the principal amount thereof, plus accrued and
unpaid interest. The notes are unsecured senior subordinated obligations and subordinated in right of payment to all of the Company's existing and future senior debt, including borrowings under the
Company's senior credit facility described above. All of the Company's wholly owned subsidiaries, other than the Company's mortgage subsidiary, have fully and unconditionally guaranteed the notes on a
joint and several, unsecured senior subordinated, basis. The guarantees are general unsecured obligations of the guarantors and will be subordinated in right of payment to all existing and future
senior debt of the guarantors, which includes their guarantees of the Company's senior credit facility. The indenture governing the senior subordinated notes contains a number of significant covenants
that restricts 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 into transactions with affiliates, and merge, consolidate or sell substantially all of the Company's assets. As of September 30, 2007, the Company was
restricted from incurring additional indebtedness (excluding available borrowings under the senior credit facility), except under certain limited circumstances.

The
Company is party to a senior secured project-specific acquisition and development loan. This loan bears interest at LIBOR plus 2.25% with maturity tied to the sale of the underlying inventory. As
of

62

---



September 30,
2007, the Company had $31.6 million outstanding related to this project-specific acquisition and development loan.

The
Company has a term loan for an office complex in Rolling Meadows, Illinois. The term loan is secured by the office complex and bears interest at 7.0%. The Company makes monthly interest payments
with the balance due October 2010. As of September 30, 2007, the Company had $3.5 million outstanding on the mortgage note.

The
Company has a term loan for an office building in Rolling Meadows, Illinois. The term loan is secured by the office building and bears interest equal to the prime rate. The Company makes monthly
interest payments with the principal balance due March 2009. As of September 30, 2007, the Company had $4.8 million outstanding on the term loan.

The
aggregate principal payments due on the notes payable are as follows:

|     
|-----
|
|     
|     
|     
|     
|     
|     
|     
|     
|Total
|     
|     

8.     Redeemable Common Stock

Under the terms of the Company's amended stock option plans (see note 9), the Company has contractual obligations to purchase shares of its outstanding common stock at
fair value from certain of its directors, executive officers and other key employees in the event of termination of board membership or employment, as applicable, by reason of specified circumstances,
including death, disability, termination, retirement or resignation. Certain outstanding options would qualify for this redemption right after exercise of the options.

At
the time outstanding shares qualify for this redemption right, the redemption amount is transferred from shareholders' equity to redeemable common stock. Subsequent changes to the redemption amount
are transferred from shareholders' equity to redeemable common stock in the case of an increasing redemption amount, or, from redeemable common stock to shareholders' equity in the case of a
decreasing redemption amount. During fiscal 2007, 55,000 shares that were not redeemable as of September 30, 2006 became redeemable, 5,000 new shares that qualified for this redemption right
were issued upon the exercise of stock options and 77,298 redeemable shares were repurchased by the Company.

The
Company establishes the fair value of its stock on a quarterly basis. The evaluation of fair value is significantly impacted by the homebuilding industry climate and the Company's relative
performance. Considering the continued deterioration in market conditions and the Company's uncertainties about its ability to continue as a going concern (see note 1), the estimated fair value
of the redeemable common stock includes significant subjective assumptions, but represents the Company's best estimate as of the dates of the consolidated balance sheets.

63

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9.     Stock Plans

Executives and other key employees have been granted options to purchase common shares of the Company. In each case, the option price equals the estimated fair market value of
the common shares on the day of the grant. The options' terms range from three to ten years and vesting terms range from immediately upon grant to vesting in equal annual installments over four years.

The
various stock option agreements issued under the Company's stock option plans, prior to September 30, 2005, included a feature that required the Company to repurchase outstanding shares,
issued under the agreements, at an amount other than fair market value, upon termination of board membership or employment by reason of specified circumstances. As those specified circumstances were
within the control of certain of the option holders as of September 30, 2005, the Company recorded 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 their other 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 any repurchases of shares under the agreements be of shares owned for longer than six months at fair market value.

The
fair value of each stock option granted is estimated on the date of grant using a Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 2006:
risk-free interest rate of 5.00%, expected lives of 3 years to 7 years and no dividend yield. The weighted average fair value of the stock options granted in 2006 using a
Black-Scholes option-pricing model was $30.36 per share. There were no stock options granted in fiscal years 2007 or 2005.

A
summary of shares is as follows:

|                                     
|-------------------------------------
|
|
|
|                                     
|Options outstandingbeginning of year
|Granted                              
|Forfeited                            
|Exercised                            
|                                     
|Options outstandingend of year      
|                                     
|Options exercisableend of year      
|                                     
|                                     

64

---



Additional information for stock options outstanding and exercisable at September 30, 2007 is as follows:

|       
|-------
|
|       
|$10.00 
|$41.80 
|$115.50
|       
|       
|       
|       

10.   Employee Stock Ownership Plan

The Company initiated an Employee Stock Ownership Plan ("ESOP") in December 2000 as part of its benefit plan package covering substantially all employees, provided they
have met certain eligibility requirements as defined in the plan document. The ESOP is designed to provide employees with ownership of the Company's stock.

In
December 2000, the ESOP borrowed $4 million from a third party and used the proceeds to purchase 234,467 shares of the Company's common stock (6.7% of the outstanding common stock of
the Company at that date). The ESOP notes were guaranteed by the 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 allocated to participants was based on the quarterly payments of principal and interest due on the ESOP notes. During the year ended September 30, 2005 shares valued at
approximately $0.7 million were allocated to participants and were included in the consolidated statements of operations as compensation cost. All shares were allocated to participants as of
September 30, 2005, therefore, there were no new shares allocated to participants during fiscal years 2007 and 2006. Forfeited shares are re-allocated pro rata to participants.

During
fiscal 2007, the Company purchased, directly from former employees, 39,937 shares that were previously allocated under the ESOP. During fiscal 2006 and 2005, the Company purchased, directly
from former employees, 20,785 shares and 25,580 shares, respectively, that were previously allocated under the ESOP.

11.   Income Taxes

The benefit from income taxes for the year ended September 30, 2007 and the provision for income taxes for the years ended September 30, 2006 and 2005 consists of
the following:

|                                    |        
|----------------------------------- | -------
|
|                                    |        
|Current tax (benefit) expense:      |        
|                                    | Federal
|                                    | State  
|                                    |        
|Total current tax (benefit) expense |        
|Deferred tax benefit                |        
|                                    | Federal
|                                    | State  
|                                    |        
|Total deferred tax benefit          |        
|                                    |        
|Total                               |        
|                                    |        
|                                    |        

65

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Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of the assets and liabilities for financial reporting purposes and for
income tax purposes. The tax effects of significant temporary differences that give rise to the net deferred tax asset as of September 30, 2007 and 2006 are as follows:

|                         
|-------------------------
|
|                         
|Deferred tax assets:     
|                         
|                         
|                         
|                         
|                         
|                         
|                         
|                         
|                         
|                         
|                         
|                         
|Deferred tax liabilities:
|                         
|                         
|                         
|                         
|Net deferred tax asset   
|                         
|                         

As of September 30, 2007, the Company has recorded valuation allowances for certain deferred tax assets as sufficient uncertainty exists regarding the future realization
of these deferred tax assets through the offset of future taxable income. As such, the Company established a valuation allowance on all deferred tax assets not assured of realization by either
offsetting existing taxable temporary differences or carryback to open tax years. If in the future the Company believes that it is more likely than not that these deferred tax benefits will be
realized, the valuation allowances will be reversed.

The
following table reconciles the federal statutory income tax rate to the effective income tax rate for the years ended September 30, 2007, 2006 and 2005:

|                                       | 
|-------------------------------------- | 
|
|                                       | 
|Income taxes at federal statutory rate | 
|State income taxes, net of federal tax | 
|Pemanent differences                   | 
|Valuation allowance                    | 
|Other                                  | 
|                                       | 
|Effective rate                         | 
|                                       | 
|                                       | 

12.   Related-Party Transactions

Transactions involving the controlling shareholder

In August 2007, the Company entered into an employment agreement with the controlling shareholder, David K. Hill. The initial term of the agreement is from
October 1, 2006 until October 1, 2011, and thereafter the agreement will renew automatically for one-year terms unless terminated by either party upon ninety days written
notice. See Item 11, "Executive CompensationEmployment and Other Agreements", for a description of the controlling shareholder's employment agreement.

66

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In
January 2007, the Company sold its ownership interest in a San Jose, California high-rise residential real estate project to an entity controlled by the controlling shareholder
of the Company for $2.9 million, which was equal to the Company's total financial investment in the project. This transaction was approved by the Company's Board of Directors.

During
fiscal 2005, an entity controlled by the controlling shareholder of the Company paid the Company $0.1 million in fees for management of non-consolidated housing projects. The
fees were based on a percentage of revenues.

An
entity controlled by the controlling shareholder of the Company had entered into several limited partnerships with the Company. A summary of the activity included in the Company's financial
statements is as follows:

|                                                                 | 
|---------------------------------------------------------------- | 
|
|                                                                 | 
|Beginning balance of related party included in minority interest | 
|Contributions from related party                                 | 
|Distributions to related party                                   | 
|Minority interest in net earnings                                | 
|                                                                 | 
|Ending balance of related party included in minority interest    | 
|                                                                 | 
|                                                                 | 

During fiscal 2005, the Company purchased the related entity's interests in these partnerships at a price of $27.3 million, which was approximately $8.4 million
over the reported minority interest financial statement basis. The transaction was treated as an exchange of assets between entities under common control, and the amount of purchase price over the
financial statement basis was treated as a distribution to the controlling shareholder of the Company.

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

Transactions involving other related parties

On September 12, 2006, the Company entered into a Subscription Agreement and Investor Rights Agreement with Equity Investments III, LLC ("EI"). Pursuant to the
Subscription Agreement, the Company sold 952,380 shares of its common stock to EI for an aggregate purchase price of $110 million, effectively making EI a related party. As of
September 30, 2007, EI owns approximately 21% of the Company's issued and outstanding stock.

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

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

67

---



Limited Partnership Investment.At September 30, 2006, an affiliate of EI was a limited partner in three consolidated partnerships
formed by the Company to engage in certain residential development and construction projects. A summary of the activity included in the Company's consolidated financial statements is as follows:

|                                                                
|----------------------------------------------------------------
|
|                                                                
|Beginning balance of related party included in minority interest
|Contributions from related party                                
|Distributions to related party(a)                               
|Partner profit recorded as a step-up in inventory(a)            
|Minority interest in net (losses) earnings                      
|                                                                
|Ending balance of related party included in minority interest   
|                                                                
|                                                                

The Company repurchased 77,298 shares from a former officer for $7.1 million during fiscal 2007 and repurchased 403,201 shares from certain current and
former directors and officers for $46.4 million during fiscal 2006.

13.   Commitments and Contingencies

In the normal course of business, the Company acquires rights under option agreements to purchase land for future development and/or developed lots. The agreements generally
are contingent upon municipality approvals. As of September 30, 2007, the Company has rights, under such agreements, to purchase approximately 6,200 lots, within 27 separate developments, with
an aggregate contract price of approximately $248 million. Approximately 1,600 of those lots contain specific performance requirements, with an aggregate purchase price of approximately
$45 million, of which the Company is obligated to pay approximately $1 million within the next twelve months and the remaining $44 million at various dates beginning in
March 2009. Approximately 2,300 of the lots, with an aggregate purchase price of approximately $134 million, are to be purchased from joint ventures in which the Company has an equity
investment.

At
September 30, 2007, excluding inventory not owned (see note 3), the Company was contingently liable to banks and financial institutions for approximately $102 million for
outstanding letters of credit and performance bonds securing performance of certain contractual obligations and land option contracts.

Under
the terms of the Company's amended stock plans (see notes 1 and 9), the Company has contractual obligations to purchase shares of its common stock, including shares issuable under outstanding
options, from certain of its directors, executive officers and other key employees in the event of termination of board membership or employment, as applicable, by reason of specified circumstances,
including death, disability, termination, retirement or resignation. As of September 30, 2007, the aggregate repurchase obligation, net of proceeds to be received from any stock option
exercises, would have been approximately $13.3 million in the event that all of these obligations were triggered. The Company's ability to satisfy its repurchase obligations is subject to
certain limitations set forth in the indenture governing the senior subordinated notes issued by the Company. In addition, if Mr. Hill's employment is terminated by reason of his death or
permanent disability, his family trust may request the Company to purchase up to 500,000 shares of its common stock, and upon receipt of such request the Company will reasonably determine in its sole
discretion how many shares to purchase in light of the Company's financial condition and prospects and the limitations, restrictions and

68

---



constraints
in its loan and financing arrangements at the time. The purchase price payable by the Company will be the fair market value at that time.

The
Company is involved in litigation incidental to its business, the disposition of which should not have a material effect on the Company's financial position or results of operations.

The
Company provides product warranties to its customers covering workmanship, materials and certain mechanical systems for two years, and structural systems for ten years. The Company estimates and
records warranty liabilities based on historical experience and known risks at the time a home closes, and in the case of unexpected claims, upon identification and quantification of the obligations.
The Company's warranty accrual is included in accounts payable and accrued expenses in its consolidated balance sheets. Changes in the Company's warranty liability for the fiscal years ended
September 30, 2007, 2006 and 2005 are as follows:

|                                  | 
|--------------------------------- | 
|
|                                  | 
|Balance at beginning of year      | 
|Warranties issued                 | 
|Settlements and other adjustments | 
|                                  | 
|Balance at end of year            | 
|                                  | 
|                                  | 

At September 30, 2007, the Company was committed to fund approximately $5.1 million in mortgage loans to homebuyers at agreed-upon rates. The Company
has entered into best-efforts and mandatory sale commitments to sell these mortgages to third parties.

14.   Segment Information and Concentrations

In accordance with Statement of Financial Accounting Standards No. 131,Disclosures about Segments of an Enterprise and Related
Information("SFAS 131"), the Company has identified five reportable
homebuilding segments, conducting business in 9 states, and one mortgage banking reportable segment. The Company's homebuilding segments are engaged in the acquisition and development of land, and
construction and sale of residential homes. The Company's mortgage banking segment originates mortgages, which are sold to third parties.

The
Company's chief decision maker, its chief executive officer, routinely reviews information on the Company's operating segments. Management evaluates a segment's performance based upon a number of
factors including segment earnings before income taxes.

The
Company's corporate departments provide certain services that are advantageous to perform in a centralized manner, given certain cost efficiencies or required technical expertise. The Company's
corporate functions include: financial analysis, human resources, information technology, legal, planning, risk management, sales training and treasury. Only corporate costs that are deemed to
directly benefit certain operating segments are allocated to those operating segments.

69

---



Operations
within the Company's reportable homebuilding segments have been determined to have similar economic characteristics, including: similar historical and expected future operating performance,
employment trends, land acquisition and land constraints, and municipality behavior and meet the other aggregation criteria in SFAS 131. The reportable homebuilding segments include operations
in the following geographical regions:



In
March 2006, the Company decided to exit the Cleveland market based on its perception regarding local market conditions currently and in the foreseeable future. The Company completed all
construction and sales activities during its second fiscal quarter of 2007.

In
May 2007, the Company decided to exit the Milwaukee, Wisconsin market. The Company's decision to exit the Milwaukee market reflects its perception regarding local market conditions currently
and in the foreseeable future.

In
May 2007, the Company decided to exit the Portland, Oregon and Vancouver, Washington markets. A decision to continue in these markets would have required near term investments to provide
lots for the future to sustain its operations. The Company decided to redeploy its capital and narrow its management focus to the other existing markets.

The
Company's internal measurement system has established accountabilities to continually improve business focus and increase its ability to react quickly to changes in particular markets as well as
changes to the overall homebuilding business cycle. This measurement system, which is not based on GAAP, is intended to motivate behavior of employees and drive performance. The sales and cost
information used for internal purposes varies from the Company's consolidated, externally reported information resulting in reconciling items.

The
following tables illustrate the revenue, earnings before income taxes and assets of the Company's reportable segments. Included are reconciliations to the amounts reported in the Company's
consolidated financial statements.

|                            
|----------------------------
|
|
|                            
|Florida                     
|Midwest                     
|Nevada                      
|Pacific Coast               
|Texas                       
|Mortgage banking            
|                            
|Segment revenue subtotal    
|Corporate and unallocated(a)
|GAAP adjustment(b)          
|                            
|Consolidated total revenues 
|                            
|                            

70

---



|                                                     | 
|---------------------------------------------------- | 
|
|
|                                                     | 
|Florida                                              | 
|Midwest                                              | 
|Nevada                                               | 
|Pacific Coast                                        | 
|Texas                                                | 
|Mortgage banking                                     | 
|                                                     | 
|Segment (loss) earnings before income taxes subtotal | 
|Corporate and unallocated                            | 
|                                                     | 
|                                                     | 
|Homebuilding interest expense                        | 
|GAAP adjustment(c)                                   | 
|                                                     | 
|Consolidated (loss) earnings before income taxes     | 
|                                                     | 
|                                                     | 

|                         
|-------------------------
|
|
|                         
|Florida                  
|Midwest                  
|Nevada                   
|Pacific Coast            
|Texas                    
|Mortgage banking         
|                         
|Segment assets subtotal  
|Corporate and unallocated
|GAAP adjustment(d)       
|                         
|Consolidated assets      
|                         
|                         

15.   Summarized Financial Information

The Company's senior subordinated notes and senior credit facility are fully and unconditionally guaranteed, on a joint and several basis, by all of the Company's wholly owned
subsidiaries ("Guarantor Subsidiaries"), other than the Company's mortgage subsidiary. The Company's mortgage subsidiary and majority owned and controlled subsidiaries are non-guarantors
("Non-Guarantor Subsidiaries") of the senior subordinated notes and the senior credit facility. In lieu of providing separate audited financial statements for the Guarantor Subsidiaries,
consolidated condensed financial statements are presented below. Separate financial statements and other disclosures concerning the Guarantor Subsidiaries are not presented because management has
determined that they are not material to investors.

71

---





|                                              
|----------------------------------------------
|
|                                              
|Assets                                        
|HOMEBUILDING:                                 
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|MORTGAGE BANKING                              
|                                              
|TOTAL ASSETS                                  
|                                              
|Liabilities and equity                        
|HOMEBUILDING:                                 
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|MORTGAGE BANKING                              
|                                              
|                                              
|MINORITY INTEREST IN CONSOLIDATED PARTNERSHIPS
|MINORITY INTEREST IN INVENTORY NOT OWNED      
|REDEEMABLE EQUITY                             
|SHAREHOLDERS' EQUITY                          
|                                              
|TOTAL LIABILITIES AND EQUITY                  
|                                              
|                                              

72

---





|                                              
|----------------------------------------------
|
|                                              
|Assets                                        
|HOMEBUILDING:                                 
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|MORTGAGE BANKING                              
|                                              
|TOTAL ASSETS                                  
|                                              
|Liabilities and equity                        
|HOMEBUILDING:                                 
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|MORTGAGE BANKING                              
|                                              
|                                              
|MINORITY INTEREST IN CONSOLIDATED PARTNERSHIPS
|MINORITY INTEREST IN INVENTORY NOT OWNED      
|REDEEMABLE EQUITY                             
|SHAREHOLDERS' EQUITY                          
|                                              
|TOTAL LIABILITIES AND EQUITY                  
|                                              
|                                              

73

---





|                                            |                                                              
|------------------------------------------- | -------------------------------------------------------------
|
|                                            |                                                              
|HOMEBUILDING:                               |                                                              
|                                            | Revenues:                                                    
|                                            |                                                              
|                                            |                                                              
|                                            |                                                              
|                                            |                                                              
|                                            | Expenses:                                                    
|                                            |                                                              
|                                            |                                                              
|                                            |                                                              
|                                            |                                                              
|                                            |                                                              
|                                            |                                                              
|                                            | Intercompany charge                                          
|                                            | Equity in losses of unconsolidated joint ventures            
|                                            | Minority interests in net losses of consolidated partnerships
|                                            |                                                              
|                                            |                                                              
|                                            |                                                              
|MORTGAGE BANKING:                           |                                                              
|                                            | Revenues:                                                    
|                                            |                                                              
|                                            |                                                              
|                                            |                                                              
|                                            |                                                              
|                                            | Expenses:                                                    
|                                            |                                                              
|                                            |                                                              
|                                            |                                                              
|                                            |                                                              
|                                            |                                                              
|                                            |                                                              
|                                            |                                                              
|EQUITY IN LOSS OF CONSOLIDATED SUBSIDIARIES |                                                              
|                                            |                                                              
|LOSS BEFORE INCOME TAXES                    |                                                              
|BENEFIT FROM INCOME TAXES                   |                                                              
|                                            |                                                              
|NET LOSS                                    |                                                              
|                                            |                                                              
|                                            |                                                              

74

---





|                                              |                                                                         
|--------------------------------------------- | ------------------------------------------------------------------------
|
|                                              |                                                                         
|HOMEBUILDING:                                 |                                                                         
|                                              | Revenues:                                                               
|                                              |                                                                         
|                                              |                                                                         
|                                              |                                                                         
|                                              |                                                                         
|                                              | Expenses:                                                               
|                                              |                                                                         
|                                              |                                                                         
|                                              |                                                                         
|                                              |                                                                         
|                                              |                                                                         
|                                              |                                                                         
|                                              | Intercompany charge                                                     
|                                              | Equity in income of unconsolidated joint ventures                       
|                                              | Minority interests in net losses (earnings) of consolidated partnerships
|                                              |                                                                         
|                                              |                                                                         
|                                              |                                                                         
|MORTGAGE BANKING:                             |                                                                         
|                                              | Revenues:                                                               
|                                              |                                                                         
|                                              |                                                                         
|                                              |                                                                         
|                                              |                                                                         
|                                              | Expenses:                                                               
|                                              |                                                                         
|                                              |                                                                         
|                                              |                                                                         
|                                              |                                                                         
|                                              |                                                                         
|                                              |                                                                         
|                                              |                                                                         
|                                              |                                                                         
|EQUITY IN INCOME OF CONSOLIDATED SUBSIDIARIES |                                                                         
|                                              |                                                                         
|EARNINGS BEFORE INCOME TAXES                  |                                                                         
|PROVISION FOR INCOME TAXES                    |                                                                         
|                                              |                                                                         
|NET EARNINGS                                  |                                                                         
|                                              |                                                                         
|                                              |                                                                         

75

---





|                                              |                                                                
|--------------------------------------------- | ---------------------------------------------------------------
|
|                                              |                                                                
|HOMEBUILDING:                                 |                                                                
|                                              | Revenues:                                                      
|                                              |                                                                
|                                              |                                                                
|                                              |                                                                
|                                              |                                                                
|                                              | Expenses:                                                      
|                                              |                                                                
|                                              |                                                                
|                                              |                                                                
|                                              |                                                                
|                                              |                                                                
|                                              |                                                                
|                                              | Intercompany charge                                            
|                                              | Equity in income of unconsolidated joint ventures              
|                                              | Minority interests in net earnings of consolidated partnerships
|                                              |                                                                
|                                              |                                                                
|                                              |                                                                
|MORTGAGE BANKING:                             |                                                                
|                                              | Revenues:                                                      
|                                              |                                                                
|                                              |                                                                
|                                              |                                                                
|                                              |                                                                
|                                              | Expenses:                                                      
|                                              |                                                                
|                                              |                                                                
|                                              |                                                                
|                                              |                                                                
|                                              |                                                                
|                                              |                                                                
|                                              |                                                                
|                                              |                                                                
|EQUITY IN INCOME OF CONSOLIDATED SUBSIDIARIES |                                                                
|                                              |                                                                
|EARNINGS BEFORE INCOME TAXES                  |                                                                
|PROVISION FOR INCOME TAXES                    |                                                                
|                                              |                                                                
|NET EARNINGS                                  |                                                                
|                                              |                                                                
|                                              |                                                                

76

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|                                                                                         |                                                                         
|---------------------------------------------------------------------------------------- | ------------------------------------------------------------------------
|
|                                                                                         |                                                                         
|Cash flows from operating activities:                                                    |                                                                         
|Net loss                                                                                 |                                                                         
|                                                                                         | Adjustments to reconcile net loss to net flows from operating activities
|                                                                                         |                                                                         
|                                                                                         |                                                                         
|Cash flows from investing activities:                                                    |                                                                         
|Purchases of property and equipment                                                      |                                                                         
|Disposals of property and equipment                                                      |                                                                         
|Distributions of contributed capital from investments in unconsolidated entities         |                                                                         
|Contributions to investments in unconsolidated entities                                  |                                                                         
|Contributions to investments in subsidiaries                                             |                                                                         
|                                                                                         |                                                                         
|                                                                                         |                                                                         
|Cash flows from financing activities:                                                    |                                                                         
|Proceeds from issuance of notes payable                                                  |                                                                         
|Repayments of notes payable                                                              |                                                                         
|Debt issuance costs                                                                      |                                                                         
|Net proceeds from issuance of common stock                                               |                                                                         
|Repurchases of common stock                                                              |                                                                         
|Contributions from minority interests                                                    |                                                                         
|Distributions to minority interests                                                      |                                                                         
|Contributions from parent and guarantors                                                 |                                                                         
|Distributions to parent and guarantors                                                   |                                                                         
|Intercompany                                                                             |                                                                         
|                                                                                         |                                                                         
|                                                                                         |                                                                         
|                                                                                         |                                                                         
|Net increase (decrease) in cash and cash equivalents                                     |                                                                         
|                                                                                         | Cash and cash equivalents
Beginning of year                            
|                                                                                         |                                                                         
|                                                                                         | Cash and cash equivalents
End of year                                  
|                                                                                         |                                                                         
|Reconciliation to cash and cash equivalents reported on the consolidated balance sheets: |                                                                         
|                                                                                         | Homebuilding                                                            
|                                                                                         | Mortgage banking                                                        
|                                                                                         |                                                                         
|                                                                                         |                                                                         
|                                                                                         |                                                                         
|                                                                                         |                                                                         

77

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|                                                                                         |                                                                             
|---------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------
|
|                                                                                         |                                                                             
|Cash flows from operating activities:                                                    |                                                                             
|Net earnings                                                                             |                                                                             
|                                                                                         | Adjustments to reconcile net earnings to net flows from operating activities
|                                                                                         |                                                                             
|                                                                                         |                                                                             
|Cash flows from investing activities:                                                    |                                                                             
|Purchases of property and equipment                                                      |                                                                             
|Disposals of property and equipment                                                      |                                                                             
|Distributions of contributed capital from investments in unconsolidated entities         |                                                                             
|Contributions to investments in unconsolidated entities                                  |                                                                             
|Contributions to investments in subsidiaries                                             |                                                                             
|                                                                                         |                                                                             
|                                                                                         |                                                                             
|Cash flows from financing activities:                                                    |                                                                             
|Proceeds from issuance of notes and mortgage loans payable                               |                                                                             
|Repayments of notes and mortgage loans payable                                           |                                                                             
|Debt issuance costs                                                                      |                                                                             
|Net proceeds from issuance of common stock                                               |                                                                             
|Repurchases of common stock                                                              |                                                                             
|Distributions to minority interests                                                      |                                                                             
|Contributions from parent and guarantors                                                 |                                                                             
|Distributions to parent and guarantors                                                   |                                                                             
|Intercompany                                                                             |                                                                             
|                                                                                         |                                                                             
|                                                                                         |                                                                             
|                                                                                         |                                                                             
|Net (decrease) increase in cash and cash equivalents                                     |                                                                             
|                                                                                         | Cash and cash equivalents
Beginning of year                                
|                                                                                         |                                                                             
|                                                                                         | Cash and cash equivalents
End of year                                      
|                                                                                         |                                                                             
|Reconciliation to cash and cash equivalents reported on the consolidated balance sheets: |                                                                             
|                                                                                         | Homebuilding                                                                
|                                                                                         | Mortgage banking                                                            
|                                                                                         |                                                                             
|                                                                                         |                                                                             
|                                                                                         |                                                                             
|                                                                                         |                                                                             

78

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|                                                                                 |                                                                             
|-------------------------------------------------------------------------------- | ----------------------------------------------------------------------------
|
|                                                                                 |                                                                             
|Cash flows from operating activities:                                            |                                                                             
|Net earnings                                                                     |                                                                             
|                                                                                 | Adjustments to reconcile net earnings to net flows from operating activities
|                                                                                 |                                                                             
|                                                                                 |                                                                             
|Cash flows from investing activities:                                            |                                                                             
|Purchases of property and equipment                                              |                                                                             
|Distributions of contributed capital from investments in unconsolidated entities |                                                                             
|Contributions to investments in unconsolidated entities                          |                                                                             
|Contributions to investments in subsidiaries                                     |                                                                             
|                                                                                 |                                                                             
|                                                                                 |                                                                             
|Cash flows from financing activities:                                            |                                                                             
|Proceeds from issuance of notes and mortgage loans payable                       |                                                                             
|Repayments of notes and mortgage loans payable                                   |                                                                             
|Net proceeds from issuance of common stock                                       |                                                                             
|Repurchases of common stock                                                      |                                                                             
|Distributions                                                                    |                                                                             
|Contributions from minority interests                                            |                                                                             
|Distributions to minority interests                                              |                                                                             
|Contributions from parent and guarantors                                         |                                                                             
|Distributions to parent and guarantors                                           |                                                                             
|Intercompany                                                                     |                                                                             
|                                                                                 |                                                                             
|                                                                                 |                                                                             
|                                                                                 |                                                                             
|Net increase in cash and cash equivalents                                        |                                                                             
|                                                                                 | Cash and cash equivalents
Beginning of year                                
|                                                                                 |                                                                             
|                                                                                 | Cash and cash equivalents
End of year                                      
|                                                                                 |                                                                             
|                                                                                 |                                                                             

79

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16.   Subsequent Events

In November 2007, the Company repurchased 55,000 shares from a former officer and issued the former officer a $2.7 million non-negotiable promissory
note for the purchase price. The note bears interest at the prime rate and will mature on January 31, 2008.

In
October 2007, the Company sold an office building in its corporate complex to an entity controlled by its controlling shareholder's brother for $1.7 million. The majority of the space
in the building has been leased to an entity controlled by the controlling shareholder's brother for over 12 years.

In
October 2007, the Company's mortgage banking subsidiary (KH Financial L.P., or "KHF"), Wells Fargo Bank, N.A. and its wholly owned subsidiary Wells Fargo Ventures, LLC (collectively, "Wells Fargo")
formed a new joint venture, KH Mortgage, LLC ("KH Mortgage"). KHF contributed $250,000 in cash and contributed various assets to establish KH Mortgage. Then, pursuant to the Assignment of Interest
Agreement between the parties, Wells Fargo paid KH Mortgage $1,875,000 for a 50.1% interest in the joint venture and KHF retained ownership of the remaining 49.9% of KH Mortgage. KH Mortgage will
provide our customers access to a full range of competitively priced mortgage products from a nationally recognized mortgage lender and loan servicer. KHF will cease day to day operations during the
second fiscal quarter of 2008 after it has fully satisfied all commitments to borrowers for loans.

17.   Summarized Consolidated Quarterly Financial Data (Unaudited)

|             |                                 
|------------ | --------------------------------
|
|             |                                 
|Fiscal 2007: |                                 
|             | Total revenues                  
|             | Gross homebuilding (loss) profit
|             | Net loss                        
|Fiscal 2006: |                                 
|             | Total revenues                  
|             | Gross homebuilding profit       
|             | Net earnings                    
|             |                                 

80

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Item 9.    Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

None.

Item 9A.    Controls and Procedures

Disclosure controls and procedures.We maintain disclosure controls and procedures (as defined in
Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the "Act")) that are designed to provide reasonable assurance that information required to be disclosed by us,
including our consolidated entities, in the reports that we file or submit under the Act, is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and
forms and that such information is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions
regarding required disclosure. Prior to the filing of this report, we completed an evaluation under the supervision and with the participation of senior management, including our principal executive
officer and our principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2007. Based on this evaluation and
our performance of additional analysis and other post-closing procedures prior to filing, our principal executive officer and our principal financial officer concluded that our disclosure controls and
procedures were effective at the reasonable assurance level as of September 30, 2007.

Changes in internal control over financial reporting.There were no changes in our internal control over financial
reporting that occurred during the fourth fiscal quarter of 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. However,
as previously reported, Edward J. Madell, Vice President, Chief Financial Officer and Treasurer, has been absent on an unexpected medical leave since the beginning of December 2007. In
his absence, certain incremental responsibilities have been borne by individuals who have significant roles in the preparation and review of our periodic reports. Bradley R. Grining, Vice
President and Controller, is acting as the principal financial officer, in addition to principal accounting officer, for purposes of this Annual Report on Form 10-K.

Item 9B.    Other Information

None.

81

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PART III

Item 10.    Directors, Executive Officers and Corporate Governance

The names, ages and positions of our directors and executive officers as of December 1, 2007 are set forth below:

|                    
|--------------------
|
|                    
|David K. Hill       
|C. Kenneth Love     
|Edward J. Madell    
|Robert J. Ryan      
|Brian A. Loftus     
|Ann M. Hamilton     
|Hal H. Barber       
|William E. Long     
|Bradley R. Grining  
|Larry H. Dale       
|Kent W. Colton      
|Roy Humphreys       
|Bruce I. McPhee     
|J. Richard Budd, III
|                    

David K. Hill,Executive Chairman, founded us in 1969 and has over 35 years of experience in the home building industry.
Mr. Hill served as our Chief Executive Officer from 1969 to 2007. In 2001, Mr. Hill was inducted into the National Association of Home Builders ("NAHB") Hall of Fame. Mr. Hill has
served as president of the Home Builders Association of Greater Chicago, a two-term chair of the NAHB Standing Committee on Mortgage Finance, a member of the NAHB Executive Committee, an
officer of the Home Building Mortgage Access Corporation, vice chairman of the AFL-CIO Housing Investment Trust, a board member of the Federal Home Loan Bank of Chicago and president of
the National Center for Housing Policy. Mr. Hill is a high honors graduate of Princeton University and of Northwestern University Law School.

C. Kenneth Love,President and Chief Executive Officer, joined us on June 1, 2005, and was elected President on October 1, 2006, and
President and Chief Executive Officer on October 1, 2007. Before joining us, Mr. Love was employed by Deloitte & Touche LLP from 1976-2005 and had significant
responsibilities in client service and firm management roles, including service as a Senior Partner. He served as Managing Partner of the Midwest Assurance and Enterprise Risk Services (AERS) practice
and was a member of the national AERS Management Committee. Mr. Love also
served as the Lead Client Service Partner for a number of Deloitte's manufacturing clients in the firm's Global Strategic Client Services program. Mr. Love graduated with honors from the
University of Texas at Austin with post graduate education at Columbia University and IMD International in Switzerland.

Edward J. Madell,Vice President, Chief Financial Officer and Treasurer, joined us in 2004 as Vice President and Treasurer. On September 21,
2007, Mr. Madell was promoted to Chief Financial Officer. Prior to joining us, Mr. Madell was a Vice President in the Commercial Real Estate MarketSpecial Industries
division of Harris Trust & Savings Bank from 2000-2004. He was responsible for syndicating over $1 billion in homebuilding credit facilities. Mr. Madell holds a
bachelor's degree from the University of IllinoisChicago and a master's degree from DePaul University.

Robert J. Ryan,Senior Vice President, People, joined us on October 23, 2006. Mr. Ryan has over 25 years of experience with both
private and public corporations in the manufacturing industry. He began his career in production management and moved into human resources in 1988 at Procter &

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Gamble.
Subsequently, he held senior human resource positions at Griffith Laboratories and Bombardier Recreation Products. Mr. Ryan holds a bachelor's degree in mechanical engineering from
Carleton University in Ottawa, Canada.

Brian A. Loftus,Senior Vice President and Secretary, joined us as Senior Vice President and General Counsel in 2001, after having served as a director
since 1996. In 2007, Mr. Loftus stepped down from his duties as General Counsel but remains active with the company. Prior to joining us, Mr. Loftus was a senior partner at
Winston & Strawn, where he served for 24 years, and served as Vice President and General Counsel of UOP LLC and UNO-VEN Company. A member of the Association of Corporate
Counsel, he served as a director and president of the Chicago chapter. Mr. Loftus is an honors graduate of Princeton University and New York University School of Law.

Ann M. Hamilton,Vice President and General Counsel, joined Kimball Hill on July 1, 2003 as the Assistant General Counsel. She was elected a Vice
President in October 2005 and was promoted to General Counsel on October 1, 2007. Prior to joining us, Ms. Hamilton was the Corporate Counsel for Fuel Tech, Inc., of
Batavia, Illinois, from 1998 to 2003, and she previously held the position of Senior Litigation Counsel for Motorola, Inc. in Schaumburg, Illinois from 1992 to 1998, and was an associate at
Kirkland & Ellis in Chicago from 1986 to 1992. Ms. Hamilton received her bachelor's degree in 1981 from the University of Illinois College of Liberal Arts and Sciences and her law degree
summa cum laude from the University of Illinois College of Law in 1985.

Hal H. Barber,Senior Vice President, Finance, joined us in 1983 as a Director and Vice President of Finance and Administration. He became a Senior Vice
President in 2003. Mr. Barber has held key positions with major corporations in the insurance industry, including as a member of the
long-range planning task force for Kemper Insurance. Mr. Barber attended the University of Denver.

William E. Long,President and Chief Executive Officer of KH Financial, L.P., our mortgage banking subsidiary, has over 35 years of experience in
the mortgage industry and was the president of a major national mortgage bank for 19 years prior to joining us in 2000. Mr. Long serves on the Mortgage Bankers Association of America's
board of governors and has chaired the organization's GNMA Liaison, Capital Markets and Membership committees. Mr. Long has also served on task forces and advisory boards for federal and state
housing finance agencies, as well as the private mortgage insurance industry. Mr. Long graduated from the University of Notre Dame and holds an MBA from the University of Chicago.

Bradley R. Grining,Vice President and Controller, joined us in 2002. Previously, Mr. Grining was employed by Deloitte & Touche LLP from
1997-2002 and most recently served as a manager in their Mergers and Acquisitions group. Mr. Grining earned a bachelor of business administration from Saint Louis University.

Larry H. Dale,Director, was elected to the Board in 1996. Mr. Dale had been employed by GMACCH Capital Corp., a subsidiary of GMAC, from 1997 to
2006 where he served as Executive Vice President. In March 2006, GMACCH Capital Corp. was sold and became CapMark Finance. Mr. Dale continued his employment through July 2006 at
which point he retired from the firm. Beginning in July 2006, Mr. Dale was retained by CapMark Finance as an independent contractor until February 2007 at which point he became a
Managing Director of Citi Community Capital, a branch of Citigroup's Municipal Securities Division. Mr. Dale is also Chairman of the Board of the National Equity Fund, Co-Chairman
of the Board of the Community Preservation and Development Corporation, and a director of the Local Initiatives Support Corporation and Mercy Housing Inc. Formerly a Deputy Assistant Secretary
for the Housing/FHA Commissioner, Mr. Dale also spent 10 years as Senior Vice President of Fannie Mae. Mr. Dale is a graduate of Cornell University and holds a master's degree
from Syracuse University.

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Kent W. Colton,Director, was elected to the Board in 1999. Mr. Colton served for 15 years as the Executive Vice President and Chief
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 the President's Commission on Housing. Currently, Mr. Colton is a senior scholar at Harvard University's Joint Center for Housing Studies and President of K. Colton LLC.
Mr. Colton currently serves on the Board of Directors of Apple REIT Seven, Inc. and Apple Hospitality Five, Inc. Mr. Colton is a graduate of Utah State University and holds
a Masters of Public Administration from Syracuse University and a Ph.D. in urban studies and planning from the Massachusetts Institute of Technology.

Roy Humphreys,Director, was elected to the Board in 2003. Mr. Humphreys was President of Shea Homes from 1980 until his retirement in 2002.
Mr. Humphreys has been named Builder of the Year byCalifornia Buildermagazine and was inducted into the California Building Industry
Foundation's Hall of Fame. A Georgia Tech University graduate, Mr. Humphreys received an MBA from the Wharton School at the University of Pennsylvania.

Bruce I. McPhee,Director, has been a director since 1990 and was a Vice Chairman of Kimball Hill, Inc. from 1993 until 2006. Mr. McPhee
remains an employee of Kimball Hill. Before joining us, Mr. McPhee was the President and Chief Executive Officer of Bank One Chicago. Mr. McPhee has 28 years of banking industry
experience and has served on several corporate boards. He holds a bachelor's degree from Drake University and an MBA from Loyola University.

J. Richard Budd, III, Director, became a director in 2007. Mr. Budd is a consultant with Cerberus Operations and Advisory Company. Since 2002,
Mr. Budd has served on the board of directors of Silverleaf, Inc. Since 2001, he has been a partner in the restructuring advisory firm of Marotta Gund Budd & Dzera, LLC where he
serves on the Audit, Compensation and Nominating committees. Mr. Budd was elected to our Board of Directors pursuant to the terms of the Investor Rights Agreement between Kimball
Hill, Inc. and Equity Investments III, LLC, a Delaware limited liability company and a wholly-owned subsidiary of Residential Funding Company, LLC. The Investor Rights Agreement provides that
Equity Investments III, LLC has the right to designate one member of Kimball Hill's Board of Directors.

Regional Presidents

Thomas W. Jacobs,41, West Regional President, began his career with us in 1991 and served as a Division
President prior to becoming Pacific Coast Regional President in 2003. In October 2007, Mr. Jacobs was promoted to West Regional President. As West Regional President, Mr. Jacobs
is responsible for our operations in the Midwest, Nevada and Pacific Coast regions. He has experienced all facets of the residential construction business. Mr. Jacobs received his degree in
construction engineering from Texas Tech University.

Michael T. Richardson,55, South Regional President, had directed our Texas operations as the Texas Regional President since 2004. In
October 2007, Mr. Richardson was promoted to South Regional President. As South Regional President, Mr. Richardson is responsible for our operations in the Florida and Texas
regions. Mr. Richardson brings over 30 years of homebuilding experience to the company. Mr. Richardson is a graduate of Angelo State University with a degree in mathematics.

Board and Board Committees

Director Independence

At the end of fiscal 2007, four of our seven directors were non-employee directors. We are a privately-owned company with no established public trading market for
our common stock. As such, we have not formally determined whether Messrs. Dale, Colton, Humphreys and Budd, each a non-employee

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director,
are "independent" under either the New York Stock Exchange or Nasdaq Stock Market listing standards.

Executive Committee

Our Board of Directors has established an Executive Committee, on which Messrs. Hill, Love and McPhee currently serve. The Executive Committee has the power and
authority to transact all business for us and on our behalf when the full Board of Directors is not in session.

Audit Committee

Our Board of Directors has established an Audit Committee, on which Messrs. McPhee, Colton, Dale and Humphreys currently serve. The Audit Committee recommends our
independent auditors, evaluates the effectiveness of our accounting practices, our internal controls, and our disclosures and reporting, reviews our periodic financial reports, reviews and recommends
approval of the annual audit report and reviews material complaints that come through our compliance hotline. We have determined that Mr. Dale is an "audit committee financial expert," as
defined under SEC regulations, but we have not determined at this time whether Mr. Dale is independent.

Compensation Committee

Our Board of Directors has established a Compensation Committee, on which Messrs. Humphreys, Love and Colton currently serve. The Compensation Committee recommends our
general compensation philosophy and policies and reviews the administration of our compensation program, including salaries, bonuses, stock options and director fees.

Community Services Committee

Our Board of Directors has established a Community Services Committee, on which Messrs. Dale, Colton, Hill and Love currently serve. The Community Services Committee
reviews our community contributions policies and procedures and provides guidance and input regarding our community contributions program.

Nominating Committee

Our Board of Directors has established a Nominating Committee, on which Messrs. Hill, McPhee and Dale currently serve. The Nominating Committee reviews the performance
of our current board members and provides guidance and input regarding the appointment of new board members.

Code of Ethics

In addition to a written code of ethics applicable to all employees, officers and directors of Kimball Hill, Inc., we have also adopted a supplemental code of ethics
applicable to our principal executive officer, principal financial officer, principal accounting officer (controller) and other senior financial officers. You may request a free copy of our code of
ethics 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.

Item 11.    Executive Compensation.

Compensation Discussion and Analysis

This section includes information regarding, among other things, Kimball Hill's compensation program and each element of compensation that Kimball Hill provides. The goal of
this section is to provide a

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summary
of Kimball Hill's executive compensation practices and the decisions that Kimball Hill made during fiscal 2007 concerning the compensation package payable to its executive officers, including
the seven executives in the Summary Compensation Table. Each of the seven executives listed in the Summary Compensation Table is referred to herein as a "named executive officer." This "Compensation
Discussion and Analysis" should be read in conjunction with the detailed tables and narrative descriptions set forth below in this Item 11.

Overview

The material principles underlying our compensation policies, philosophies and decisions are intended to:



Process for Setting Executive Compensation

Our Compensation Committee is responsible for evaluating the performance and approving the compensation of our Executive Chairman, President and Chief Executive Officer and
Chief Financial Officer. However, Mr. Love does not participate in decisions made by the Compensation Committee with respect to his compensation. With input from appropriate members of our
senior management, our human resources department and, from time to time, independent compensation consulting firms, our Compensation Committee annually reviews the compensation of our other named
executive officers and makes recommendations as appropriate. In setting compensation levels and determining equity, bonus and other incentive awards in fiscal 2007, our Compensation Committee and
senior management, working with the company's human resources personnel, reviewed publicly available market data and data provided by the annual Homebuilders Compensation Survey 2006, which is a
market-based survey comprised of 35 homebuilders in the United States.

We
engaged Towers Perrin, an independent compensation consulting firm, to assist us in determining the pay levels of executive officers for fiscal 2008, including our named executive officers, and to
assist in the development of a new long-term incentive plan briefly discussed below. Going forward, we anticipate continuing to use the services of Towers Perrin in order to assist in
providing benchmarking data and to ensure that our actual compensation practices remain competitive and consistent with our stated compensation policies and philosophies.

Elements of Our Compensation Program

Our compensation program is structured to expressly tie a significant portion of our executives' overall compensation to the performance of Kimball Hill and/or specific
business units. The principal components of compensation for our named executive officers are:



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Actual
levels of compensation received by participants are determined based upon individual skill and contribution, company and/or business unit performance and individual performance.

Base Salary.As is customary, we provide a base salary to our named executive officers. We annually review the base
salaries of our named executive officers. During such review, we take into account the following:



Variations
in salary levels may occur as dictated by the experience level of the individual and market factors as well as our performance, retention concerns and other individual circumstances. In
fiscal 2007, we did not increase the base salary for any of our named executive officers (except for a small inflationary increase for Mr. Madell), because we believed the total cash
compensation provided to our named executive officers fairly compensated them and was consistent with our compensation policies and philosophies.

Effective
October 1, 2007, in connection with Mr. Love's new position as Chief Executive Officer and President and Mr. Madell's new position as Vice President, Chief Financial
Officer and Treasurer, our Compensation Committee approved increases in Messrs. Love's and Madell's base salary to $1,000,000 and $350,000, respectively. Mr. Love's base salary increase
was pursuant to the terms of his employment agreement, which required an increase commensurate with his new position in light of the salaries of other senior executive officers of Kimball Hill. We
targeted Mr. Madell's salary at the median of other principal financial officers at companies in the Homebuilders Compensation Survey.

Annual Cash Incentive Bonuses.Kimball Hill provides annual cash incentive bonuses to its named executive officers.
For fiscal 2007, our named executive officers' target bonuses and actual bonuses were as follows:

|                   
|-------------------
|
|                   
|David K. Hill      
|C. Kenneth Love    
|Eugene K. Rowehl(1)
|Edward J. Madell   
|William E. Long    
|Brian A. Loftus    
|Robert J. Ryan     
|                   

For fiscal 2007, the company's annual bonus program was designed to be discretionary in nature and based upon the company's overall performance and the performance of specific
business units and a review of each individual's qualitative performance. The discretionary nature of the annual bonuses allowed us to consider internal and external factors in determining each of our
named executive

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officers'
annual bonus. In addition, we believe the discretionary nature of our annual bonuses strengthens our core values by rewarding leadership, performance, teamwork, integrity and respect in a
non-formulaic way. Due to deteriorating market conditions in the homebuilding industry, the actual bonuses paid out for fiscal 2007 were less than the target bonus amounts established at
the beginning of fiscal 2007. Our Compensation Committee considered external factors as well as qualitative measures in determining the actual bonus awards for fiscal 2007, and the amounts listed
above reflect such considerations.

For
fiscal 2008, our named executive officers' target bonuses were set as a percentage of their respective base salaries:

|                   | 
|------------------ | 
|
|                   | 
|David K. Hill      | 
|C. Kenneth Love    | 
|Edward J. Madell   | 
|William E. Long(1) | 
|Brian A. Loftus    | 
|Robert J. Ryan     | 
|                   | 

These bonuses will again be discretionary in nature and based upon the company's overall performance and the performance of specific business units and a review
of each individual's qualitative performance.

Equity-Based Incentives.We have historically granted options to purchase our common stock to certain of our
executives, other key employees and directors. The exercise price for each option granted is the estimated fair market value of the common stock into which the option is exercisable, measured as of
the date of the grant. The terms of the stock options range from three to ten years with vesting terms from immediately upon grant to vesting in equal annual installments over four years. As of
September 30, 2007, an aggregate of 61,000 shares of our common stock, representing approximately 1% of our issued and outstanding shares on a fully-diluted basis, were subject to unexpired
options. In fiscal 2007, we did not grant any equity-based incentives, because we believed the total compensation provided to our named executive officers fairly compensated them and was consistent
with our compensation policies and philosophies.

Incentive Stock Option Plan

We adopted the Kimball Hill Homes Incentive Stock Option Plan on October 28, 1995. The plan, as amended, provides for the grant to certain of our executive and other key
employees of options to purchase shares of our common stock. A committee designated by our Board of Directors administers the provided plan. The committee has broad powers under the plan, including
exclusive authority (except as otherwise provided in the plan) to determine who will receive awards and the type, size and terms of awards to be granted. Options awarded under the Incentive Stock
Option Plan are exercisable into shares of our common stock. The original plan provided for the grant of options to purchase up to 65,000 shares of our common stock, and subsequent amendments have
provided for the issuance of options to purchase an additional 1,004,000 shares of common stock. The original plan and each amendment thereto specifically allocated all of the shares to individual
executives and other key employees such that an amendment would be required to grant additional options.

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All shares issued to participants in the Incentive Stock Option Plan upon exercise of a stock option issued pursuant to that plan are subject to certain transfer restrictions contained in the relevant
stock option agreement, including a right of first refusal by us. Furthermore, in the event that any participant ceases to be employed by us or our subsidiaries, we may have the right to, or we may in
certain cases be required to, repurchase all shares owned by that participant. Any share repurchases are at fair market value and are only of shares held by the shareholder for greater than six
months.

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
and outstanding options in order to prevent dilution of or enlargement of rights under outstanding options. In the event of a sale of our company, the options awarded under the plan become immediately
exercisable unless provision is made in writing in connection with such transaction for the continuance of the plan.

No
new options have been granted under this plan since it expired on October 31, 2005.

Nonstatutory Stock Option Plan

We adopted the Kimball Hill Homes Nonstatutory Stock Option Plan on December 31, 1997. The plan allows us to grant stock options to those of our directors who are not
employees and therefore are not eligible to receive stock options under our Incentive Stock Option Plan and certain other employees who have not been designated under the Incentive Stock Option Plan.
The original plan provided for 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 purchase an additional
93,000 shares of common stock. The terms of the stock options granted under the plan are substantially similar to those granted under our Incentive Stock Option Plan. We do not anticipate granting
additional options under this plan and plan to grant awards going forward under our proposed new long-term incentive plan discussed below.

Long-Term Incentive Plan

In fiscal 2008, we plan to adopt a new long-term incentive plan. The long-term incentive plan will be designed to align the interests of our executive
officers and other key employees to the long-term interests of our company and stockholders by compensating our executive officers and other key employees through the use of stock-based
awards. Once adopted, we anticipate the primary awards granted under the plan will initially be stock appreciation rights and phantom stock. All awards will be settled in cash.

Employee Stock Ownership Plan

We established an employee stock ownership plan or "ESOP" in 2000. An ESOP is a special type of qualified retirement plan described in and subject to requirements contained in
the Internal Revenue Code of 1986 and the Employee Retirement Income Security Act of 1974. The ESOP is designed to provide employees with ownership of Kimball Hill's stock. We have not made any
contributions to the ESOP since 2004; however, from time to time employees who leave Kimball Hill may forfeit unvested shares of Kimball Hill's common stock granted to them under the ESOP. Forfeited
shares are re-allocated pro rata to plan participants.

Perquisites.We provide certain perquisites to named executive officers which the Compensation Committee believes
are reasonable and appropriate based on the results of market surveys reviewed from time to time. The perquisites assist in the attraction and retention of named executive officers and, in the case of
certain perquisites, promote the health, safety and efficiency of the named executive officers. For further information on the perquisites provided to our named executive officers during fiscal year
2007, refer to "Summary Compensation Table" below.

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Retirement and Welfare Benefits.We provide to each of our named executive officers retirement and welfare
benefits, such as health, life and disability insurance under the same programs as all other salaried employees. We believe these benefits are both reasonable and an important tool in the attraction
and retention of named executive officers as well as other employees eligible to participate in these benefit plans.

We
maintain a tax-qualified retirement plan that provides eligible employees, including each of our named executive officers, with an opportunity to save for retirement on a tax advantaged
basis. Eligible employees are able to participate in our 401(k) plan. We match 35% of our employees'
contributions of up to 6% of compensation. Pre-tax contributions are allocated to each participant's individual account and are then invested in selected investment alternatives according
to the participants' directions. All employee contributions are 100% vested. The 401(k) plan is intended to qualify under Sections 401(a) and 501(a) of the Internal Revenue Code. As a
tax-qualified retirement plan, contributions to the 401(k) plan and earnings on those contributions are not taxable to the employees until distributed from the 401(k) plan. We believe that
offering a 401(k) retirement plan fosters our ability to attract and retain the best possible executive talent.

Severance Benefits.Other than for Messrs. Hill, Love and Ryan, we generally do not provide employment or
severance agreements for the named executive officers. We entered into the agreement with Mr. Hill in 2007 to retain his services as Executive Chairman and we entered into the agreements with
Messrs. Love and Ryan in order to attract them to Kimball Hill in 2005 and 2006, respectively. The agreements for Messrs. Hill, Love and Ryan provide the type and amount of payments
based on the nature of the termination. See "Employment and Other Agreements" and "Potential Payments Upon Certain Terminations" below. The terms of all other executive
terminations and retirements are determined individually based on specific facts and circumstances at the time of such events, and not on formulaic rules.

Tax and Accounting Treatment of Executive Compensation

We generally structure our compensation programs so that they are deductible for federal income tax purposes. We account for stock-based awards in accordance with the
requirements of SFAS 123R, which requires companies to recognize in the income statement the grant date fair value of equity-based compensation issued to employees.

Compensation Committee Report

As detailed in its charter, the Compensation Committee of the Board of Directors oversees Kimball Hill's compensation program on behalf of the Board. In the performance of its
oversight function, the Compensation Committee, among other things, reviewed and discussed with management the "Compensation Discussion and Analysis" set forth above in this
Form 10-K. Based upon the review and discussions referred to above, the Compensation Committee recommended to the Board that the Compensation Discussion and Analysis be included in
this Form 10-K for the fiscal year ended September 30, 2007.

Compensation Committee

Roy Humphreys

C.
Kenneth Love

Kent
W. Colton

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Summary Compensation Table

The following narrative, tables and footnotes describe the "total compensation" earned during our 2007 fiscal year by our named executive officers.

|                                                                            
|----------------------------------------------------------------------------
|
|                                                                            
|David K. Hill
Executive Chairman(5)                                         
|C. Kenneth Love
President and Chief Executive Officer(5)                    
|Eugene K. Rowehl
Former Senior Vice President and Chief Financial Officer(6)
|Edward J. Madell
Vice President, Chief Financial Officer and Treasurer(7)   
|William E. Long
President and Chief Executive Officer, KH Financial, L.P    
|Brian A. Loftus
Senior Vice President and Secretary                         
|Robert J. Ryan
Senior Vice President, People                                
|                                                                            

401(k) Matching
Contribution ($)(a)

Severance ($)(b)

Relocation
Assistance
($)

Charitable
Matching
Contribution ($)

ESOP ($)(c)

Total ($)David K. Hill

4,725





1,000

2,769

8,494C. Kenneth Love

4,725





19,500

2,769

26,994Eugene K. Rowehl

4,725

550,000





2,769

557,494Edward J. Madell

4,699







2,769

7,468William E. Long

4,725







2,769

7,494Brian A. Loftus

3,963







2,769

6,732Robert J. Ryan

4,113



49,056

2,500



55,669




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In addition to the foregoing compensation, the named executive officers also participated in health and welfare benefit programs, including vacation and
medical, dental, prescription drug and disability coverage. These programs are generally available and comparable to those programs provided to all salaried employees.

Grants of Plan-Based Awards

We did not grant any equity or non-equity incentive awards to our named executive officers in fiscal year 2007.

Outstanding Equity Awards at Fiscal Year-End

The following table summarizes the outstanding equity awards held by our named executive officers at the end of fiscal year 2007, which were comprised solely of
time-based option awards. All outstanding option awards listed below have vested and may be exercised at any time prior to the option expiration date.

|                
|----------------
|
|
|                
|David K. Hill   
|C. Kenneth Love 
|Eugene K. Rowehl
|Edward J. Madell
|William E. Long 
|Brian A. Loftus 
|Robert J. Ryan  
|                

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Option Exercises and Stock Vested

The following table summarizes the number of shares of stock vested in fiscal 2007 for each of our named executive officers. No stock options were exercised by the named
executive officers during fiscal 2007.

|                
|----------------
|
|
|                
|David K. Hill   
|C. Kenneth Love 
|Eugene K. Rowehl
|Edward J. Madell
|William E. Long 
|Brian A. Loftus 
|Robert J. Ryan  
|                

Retirement and Non-Qualified Defined Contribution and Deferred Compensation Plans

We do not sponsor or maintain any pension plans or non-qualified deferred compensation plans in which our named executive officers participate.

Employment and Other Agreements

David K. Hill.Mr. Hill is the founder of our company, was our Chief Executive Officer from our foundation until October 1,
2007 and has had primary responsibility for our growth, profitability and success. On August 10, 2007, we entered into an employment agreement with Mr. Hill. The agreement provides that,
effective October 1, 2007, Mr. Hill will serve as Executive Chairman, Chairman of the Executive Committee of the Board of Directors and a director. The initial term of the agreement is
from October 1, 2006 until October 1, 2011, and thereafter the agreement will renew automatically for one-year terms unless terminated by either party upon ninety days prior
written notice. The agreement provides for a minimum base salary of $1,500,000 effective October 1, 2006 (which may be increased by us not less frequently than annually) and an annual bonus
ranging from 120-160% of base salary subject to achievement of performance goals. In addition, the Board has discretion to award an additional bonus based on factors that the Board deems
appropriate. If Mr. Hill's employment is terminated by us without cause, by Mr. Hill for good reason, or by reason of Mr. Hill's death or permanent disability, he is entitled to
receive: (a) a lump sum payment equal to his base salary and target bonus earned but unpaid through the date of termination; (b) periodic payments, for a period of three years, equal to
the sum of (i) his then current base salary, and (ii) his target bonus in an amount equal to 120% of base salary; (c) continued coverage under our employee benefit and welfare
plans for three years; and (d) if applicable, specified excise and other tax reimbursement payments. In addition, if Mr. Hill's employment is terminated by reason of his death or
permanent disability, his family trust may request us to purchase up to 500,000 shares of our common stock, and upon receipt of such request we will reasonably determine in our sole discretion how
many shares to purchase in light of our financial condition and prospects and the limitations, restrictions and constraints in our loan and financing arrangements at the time. The purchase price
payable by us will be the fair market value at that time. The employment agreement also contains non-competition and non-solicitation provisions that continue for a period of
three years after termination of Mr. Hill's employment with us.

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C. Kenneth Love.On March 3, 2005, we entered into an employment agreement with C. Kenneth Love pursuant to which he currently
serves as President and Chief Executive Officer. The initial term of the agreement is from June 1, 2005 until June 1, 2010, and the employment agreement will renew automatically for one
year terms unless terminated by either party upon 90 days notice. The employment agreement provides for a minimum base salary of $700,000 effective October 1, 2005, which was increased
to $1,000,000 effective October 1, 2007, in connection with his new position as Chief Executive Officer and President. Mr. Love's employment agreement also provides for an annual bonus
ranging from 120-160% of base salary based on achievement of performance goals (subject, except for fiscal 2006, to the achievement of minimum target performance goals), and equity
compensation consisting of 37,500 deferred stock units which are fully vested as of October 1, 2007. If Mr. Love's employment is terminated by us without cause or by Mr. Love for
good reason, he is entitled to receive: (a) a payment equal to his base salary earned but unpaid through the date of termination, a prorated portion of his target bonus and any incentive bonus
amount earned but not yet paid, (b) a payment equal to the product of (x) his then current annual base salary plus a target bonus in an amount equal to 120% of such salary and
(y) a specified multiplier factor that depends on the circumstances of employment termination, (c) vesting of any outstanding unvested equity-based awards, (d) continued coverage
under all health and employee benefit plans for a number of years equal to the multiplier factor and (e) if applicable, specified excise and other tax reimbursement payments. If
Mr. Love's employment is terminated by us without cause prior to June 1, 2010, the multiplier factor is two (three if the termination occurs in anticipation of or within one year
following a change of control) plus the number of years and months (if less than a full year) between the full initial five year term of
the agreement and the actual termination date. If Mr. Love's employment is terminated by us without cause on or after June 1, 2010 or at any time by Mr. Love for good reason, the
multiplier factor is two (three if the termination occurs in anticipation of or within one year following a change of control). The employment agreement also contains transfer restrictions on
Mr. Love's equity, equity put and call rights upon employment termination and equity registration rights, as well as non-competition and non-solicitation provisions that
continue for a period of two years after his employment with us has been terminated.

As
a result of the filing by Kimball Hill of a registration statement with the SEC in 2006, we were required to provide financial statements audited by an auditor that was independent under the
independence rules of the SEC. In order to comply with the SEC's independence rules, Mr. Love (at the time Vice Chairman of Kimball Hill), a former partner with our auditor, Deloitte &
Touche LLP, voluntarily agreed to a cash payment in settlement of his pension benefits. If Mr. Love had not agreed to voluntarily settle his pension benefits, we may have had to change auditors
which would have had an adverse impact on our then active financing transaction. On October 26, 2007, the Compensation Committee approved the payment of $1.75 million to Mr. Love
to offset any personal negative tax impact or perceived financial consequences realized by Mr. Love upon his receipt of the lump sum payment of his pension benefits.

Robert J. Ryan.On October 2, 2006, we entered into a letter agreement with Mr. Ryan regarding his employment. The agreement
provides for an initial annual base salary of $300,000 and provides that Mr. Ryan is eligible for the company's health and welfare programs. Pursuant to the terms of the letter agreement, if
Mr. Ryan is terminated without good cause, he will be entitled to severance compensation equal to 9 months of his then current base salary.

Eugene K. Rowehl.Mr. Rowehl resigned from Kimball Hill effective as of October 19, 2007. On November 12, 2007, we
finalized a separation agreement with Mr. Rowehl. Pursuant to the agreement, we agreed to pay Mr. Rowehl a lump-sum separation payment of $550,000 plus any accrued and unpaid
vacation days, and a bonus for Kimball Hill's 2007 fiscal year in the amount of $165,000. In addition, Mr. Rowehl agreed to sell to us at fair market value his 55,000 shares of Kimball Hill
common stock for $2,706,000. The separation agreement contains other customary provisions, such as continuing health benefits, outplacement assistance, nondisclosure of Kimball Hill's confidential
information and a 12 month non-solicitation covenant.

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Potential Payments Upon Certain Terminations

This table shows the potential compensation payable to Messrs. Hill, Love and Ryan upon a termination following a termination attributable to death, disability, "cause"
or "without cause" (as defined in the applicable agreements) in connection with a change in control and in the absence of a change in control. The table excludes certain amounts payable pursuant to
plans that do not discriminate in favor of executive officers and that are available generally to all salaried employees. The amounts shown assume that termination of employment was effective
September 30, 2007 and, in the case of amounts reflected under a termination in connection with a change of control, that a change of control event occurred as of September 30, 2007. The
amounts shown are only estimates of the amounts that would be payable to the executives upon termination of employment and do not reflect tax positions we may take or the accounting treatment of such
payments. Actual amounts to be paid can only be determined at the time of separation. Although the calculations are intended to provide reasonable estimates of the potential benefits, they are based
on numerous assumptions and do not represent the actual amount an executive would receive if an eligible termination event were to occur. Kimball Hill does not have formal severance agreements or
arrangements with the other named executive officers. Payments to be made upon a termination of our named executive officers other than Messrs. Hill, Love and Ryan would be addressed on an
individual, non-formulaic basis.

|               
|---------------
|
|
|
|David K. Hill  
|               
|               
|               
|               
|               
|               
|C. Kenneth Love
|               
|               
|               
|               
|               
|               
|Robert J. Ryan 
|               
|               
|               
|               
|               
|               
|               

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Non-Executive Director Compensation and Benefits

Directors who are our employees receive no additional compensation for their services as directors. Other than Mr. McPhee, directors who are not our employees receive
annual compensation of $30,000 each (paid quarterly) plus $7,500 for each board meeting attended and are reimbursed for reasonable travel expenses related to meeting attendance. Directors are also
eligible to receive stock options at the discretion of our Executive Chairman. No stock options were granted to directors in fiscal year 2007. Kimball Hill maintains a director and officer liability
insurance policy. Because Mr. McPhee is also an employee of Kimball Hill, the amounts reported below represent his compensation as both a director and an employee.

The
following table shows information regarding the compensation of our non-executive directors for the 2007 fiscal year.

|                     
|---------------------
|
|                     
|Larry H. Dale        
|Kent W. Colton       
|Roy Humphreys        
|Bruce I. McPhee      
|Gregory B. Schultz(4)
|                     

Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Principal Shareholders

The following table sets forth information with respect to the beneficial ownership of our common stock as of September 30, 2007 by:



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To
our knowledge, each of the holders of common stock listed below has sole voting and investment power as to the shares of common stock owned, unless otherwise noted:

|                                                             | 
|------------------------------------------------------------ | 
|
|                                                             | 
|David K. Hill(3)                                             | 
|Equity Investments III, LLC(4)                               | 
|C. Kenneth Love(5)                                           | 
|Eugene K. Rowehl                                             | 
|Edward J. Madell                                             | 
|William E. Long                                              | 
|Brian A. Loftus                                              | 
|Robert J. Ryan                                               | 
|Bruce I. McPhee(6)                                           | 
|Larry H. Dale                                                | 
|Kent W. Colton                                               | 
|Roy Humphreys                                                | 
|J. Richard Budd, III (4)                                     | 
|All directors and executive officers as a group
(14 persons) | 
|                                                             | 

Securities Authorized for Issuance Under Equity Compensation Plans

We occasionally issue options to purchase our common stock to our employees and directors as discussed in Item 11, "Executive Compensation", included elsewhere in this
report. All of these options have an exercise price equal to the fair market value of the underlying common shares on the date of

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grant
and either vested immediately or vest in equal annual installments over four years from the anniversary of the grant date. The following table provides further information regarding securities
authorized for issuance under our equity compensation plans as of September 30, 2007. See Item 11, "Executive CompensationStock Option Plans" for a description of our equity
compensation plans.

|                                                         
|---------------------------------------------------------
|
|
|
|                                                         
|Equity compensation plans approved by stockholders       
|Equity compensation plans not approved by stockholders(1)
|                                                         
|                                                         
|                                                         
|                                                         

Item 13.    Certain Relationships and Related Transactions, Director Independence

Director Independence

The information set forth under "Board and Board CommitteesDirector Independence" in Item 11 of this Part III is incorporated herein by reference.

Relationships with David K. Hill and His Family and Affiliated Entities

David K. Hill, our Executive Chairman, together with members of Mr. Hill's immediate family, beneficially owns approximately 71% of our common stock.

In
January 2007, we sold are ownership interest in a San Jose, California high-rise residential real estate project to Mr. Hill for $2.9 million, which was equal to
our total financial investment in the project. This transaction was approved by our Board of Directors.

We
have entered into arrangements with Property Specialists, Inc. ("PSI"), a property management company owned by Mr. Hill's brother. During fiscal year 2007, we paid management fees of
$46,000 to PSI in exchange for property management services relating to our principal executive office and certain of our rental properties. PSI also serves as manager for many of the homeowner
associations we have established for residential communities we have developed in Illinois. We typically contribute to the operating expenses of these homeowner associations during the development
period. During fiscal year 2007, PSI received $111,000 in fees from the homeowner associations. We also make available office space at our corporate headquarters in Rolling Meadows, Illinois to PSI in
connection with these arrangements. During fiscal 2007, PSI paid us $123,000 in rent. In October 2007, we sold an office building in its corporate complex to PSI for $1.7 million. The
majority of the space in the building has been leased to PSI for over 12 years.

Certain Other Relationships and Related Party Transactions

On September 12, 2006, the Company entered into a Subscription Agreement and Investor Rights Agreement with Equity Investments III, LLC ("EI"). Pursuant to
the Subscription Agreement, we sold 952,380 shares of our common stock to EI for an aggregate purchase price of $110 million.

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Approximately
$74 million of the net proceeds from the sale of the shares was used to reduce our outstanding indebtedness and the remainder of the proceeds were used to repurchase shares of
common stock from certain current and former directors and officers. As of September 30, 2007, EI owns approximately 21% of our issued and outstanding stock.

The
Investor Rights Agreement provides for, among other things:



Certain
of the rights provided to EI under the Investor Rights Agreement expire upon the consummation of an initial public offering.

In
addition to the transaction described above, the following is a summary of the transactions between us and EI or its affiliates since October 1, 2006:

Limited Partnership Investment.At September 30, 2006, an affiliate of EI was a limited partner in three consolidated partnerships
formed by us to engage in certain residential development and construction projects. A summary of the activity included in our consolidated financial statements is as follows:

|                                                                
|----------------------------------------------------------------
|
|                                                                
|Beginning balance of related party included in minority interest
|Contributions from related party                                
|Distributions to related party(a)                               
|Partner profit recorded as a step-up in inventory(a)            
|Minority interest in net (losses) earnings                      
|                                                                
|Ending balance of related party included in minority interest   
|                                                                
|                                                                

Gregory B. Schultz served as one of our directors in fiscal 2007 and until his resignation on November 30, 2007. Mr. Schultz is a Senior Managing
Director and President of the Business Capital Group of GMAC Residential Funding Corporation, which is the sole member of EI. Throughout fiscal 2007, Mr. Schultz had a direct relationship with
EI and was involved with and participated in aspects of the relationship between EI and us. Mr. Schultz was appointed to our Board of Directors pursuant to EI's right under the Investor Rights
Agreement.

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J.
Richard Budd, III, one of our directors, is a consultant with Cerebus Operations and Advisory Company. Cerebus Operations and Advisory Company is an affiliate of Cerebus Capital
Management, L.P., which (with a consortium of other investors) owns a controlling interest in RFC, the sole member of EI. Mr. Budd was appointed to our Board of Directors on
December 1, 2007 pursuant to the terms of the Investor Rights Agreement between Kimball Hill and EI.

Larry
H. Dale, one of our directors, was Executive Vice President of GMACCH Capital Corp., which was an affiliate of EI prior to EI's investment in Kimball Hill, Inc. Mr. Dale has never
been involved with and has never participated in any aspect of the relationship between EI or its affiliates and us.

During
fiscal 2007 and 2006, we repurchased common shares from certain current and former directors and officers as follows:

|                         
|-------------------------
|
|                         
|David K. Hill            
|Isaac Heimbinder(2)      
|Hal H. Barber            
|Brian A. Loftus          
|Eugene K. Rowehl(3)      
|William E. Long          
|Kirk T. Breitenwischer(4)
|Larry H. Dale            
|Kent W. Colton           
|Roy Humphreys            
|Bruce I. McPhee          
|John P. Toren(5)         
|                         

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Policy for Evaluating Related Person Transactions

Kimball Hill has not adopted any formal policies or procedures for the review, approval or ratification of related person transactions that may be required to be reported under
the SEC disclosure rules. A "related person" is defined under the applicable SEC regulation and includes Kimball Hill's directors, executive officers, and 5% or more beneficial owners of Kimball
Hill's common stock. Such transactions, if and when they are proposed or have occurred, have traditionally been (and will continue to be) reviewed by our Board (other than the directors involved, if
any) on a case-by-case basis. The Board may consider any relevant factors when reviewing the appropriateness of a related-party transaction, including (1) the importance
of the transaction to Kimball Hill, (2) the amount involved in the proposed transaction, (3) the specific interest of the director or executive officer (or immediate family
members of same) in the proposed transaction, (4) the overall fairness of the terms of the transaction to Kimball Hill and (5) any contractual limitations, such as under our
indenture or the Investor Rights Agreement.

Item 14.    Principal Accounting Fees and Services

For the fiscal years ended September 30, 2007 and 2006, professional services were performed by Deloitte & Touche LLP ("D&T").

Fees
paid to D&T during the fiscal years ended September 30, 2007 and 2006 were composed of the following:

Audit FeesThe aggregate fees paid during fiscal 2007 and 2006 for the audits of our annual financial statements, for reviews of our
quarterly financial statements and for assurance and related services in connection with our senior subordinated debt offering and subsequent registration statement with the SEC were $423,800 and
$531,235, respectively.

Audit-Related FeesThe aggregate fees billed for the audit of our mortgage banking company for the fiscal years ended September 30,
2007 and 2006 were $65,900 and $63,000, respectively.

Tax FeesThe aggregate fees billed for tax services for the fiscal years ended September 30, 2007 and 2006 were $199,200 and
$121,818, respectively. These fees relate to professional services performed by D&T with respect to tax compliance, tax advice and tax planning.

All Other FeesThe aggregate fees billed for all other fees was $1,500 for an online subscription to D&T's internal accounting literature
database for each of the fiscal years ending September 30, 2007 and 2006.

The
audit committee annually approves each year's engagement for audit services in advance. The audit committee has also established complementary procedures to require pre-approval of all
permitted non-audit services provided by our independent auditors.

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PART IV

Item 15.    Exhibits and Financial Statement Schedules

The
consolidated financial statements required to be filed in the Annual Report on Form 10-K are in Part II, Item 8.

None
required.

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

EXHIBIT INDEX

|EXHIBIT NO. |  | DESCRIPTION                                                                             
|----------- |  | ----------------------------------------------------------------------------------------
|3.1         |  | Articles of Incorporation of Kimball Hill, Inc.(1)                                      
|3.2         |  | By-Laws of Kimball Hill, Inc. (Amended and Restated as of August 10, 2007)(4)           
|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)                      
|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)
|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)
|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)
|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)                         
|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)                 
|            |  |                                                                                         

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|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)                
|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)                        
|3.18(b) |  | Second Amendment to Limited Partnership Agreement of Gables at Hiddenbrook Limited Partnership.(3)    
|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)          
|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) |  | Third Amendment to Limited Partnership of Indian Trails Limited Partnership.(3)                       
|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.(1)               
|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)              
|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)
|        |  |                                                                                                       

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|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)
|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.(3)    
|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)                            
|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)  
|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)                    
|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)                    
|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)                   
|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)                                               
|        |  |                                                                                                             

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|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)             
|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)                                        
|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)
|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)                        
|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)                  
|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)                             
|        |  |                                                                                                           

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|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)       
|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)       
|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)                   
|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)
|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)                      
|3.98(b)  |  | Third Amendment Limited Partnership Agreement of Kimball West Frisco Limited Partnership.(3)      
|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)          
|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)                                   
|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)              
|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)                                  
|         |  |                                                                                                   

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|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)                 
|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)       
|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)  
|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)
|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)         
|3.123    |  | Certificate of Limited Partnership of Whispering Meadow Limited Partnership.(1)                
|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) 
|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)          
|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)      
|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)                        
|         |  |                                                                                                

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|3.130(b) |  | First Amendment to Operating Agreement of Kimball Hill Homes Austin Investments, L.L.C.(3)                                                                                                                            
|-------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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)                                                                                                                             
|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)                                                                                                                            
|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)                                                                                                                             
|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)                                                                                                                           
|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.(3)                                                                                                                            
|3.141    |  | Articles of Organization of Stonehill Square LLC                                                                                                                                                                      
|3.142    |  | Operating Agreement of Stonehill Square LLC                                                                                                                                                                           
|3.143    |  | Certificate of Formation of Terramina LLC                                                                                                                                                                             
|3.144    |  | Operating Agreement of Terramina LLC                                                                                                                                                                                  
|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.(3)   
|4.1(c)   |  | Second Supplemental Indenture, dated September 17, 2007, 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.
|4.1(d)   |  | Third Supplemental Indenture, dated October 2, 2007, 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.    
|         |  |                                                                                                                                                                                                                       

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|4.2     |  | Form of Senior Subordinated Note (attached as exhibit to Exhibit 4.1(a)).                                                                                                                                                                                                                                                               
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.1    |  | Amended and Restated Credit Agreement, dated August 10, 2007, 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.(4)
|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(a) |  | Employment Agreement, dated August 10, 2007, by and between Kimball Hill, Inc. and David K. Hill.(4)                                                                                                                                                                                                                                   
|10.8(b) |  | Confidential Separation Agreement by and between Kimball Hill, Inc. and Eugene K. Rowehl.(5)                                                                                                                                                                                                                                           
|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)                                                                                                                                                                                                                
|10.11   |  | Letter Agreement, dated October 2, 2006, by and between Kimball Hill, Inc. and Robert J. Ryan.                                                                                                                                                                                                                                         
|12.1    |  | Statement re computation of ratio of earnings to fixed charges.                                                                                                                                                                                                                                                                         
|14.1    |  | Code of Ethics                                                                                                                                                                                                                                                                                                                          
|21.1    |  | Subsidiaries of Kimball Hill, Inc.                                                                                                                                                                                                                                                                                                      
|31.1    |  | Rule 13a-14(a)/15d-14(a) Certification of C. Kenneth Love, President, Chief Executive Officer and Director.                                                                                                                                                                                                                             
|31.2    |  | Rule 13a-14(a)/15d-14(a) Certification of Bradley R. Grining, Acting Principal Financial Officer.                                                                                                                                                                                                                                       
|32.1    |  | Section 1350 Certification of C. Kenneth Love, President, Chief Executive Officer and Director.                                                                                                                                                                                                                                         
|32.2    |  | Section 1350 Certification of Bradley R. Grining, Acting Principal Financial Officer.                                                                                                                                                                                                                                                   
|       

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.

|                        |  | KIMBALL HILL, INC.Registrant                                                                                                               
|----------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------
|Dated: January 14, 2008 |  | /s/C. KENNETH LOVEC. Kenneth Love President, Chief Executive Officer and Director
(Principal Executive Officer)                            
|Dated: January 14, 2008 |  | /s/BRADLEY R. GRININGBradley R. Grining Vice President and Controller
(Principal Accounting Officer and
Acting Principal Financial Officer)
|Dated: January 14, 2008 |  | /s/DAVID K. HILLDavid K. Hill Executive Chairman of the Board of Directors                                                                 
|Dated: January 14, 2008 |  | /s/KENT W. COLTONKent W. Colton Director                                                                                                   
|Dated: January 14, 2008 |  | /s/LARRY H. DALELarry H. Dale Director                                                                                                     
|Dated: January 14, 2008 |  | /s/ROY HUMPHREYSRoy Humphreys Director                                                                                                     
|Dated: January 14, 2008 |  | /s/BRUCE I. MCPHEEBruce I. McPhee Director                                                                                                 

SUPPLEMENTAL
INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12
OF THE ACT.

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

110

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